FSOC report: Climate change ‘increasing threat’ to U.S. financial stability

The FSOC stated climate change’s threats to the market are both physical (wildfires, rising sea levels, stronger and more powerful storms) and transitional (changes in policy and public sentiment to entities that produce carbon emissions).

In a report released Thursday, the FSOC urged market participants, public companies, and regulators to develop a common agenda to respond, laying out a suggested course of action that includes assessing and measuring the risks posed by climate change, disclosing those risks, and managing them over the long term.

Established by the Dodd-Frank Act of 2010 and operating under the umbrella of the Treasury Department, the FSOC has the responsibility of monitoring and addressing overall risks to stability of the U.S. financial system. Its report was requested by President Joe Biden as part of an executive order on climate-related financial risk in May.

“FSOC’s report and recommendations represent an important first step towards making our financial system more resilient to the threat of climate change,” Treasury Secretary Janet Yellen said in a press release. “These measures will support the administration’s urgent, whole-of-government effort on climate change and help the financial system support an orderly, economy-wide transition toward the goal of net-zero emissions.”

A fact sheet the FSOC included with the report outlined four steps it is recommending to members as a response to climate change-related financial risk. Some regulators that are FSOC members include the Securities and Exchange Commission (SEC), the Federal Reserve Board, and the Commodity Futures Trading Commission (CFTC). The steps are:

• Expand capacities to measure climate change-related risks to financial performance of regulated entities by helping them to define, identify, measure, monitor, assess, and report on those risks. The effort “should include investments in staffing, training, expertise, data, analytic and modeling methodologies, and monitoring.” Results of such assessments should be made available to the public in annual reports, risk reports, and other public documents.
• Fill gaps in climate change-related data and methodologies by identifying existing data and then “develop plans for acquiring necessary additional data through data collection, data sharing, or data procurement.” As part of that process, FSOC members should “develop consistent data standards, definitions, and relevant metrics, and coordinate as they identify and fill data gaps and address data issues.”
• Encourage regulated entities to enhance and improve public disclosures on climate change-related risk, with an eye toward making those disclosures consistent, comparable, and actionable. Disclosures could, for example, reveal an estimate on how much greenhouse gases were emitted by the company in the past year, as much as that is possible and appropriate.
• Use scenario analysis as a tool for assessing climate change-related risks, building on existing work developed by the Network of Central Banks and the Financial Stability Board.

As far as analyzing climate change-related risks to the U.S. financial markets, several regulators already have initiatives underway.

The SEC has indicated it will evaluate its rules on climate change-related disclosures and has requested public comment on the matter.

In remarks to the FSOC on Thursday, SEC Chair Gary Gensler said the agency is developing a proposal seeking to ”facilitate consistent, comparable, and decision-useful disclosures from companies” on climate change-related risk.

Gensler said the SEC is developing another proposal to address so-called “greenwashing” by investment firms who claim their investment strategies or funds are environmentally friendly.

“I think we ought to consider updating those naming rules and enhancing disclosures so that investors can see what data, methodologies, and criteria stand behind these names and claims,” he said.

The Federal Reserve Board has established two committees tasked with better understanding climate risks and incorporating them into its supervision efforts. Fed Chair Jerome Powell added Thursday that the agency is “developing a program of scenario analysis to evaluate the potential economic and financial risks posed by different climate outcomes.”

Michael Hsu, acting comptroller of the currency, said in a statement the FSOC’s report ”provides an excellent road map for us and the other FSOC members,” and added his office is ”strongly committed to acting on the risks that climate change present to the financial system and will approach this issue with the urgency it warrants.”

The CFTC formed a climate risk unit in March to support the agency’s efforts to determine the role of derivatives in addressing climate-related risks.