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ESG investors urge regulators to create game plan for climate risk

Group adds voice to progressive advocates and Democrats calling for such regulations

Sen. Jack Reed led a letter by 11 Democrats calling for U.S. financial officials to update supervisory expectations for management to account for climate-related financial risks.
Sen. Jack Reed led a letter by 11 Democrats calling for U.S. financial officials to update supervisory expectations for management to account for climate-related financial risks. (Bill Clark/CQ Roll Call file photo)

A leading U.S. nonprofit association for impact investors issued sweeping recommendations for federal agencies to address climate-related risks on banks and financial institutions, joining the chorus of progressive advocates and Democrats calling for such regulations.

Ceres last week publicly disclosed its recommendations to the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the U.S. Treasury Department, calling on the regulators to incorporate climate risk into their rule-making and policy frameworks.

The organization works with hundreds of institutional investors and companies that have compelled the private sector to recognize financial risks from environmental, social and governance issues such as climate change and now want the U.S. government to not just play catch-up but also be a leader.

Ceres urged the Fed to issue supervision letters on climate risk to banks and bank holding companies to acknowledge that climate change poses risks to the financial system and provide guidance to financial institutions on identifying and monitoring the risks. The group also calls on the U.S. central bank to review the largest bank holding companies to gain an understanding of how they are identifying and managing climate risk and coordinate a study with the OCC and FDIC, as well as New York and Massachusetts’ state financial regulators.

“These recommendations build on that momentum by identifying practical and familiar steps that these agencies can take within their existing authorities to make good on their commitments to take action on climate financial risk,” said Steven M. Rothstein, managing director of the Ceres Accelerator for Sustainable Capital Markets.

Many of the recommendations echo similar findings from an October report from the Financial Stability Oversight Council. As part of its nonbinding recommendations, the council, led by Treasury Secretary Janet L. Yellen and comprising the leadership of the top U.S. banking and financial regulators, called on member agencies to consider mandatory public disclosures on climate-related risks by companies including insurers, banks and issuers of municipal securities. It also recommended scenario analysis of potential risk outcomes associated with global warming. 

At the time, ESG proponents were disappointed that regulators endorsed increased disclosure while declining to pursue more aggressive climate risk regulations. Since then, progressives and Democrats have pushed regulators to implement the FSOC recommendations with a particular focus on bank supervision. 

“The U.S. regulatory agencies remain woefully behind in managing and addressing climate-related risks in the banking system,” said Phillip Basil, director of banking policy at left-leaning financial reform advocate Better Markets. “Addressing the potentially destabilizing risks from climate change clearly fall within the mandates of the agencies, which are to promote a strong banking system and to work to maintain financial stability.”

In November, Better Markets released its own recommendations on how the government should address climate-related financial risk. The report echoed similar recommendations FSOC had, like incorporating climate risk into the supervisory process, but the organization pushed for more robust measures such as specific stress tests.

Democrats’ letter

In December, a coalition of 11 Democratic senators sent a letter to top U.S. financial officials urging them to update outdated supervisory expectations for management to account for climate-related financial risks. The senators, led by Jack Reed of Rhode Island, argued that “current supervisory guidance in the United States has not been revisited in decades, nor does it address the unique risks associated with today’s rapidly changing climate.”

The lawmakers urged the agencies to explicitly incorporate climate risks identified in the FSOC report into overall risk management expectations and issue updated guidance now through their existing authority. 

“Federal regulators should implement this recommendation by explicitly incorporating climate-related financial risk into overall risk management expectations,” they said. “Providing updated guidance would be an effective way to strengthen climate-related risk management using existing authorities.”

The OCC last month unveiled its proposed “draft principles” that would inform eventual supervisory guidance on climate-related risk, which would affect regulated institutions with more than $100 billion in total consolidated assets. The framework focuses on banks’ risk management of credit, liquidity and operations, as well as nonfinancial factors, and tools that OCC-regulated entities could use to address those risks. The agency will receive comments on the principles until Feb. 14.

Federal Reserve Chairman Jerome Powell told the Senate Banking Committee this week that it is “very likely” that the agency will use “climate stress scenarios” to ensure financial institutions understand the potential material risks from global warming. 

That said, Ceres stressed the need for the agencies to work together and pursue interagency initiatives to optimize the regulatory response to climate change. 

“Short-term actions by each of the Financial Stability Oversight Council members individually is critical to address the risks to the financial system from climate change,” the organization said. 

“While individual agency actions are important, collective action can sometimes send a more powerful and consistent message to the financial services industry. The benefits from the government acting on a joint or interagency basis are clear. Such joint actions avoid conflicting or duplicative messages which create burden for industry and they can result in a more efficient allocation of resources by the agencies.”

Regulators acted swiftly on other identified threats to the financial system, the organization noted; agencies started working together in 1996 on preventing Y2K, a feared phenomenon that computer systems would crash and wreak havoc on the global economy as the year changed to 2000, and have been collaborating on tackling cybersecurity issues. They have also embraced “tech sprints,” a time-sensitive initiative to build innovative solutions to industry issues, on digital assets and other topics that are becoming increasingly relevant in the banking world.

“The agencies have demonstrated in the past that they can work quickly when they believe an emerging risk is significant and imminent,” Ceres added.

Those investor concerns will only continue to grow in 2022 and the future as inherent exposure to physical climate risk remains high across multiple industries, according to Moody’s Investors Service. 

Global asset managers and institutional investors now understand the potential consequences of global warming and are also more mindful that countries’ current decarbonization pledges have limitations on mitigating the worst effects of climate change, said Lucia Lopez, vice president and senior credit officer at Moody’s.

“Financial institutions will continue to come under greater pressure from investors and financial regulators to align their investment and lending practices with the decarbonization of the global economy,” Lopez said in an analyst note. “G-20 financial firms hold $22 trillion in loans and investments subject to carbon transition risk, which will require them over the coming years to ramp up climate risk assessments and set clear goals for reaching net zero in their financed emissions.”

Steven Harras contributed to this report.

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