The Climate Crisis Must Be Priority for Financial Regulators

By Steven Rothstein, Managing Director of the Ceres Accelerator for Sustainable Capital Markets

Central banks around the world are responsible for ensuring economic and financial stability. So why would some of them minimize perhaps the most significant threat to the future of our society and its financial markets – climate change?

Business headlines in the last few months are full of encouraging stories on climate action. The European Central Bank is increasing its contribution to addressing the climate crisis. U.S. President Biden committed to reducing emissions by 50-52% by 2030, and U.S. Treasury Secretary Janet Yellen is leading a regulatory review to examine climate change’s potential risk to America’s financial system. And earlier this year, the U.K.’s HM Treasury announced its principal financial regulators will be required to consider climate change as part of a government-mandated transition to a net zero economy by 2050.

However, as we experience increasingly frequent natural disasters worldwide – such as the U.S.’ severe temperatures and the devastating floods in Germany and China – it’s clear this trend toward climate-related financial regulation considerations isn’t happening quickly enough. Unfortunately, we are running out of extreme weather-related records to break.

Despite evidence to the contrary, skepticism remains about whether the responsibility to combat the climate crisis lies with financial regulators and central banks at all. In the U.S., for example, the Federal Reserve has been accused of mission creep by some lawmakers.

This is no more than an ill-advised attempt at ignoring the biggest potential risk to our financial markets.

Government agencies and financial institutions regularly assess risk. This is a critically important and, frankly, baseline responsibility, and this regularly involves examining how global crises stand to impact the markets. In the last few months alone, the Fed recognized coronavirus as a top U.S. financial risk and indicated it will enhance its risk and tax regulation of cryptocurrency, while the Federal Deposit Insurance Corporation (FDIC) took several steps to bolster the U.S. banking system’s resilience against COVID-19. After the 2008 recession, several new safeguards were put in place by regulators and legislators. We know climate change poses a systemic risk to our economy. Are we really going to have to wait until after the climate changes hits us even harder, despite the fact we know the problem is here and getting seriously worse?

If a banker or bank regulator were to suggest they did not need to plan for the next pandemic, the next cyberattack, or any other potentially major disruption, they would be met by a chorus of criticism alleging they were not meeting their fiduciary responsibility. Climate risk poses a bigger and more systemic potential threat, yet leaders across banking, insurance, and even financial regulation do not fully account for climate risk.

Central bankers in some countries are starting to sound the alarm and acknowledge the value of tools like climate stress tests, climate scenario analysis, and other risk assessments. These regulatory steps are in the right direction, but we need more central banks, including the Federal Reserve, to act faster. There are great examples of private sector climate leadership, in many cases pooling its collective influence to drive change. For example, tech giants like Apple, HP, and Salesforce are calling for uniform regulations that require corporations to disclose greenhouse gas emissions. Over 400 companies urged the Biden administration to reduce the 2030 emissions level by at least 50% and investors representing $43 trillion in assets have made important commitments to meet net zero commitments by 2050 with strong 2030 interim goals as part of the Net Zero Asset Managers Initiative.

But without meaningful guidance from the top-down, our economies will be unable to reach their fullest climate-positive potential. We stand to do damage today that will be irreversible in the long run.

To protect our banks, insurance companies, and financial institutions against growing climate risks, there are several things the Treasury Department, Fed, Securities and Exchange Commission, and other U.S. regulators must do:

1. Immediately affirm the systemic nature of the climate crisis and its impacts on financial market stability via a statement from the agency chair or an agency-issued report that underscores climate change’s risks to financial markets.
2. Activate action on prudential supervision. U.S. regulators have explicit responsibilities to supervise the risks that financial institutions take on. Financial regulators should integrate climate change into their prudential supervision of banks, insurance companies, and other regulated financial institutions. This includes pilot climate stress tests and potentially enhancing capital and liquidity requirements to integrate climate risk.
3. Support the Securities and Exchange Commission’s work on mandatory climate disclosure. The SEC recently sought comments on climate change disclosure. We hope they issue bold rules later this year mandating corporate climate disclosure.
4. Address how climate risks further exacerbate systemic racism, particularly reflected in financial institutions. Financial regulators should develop strategies to address systemic climate risks and structural racism in an integrated way. The Community Reinvestment Act offers ripe opportunities to enhance economic and climate resilience for low-income and vulnerable communities.
5. Build capacity for smart decision-making on climate change by coordinating action with other U.S. and global financial regulators and by hiring and training additional staff. Coordinated action by U.S. financial regulators at the global, federal, and state levels is essential to accelerating efforts to address climate risk. The Financial Stability Oversight Council generally and the Executive Order on Climate-Related Financial Risk play a critical coordination role.

Financial regulators have a critical role to play in ensuring the resilience of our economy, and climate risk must be a central focus if they are to execute their mandates to their fullest potential. Only through accountability and ownership will we make substantial progress in the fight against the climate crisis.