Climate-related Financial Risk Policy at Home and Globally: US Regulators must "walk the Talk"

In recent years, there have been growing debates around the actual position of the US on climate-related financial risk management, as its engagement at national and international levels remain limited and, to an extent, inconsistent:

(1)   At national level: While the finalised US regulatory climate-related disclosure mandate announced in March 2024 are signs of a significant shift in US climate policy on the surface – requiring domestic and foreign companies operating on US soil to disclose “details related to climate targets, plans for meeting those targets, their oversight and governance practices, climate-related financial expenditures, and governance practices on climate-related risks and relevant risk management processes [among other rules]”, they appear less ambitious than the initial 2022 proposals from a closer look.

(2)   At global level: In April 2024, US regulators (notably the Federal Reserve) were quite vocal to oppose an attempt by European central bankers to make climate risk a focus of global financial rules on the one hand, while on the other hand remain broadly less active in drawing a clear roadmap on a global approach and alignment to address climate-related financial risks.

As these are some of the many signs that the US is struggling to take a proactive stance on climate-related financial risk treatment at home and at the global stage particularly, it is crucial to understanding what this struggle mean for US climate policy objectives and direction domestically and at the international scene. Let’s dive into some key points.

Brief Background: The US Climate-Related Financial Crisis

The US climate-related financial crisis can be traced back to the recognition of climate change as a significant factor in financial risk. The Biden Administration has been particularly active in addressing this issue:

·       On January 27, 2021, President Biden signed an Executive Order on Tackling the Climate Crisis at Home and Abroad (E.O. 14008). This order called for the preparation of a Climate Finance Plan, the first of its kind in the US government, which focuses on international climate finance.

·       The plan aims to assist developing countries in reducing greenhouse gas emissions and building resilience to the impacts of climate change. The US intends to double its annual public climate finance to developing countries by 2024.

·       In April 2023, the Biden Administration announced plans to contribute $1.0 billion to the Green Climate Fund with FY2022-FY2023 budget authority from the State Department’s Economic Support Fund account.

Note for non-experts: However, it is important to note that the term “climate-related financial crisis” is often used to refer to the potential economic and financial risks associated with climate change, rather than a specific event or period. These risks include physical risks due to climate change impacts, and transition risks associated with the shift towards a low-carbon economy.

Recent US Progress and Controversies around Climate-Related Financial Risk Management

Despite being at an early stage in approaching climate-related financial risk management, the US has made undoubtedly some progress in this area – particularly, finalising the new climate-related disclosure rules, and conducting assessment and providing findings of the US climate scenarios analysis pilot exercise (involving 6 large banks and mainly focusing on physical risk assessment) are relevant for the effective treatment of climate-related financial risks.

While this development marks a turning point in US initiatives, there are setbacks signalling that more work needs to be done. For instance, although the finalised US climate disclosure mandate is a step in the right direction, these measures have been criticised for being less ambitious than the 2022 rules. Let’s remember that the new climate disclosure rules were delayed two years before a filtered version was released in March 2024, excluding an important rule (originally considered) requiring companies to disclose their Scope 3 emissions (all emissions associated with a company’s value chain, including investments) which happens to account for an average of “around 75%” of companies’ GHG emissions. This move also opposes the call from California lawmakers, urging regulators to “follow their lead and specifically include Scope 3 disclosure requirements in addition to Scope 1 and 2”.

From an international angle, the firm opposition by the Federal Reserve to the European Central Bank’s (ECB) push to make climate risk a focus of global financial rules targeting supervisory and monetary policy (by influencing decisions of the Basel Committee) and the absence of a proactive stance by US regulators to approach international treatment of climate-related financial risks, suggest that the US is still grappling with how to balance its domestic priorities with its international responsibilities. But let’s examine potential build-ups to this opposition:

In October 2023, principles concerning the management of climate-related financial risks for major institutions were released by the Federal Reserve (Fed), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC). Reacting to this, Christopher Waller, a Governor at the Federal Reserve, expressed that climate risks did not stand out as particularly unique or significant enough to warrant exceptional attention compared to other risks. Similarly, Governor Michelle Bowman voiced concerns that concentrating specifically on climate issues could potentially divert focus and resources away from fundamental risks, such as those related to credit and interest rates. This suggests that there is a level of caution or even scepticism among US regulators, particularly within the Federal Reserve, towards the idea of treating climate-related financial risks as a distinct category that requires special attention:

(1)   At the national level, the issuance of principles on climate-related financial risk management by the Fed, FDIC, and OCC indicates a recognition of climate change as a potential financial risk. However, the comments from Fed Governors Christopher Waller and Michelle Bowman suggest a reluctance to prioritise or single out climate risks over other types of financial risks such as credit and interest rates.

(2)   At the international level, this could be a deeper justification as to why US regulators are not in favour of global financial rules that focus specifically on climate risks, as they believe it could divert resources from managing other core financial risks. As a result, it influences the US’s stance in international discussions on climate-related financial risk management. Furthermore, they have already engaged in a similar move back in August 2023, submitting a letter to the Basel Committee to request modifications to the proposed framework for climate-risk disclosure for banks – claiming that the Committee might be exceeding its authority and asking for the removal of more prescriptive elements of the framework, such as financed emissions disclosures. In parallel, the American Bankers Association (ABA) sent a comment letter to the Committee in March 2024, expressing substantial apprehensions about crucial components of the Consultative Document – Disclosure of Climate-Related Financial Risks (“CD”). In the letter, they encouraged the Committee to collaborate with banking institutions to evaluate and suggest alternative disclosures that align with the stated objectives of Pillar 3 and the overall framework of the Committee.

Clearly, while it is widely acknowledged that climate-related risks can materially reflect on a number of US businesses and that the Basel Committee still needs to develop its approach to the related disclosure, US regulators seem to remain cautious about giving these risks a unique status or priority, both at the national and international levels, and choose a more critical stance to the Committee’s initiatives rather than proposing a concrete approach to advance international efforts to address those risks.  This could negatively influence the pace and direction of climate-related financial risk management policies in the US and globally.

A Way Forward for the US

A Clearer Stance is Needed: The US’s stance on climate-financial risk treatment is currently ambiguous at both national and international levels. To resolve this ambiguity, the US needs to clearly articulate its position on climate-financial risk treatment and ensure that its domestic policies align with its international commitments. This could involve strengthening its regulatory mandates and actively supporting global efforts to address climate-related financial risks.

A More Pragmatic Consensus is Needed: The US is still in the early stages of developing its approach to climate-related financial risk treatment, in comparison to some of its European and Asian peers. However, there is a need for a more pragmatic consensus among key financial, legal, and government institutions. This consensus should be based on scientific evidence rather than political ideology, and it should guide the US’s efforts to achieve its 2050 Net-Zero emissions ambition. For instance, decision-making processes among regulators should remain unbiased and pragmatic, and they should recognise the importance of keeping a Scope 3 emissions rule. This rule, which requires companies to disclose all emissions associated with their value chain, is crucial for accurately assessing and managing climate-related financial risks.

Deeper International Relations are Needed: The US should continue to learn from its foreign counterparts that have more advanced models for addressing climate-related financial risks. This learning process should not be based on preferential assessment but on fact-based alignment. By deepening its international relations in this way, the US can refine its approach to climate-related financial risk treatment and ensure that it is effective and adaptable to the US context.

Continued Investment in Climate Resilience: The US should maintain its national and international investment in building climate resilience. This includes investing in green infrastructure, renewable energy, and other initiatives that help to mitigate climate-related financial risks. The US should also provide financial incentives for companies to invest in climate resilience and to transition to a low-carbon economy.

By taking these steps, the US can demonstrate proactive leadership in addressing climate-related financial risks, both at home and on the global stage. This will not only help to protect the US economy from the impacts of climate change but will also contribute to the global effort to mitigate climate change and its associated financial risks.