To say that climate change has the potential to threaten financial stability is not news. 2020 will mark five years since Mark Carney’s famous speech about the Tragedy of the Horizons, which highlighted the short-termism inherent in most financial decision making – both by investors and policymakers – as perhaps the single biggest barrier preventing the full integration of climate considerations into the financial system, and thus an often overlooked potential risk.
Much “issue spotting” on the topic of the financial risks from a warming planet has been done since then, including the groundbreaking work of the Task Force on Climate-related Financial Disclosure (TCFD),which provides a common lexicon for investors and financial policymakers to understand climate-related financial risk. Perhaps more importantly TCFD may have been the catalyst for some investors and banks to pivot beyond disclosure to active and ongoing climate risk management, which is welcome news for driving dollars (and Euros) into climate-resilient, low-carbon investment.
But good policy frameworks are always critically important. Today, it is fair to say that serious attention is being paid by many central banks and finance ministries around the world to the topic of climate risk, as evidenced by 51 central banks participating in the Network for Greening the Financial System (NGFS) and 51 finance ministers comprising the Coalition of Finance Ministers for Climate Action. These coalitions serve as bodies for financial policymakers to share best practices to further advance climate risk management practices and are doing the hard analytical work to lay the foundation globally for sound climate-related financial policy, such as mapping transmission channels of climate-related risks into the economy and the financial system.
That the U.S. has been noticeably absent from these coalitions can be explained in large part by the politics of the day. But to a larger degree, the institutions in the U.S. responsible for financial governance have also heretofore largely thought of climate change as an issue for other government agencies.
That may be changing, which is good news, given that we are all exposed to the potential financial and economic consequences of climate change, and the U.S. is no exception. In fact, 2019 will mark the fifth consecutive year in which the U.S. had 10 extreme weather disasters that caused over $1 billion in damages each. The most recent National Climate Assessment noted that annual losses in some U.S. economic sectors are projected to reach hundreds of billions of dollars by the end of the century—more than the current gross domestic product (GDP) of many U.S. states if emissions are unchecked. Both acute and chronic impacts from a changing climate are already manifesting in financial and economic losses to consumers, businesses, communities, and the federal budget. The threat to financial stability from these impacts is real, both locally and across the financial system.
Over the last six months, a number of quiet – but noticeable – initiatives have emerged from U.S. financial policymakers. Most recently, Senator Brian Schatz introduced the Climate Change Financial Risk Act of 2019, which aims to codify the Fed’s ability to address climate risks and specifically to develop and employ financial risk analyses relating to climate change. Citing that “climate change poses uniquely far-reaching risks to the financial services industry, including with respect to underwriting, credit, and market risks,” Senator Schatz’s bill would give the Fed the ability to stress test financial institutions to ensure adequate capital levels under varying (climate) scenarios, allow them to take into account the potentially systemic impact of climate-related risks on the financial system, and empower them to develop new analytical tools to accurately assess and manage climate risks. Such a policy, if enacted, would significantly strengthen financial oversight of climate risks in the U.S. financial system and serve as a key step for the Fed to match the policy actions of other prominent central banks.
This is not all that’s happening. Earlier this fall, the Federal Reserve Bank of San Francisco, led by President and CEO Mary Daly, hosted The Economics of Climate Change Conference, the first conference of its kind in the bank’s history. In her opening remarks, Daly put the issue of climate change and financial stability front and center: “The Federal Reserve’s job is to promote a healthy, stable economy. This requires us to consider current and future risks – whether we have a direct influence on them or not. Climate change is one of those risks.” New York Fed Executive Vice President Kevin Stiroh, has also recently made the connection between climate risk and financial stability, citing $500 billion in direct losses to the U.S. economy over the last five years related to climate change, noting that “supervisors can use our tools to ensure financial institutions are prepared for and resilient to all types of relevant risks, including climate-related events.”
In this vein, both Daly’s and Stiroh’s remarks echo those of many other central bankers and financial regulators and are consistent with the sentiment coming out of the NGFS and the Coalition of Finance Ministers for Climate Action. Furthermore, the growing attention paid to climate change from U.S. financial policymakers is not limited to the Fed. In July, Commodity Futures Trading Commissioner Rostin Behnam launched a Climate-Related Market Risk Subcommittee of the Market Risk Advisory Committee (MRAC) to examine climate-related financial and market risks and work on issues related to disclosures, reporting, and stress testing of climate risks. This first-of-its-kind Climate Subcommittee of the CFTC comprises experts from the financial sector, including the banking and insurance sectors,the agricultural and energy markets, the data and intelligence service providers, the environmental and sustainability public-interest sector, and the academic disciplines singularly focused on climate change, adaptation, public policy, and finance.
These efforts are all welcome and show progress on an issue where U.S. leadership at the federal level has been noticeably silent in recent years.
While such efforts to integrate climate considerations into financial policy are necessary, they are not alone sufficient to truly enable the financial sector to either respond to the financial risks of climate change or realign to capture the investment opportunities that addressing climate change offers. Central banks and financial regulators need to be actively involved in the identification and management of climate risks, but financial institutions and investors also need to be actively managing their exposure to climate-related financial risks and seeking out opportunities to accelerate sustainable and climate-resilient investments.
But as Senator Schatz notes, “risk is risk” whether derived from climate change or otherwise, and unfortunately, we may not have five more years to study or think about these issues. At some point – soon – policies should be in place that provide the roadmap for addressing climate risks, and by extension accelerating the investment needed to achieve net-zero by 2050. This includes fully embedding climate risk management practices to help financial decision-making of all types manage climate risk.
In many parts of the financial sector, the “short-termism” that Carney highlighted continues to this day, and while we’ve achieved a greater level of awareness about climate change, adopting good financial policies that support the necessary low-carbon, climate-resilient transition are needed. We’re not there yet, but with the Fed and others in the U.S. joining their peers, one more step forward has been taken.
