A wide-ranging report encourages regulators to take a concerted approach to combat climate-related risks to the US financial system.

By Jean-Philippe Brisson, Paul A. Davies, Nicola Higgs, Malorie R. Medellin, and Deric Behar

On October 21, 2021, the Financial Stability Oversight Council (FSOC) published a lengthy report on Climate-Related Financial Risk (the Report), marking the first time that FSOC has officially identified climate change as an emerging and increasing threat to US financial stability. FSOC issued the Report pursuant to a directive in President Biden’s May 2021 Executive Order on Climate-Related Financial Risk, which tasked FSOC to assess and collaboratively address climate-related impacts on US financial system stability.

The Report is another building block in the Biden Administration’s “whole of government” approach to combating climate change and the climate-related risks that threaten the US economy. The Report comes just days after the Administration issued “A Roadmap to Build a Climate-Resilient Economy” (the Roadmap), which heralded the Report as “the first step in a robust process of US financial regulators developing the capacity and analytical tools to mitigate climate-related financial risks.” (See this Latham post for more information.)

The Report

The Report includes 35 proposals to US financial regulators aimed at improving efforts to identify and assess climate-related risks. Highlighted initiatives and key recommendations include:

• Building Capacity and Expanding Efforts to Address Financial Risks: Regulators should expand their capacities to define, identify, measure, monitor, assess, and report on climate-related financial risks and their effects on financial stability through increased investment in staffing, training, expertise, data, analytic and modeling methodologies, monitoring, and public communications.
• Filling Data and Methodological Gaps: Regulators should perform an internal inventory of currently available data and ensure that they have (or can procure) consistent and reliable data to help assess climate-related risks. Regulators should also coordinate to develop consistent data standards, definitions, and relevant metrics.
• Enhancing Public Disclosures: Regulators should review their existing public disclosure requirements and consider updating and standardizing them to promote the consistency, comparability, and decision-usefulness of information on climate-related risks and opportunities. FSOC recommends that this initiative build on the four core elements of the Task Force on Climate-related Financial Disclosures (TCFD): governance, strategy, risk management, and metrics and targets. (See this Latham post for more information.)
• Assessing and Mitigating Risks to Financial Stability: Regulators should use scenario analysis to assess climate-related financial risks, including those scenarios already developed by the Network of Central Banks, the Supervisors for Greening the Financial System, and the Financial Stability Board. (In scenario analysis, financial institutions and the financial system are analyzed under different hypothetical scenarios, without the capital reserve requirements that come with stress-testing.) Regulators should also promote scenario analysis by supervised institutions to maximize data disclosure across the financial system, thus contributing to a more comprehensive climate risk analysis by FSOC.

The Report calls for FSOC to create two new committees to ensure coordination among FSOC member agencies:

• Climate-Related Financial Risk Committee (CFRC): This committee will consist of regulatory staff and will be charged with identifying priority areas, tracking agency efforts, coordinating efforts, reviewing progress, and sharing information. It will report on its findings to FSOC at least semi-annually.
• Climate-Related Financial Risk Advisory Committee (CFRAC): This committee will consist of individuals from climate science institutions, academia, financial services, consumer groups, environmental groups, etc., and will report to the CFRC. Its purpose is to help FSOC gather information and analysis from a broad array of stakeholders on climate-related financial risks.

In keeping with the Biden Administration’s priority of improving the resilience of communities and protecting populations that may be disproportionately affected by climate change (as described in the Roadmap), the Report also recommends that regulators coordinate and explore policies that could help protect populations that are most vulnerable to these risks.

While the Report makes some new recommendations and promotes enhanced coordination among regulators and international counterparts, it also devotes considerable space to recapitulating many of the initiatives that regulators have previously announced, such as work on mandatory climate disclosures for public issuers at the Securities and Exchange Commission and the establishment of dedicated climate risk committees at the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Commodity Futures Trading Commission. None of the recommendations in the Report is binding on FSOC member agencies, and few are given any concrete timeframes.

Climate Change as a Systemic Risk

According to Treasury Secretary Janet Yellen (Chair of FSOC), climate change is “a unique, existential risk for the planet that will affect every aspect of our lives and the lives of our children.” Despite the sense of urgency, the Report poses as “a critical first step,” and Yellen concedes that it is “by no means…the end of this work.” For many observers, these qualifications are an indication that the recommendations in the Report are not yet comprehensive enough to set the US on the same course as that of the EU and the UK.

Whether or not the Report is as robust as anticipated, it builds on existing efforts and drives coordination across agencies. To the extent that it accelerates current initiatives to tackle climate change risks while encouraging new ones, the Report can be seen as another milestone in the Biden Administration’s attempt to facilitate an orderly, economy-wide transition toward net zero emissions.

For information on a parallel EU effort, see Latham’s post European Commission Releases Legislative Package to Meet Emissions Target.

For information on a parallel UK effort, see Latham’s posts UK Government Released Roadmap to Sustainable Investing and UK Net Zero Strategy: Understanding the Impact on Key Sectors.