Climate Change Risk Management in Regulators’ Crosshairs
Regulators are gearing up to ask questions about how financial institutions are managing climate change risk. While NCUA to date has not published any specifics on the subject, there are plenty of documents from other regulators that can serve as tea leaves on what may be coming in the months ahead this topic.
Federal regulators are signaling concerns about how climate-related risks are managed by financial institutions in part because of an Executive Order issued by the White House on May 20, 2021, Executive Order on Climate-Related Financial Risk (Order). The Order beings by noting that climate change presents a physical risk to assets, publicly traded securities and other investments in the economy (physical risk). Meanwhile, as the world shifts from carbon-intensive sources of energy, that can create opportunity but a failure to appropriately anticipate the risks from such a transition can threaten pensions, savings and US competitiveness (transition risk). The Order sets forth a policy of advancing “clear, intelligible, comparable and accurate disclosure of climate-related financial risk.” Section 3, “Assessment of Climate-Related Financial Risk by Financial Regulators” in part tasks Secretary of Treasury Janet Yellen, as the head of the Financial Stability Oversight Council (FSOC), with coordinating with other FSOC members, which includes NCUA and the CFPB, to work on several things:
- Assess climate related financial risk to the stability of the Federal government and the US financial system.
- Facilitate sharing climate-related financial risk data among FSOC member agencies.
- Issuing a report to the President by November 16, 2021 on any efforts by FSOC members to integrate climate-related financial risk into their policies and programs.
Yesterday, FSOC released a report at its late afternoon meeting that made several recommendations that its members, including NCUA:
- Should develop plans for acquiring additional data to assess climate risk;
- Should work to develop standard data inputs and metrics;
- Should use common scenarios and build upon existing international work that leverages "scenario analysis" to assess climate related risk, and to apply such analysis to determine whether existing laws and regulations are adequate to appropriately address climate related risk.
Even before this report, some of the federal financial regulators have already been addressing climate related risk. Back in January 2021, the Federal Reserve created an internal Supervision Climate Committee to identify and assess potential financial risks from climate change. The Fed is already developing a scenario analysis to assess the financial risks associated with climate change. Meanwhile, the Office of Comptroller of Currency (OCC) named a climate change risk officer back in late July 2021, saying that “prudently managing climate change risk is a safety and soundness issue.” The OCC is planning a two-prong approach – learning and engaging from others and supporting the adoption of climate risk management at banks. This is reflected in its recently released Bank Supervision Operating Plan for Fiscal Year 2022 where climate risk is one of the agency’s priorities for the banking industry. According to the plan, in 2022 the OCC will continue working to “better understand how the financial risks associated with climate change may affect the safety and soundness of institutions.” This will include conducting industry outreach, and at the “largest banks,” examiners will work to establish a baseline understanding of “physical and transition risks” including developing “climate risk management frameworks and governance processes.”
While NCUA has not issued any formal documents on this topic to date, Chairman Todd Harper discussed climate financial risk in August 2021 testimony before Congress and his comments were similar to the OCC positioning. According to Harper, NCUA can fulfil its safety and soundness obligations in part by measuring, monitoring and mitigating risks presented by climate change. While there are not many more specifics in his comments, with Treasury and FSOC taking the lead, NCUA may base some future guidance in part on the work of this broader coalition of federal regulators.
Meanwhile, some state regulators are already tackling this issue such as New York and Washington. In September 2020, the New York Department of Financial Services issued a bulletin on climate change and later proposed guidance specific to the insurance industry.
So both federal and state regulators are flagging both physical and transition risks, but what is meant by that? Physical risks are rather straightforward with regulators framing this issue as the potential for damage or losses to a credit union’s assets like branches and offices due to extreme weather events, wildfires, increasing flood risks and similar incidents. Besides credit union owned facilities, loans are also secured by buildings or property that may face more threat of damage.
What is transition risk? This stems from the economy seeming to make a move, or transition, towards a low or net-zero carbon economy, reducing usage of fossil fuels. According to regulators, there are various factors indicating such a transition is happening such as changing consumer and investment sentiment, discussions around infrastructure spending, advancing technology, and policy or regulatory changes. This in turn represents a shift in the economy and market forces, which can place additional costs on some industries and perhaps make investments less valuable. Assets that have a high carbon footprint or that are linked to carbon-heavy industries could also be “stranded” meaning the value of some assets used to secure loans could end up lower in value rather than appreciating. Similarly, assets securing loans could depreciate faster than expected, perhaps by becoming unusable earlier than originally anticipated. For example, an agricultural property may become less productive due to drought. Some regulators have noted that industries which rely on fossil fuels face transition risk, as do the manufacturing, construction and transportation industries.
Overall, this issue is developing and there will be more to come. NAFCU will keep members posted through our daily news publication, NAFCU Today and the Compliance Blog.
About the Author
Brandy Bruyere, NCCO was named vice president of regulatory compliance in February 2017. In her role, Bruyere oversees NAFCU's regulatory compliance team who help credit unions with a variety of compliance issues.