FSOC recognizes climate change as an emerging threat to the financial system

Abstract

  • The Financial Stability Supervisory Board (FSOC) released its report on climate-related financial risk as part of a larger effort by the Biden administration to institute industry-wide climate change analyzes executive.
  • The FSOC report recommends practices for its member agencies to better reflect the role of climate change in the financial sector, such as data collection, disclosure requirements and scenario analysis.
  • Without law enforcement power, FSOC recommendations serve as an additional message that, at best, highlights actions already underway in agencies and industry.

The context

Following a Biden administration decree in May 2021, calling for the launch of a government-wide climate risk assessment, the Financial Stability Supervisory Board (FSOC) released its Climate Financial Risk Report, calling climate change an “emerging threat to the financial system”. This report is the latest in a series of climate-related initiatives, the highlights of which include a commitment by the U.S. government to reduce greenhouse gas pollution by 50 to 52 percent by 2030, and the publication of a “roadmap“Identifying for the first time climate risk as” systemic “. While the release of the FSOC report is timely given the United Nations Climate Change Conference next month, the report stops well short of what climate activists had hoped for, with a significant portion of the report devoted to data collection recommendations.

The recommendations of the report

The report makes four major policy recommendations, none of which has the force of law; because the FSOC does not have the power to directly regulate activities throughout the financial system.

A new climate-related financial risk committee

The FSOC has pledged to form a Climate-Related Financial Risks Committee (CRFC) which will “identify priority areas to assess and mitigate climate-related risks to the financial system and serve as a coordinating body,” sharing information when “appropriate”. The committee will update the FSOC semi-annually and include a public summary of progress in the FSOC’s annual report. The CFRC will would have will be the first formal committee formed by the FSOC in a decade, and will “guide[d]»By an Advisory Committee on Climate-Related Financial Risks (CFRAC).

If the FSOC consolidates its expertise in climate matters and creates a focal point in the form of a new committee seems reasonable, this raises the question of how the FSOC has been monitoring this “emerging risk” so far. The whole raison d’être of the FSOC is research and coordination to identify and prevent systemic shocks that could lead to catastrophic failure. The “news” that the FSOC will simply continue to perform this function, via the dizzying excitement of a new committee, would be baffling in any setting, let alone as heralded as the FSOC’s first recommendation out of four.

As part of this recommendation, the FSOC also encourages the Federal Office of Insurance (FIO), a subset of the Treasury dedicated to monitoring the insurance sector, to “act quickly to analyze the potential of climate change to affect insurance and reinsurance coverage”. This recommendation follows a similar plea made in the White House roadmap released a week earlier, but in both cases the request is slightly odd given the steps already taken by the FIO in the wake of the dissemination of a request for information in August. As one of the few government agencies to take concrete action and establish contact with industry, these repeated instructions for action aimed specifically at this relatively small part of the treasury are unusual to say the least.

FSOC members urged to ‘complete climate data and methodological gaps’

The FSOC recommends that its member agencies (including Federal Reserve, Treasury, Office of the Comptroller of the Currency (OCC), Securities and Exchange Commission (SEC), and Federal Housing Finance Agency (FHFA)) identify relevant climate-related data and develop a data collection plan if necessary to fill in the gaps.

While the report recommends that FSOC member agencies coordinate with the CFRC to avoid duplication of efforts, develop consistent data standards and measures, and coordinate with relevant international bodies, it is less clear what the FSOC might do. consider it as relevant climate-related data. The report attempts to provide some guidance on this, discussing, among other suggestions, various methodologies for measuring emissions and leveraging bank capital adequacy statements to identify portfolio exposures. Some of these details might be useful for FSOC member agencies to assess their data and needs; it is not, however, clear that this particular recommendation is fundamentally different from the same call to action issued to federal agencies by executive decree in January, which Is have force of law.

Public climate disclosures

FSOC members are encouraged to review their public disclosure requirements and consider updating them not only for reasons of utility, but also for reasons of consistency and comparability. FSOC members are also urged to consider explicit disclosure of greenhouse gas emissions, a potential exceedance by the FSOC given that the Environmental Protection Agency is one of the few federal agencies. not be a member of the FSOC.

Note that this recommendation and the appropriate climate-related disclosures apply to FSOC members themselves, and not necessarily to the private actors that these members oversee and regulate. Yet the FSOC specifically draws attention to and praises the SEC’s continued efforts to develop a proposal on disclosure requirements for public issuers related to climate-related risks, and includes recommendations by industry. Federal banking regulators, for example, are encouraged to consider banks’ public reporting requirements to assess whether the current disclosure regime adequately provides market participants with information about climate-related financial risks.

Assess and mitigate climate-related risks through scenario analysis

The FSOC recommends that its members work with experts (national and international) to identify and develop climate forecasts and scenarios to better identify the exposure of regulated entities to climate-related risks. The FSOC specifically recommends scenario analysis, similar to bank stress tests, to assess the ability of regulated institutions to cope with a variety of hypothetical climate scenarios.

The development of climate scenario analyzes for banks is well under way, both nationally and internationally. While an Accenture to study in June this year, America’s largest banks suggested that 61% are already equipped to deal with climate stress tests (and, some argue, if the climate risk is real, banks would be the first to analyze these risks simply as a matter of good underwriting). While the writing appears to be on the wall as to the direction the US federal banking regulators will take on this matter, a major concern remains industry regarding the weakness, inconsistency and lack of granularity of available climate data and the disproportionate regulatory burden that such disclosures will impose on smaller players.

Conclusion

Basically, the FSOC is in effect an advisory committee whose recommendations have no legal value and are only recommendations at best. Climate activists hoping for stronger policy guidance or regulatory disincentives for financial players involved in financing the fossil fuel industry may have misunderstood the strength of the tools the FSOC has to bring about real change. As such, the FSOC’s “go slow” approach focused on data collection comes as no surprise; that this is the limit of what the FSOC is capable of producing, however, refocuses attention on its ability to mitigate in any way the financial shock that could risk systemic collapse.


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Don F. Davis

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