Overview
Tomorrow, Treasury Secretary Janet Yellen will lead a meeting of the Financial Stability Oversight Council (FSOC). The preliminary agenda for the open session includes climate change and its potential impacts on financial stability.
Appearing before Congress last week, Secretary Yellen stressed the importance of FSOC and its unique role in coordinating responses to issues like climate change. She specifically noted that climate change is a "top priority of the Biden [a]dministration" and FSOC "can play a role in arranging discussions among financial regulators all of whom have responsibilities for assessing risks from climate change … to coordinate a systemwide response using the best available tools." She added that "FSOC can facilitate identification of data and information including high quality financial disclosures that are needed to understand climate risks and make sure that climate risks are addressed fully in light of these assessments."
FSOC, which was established by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, has been used by prior administrations to centralize and coordinate multi-agency responses to developing issues, like market volatility events or systemic risks posed by large nonbank financial companies. FSOC has also been used to highlight an important issue at one of its member agencies and push that agency to action, such as when the FSOC engaged on money market fund oversight, a role traditionally performed by the Securities and Exchange Commission (SEC).
It remains to be seen how Secretary Yellen will lead the FSOC during the Biden administration, although she and other members have FSOC experience: Secretary Yellen served on the FSOC as the representative of the Federal Reserve Board of Governors (Federal Reserve); Gary Gensler, President Biden’s nominee to chair the SEC, previously sat on the FSOC while chair of the Commodity Futures Trading Commission (CFTC); and FDIC Chair Jelena McWilliams and Federal Reserve Chair Jerome Powell are current members.
Reflecting Secretary Yellen's comments to Congress last week, tomorrow's FSOC meeting will demonstrate that US financial regulators, coordinated within FSOC, are ready to aggressively pursue actions within their existing statutory authority to address climate change and environmental, social, and governance (ESG) issues. Their initiatives will likely be designed to ensure sufficient disclosure and understanding of how the effects of climate change can impact the financial services sector and, from an investor protection perspective, the risks faced by public companies.
This alert highlights some of the early actions taken by certain FSOC members, including the Treasury Department, the SEC, the Federal Reserve, and CFTC.
Treasury Department
Secretary Yellen has pledged to create a "climate hub" in her department that would examine financial risks arising from climate change and on related tax policy incentives. This hub is expected to include a senior advisor position at Treasury, reporting to the secretary on climate change issues.
Additionally, in late February, Secretary Yellen sent a letter to her peers among G20 nations about the need for the G20 to work together on COVID-19, and how it is affecting the economies and the "social fabric of our societies," and to, together, "build a better, stronger, more even global recovery." Included in that letter was a call for "global cooperation to address the existential threat of our time: climate change."
Then, the US-EU Joint Financial Regulatory Forum held a virtual meeting on March 24 and 25. This included officials from the Treasury, as well as staff from several FSOC member independent regulatory agencies and several EU regulatory agencies. While the agenda was broad, relating to coordination and cooperation across developments and issues, included in the discussion were, according to a recent Treasury press release, "issues and priorities relating to sustainable finance, along with addressing climate-related financial risks, consistent with their respective mandates."
It is important to recall that the post credit crisis accord that came out of the G20 summit in 2009 in Pittsburgh, Pennsylvania served as, and continues to be, the roadmap for US and global financial services regulatory reform. It can be expected that the issues and programs raised at Wednesday's FSOC meeting and last week's US-EU Financial Regulatory Forum could become agenda items for future G20 finance ministers' meetings and even potential future multilateral summit meetings.
Securities and Exchange Commission
Of the FSOC members, the SEC has been the most active with respect to climate change and ESG issues.
Beginning just one week after the presidential inauguration, Acting Chair Allison Herren Lee announced the hiring of Satyam Khanna as senior policy advisor for climate and ESG. Not long thereafter, the SEC issued an Investor Bulletin, a Statement on the Review of Climate-Related Disclosure, and initiated an "all-agency" approach to address an identified need for increased investor information and protection in matters pertaining to climate and other ESG concerns. In her statement, Acting Chair Lee directed the Division of Corporation Finance to enhance its focus on climate-related disclosure in public company filings. The bulletin, issued by the SEC's Office of Investor Education and Advocacy, is designed to educate investors about funds that focus on ESG and identifies important questions to ask when investors consider investing in these funds.
In early March, the SEC's Division of Examinations announced its 2021 examination priorities, including a greater focus on climate-related risks. In making this announcement, Acting Chair Lee described plans to integrate ESG and climate considerations into the agency's broader regulatory framework and stated that "this year, the Division is enhancing its focus on climate and ESG-related risks by examining proxy voting policies and practices to ensure voting aligns with investors' best interests and expectations, as well as firms' business continuity plans in light of intensifying physical risks associated with climate change."
The SEC also announced the creation of a Climate and ESG Task Force in the Division of Enforcement, headed by Kelly L. Gibson, the acting deputy director of enforcement, who will oversee a division-wide effort, with 22 members drawn from the SEC's headquarters, regional offices, and Enforcement specialized units. The Climate and ESG Task Force will develop initiatives to proactively identify ESG-related misconduct. The task force will also coordinate the effective use of division resources, including through the use of sophisticated data analysis to mine and assess information across registrants, to identify potential violations, including material gaps or misstatements in issuers' disclosure of climate risks under existing rules. In addition, the Climate and ESG Task Force will evaluate and pursue tips, referrals, and whistleblower complaints on ESG-related issues, and provide expertise and insight to teams working on ESG-related matters across the division.
Finally, in mid-March, the SEC requested public input from investors, registrants, and other market participants on climate change disclosure with an eye toward facilitating the disclosure of consistent, comparable, and reliable information on climate change. Comments are being sought on the SEC's disclosure rules and guidance as they apply to climate change disclosures, and whether and how they should be modified. Comments on the existing disclosure regulations (Regulation S-K and Regulation S-X), potential new SEC disclosure requirements, and potential new disclosure frameworks that the SEC might adopt or incorporate in its disclosure rules may be submitted until June 14.
Acting Chair Lee has noted that "climate and ESG are front and center for the SEC" and "key to [the SEC's] core mission." With that in mind, she previewed how the SEC is "taking a holistic look at all of the ways climate and ESG intersect with [its] regulatory framework, and moving ahead with efforts across [] offices and divisions to account for that."
When the SEC turns to Gary Gensler, whose nomination to serve as the next chair of the SEC is pending Senate confirmation, the SEC will likely not experience a significant shift from Acting Chair Lee to Chair Gensler. During Mr. Gensler's Congressional confirmation hearing, he observed that "there's tens of trillions of dollars of invested assets that are looking for more information about climate risk," and that "[investors] want to see climate risk disclosures." Mr. Gensler suggested that "the SEC has a role to play to help bring some consistency and comparability to those guidelines."
Federal Reserve Board of Governors
In the past few months, the Federal Reserve Board of Governors took several actions that indicate a commitment to assess climate change risks and consideration of possible steps to deal with risks posed by climate change. The Federal Reserve joined the Network for Greening the Financial System (NGFS), a group of central banks and financial supervisors, which will define and encourage "best practices" for members of the NGFS and others, and "conduct or commission analytical work on green finance."
The Federal Reserve also announced the establishment of a Supervision Climate Committee "to assess the implications of climate change for the financial system — including firms, infrastructure and markets in general" and the establishment of a Financial Stability Climate Committee "to identify, assess, and address climate-related risks to macroprudential financial stability … across the financial system." The Federal Reserve has also discussed climate issues in recent reports and staff studies.
The Federal Reserve also participates in the Financial Stability Board (FSB), an international organization of central banks and finance ministers, which has identified climate-related risks as one of its 2021 work program priorities. The chair of the FSB is Randal Quarles, a member of the Federal Reserve and vice chair for supervision.
Federal Reserve Chair Powell provided some indication of the purpose and direction of the Fed's recent actions in testimony before the Senate Banking Committee on March 23, and the House Financial Services Committee on March 24. He told the Banking Committee that the Federal Reserve’s mandate is "to supervise financial institutions and to look after financial stability" and that it is looking at climate change within those existing mandates.
Chair Powell emphasized to the Financial Services Committee that the Federal Reserve is "in the early stage" of trying to understand what climate change means and its longer-term implications for the Federal Reserve and the financial system. He also said climate change is an emerging risk and that the Federal Reserve will consider climate change stress scenarios, or what have been called "scenario analyses," for financial institutions. How close all this comes to discouraging loans to certain businesses was addressed by Chair Powell’s underscoring that the Federal Reserve has a "long-held policy" of not telling banks "what legal businesses they can lend to."
Commodity Futures Trading Commission
CFTC Acting Chairman Rostin Behnam announced the creation of a Climate Risk Unit, to focus on the role of derivatives in understanding, pricing, and addressing climate-related risk and transitioning to a low-carbon economy. In announcing the new initiative, Acting Chair Behnam explained, "[t]he Covid-19 pandemic as well as increasingly severe weather and environmental impacts have firmly established the role of financial regulators in providing decisive leadership in times of market stress," and because "[c]limate change poses a major threat to US financial stability," the CFTC must "move urgently and assertively in utilizing [its] wide-ranging and flexible authorities to address emerging risks."
The Climate Risk Unit will have a number of responsibilities, including working with industry to highlight climate risks and improving the agency's understanding of financial derivatives that may be used to help facilitate the transition to a lower-carbon economy. It is intended to spur early engagement in connection with industry-led and market-driven processes in the ESG space, with the specific objective of ensuring that new products and markets fairly facilitate hedging, price discovery, market transparency, and capital allocation.
The announcement of the Climate Risk Unit identified a number of areas of focus, including: research, and market and stakeholder outreach; addressing climate change risks and the impact of severe weather events in a fair and equitable way; evaluating how derivatives that are being developed to address climate-related market risks and to facilitate the transition to a net-zero economy fit with the CFTC's regulatory and supervisory framework; working with other agencies, here and abroad, to strive for consistent standards, disclosures, and practices across derivatives products and markets; developing data resources for climate market risks; and evaluating whether the agency's work would be facilitated by climate finance labs or regulatory sandboxes.
The CFTC, particularly through the leadership of Acting Chair Behnam, was an early leader on climate risk issues. As the sponsor of the Market Risk Advisory Committee, he created the Climate-Related Market Risk Subcommittee. The subcommittee prepared the September 2020 report Managing Climate Risk in the US Financial System that contained a number of recommendations for prudential and market regulators that could be enacted by the current leadership at US and global regulatory agencies.
Conclusion
While US financial regulatory agencies have moved rapidly to launch climate change focused initiatives in the last two months, tomorrow's FSOC meeting still marks the opening actions of the Biden administration. Secretary Yellen has already demonstrated that she and her FSOC member colleagues plan to move quickly and deliberately.
Market participants and interested parties should engage with the FSOC and its members in a meaningful way now, using opportunities like the SEC's open comment period as an opportunity to provide feedback and begin a very important dialogue.
