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Assessing Climate Risk in Financial Regulation
Major Securities and Exchange Commission rulemakings are underway and other agencies are taking action to address climate risk; legal challenges are expected.
As companies face the financial, strategic, and logistical impacts of accelerating climate change, investors are demanding information about those climate-related risks. Financial regulatory agencies are working to manage climate risks in the markets by requiring firms to disclosure more of their climate-related risks. Some of the federal agencies that are responsible for issuing financial regulations are independent agencies, which limits presidential regulatory authority. However, President Biden appoints chairs and commissioners to several independent agencies, and, as under any administration, the leadership shapes the focus of agencies.
In May 2021, President Biden issued an executive order on climate-related financial risk that called for “consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk” and for adopting a government-wide strategy to address climate-related risks to US financial stability. The executive order directed the Federal Stability Oversight Council (FSOC) to assess climate-related risk to the federal government and the US financial system and ordered the Department of Labor to identify actions to mitigate climate risk in savings and pension plans.
Federal financial regulators have authority over different aspects of the financial system, and several agencies have taken steps to better understand and manage climate risk. Some independent agencies, including the Securities and Exchange Commission (SEC), the Federal Reserve, the Commodity Futures Trading Commission (CFTC), and the Department of Treasury’s Office of the Comptroller of Currency Department (OCC), have taken steps to address potential climate change risks in financial markets. The SEC has been most active among financial regulators incorporating this growing risk into agency policy.
Securities and Exchange Commission Climate Risk Rule
The SEC released a proposed climate risk disclosure rule in March 2022 under the leadership of Chair Gary Gensler. The proposed rule builds on the framework of the 2010 guidance by requiring a registrant to disclose information about the material impact of climate-related risks on its business and financial statements; the effect of those risks on its strategy, business model, and outlook; its process for identifying, assessing, and managing those risks; Scopes 1 and 2 greenhouse gas emissions; and Scope 3 greenhouse gas emissions under more limited circumstances. Our summary of the proposed rule is available here.
This rule recognizes that climate-related risks create financial risks for companies and for their investors, from physical risks including extreme floods and fires to transition risks like changing consumer preferences. In response to these increasing risks, investors are demanding clear and reliable information from companies to inform investment decisions. The proposed rule, which draws on the existing and widely accepted Task Force on Climate-Related Financial Disclosure framework, will give investors consistent, reliable, and actionable information when investing. The SEC has crafted this proposed rule to respond to investor demand while creating flexibility for companies.
The SEC also announced efforts in its Divisions of Corporation Finance, Examinations, and Enforcement to look closely at how regulated entities disclose climate change risks. The Division of Examinations included climate change in its 2021 examination priorities, and the Division of Enforcement created a Climate and Environmental, Social, and Governance (ESG) Enforcement Task Force that has initiated enforcement actions against misleading ESG-related claims.
The SEC’s final climate risk disclosure rule will likely face legal challenges, including under the major questions doctrine, but the commission designed the proposed rule to be consistent with its statutory authority and to build on SEC’s traditional disclosure framework. Importantly, the rule requires information from companies about how they respond to and plan for climate impacts but does not require companies to take any actions to address identified climate risk. Input on the draft rule from commenters will bolster the rule’s effectiveness and legal durability.
In May 2022, the SEC announced a pair of proposed rules designed to improve the transparency of ESG investment funds. First, the agency proposed amendments to rules and reporting forms to facilitate “consistent, comparable, and reliable information” for investors about ESG strategies. Second, the SEC announced proposed changes to Rule 35d-1 under the Investment Company Act of 1940, known as the fund names rule, to enhance transparency and avoid misleading investors.
While challenges to these proposed ESG rules are possible, the SEC has designed rules that are responsive to the investor community’s need for more comparable, transparent information and fall squarely within the agency’s disclosure-based approach. These features of the proposed rules and input from commenters will help the SEC develop robust, defensible final rules.
Other Major Climate-Related Financial Actions
Along with the SEC’s work on climate risk disclosures, other financial regulators have taken steps within their existing authority to address climate risk in the financial system.
Department of Treasury
In April 2021, the Department of Treasury announced a coordinated climate policy strategy focused on three areas: climate transition finance, climate-related economic and tax policy, and climate-related financial risks. To implement this strategy, Treasury created a Climate Hub and appointed a climate counselor to coordinate these efforts.
The FSOC released a report in October 2021 identifying climate change as a risk to the US financial system and providing over 30 recommendations for how regulators could integrate climate-related financial risk assessment. These recommendations include enhancing public disclosure requirements, evaluating standardizing data formats for climate-related disclosures to promote comparability, and considering greenhouse gas emission disclosures.
Treasury’s Office of Financial Research unveiled its new Climate Data and Analytics Hub pilot in July 2022, which is a tool designed to help financial regulators assess climate-related financial risks. During the pilot phase, the Federal Reserve Board of Governors and the Federal Reserve Bank of New York will have access to the tool, with the goal of providing wider access in the future.
In December 2021, the Department of Treasury’s Office of the Comptroller of the Currency (OCC) requested feedback on proposed principles for climate-related risk management for banks with over $100 billion in total consolidated assets. In April 2022, the Federal Deposit Insurance Corporation (FDIC) issued similar draft principles to provide a framework for managing climate-related financial risks for banks with over $100 billion in consolidated assets that are closely related to the OCC principles.
The Federal Reserve, which regulates banks and other financial institutions to ensure the safety and stability of the US financial system, has signaled strong interest in addressing climate risk in the financial sector, and created an internal Supervision Climate Committee and Financial Stability Climate Committee. In October 2021, Federal Reserve Governor Lael Brainard indicated that the Federal Reserve is developing scenario analysis tools to understand the economic risk of climate change and plans to provide supervisory guidance on how banks should “measure, monitor, and manage material climate-related risks.”
In September 2022, the Federal Reserve announced that six of the largest US banks will participate in a pilot climate scenario analysis exercise to assess climate-related risks. The scenario analysis pilot, scheduled to launch in early 2023, is designed to improve firms’ ability to measure and manage climate risks.
Department of Labor
In October 2021, the Department of Labor released proposed changes under the Employee Retirement Income Security Act of 1974 (ERISA) clarifying that fiduciaries may consider climate change and other ESG factors when making investment decisions and exercising shareholder rights, including voting. The department then issued a request for information on Employee Benefits Security Administration’s work relating to retirement savings and climate-related financial risk, which posed a set of questions about how the administration should incorporate climate risk going forward. In October 2022, the department submitted its final rule easing restrictions on the use of ESG factors in retirement investment to the White House for review, with a release of the final rule expected in the coming months.
Commodity Futures Trading Commission
In March 2021, the Commodity Futures Trading Commission (CFTC), which regulates options, derivatives, futures, and commodities, announced 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 June 2022, the commission released a Request for Information for public comment on climate-related financial risk with respect to the derivative market and the underlying commodities market.
These incremental steps by financial regulators reflect growing awareness of the risks that climate change pose to the US financial system and the shift in investor and business demand for more comprehensive and transparent information about climate risks in the financial markets. As regulators gather data and request public input, they are building a robust administrative record and developing best practices for managing financial sector climate-related risks.
We can expect more progress ahead, and we will be tracking new developments on our Financial Regulation, Climate Change, and Climate-related Risk Disclosure Regulatory Tracker page.
 Independent agencies lack a general requirement to report to any higher official in the executive branch such as a department secretary. Independent agency leaders usually can only be removed by the president “for cause.” David E. Lewis & Jennifer L. Selin, Sourcebook of United States Executive Agencies 48-49 (Admin. Conf. of the United States, 1st ed. 2012).
 A registrant includes companies filing a registration statement under either the Securities Act of 1933 (“Securities Act”) or the Securities Exchange Act of 1934 (“Exchange Act”), including domestic public companies and foreign private issuers. The Enhancement and Standardization of Climate-Related Disclosures for Investors, 87 Fed. Reg. 21,334 (proposed Apr. 11, 2022) (to be codified at 17 C.F.R. pts. 210, 229, 232, 239, 249).
 Gov. Lael Brainard, Building Climate Scenario Analysis on the Foundations of Economic Research, Fed. Reserve (Oct. 7, 2021), https://www.federalreserve.gov/newsevents/speech/brainard20211007a.htm [https://perma.cc/7UMY-VZVW].