US FSOC Report: Climate-Related Financial Risk an Emerging Threat

On October 21, 2021, the United States Financial Stability Oversight Council (FSOC¹ or Council) released its 133-page report on Climate-Related Financial Risk (Report) and related Factsheet.² The Report was produced in response to a directive in President Biden’s May 20, 2021, Executive Order on Climate-Related Financial Risk³ and followed closely on the heels of the Biden administration’s release of its Roadmap to Build a Resilient Economy (Roadmap) on October 14, 2021, and was issued only days before the opening of the UN’s Climate Change Conference (COP26).

The Report discusses how climate-related financial risks can implicate financial stability and declares climate-related finance risk as an emerging threat to financial stability. The Report provides an overview of ongoing regulatory and supervisory actions relating to climate-related financial risks and discusses climate-related financial risk data and methods. The Report details the information currently available with respect to banks, nonbank lenders, government-sponsored enterprises, insurance, and fund and asset managers, but notes that there is limited research and data on how climate risk translates into risks to financial institutions and markets.

In the Report, the FSOC makes 35 high-level recommendations⁴ for further regulatory action, focused on collecting and analyzing data on climate-related financial risks, building regulatory capacity for assessing climate-related financial risks (including by regulators using scenario analysis) and requiring the public disclosure of climate-related financial risks. The FSOC did not recommend that financial regulators impose capital charges or other prudential restrictions on lending to address climate-related financial risks, though the Report certainly lays a foundation for such policies and may be further justified by the Roadmap’s core principle for “Safeguarding the U.S. financial system against climate-related financial risk by holding financial institutions accountable for properly measuring, disclosing, managing, and mitigating climate-related financial risks.” (Emphasis added.)

However, the FSOC recommended that its members examine where existing regulations, guidance and reports could be updated to address climate-related financial risk. Thus, the Report signals that regulated financial institutions should expect increased supervisory attention to their climate risk management likely on an ad hoc basis. The FSOC’s key recommendations are as follows:

• Building capacity and expanding efforts to address climate-related financial risks

The Report announced the formation of a Climate-related Financial Risk Committee (CFRC) within FSOC to facilitate cooperation among FSOC members in building their capacity to address climate-related financial risks. The CFRC will identify priority areas for assessing and mitigating climate-related risks to the financial system and serve as a coordinating body to share information, facilitate the development of common approaches and standards, and foster communication across FSOC members. This staff-level committee also will review progress to address climate-related financial risks. The CFRC will update the FSOC on its work at least twice a year, and the FSOC annual report will report on progress its member have made in addressing climate-related financial risks. FSOC also announced that it will form a Climate-related Financial Risk Advisory Committee (CFRAC). The CFRAC, which will report to the CFRC, will help the FSOC gather information and analysis from a broad array of stakeholders on climate-related financial risks.

In the Report, the FSOC recommends that its members prioritize internal investments to expand their respective capacities to define, identify, measure, monitor, assess and report on climate-related financial risks and their effects on financial stability. These investments should include investments in staffing, training, expertise, data, analytic and modeling methodologies, and monitoring. FSOC also recommends that FSOC members enhance public communication of climate-related efforts, including in annual reports and any relevant risk reports they publish.

• Filling climate-related data and methodological gaps

The FSOC recommended that FSOC members promptly identify and take the appropriate next steps towards ensuring that they have consistent and reliable data to assist in assessing climate-related risks. The FSOC also recommended that FSOC members perform an internal inventory of currently available data and develop plans for acquiring necessary additional data through data collection, data sharing or data procurement. In addition, FSOC members are encouraged to develop consistent data standards, definitions and relevant metrics, and coordinate as they identify and fill data gaps and address data consistency and comparability issues.

• Enhancing public climate-related disclosures

The Report’s core policy recommendations are for FSOC members to update their public reporting requirements to enhance the consistency, comparability and decision-usefulness of information on climate-related risks. To the extent consistent with their statutory authorities and the US regulatory framework, FSOC members are encouraged to build on the core elements of the Task Force on Climate Related Financial Disclosure and that disclosures include greenhouse gas (GHG) emissions. The FSOC stated its support for the Securities and Exchange Commission’s work on developing such disclosure requirements for public issuers, registered funds and investment advisers. The FSOC recommended that federal banking regulators assess whether bank public reporting requirements for climate-related financial risks should be enhanced in a manner that takes into account a bank’s size, complexity and activities. The FSOC also stated its support for the Federal Insurance Office and state insurance regulators’ work to enhance climate-related disclosures by insurance companies.

• Assessing climate-related risks to financial stability

The FSOC recommends that its members use scenario analysis as a tool for assessing climate-related financial risks to key sectors of the financial sector and the financial system as a whole. FSOC also recommends that its members should consider using common scenarios that build on existing work, including scenarios developed by the Network of Central Banks and Supervisors for Greening the Financial System and work at the Financial Stability Board. Although the Report does not advocate any particular new prudential requirements with respect to climate-related financial risks, FSOC recommends that its members should review regulated entities’ efforts to address climate-related risk and clarify risk management requirements for climate-related financial risks. Finally, the FSOC advised that its members review and, where necessary, update existing regulations, guidance and regulatory reporting relevant to climate-related risks, including with respect to credit risks, market risks, counterparty risks and operational risks.

Looking Ahead

Importantly, the Report finds that, while substantial work has been done (and notes that such work has accelerated in the last year), a lot of work remains to be done. Therefore, federally-regulated financial institutions should expect that their regulators will seek their cooperation in collecting and assessing climate-related risks and will devote more attention to their management and reporting of climate-related risks in the months ahead. During their open meeting to adopt and release the Report, FSOC members expressed generally strong support for the Report and working together to address climate-related financial risks. Only FDIC Chair Jelena McWilliams did not support the Report and instead abstained from voting on grounds that the FSOC members had not had time to properly evaluate the Report or the impact of its recommendations.

To discuss any of the issues raised in this Legal Update, please reach out to any of the authors listed above or your regular Mayer Brown contact.

¹ FSOC was created under the Dodd Frank Act (Pub. L. No. 111-203, 124 Stat. 1376.), and its duties include: monitoring the financial services marketplace in order to identify potential threats to US financial stability; monitoring financial regulatory proposals and developments, and making recommendations in such areas that will enhance the integrity, efficiency, competitiveness and stability of the US financial markets; facilitating information sharing and coordination among Council member agencies and other federal and state agencies; recommending to the Council member agencies general supervisory priorities and principles reflecting the outcome of discussions among the member agencies; and identifying gaps in regulation that could pose risks to US financial stability. FSOC is composed of 10 voting members who head the US Department of the Treasury, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Consumer Financial Protection Bureau, the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, the Federal Housing Finance Agency and the National Credit Union Administration, along with the independent member with insurance expertise, plus five nonvoting members. Two of the nonvoting members are the head the Office of Financial Research and the Federal Insurance Office. The other three nonvoting members are a state insurance commissioner, a state banking supervisor and a state securities commissioner, each as designated by their peers.

² Press Release, Financial Stability Oversight Council Identifies Climate Change as an Emerging and Increasing Threat to Financial Stability (Oct. 21, 2021), https://home.treasury.gov/news/press-releases/jy0426.

³ Exec. Order No. 14,030, 87 Fed. Reg. 27967 (May 20, 2021), at https://www.federalregister.gov/documents/2021/05/25/2021-11168/climate-related-financial-risk. Discussed in our related May 24, 2021, Legal Update, “President Biden Signs Executive Order on Addressing Climate Change Risk through Financial Regulation.”

⁴ Copied into Annex A for convenient reference.