Student Voices | Playing Catch-Up – Climate Risk Regulation in the US
Responsible Business Center | May 29, 2024 | Gabelli School of Business
As the impacts of climate change intensify, it is crucial to assess the preparedness of financial institutions. Globally, central banks and financial supervisors have taken proactive measures by conducting climate stress testing exercises to evaluate the financial system’s vulnerability to climate risks. In the US, efforts are in early stages, as the Federal Reserve Board (FRB) has taken a significant step by publishing its first climate scenario analysis (CSA) pilot in 2022.
Responsible Business Center fellows Isabella Vallory, Walder Almeida, and Ali Zeidi explore this topic, focusing on the search for consistent approaches, US climate risk regulation, and the role of public-private partnerships.
The Search for Consistent Approaches across Financial Institutions
Climate change poses significant risks to the financial sector, necessitating the development of robust roles for assessing and managing these risks. Climate scenario analysis has emerged as a crucial methodology. These tools are designed to evaluate the resilience of financial institutions and the broader financial system to various climate-related risks, including physical dangers, such as extreme weather events, and transition risks associated with the shift to a low-carbon economy.
One of the main challenges in implementing climate scenario analysis is the lack of sufficient consistent, comparable, granular, and reliable climate data reported by financial institutions. This challenge underscores the need for improved data collection and reporting standards to facilitate more accurate and comprehensive risk assessments. A consistent global approach to addressing climate-related risks is essential to reducing market fragmentation risk and better assessing and mitigating financial vulnerabilities. The Financial Stability Board (FSB)* emphasizes the importance of promoting consistent approaches across sectors and jurisdictions to monitor, manage, and reduce risks arising from climate change.
US Climate Risk Regulation
In the last three years, there has been a significant shift in the US regulatory landscape regarding climate risk. The first exercise, the CSA pilot, required six of the nation’s largest banks to conduct a climate scenario analysis of their exposures. This exercise focused on two climate scenarios: ‘Current Policies’ and ‘Net Zero 2050’, published by the Network for Greening the Financial System (NGFS). The former represents a status quo scenario with high physical risk. At the same time, the latter depicts an ambitious path to limit global warming to 1.5 °C through stringent climate policies and innovation, aiming for net zero CO₂ emissions by around 2050. The time horizon of interest was the next ten years (up to 2033), and the exercise incorporated macroeconomic variables from the National Institute Global Econometric Model.
In addition, the California Senate passed the Climate-Related Financial Risk Act S.B. 261 last year, which mandates companies with total annual revenues of five hundred million to disclose climate-related financial risks in accordance with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations.
The most recent development is the SEC Climate Risk Rule, which was approved last March and it is now on pause, requires registrants to identify and report any material climate-related risks. This includes determining whether a material physical or transition risk has been or is reasonably likely to be incurred, deciding whether to mitigate, accept, or adapt to a particular risk, and determining how to prioritize the climate-related risk.
Strengthening Climate Risk Regulation through Public-Private Partnerships
Public-private partnerships (PPPs) are essential in climate risk regulation. They merge regulatory guidance with private sector innovation to enhance financial sector resilience. A standout example is the Green Climate Fund’s collaboration with the European Investment Bank, which supports renewable energy projects like solar and wind farms in East Africa. This initiative not only reduces emissions but also promotes sustainable energy development in the region.
Similarly, the NY Green Bank plays a pivotal role in leveraging private capital for diverse clean energy projects across New York, significantly bolstering climate resilience. The International Finance Corporation (IFC) has also demonstrated successful PPPs by introducing financial products like green bonds and sustainability-linked loans, vital for climate mitigation. Additionally, California’s Climate Investments uses cap-and-trade dollars to fund projects such as urban forestry, providing substantial environmental benefits in disadvantaged areas.
These partnerships are reinforced by frameworks from the TCFD, which enhance risk management capabilities through strategic knowledge sharing.
Moreover, the strategic deployment of PPPs transcends financial transactions to encompass broader societal impacts. These partnerships accelerate the adoption of green technologies and practices that could otherwise be hindered by cost or complexity. By facilitating a swifter transition to a sustainable economy, PPPs address immediate environmental challenges and contribute to long-term economic stability and health resilience. Their success serves as a global model, encouraging similar initiatives worldwide and fostering a collaborative approach to combating climate change.
Conclusion
As climate change intensifies, financial institutions’ preparedness becomes increasingly crucial. PPPs emerge as vital enablers of climate risk regulation. These collaborations between regulatory bodies and financial institutions facilitate introducing innovative financial products and enhance knowledge sharing, contributing to effective climate risk management.
In conclusion, collaboration between regulatory efforts and PPPs will be pivotal as the Global regulatory landscape evolves to address climate risks. Together, they can ensure sector preparedness and promote sustainability in the face of climate change.
Written by the 2024 Responsible Business Fellows: Isabella Vallory, MBA 2024; Walder Almeida, MBA 2024; Ali Zeidi, MS Business Analytics 2024
Advised by Kate Kennon and Miguel Alzola
*The FSB is an international organization monitoring the global financial systems seeking its strengthening and the stability of international financial markets. Its mandate includes making recommendations, setting guidelines, and coordinating information exchange among local authorities, among others.
