White House Focuses FSOC Regulators on Climate Change Risks in Banking
Recently, the Biden Administration took another step toward incorporating environmental risk analysis into all financial institution oversight. The new executive order is consistent with recent signals that regulators will soon require banks and other regulated financial institutions to defend their relative exposure to long-term environmental risks.
The President’s Executive Order on Climate-Related Financial Risk establishes a “whole-of-government approach” to mitigating climate-related financial risk and focuses on capturing climate-related financial risk to government programs, assets, and liabilities. The Administration’s strategy also asks regulators to identify public and private financing needs for reaching economy-wide net-zero emissions by 2050.
The Administration said it was acting in the face of “a failure by financial institutions to appropriately and adequately account for and measure climate-related financial risks.”
Risk assessment
The executive order requires federal financial regulators (specifically, Financial Stability Oversight Council (FSOC) member agencies) to consider:
- Developing a detailed and comprehensive risk assessment for climate-related financial risk
- including a risk assessment in the FSOC’s annual report to Congress;
- facilitating federal interagency climate-related financial risk data sharing; and
- issuing a report within 180 days detailing any efforts to integrate climate-related financial risk into member agency policies and programs, including climate-related financial risk disclosure enhancement.
Federal lending, underwriting, and procurement
Federal lending programs are likely to be impacted by provisions requiring:
- Development of recommendations for the National Climate Task Force on approaches related to the integration of climate-related financial risk into federal management and financial reporting, especially as they relate to federal lending programs; and
- consideration by the USDA, HUD, and VA of approaches that better integrate climate-related financial risk into underwriting standards, loan terms and conditions, and asset management and servicing procedures for federal lending policies and programs.
The executive order also reinstates the Federal Flood Risk Management Standard (FFRMS), which may impact federal lending compliance requirements for certain loans. The FFRMS requires the planning and design of federally funded projects located in flood-prone areas to account for future risk, including heavier downpours and sea-level rise.
Based on previous FEMA guidance (which has been since rescinded, presumably due to revocation of the FFRMS by the Trump Administration), the FFRMS is not expected to change the minimum floodplain management criteria that communities are required to adopt in order to participate in the NFIP, flood mapping standards, or the rating and claims practices of the NFIP. However, it is important to note that other aspects of the NFIP or other FEMA programs, such as public assistance and hazard mitigation grants, may qualify projects as federally funded, making them subject to the FFRMS.
Life savings and pensions
The executive order also directs the Labor Department to consider suspending, revising, or rescinding Trump-era rules that barred investment firms from considering environmental, social, and governance factors, including climate-related risks, in investment decisions related to pensions. The Department is also required to report on any other measures that can be implemented to protect life savings and pensions from climate-related financial risk.
Action items
Rigorous portfolio-wide environmental risk assessments are a coming safety-and-soundness focus for regulators. Just as cybersecurity risk assessment left many institutions scrambling to define and mitigate their risks, this wave of regulation has an equal capacity to upend institutions that lack a proactive approach. Institutions should move toward internal assessments of environmental risk consistent with recommendations from industry leaders like the Basel Committee’s Task Force on Climate-related Financial Risks.
According to Joe Sergienko, a Managing Director in BRG’s Financial Institutions Practice, “banking regulators have already sought input on climate-related financial risk from the nation’s largest financial institutions, indicating a coming shift in regulatory expectations that will include a renewed focus on climate-related financial risk management.”
As far as the potential implications of such a shift in regulatory focus, Sergienko says that “while it remains to be seen how exactly this plays out during a safety-and-soundness exam, it is likely that the renewed regulatory focus in this area will extend beyond existing credit exposures, concentrations, and lending practices, to include scrutiny of an institution’s lending efforts to net-zero emissions industries.”
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