Climate Risk Management Principles Finalized by Basel Committee

On June 15, 2022, the Basel Committee on Banking Supervision (“BCBS”) finalized principles for the effective management and supervision of climate-related financial risks (“Climate Principles”).¹ The Climate Principles are targeted at banking organizations and banking regulators and are intended to help address climate-related financial risks to the global banking system.

BCBS proposed the Climate Principles in November 2021, and US regulators have already released their own proposals that would largely adopt the BCBS approach.² While some in the banking industry have been broadly supportive of efforts to address climate-related financial risks, concerns remain regarding the scope, prescriptiveness, data requirements, and consequences of the actions by BCBS and US regulators.³

In this Legal Update, we review the changes BCBS made to the draft Climate Principles and discuss what the industry may expect next.

Final Climate Principles

As discussed in our prior Legal Update, the draft Climate Principles consisted of 18 high-level principles, 12 of which are intended to provide banking organizations with guidance on effective management of climate-related financial risks and six of which are targeted to provide guidance to banking regulators on how to supervise climate risk management activities. This structure was retained in the final Climate Principles, which contain few substantive changes from the proposal. These changes are:

1. The final Climate Principles explicitly recognize that climate risk management practices are evolving and are expected to evolve further. This change appears to address industry concerns that supervisors could impose prescriptive risk management requirements that quickly become outdated.
2. The final Climate Principles clarify that BCBS does not intend them to change existing guidance regarding the roles of and allocation of responsibilities between management and the board of directors.
3. The commentary to Principle 1 (understanding climate-related financial risk to an organization) has been expanded to state explicitly that organizations should consider whether climate risk management efforts should affect their compensation policies and should ensure that internal climate risk management positions and activities are consistent with public communications and commitments.
4. The commentary to Principle 4 (incorporating climate-related financial risk into the three-lines-of-defense model) has been changed to clarify the roles of each line of defense. It also now specifies that the first line of defense is responsible for conducting climate-related risk assessments throughout the lifecycle of product design and client relationships, not just at the initiation of a client relationship.
5. Principle 5 has been expanded to state explicitly that regulators may, where appropriate, require organizations to incorporate climate-related financial risk in capital and liquidity stress tests, including stress tests that are used to evaluate an organization’s financial position under severe but plausible scenarios.
6. Guidance on climate stress testing is further clarified in Principle 18, which now states that regulators may consider incorporating climate-related financial risk in the stress tests that they use to evaluate an organization’s financial position. However, the commentary to Principle 18 also includes a note that climate-related stress testing is expected to mature with the further development of climate data and stress testing methodologies. Further, BCBS explicitly encourages banking regulators to use common scenarios when possible and to leverage existing cross-border frameworks and information-sharing authorities.
7. Principle 15 has been modestly revised to clarify that banking regulators should determine the extent to which banks manage climate-related financial risk, replacing language from the proposal that implied banks must comprehensively manage climate-related financial risks.

Next Steps

As with other BCBS pronouncements, the Climate Principles do not have the force of law in the United States. Rather, the US banking regulators will need to determine whether and how to apply the Climate Principles to US banking organizations. This could be done through the supervisory guidance process or the notice-and-comment process and may result in a US approach to managing climate-related financial risk that differs from the BCBS approach.⁴ However, US regulators have been clear that they intend to issue final guidance on this topic, and we expect that they will at least consider the changes made by BCBS in the final Climate Principles when finalizing their own guidance.

Until final guidance is issued in the United States, larger US banking organizations may consider the Climate Principles as a set of best practices for their own climate risk management efforts.⁵ The related US proposals for managing climate-related financial risks were largely aligned to the proposed Climate Principles, and other than with respect to stress testing, the final Climate Principles do not appear to materially expand on the proposed version. This approach may be particularly useful for cross-border banking organizations that look to BCBS materials as a way to harmonize the different styles and approaches to regulation used by US and European regulators.

¹ BCBS, Principles for the effective management and supervision of climate-related financial risks (June 15, 2022), https://www.bis.org/bcbs/publ/d532.htm.

² Please see our Legal Updates on the original BCBS proposal and subsequent actions by US regulators: https://www.mayerbrown.com/en/perspectives-events/publications/2021/12/climaterelated-financial-risks-bis-issues-consultation-on-principles-for-effective-management-and-supervision; https://www.mayerbrown.com/en/perspectives-events/publications/2021/12/climaterelated-risk-management-principles-released-by-us-occ; https://www.mayerbrown.com/en/perspectives-events/publications/2022/03/climate-related-risk-management-principles-released-by-us-fdic.

³ E.g., BPI, Comments on FDIC Climate-Related Financial Risk Management Proposal for Large Financial Institutions (May 20, 2022) (“BPI supports the FDIC’s efforts to develop and articulate principles-based guidance for climate-related financial risk management”); ABA, Comments on OCC Climate-Related Financial Risk Management Proposal for Large Banks (Feb. 14, 2022) (“we support the Principles as a guide for larger institutions”).

⁴ E.g., BPI, Basel III Endgame and the Cost of Credit for American Business (Jan. 10, 2022) (“U.S. agencies already ‘gold-plate’ so many other facets of the Basel standards (meaning they often impose requirements that are much higher than the standards articulated under Basel agreements)”).

⁵ While not explicitly stated in the Climate Principles, most BCBS guidance tends to be targeted, at least initially, at larger, more complex banking organizations.