Regulatory Note – Climate Change – FSOC Report
Yesterday, October 21, the Financial Stability Oversight Council published the Report on Climate-Related Financial Risk, which states that “[c]limate change is an emerging threat to the financial stability of the United States.”(1) The Report is “an initial review” of the work of the financial regulatory agencies on climate change and makes several recommendations to the agencies about the incorporation of climate-related financial risk into their supervisory and regulatory programs.
One important aspect of the Report is that it addresses a risk to virtually all institutions in the financial services industry; the Report and its recommendations are not limited to systemically important institutions. The work of the banking agencies on climate-related financial risk will affect banks of all sizes. State nonmember banks may notice that FDIC Chairman Jelena McWilliams abstained from voting to endorse the Report, but it seems unlikely that the FDIC would be an outlier as the financial regulatory agencies move forward on climate issues.
The Report contains four sets of recommendations to all the regulatory agencies with jurisdiction over any sector of the financial services industry. With one exception, the recommendations do not not differentiate among sectors or regulatory agencies. The Report is centered on four regulatory activities:
Building internal analytic capacity. The Report includes several recommendations on improving an agency’s ability to understand and address climate-related financial risk. In connection with these tasks, the Council will form a Climate-related Financial Risk Committee to identify priority areas for the agencies and to facilitate common approaches and standards.
Data collection. Agencies should identify the data that they need to evaluate the climate-related financial risk exposures of their regulated institutions, determine the extent to which currently collected data meet their needs, and make plans for procuring other necessary data.
Public disclosure. The agencies should enhance public disclosure requirements for climate-related financial risk. Among other things, the Report encourages the agencies build on the recommendations of an international group, the Task Force on Climate-related Financial Disclosures. That task force identified four “core elements” of disclosure – governance, strategy, risk management, and metrics and targets.
For the banking industry in particular, the Report recommends that the federal banking agencies (consistent with their mandates and authorities) “continue to review banks’ public regulatory reporting requirements to assess whether enhancements are needed to provide market participants with information on institutions’ climate-related financial risks, taking into account a bank’s size, complexity, and activities.”
Risk assessment and mitigation. The Report focuses on two aspects of risk management by the agencies. First, the agencies should use “scenario analysis” – a term of art vaguely comparable to “stress test” – to assess the impact of climate-related risk on individual institutions. In doing so, the agencies should look to scenarios developed by one international body, the Network of Central Banks and Supervisors for Greening the Financial System, and the work of another, the Financial Stability Board.
Second, the agencies should determine which of their regulations, guidance, and regulatory reporting requirements may require updating to account for climate-related risks. This review should consider specific types of risk that are well known to banks and their regulators: credit risk, market risk, counterparty risk, and operational risk.
While the Report contemplates a long-term process for understanding and mitigating climate-related financial risk, the agencies (including the FDIC) have already begun to address the duties of the banking industry to manage this risk.(2)
Yesterday’s release also included a fact sheet and remarks of Treasury Secretary Janet L. Yellen.
E.g., Statement of Chair Jerome H. Powell (Oct. 21, 2021); Statement by the Acting Comptroller (Oct. 21, 2021); Statement by FDIC Chairman Jelena McWilliams (Oct. 21, 2021).