Steven M. Rothstein
If the last few weeks are any indication of what’s to come, the U.S. will make leaps and bounds in addressing climate change as a systemic financial risk over the next four years.
Last month, just days after BlackRock CEO Larry Fink put lagging companies on notice, the Biden administration announced a suite of executive orders aimed at tackling the climate crisis – including orders making climate a national security priority, halting oil and gas leases on federal land and requiring federal agencies to factor climate change into federal procurement decisions.
Complementary to these actions, President Joe Biden has assembled a formidable team of financial regulators with a long history of climate action – and a willingness to reign in risky behavior. With Janet Yellen at Treasury, Gary Gensler and Allison Herren Lee at the SEC, Rostin Behnam at the CFTC and Kevin Stiroh heading up the Federal Reserve’s newly created Supervision Climate Committee, we can expect U.S. financial regulators to not only catch up to their global peers – but assume a leadership role in addressing systemic climate risk.
That will likely mean increased scrutiny and supervision, from both investors and regulators, of the banking sector – which our findings show is far more exposed to climate risk than banks are disclosing. Here’s what U.S banks can do right now to plan for the future and foster a more resilient banking sector in the face of both climate change and our fast-moving response to it.
Dan Saccardi
Understand Transition Risk
We strongly encourage all U.S. banks to learn more about their exposure not only to physical climate risk, but to transition risk as well. This is the risk posed to banks by the failure of the companies they finance and invest in to prepare for climate-related market shifts – particularly a rapid and unplanned for shift in investor and public sentiment away from fossil fuels.
A recent report from the Ceres Accelerator for Sustainable Capital Markets found the U.S. banking system’s exposure to climate risk could lead to destabilizing losses across the banking system if mitigation strategies are not developed and implemented.
Large parts of banks’ portfolios would be impacted by a potential sudden devaluing of fossil fuel assets – risk is not only linked to banks’ holdings in fossil fuels but to holdings in the many sectors that rely on fossil fuels, such as manufacturing, transportation and agriculture. It even includes the financial exposures banks have to other banks.
Assess and Disclose
Recent developments on the regulatory front, as well as statements from Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen, signal that financial regulators are likely to mandate that banks assess and disclose their climate risk exposure – and banks should act now to get out in front of that change. But even if regulators don’t immediately enact new rules, banks should still act on climate risk – making for more efficient markets, more resilient banks and a more sustainable banking system.
We also encourage banks to quantify climate risk at both the firm and portfolio levels – across all asset classes and business lines. They should aim for disclosure that assesses the entire lending portfolio, including both past emissions and indicators of future performance, such as client capital spending.
Once banks begin assessing this risk, they should disclose it to their investors. Citigroup, Bank of America and JPMorgan have taken steps in this direction, publishing their first climate risk reports. Their peers should join them, in advance of impending regulation, as there is every reason to believe that the U.S. could follow New Zealand, France and the United Kingdom – mandating climate risk disclosure in short order.
Engage Clients, Set Targets
Once banks understand the climate risks they’re exposed to, they can start to mitigate those risks. Banks should start by leveraging their lending power to make sure their borrowers disclose their own emissions and lay out their plans for business in a significantly carbon-constrained world.
We’re beginning to see important movement in this direction, for example, in the recent announcement by JPMorgan Chase of its Center for Carbon Transition. But the success of this type of engagement will depend on meaningful action from banks’ clients – and engagement by all banks to ensure that there are real world benefits, rather than obstinate clients taking their business to other banks less inclined to do this critical work.
Finally, banks should work to reduce their exposure to climate risk – and measure the success of that work against concrete emissions reduction commitments with detailed targets and specific timelines.
Banks are both particularly vulnerable to climate change and particularly powerful in their ability to right the ship. By leaning into this work, they can distinguish themselves from their peers and ensure investors, customers and regulators that they are clear-eyed and proactive about the financial risk that climate change poses for themselves and the economic system – as well as society.
Steven M. Rothstein is the Managing Director of the Ceres Accelerator for Sustainable Capital Markets. Dan Saccardi is a Senior Director, Company Network at Ceres.
