Preview of Regulations to Safeguard the Financial System from the Effects of Climate Change

As we noted previously, in May 2021, President Biden issued an Executive Order (EO) on Climate-Related Financial Risk in which he called upon the federal government to assess and develop solutions to address climate risk to the financial system. As noted in our last post in this series, on October 15, 2021, President Biden released a roadmap to execution of the order’s mandates, entitled “A Roadmap to Build a Climate-Resilient Economy,” which provides additional insight into what lies ahead.

A Roadmap to Build a Climate-Resilient Economy

One of the principles set forth in the EO was: “Safeguarding the US financial system against climate-related financial risk by holding financial institutions accountable for properly measuring, disclosing, managing, and mitigating climate-related financial risks.” In the roadmap, the White House underscores the climate-related risks to the US financial system, including disruptions to liquidity or financial market utilities because of extreme climate-related events and financial institutions’ exposure to shifts in asset values with the transition to a net zero economy.

The roadmap lists five components that require an assessment through the lens of climate risk to maintain a stable financial system: (1) assets; (2) liabilities; (3) risk; (4) uncertainty; and (5) rules to limit potential risk to the system. The roadmap acknowledges the complexity involved in this exercise. It notes that the unprecedented changes caused by climate change, as well as the uncertainty associated with climate change “tipping points,” which are conditions, such as thawing permafrost, that would have a sudden and severe impact on society, may fall outside the bounds of traditional financial sector risk management frameworks.

FSOC Report

The roadmap noted its directive to the Financial Stability Oversight Council (FSOC), chaired by the US Treasury secretary, to issue a report that will discuss, among other things, “the importance of climate-related financial disclosures by regulated entities” and “approaches to incorporating climate-related financial risk into regulatory and supervisory activities,” as well as recommendations for “processes to identify climate-related financial risks to US financial stability.” The FSOC’s report, which was released on October 21, 2021, foreshadows potential changes that might occur in the climate risk regulatory landscape, and also makes recommendations to regulators considering how best to oversee climate risk management in the financial system.

The FSOC notes that depository institution regulators already expect financial institutions to manage material risks, including climate-related risks, and some are incorporating climate-related financial risk into their monitoring and assessment programs. The FSOC further advised that these regulators may issue additional regulations and guidance as their understanding of climate-related financial risks develop, and recommended the agencies consider guidance other jurisdictions have published on management of these risks. 

The FSOC also discusses climate-risk related actions agencies such as the US Securities and Exchange Commission and Commodity Futures Trading Commission have already taken. Measures currently under consideration include climate-related disclosures from regulated entities and disclosures of strategies and criteria investment managers use for environmental, social and corporate governance, and green marketing.

With respect to climate-related disclosures, the FSOC report notes the lack of consistent, comparable, and decision-useful information available based on the current regulatory and voluntary disclosure frameworks and acknowledges that “the lack of common standards is a significant problem.” The report provides a series of recommendations to regulators drafting disclosure requirements, including: 

• Leveraging the Task Force on Climate-Related Financial Disclosures (TCFD) framework, under which companies report climate-related governance, strategy, risk management, and targets and metrics, as a useful starting point, particularly in light of the TCFD’s widespread adoption globally.
• Consideration of a requirement for disclosure of greenhouse gas emissions, including financed emissions. The framework cites the Partnership for Carbon Accounting Financials (PCAF), which has been endorsed by TCFD, as a standardized methodology for the measurement and disclosure of financed emissions. Guidehouse serves as the PCAF Secretariat.
• Promoting decision-useful information for investors through mechanisms such as standardized data formats, machine-readable disclosures, and consistency across different types of disclosures, including those required in the US and, as appropriate, internationally.

With the issuance of this report, financial institutions and other regulated companies should have a clearer picture of what to expect in terms of climate-related regulatory requirements.

Our next post explores the impact of climate change on vulnerable communities and examines steps the government has/will take to address them.