On Sept. 9, the Climate-Related Market Risk Subcommittee of the Market Risk Advisory Committee of the Commodity Futures Trading Commission (CFTC) released its long-awaited report, Managing Climate Risk in the U.S. Financial System.
The report’s unanimous recommendations are non-binding but argue in favor of an urgent, coordinated effort by federal regulators, including the CFTC and the Securities and Exchange Commission, to measure, understand, and address the financial risks presented by climate change.
The report represents a significant effort, but enacting the 53 recommendations in it would be a monumental undertaking of political will and regulatory coordination, much of which likely hangs on the outcome of the November elections.
The nearly three dozen members of the task force sponsored by CFTC Commissioner Rostin Benham (a Democrat appointed by President Trump) include representatives from U.S. banks, asset managers, academia, industry, and public interest groups.
Legislative Action Needed
The report begins with a strong message that an economy-wide price on carbon, either in the form of a carbon tax or an emissions trading system, is a fundamental underpinning for the financial markets’ ability to channel resources efficiently. However, the report recognizes that building such an expansive regulatory system would require legislative action by Congress.
While the markets await an economy-wide carbon price, the report advocates in favor of U.S. financial regulators using existing authorities relating to oversight of systemic financial risk, risk management of particular markets and financial institutions, disclosure of material information, and the safeguarding of financial sector utilities.
With regard to disclosure, the report concludes that the 2010 SEC Commission Guidance Regarding Disclosure Related to Climate Change “has not resulted in high-quality disclosure” and recommends that it be “updated in light of global advancements in the past 10 years.”
The report recognizes the progress that has been made by voluntary disclosure frameworks, such as the Task Force for Climate-related Financial Disclosures, but concludes that there is a critical need for common definitions and standards and more robust data and analytical tools to measure and manage climate-related financial risks.
Additionally, the report suggests that financial regulators should clarify the definition of materiality and make clear that medium- to long-term climate-related risks may be material to investors and require disclosure.
Climate Risk Stress Tests
The report calls for climate risk stress testing of U.S. banks and insurers, working closely with intergovernmental forums and other jurisdictions undertaking similar efforts, such as the Bank of England, which announced in May that it would postpone its climate stress test until at least mid-2021 due to Covid-19.
In addition, it recommends that the Financial Stability Oversight Council should incorporate climate risks into its oversight activities in order to identify and monitor threats to financial stability.
The report also notes that current U.S. policy uncertainty remains a barrier to capital flowing into low-carbon activities, referring to the Department of Labor’s recent proposed regulation affecting sustainable or ESG (environmental, social and governance) investing.
The report suggests that existing regulations on fiduciary duty should be clarified to “confirm the appropriateness of making investment decisions using climate-related factors—and more broadly, ESG factors that impact risk-return.”
It also recommends the development of a unified federal umbrella to coordinate and expand existing government programs (e.g., credit guarantees and other incentives) and leverage institutional capital to maximize impact and align the various federal programs.
The report concludes that, once transparent, reliable, and trusted climate risk data is available, derivative markets may be utilized in numerous ways for directing capital to climate-related opportunities.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Zachary S. Brez is a partner in the Government, Regulatory & Internal Investigations group at Kirkland & Ellis LLP in New York. He works with companies to investigate, mitigate, defend and advise on complex enforcement and regulatory matters in two primary areas: international risk, such as anti-bribery and corruption, sanctions, anti-money laundering; and securities, futures, and derivative financial products.
Erica Williams is a partner in the Government, Regulatory & Investigations Group of Kirkland & Ellis LLP. She focuses on internal investigations and defense of companies and individuals accused by the government of involvement in securities law violations, white collar crime, and other business litigation issues.
Alexandra N. Farmer is a partner and leader in Kirkland & Ellis LLP’s Sustainable Investment and Global Impact practice group. She counsels PE firms, corporations, lenders, and other companies seeking to enhance or build their sustainable investing programs, including ESG and climate governance, disclosure, and risk management capacities.