In the first ever comprehensive recommendation to be provided by a US financial regulatory agency to other regulators and financial institutions, the US Commodity Futures Trading Commission’s (CFTC) Climate-Related Market Risk Subcommittee has released a strong warning signal about climate risk management.
The report entitled ‘Managing Climate Risk in the US Financial System’ presents a swathe of 53 recommendations designed to mitigate the risks climate change poses to financial markets.
Truman Semans CEO and planning team chair, OS-Climate, explains that the report “urges rapid, sweeping action by regulators, financial firms, and companies to manage the systemic risk that climate change poses to the U.S. financial system. This systemic risk can be reduced by rapidly increasing capital flows to opportunities in the transition to a low carbon, resilient economy.”
The role that data is set to play in this space is a key component detailed in the report, finding that “insufficient data and analytical tools to measure and manage climate-related financial risks remain a critical constraint.” It elaborates that there is likely to be a significant surge in demand for public and open access to data, which would enable players across financial services to effectively compare disclosure information and financial products.
Another key challenge for regulators flagged in the report is balancing the need for transparency of public data, alongside the need to support and protect the advances of private innovation made through proprietary data.
While there has been positive progress on this front through voluntary disclosure frameworks (outside of the US), the CFTC’s report qualifies that this progress is plagued with inconsistencies, and that the issue has been compounded by a lack of international coordination to develop clear methodologies or standards.
Semans furthers: “The report makes it clear that more accurate, publicly available climate-related data about companies and financial institutions is crucially needed for this to happen.”
The report also makes a vital observation regarding the application of the typical approach to risk and uncertainty taken across financial markets in the case of climate change. As the consequences of climate change and climate risk are highly uncertain, the report underscores the need to err on the side of caution when attempting to model, pre-empt or manage climate related risk, because “we recognise that the real world does not behave according to a model.”
On this point the CFTC emphasises the necessity of meaningful climate risk related data and analytic tools to interpret this data in order for regulators, investors and financial institutions to effectively understand the complex impact climate risk will bear on the valuations of financial instruments.
Importantly, the report notes that the financial community holds a central role in acting to mitigate climate risk and that it must not simply be a reactive participant. Rather, it is vital for the financial community to provide solutions and innovation to help “better manage climate risk and channel more capital into technologies which are essential for the transition.”
While calling directly on financial regulators to “get incentives right” and on market participants to refine and innovate their own risk management processes, the report argues that the buck stops with Congress. “Ultimately, these critical policies must come from Congress, coupled with an international framework that can facilitate synchronised reductions in greenhouse gas emissions across countries.”
In a refreshing acknowledgement, the report also states that “the United States remains, at best, a reluctant participant in these efforts, and in some cases it is absent.”
The sentiment is echoed in a joint statement from Ceres, Environmental Defense Fund, OSClimate, The Nature Conservancy and the World Resources Institute in response to the report: “Make no mistake: This report merely recognises what not only we but leading academics, private sector leaders, and peer regulators around the world already know: U.S. financial regulators should move urgently and decisively to measure, understand, and address climate risks.
“Left unaddressed, these risks will undermine the financial system’s capacity to serve and support America’s economy. What is needed now is action from financial regulators, who under existing legislation already possess wide-ranging, flexible authority to address climate-related financial risk. Later will be too late.”