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Banking-committee Republicans may have revived their call for the Federal Reserve to tap the brakes in regulating climate-change risk. But at least one Fed leader told investors Tuesday that the pursuit of financial system climate-change preparedness, though “imperfect” right now, must move forward.
“Despite the challenges, it will be critical to make progress, even if initially imperfect, in order to ensure that the financial system is resilient to climate-related risks and well positioned for the transition to a sustainable economy,” Federal Reserve Governor Lael Brainard told the Ceres 2021 conference.
Brainard said the Fed is establishing a Financial Stability Climate Committee (FSCC), which will add to the work taken on by the Supervision Climate Committee formed earlier this year. FSCC will identify, assess and address climate-related risks to financial stability from a macroprudential perspective — that is, one that considers the potential for complex interactions across the financial system, including international implications, she said.
The new committee will draw from a pool across the Fed’s dozen banks and Washington, using new data and modeling. The Fed is also watching the work underway at the European Central Bank and the Bank of England, as well as the scenarios developed by the Network of Central Banks and Supervisors for Greening the Financial System.
Brainard said it’s important for the Fed’s work on climate change to distinguish when a micro-focused market adjustment doesn’t do enough to prevent shocks through the financial system, or bring “cascade effects.” For example, the usability of real estate in many areas will be directly affected by the increased risks of floods, wildfires, severe storms and sea-level rise associated with climate change, she said. The direct effects on homeowners and businesses are geographically concentrated and can have severe effects on safety and the usability of properties — a local or regional issue that market pricing may reflect.
“But if climate risks grow over time, the mortgages on these properties may become riskier, along with financial instruments involving these mortgages that may embed opaque, concentrated climate-related risks,” she said.
Insurance markets rapidly adjusting to climate change also carry the likelihood of systemic impact.
“As we have seen in California and in Florida, insurance companies can pull back from insuring properties and facilities in geographic areas subject to heightened flood or fire risk or seek to raise insurance rates on these properties and facilities to more accurately reflect risk,” she said. “Although such changes may ultimately result in a more accurate assessment of actual risks, the abrupt changes to a wide range of contracts that embed systemic mispricing could initially amplify the shock.”
Brainard is also monitoring climate-related physical risks that are increasing financial burdens on local, state and federal finances.
Although not acting as an official climate-change point person for the Fed, Brainard has taken on the topic more than once.
She has said she favors “mandatory disclosures” to help investors assess and price climate risks and she repeated that desire Tuesday. Brainard has also said this type of review should happen outside of the Fed’s annual bank stress tests, saying that the current “stress” formula as is does not make sense for the longer time horizon of climate change.
Read: Federal Reserve starts playing catch-up on climate change
Mostly Republican lawmakers have pushed back on the Fed’s earlier indications that it is mulling stepping up climate-related regulation of banks.
Last week, U.S. Senate Banking Committee Ranking Member Pat Toomey, Republican of Pennsylvania, and all Republican members of the committee wrote to Fed Chair Jerome Powell saying that banks and their boards should assess and price climate risk, but not by regulatory requirement. The lawmakers also raised concerns about the challenge of modeling severe weather conditions.
Read: BlackRock’s push on ESG and climate goals is coming at ‘a business-friendly pace’
Allison Herren Lee, acting chair of the Securities and Exchange Commission, was also part of the Ceres 2021 panel.
She reemphasized comments made in a recent speech that said the stock market regulator is seeking comments on new disclosure requirements on risks related to climate change and other environmental, social and governance issues.
The SEC remains in the comment period that could “help inform a rule proposal” if that’s what the Commission decides and if so, there will be an additional comment period around that step, she said.
Herren Lee said the bulk of comments are pushing for SEC action but are not yet focused on the granular aspects of what such disclosure will look like.
Read: Acting chief says climate, ESG are ‘front and center for the SEC,’ ahead of new disclosure push
The Commodity Futures Trading Commission — led by Commissioner Rostin Behnam who also spoke at the Tuesday Ceres conference — led a bipartisan group in 2019 that released a first-of-its-kind climate-change report for the financial sector. The report labeled climate change as the biggest long-running risk to the financial system and recommended that 16 financial regulators and other bodies “incorporate climate-related risk into their mandates and develop a strategy for integrating these risks in their work, including into their existing monitoring and oversight functions.”
The CFTC announced a new climate-change risk unit last week.
Read: Bank of America matches efforts by Morgan Stanley, JPMorgan Chase with net-zero financing goal
