[House Hearing, 117 Congress]
[From the U.S. Government Publishing Office]
ADDRESSING CLIMATE AS A
SYSTEMIC RISK: THE NEED TO
BUILD RESILIENCE WITHIN OUR
BANKING AND FINANCIAL SYSTEM
=======================================================================
HYBRID HEARING
BEFORE THE
SUBCOMMITTEE ON CONSUMER PROTECTION
AND FINANCIAL INSTITUTIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTEENTH CONGRESS
FIRST SESSION
__________
JUNE 30, 2021
__________
Printed for the use of the Committee on Financial Services
Serial No. 117-36
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
______
U.S. GOVERNMENT PUBLISHING OFFICE
45-383 PDF WASHINGTON : 2021
HOUSE COMMITTEE ON FINANCIAL SERVICES
MAXINE WATERS, California, Chairwoman
CAROLYN B. MALONEY, New York PATRICK McHENRY, North Carolina,
NYDIA M. VELAZQUEZ, New York Ranking Member
BRAD SHERMAN, California FRANK D. LUCAS, Oklahoma
GREGORY W. MEEKS, New York PETE SESSIONS, Texas
DAVID SCOTT, Georgia BILL POSEY, Florida
AL GREEN, Texas BLAINE LUETKEMEYER, Missouri
EMANUEL CLEAVER, Missouri BILL HUIZENGA, Michigan
ED PERLMUTTER, Colorado ANN WAGNER, Missouri
JIM A. HIMES, Connecticut ANDY BARR, Kentucky
BILL FOSTER, Illinois ROGER WILLIAMS, Texas
JOYCE BEATTY, Ohio FRENCH HILL, Arkansas
JUAN VARGAS, California TOM EMMER, Minnesota
JOSH GOTTHEIMER, New Jersey LEE M. ZELDIN, New York
VICENTE GONZALEZ, Texas BARRY LOUDERMILK, Georgia
AL LAWSON, Florida ALEXANDER X. MOONEY, West Virginia
MICHAEL SAN NICOLAS, Guam WARREN DAVIDSON, Ohio
CINDY AXNE, Iowa TED BUDD, North Carolina
SEAN CASTEN, Illinois DAVID KUSTOFF, Tennessee
AYANNA PRESSLEY, Massachusetts TREY HOLLINGSWORTH, Indiana
RITCHIE TORRES, New York ANTHONY GONZALEZ, Ohio
STEPHEN F. LYNCH, Massachusetts JOHN ROSE, Tennessee
ALMA ADAMS, North Carolina BRYAN STEIL, Wisconsin
RASHIDA TLAIB, Michigan LANCE GOODEN, Texas
MADELEINE DEAN, Pennsylvania WILLIAM TIMMONS, South Carolina
ALEXANDRIA OCASIO-CORTEZ, New York VAN TAYLOR, Texas
JESUS ``CHUY'' GARCIA, Illinois
SYLVIA GARCIA, Texas
NIKEMA WILLIAMS, Georgia
JAKE AUCHINCLOSS, Massachusetts
Charla Ouertatani, Staff Director
Subcommittee on Consumer Protection and Financial Institutions
ED PERLMUTTER, Colorado, Chairman
GREGORY W. MEEKS, New York BLAINE LUETKEMEYER, Missouri,
DAVID SCOTT, Georgia Ranking Member
NYDIA M. VELAZQUEZ, New York FRANK D. LUCAS, Oklahoma
BRAD SHERMAN, California BILL POSEY, Florida
AL GREEN, Texas ANDY BARR, Kentucky
BILL FOSTER, Illinois ROGER WILLIAMS, Texas
JUAN VARGAS, California BARRY LOUDERMILK, Georgia
AL LAWSON, Florida TED BUDD, North Carolina
MICHAEL SAN NICOLAS, Guam DAVID KUSTOFF, Tennessee, Vice
SEAN CASTEN, Illinois Ranking Member
AYANNA PRESSLEY, Massachusetts JOHN ROSE, Tennessee
RITCHIE TORRES, New York WILLIAM TIMMONS, South Carolina
C O N T E N T S
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Page
Hearing held on:
June 30, 2021................................................ 1
Appendix:
June 30, 2021................................................ 31
WITNESSES
Wednesday, June 30, 2021
Allen, Hilary J., Associate Professor of Law, American University
Washington College of Law...................................... 6
Cleetus, Rachel, Policy Director, Union of Concerned Scientists.. 7
Rodriguez Valladares, Mayra, Managing Principal, MRV Associates.. 9
Rossi, Clifford V., Executive-in-Residence and Professor-of-the-
Practice, Robert H. Smith School of Business, University of
Maryland....................................................... 13
Rothstein, Steven, Managing Director, Ceres Accelerator for
Sustainable Capital Markets.................................... 11
APPENDIX
Prepared statements:
Allen, Hilary J.............................................. 32
Cleetus, Rachel.............................................. 52
Rodriguez Valladares, Mayra.................................. 66
Rossi, Clifford V............................................ 95
Rothstein, Steven............................................ 104
Additional Material Submitted for the Record
Perlmutter, Hon. Ed:
CoreLogic 2020 Climate Change Catastrophe Report............. 139
ADDRESSING CLIMATE AS A
SYSTEMIC RISK: THE NEED TO
BUILD RESILIENCE WITHIN OUR
BANKING AND FINANCIAL SYSTEM
----------
Wednesday, June 30, 2021
U.S. House of Representatives,
Subcommittee on Consumer Protection
and Financial Institutions,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 2:01 p.m., in
room 2128, Rayburn House Office Building, Hon. Ed Perlmutter
[chairman of the subcommittee] presiding.
Members present: Representatives Perlmutter, Foster,
Vargas, Lawson, Casten; Luetkemeyer, Lucas, Posey, Barr,
Loudermilk, Kustoff, and Timmons.
Ex officio present: Representatives Waters and McHenry.
Chairman Perlmutter. The Subcommittee on Consumer
Protection and Financial Institutions will come to order.
Without objection, the Chair is authorized to declare a
recess of the subcommittee at any time. Also, without
objection, members of the full Financial Services Committee who
are not members of this subcommittee are authorized to
participate in today's hearing.
With the hybrid format of this hearing, we have some
Members and witnesses participating in person, and others on
the Webex platform.
I would like to remind all Members participating remotely
to keep themselves muted when they are not being recognized by
the Chair. The staff has been instructed not to mute Members
except when a Member is not being recognized by the Chair, and
there is inadvertent background noise.
Members are also reminded that they may only participate in
one remote proceeding at a time. If you are participating
remotely today, please keep your camera on, and if you choose
to attend a different remote proceeding, please turn your
camera off.
Today's hearing is entitled, ``Addressing Climate as a
Systemic Risk: The Need to Build Resilience Within Our Banking
and Financial System.''
I now recognize myself for 4 minutes to give an opening
statement.
In 2008, the housing bubble collapse and financial crisis
caught many experts, investors, and policymakers off guard, and
the resulting Great Recession devastated communities across the
country.
When threats to financial stability are not properly valued
and mitigated, the consequences can be severe and longstanding:
2020 tied 2016 as the hottest year on record, and the 7 hottest
years recorded have all occurred since 2014. In 2020 alone,
more than 58,000 wildfires burned 10.1 million acres and caused
$20 billion in damages.
In my home State of Colorado, in addition to more severe
and frequent wildfires, we are seeing less annual snowpack,
more water scarcity and droughts, and more heat waves. These
changes pose long-term risks for Colorado's agriculture,
tourism, and housing industries.
Whether it is rising sea levels threatening coastal
communities, more severe hurricanes on the East and Gulf
Coasts, wildfires in the West, or regional climate changes
affecting crop yields on the plains, climate change is
affecting every State and community in our nation.
These risks are intertwined with the financial system.
Insurers can expect more claims related to extreme weather
events, lenders will see more risks in underwriting carbon-
dependent industries, and economic changes will affect asset
values across many sectors. Climate change is creating
significant and complex risks in our financial system that we
cannot ignore.
Last month, President Biden signed an Executive Order
directing the National Economic Council, the Treasury
Department, and the Office of Management and Budget to develop
a government-wide strategy for evaluating and addressing
climate-related financial risk and assessing the necessary
financing to achieve net-zero emissions by 2050.
Several of the financial regulators have already begun work
to understand climate risk. We can either work together in
Congress and across the government to coordinate sensible
policies to evaluate and mitigate financial risk related to
climate, and help our economy transition to a carbon-neutral
future, or we can wait until the market and the consequences of
climate change dictate such actions for us.
Last week, I reintroduced the Green Neighborhoods Act, a
bill aimed at making the housing sector more energy-efficient,
and ensuring that workers can get trained for green jobs. This
is one example of how Congress can help facilitate an orderly
transition of our economy and make the housing sector greener.
The canary in the coal mine has stopped singing. We must
act now to ensure our financial system is resilient in the face
of climate change and the economic transition.
Today's hearing will examine physical and transition risks
posed by climate change and how financial regulators can work
to evaluate and mitigate these risks. I look forward to our
discussion today, so we can ensure that our financial system is
ready for what is coming.
With that, I now recognize the ranking member of the
subcommittee, Mr. Luetkemeyer from Missouri, for 4 minutes for
an opening statement.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
Climate risk has certainly been a buzzword, both within the
banking industry and within the Biden Administration. The
Administration has issued multiple Executive Orders focused on
climate risk, specifically an Executive Order titled,
``Climate-Related Financial Risk,'' which requires the
Financial Stability Oversight Council (FSOC) to assess climate-
related financial risk to the stability of the Federal
Government and the stability of the financial system.
Within the Administration, the Federal Reserve has been the
most active regulator in this space. In May, they announced the
establishment of the Financial Stability Climate Committee to
identify, assess, and address climate-related risk.
Furthermore, the Federal Reserve has requested information from
lenders on how they handle climate risk at their institutions.
Let me be clear: Federal regulators should understand how
financial institutions are handling risk mitigation in their
lending portfolio. This includes numerous types of risk,
including credit risk, concentration risk, and default risk.
However, the inclusion of climate-related financial risk
must be better understood by both regulators and financial
institutions before any framework around this risk can be
initiated.
It is clear that certain financial institutions,
particularly the largest U.S. firms, are including climate risk
in their risk-assessment processes. The U.S. global
systemically important banks (G-SIBs) have all limited their
approach to carbon financing in one way or another. Some have
pledged to provide investments in sustainable businesses and
technologies, and others have pledged to reach net-zero
greenhouse gas emissions in their financial activities by a
certain year.
As the economy and consumer demands change, it is
appropriate for financial institutions to change as well.
Ensuring your lending and investment portfolio is diversified
and risk-averse is a core tenet of risk management.
However, as financial institutions move in the direction of
sustainable investment, it is appropriate to determine if the
U.S. economy, in particular the energy industry, is ready to
move away from fossil fuels and carbon-intensive energy.
Will the energy sector be choked off from financial
services that they need to exist? What are the costs of the
transition risks to the U.S. economy?
These are questions that must be seriously considered and
understood before an industry-wide stance is taken regarding
investments in carbon-intensive industries.
While Federal regulators should understand these risks, I
must associate myself with the comments of Federal Reserve Vice
Chairman of Supervision Randal Quarles, who said, ``Broad
climate policy is the role of Congress and other Federal
agencies, not the Federal Reserve.''
Congress should not deputize the financial services
industry to be the climate police, greenlighting sustainable
projects and shutting down legally-operating businesses that
are carbon-intensive, especially when they have no
understanding of how climate risks will impact the economy and
do not have sufficient data and modeling to determine these
impacts.
The Comprehensive Capital Analysis and Review (CCAR) stress
testing amongst financial institutions looks 9 quarters into
the future. Most climate change models look about 30 to 100
years into the future. If we go down the path of forcing
institutions to speculate on future risk, and tying their
capital requirements to this risk before we have an appropriate
understanding of the economic impacts and the effect on access
to credit and the ability of the energy sector to pivot to new
technologies, we could do irreparable harm to our economy.
And yet, that is exactly what my colleagues on the other
side of the aisle are proposing. They have noticed legislation
in this hearing that would directly tie climate-related risks
to bank capital by increasing the risk weighting of assets
financing greenhouse gas (GHG) emissions.
This is an extremely irresponsible proposal. Again, we have
no understanding of how this would impact the economy, no real
data on how this would impact the world's climate, no clear
information on how we can accurately predict climate-related
financial risk, and no clear understanding of how transition
risks could impact the safety and soundness of financial
institutions and the U.S. economy at large.
I look forward to bringing up these concerns with the
panelists today.
And with that, Mr. Chairman, I yield back.
Chairman Perlmutter. The gentleman yields back.
The Chair of the full Financial Services Committee, the
gentlewoman from California, Chairwoman Waters, is now
recognized for 1 minute.
Chairwoman Waters. Thank you, Chairman Perlmutter.
Over the past year, we have witnessed examples of how
climate change can disrupt our financial system. The financial
toll, including insurance losses from the most devastating
wildfire seasons on record, grew so sharply that our Governor
in California had to issue a moratorium to prevent insurers
from denying insurance coverage to homeowners.
Meanwhile, the hundreds of bankruptcies in the oil and gas
sector as a result of the economic fallout from COVID-19 have
provided a preview of the type of pain our economy will likely
face as climate change becomes worse.
I am pleased that President Biden, Treasury Secretary
Yellen, and policymakers at the Fed and elsewhere have listened
to those of us who have raised concerns about the urgent
financial stability risk of climate change and that they are
beginning to take action.
So, I am looking forward to the hearing today. And I assure
you, Chairman Perlmutter, that we are going to be hearing from
Seattle and Portland. Portland was 116 degrees as of yesterday,
and Seattle was 104 as of Sunday. And I don't know what
financial disruption this is going to cause, but climate change
is real.
I yield back the balance of my time.
Chairman Perlmutter. The gentlelady yields back.
The ranking member of the Full Committee, the gentleman
from North Carolina, Ranking Member McHenry, is recognized for
1 minute.
Mr. McHenry. Thank you, Chairman Perlmutter.
You have heard me say this before, and I have said it
repeatedly: Climate change is real. But instead of taking the
time to get this legislation right, my Democrat colleagues are
once again rushing to legislate to appease the progressive
left.
Usurious policies will have far-reaching and unintended
harmful consequences. Just as with the so-called Climate Crisis
Financial Stability Act, without doing any work, without
listening to any experts, without any data, the Democrats want
to take the step of determining risks for financial
institutions and punishing certain institutions with a capital
surcharge.
Now, not only is this unrealistic, I think it is a
dangerous step. We need to make sure that any next step
strengthens the resiliency of the system and seriously
addresses climate risk, not appeases some progressive
stakeholder group.
I yield back.
Chairman Perlmutter. The gentleman yields back.
And I would just like to alert the Members and the
panelists that we are expecting votes probably around 3:00, and
what I would like to do is get through the statements of all of
the witnesses as much as we can before we have to take a break
for those votes. And if we can get some questioning in before
the votes are called, we will do that. Otherwise, we will
recess until we finish the votes on the Floor, and then we will
reconvene once the votes are finished.
With that, we will turn to our witnesses.
Professor Hilary Allen is an associate professor of law at
American University. Professor Allen's research is focused on
domestic and international financial stability regulation, and
she teaches classes in banking law, securities regulation,
financial regulation, and other topics.
Dr. Rachel Cleetus is a policy director with the Union of
Concerned Scientists. Dr. Cleetus is an economist with 20 years
of experience working on climate and clean energy policies and
is an expert on the United Nations Framework Convention on
Climate Change process.
Ms. Mayra Rodriguez Valladares is the managing principal
with MRV Associates. Ms. Rodriguez Valladares is an independent
consultant who has advised central banks, insurers, regulators,
and financial services firms on risk and compliance issues.
Mr. Steven Rothstein is the managing director of Ceres
Accelerator for Sustainable Capital Markets. Mr. Rothstein's
work at Ceres Accelerator is focused on transforming practices
governing capital markets to reduce the financial impacts of
the climate crisis.
And Dr. Clifford Rossi is the executive-in-residence and
professor of the practice at the Robert H. Smith School of
Business, University of Maryland. Dr. Rossi has almost 25 years
of experience in government and financial services and has held
senior roles in risk management at several of the largest
financial services companies.
Our witnesses are reminded that their oral testimony will
be limited to 5 minutes. You should be able to see a timer on
your screen or on your desk in front of you that will indicate
how much time you have left. When you have 1 minute remaining,
a yellow light will appear. I would ask that you be mindful of
the timer, and when the light appears, wrap up your testimony
so that we can be respectful of both the other witnesses' and
the subcommittee members' time.
And without objection, your written statements will be made
a part of the record.
Professor Allen, you are now recognized for 5 minutes to
give an oral presentation of your testimony.
STATEMENT OF HILARY J. ALLEN, ASSOCIATE PROFESSOR OF LAW,
AMERICAN UNIVERSITY WASHINGTON COLLEGE OF LAW
Ms. Allen. Thank you, Chairman Perlmutter. Thank you, also,
Chairwoman Waters, Ranking Member McHenry, and Ranking Member
Luetkemeyer. And thank you, members of the subcommittee.
I very much appreciate the opportunity to testify at
today's hearing. As Chairman Perlmutter already mentioned, my
name is Hilary Allen, and I am an associate professor at the
American University Washington College of Law. I teach classes
in corporate law and financial regulation, and my research
focuses on financial stability regulation.
Prior to entering academia, I spent 7 years working in the
financial services groups of prominent law firms in London,
Sydney, and New York, and in 2010, I worked with the Financial
Crisis Inquiry Commission, which was appointed by Congress to
study the causes of the financial crisis of 2008.
The views I am expressing today are entirely my own. They
do not represent American University or any other institution.
In my testimony today, I would like to highlight three
points for the committee.
First, I will underline the stakes involved in preparing
the financial system for the physical and transitional risks
associated with climate change. The impacts of a financial
crisis can be irreversible and catastrophic, particularly for
the most vulnerable members of society, so financial regulators
should take steps to make the financial system more robust to
the climate-related uncertainty that we face.
Second, I would like to advocate for increased focus on the
potential systemic effects of operational problems arising from
extreme weather events and other environmental changes, because
financial stability regulation often neglects these operational
risks.
Finally, I will speak about reforming the Office of
Financial Research, known as the OFR.
All of the Federal financial regulatory agencies need to be
involved in making this financial system more robust to
climate-related threats, but the OFR can play a unique and
crucial part in that effort if it is rebuilt as an
interdisciplinary hub of the different kinds of expertise
needed to assess and respond to these threats.
It has never been good policy to just let financial crises
happen and then clean up afterwards. Even with the Herculean
and imaginative crisis response efforts that we saw from the
Federal Reserve and other governmental bodies in the wake of
the financial crisis of 2008, the economic fallout of that
crisis could not be fully contained. Many of the most
vulnerable members of our society still have not recovered from
it.
I therefore urge the committee to take a precautionary
approach to financial stability regulation in general and, in
particular, towards climate-related risks.
A precautionary approach requires us to be creative in our
thinking about risks to financial stability and favors bold,
simple responses where possible.
I have outlined a number of responses in my written
statement that are designed to help manage the uncertainty
about the precise physical and transitional risks we face,
including regulatory capital requirements that require banks to
fund themselves with more common equity to act as a buffer
against uncertainty and help prevent financial institution
failures and asset fire sales.
One reform that I want to stress for the committee today is
the need for what I call macro-operational regulation, which
takes seriously the possible systemic consequences of the steps
taken by individual financial institutions to manage their own
operational risks.
For example, a financial institution that finds part of its
physical infrastructure damaged could shift its operations to
alternative infrastructure. That would be a rational step by
the institution, designed to enable it to keep providing
financial services. But if that alternative infrastructure is
overloaded as a result, that may create problems for other
financial institutions that also rely on the alternative
infrastructure.
Different kinds of experts are needed to help think
creatively about the types of threats that climate change poses
for the financial system. In the case of the operational risk
spillovers that I just mentioned, complex science expertise
would be very helpful.
Climate scientists and environmental economists will
obviously be crucial to the effort. Data scientists and
software engineers would also make important contributions.
The Office of Financial Research should be the new home for
these types of interdisciplinary personnel, because
consolidating interdisciplinary expertise in one agency can
create virtuous cycles that make hiring easier and promote
collaboration and consistency in responding to new threats.
In my written testimony, I set out proposals for rebuilding
the OFR as an interdisciplinary expertise hub. Many of these
proposals relate to staffing and to the OFR's relationship with
other financial regulatory bodies, particularly the Financial
Stability Oversight Council (FSOC).
I urge the committee to pursue these proposals as a matter
of urgency in order to ensure that our financial regulatory
architecture is equipped to deal with the challenges of climate
change.
Thank you.
[The prepared statement of Professor Allen can be found on
page 32 of the appendix.]
Chairman Perlmutter. Thank you for your testimony.
Now, I would like to recognize Dr. Rachel Cleetus for 5
minutes for her testimony.
STATEMENT OF RACHEL CLEETUS, POLICY DIRECTOR, UNION OF
CONCERNED SCIENTISTS
Ms. Cleetus. Thank you very much, Chairman Perlmutter,
Ranking Member Luetkemeyer, and members of the subcommittee,
for providing me the opportunity to testify remotely here today
on the systemic risks of climate change. My name is Rachel
Cleetus, and I am the policy director for the climate and
energy program at the Union of Concerned Scientists.
Summer has barely begun and we are already in the midst of
a stunning drought in much of the Western United States.
Record-setting heatwaves are underway, including an
unprecedented one in the Pacific Northwest. The Midwest has
been hit by heavy rain and flash flooding. The wildfire season
is underway, another intense one. We are projected to have an
above-normal hurricane season.
Meanwhile, the COVID-19 pandemic and the economic crisis
continue to be a threat.
What we are experiencing this summer is part of a very
sobering trend. In addition to steadily rising temperatures,
climate change is also driving accelerating sea level rise and
ocean acidification. Many sectors of the economy are at risk.
Our infrastructure, agriculture, fisheries, insurance, real
estate, tourism, and the impact on the health and safety of
people, including outdoor workers, is very significant, too.
Our nation experienced $22 billion-plus extreme weather and
climate-related disasters last year. Climate-related
infrastructure disruptions are increasing. Our roads, bridges,
rail lines, and air travel are all at risk.
The electricity system which underpins our daily lives has
repeatedly failed. Heat waves put enormous pressure on the
power grid right at a time when we need power for cooling. We
get power outages, as we are seeing in the Northwest right now,
which can trigger cascading effects, including business
interruptions and loss of critical services that depend on
electricity.
Meanwhile, heat-trapping emissions that fuel climate change
are still rising. The science is clear: We need to cut
emissions by half in 2030 and get to net zero no later than
2050.
And yet, today our economic and financial systems are not
accounting for these risks, nor are they helping drive a rapid
shift to a net-zero economy.
A combination of shortsightedness, inadequate policies, the
outsized power of fossil fuel companies, and business-as-usual
inertia is getting in the way.
And if we fail to take action now, the potential for severe
shocks to our financial system will grow. And as with previous
crises, the impacts will be especially harsh for those who can
least afford it--low-income households, communities of color.
Instead, we have an opportunity now to ensure that our
economy and financial system are put on a path to be fairer,
more climate-resilient, and compatible with a low-carbon
future.
We need a coordinated, comprehensive approach from the
national to the international, the local level, with Congress,
financial regulators, and the Federal Government all playing
their part.
We need mandatory risk disclosure in the marketplace to
help correct market failures. Fossil fuel companies and their
investors who bear an outsized responsibility for climate
change must face market pressures to change their business
model and lending practices. We need transparent, uniform
disclosure of market risks from climate change based on the
best available science.
Congress must pass legislation to set up an advisory
committee on climate risk in the FSOC, require climate risk
disclosure in the marketplace, and take steps to prioritize the
well-being of marginalized communities.
Much more is at stake than the fiscal well-being of U.S.
businesses. The public relies on these companies to grow and
manage our savings, investments, pension funds, and energy
choices. Our market rules and financial safeguards must help
develop the outcomes we need to protect our health, welfare,
and prosperity, not simply the profits for the powerful and
elite few.
We need a transformative climate strategy that addresses
underlying systemic challenges, like structural racism and
social-economic inequities. We have urgent choices before us.
But because it is our actions that are the source of heat-
trapping emissions, here in one of the most powerful economies
in the world, we can also help set the rules of the market. We
cannot have a healthy economy if the planet is on fire and vast
areas are under water.
Thank you for this opportunity to testify today, and for
your efforts to protect our financial system from climate risk
and to ensure that it helps contribute to the climate solutions
we so urgently need.
[The prepared statement of Dr. Cleetus can be found on page
52 of the appendix.]
Chairman Perlmutter. Thank you, Dr. Cleetus, for your
testimony.
Ms. Rodriguez Valladares, you are now recognized for 5
minutes to give an oral presentation of your testimony.
STATEMENT OF MAYRA RODRIGUEZ VALLADARES, MANAGING PRINCIPAL,
MRV ASSOCIATES
Ms. Rodriguez Valladares. Chairman Perlmutter, Ranking
Member Luetkemeyer, and distinguished members of the
subcommittee, thank you for the opportunity to appear before
you.
I am Mayra Rodriguez Valladares, managing partner of MRV
Associates. For over 3 decades, I have worked with bankers and
financial regulators in over 30 countries on a wide range of
risks that can threaten financial institutions' safety and
soundness.
Unlike the global financial crisis, scientists have been
warning us for decades about the danger of climate change.
Through the numerous financial crises I have endured, I have
learned that when someone tells me this time it is going to be
different, it is a warning signal that urgent action is
critical now to avoid another painful crisis.
U.S. global systemically important banks are very exposed
to climate risks. Not only do they provide financial services
in States vulnerable to intensifying climate events, they have
operations in foreign countries such as the UK, Japan, Canada,
and Mexico, which are exposed to physical and transition risks.
Regional, community, and agricultural banks are also
exposed to climate change. In 2019, severe flooding in the
Midwest brought loan defaults and payment challenges to their
highest levels in 20 years.
Banks in areas that serve people of color are also
vulnerable to climate change since many of them are also in
areas with a myriad of environmental, infrastructure, and
housing challenges.
I must note that the very significant rise in corporate
leverage in the United States in the last 2 decades means that
those companies are the most likely to default in the event
that they are affected by climate change.
Market investors have not priced in climate change risks
because financial institutions and corporations are not
required to identify, measure, control, and monitor their
climate-related risks and to disclose them to the public.
Opacity in the financial system is dangerous to investors
and ordinary Americans.
Given its membership of leading international standard-
setting bodies, such as the Financial Stability Board and the
Basel Committee on Banking Supervision, U.S. regulators already
work on climate change risk frameworks.
In the U.S., the Financial Stability Oversight Council and
its Office of Financial Research should be given the necessary
human, data, and technological resources so they can analyze
how climate change is impacting the entire financial system and
to detect sources of systemic risk.
Inaction is costly.
FSOC and OFR should focus on non-banks that are exposed to
climate-related risks. They are interconnected to banks, do not
have strong management requirements, and are very opaque.
Under Basel III, Pillar 1, bank regulators can require
banks to model operational risk, which includes natural
disasters that can hurt a bank's assets, both in the banking
and trading portfolios.
Under Pillar 2, banks can incorporate different risks,
including climate change-induced defaults or market volatility,
into their Internal Capital Adequacy Assessment Processes to
determine economic capital levels to sustain unexpected losses.
I respectfully recommend that financial regulators,
especially the Federal Reserve, the OCC, and the FDIC,
recommend to them that they should: one, create climate change
stress tests or add climate change scenarios to existing
supervisory exercises, such as the Comprehensive Capital
Analysis Review and Dodd-Frank Stress Test; two, design
specific climate change supervisory guidance for banks; three,
update supervisory bank examination manuals to include how
climate change impacts banks; four, conduct a review of the
human resources to determine if they have enough professionals
with knowledge about climate science, risk data aggregation,
and modeling; five, review if they have robust technological
systems to analyze climate change data and its impact on banks'
risks; and six, address their climate change data gaps.
I also recommend that bank regulators require banks to:
one, conduct a gap analysis to determine what resources they
need to improve risk data aggregation, climate change risk
modeling, and technology; two, incorporate physical and
transition risks into their enterprise-wide risk management
frameworks and long-term financial plans to measure their
climate risk exposures; three, include in their bank recovery
and resolution plans and their comprehensive liquidity
assessment reviews how physical and transition risks impact
banks' funding, cost of borrowing, liquidity, and risk
mitigation ability; and, lastly, disclose to the public climate
change model results, including tail risks, via Basel III's
Pillar 3 disclosures.
I look forward to your questions, and I would be pleased to
serve as a resource to you in the future as you continue to
explore how to reduce the adverse impact of climate change on
the safety and soundness of the American financial system.
Thank you.
[The prepared statement of Ms. Rodriguez Valladares can be
found on page 66 of the appendix.]
Chairman Perlmutter. Thank you very much for your
testimony.
I now recognize Mr. Rothstein for 5 minutes for his oral
testimony.
STATEMENT OF STEVEN ROTHSTEIN, MANAGING DIRECTOR, CERES
ACCELERATOR FOR SUSTAINABLE CAPITAL MARKETS
Mr. Rothstein. Thank you, Chairman Perlmutter, and
distinguished Members of Congress. Thank you for the invitation
to be here.
My name is Steven Rothstein, and I am the managing director
of the Ceres Accelerator for Sustainable Capital Markets. Ceres
is a nonprofit organization working with investors and
companies to build sustainable leadership within our firms and
drive policy solutions throughout our economy. Our membership
represents Fortune 500 companies and investors with over $30
trillion of assets under management.
Our testimony draws from Ceres reports that we have also
submitted into the record, Mr. Chairman. I am not here to talk
about the systemic risk our climate has to our planet and our
people, although it is paramount to the lives of our children
and grandchildren.
I am here to highlight the underrecognized risk to the
safety and soundness of our financial institutions due to
climate risk and the risks of the business-as-usual approach
that some of the financial institutions pose on a livable,
climate-safe world.
If a banker or a bank regulator suggested that they don't
need to plan for another pandemic or cyber attack, there would
be a chorus of opinions saying they are not meeting their
fiduciary responsibility.
Potential exposure to climate risk is bigger and more
systemic. Yet, there are leaders today in banking, insurance,
and among financial regulators that do not fully account for
financial risk.
Even as we are working to overcome the unprecedented
pandemic and the pain and loss that it brought, we have
simultaneously had record-breaking fires, hurricanes, and
unparalleled climate-related risks. As our Secretary of State
said recently, we are running out of records to break.
In short, we know more about the climate risk, as the
chairman said in his introductory remarks, than we knew about
the mortgage finance risk in 2008. But, surprisingly, we are
not acting with the urgency required.
There are dozens of strong international examples from
financial regulators around the world, and we appreciate the
initial steps from the Department of the Treasury, the Federal
Reserve, and the SEC. But that is all they are, initial steps.
So, we recommend that regulators take five immediate steps.
One, immediately affirm the systemic nature of climate risk
and its impacts on the financial market. The affirmation can
take the form of a statement of an agency Chair or a report
from the agency.
Two, activate action on prudential supervision, as some of
my colleagues have said. U.S. regulators have an explicit
responsibility to supervise the risks that financial
institutions take on. Consistent with that mandate, financial
regulators should integrate climate change into the prudential
supervision of banks, insurance companies, and other regulated
financial institutions.
The Federal Reserve, in particular, should take immediate
steps to assess the climate risk to financial markets and
mandate scenario analysis by the banks and the other financial
institutions it supervises.
They should also outline plans for conducting pilot climate
stress tests of its supervised institutions to measure the
impact of climate-related shocks and consider enhancing capital
and liquidity requirements.
In addition, we recommend that the Federal Reserve, the
FDIC, the OCC, and the National Credit Union Administration
expand their examiner training programs and manuals to ensure
that staff fully understand climate risks faced by the
financial institutions they monitor.
Three, support the SEC's work on mandatory climate
disclosure. We congratulate the SEC for their initial steps and
hope they will be issuing bold rules later this year.
Four, address how climate risks further exacerbate systemic
racism, particularly as reflected in financial institutions.
Financial regulators should develop strategies to address
systemic climate risks and structural racism in an integrated
way. The Community Reinvestment Act is a ripe opportunity to do
this.
Five, build capacity for smart decision-making on climate
change by coordinating action with other U.S. and global
regulators and by hiring and training additional staff.
Coordinated action by U.S. regulators at the global,
Federal, and State levels is essential to accelerating this.
The FSOC generally, and the Biden Executive Order that has been
referred to, are critical steps. We appreciate the recent
actions of U.S. financial regulators to coordinate with global
peers as a start.
To conclude, U.S. financial regulators have a critical role
to play in ensuring the resilience of our economy, weakened by
the global pandemic and systemic racism, and threatened by
future climate shocks. The fundamental safety and soundness of
our financial institutions is relying on them and on each of
you.
Thank you again for this opportunity.
[The prepared statement of Mr. Rothstein can be found on
page 104 of the appendix.]
Chairman Perlmutter. Thank you for your testimony. You hit
that right on 5 minutes, so I appreciate that.
Dr. Rossi, you are now recognized for 5 minutes.
STATEMENT OF CLIFFORD V. ROSSI, EXECUTIVE-IN-RESIDENCE AND
PROFESSOR-OF-THE-PRACTICE, ROBERT H. SMITH SCHOOL OF BUSINESS,
UNIVERSITY OF MARYLAND
Mr. Rossi. Thank you, Chairman Perlmutter, Ranking Member
Luetkemeyer, and members of the subcommittee. I am Dr. Clifford
Rossi, professor of the practice and executive-in-residence at
the Robert H. Smith School of Business at the University of
Maryland.
The views that I am expressing today are solely my own and
do not represent those of the University of Maryland.
I am here today to inform the subcommittee that imposing
climate risk mandates on regulated depository institutions at
this time would be detrimental to consumers, to the financial
services sector, and to the economy at large.
Let me be clear: Climate change is a real risk that
requires a firm understanding of the current limitations of
climate models, underlying data, how those data do and do not
integrate with standard financial and risk models, and numerous
other components in order to craft effective solutions to the
underlying risk.
I offer a unique perspective on this issue, having worked
for about 23, 25 years, depending on sort of how you calculate
those things, in the financial services industry, first as a
regulator during the S&L crisis, and then at both Fannie Mae
and Freddie Mac--pre-conservatorship--as well as at one of the
largest commercial banks, the largest savings and loan, and the
largest non-bank mortgage company during my tenure as a C-level
risk executive, and now as a finance and risk professor working
on climate risk issues and banking.
Models in use today for climate scenario analysis are
designed to represent the physics of a complex Earth system
well into the future, and their output is limited for near-term
use by financial institutions.
As I have outlined in my written testimony, the models upon
which urgent demands for a public policy response are based are
subject to significant model risk. Model risk can be defined as
the risk associated with errors in data, methods, or
assumptions used to generate output from analytical models used
for decision-making.
Forcing financial institutions and their regulators toward
expansive climate risk regulation based on effects that are not
well-understood presents more risk to the financial system than
a staged and methodical approach.
Now, I applaud the intent of the Biden Administration,
through their Executive Order, to assess climate-related
financial risks and data. However, I would caution policymakers
and regulators from imposing measures on regulated depositories
based on the state of current climate analytics for the
following reasons.
First, the output from climate and associated integrated
assessment models, or IAMs, are not close to being ready for
use in bank financial and risk analytics such as bank stress
test modeling, and suffer from the supposed, ``square peg in
the round hole'' syndrome.
The empirical linkages between long-term climate effects
and short- to intermediate-term financial and risk factors are
not sufficiently established currently to properly assess
physical or transition risk impacts to the banking system from
climate change.
Second, both the climate and integrated assessment models
upon which scenarios such as those proposed by the Network for
Greening the Financial System (NGFS) are based are subject to
considerable empirical error due to the underlying complexity
of these models on interactions that are not fully understood
in the scientific and financial research communities.
Now, why is this important? Requiring banks to make hard
money strategic decisions on lending, capital allocation,
pricing, and other activities that have long-term consequences
for consumers, the financial system, and economic growth based
on models with a high degree of uncertainty is not at all
consistent with prudent model risk management practices.
Third, it is well-established in the psychology and
economics literature that decision-making is affected by a
number of cognitive biases. One of these is what I refer to as
model or shiny object bias.
Model bias occurs when decision-makers embrace the results
from highly-sophisticated quantitative models based on
perceptions that the apparent analytical rigor in those models
necessarily translates into accurate and reliable outputs.
There is widespread shiny object bias in the use of climate
and integrated assessment models today among policymakers
worldwide. This poses serious concerns regarding the use of
these models for anything other than research applications at
this time, as described earlier. Placing bets on financial
markets on such models invites a host of long-term unintended
consequences on the financial system.
Climate change is a real risk that banks and other
financial institutions should actively incorporate in with
their existing risk management processes. However, such firms
must take measured steps to understand these risks and not be
forced into conducting analyses for which the models and
outputs are not well-understood as they relate to financial
services.
Banks should instead focus attention on bolstering their
risk awareness to climate change, starting with enhancing their
risk governance process and controls, data, and analytics.
Quantifying with a reasonable degree of confidence the
impacts of physical and transition risk from climate change
will require significant effort, time, and a true
interdisciplinary approach between climate scientists and the
very people who are actually running financial and risk
management at these organizations and gathering additional data
and modifying existing models.
This work should commence, and only when the results have
been deemed to conform to regulatory model risk standards
should consideration of the disclosure and use in financial
decision-making be permitted.
Thank you for your time, and the invitation to testify on
this important matter, and I look forward to answering your
questions.
[The prepared statement of Dr. Rossi can be found on page
95 of the appendix.]
Chairman Perlmutter. Thank you, Dr. Rossi.
And thank you to all of the panelists. You were all right
on time or a little early. So, I appreciate that.
I will now recognize myself for 5 minutes for questions.
And we will get through as many of the Members as we can before
we have to break for votes. We might be lucky and get through
all of us. We will see.
Dr. Rossi, I want to just start with where you have left
off. And I think we would agree. A number of us on this
committee are also on the Science Committee, and yesterday we
had a hearing on the science of wildfires or wildfire
predictions, mitigation, and a whole variety of things. And I
don't think we would disagree with you that we don't have all
of the science we would like to predict wildfires.
In Colorado, we had our worst wildfire season ever last
year, and most of the Northwest is frying right now. But, in my
opinion, that is not a reason to not begin to put precautions
in place.
So, Dr. Cleetus, Colorado, as I just said, had its worst
wildfire season on record. The three largest wildfires in our
State's history occurred in 2020, torching over 540,000 acres.
Climate change is now forcing Colorado and many other
States to prepare for larger and more destructive wildfire
seasons. In fact, the director of the Colorado Division of Fire
Prevention and Control just remarked, ``We are having fire
years, not fire seasons anymore.''
In the West, we have wildfires. The Gulf has hurricanes.
There is increased flooding in the South and the Midwest. And
these changes are having a significant impact. The smoke that
comes into the Denver area from the wildfires either in
Colorado or the West is affecting our tourist industry and our
housing industry.
As the severity and frequency of extreme weather events
continues to rise, how will the housing market react? And what
does it mean for homeowners in climate-sensitive areas?
Ms. Cleetus. Yes, as you are pointing out, the reality is
that this is not some distant future. These climate impacts are
here and now. And it is very clear from the science that
hotter, dryer conditions in the West are contributing to these
longer, more intense fire seasons. It is undeniable. And,
unfortunately, the uncertainty, to the extent it exists, seems
to be breaking in the wrong direction.
This is why the precautionary principle that the other
panelists highlighted is so important. We are talking about
managing risks; we cannot avoid them completely.
And what we are starting to see is the insurance market
reflecting this risk with wildfires, where we have seen
insurers drop policyholders, or try to raise rates. State
regulators have had to step in with stop-gap measures. We have
thousands of homes at risk right now in the West, millions,
actually, if you look across all of the States in the American
West. And this risk is growing, both because of climate change
and also our development patterns and how we manage our
forests.
So, we have to act on all fronts to make sure that we
contain this risk. Otherwise, both the economic consequences,
as well as the public health and human toll, will rise every
year, unfortunately.
Chairman Perlmutter. Thank you for your answer.
Several of us on this committee--I was a bankruptcy lawyer
representing financial institutions for many years, and we have
individuals who were bankers or bank regulators on this
committee. And the failure of Pacific Gas and Electric, the
failure of many oil and gas companies and their bankruptcies,
make me concerned about the impact on the financial industry.
So, Ms. Rodriguez Valladares, 2 years ago this subcommittee
held a hearing about how leveraged lending may pose a threat to
financial stability. As you know, leveraged loans are
characterized as corporate debt extended to highly-indebted
non-financial businesses.
How does leveraged lending interact with climate risk? And
what types of institutions are particularly exposed?
Ms. Rodriguez Valladares. This is really a very good point
that you make. I have published 40-some-odd articles about
leveraged lending and collateralized loan obligations, and we
should definitely be very concerned, because American companies
are more leveraged than they ever have been historically,
either in aggregate amounts or when you see it as an equivalent
percent of gross domestic product (GDP).
And there are incredible interconnections because a lot of
these companies, especially in the energy sector, which
presently is exhibiting a very, very high default probability,
are incredibly vulnerable to extreme climate events.
And there is a lot of opacity in leveraged lending and
collateralized loan obligations, and there are a lot of
interconnections between the non-banks such as hedge funds and
private equity, home offices, and other types of financial
institutions of that nature. They are very interconnected to
banks. They hold a lot of these leveraged loans and a lot of
these securitizations.
We definitely need to be very, very mindful about their
probability of default, and especially those companies that are
imminently affected either by the physical or the transition
risks.
Chairman Perlmutter. Thank you very much for your response.
My time has expired. I now recognize the ranking member of
the subcommittee, the gentleman from Missouri, Mr. Luetkemeyer,
for 5 minutes.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
Mr. Rossi, in your testimony you have a graph in there,
``Long-Term Changes in the Earth System.'' And the first graph
talks about land surface temperatures, and it starts out at
1850.
And it is interesting, because that seems to be where most
people who want to talk about climate change want to start, is
1850. It is interesting, because that is actually the trough of
the cold trend that started at that point--or ended at that
point. If you actually take the chart and you go back 1,000 or
2,000 years, you see this wave effect.
And so what I am saying is, if you take that chart and go
in the other direction, which is what we are trying to talk
about today, actually within the next probably 25 to 50 years,
you are going to see the wave start going in the other
direction.
And we are talking here today about modeling. If you are in
the banking business and you are trying to model what your
risks are with regard to climate change, if you go back 5 years
or 50 years, it is one thing, and if you look forward 5 years
or 50 years based on what you saw in the past, that is really--
you need a crystal ball to look at all of the things that have
happened in our economy and the world in the last 5 years or 50
years. And then try and project that to the next 5 years or 50
years and look at--and you throw in there the technology and
things like that.
How do you, Dr. Rossi, analyze this when you look at the
fact that this wave could actually go in the other direction?
And we are looking at trying to model this so we actually get
an assessment of true risk. How can you do that? You just got
done talking about how you didn't think that could actually
work. Could you elaborate on that a little bit? Am I wrong in
my assessments here?
Mr. Rossi. No. And as someone who actually either developed
or oversaw the development of such models in the past, either
loan loss reserving models or stress test models, I can tell
you for sure that this is probably one of the most difficult,
if not the most difficult exercise that banks will face in
estimating or assessing risk in their portfolios.
As for all the reasons that you just described, in the case
of credit risk or market liquidity or these other risks that
are out there, we can get our arms around that pretty readily
because we have that data, we have that historical time series,
that is, to be able to kind of ingest that into our financial
and risk models and project out how much capital we will have.
When we are talking about taking physical outputs, such as
how many gigatons of greenhouse gases are spewed out, and
trying to translate that into macroeconomic factors that then
translate in turn to how much risk is on our lending or
investment portfolios, that is what we are talking about as
being extraordinarily difficult to do.
And keep in mind that when we do that, we are today really
only going out, as was said earlier, 9 quarters forward on our
stress test, so trying to go out 5 years or even 10 years, or
more than that creates an enormous amount of uncertainty, such
that if we are trying to estimate the tail of the distribution,
as other witnesses have talked about, the tail of that
distribution is so noisy, it would be very, very difficult to
quantify that with any degree of reliability.
And personally, as someone, as a former CRO, signing a sub-
attestation, I would not today, given where the state of
climate models are today, sign any sub-attestations related to
climate risk.
Mr. Luetkemeyer. If you take that one step further then,
the concern that we need to be thinking about here is if you
destroy the fossil fuels industry based on this graph showing
continued warming, and all of a sudden in a few years it turns
the other way, we have destroyed an industry that we definitely
need and are going to need in the long term for many different
reasons.
It would seem to me that we need to be very careful how we
go into this modeling situation. Would you agree with that?
Mr. Rossi. I would agree with that. And I want to be clear
here. I am not saying not to do anything--I am not saying that.
I am saying that we need to start in a very methodical fashion.
There are things that we can do today that aren't going--
leapfrogging to, let's adopt what is in these IAMs and climate
models today and just start to implement stress tests and--
Mr. Luetkemeyer. Mr. Rossi, let me quickly interject here.
You talked about some things we could do. Would you
identify things that financial institutions or regulators, what
significant data things they can put together today to actually
make it work?
Mr. Rossi. Yes, absolutely. First and foremost--and I am a
simple-minded guy when it comes to these things--is to do what
you understand right now.
What banks can understand right now are the positions on
their portfolios that are exposed to different climate events.
They can actually engage with vendors that are out there that
can supply this information that can help them assess what
their exposure is to wildfire risk or drought or flooding, and
they can size that up in terms of the probability of those
outcomes, as well as the impact or the severity of those
outcomes. They can do that today.
The other thing that they can do is to start to do what I
have done in an academic research paper that will be published
later this year, to actually try to tie, to determine these
empirical linkages between physical outputs, let's just say
hurricane impacts, severity and frequency of hurricanes, to,
let's say, mortgage default. Trying to establish those
empirical linkages will be extraordinarily important to
actually getting a better handle on estimating what this
climate risk looks like on these bank portfolios.
Mr. Luetkemeyer. Thank you for your response. I am out of
time. Thank you, Dr. Rossi.
Chairman Perlmutter. Thank you, Dr. Rossi, and Mr.
Luetkemeyer.
The Chair will now recognize Mr. Foster, who is the only
physicist in Congress. But apparently, he is going to yield to
Mr. Casten, an engineer.
Mr. Foster. Thank you. And I yield to Mr. Casten.
Mr. Casten. Thank you, Mr. Physicist.
I truly hope we are not still arguing about whether climate
change is real. My goodness, the science is so settled. We know
the last time CO2 was this high. Sea levels were 50 feet
higher. Let's move on.
If you don't believe the scientists, listen to Fed Governor
Lael Brainard, who said in January that the science is settled
but the impact on our financial sector is highly uncertain,
that we should be concerned about the impact of rapid repricing
events. I am partially misquoting that.
We had Jamie Dimon in a couple of weeks ago, and he said
that JPMorgan is not reducing their fossil fuel exposure. And I
said, ``Okay, have you changed your senior debt, sub debt
equity level?'' He said, ``No, not yet.'' And I said, ``Can I
assume that you will once you see things coming?'' And he said,
``Oh, absolutely.''
So my first question for you, Mr. Rothstein, is, we know
once these changes come, the sophisticated players will see it
coming first and we will have capital movement in the system.
Can you explain to us the difference between stress testing
the banks and scenario modeling the system, and how you think
we should be balancing those two to make sure that our system
is robust and continues to be robust?
Mr. Rothstein. Thank you, Congressman. And thanks for all
of your leadership on this issue.
We have a very diverse system with thousands of banks, and
while the biggest banks, obviously, are responsible for the
loans, most people operate with small banks. They have to
operate in a very concentrated area. They are more at risk for
physical risk because they tend to loan within a 5- to 10-mile
area.
We did an analysis of the largest 20 banks and looked at
their syndicated loan portfolio, just to use the same
methodology that the European Central Bank did, and for that we
identified over half-a-trillion dollars of exposure.
What we need to do is use every tool. Climate change is an
all-of-government initiative, it is an all-of-society
initiative. We have to do stress tests on individual bank
portfolios and then we have to look at scenario analysis for
the whole system, both small and large.
Mr. Casten. I want to follow up, because your point about
small banks intrigues me, because there is the physical risk
that at least we think we understand--there are lots of ripple
effects--but then there is the transitional risk that shifting
wealth from energy producers to energy consumers is good for
Americans, but it creates our political tension. And I find
myself thinking, is the First Bank of Frankfort, Kentucky,
going to be okay?
Does this feel more like the S&L crisis than the 2008
crisis to you, as we think about how diverse the exposure is
going to be in the system?
Mr. Rothstein. I believe, Congressman, that the exposure is
even broader and more systemic than either of those.
For a small bank, they could be affected on physical risk
if they are in an area with fires, floods, or tornadoes. But
they also could be if they are in an area that is an energy-
producing community and the jobs decline in that sense.
Last year, the oil companies wrote off $145 billion of
assets in the first 3 quarters. That is banks, insurance
companies, and investors that are somehow dealing with that, so
this is a deeper and wider potential area of exposure than any
of those.
Mr. Casten. As I pointed out recently, ExxonMobil didn't
write off all of that money because they were woke.
I want to shift, if I could, with the little time I have
left, to Ms. Rodriguez Valladares.
I really appreciated your comments. I was in the energy
industry for 20 years before I got here, and we used to joke
that you could always tell that there was a downturn coming in
the energy sector because the big banks started creating
special purpose energy opportunities funds for--that was the
thing they were doing to move assets into non-Dodd-Frank-
compliant vehicles.
Assuming that we pass this legislation, including my bills
that are noticed in this markup, and the Biden White House
moves, we are probably 2 years away, realistically, from
getting all of these changes implemented.
I don't know what you think of my own metric, but are there
metrics you think we should be watching in the financial system
that will be a sign that the sophisticated players are starting
to offload risk onto other players?
What are the red lights you are watching that you think we
should be paying attention to in these next few years?
Ms. Rodriguez Valladares. One thing, of course, is to watch
whether banks are increasingly selling their loans that are
exposed to climate change. Are they selling their commercial
real estate loans, ag loans, energy loans to special purpose
vehicles? Then that tells you that they are trying to get rid
of that risk because it weighs on their capital and their
leverage requirements.
I think also watching the number of loans that they
underwrite to these sectors that are so sensitive to climate
change is also another important signal.
But it is not just about banks' exposure to these kinds of
companies from the lending side. Let's not forget that banks
also are in financial derivatives and repos with these
different kinds of companies, to also see whether that is
lessening. That is another signal that they feel that this is
of concern.
I am a little concerned about some of the comments that I
am hearing that we have no data to be measuring climate change
risk and how it can affect default probabilities or how it can
affect market volatility, because if there is one thing
Americans are known for, it is for data.
Chairman Perlmutter. I am going to interrupt you, and
somebody else will let you finish your answer to that question.
But thank you very much for your testimony.
And I thank the gentleman for his time.
I now recognize the gentleman from Oklahoma, who is also
the ranking member on the House Science Committee, Mr. Lucas.
Mr. Lucas. Thank you, Mr. Chairman.
Today's hearing is an opportunity to have a constructive
dialogue on the issue of climate risk in the financial system.
We know that the climate is changing and that global
industrial activity has played a role in this. Further, I
believe my friends on the other side of the aisle would agree
that Congress and the regulators still have much to learn about
the implications of climate change in the financial system.
However, the argument that we are in a race against a ticking
climate Doomsday Clock is counterproductive to achieving real
progress on this issue.
The United States has already made progress in the science
and innovation needed for cleaner energy production.
Weaponizing the financial regulators to drive capital away from
fossil fuels, still the most reliable and essential form of
energy in the United States, would have dire consequences for
the economy and U.S. competitiveness abroad.
Instead, we need a more thoughtful approach based on the
current state of climate risk assessment tools.
Dr. Rossi, the electric power grid is absolutely essential
to the U.S. economy, generating the energy needed for
businesses and families across the country. In 2020, fossil
fuels were the largest source of U.S. electricity generation,
at about 60 percent. Nuclear energy was the source of roughly
20 percent.
So, Dr. Rossi, could you speak to the potential
consequences to the U.S. economy if we see a rapid government-
driven disinvestment away from fossil fuels and nuclear energy?
Mr. Rossi. Yes. In the near-term, we could see several
things.
First of all, let me give you some perspective. These are
numbers--I have been looking at Citigroup recently, and a
little while ago, they released their climate financial
disclosure for this year, and it was very interesting. One of
the things that they flagged was their oil and gas exposure of
something in the order of 50-plus billion dollars or so, pretty
sizeable, but only about 6 or 7 percent of their overall
exposure.
Why that is important is because imagine now if you have
multiple banks, just like what happened during the liquidity
coverage ratio implementation several years back when banks
were looking at trying to measure how much liquidity they had
on their balance sheet from a regulatory requirement standpoint
and found that they were--some of the largest banks were
certainly not in compliance.
And what would they do? They would have to then rotate out
of some of their lesser high-quality assets into higher-quality
assets. They would have to sell mortgage-backed securities in
order to try and comply by buying U.S. Treasuries.
In this case, divesting from oil and gas investments would
actually have a further amplifying effect, downward movement
effect, that is, for some time period, which would actually
cause the prices of oil and gas to go down, those securities,
and in addition would--temporarily anyway--impose some harm to
the balance sheets of these banks.
Now, I am not saying it is crushing by any sense. They are
well-capitalized. So, that is not going to be an issue.
But from a knock-on effect standpoint, we are talking about
impacts associated with lack of investment if banks aren't
lending again to oil and gas companies, their inability to do
the kind of exploration that is needed to continue to provide
us with the supply necessary to have heating and having to fuel
our cars, and that sort of thing.
So, it would have adjacent effects on increasing prices to
consumers for things like utility bills, prices at the gas
pump, et cetera, and so certainly would have adverse
consequences in the near-term for that.
Mr. Lucas. Continuing with you, Dr. Rossi, you explained in
your written testimony how climate credit default swaps could
be utilized as a risk-mitigation tool for climate-related
events. Could you discuss further how this financial tool could
be used?
Mr. Rossi. Sure. The idea here is simply--and I think one
of the other witnesses mentioned the use of financial
derivatives by financial institutions. And during the financial
crisis, I think Warren Buffet famously said something to the
effect of, these were weapons of financial mass destruction.
Actually, derivatives are an important risk-mitigation tool
that are used extensively in the industry for things like
transferring credit risk to private investors, such as what is
going on with the Government-Sponsored Enterprises (GSEs),
Fannie Mae and Freddie Mac, in transferring credit risk off
their balance sheets and onto other private investors.
In the case we are talking about here, we have had for many
years weather derivatives, rainfall derivatives, and we have
had temperature derivatives that have not really kind of taken
off much in the industry.
But as climate change accelerates and continues to evolve,
we need to think about developing credit- or climate-related
derivative tools that could remove that risk off of these
balance sheets.
You could imagine that both Fannie and Freddie, for
example, that are engaged heavily in credit risk transfer of
their securities to--or of their mortgage losses, that is--are
exposed increasingly, potentially, to more hurricanes and
flooding events if and when that occurs from climate change.
Being able to transfer that off directly by way of what is
called a climate derivative instrument, just like a credit
default swap (CDS), where there is a buyer and a seller in that
market for that, a bank or a GSE could, for that matter, buy
protection from a seller on the other side, and that is how
that climate derivative could actually function.
Chairman Perlmutter. Thank you, Dr. Rossi.
Mr. Lucas. Thank you, Mr. Chairman.
Chairman Perlmutter. The gentleman's time has expired.
Mr. Vargas, the gentleman from California, is now
recognized for 5 minutes.
Mr. Vargas. Mr. Chairman, thank you very much for holding
this hearing.
I want to thank all of the witnesses for being here today.
I found this very informative.
Dr. Rossi, have you ever seen hearings like this before
with Congress, when you have witnesses testifying?
Mr. Rossi. I have actually testified twice before, yes.
Mr. Vargas. The way I think it usually works is this way.
You have one side, it doesn't matter, but one side will say
something, and then, if they are in the Majority, they will
have two or three witnesses, and then the last witness will say
just the opposite.
It is sort of analogous to the issue: Do cigarettes cause
cancer? Yes, they do, and they destroy your lungs. And the next
one: Oh, yes, they cause cancer, yes, they do. And then the
last guy always says: No, they are healthy. They keep you thin
and fit.
But in this case, I think that almost everyone agrees that
climate change is real.
Now, I have been arguing this point for decades, and I have
had a hard time with some of my colleagues on the other side
accepting it. And I think you said it until I heard you say,
from some of the examples given by my friends on the other
side, well, this kind of happens in history, you kind of go one
way and then the other way.
Do you think that climate change today, a large part of
that is because of human actions and what we do?
Mr. Rossi. I do. And that is based on the fact that I work
on a fairly regular basis with climate scientists now at the
University of Maryland and I have seen the data. I am not a
climate naysayer. And I don't know that folks on the other
side, of your side, are either.
I think what we are trying to figure out, though, is how
best to move the ball along in a way that doesn't destroy the
economy in the short term, while making sure that we have what
we need to protect everybody from climate change.
Mr. Vargas. I have to tell you, I think that is a big step
forward, honestly. I think that is a big step forward, just
saying that the science is settled. Because, again, I hear some
of my friends on the other side say, well, wait a minute, but
it does this all the time, and we can't really do much about
it, it will destroy our economy, it will destroy our world if
we try to do anything about our actions.
You don't agree with that?
Mr. Rossi. I would say that there are long-term
climatological effects that have occurred throughout thousands
of years, and that there is no dispute. I also don't think that
there is any dispute that there are human-based changes that
have occurred over the last 150 or so years based on the data
that I have seen.
At the same time, we do need to take care about how we move
forward, because the models underlying that have significant
issues. I don't think we are debating the climate change; we
are debating how we can best implement them into financial
models.
Mr. Vargas. I think I understood your testimony well, and
you said you have the shiny models and you chase the shiny
thing. You find out the shiny thing is going to hurt you
because it is not modeling it right, and you can do real damage
to the economy and these large companies and other companies. I
think I understood that.
And I appreciate your testimony, I really do. I think it is
a huge step forward.
Dr. Cleetus, you said that back in 2020, the nation
experienced nearly 59,000 wildfires, which burned approximately
10 million acres. About 40 percent of that was in California,
and CAL FIRE now says that 3 million homes are at risk in
California, so much that, in fact, we have to do something.
What can we do? I have a bill that passed out of here with
others about at least disclosures, at least disclosing this
information. Don't you think that is a good idea, at least
doing that?
Ms. Cleetus. I think this is the main problem here. We have
a real information asymmetry going on in the financial sector.
Believe me, there are sophisticated actors in the financial
sector who have proprietary data sets. They are moving their
assets around. It is the ordinary public that is being left
exposed, the taxpayer that is being left exposed.
We have done some research just using publicly-available
data from NOAA, tide gauge data, looking at sea level rise and
the risk to coastal property.
What we found was that over 300,000 homes and commercial
properties with a collective market value of $136 billion today
are at risk just by 2045. That is within the lifetime of a
mortgage issued today. There is someone who is going to be left
holding the bag when those houses start to flood.
Mr. Vargas. I want to interrupt you just for a second to
give Ms. Mayra Rodriguez Valladares an opportunity to tell us
about that data you were talking about.
I have 23 seconds. Go ahead.
Ms. Rodriguez Valladares. We have a lot of data in the
United States, both from scientists, so we have just hundreds
of years of scientific data that can be used, and we also have
a lot of different kinds of probability of default data. We
have incredible professionals in quantitative fields both in
and outside of financial institutions.
There is a lot there that we can be doing to model climate
change risks. And models are dynamic. We should be working on
that already, and not wait until it is too late.
Mr. Vargas. Thank you. My time has expired.
Thank you very much, Mr. Chairman.
Chairman Perlmutter. Thank you, Mr. Vargas.
Votes have been called, but I think we can get through the
questions of Mr. Posey, Mr. Lawson, Mr. Barr, and Mr. Kustoff.
So, those of you who aren't going to be asking questions can go
vote, if you choose.
I would now like to recognize the gentleman from Florida,
Mr. Posey, for 5 minutes of questioning.
Mr. Posey. Thank you very much, Mr. Chairman.
Dr. Rossi, we are here today to explore an expansive role
of the government in our economy to reduce systemic financial
risk. History suggests that government has repeatedly missed
the mark on ensuring such financial stability.
What assurances do we have that government can and will do
better than the private sector and individuals in assessing and
responding to potential financial risks posed by climate
change?
Mr. Rossi. If what you are asking is about whether or not
we can regulate climate change by way of financial
institutions, I think that is a tricky problem to address,
because on the one hand, as we were talking about earlier,
forcing divestment, for example, or some variation of that from
financial institutions out of oil and gas would very much have
a negative impact.
And so, from a safety and soundness standpoint, when we
think about what the role of those safety and soundness
regulators are, they are there to ensure that the long-term
viability of those financial institutions is, in fact, intact.
Forcing them to implement some sort of changes in the way
in which they are balance-sheeting certain asset types is
certainly not consistent with the way in which our economy or
our financial system has gone in the past.
That is an issue that I see associated with that.
Mr. Posey. Thank you.
To follow up on that, Dr. Rossi, we have in recent history
faced some pretty large shocks. I recall the large oil price
shocks from OPEC that plagued us for years before we attained
our recent energy independence.
Looking over our shoulder literally right now at COVID-19,
should we really start selecting out the risks of the day, like
climate change, and build an entire new regulatory apparatus
around them?
Mr. Rossi. Here's the thing. Climate risk, depending on
whom you talk to, is a fairly long-tailed risk. It is not one
you could say, okay, today we had 115-degree temperatures in
Portland and Seattle. There is a difference between weather and
climate. So, those things might, in fact, turn out to be
predictive of longer-term climatological changes.
But what I will say from a risk-management standpoint is,
from a banking perspective, there are risks that we--financial
risks, market, credit, liquidity risks that we need to be
managing, and banks do manage those very effectively today,
credit risk. And then the nonfinancial risk, in which I would
include operational risk, those actually are things that also
have to be addressed.
Mr. Posey. People like to talk about risk, and there is a
reference to the risk that government climate regulations might
pose in the Chair's memo for this hearing.
I recall that Milton Friedman said, ``The Great Depression,
like most other periods of severe unemployment, was produced by
government mismanagement rather than by any inherent
instability of the private economy.''
Isn't there a rather large risk about regulators who get it
wrong on climate risks like they did in mismanaging the money
supply in the Great Depression? And should we--
Mr. Rossi. Well--
Mr. Posey. Go ahead.
Mr. Rossi. I'm sorry. Absolutely. I do think that there is
exactly that type of risk until we are armed with the
information that would give us the degree of reliability that
we have those risks understood.
And all of the risks that I just mentioned earlier, the
financial risk, the nonfinancial risk that banks are on point
to manage today in their day-to-day operations, there is a
wealth of historical information from which they can draw upon
to be able to make those assessments.
I will say that the one that they have the most difficulty
with is the risk associated with operational risk, because we
just don't have that type of data there.
And if we don't have the right type of data there, and we
have been dealing with operational risks for many, many years,
imagine the issues that we have associated with trying to get
our arms around and quantify climate risk impacts from a
physical and transition risk standpoint.
That is extraordinarily difficult. And anybody who will
tell you that the data exists for banks to be able to make very
precise estimates and make hard money decisions on that, I am
just not a buyer on that.
Mr. Posey. Okay. Thank you very much, Dr. Rossi.
I see my time is about to expire. And so, Mr. Chairman, I
yield back.
Chairman Perlmutter. Thank you, Mr. Posey.
I now recognize another gentleman from Florida, Mr. Lawson,
for 5 minutes.
Mr. Lawson. I would just like to say to my colleague, Mr.
Posey, that we worked so hard, because of natural disasters in
Florida, on citizens establishing a government-run insurance
program to make insurance available.
And this is to everyone. The effects of climate change, as
seen year after year, are strong, and more frequently, natural
disasters are destroying homes and businesses at record-
breaking rates.
In 2018, Hurricane Michael hit the Florida Panhandle where
I am, causing approximately $25 billion in damage and
devastating our local community. Only a few months after
Michael hit, we saw property insurance rates increase, leaving
some Florida homeowners unable to find affordable policies.
What steps should Congress ensure be taken to address these
issues, because they come every time? And we were devastated in
Florida after Andrew, and even Michael, and it is just never
going to stop. But we have to do something here in Congress to
make things happen.
This question is posed to everyone: What do you think we
should be doing in Congress?
Ms. Cleetus. If I could jump in, I think that there are two
really important things going on here. One is that we are
seeing in a systemic way these risks rising over time, as you
pointed out. And the other is that we have many, many people,
low-income folks, fixed-income folks, who are being really
harshly punished by the financial consequences of these
disasters.
In terms of insurance, we need to make sure that more
people are carrying insurance in the first place. It needs to
be more widely available, and more affordable. But at the same
time, we need to recognize that some of these risks over time
are going to become inherently uninsurable in some of the
highest-risk places.
So, we have to create other pathways out of risk for
people. There are so many, many people on the front lines of
this risk. In the State of Florida, for example, we have to
create pathways out of risk, because right now it is not just
having financial consequences, but taking a real toll on
people's lives and their well-being.
Mr. Lawson. I have a little bit of a follow-up. Many
residents quickly found out, as you stated earlier, that their
policy didn't cover the damage caused by rising waters. Climate
risk is not adequately priced in the housing market.
[Inaudible] Found that current home prices, mortgage interest
rates, and guaranteed fees in the secondary mortgage market did
not make much sense either.
There are a lot of concerns about rising water playing a
role in property values. What should Congress, the GSEs, and
the housing agencies be doing to address this concern?
Ms. Cleetus. I think in the first place, it is really
important to evaluate the risk fairly and communicate that risk
to the public. We need better flood risk maps that actually
communicate this information to the public so that they can
make informed decisions about what is likely to be their single
biggest asset.
Right now, we have large swaths of the public who are
largely unaware of how serious these risks are and how quickly
they are coming.
The other piece of this is really building in an equity and
justice component into our climate resilience policies, because
we are seeing communities of color get gentrified out of their
communities, and we are seeing resilience investments that
benefit an elite few and not the broader public. And that needs
to change as we go forward, because these risks are now
affecting way too many parts of our country.
Mr. Lawson. Dr. Cleetus, you also testified that we can fix
the climate crisis. [Inaudible] Which I am not sure, if we
don't build justice and equity into our solutions from the
onset.
Will you please elaborate a little bit more on that, and
how can the whole-of-government approach be undertaken by
Treasury Secretary Yellen and the National Economic Council
(NEC) and others through the recent climate financial Executive
Order to inform our approach here?
Ms. Cleetus. I think we ought to start with the fact that
our current market outcomes inherently have baked into them
years of structural racism and social-economic inequities. We
have had communities that haven't been able to build
generational wealth because of the legacy of mortgage redlining
and the lack of access to credit, as just one example.
And that means, when you have climate risk coming on, they
are coming on as a layer of additional risk over these
longstanding problems. As we create solutions, let's not have
Band-Aids on top of the current system. Let's actually be
thinking about a more fair and equitable system that keeps
people safe, for everybody, not just for a few.
Mr. Lawson. With that, Mr. Chairman, I yield back.
Chairman Perlmutter. Thank you, Mr. Lawson.
We will get through Mr. Barr's questioning, and then I
think we can adjourn this panel.
I would now recognize the gentleman from Kentucky, Mr.
Barr.
Mr. Barr. I thank my friend, the chairman of the
subcommittee, and I appreciate the testimony of the witnesses.
I know that fighting climate change is in vogue and
everyone wants in on the action. But count me as someone who is
a skeptic that increasing bank capital requirements or
punishing lenders for not redlining energy companies is the way
to go about it.
My colleagues and also some folks in the Administration
clearly want to weaponize the blunt instrument of bank capital
requirements to force a precipitous and unrealistic and, I
would argue, uneconomic transition away from fossil energy.
The problem is, this will do nothing to change demand.
People will still need to drive cars, turn on their lights, and
heat their homes. And the Biden Administration's own data shows
that fossil energy will still make up more than 70 percent of
consumption in 2050.
These efforts will just disrupt the supply side by shifting
financing for those industries to less-regulated non-bank
lenders, drive up the cost of capital, and raise prices for
consumers.
Now, I know some of the witnesses want our regulators to go
beyond just banks and go into non-bank financing as well. But
combine all of this with data aggregated by the Bank for
International Settlements which shows that increases in capital
requirements lead directly to reductions in lending and it
becomes clear that this effort is not about managing financial
stress, but it is really about causing financial stress,
specifically to those companies and industries that are
politically unpopular.
Dr. Rossi, what impact would the assessment of capital
surcharges, like those detailed in the draft Climate Crisis
Financial Stability Act, have on lending to fossil energy
firms?
Mr. Rossi. You have hit on many of the points that I would
make. I think the first one that I would mention is that
raising capital, first of all, will squeeze out lending in
other segments, particularly in that segment.
If you are talking about, as I have seen, 150-percent risk
rate associated with oil and gas investments as one of those
proposed bills has in it, I would be concerned, first of all,
as to where does that 150-percent risk rate actually come from?
What is the empirical basis for that?
Because if you can imagine what that means, we are talking
about significant amounts of capital being dedicated to
investments in oil and gas which have knock-on effects, as I
mentioned earlier, in terms of lack of ability through lack of
lending to be able to go out and do the kind of oil and gas
exploration that is needed to keep us protected against having
to go elsewhere abroad for our fuel needs.
Mr. Barr. I do think there is a risk here that by choking
off financing to some of these energy companies that are really
at the forefront of innovation in carbon capture and other
technologies, that this could actually be very
counterproductive.
And it does look like an effort to exploit climate as an
excuse to justify a move towards government central planning as
opposed to an effort to help deploy capital to innovative
companies that actually might ameliorate emissions and decrease
emissions.
Let's talk about systemic risk for a second. There is an
important distinction between systemic risk and business risk.
Systemic risk has a very specific definition: A certain
activity or entity has the potential to actually bring down the
entire financial system without enhanced supervision. But
business risks are the countless risks firms manage every day,
that if not mitigated properly, may have an impact on their
bottom line.
No one is denying the risk of changing weather patterns,
and, in fact, banks, insurers, and other financial firms are
already managing them as traditional business risk.
It is hyperbolic to suggest, as some of my colleagues and
vocal advocates have, that climate change, a phenomenon that
occurs over literally decades, can somehow suddenly and
precipitously overwhelm the banking system, the insurance
sector, and the reinsurance sector, especially when you
consider that a lot of the stress testing happens only over 9
quarters.
So, Dr. Rossi, how are banks currently managing climate
risk, and are they capable of effectively managing it without
prudential supervision?
Mr. Rossi. I am going to take you back, Congressman, to the
earlier comment that I made about this with regard to
Citigroup's climate disclosure.
Now, again, I don't work at Citigroup any longer, but
having looked at that just objectively, I would say that is a
really good first step in the process.
They have gone through and they have identified where their
climate risk exposures are, and they have identified the
governance and the processes and controls that are necessary to
manage climate risk. And they are doing it fairly
comprehensively. Again, you are talking about a far-flung
portfolio reaching out to many, many countries in terms of
their investments.
I think they are on the right track, and I am sure all of
the other big banks are on a similar path to do that.
Mr. Barr. My time has expired. If I could just--if the
chairman would just indulge one final comment.
We talk about transition risk. A lot of these bills that
are being proposed by this hearing, I think create the
transition risk.
Chairman Perlmutter. The gentleman's time has expired.
Mr. Barr. I yield back.
Chairman Perlmutter. I thank him for that one additional
comment.
I would like to thank the witnesses.
I think there is agreement here that there is some real
risk in the financial system. And I think the question is, how
long of a horizon can we really analyze and determine?
But there is no question that there is risk here. I think
all the panelists would agree.
And I just appreciate the testimony. I am sorry that it has
been kind of a rushed afternoon. I want to thank you all for
your testimony and for devoting the time and resources to share
your expertise with this subcommittee. Your testimony today
will help advance the work of our subcommittee and of the
House.
The Chair notes that some Members may have additional
questions for these witnesses, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
This hearing is now adjourned, and I thank the witnesses. I
am going to come down and thank you personally.
And to those of you on the screen, thank you very much.
Your testimony was really appreciated.
And, again, we are in the middle of a very busy afternoon,
so we really appreciate you being here. Thank you.
[Whereupon, at 3:28 p.m., the hearing was adjourned.]
A P P E N D I X
June 30, 2021
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