The Climate-Related Market Risk Subcommittee of CFTC released a report on the management of climate risk in the financial system in U.S. One of the conclusions of the report is that climate change poses a major risk to the stability of the U.S. financial system and to its ability to sustain the American economy. The report presents 53 recommendations to facilitate comprehensive integration of climate risk into the US financial system and regulatory frameworks. The report recommends carbon pricing as the single most important step to manage climate risk and drive the appropriate allocation of capital.
Another key conclusion of the report is that financial innovations, in the form of new financial products, services, and technologies, can help the U.S. economy better manage climate risk and help channel more capital into technologies essential for the transition. The following are some of the key recommendations presented in the report:
- Research arms of federal financial regulators should undertake research on the financial implications of climate-related risks. This research program should cover the potential for and implications of climate-related “sub-systemic” shocks to financial markets and institutions in particular sectors and regions of the United States, including agricultural and community banks and financial institutions serving low-to-moderate income or marginalized communities.
- U.S. regulators should join, as full members, international groups convened to address climate risks, including the Central Banks and Supervisors Network for Greening the Financial System (NGFS), the Coalition of Finance Ministers for Climate Action, and the Sustainable Insurance Forum. The United States should also engage actively to ensure that climate risk is on the agenda of G7 and G20 meetings and bodies, including the FSB and related committees and working groups.
- Financial supervisors should require bank and nonbank financial firms to address climate-related financial risks through their existing risk management frameworks in a way that is appropriately governed by corporate management. That includes embedding climate risk monitoring and management into the firms’ governance frameworks, including by means of clearly defined oversight responsibilities in the board of directors.
- Working closely with financial institutions, regulators should undertake—as well as assist financial institutions to undertake on their own—pilot climate risk stress testing as is being undertaken in other jurisdictions and as recommended by the NGFS. This climate risk stress testing pilot program should include institutions such as agricultural, community banks, and non-systemically important regional banks. In this context, regulators should prescribe a consistent and common set of broad climate risk scenarios, guidelines, and assumptions and mandate assessment against these scenarios.
- Financial authorities should consider integrating climate risk into their balance sheet management and asset purchases, particularly relating to corporate and municipal debt. State insurance regulators should require insurers to assess how their underwriting activity and investment portfolios may be impacted by climate-related risks and, based on that assessment, require them to address and disclose these risks.
- Financial regulators, in coordination with the private sector, should support the availability of consistent, comparable, and reliable climate risk data and analysis to advance the effective measurement and management of climate risk.
- Financial regulators, in coordination with the private sector, should support the development of U.S.-appropriate standardized and consistent classification systems or taxonomies for physical and transition risks, exposure, sensitivity, vulnerability, adaptation, and resilience, spanning asset classes and sectors, with the aim to define core terms supporting the comparison of climate risk data and associated financial products and services.
- Material climate risks must be disclosed under existing law, with the climate risk disclosure covering material risks for various time horizons. To address investor concerns around ambiguity on when climate change rises to the threshold of materiality, financial regulators should clarify the definition of materiality for disclosing medium- and long-term climate risks, including through quantitative and qualitative factors, as appropriate.
- Regulators should require listed companies to disclose Scope 1 and 2 emissions. As reliable transition risk metrics and consistent methodologies for Scope 3 emissions are developed, financial regulators should require their disclosure, to the extent they are material.
- Financial regulators should establish climate finance labs or regulatory sandboxes to enhance the development of innovative climate risk tools as well as financial products and services that directly integrate climate risk into new or existing instruments. The United States and financial regulators should review relevant laws, regulations and codes and provide any necessary clarity to confirm the appropriateness of making investment decisions using climate-related factors in retirement and pension plans covered by the Employee Retirement Income Security Act (ERISA), as well as non-ERISA managed situations where there is fiduciary duty. This should clarify that climate-related factors—as well as ESG factors that impact risk-return more broadly—may be considered to the same extent as “traditional” financial factors, without creating additional burdens.
Keywords: Americas, US, Banking, Insurance, Securities, Climate Change Risk, ESG, Sustainable Finance, Stress Testing, Regulatory Sandbox, Disclosures, Systemic Risk, Carbon Pricing, Taxonomy, ALM, CFTC
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