Views on improving the integrity of global capital markets
04 August 2020

ESG Q&A: The role of financial regulators in treating climate change as a systemic risk

Posted In: ESG

Climate change is an issue of growing concern to investors, who increasingly are factoring climate data into their analysis. CFA Institute is contributing to the conversation around climate data with the September publication of its report “Climate Change Analysis in the Investment Process.” One of the most important issues surrounding climate change for financial professionals is the policy response regulators and policymakers make around such issues as climate change data transparency and quality.  

The recent Ceres report, “Addressing Climate Change as a Systemic Risk: A Call to Action for U.S. Financial Regulators,” speaks to some of the issues about climate change analysis that are most important to investors. The report outlines how US financial regulators can act on climate change as a systemic risk. It provides more than 50 recommendations for key financial regulators to adopt.

I recently talked to Veena Ramani, author of the report and senior program director of Capital Markets Systems at Ceres.

How did this report come about, how was it conceived of, and what was the timeline from conception to publication?

The inspiration for this report and our dedicated initiative to get US financial regulators to address and act on climate as a systemic financial risk dates back to the Intergovernmental Panel on Climate Change Special Report on Global Warming of 1.5°C, which was released in 2018. That report sounded the alarm bell that we had a little over a decade to act, and act with ambition, before the impacts of climate change became irreversible. We at Ceres recognized that we needed to invest new resources to engage those critical capital market actors whose efforts would cause markets to price in climate risk at scale.

The report is about the systemic risks brought about by climate change. I highly encourage people to read the report, but could you give us a summary of what you found?

The report finds that climate change threatens the stability and competitiveness of US financial markets. It explores the physical risks of climate change, the economic risks associated with being on the wrong side of a global zero-carbon transition, and the socioeconomic and productivity risks of a warming world. What’s more, it focuses on the ways these risks can combine and compound to wreak havoc on our economic system.

It finds that financial regulators have the responsibility to better understand and protect financial markets from those risks. It also provides an overview of what other regulatory bodies and central banks around the world are doing to act on climate change, and recommends more than 50 key actions US financial regulators can take right now to act on climate — actions that already fall well within their existing mandate.

This report is targeted at regulators in the United States. Although I think this will be a great resource for investors. What would you want investors to take away from this report?

The big takeaway for investors is that climate change is a material and systemic risk to markets. Investors should be aware of these risks, and they should push for regulators to understand them and to supervise in a way that manages them. Many investors are already acting. Earlier this year, investors with nearly $1 trillion in assets under management wrote to the heads of the Fed, the SEC, the FDIC, and other regulatory agencies, urging them to consider the climate impacts of their decisions, to act on climate change as a systemic financial risk, and to heed the recommendations of our report.

There is a perception that the European Union is far ahead of everyone in integrating climate-based risks into policymaking. Can you comment on this, just letting our readers know where things stand comparatively between Europe and the United States? And are there other areas of the world where interesting things are happening to address climate risks?

There’s no question that regulators in Europe are showing leadership on climate risks. The Bank of England announced plans to ask banks, insurers, and asset managers to regularly conduct stress tests for climate resilience. Bank of France has followed suit. Some of the timing for these stress tests have been extended given the pandemic, but the regulators are still planning to conduct them. The central bank of the Netherlands has begun conducting stress tests of climate risks, and Norway’s central bank issued a statement saying that climate risks “must be integrated in the risk assessment and hence in the overall assessment of the capitalization and funding of financial institutions.”

And it’s not just Europe. Australia has announced plans to conduct stress testing for climate change. The Canadian government announced that companies would be required to commit to publish annual climate-related disclosure reports to tap into Covid-19 relief. Sixty-nine regulatory bodies from around the world are members of the Network for Greening the Financial System, a global network of central banks and supervisory authorities advocating a more sustainable financial system.

From an investor perspective, much of the attention around climate change is focused on the quality, timeliness, comparability, and veracity of climate data. Where do you see the quality of climate-related data now and where do you think we are headed?

It is important to note that we’ve come a long way! Research from Ceres and other groups shows that a growing number of companies are disclosing ESG and climate information in their sustainability reports, CDP responses, and even increasingly in their financial filings. However, much of this is still coming from larger companies. The research, including from the Task Force on Climate-Related Financial Disclosures, also shows that the quality of the disclosure largely still does not meet the needs for financially relevant decision making. This significantly impedes investors who don’t have what they need to factor in climate risks into their investment processes. It’s also to the detriment of regulators themselves who don’t have what they need to conduct macroeconomic analyses on climate impacts on financial markets. That is why the report calls on regulators to issue rules for climate change disclosures.

Your acknowledgments section of the report is a very impressive list of luminaries in the climate change world. What was the process for working with such a group?

Thank you! When we began to do the research for this report, we wanted to make sure we were creating a report that was mindful of what some of these regulatory agencies were already doing on climate change, and also mindful of where their mandate begins and ends. We wanted to take stock of who was doing work in this space. The fact that we were able to get in touch with and work with such high-profile leaders on this report is testament to how timely and how critical this issue is. Climate change is a systemic risk to financial markets, and former regulators, members of Congress, major investors, CEOs, and other leaders understand that and are eager to make sure regulators understand it and act on it, too.

Image Credit @ Getty Images/Panuwat Katlungka/EyeEm

About the Author(s)
Matt Orsagh, CFA, CIPM

Matt Orsagh, CFA, CIPM, is a senior director of capital markets policy at CFA Institute, where he focuses on corporate governance, ESG, and climate change analysis. He writes and speaks frequently on these topics on behalf of CFA Institute. His paper, Climate Change Analysis in the Investment Process was named “Best ESG Paper” by Savvy Investor in 2021.

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