On September 24, 2020 – which seems like eons ago but was less than two months – we published our Musing “Seismic Shift on Climate Financial Risk”, pointing out that, for the first time ever, a subcommittee of a United States federal financial regulatory agency (the Commodity Futures Trading Commission - CFTC) had published a report on the risks that a broad range of climate-change related events could pose for financial markets/assets. The key point was that the CFTC report recommended that these risks should be formally classified and disclosed as material risks for insurance, Securities and Exchange Commission (SEC) and other regulated and reporting purposes. We pointed out in that same blog that during a SEC meeting shortly before the issuance of the September 9, CFTC report, the SEC Commissioners discussed the need to integrate climate risk measurement and disclosure in future reporting requirements. We said in our Musing “watch this space” as this quiet start to quantifying climate-change economic impacts would eventually have game-changing consequence.
And now we see that the game change is underway, and the floodgates are opening on this new era. This past week, on November 9, the U.S. Federal Reserve (Fed) published its semi-annual Financial Stability Report (FSR) and for the first time ever cited climate change as a risk to financial markets that should be treated with greater transparency, identified, measured, disclosed and taken into account by the FED in setting U.S. monetary policy.[1] Fed Governor Lael Brainard (currently being mentioned as a potential Treasury Secretary nominee under the new Biden Administration) issued a statement welcoming the inclusion of climate risk transparency in the FSR, saying “It is vitally important to move from the recognition that climate change poses significant financial stability risks to the stage where the quantitative implications of those risks are appropriately assessed and addressed”. This mirrored comments she had made almost a year earlier, on November 8, 2019 in San Francisco on “Why Climate Change Matters for Monetary Policy and Financial Stability”. Fed Chairman Jerome Powell this past week said that the U.S. central bank is cooperating with its counterparts globally to understand and address the risks created by climate change, and Fed Vice Chair Randal Quarles said this past week that the Fed has requested membership as an observer to the Network for Greening the Financial System (NGFS).
As Utility Dive reported, the Fed’s broader acknowledgement of climate change risks mirrors recent actions by banks and other regulators (including the CFTC), citing New York’s Department of Financial Services which last month pushed banks to “integrate climate change related financial risks into their business strategies, risk management processes and governance frameworks”. North American bank, TD Bank, committed last week to “net zero carbon emissions by 2050 for projects it finances” (joining JP Morgan Chase and Barclays, among others) in line with the Paris Climate Agreement, and joined the Partnership for Carbon Accounting Financials(PCAF), a Dutch-led consortium seeking to standardize the way banks measure and manage their portfolio carbon impacts (along with Morgan Stanley, CITI and Bank of America which had joined the PCAF group in July 2020).
As head-spinning as these recent announcements might be, they are really just playing catch-up to action in Europe and elsewhere, and, as Bloomberg Green reported on Nov. 13, the NGFS already includes nearly every major economy (except the U.S.), and “many regulators have moved past joining multilateral initiatives to implementing rules on their own”. Indeed, this past Monday, U.K. companies (specified as seven categories, including listed companies, insurance companies, asset managers, and pension schemes) were told that they would be required to disclose climate-related financial risks starting in 2025 and issued an interim report and indicative guidance on those disclosure requirements and likely timing, in “Roadmap Towards Mandatory Climate Related Disclosures”. New Zealand announced a pledge to require reporting on climate financial risks in September and the European Union is “more than two years into deploying a wide-ranging program of sustainable finance rules. Even Australia and Canada, which are heavily reliant on fossil fuels, are developing climate stress tests for financial institutions”.
Yet as Bloomberg also points out, banks and other lobbying groups are starting to push back on stress test and other measures that might be put in place, and the actual design and implementation of these new rules is likely to be very hard-fought, everywhere – including within the new U.S. Administration. Just last month, the U.S.-based Bank Policy Institute published a blog (“Challenges in Stress Testing and Climate Change”) pointing to the difficulties in developing such measures, including the lack of historical data, the long-term nature of climate-related change that is typically far outside the nine-quarter timeframe applied for current macroeconomic testing, the absence of information or insight into likely future market-participant behavior in response to climate change, and a lack of clarity regarding future ability to hedge or mitigate risk exposures. In other words, they point out that we don’t yet have the tools to model the world we have moved into in which assumptions about stationarity very likely no longer apply.
But that’s not the whole story either. Beyond the regulatory and disclosure requirements looming for companies and banks, and the likely industry push-back on those requirements, there are other climate risk “rethinks” taking place. A November 10, 2020 Greentech Media (GTM) webinar featured a discussion of “Strategies in Climate Risk Mitigation” with an overview from insurance-giant Marsh & McLennan, focused on how the insurance industry is working with companies to correctly assess and underwrite future climate-change related project risk. The points made by Marsh and other solutions providers stressed the benefits to be had from increased future scenario modeling, location-specific weather and climate-forecast information, creative technology solutions to mitigate future climate-risk, and broader project syndication and stakeholder engagement. Marsh’s point was that all these are increasingly important and relevant, and as climate risk is given a far harder look, solutions are being proactively put in place that can potentially mitigate those risks. So maybe the process of forcing a harder look has some real and important benefits beyond financial market stabilization, and is actually helping project sponsors find (and justify) project improvements – from insurance to technology -- that respond to those newly-quantified risks.
Much is still unknown, to be sure. And while regulatory requirements are coming that will in some fashion necessitate more formalized identification, measurement and reporting on climate-risks, many project developers, technology providers and insurers are already moving in that direction on their own. The precise timing of all this is still working through global bureaucracies, and only time will tell what the final form of these requirement will be, but it would be foolish to expect that this direction isn’t where we are headed -- and headed very soon. And it might not be a bad thing if, as Marsh points out, risk mitigants are proactively put in place (and increased project costs offset by lower insurance and other risk premiums) as a result of this reporting.
At IW we have been continually writing about the need to build the infrastructure of the future for a climate-altered world – and especially beating that drum as the new U.S. Administration thinks about a major “build-back better” infrastructure initiative. This exploding global recognition of the need to identify and quantify climate-risk is certainly going to shape the decisions that are made in the U.S. and globally. Sure we need clean tech and decarbonization, but all the rebuilding and new infrastructure also needs to take into account the future weather and climate related changes confronting us daily: rising sea levels; increased storm frequency and intensity; higher storm surges and increased flooding; relocation of human habitats and climate migration; increased wildfire frequency; shifting climate zones; shifting flora and fauna habitats; increased desertification; water shortages; and urban heat islands, among others.
Building climate-resilient infrastructure for the changes that are already impacting our world is critical. Of that we are certain. Now global regulators and industry players are saying they want to be sure those risks are explicitly recognized, disclosed and quantified. This will surely drive us even further towards a future in which infrastructure is built to explicitly recognize and adapt to a climate-altered future. As we said in our earlier Musing: “watch this space”.
[1] US Federal Reserve, “Financial Stability Report”, Nov. 9, 2020; page 60: “The Federal Reserve is evaluating and investing in ways to deepen its understanding of the full scope of implications of climate change for markets, financial exposures, and interconnections between markets and financial institutions. It will monitor and assess the financial system for vulnerabilities related to climate change through its financial stability framework. Moreover, Federal Reserve supervisors expect banks to have systems in place that appropriately identify, measure, control, and monitor all of their material risks, which for many banks are likely to extend to climate risks.
Comments