[Senate Hearing 117-214]
[From the U.S. Government Publishing Office]
S. Hrg. 117-214
21ST CENTURY ECONOMY: PROTECTING THE
FINANCIAL SYSTEM FROM RISKS ASSOCIATED
WITH CLIMATE CHANGE
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING THE RISK CLIMATE CHANGE POSES TO OUR ECONOMY
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MARCH 18, 2021
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Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
__________
U.S. GOVERNMENT PUBLISHING OFFICE
47-082 PDF WASHINGTON : 2022
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
SHERROD BROWN, Ohio, Chairman
JACK REED, Rhode Island PATRICK J. TOOMEY, Pennsylvania
ROBERT MENENDEZ, New Jersey RICHARD C. SHELBY, Alabama
JON TESTER, Montana MIKE CRAPO, Idaho
MARK R. WARNER, Virginia TIM SCOTT, South Carolina
ELIZABETH WARREN, Massachusetts MIKE ROUNDS, South Dakota
CHRIS VAN HOLLEN, Maryland THOM TILLIS, North Carolina
CATHERINE CORTEZ MASTO, Nevada JOHN KENNEDY, Louisiana
TINA SMITH, Minnesota BILL HAGERTY, Tennessee
KYRSTEN SINEMA, Arizona CYNTHIA LUMMIS, Wyoming
JON OSSOFF, Georgia JERRY MORAN, Kansas
RAPHAEL WARNOCK, Georgia KEVIN CRAMER, North Dakota
STEVE DAINES, Montana
Laura Swanson, Staff Director
Brad Grantz, Republican Staff Director
Elisha Tuku, Chief Counsel
John Richards, Counsel
Dan Sullivan, Republican Chief Counsel
Alexander LePore, Republican Detail
Cameron Ricker, Chief Clerk
Shelvin Simmons, IT Director
Charles J. Moffat, Hearing Clerk
(ii)
C O N T E N T S
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THURSDAY, MARCH 18, 2021
Page
Opening statement of Chairman Brown.............................. 1
Prepared statement....................................... 43
Opening statements, comments, or prepared statements of:
Senator Toomey............................................... 4
WITNESSES
Gregory Gelzinis, Associate Director, Economic Policy, Center for
American Progress.............................................. 7
Prepared statement........................................... 44
Responses to written questions of:
Senator Cortez Masto..................................... 102
Nathaniel Keohane, Senior Vice President, Climate, Environmental
Defense Fund................................................... 9
Prepared statement........................................... 68
Responses to written questions of:
Senator Cortez Masto..................................... 104
Marilyn Waite, Climate And Clean Energy Finance Program Officer,
The William and Flora Hewlett Foundation....................... 11
Prepared statement........................................... 78
John H. Cochrane, Senior Fellow, Hoover Institution, Stanford
University..................................................... 12
Prepared statement........................................... 92
Benjamin Zycher, Resident Scholar, American Enterprise Institute. 14
Prepared statement........................................... 93
Additional Material Supplied for the Record
Managing Climate Risk in the U.S. Financial System............... 110
GAO Report: Public Companies--Disclosure of Environmental,
Social, and Governance Factors and Options To Enhance Them..... 284
(iii)
21ST CENTURY ECONOMY: PROTECTING THE FINANCIAL SYSTEM FROM RISKS
ASSOCIATED WITH CLIMATE CHANGE
----------
THURSDAY, MARCH 18, 2021
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10 a.m., via Webex, Hon. Sherrod
Brown, Chairman of the Committee, presiding.
OPENING STATEMENT OF CHAIRMAN SHERROD BROWN
Chairman Brown. The hearing of the Banking, Housing, and
Urban Affairs Committee will come to order.
This hearing is in the virtual format. For those joining
remotely, a few reminders.
Once you start speaking, there will be a slight delay
before you are displayed on the screen. To minimize background
noise, please click the mute button until it is your turn to
speak or to ask questions.
You should all have one box on your screens labeled
``Clock'' that will show you how much time is remaining. For
all Senators, the 5-minute clock still applies for your
questions. At 30 seconds remaining, you will hear a bell ring
to remind you your time has almost expired. It will ring again
when your time has expired.
If there is a technology issue, we will move to the next
Senator until it is resolved. To simplify the speaking order,
Senator Toomey and I have agreed to go by seniority for this
hearing.
Today the Banking and Housing Committee is holding its
first-ever hearing on the risk climate change poses to our
economy.
It makes it the first time our Committee will consider all
the economic opportunities that exist by addressing climate
change.
More than ever, people in Ohio and Pennsylvania and around
the country are experiencing how climate change affects their
lives--from devastating hurricanes to raging wildfires, from
harmful algal blooms in my beloved Lake Erie, to landslides in
Cincinnati, to erratic farming seasons across the Midwest.
People are not stupid. They see what is happening; they
know it threatens not only their air and their water, but it
threatens their homes and their livelihoods.
They know also that there are all sorts of opportunities in
communities in every State that come with taking climate change
seriously.
They see the wind turbines across the Great Plains made
with steel made in Pennsylvania or Ohio or Illinois. They see
people installing solar panels made in Toledo at one of the
biggest solar energy manufacturers in the country.
We cannot have a 21st century economy built on a 19th
century model. That does not make environmental sense.
It also does not make economic sense.
If we want an economy that creates jobs and improves
infrastructure in all our communities and allows our businesses
and our workers to compete around the world, then instead of
running from these opportunities, we have to seize them.
I want to be clear: It is not the role of this committee to
vilify--or for that matter, to prop up--any specific technology
or any source of energy. The work of coal miners in eastern
Ohio, in Belmont County, has every bit as much dignity as the
work of a battery manufacturer in Fremont, Ohio.
We show those workers no respect if we do not plan now for
how we are going to protect their communities from flooding and
drought and economic upheaval, and how we are going to protect
their retirement and their children's college savings from
risky investments.
On this Committee, we are charged with looking at anything
that could hurt the stability of our economy.
This is a set of issues my Democratic colleagues have
talked about for a long time.
And a lot of what we will talk about today got a jump start
last year when now-Acting CFTC Chair Rostin Behnam created his
Climate-Related Market Risk Subcommittee.
The Subcommittee put out an important report, ``Managing
Climate Risk in the U.S. Financial System.''
Just yesterday he announced he is establishing a Climate
Risk Unit in CFTC to focus on the role of derivatives in
understanding, pricing, and addressing climate-related risk.
I would like to ask unanimous consent to enter the CFTC
subcommittee report, ``Managing Climate Risk in the U.S.
Financial System'', into the record for this hearing. Without
objection, it is entered.
Being on the lookout for risk is our job here. We cannot
always predict what it might be. It could be the business
decisions of a few bad actors in a particular industry. Or we
might be forced to act because of events beyond our borders.
In this case, though, we can predict something that is
going to hurt the economy. We know--underscore ``know''--that
climate change threatens the country's financial stability.
And the financial sector and the Government agencies that
oversee it are going to have to reckon with the consequences of
decades of risky investments in industries that fuel natural
disasters and threaten people's paychecks and threaten their
retirement security.
For years, the biggest corporations have fought Government
action on climate change because CEOs could make a lot of money
in the short term by endangering our planet in the long term.
And then those corporations and these CEOs expect workers and
their families to foot these very expensive bills.
We cannot protect the economy--and the people who make it
work--if we do not start by identifying the risks.
We know far too little about how much climate-related risk
is sitting on the books of banks and insurance companies.
It is not a surprise that Wall Street is trying to hide
just how heavily they have invested in corporate polluters.
This lack of transparency about the largest U.S. banks'
significant investments in long-term fossil fuel projects here
and abroad hides potential financial risks.
These are risks that workers and families investing their
pensions and 401(k)s will likely pay the price for.
We need to know where Wall Street is investing people's
hard-earned savings. And if it is invested in shrinking
industries that threaten their jobs and their communities, we
need to know about it.
That means looking at stronger transparency rules. It means
looking at whether the tools that financial watchdogs already
have can help us shine a light on these risks.
While some large banks and other companies have voluntarily
disclosed some of their investments, not enough of them have.
They are not moving fast enough.
We needed this years ago.
Look around. Climate-related disasters are already here,
already grinding some local economies to a halt, already
forcing some out of work, already destroying some communities.
The second polar vortex in a decade to cripple Texas is not
far behind us. We are already approaching what some are
predicting will be an above-average hurricane. Those are
economic risks.
Persistent drought leaves the Mountain West dealing with
wildfires that rack up multi-billion-dollar economic losses
year after year, in fire seasons that are so constant they have
ceased to be seasons. That is an economic risk.
Farmers in the Plains States lost an entire planting season
because of wet fields or flooding that once would have been
shocking, but now is all too common. That is also an economic
risk.
A 3-day downpour flooded 100,000 homes in Houston, forced
hundreds of thousands of people out of their homes, ground
commerce to a standstill at one of the three busiest ports in
the country. With effects like that, it is hard not to think
that the only way you could fail to see an economic risk, is if
you are being paid not to see one.
It is also not enough to just think about the climate risks
to companies' balance sheets or stock prices. The financial
industry and our Government have to take into account the risks
to people's livelihoods, the communities they live in, the food
they eat, the investments they have made for their retirement.
And as we look for opportunities, we need to make sure that
American industry--steel and aluminum, paper and autos, and
beyond--can access the capital they need to reduce or eliminate
emissions.
And when we increase transparency across the financial
sector and take into account the clear economic costs of
climate change, then lenders and industry and workers will be
rewarded by making those capital investments.
Today we will hear from five witnesses who will share their
insights and expertise on these risks and the opportunities we
have to protect and rebuild our economy. I hope my colleagues,
all of us, will keep an open mind about all of this.
Every day we delay is another missed opportunity to invest
in new technologies, in new industries, to make our businesses
more competitive, to create jobs in communities that have so
often been left behind. The Ranking Member and I have many
places in our States that feel that way.
If we do not tell people the truth and take this seriously,
we know who pays the price. It is never CEOs. It is never the
corporate boards. It is never people that work at think tanks.
It is never Senators who pay the price.
It is going to be the ranchers in North Dakota and South
Dakota, the line cook in New Orleans, the kindergartner with
asthma in Las Vegas, the steel worker in Cleveland, the clerk
in New Hampshire.
It is their jobs, their savings, and their futures on the
line. It is our job to be on their side.
Senator Toomey is recognized for 5 minutes or whatever you
need.
OPENING STATEMENT OF SENATOR PATRICK J. TOOMEY
Senator Toomey. Thank you, Mr. Chairman.
The title of today's hearing is ``21st Century Economy:
Protecting the Financial System from Risks Associated with
Climate Change,'' which begs the question: Who is supposed to
protect the financial system from these risks, and how?
In the view of at least some of my Democratic colleagues,
the answers seem to be the Fed, the SEC, and other----
Chairman Brown. Your volume is off. There we go.
Senator Toomey. Can you hear me now? Can you hear me, Mr.
Chairman? Can you hear me now? I am not on mute, according to
my screen.
Senator Smith. I can hear you, Senator Toomey. This is
Senator Smith.
Senator Toomey. OK. Thank you, Senator Smith. Cameron, can
you hear me?
Mr. Ricker. Yes, sir, I can hear you.
Senator Toomey. OK.
Chairman Brown. Everybody else hears you but me. I do not
know quite what is wrong. Sorry about that.
Senator Toomey. Why don't I resume?
Chairman Brown. Go ahead.
Senator Toomey. OK, I will resume. And what I want to do is
offer a different perspective.
Just as we would not task the EPA with auditing corporate
books even of energy companies, financial regulation and
supervision is not meant for advancing environmental policy. As
Fed Chairman Powell himself has said, ``Society's broad
response to climate change is for others to decide, in
particular elected leaders. If Congress believes current
environmental policies do not adequately address climate risk,
then changes should be enacted through the legislative process,
not through financial regulation.''
Of course, this should be the responsibility of Congress.
It is Congress that is accountable to the American people and
would take responsibility for the costly tradeoffs if, for
instance, we decided to rely more on expensive renewable energy
rather than less expensive conventional energy.
Regarding the Fed, the climate policy is clearly beyond the
scope of its mission and authorities. The Fed was created to be
independent and free from political influence. As one of
today's witnesses, John Cochrane, has observed, ``A central
bank in a democracy is not an all-purpose do-good agency to
subsidize what it decides to be worthy, defund what it
dislikes, and force banks and companies to do the same.''
The Fed's recent actions on climate, however, suggest that
this is the direction that some at the Fed would like to
pursue. For example, the Fed's newly created committee that is
focused exclusively on climate risk raises a number of
questions. Although it was announced nearly 2 months ago, we
still do not have any details on its objective or how it
intends to achieve them. Similarly, Fed Governor Lael Brainard
has suggested the Fed may require banks to engage in ``climate
scenario analysis,'' but she has not provided any specificity
on the purpose or rationale or process for such an exercise.
And this is in spite of the fact that banks already evaluate
their risks and respond accordingly. By straying from its core
mission and authorities in support of vague and ill-defined
climate goals, the Fed's actions threaten to undermine its
credibility and to betray its independence.
Climate policy is also beyond the scope of the Fed's
expertise. We know there are significant shortcomings and gaps
in climate models and data. The Fed has acknowledged that
historical climate data is insufficient to make accurate
predictions of future climate scenarios. And climate
researchers themselves have warned that their models are built
for 100-year simulations, not projections of the immediate
years or even decades ahead.
Given the uncertainty within the climate community itself,
why should we believe that the Fed has a greater understanding
of climate risks than regulated institutions? The answer is we
should not.
One recent paper by a group of climate researchers found
that current climate models cannot provide financially
meaningful information. The Fed should not become a climate
soothsayer any more than they should start regulating based on
the risk of domestic instability, widespread famine, or other
black swan events. As one of today's witnesses, Ben Zycher,
will explain in more detail, the Fed is not in a position to
navigate the enormous uncertainties and complexities underlying
climate models. Financial regulators just have no experience or
expertise in environmental policy, and any attempt to impose
new requirements will only result in the Government picking
winners and losers.
The Fed should not follow the example of some other
regulators engaged in mission creep, nor should the SEC. I have
warned that many on the left want the SEC to use its regulatory
powers to advance a progressive social agenda, including on
climate change. Now under the SEC's Acting Chair, the agency is
beginning to do exactly that.
For example, earlier this month, the SEC announced the
creation of a Climate and ESG Task Force to scrutinize issuers'
disclosure of climate risk. And on Monday, the Acting SEC Chair
proposed a chilling and authoritarian idea. She argued the SEC
should force companies to disclose any type of political
advocacy spending because firms may, and I quote, ``state that
they support climate-friendly initiatives but have donated
substantial sums to candidates with climate voting records
inconsistent with such assertions.''
Well, inconsistent according to whom? I mean, what this
really means is that these green friendly companies may support
some Republicans, and that is unacceptable. These actions
represent a clear abuse of power and a politicization of the
SEC's disclosure standard. The concept of materiality is the
cornerstone of the disclosure- based regime under Federal
securities laws, and what matters is whether an issue is
financially material to a reasonable investor.
The real objective here seems to be to punish politically
disfavored industries. By straying from beyond their mandates
into the climate arena, financial regulators will pressure
banks not to serve politically disfavored industries such as
fossil fuel companies. But who is next? Gun manufacturers?
Conservative media? Religious-minded businesses like Hobby
Lobby? This is a wholly inappropriate use of financial
regulation in an attempt to substitute political favoritism for
private business decisions.
Radical policies to force banks to cutoff capital to these
companies would not have a meaningful impact on the climate, as
Dr. Zycher will testify, but will only raise energy prices for
consumers.
So I began my statement by asking, Who is supposed to
protect the financial system from risks associated with climate
change and how? Or you could simply ask, Exactly what risks?
The major threat to energy-related assets is not financial risk
caused by weather-related events. It is the risk that
unelected, unaccountable, woke regulator will misuse the levers
of power in ways never imagined to remake society according to
their politics. That result, political favoritism caused by
regulatory abuse, that is what we really need to protect the
financial system, business, and workers from.
Chairman Brown. Thank you, Senator Toomey, and I apologize
for the beginning. I guess all of you could hear and for some
reason we could not. I apologize for interrupting like that. So
thank you for your words.
I will introduce today's witnesses. We will hear from five
witnesses.
Gregory Gelzinis is the associated director for economic
policy at the Center for American Progress. At CAP, Mr.
Gelzinis focuses primarily on financial institutions, financial
markets, and consumer finance policy. His experience includes
stints at Swiss Re, the Federal Home Loan Bank of Atlanta, and
on Capitol Hill.
Dr. Nat Keohane is the senior vice president, climate, the
Environmental Defense Fund. He is a Ph.D. economist, leads
EDF's climate program. He is an adjunct professor at the New
York University School of Law where he teaches a seminar on
climate change policy. During the Obama administration, Dr.
Keohane was appointed to be a Special Assistant to the
President for Energy and Environment on the National Economic
Council and Domestic Policy Council.
Ms. Marilyn Waite is the climate and clean energy finance
program officer at the William and Flora Hewlett Foundation.
She manages the foundations grantmaking and other activities in
the foundation's climate and clean energy finance portfolio.
Prior to joining Hewlett, she worked on clean energy venture
investment and economic development on four continents.
Dr. John Cochrane is the Rose-Marie and Jack Anderson
Senior Fellow at the Hoover Institution at Stanford University.
Prior to Stanford, Dr. Cochrane taught first in the Economics
Department, later in the Booth School of Business at the
University of Chicago, where he was the AQR Capital Management
Distinguished Service Professor of Finance.
And, last, Dr. Benjamin Zycher is a resident scholar at the
American Enterprise Institute. Dr. Zycher researches and writes
on energy and environmental policy for AEI. Prior to joining
them, Dr. Zycher ran his own public policy research firm,
served in the Office of Economic Analysis, Bureau of
Intelligence and Research at the U.S. Department of State. He
taught economics at UCLA and at Cal State, Channel Islands. He
has been a senior economist at RAND and the Jet Propulsion Lab,
was a senior staff economist of the Council of Economic
Advisers for President Reagan.
We are fortunate to have such an esteemed panel of experts
to discuss a topic that I believe Banking and Housing is
frankly overdue tackling, namely, potential impacts on our
economy from climate change and climate- related risks to the
financial system. I welcome all five of our witnesses. I thank
you all for agreeing to appear before our Committee.
Mr. Gelzinis, I welcome you to give your opening remarks,
and we will follow with other witnesses in the order I have
introduced you this morning. So, Mr. Gelzinis, if you would
begin. Thank you.
STATEMENT OF GREGORY GELZINIS, ASSOCIATE DIRECTOR, ECONOMIC
POLICY, CENTER FOR AMERICAN PROGRESS
Mr. Gelzinis. Thank you. Chairman Brown, Ranking Member
Toomey, and Members of the Committee, thank you for the
opportunity to testify before the Committee on this critical
issue. My name is Gregory Gelzinis. I am an associate director
for economic policy at the Center for American Progress, where
I research, and advocate for, policies that would create a
safer, more stable, and less predatory financial system--one
that is well positioned to support long-term economic growth.
The coronavirus pandemic has proven to be a terrifying
reminder that our collective livelihoods can be upended by
catastrophic exogenous shocks, seemingly at a moment's notice.
It is incumbent on policymakers to use this experience as a
catalyst toward addressing the impending exogenous shock that
will likely disrupt our lives on a much greater scale: climate
change.
The climate crisis has profound implications for life and
health, as it challenges our very ability to sustain a
habitable planet. Climate change is also going to have a
fundamental impact on every sector of our economy, including
the sector we are here to discuss today: the financial sector.
The increase in frequency and severity of extreme weather
events and long-term environmental shifts threatens an array of
real assets and financial assets. From commercial and
residential real estate exposures along the coast to
agricultural lending in the Midwest, climate change could
severely impair the value of physical collateral, disrupt
supply chains, limit economic activity, increase financial
uncertainty, and strain profitability. These effects would
reduce real estate and commodity values, lower corporate equity
prices, and limit the ability of businesses and households to
repay debt.
In addition, the financial system is exposed to transition-
related risks. If policymakers take the legal and regulatory
actions necessary to meet emissions and temperature targets,
financial institutions whose balance sheets do not align with
the transition could face significant losses. Financial
instruments tied to carbon- intensive sectors could face a
severe repricing as policies restrict and raise the costs of
emissions. Technological advancements and shifts in investor
sentiment could also trigger such losses in advance of any
legal or regulatory actions.
Under certain scenarios, financial institutions could
adjust to these transition effects abruptly, bursting the
carbon bubble and creating what former Bank of England Governor
Mark Carney has coined a ``climate Minsky moment.''
Climate change does not only present risks to individual
financial institutions. It also poses a systemic threat due to
the potential magnitude of the physical and transition-related
risks, the wide array of financial institutions and markets
exposed to these risks, and the speed with which these possibly
correlated risks could materialize. These risks are not
theoretical. In just the past 2 years, we have seen arguably
first climate bankruptcy in PG&E and witnessed energy companies
like BP and Total, write down the value of stranded assets, as
energy price assumptions are recalibrated.
The financial sector is finally starting to adjust to these
risks, and recent net-zero commitments from the largest Wall
Street banks are a welcome development, although such
commitments have been light on details and lack near-term plans
to meet those long-term goals. But it is critical for
regulators to step in and account for these risks in the
supervision and regulation of the financial system. We cannot
let Wall Street write the rules and rely upon the disproven
strategy of self-regulation, especially as these firms continue
to finance the very drivers of the climate crisis that put
their own balance sheets, as well as those of responsible
firms, at risk.
Financial regulators have broad responsibilities under
existing law to mitigate these climate-related risks. Markets
regulators have a responsibility to protect investors, to
promote transparency, and to foster healthy markets for
securities and derivatives. Prudential regulators have a
statutory mandate to ensure the safety and soundness of
financial institutions and to promote the stability of the
financial system.
Climate change clearly falls within these mandates, and a
failure to mitigate climate-related risks would violate the
duties Congress bestowed upon the financial regulators.
Thankfully, over the past few months a bipartisan collection of
U.S. financial regulators have acknowledged that climate change
falls within their remit. Even though the U.S. is several years
behind its international peers, recent actions and
announcements by the White House, Treasury Department, Fed,
SEC, CFTC, FHFA, FDIC, and State-level regulators signal that
momentum is building. Like many economic variables, these risks
will not be easy to model or quantify, given the inherent
uncertainty climate change entails. But the potential magnitude
of the risk demands regulators employ a precautionary principle
and safeguard the financial system from the worst outcomes.
Integrating climate change into corporate and financial
disclosure requirements, fiduciary obligations, stress testing,
supervision, capital requirements, and systemic risk oversight
would bolster the resilience of the financial system and
position it to serve as a source of strength to the economy
during the low-carbon transition. If regulators fail to act
with sufficient speed or refuse to use their full panoply of
tools, it is imperative for Congress to insist that they do so.
The stakes are simply too high.
Thank you, and I look forward to your questions.
Chairman Brown. Thank you very much, Mr. Gelzinis.
Dr. Keohane.
STATEMENT OF NATHANIEL KEOHANE, SENIOR VICE PRESIDENT, CLIMATE,
ENVIRONMENTAL DEFENSE FUND
Mr. Keohane. Thank you. Chairman Brown, Ranking Member
Toomey, and honorable Members of the Committee, thank you for
inviting me to testify with such a great group.
My name is Nat Keohane, and I am the senior vice president
for climate at Environmental Defense Fund, a global, U.S.-
based, nonprofit environmental organization with over 2 million
members and activists. This is a timely and urgent hearing as
the impacts of climate change grow more visible every year.
I would like to make three main points.
First, climate change poses significant risks to the U.S.
economy and financial system. I was a member of the Climate-
related Market Risk Subcommittee of the Commodity Futures
Trading Commission that Chairman Brown mentioned and the co-
author of that report, which was unanimously approved by the
subcommittee's 34 members drawn from a range of industries and
civil society. The report conveys a stark message to financial
institutions, regulators, and policymakers: Climate change
poses serious risks that, if ignored, will undermine the
financial system's ability to support the American economy.
As the report shows, climate risk extends throughout the
economy, covering sectors including agriculture, airlines,
automobile manufacturers, hospitality, power generation, and a
wide range of industrial sectors like concrete and steel. The
report highlights some specific examples of financial
institutions and assets that are particularly vulnerable to
climate risk. Here are a few.
Regional and community banks, whose loan books are
typically dominated by commercial real estate loans in a given
area. As a result, local financial institutions in areas of
climate risk, coastal areas or areas vulnerable to hurricanes,
are particularly vulnerable to climate risk and to the
financial risk it conveys.
Second, agricultural banks, which also face correlated risk
because of their concentrated loans in particular geographic
areas and in the agricultural businesses, a credit-stressed
agricultural lending system, which we have already seen signs
of in the Midwest in recent years, would decrease farmers'
access to affordable credit and make it harder to recover from
climate shocks.
Municipal bonds are a third example. An analysis from
BlackRock Institute demonstrated that municipalities threatened
by climate change could face significant losses of GDP,
impairing their ability to service their obligations, and
raising financial risk to bond holders.
In other words, this is not just about big banks on Wall
Street. This is about everyday transactions on Main Street:
commercial real estate loans, farm credit, and small business
loans that underpin the U.S. economy and that depend on a
stable financial system.
How likely are these climate risks? The scary answer is we
do not know because we are not tracking them and getting the
information we need. Members of the financial community who
ignore climate change, whether they are banks, investors, or
regulators, do so at their peril.
So this leads to my second point, which is that financial
regulators have a clear responsibility to address climate risk,
particularly with respect to mandatory climate disclosure. It
is important to note that the duties and authorities of
regulators remain the same as they have been. What is new is
the magnitude and materiality of climate risk.
The most important recommendation for regulators is that
the SEC should strengthen mandatory climate risk disclosure in
order to drive comparable, specific, and decision-useful
information from regulated entities rather than the boilerplate
climate reporting that is all too common. Better disclosure of
climate risk would benefit investors, companies, and the
American public and improve the functioning of markets.
My third and last point is that there is significant demand
and opportunity to channel private capital into low- carbon and
climate-friendly investment opportunities. Over the past 5
years, we have seen private demand increase dramatically for
this kind of lending. The Climate Action 100+ Initiative,
designed to support transition to net-zero business strategies,
now has nearly 550 investors and $52 trillion in assets under
member management.
In this area of opportunity, the single most important
thing that policymakers could do in order to ensure that
private capital flows more efficiently to low-carbon economies
is to implement a fair and effective price on carbon across the
economy. This is a core recommendation as well of the CFTC
report that I mentioned at the beginning.
In conclusion, climate change poses significant risks to
the U.S. financial system, but well-designed policies,
particularly including strengthening mandatory climate risk
disclosure rules and implementing a price on carbon, could help
to manage and mitigate those risks.
Thank you for your attention.
Chairman Brown. Thank you, Dr. Keohane.
Ms. Waite, you are recognized for 5 minutes. Thank you for
joining us.
STATEMENT OF MARILYN WAITE, CLIMATE AND CLEAN ENERGY FINANCE
PROGRAM OFFICER, THE WILLIAM AND FLORA HEWLETT FOUNDATION
Ms. Waite. Chairman Brown, Ranking Member Toomey, and
Members of the Committee, thank you for inviting me to testify
today.
I am a program officer for climate and clean energy finance
at the William and Flora Hewlett Foundation where my work
involves setting and implementing securities to mobilize
capital for climate change solutions. I focus primarily on
venture capital, asset management, and bank lending, including
the market rules needed to decarbonize the financial system.
Prior to the foundation, I worked in nuclear and renewable
energy and venture capital for clean transportation.
In 2020, the United States experienced almost two dozen
separate climate-related disasters, exacerbating the economic
toll of COVID-19 and costing $95 billion. As climate change
continues, we will see a number of sectors hurt from aviation--
think of crippling heat grounding planes in Arizona--to
agriculture, with heavy rain and snow overwhelming the Western
farms.
As both climate-related physical and transition risks
indicate, the financial system and the real economy will be
devastated as the planet continues to warm, with real losses
already manifesting in some sectors and assets classes. The
challenge goes far beyond just protecting the financial system
from climate risk. In fact, finance is an essential part of
solving climate change and can do so while creating jobs and
innovation. The U.S. must bring our annual 6 gigatons of carbon
emissions down to zero, which requires roughly $250 billion of
additional investment annually.
Taken together, the following practical policy actions
endorsed by key finance experts can unlock the capital needed.
After all, we have $15 trillion sitting in our everyday account
as deposits. Mobilizing less than 2 percent of that will allow
us to achieve a net-zero goal.
First, we must get our measurement house in order for
transparency and accountability. Policymakers, including the
SEC and OCC, should require financial institutions to measure
and disclose the carbon emissions of their loans and
investments. This should be done on an annual basis with very
clear reduction targets. Banks and asset managers representing
over $25 trillion, including credit unions in Montana and
trillion-dollar banks in North Carolina, are already doing so.
Yet to protect the entire financial system and real economy,
Government must step in and mandate this accounting for all.
Second, we must climate-proof the Nation's balance sheet.
The Federal Reserve must use the absolute emissions data
provided by banks to increase the risk rates for loans in
climate change-driving assets.
Third, we have to enable community-focused lenders to scale
climate-friendly loans. Communities of color bear the brunt of
environmental pollution and are likely to be disproportionate
impacted by unabated climate change. The good news is that
there are over 100 MDIs, 1,000 CDFIs, 5,000 credit unions, and
5,000 deposit-taking banks that stand ready to support
communities in wealth-building decarbonization. Treasury should
provide secondary capital into community-focused lenders to
support long-term climate resiliency.
Fourth, we can deploy trillions without public spending
through mandates mirrored after the Community Reinvestment Act.
Not only can the existing CRA be strengthened to explicitly
provide credit for climate-friendly loans, Congress can instate
a new mandate that incentivizes banks to invest in climate-
friendly infrastructure.
Fifth, we must enable consumer finance for climate action.
Just as mobile number portability in telecommunications and the
automated customer account transfer service in broker-dealers
lowered the barriers to customer choice, so too can new
policies by the CFPB lower the cost of closing and switching
bank accounts.
Finally, policymakers at all levels of Government,
including the SEC, FINRA, and the Department of Labor, should
modernize fiduciary duty definitions to align with climate risk
and impact. DOL should issue rules to require ERISA plan
managers to adopt and implement sustainable climate-friendly
investment policies.
In summary, the market rules that enable a climate-safe
economy should be as robust, pervasive, and serious as the
climate crisis itself. Financial regulation and congressional
mandates should ensure that the recovery is one that brings
prosperity to all.
Thank you.
Chairman Brown. Thank you, Ms. Waite.
Dr. Cochrane, you are recognized for 5 minutes. Thank you
for joining us.
STATEMENT OF JOHN H. COCHRANE, SENIOR FELLOW, HOOVER
INSTITUTION, STANFORD UNIVERSITY
Mr. Cochrane. Thank you. Chairman Brown, Ranking Member
Toomey, and Members of the Committee, thank you very much for
the opportunity to testify today.
Climate change is a very important challenge. But climate
change poses no measurable risk to the financial system.
``Risk'' means unforeseen events. We know exactly where the
climate is going over the horizon that financial regulation can
contemplate. Weather is risky, but even the biggest floods,
hurricanes, and heat waves have essentially no impact on our
financial system, and they are well modeled.
Moreover, the financial system is only at risk when
financial institutions as a whole lose so much, and so
suddenly, that they blow through their capital, and a run on
short-term debt erupts. That climate may cause a sudden,
unexpected, and enormous economic effect which could endanger
the financial system is a fantasy.
Now, sure, we do not know what will happen in 100 years.
But banks did not fail in 2008 because they bet on radios, not
TV, in the 1920s. Financial regulation does not try to look
past 5 or 10 years or so. Sure, a switch to renewables might
lower oil company profits. Oil stockholders might lose money.
But risk to the financial system cannot mean that nobody ever
loses any money. Tesla could not have been built if people
could not take risks.
So why is there a push for regulators to take on fictitious
climate risks? These proposals aim simply to defund the fossil
fuel industry before alternatives are available and to steer
funds to fashionable but unprofitable investments, by
regulatory subterfuge rather than aboveboard legislation or
transparent agency rulemaking.
This goal is not a secret. For example, the NGFS, which the
Federal Reserve recently joined, states plainly its goal is to
``mobilize mainstream finance to support the transition toward
a sustainable economy.'' But financial regulators are not
allowed to mobilize the financial system to projects they
choose and to defund projects they disfavor. So regulators must
pretend that they are dispassionately finding risks to the
financial system, and oh, we just happen to stumble on climate
here.
There are plenty of genuine severe risks to the financial
system. Imagine a new pandemic, one that kills 10 percent of
people and lasts for years without a vaccine. Suppose China
invades Taiwan or a nuclear bomb goes off. Suppose there is a
sovereign debt crisis. What happens if Treasury cannot roll
over its big debts and banks no longer take Treasury
collateral? Suppose a massive cyber attack wipes out the
accounts at a major bank and everybody rushes for cash
everywhere. These would indeed be genuine financial system
catastrophes. Yet of all of these large, obvious, and plausible
risks, our financial regulators want to focus on just one, a
fictitious climate risk. Why? Well, obviously, the end
justifies the means.
Climate is really important. Climate is too important to
let financial regulators play with it. Climate needs clear-
headed, science-based, steady, transparent policy, with
explicit cost-benefit analysis. Underhandedly funding and
defunding financial regulators' enthusiasms will produce
counterproductive feel-good policies.
True climate answers might include nuclear power,
geoengineering, carbon capture, hydrogen fuel cells,
genetically engineered foods, zoning reform, a carbon tax, as
Dr. Keohane suggested, and other approaches, which financial
regulators will never envision. If we had done this 10 years
ago, we would not have hydraulic fracking and natural gas,
which means the U.S. is leading the world in carbon reductions
and without which Russia, Iran, and Saudi Arabia would be
rolling in the money and America would be in much worse
economic shape.
Financial regulation is too important to be eviscerated on
the altar of defunding fossil fuels. Financial regulation needs
to get back to making sure that financial institutions have
capital to withstand all sorts of shocks which nobody can
foresee. It is hard work and it is boring work. You do not get
invited to Davos. Industry hates being told to get more
capital. But that is their job, and there is plenty to do.
The financial system is in peril. Last year was an abject
failure. Despite 12 years of intensive regulation and stress
tests and centuries of experience, financial regulators never
thought a pandemic might come. We made it through the last year
by one more massive bailout, not regulatory prescience, and now
they want to soothsay the climate?
Do not let the EPA regulate banks. Do not let our financial
regulators dream up climate policy. You will get bad climate
policy and a more fragile and sclerotic financial system if you
do.
Chairman Brown. Thank you, Dr. Cochrane.
Dr. Zycher is recognized for 5 minutes.
STATEMENT OF BENJAMIN ZYCHER, RESIDENT SCHOLAR, AMERICAN
ENTERPRISE INSTITUTE
Mr. Zycher. Thank you, Chairman Brown and Ranking Member
Toomey.
Neither Government agencies nor financial institutions are
in a position to evaluate climate phenomena with respect to
which the scientific uncertainties are vastly greater than
commonly asserted. The range of alternative assumptions about
central parameters is too great to yield clear implications for
the climate ``risks'' attendant upon the allocation of
financial capital among economic sectors. Those central
parameters include choices among climate models, the assumed
sensitivity of the climate system, the assumed future increase
in greenhouse gas concentrations, and many others.
If the Federal Reserve and the financial institutions opt
to use similar sets of analytic assumptions, a very real danger
would arise of more or less homogeneous predictions
inconsistent with the evidence on climate phenomena. If instead
opt to us differing sets of assumptions, the ensuing
predictions about future climate phenomena--that is, risks--
would vary substantially, yielding very large uncertainties in
terms of attendant implications.
Financial institutions would have powerful incentives to
undertake climate analysis driven not by the actual evidence
and the peer-reviewed literature. Instead, they will be driven
to undertake such analysis under assumptions and methodologies
distorted by regulatory directives, political pressures, and
litigation threats.
The aggregate benefits--that is, the positive risks--of
increasing greenhouse gas concentrations, as reported by NOAA
and in the peer-reviewed literature, almost certainly will be
excluded from the analyses of climate risks. Such analyses will
exclude also the risks of climate themselves, prominent among
which are the large and adverse implications of artificial
increases in energy costs. Such policy risks are likely to be
greater when implemented by bureaucracies insulated from
democratic accountability.
In any event, the major integrated climate and economy
model used by the U.S. Government suggests that the future
aggregate economic risks of anthropogenic climate change are
much smaller than many assert. Anthropogenic climate change is
real, increasing atmospheric concentrations of greenhouse gases
have yielded effects that are detectable, but they are much
smaller than commonly asserted, and there is no evidence--
none--in support of the climate crisis argument. We can discuss
this later if any members of the Committee deem it appropriate
to do so.
Moreover, temperature trends are driven by both natural and
anthropogenic influences that peer-reviewed literature suggests
the anthropogenic effects are responsible for about one-third
of the overall temperature increase observed since the end of
the Little Ice Age. The mainstream climate models have
predicted the actual temperature trend in recent decades
correlate, consistently overstating that trend by a factor of
more than two.
Application of the EPA climate model predicts that climate
policies, whether implemented by the U.S. Government alone or
as an international cooperative policy, would have temperature
effects by 2100 that would be virtually undetectable. Such
policies cannot satisfy any plausible benefit-cost test.
The incorporate of climate ``risks'' into the business
decisions of financial institutions would weaken the
materiality standard for disclosures by those institutions.
``Materiality'' always has meant the disclosure of information
directly relevant to the financial performance of the bank or
other institution. When ``risk'' analysis becomes an arbitrary
function of difficult choices among complex assumptions, the
traditional materiality standard inexorably will be diluted and
rendered far less useful for the financial markets, an outcome
diametrically at odds with the ostensible objectives of those
advocating the evaluation of climate ``risks.''
The reality is that a climate risk disclosure requirement
would be deeply speculative, and the level of detail and the
scientific sophistication that would be needed to satisfy such
a requirement are staggering. Such disclosures and supporting
analysis and documentation would take up many thousands of
pages, with references to many thousands more, and the premise
that this disclosure requirement would facilitate improved
decisionmaking by the financial sector is difficult to take
seriously.
A far wiser approach would entail allowing market forces to
make such risk determinations in a bottom-up fashion, thus
avoiding an obvious politicization of the allocation of
capital.
These proposals represent a blatant effort to distort the
allocation of capital away from economic sectors disfavored by
certain political interest groups pursuing ideological agendas.
This would represent the return of Operation Choke Point.
Thank you again, Chairman Brown and Ranking Member Toomey.
I will be pleased to address any questions that members of this
Committee may have.
Chairman Brown. Thank you, Dr. Zycher.
Mr. Gelzinis, I will start with you. What should financial
regulators do to make sure banks meet their 2030 and 2050 low-
carbon goals? Should regulators have a responsibility to
protect the banking system and responsible financial
institutions from banks that fund activity that contributes to
climate change?
Mr. Gelzinis. Yes, thank you for the question, Mr.
Chairman. In terms of meeting 2030 and 2050 targets that banks
are setting, I think regulators can use stress testing,
transition risk adjustments to our risk-rated capital
framework, and risk management standards that include
actionable transition plans. And just to be clear, these
policies are not intended to achieve climate goals. They are
intended to bolster the resilience of banks in the face of the
inevitable decarbonization of our economy.
And I am glad you asked the question, Mr. Chairman, about
banks that are financing, you know, emissions-driven sectors.
On banks that fund that climate change activity, Dodd-Frank is
quite clear that regulators should not only focus on the risks
a financial institution is facing, but also the risks that its
ongoing activities are creating for other financial firms. So
those banks funding significant emissions should have to
internalize the costs they are placing on other banks.
Chairman Brown. Thank you.
Dr. Keohane, banks have made a number of commitments to
supporting a transition to a low-carbon 21st century economy.
What steps should these banks take to show that this just is
not a PR campaign and that the banks will take the steps they
need to take to make good on these promises?
Mr. Keohane. Thank you, Mr. Chairman. I can identify three
areas where I think banks can do more, and I will just open by
saying I think it is--and I mention this in my written
testimony. I think it is a welcome sign that a number of major
banks, including Bank of America, Citi, Goldman Sachs, JPMorgan
Chase, Morgan Stanley, Wells Fargo, they have all made net-zero
commitments, and I just want to make a point. They have done
that not because of some regulatory requirement or some
regulator in Washington or bureaucrat in Washington. They have
done it because there is enormous demand from their customers
to do this. And so I just want to make that point because that
is--when we talk about what banks are doing, we talk about how
they are responding to the demand of their customers. From our
point of view, we think there is more that they should do, and
I think that is reflected because they are hearing that from
their customers.
The first point is transparency. We have seen a lot of
pledges. That is valuable. Now we need to see the plans. We
need to see how they are going to measure and report their
financed emissions, how they are going to reduce their own
emissions, but more importantly, how they see reducing the
emissions in their portfolios. And, you know, we need to see
what their plans are for reducing or compensating for remaining
emissions. So that transparency piece is the first.
The second is engagement. In particular, we see lots of
room for engagement. For example, with oil and gas companies,
during the transition to a low-carbon future, we need to be
addressing methane emissions from the oil and ga sector. This
is the easiest and cheapest way to cut warming now. And there
is a lot that banks can do and companies can do to engage with
oil and gas companies. This is already happening, and we need
to see more of it.
Finally, policy advocacy. One thing I would like to see
banks do is call for and support mandatory climate risk
disclosure. They acknowledge that climate risk is material, but
too many of them or too many companies are still putting
boilerplate comments together. We would like to see more robust
disclosure.
Chairman Brown. Thank you, Dr. Keohane.
Ms. Waite, you discussed enabling community-focused lenders
to lead in your testimony as a way low-income and middle-class
communities and communities of color can take advantage of the
opportunities that come with addressing climate change. Expand,
if you would, on what community- focused lenders can do to
improve the lives of those they serve and mitigate the effects
of both climate change and the industrial pollution that they
have endured for so long. What are the opportunities you see
for both banks and for businesses?
Ms. Waite. Thank you, Chairman. Community-focused lenders
are already helping communities mitigate and build wealth
through energy savings. They are providing affordable loans for
electric vehicles, healthy and efficient HVAC systems, and
rooftop solar. In its first 3 years of operation, the Clean
Energy Federal Credit Union, for example, has recorded zero
delinquencies and has sown loan participation across the U.S.,
including Tennessee, Wyoming, Pennsylvania, and Montana.
As a low-income-designated cooperative bank, they are
already teaching other credit unions how to value this asset
class. Remember that for some lenders who have a high exposure
to the dwindling taxi medallion industry, the clean energy
asset class provides an opportunity for diversification.
For businesses, which do not have credit scores, community-
focused lenders who know local operations are well positioned
to provide products and services as they transition their
assets to low carbon. At the same time, we see the need for
injection of long-term low-cost capital to enable rapid scaling
of these lending capacities.
Chairman Brown. Quickly, a couple of yes-or-no questions to
Dr. Cochrane and Mr. Gelzinis, if you would answer. Dr.
Cochrane, regardless of climate change, I understand that you
believe banks, the largest banks, should have much higher
capital requirements than they do currently. Is that correct?
Mr. Cochrane. For all risks, not just climate, yes.
Chairman Brown. Right. The Federal Reserve weakened the
supplemental leverage ratio last year, effectively lowering
capital standards. Do you think the Fed should extend that
exemption past the end of this month?
Mr. Cochrane. Yes, I do, because leverage is not capital.
Chairman Brown. Thank you.
Senator Toomey is recognized.
Senator Toomey. Thank you, Mr. Chairman.
Dr. Cochrane, you correctly noted that the far-reaching
postcrisis financial regulatory framework that was imposed on
financial institutions completely failed to consider the
possibility of a global pandemic disrupting the financial
system. Do you think the financial regulators would correctly
anticipate the way that climate change will affect different
regions of the country in the course of the next 3 or 4 or 5
years?
Mr. Cochrane. No.
Senator Toomey. I do not think so either.
Mr. Cochrane. I cannot expand on that one.
[Laughter.]
Senator Toomey. A yes-no answer is OK. Let me ask you this:
You also noted that central banks and certainly the Fed has no
authority to steer credit to areas they like and to defund
areas that they disfavor. Could you talk a little bit about
some of the risks if the Fed were to take it upon itself to
become an allocator of credit even if it did so indirectly?
Mr. Cochrane. Well, it is going to send things into
whatever pet projects the Fed decides are fun than into things
that it does not.
I should clarify a previous answer. The reason is because
there is no risk of climate within 4 or 5 years to different
regions of the country. ``Risk'' means things you do not know
what is going to happen. We know what the weather is going to
be like for the next 4 or 5 years.
Senator Toomey. And with respect to extreme weather events,
to what extent do financial institutions already consider the
applicable risks associated with weather? So, for instance, if
you are a bank and you lend money for the development of
condominiums on the waterfront in South Florida, do you think
it occurs to that bank to think that maybe a hurricane will
come along at some point?
Mr. Cochrane. Yeah, there is a big confusion here of
climate versus weather, and banks like that understand they are
exposed to weather risks, and they understand what the big
weather risks are, and they provision for them. And big weather
events just have had no effect on our financial system and will
continue not to have any effect on our financial system,
because people know that is coming.
Senator Toomey. Thank you.
Dr. Zycher, your testimony recognizes the enormous
complexities underlying climate models and projections. Is
there any reason at all to believe that the Fed is in a better
position to navigate these uncertainties and resolve these
challenges as opposed to other public and private sector
entities?
Mr. Zycher. No, there is no reason at all. Neither the Fed
nor the SEC nor other financial regulatory institutions have
particular expertise in this area. Inevitably, they would rely
upon analyses conducted at the EPA or other agencies' analyses
that themselves are deeply politicized as they have been, you
know, through the last several decades. And I think that there
is no particular reason to believe the Fed would add to the
stock of knowledge on these matters.
Senator Toomey. And do the climate models, as you know of
them, are they capable of telling us anything meaningful about
near-term financial risks?
Mr. Zycher. Well, the climate models are not designed to do
that. They are designed to incorporate a set of assumptions
yielding predictions about temperatures and other climate
phenomena--sea levels and the rest--over a horizon of between
50 and 300 years. That is what the climate models do. And with
one or two exceptions, they do it very poorly.
Senator Toomey. Now, if weather risks are material for any
particular public company, isn't it true that current SEC
regulations require full disclosure of those material risks?
Mr. Zycher. Well, I am not really an expert on the SEC
materiality requirements, but my understanding is that the
answer is yes; if there is strong data suggesting that there is
a risk to profitability, then the SEC framework requires that
those be disclosed.
Senator Toomey. And do you think it would be a good idea
for the SEC to require nonmaterial risks, nonmaterial in the
sense that they do not bear any risk to the financial
performance of the company?
Mr. Zycher. No, I do not believe that would be wise at all,
and the broader point is that the disclosure of climate risks
is so speculative that it is difficult to define it as
material. That is the central point.
Senator Toomey. All right. Thank you very much.
Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Toomey.
Senator Tester of Montana is recognized.
Senator Tester. Thank you, Chairman Brown. I want to thank
all the witnesses for being here today. There have been
multiple hearings going on today, so it is tough to be in two
places at once.
But this is an important issue for me. I am a third-
generation farmer. I have a real job outside the Senate, and I
will tell you that I have seen the impact of climate change
firsthand. It is undeniable: longer, hotter summers; flooding;
droughts. I have been on the farm since 1978, and I have seen
things happen the last 25 years that my father never saw
happen, and my grandfather certainly did not either. And I
think that it is something that is real, and I think it is
something that does impact people's financial decisions and
banks' financial decisions as to whether they are going to loan
money or not. And if we do not at least make some strides
toward how we are going to deal with climate, I think we are
going to lose family farms. I think we are going to lose our
ability to feed this Nation, and that is not a pretty sight, in
my opinion.
So this is a question for Mr. Gelzinis. Could you describe
to me the impacts we have already seen in the financial sector
from severe climate-related events? Or have we not seen any
impacts in the financial sector?
Mr. Gelzinis. It is a great question, Senator. So one of
the impacts that we have seen is on insurance company losses.
So over the past 5 years, on average, there have been over $100
billion of losses for insurers. If you go back, you know, 40
years, the annual average was less than $50 billion. So that
has significantly increased.
So one of the reasons why I bring up insurance is because
if those insurance companies start pulling out of business
lines or geographies, given the 1-year policies, then all of a
sudden the bank that thought it was protected against some of
these risks because it had a good insurance policy on its
longer-term asset no longer is. So we are starting to see those
physical risks, you know, creep in, and there are examples on
the coast as well.
Senator Tester. So I want to talk to you about an area that
you may or may not be familiar with, and that is crop insurance
that is something that is backed by the American taxpayer.
Something that, by the way, as a farmer, is absolutely
necessary that we have this, especially with climate change.
Can you tell me moving forward, from your point of view, is
the taxpayer going to be putting more and more money into crop
insurance? Or do you think that will be static because of
climate?
Mr. Gelzinis. So that is a little big outside my remit, but
I am happy to follow up with you and your staff, Senator.
Senator Tester. I appreciate it. I can tell you that with
the uncertainty that I see, I think that it is going to require
more and more subsidy moving forward. But I would love to hear
your opinion on that moving forward.
Look, I think we need to do a better job understanding the
risks posed to our economy by climate. We need to have
information on how to address these challenges that come along
with climate change. Consumers and investors deserve to know
how companies are exposed to these risks, what they are doing
to mitigate climate risks, and that means looking to the
future.
I think disclosure and transparency is very, very
important, whether it is corporate political spending or the
impacts of climate change on businesses.
Mr. Gelzinis, how important do you think access t
information about potential impacts of climate change is for
investor decisionmaking?
Mr. Gelzinis. It is critical. Think about the SEC's mission
to protect investors, to promote fair, efficient, and orderly
markets, and, you know, from capital formation, how are
investors supposed to do that if they do not have the necessary
information on climate-related risks that are of such a
magnitude that if they do not have those risks and those risks
are hidden, we are going to get overinvestment in certain
areas, underinvestment in others. You know, capital is going to
be inefficiently allocated, and folks are going to lose
confidence in both the transparency and resilience of our
capital markets.
Senator Tester. Are you concerned about the risks posed to
our economy by the climate change issue?
Mr. Gelzinis. Absolutely. Nearly every sector of our
economy is going to be impacted in one way or another.
Senator Tester. All I would like to say is--well, I just
came from a Senate Veterans' Affairs Committee meeting when I
turned it one, and it may be nomenclature, but the first thing
I heard was, ``We know what the weather is going to be like for
the next 4 or 5 years.'' Hell, I do not know what the weather
on my farm is going to be like for the next 4 or 5 days. So we
have got some challenges out there.
I want to thank all the witnesses for being here on this
panel.
Chairman Brown. Thank you, Senator Tester.
Senator Hagerty from Tennessee is recognized for 5 minutes.
Senator Hagerty. Chairman Brown, Ranking Member Toomey,
thank you for holding this important hearing, and I want to
thank all of our witnesses who are present today to give us
their perspectives on climate change.
A lot of so-called environmental, social, and governance--
ESG--focused investing is concerned with climate change. So
this hearing is also a really good opportunity to point out the
hypocrisy of many of these supposedly ESG-focused funds when
they fund through their investments the Chinese Communist
Party's human rights violations against the Uyghur ethnic
minority population, as well as funding China's economic
practices that distort global markets and China's companies
that lack transparency and accountability.
Our financial regulators should certainly be focused on the
resilience of our financial system, but as others have noted,
they do not have the jurisdictional authority nor do they have
the institutional capacity to regulate in the area of climate
change.
We should not be imposing any unnecessary constraints on
our financial institutions' lending or excess costs on our
public markets participants. Nor should we be enacting policies
that would undercut hard-won American energy independence that
would raise our energy costs or that would eliminate American
jobs. This is especially the case now as we look to continue to
fully rebound from this pandemic- induced economic recession as
quickly as possible.
What I would like to do is turn my questions to Dr. Zycher
and Dr. Cochrane. I appreciate your focus on ensuring that
regulatory oversight in our financial system is not used to
advance a simple liberal socialist agenda. We currently have
deep and sophisticated pools of private capital and private
markets to deal with potential catastrophic risks that are both
weather- and climate- related.
For example, our property and casualty reinsurance markets
underwrite hundreds of billions of premiums annually. In fact,
according to S&P, most of the top 20 global reinsurers
increased their exposure to property catastrophic risk last
year. So I am going to ask these questions of both of you, Dr.
Zycher first, then Dr. Cochrane.
In your view, whether through risk-sharing instruments or
other long-term capital planning devices, does the private
sector have tools and incentives for making sound business and
risk management decisions concerning potential climate risks?
Mr. Zycher. You know, I see no reason to believe that the
private sector has inefficient incentives in terms of adjusting
to perceived risks. What is being advocated by many people is a
top-down approach to forcing the evaluation of these risks by
the financial sector. I think it would be much wiser to use a
bottom-up approach in which the market makes whatever judgments
about these risks that it deems appropriate and then prices
those into the products for insurance services or other things
that prove efficient.
Senator Hagerty. Dr. Cochrane.
Mr. Cochrane. You know, weather comes and goes. We do not
know if it is going to rain or snow tomorrow, but we know
pretty much what the range of weather can be. Climate is about
changes in that range of weather, and we know that in the next
5, 10, even 20 years, the change in weather is not going to be
that big. People whose businesses depend on the weather make
pretty good assessments of how bad the weather can be. And
weather is just a small part of the U.S. economy. So the risk
is small, and it is well modeled by people who have that risk.
Senator Hagerty. Yeah, in fact, the sophistication of those
that do model the risk--and, again, billions of dollars are
moved into capital markets to address weather- related risk--
very highly sophisticated modeling that takes place.
My second question, again, to Dr. Zycher first, then I will
come back to you, Dr. Cochrane: Ranking Member Toomey already
touched on this a little bit earlier with you. Are you more
comfortable with financial regulators wading into this area or
with, again, for example, private insurers that have expertise
in modeling and assessing catastrophic risk exposures,
educating shareholders on risk, and creating tailored
solutions? Which would you be more comfortable with: financial
regulators or the private market participants that are in this
business?
Mr. Zycher. You know, I do not think there is much question
that such risk evaluation by the private sector would be much
more unbiased and much more efficient. Insurance companies and
others have powerful incentives to evaluate these risks and are
much less subject to political pressures, litigation threats,
and regulatory mandates than is the case for the Fed or the SEC
and other top-down agencies issuing edicts in a top-down
fashion.
Senator Hagerty. Yeah, well put. Dr. Cochrane.
Mr. Cochrane. I would not mind if our financial regulators
were looking at all sorts of the out-of-box risks, but they are
not looking at all the big ones, and they are looking at one
that is basically made up.
Let us also remember financial regulation is not about the
proposition that nobody can ever lose money. Financial
regulation has to be just about will banks fail, will there be
a crisis, and we seem to have slipped into the idea that nobody
can ever bear any risk anymore.
And, finally, remember, the worst-case economic scenarios
for climate is 7 percent to 10 percent of GDP in 100 years, a
tenth of a percent per year. And that is the worst case. Ben
will explode with how much that has the thumbs on the scale. So
over the horizon we can think about things, this is a small
risk to the U.S. economic and financial system. Sorry. That is
a fact.
Mr. Zycher. Senator, if I may add something, the major
integrated climate economy assessment model predicts that by
the end of the century, across policy scenarios, the
differences in GDP for the U.S.--not GDP growth but GDP--in
absolute dollars would be about 3 percent by the end of the
century. The effect of these risks is much smaller than is
commonly asserted.
Senator Hagerty. Thank you.
Chairman Brown. Thank you, Senator Hagerty.
We will go next to Senator Menendez. I am going to duck out
for 5 to 10 minutes to go to the Finance Committee, so it will
be Senator Menendez, then Senator Daines of Montana, then
Senator Warner of Virginia. So that will be the order if I am--
when I get back. So please proceed, Senator Menendez, for 5
minutes.
Senator Menendez [presiding]. Thank you, Mr. Chairman.
More than 8 years ago, Superstorm Sandy crashed onto New
Jersey's shoreline, causing the greatest natural disaster in
our State's history. It caused billions of dollars in damage,
including some sustained damage to home values. A large share
of homeowners' wealth is locked up in their homes, and
homeownership is the most important and accessible way to build
wealth. And climate change increases the frequency and
intensity of storms like Sandy and endangers, I think, the
cornerstone of wealth building. If due to climate change these
homes become uninsurable and unmarketable, the value of these
homes and the wealth of homeowners is at risk.
So, Mr. Gelzinis, as storms like Sandy increase in
frequency and severity, do you expect coastal homes to lose
value relative to the balance of homeowners' mortgages, causing
these mortgages to become financially underwater?
Mr. Gelzinis. Thank you for the question, Senator. So to
the extent that they are exposed to rising sea levels and
increasingly severe frequent floods and extreme weather events
like Sandy, those homes will lose value as the physical impacts
of climate change intensify and threaten to damage those
properties. There is some evidence that those risks are
starting to make their way into house prices in certain coastal
geographies already. And, of course, whether a specific home is
driven underwater will depend on the level of home equity and
the extent of the damage the home is vulnerable to, but it is
certainly possible, especially under the most severe warming
pathways, that climate effects could drive up a large swath of
coastal homes and put them underwater financially.
Senator Menendez. Well, according to one report, New Jersey
has lost $4.5 billion in home value since 2005, a time period
covering Sandy, because of flooding related to sea level rises.
So it is just one dimension, I think, of the challenge before
us.
Under current rules, public companies are not required to
disclose political spending to shareholders. As a result,
corporate executives can spend investor money on political
causes without any consideration for shareholder views or the
company's public commitments to climate- friendly initiatives.
Mr. Gelzinis, should shareholders of public companies that
make carbon-neutral or other climate-friendly pledges expect
their company to act in a manner consistent with that stated
company policy?
Mr. Gelzinis. Yes, Senator, a public company's shareholders
should absolutely expect that a company's actions will align
with pledges or other public commitments.
Senator Menendez. Well, in 2017, while companies publicly
stated that the U.S. should remain in the Paris climate accord,
many spent shareholder money to oppose the very essence of what
they were saying; and because there are no disclosure
requirements, their shareholders had no way to know.
So do shareholders have the right to know whether their
company's political donations contradict their public
commitments and whether those companies may be supporting
outcomes that might pose a material risk to the company's
bottom line.
Mr. Gelzinis. Senator, shareholders do have the right to
know whether the company's political spending is consistent
with the publicly stated policy of the company. We have seen
plenty of examples of companies that have said one thing
publicly and spent shareholder dollars to advance contradictory
goals in the political process. That creates material
reputational harm and can certainly impact performance. And I
would just note that your efforts around the Shareholder
Protection Act have been critical. The bill would give
investors both the transparency they need and the ability to
hold companies accountable.
So the SEC really must center disclosure requirements on
the information investors need, and investors have made it
abundantly clear that this information is important to them.
Senator Menendez. Thank you. Now, when we talk about
systemic financial risk due to climate change and ensuring that
companies are transparent about those risks in various filings
and disclosures, we are really talking about two kinds of
risks. There are risks to physical assets that can be impacted
by various climate events, like extreme weather and sea level
rise, as well as risks associated with our transition away from
a dirtier, more polluting form of energy toward a clean 21st
century economy. That transition brings some extraordinary
opportunity to create new middle-class jobs and reinvigorate
our manufacturing and energy sectors. But at the same time,
investors and financial institutions have to understand the
market risks associated with carbon-intensive industries as the
U.S. and the rest of the world moves toward a zero emission
economy.
Dr. Keohane, as the SEC looks to revamp its climate risk
disclosure requirements, how can these rules better speak to
both physical and transitional risks associated with climate
change? And how do we best quantify those risks?
Mr. Keohane. Well, thanks very much Senator, for the
question. The first thing I want to say is the reason we focus
so much on climate risk disclosure is because transparent
information is a fundamental aspect and a requirement, a
condition, for an efficient market. I think Dr. Cochrane and
Dr. Zycher know this, but we are not talking about directing
allocation of capital. We are talking about allowing investors
to know what they are investing in and to give them that
information.
And to your question, Senator Menendez, we focus on three
criteria that we think the SEC should look to when it
strengthens mandatory disclosure of climate risk.
The first is information should be comparable. Investors
need to know how corporations compare with one another in terms
of the risk and performance both with respect to that
transition risk, Senator, as well as with respect to exposure
to physical risk.
Second, the disclosure needs to be specific, the
information that is particular to the corporation. Too often we
just see generic language and sort of boilerplate language.
That has been the result of several studies that have found
that.
And the third is decision-useful. It needs to be relevant
to the decisions that investors are making, and so comparable
specific decision-useful information is what the SEC should
mandate companies disclose.
Senator Menendez. Thank you.
I understand by the Chairman's order Senator Lummis is
next.
Senator Lummis. Thank you very much.
My first question is for all of our witnesses, and it is a
simple yes-or-no answer. The question is: Did Operation Choke
Point damage our financial system? And I will start with Dr.
Cochrane.
Mr. Cochrane. I have not studied it enough to be able to
comment for you. Sorry.
Senator Lummis. Thank you. Dr. Zycher.
Mr. Zycher. Yeah, I think that Operation Choke Point was
deeply corrosive to the rule of law and our constitutional
institutions. It was a blatant attempt to bypass Congress and
implement a politicized allocation of credit in a way that
disfavored politically unpopular industries.
Senator Lummis. Thank you.
Ms. Waite, do you have an opinion about Operation Choke
Point?
Ms. Waite. I also have not studied it enough to have an
opinion about this. Thank you.
Senator Lummis. Mr. Keohane? And excuse me if I have
butchered your name.
Mr. Keohane. That is OK, Senator. I am afraid I am in the
same boat as Dr. Cochrane and Ms. Waite.
Senator Lummis. And, Mr. Gelzinis.
Mr. Gelzinis. Senator, I cannot speak to the Department of
Justice portion, nor the specifics of some of the financial
regulatory actions. I would just say, though, that it is
important to remember that reputational risk is financial risk.
Senator Lummis. Well, thank you. I am going to then ask Dr.
Zycher to respond further on this point. To me, the climate
change-related proposals being discussed sound a lot like
Operation Choke Point, and so to Dr. Zycher--actually, it was
Dr. Cochrane, wasn't it, who responded earlier? Why is that?
Why do these sound so much alike?
Mr. Cochrane. I am not good on the details of Operation
Choke Point. I am going to be hard pressed to make a
comparison. I can fulminate all you would like on proposals of
regulating and disclosing fictitious climate risks on their own
basis.
Senator Lummis. So it is Dr. Zycher that I want to ask to
respond. You can see the tie I am trying to make, I hope, Dr.
Zycher.
Mr. Zycher. Yes. I made the point in my formal statement
submitted to this Committee and in very brief passing during my
oral comments a few minutes ago that the risk disclosure
requirement, given the biases to which the financial sector
would be subjected, amounts to a blatant effort to distort the
allocation of the capital away from certain industries on the
basis of the ideological goals of certain political interest
groups. That is exactly what we observed during Operation Choke
Point, and so the proposals being made here today by some of
the Senators and some of the witnesses that the Fed and that
financial institutions be required to disclose climate risks is
an indirect but obvious way to distort the allocation of the
capital away from the fossil fuel industry and perhaps others
that are politically disfavored by certain ideological groups.
Senator Lummis. And, further, do you believe that there is
consensus on how we should mitigate climate risk in the
financial system?
Mr. Zycher. No, there is no consensus on the extent to
which climate change is caused by man or is the result of
natural phenomena. It is a combination of both. And I do not
think there is any consensus certainly if we look at the
disagreement being exposed during this hearing today about how
risks should be measured, how they should be disclosed, what
implications they should carry, et cetera, et cetera.
Senator Lummis. Dr. Cochrane, would you also weigh in on
this point? Do you think there is a lot of consensus?
Mr. Cochrane. Climate change poses no risk to the financial
system. This is a made-up risk. So there is no consensus in the
sense that we are just asking banks to make up numbers to
please regulators, and once banks are making up numbers of
fictitious climate risks, then we lose the integrity of the
financial regulation system. So there is consensus by people
who want to push a particular agenda, but, you know, we are
talking about a fiction here, not a fact. So you cannot have
consensus on how to measure a fiction.
Senator Lummis. Well, thank you all, witnesses, and for
those of you who are unfamiliar with Operation Choke Point,
which I confess I was unfamiliar with it, too, you might go
back and look at it because I think that it is something worth
referring to, and it is a cautionary tale as we engage in this
discussion.
Thank you, Mr. Chairman. I yield back.
Chairman Brown [presiding]. Thank you, Senator Lummis.
Senator Warren from Virginia--or Warner, from Virginia--I
am sorry--is recognized for 5 minutes. I know the difference.
Senator Warner. I know you sometimes get us mixed up,
Sherrod. Listen, I appreciate the diversity of opinion on the
panel, but I am little bit stunned by some of the commentators'
indication that somehow climate is made up or fictitious. I am
not going to fully engage on this other than the fact that I
would clearly urge them to talk to the United States Navy,
which is not viewed as kind of an out-of-the-ballpark group
who--we are blessed in Virginia to have the largest naval base,
and it is--we spend hundreds of millions of dollars a year
raising the piers because of the threat from sea level rise.
Whether you call that climate change or sea level rise, I do
not call what you call it; it is affecting our naval base,
Hampton Roads, the resiliency level. This is an issue that
everyone of every political persuasion who lives this risk each
and every day--and I am astonished that there are so-called
experts that are denying the validity of what is happening
real-time in my State. Again, we ought to have a lot of
different opinions.
I would like to go to the market questions now, and, Mr.
Chairman, I have got right here--I am trying to make sure I am
watching my numbers. This is the GAO study that I requested
back in 2018. It came out in 2020. I ask unanimous consent that
it gets submitted for the record.
Chairman Brown. Without objection, so ordered.
Senator Warner. Mr. Chairman, this GAO study uncovered that
12 out of 14 institutional investors seek information on ESG--
environmental, societal, and governance--metrics to understand
risk and assess long-term financial performance. These
institutional investors find that as they look at the long-term
financial risk--and these are not mandated by the SEC, although
I am happy to say that the SEC is doing a study on this matter.
But they have not mandated. These are institutional investors
who say, ``We need this information because we believe as
institutional investors that climate is providing a long-term
financial risk.''
As a matter of fact, BlackRock just last night, BlackRock
that I know, Mr. Chairman, is one of your favorite
organizations, somebody that you have not always agreed with,
but BlackRock came out last night saying they think we ought to
have mandatory financial reporting on environmental risks. So
while I know some of the members of the panel may want to
dismiss this science or somehow say that it is simply being
promoted by the political interests, I actually call BlackRock
and 12 out of the 14 institutional investor groups of the GAO
study examples of where the market is demanding this
information so that institutional investors on behalf of their
long-term pension shareholders and others can have this
information as they make the kind of long-term assessments,
because, otherwise, the rate of return to those investors is
going to be diminished by the effects of what we call climate
change, sea level rise, weather changes. You call it and name
it, but it is out there and it is real.
Mr. Gelzinis, you have talked in your testimony about the
need for ESG metrics. Can you talk about how not having robust
disclosure requirements on ESG actually puts American companies
at a competitive disadvantage against other companies around
the world that have to make these kind of reports?
Mr. Gelzinis. Thank you for the question, Senator. So if
the SEC fails to integrate climate-related risks into its core
regulatory framework, investors will be exposed to risks that
were not sufficiently disclosed to them, capital will be
inefficiently allocated, and our markets will be anything but
orderly. And that will serve as a drag on capital formation due
to a loss of investor confidence in the resilience and
transparency of our markets.
So essentially a failure to address these issues here in
the United States would undermine the health and attractiveness
of our capital markets globally. But if other major markets in
the world are modernizing and providing investors with the
information they need to efficiently allocate capital and we
are not, it is going to put U.S. companies at a disadvantage.
Mr. Cochrane. Can I just--as a matter of fact, nobody on
this panel denied climate change. We all agree that climate
change is real.
Senator Warner. Mr. Cochrane, all I know is I just--I had
not heard your whole commentary, but I heard you and Mr. Zycher
indicate that somehow factoring in these standards would
distort the market. And respectfully, sir, I could not--and I
have spent--I get a lot of criticism from my Democratic
colleagues as being too pro-market-oriented, and I can take you
to parts of Virginia where we are grappling with this risk. And
I think, quite honestly, when groups like BlackRock, when 12
out of 14 institutional investors say we need these kind of
metrics, and when we fail to have metrics that are actually
commonly measurable between companies, we put American
companies at a disadvantage.
Thank you, Mr. Chairman. I hope that we will come back and
be able to revisit this because I think it is a critically
important issue.
Chairman Brown. Thank you, Senator Warner.
Senator Daines from Montana is recognized.
Senator Daines. Yes, thank you, Chairman. Let me first say
this hearing comes just weeks after the Biden administration
canceled the Keystone Pipeline, and as a chemical engineer,
somebody who believes in science, it is jaw-dropping. This is
such classic virtue signaling, even though the pipeline is the
safest way and most environmentally sound way to move oil, in
fact, has the least amount of carbon emissions, because here is
what is going to happen. If there is not a pipeline, it is
going to be either through rail or by truck, which emits more
carbon. I just wanted to lay that out there. We want to stay
focused, I agree, on the science and the data as we look at
this issue of climate and of risk. I urge the President to
reverse this decision. It is reckless, it is devastating, it is
bad for the climate, and it is even worse for our communities.
I am concerned that what is really under discussion today
is really not an effort to protect the financial system from
climate risks but, rather, to establish conditions by which
certain businesses deemed politically unfavorable can be
starved of capital and shut out of the financial system. I
joined Senator Cramer in introducing the Fair Access to Banking
Act, which would prevent banks, prevent financial services
providers from discriminating against law-abiding businesses
such as oil, gas, and coal producers. In fact, we introduced
this legislation after seeing private institutions succumbing
to political pressure. That is wrong.
I worry that a historically bipartisan agency such as the
SEC might move aware from its mission that is supposed to
protect investors, maintain fair and orderly efficient markets,
and facilitate capital formation, and instead act to reshape
the financial system in ways that I do not think themselves
have really fully thought through.
Dr. Zycher, can you tell me how mandatory climate
disclosures will by itself decrease climate-related risks in
the financial system?
Mr. Zycher. I do not think that mandatory disclosures would
have any such effect at all because it is not quite clear what
would be required to be disclosed. What model would a financial
institution use? What assumption would it make or be required
to make about the sensitivity of the climate system to growing
greenhouse gas atmospheric concentrations? What concentration
would be assumed for the year 2100?
The disclosure requirement being proposed would turn out to
be so speculative and so subject to political pressures and
litigation threats and other similar distortions that no useful
information would, in fact, be provided to the market.
Senator Daines. Thank you. I know this is not going to be a
debate on climate change, and I think all of us agree there is
climate change. It is a dynamic environment. It has never been
static. It is either always going through natural cooling or
warming trends. The real question is in this multivariable
equation--and I guess I pride myself of having spent a lot of
time studying thermodynamics, physics, chemistry, and so forth.
What component of this is human- caused? It is very much one of
the components. Let us all agree there are multiple variables
in this equation.
But I want to switch and ask a question of Dr. Cochrane.
Can you tell me what ESG means in practice when it comes to
index funds? Is there a standardized definition or is this just
jargon?
Mr. Cochrane. Well, it is marketing, and you can sell
indulgences and charge a high fee. I think to your previous
question, I just wanted to comment as well. I think you hit the
nail on the head. We might be able to get companies to disclose
carbon indirectly, but the proposal is to get them to disclose
financial risks due to carbon, and that is the part that is
made up.
Senator Daines. Let me go to these ESG index funds. I have
got a follow-up question. If we looked at the data from
FactSet, exchange-traded funds explicitly focus on socially
responsible investments and have a 43-percent higher fee than
widely popular standard ETFs. And, in fact, the environmental,
social, and governance funds' average fee was 0.2 percent at
the end of last year, while your standard ETFs are at the 0.14
percent average. That has a real impact on investors' bottom
lines. In fact, according to one recent analysis, over a 10-
year period $10,000 in an ESG fund would be about 44 percent
smaller compared with an investment in an S&P 500 tracking
fund.
Either Dr. Zycher or Dr. Cochrane, because I am running out
of time here, why do ESG funds on average charge much higher
fees than standard broad-based index funds?
Mr. Cochrane. Because people are willing to pay them. You
know, if people want to pay to feel good, that is their
business. I am for free markets always.
Mr. Zycher. I am not quite as cynical as John, even though
he is so much younger than I am. I mean, an ESG fund by
definition has to be actively managed in order to make sure
that the underlying assets satisfy the politicized requirements
of the ESG objectives. That means fees have to be higher than
those charged for an index fund, which is not actively managed.
And so if we believe the standard hypothesis, which I do, that
securities prices always reflect all available information, it
is very difficult to beat the market, and individual investors
can approach that goal by minimizing fees--in other words, by
investing in index funds. That is the central message from
Burton Malkiel and other analysts. And I think that it is
obvious why ESG funds charge higher fees. They are charging a
fee to actively manage a fund in order to achieve a politicized
goal.
Senator Daines. Thank you. I am out of time.
Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Daines.
Senator Van Hollen is recognized for 5 minutes.
Senator Van Hollen. Thank you, Mr. Chairman. Can you hear
me OK?
Chairman Brown. Perfectly.
Senator Van Hollen. Good. Well, let me thank all the
witnesses. Thank you, Mr. Chairman, for holding this hearing.
And I agree that markets work best when investors and consumers
have all available information, which is why it is troubling to
hear some witnesses suggest that we should not be providing
investors with information about the risks from climate change.
As someone who would make an investment, I would think that we
would want everybody to have information about what risks they
are taking. That is why I am pleased to see the SEC moving
forward, and the CFTC, and what they are doing is moving
forward to study how best to measure those risks, because
obviously we do need to standardize that approach. You are
already seeing a lot of financial institutions in Europe begin
to take those risks into account. They are real.
Here is a quote from somebody who has been involved with
the American Property Casualty Insurance Association: ```The
alarm bells are now ringing loudly,' says Karen Collins, who
handles home insurance and other personal lines for the
American Property Casualty Insurance Association. `Climate
change is leading to skyrocketing costs to insure and rebuild.'
''
You know, this is a statement from somebody who is directly
involved in having to price in these risks, and it would seem
to me that we would want everybody involved in that area to be
informing investors and consumers about those risks, which are
real.
Mr. Keohane, I would like to ask you about the insurance
companies because from Lloyd's of London to others, they have
been very clear that prices are going to go up, but we do not
know if they are yet at a place where they capture all the
risk. Can you talk a little bit about the insurance industry,
property and casualty insurance industry, and why it is
important that we calculate these climate change risks?
Mr. Keohane. Absolutely. Thank you, Senator, and I want to
just express a note of appreciation for what you said about the
importance of choice. We are talking about informing investors.
We are talking about investor choice. I think it is puzzling to
see folks saying we should not allow investors to have the
information they need to make the choices they want.
With respect to insurance, Senator, that was raised
earlier, I think, by a couple of the other witnesses on the
panel. I found that ironic that insurance was raised, private
insurers were raised as the solution here. If you ask folks in
California, they will tell you wildfire insurance is
essentially no longer available. The California State
government had to step in because wildfire insurance was not
going to be offered anymore by private insurers. Why is that?
It is because the uncertainties and the risk around climate
change are changing--or as a result of climate change, are
changing in ways that the insurers do not understand. With all
due respect to Dr. Cochrane, the probability distributions are
shifting. And when that happens the insurers, their response
is, ``I do not know how to price this. I am going to get out.''
So we are looking at--across a range of sectors, we are
looking at what happened, frankly, with flood insurance in the
1960s when the private insurers stepped out, and then the
Federal Government has to step in. And what that ends up doing,
when the Federal Government or a State government, as in
California, is the last resort, that puts taxpayers on the hook
for these risks. Obviously, someone needs to insure, but it
would be much better if we had a system where there was clear
and transparent information that investors need and that
insurers need and that people making decisions about insurance,
that they need as well.
Senator Van Hollen. Well, that is right, and if that risk
is not priced into these products, as you say, when the
companies are unable to pay out on the insurance claims, it is
the taxpayers who end up picking up the bill. We have already
seen that when it comes to the flood insurance, and that is
just getting even more so in that area.
Let me ask you, Mr. Gelzinis, about stress testing other
financial institutions like banks for this kind of a risk.
Sarah Bloom Raskin, who is a Rubenstein Fellow at Duke
University, has said that regulators should begin to collect
data and create models that would enable them to carry out
meaningful climate-related stress tests, again, to see if there
are hidden risks which could explode and require taxpayers
potentially to pick up the bill, at least if they are
systemically important entities.
So could you comment a little bit on that idea?
Mr. Gelzinis. Yeah, I think stress tests could be a really
important tool here, and I want to be very clear about what
stress tests are and what they are not. Stress tests are not
meant to predict the future, so a lot of what banks that have
brought up opposing the establishment of these tests say, well,
climate change is really hard to model and predict, so why
should financial regulators try?
The point is not to predict the precise outcomes here. The
point is to test bank balance sheets against extreme but
plausible scenarios. And so I think that is a hurdle the
Federal Reserve and other financial regulators could meet to
make sure bank balance sheets are resilient to these risks.
Senator Van Hollen. Right. I think when we are talking
about all this, we are trying to create standard models that
are broadly accepted for assessing risk.
Thank you all, and thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Van Hollen.
Senator Tillis from North Carolina is recognized for 5
minutes.
Senator Tillis. Thank you, Chairman Brown. Can you hear me?
Chairman Brown. Yes.
Senator Tillis. Thank you. Actually, I want to follow on a
bit to the last conversation for Dr. Zycher and Dr. Cochrane. A
2020 survey by the International Basel
Committee on Banking supervision found that 10 of 15
jurisdictions indicated, ``Current data are not sufficiently
granular or reliable to feed into potential assessment
models.''
And another article in Nature Climate Change journal finds
that, ``Calls for the integration of climate science into risk
disclosure and decisionmaking across many levels of economic
activity has leap-frogged the current capabilities of climate
science and climate models by at least a decade.''
There was another Politico article that was just talking
about the reliability of information and transparency,
accessibility to information that could help with certain
assessments.
So, Dr. Zycher and Dr. Cochrane, what sources are the
relevant domestic and international regulators currently using
to model climate risk?
Mr. Zycher. Well, I think that what most public officials
both in the U.S. and around the world are reduced to using are
the reports from the Intergovernmental Panel on Climate Change.
The assessment reports, the last of which came out in 2013, and
the next one, the sixth report, will come out in 2022, and
those reports are peer-reviewed; they are written by serious
people, and there is enormous uncertainty, and to a significant
degree, the conclusions both in terms of policy and climate
science can be questioned quite significantly.
There are other IPCC-type reports, for example, the 1.5
Degree report that came out in 2019 that some people rely upon,
it is just rather silly, frankly, in all kinds of ways and is
not to be taken seriously.
I think that the IPCC work is primarily what is used along
with various Government reports and analyses by various
agencies.
Mr. Cochrane. I might add that they are making it up,
because what we are talking about here is risk to the financial
system, not even economic risk. And I think following the
discussion you can see--so we talked about-- Senator Menendez
talked about $4.5 billion of home value and some homes that
went under in New Jersey. The stock market did not crash; banks
did not fail. We talked about wildfires in California, which,
yeah, that is a problem, almost all due to horrible forest
management. Banks did not fail; the stock market did not crash.
And we are ignoring the real risks--pandemic, war, Treasury
failure, cyber attack.
So the idea that it is a financial risk--and you can see it
in the regulators. They are kind of floating around. It is
mostly that we need to regulate this, but they really have no
idea how.
Senator Tillis. So what risk do we run if we move too
quickly in modeling climate risk when there are questions about
actionable and reliable data?
Mr. Zycher. Well, we run the risk of leading the financial
system toward distorting the allocation of capital in ways that
are not productive, away from the fossil fuel industry and away
from other sectors in response to analyses that are seriously
distorted. That is one set of risks.
We risk also ignoring the benefits of anthropogenic climate
change, greening of the planetary ecosystem, greater water
efficiency, greater agricultural production. There are benefits
from increasing greenhouse gas concentrations, and we will
ignore also, as I mentioned in my testimony, the risks of
Government policies. Government policies cannot be predicted
uniformly to yield positive results. Forgive me, Senators, but
that is simply reality. And the central thrust of climate
policy is an increase in energy costs. There is no way around
that, and that will carry implications for the economy and,
indeed, for the financial system that are not salutary.
Mr. Cochrane. I would add we pollute financial regulation.
Look, an honest bank, the size of the big banks, which is what
is dangerous for the financial system, they put up the numbers
correctly, they have to say, ``Look, climate does not pose any
risk to us over the foreseeable horizon of our risks. But the
regulators want to see something, so we have got to cook up
some fictitious financial risks to make them happy and to give
the answers they want.''
Well, now the books have been cooked, and financial
regulation against the real risks, the big ones that they do
not see coming, then we will lose the power to do that, too. So
it pollutes financial regulation as much as distorts the
economy.
Senator Tillis. I agree. Thank you.
Thank you, Mr. Chair.
Chairman Brown. Thanks, Senator Tillis.
Senator Warren from Massachusetts is recognized for 5
minutes.
Senator Warren. Thank you, Mr. Chairman, and thank you for
holding this hearing.
There is just no more room to dance around here. The
evidence is undeniable that climate change threatens our
economy. In a speech last month, Federal Reserve Governor Lael
Brainard said that climate change is already imposing
substantial economic costs and is projected to have a profound
effect on the economy at home and abroad.
So, Mr. Gelzinis, how about if you connect the dots for us
here? How does climate change put our financial system at risk?
Mr. Gelzinis. Yes, thank you for the question, Senator. So
the physical effects of climate change could devalue a range of
real assets and financial assets, including commercial and
residential real estate, corporate bonds and loans in certain
sectors and geographies, municipal debt, commodities, and the
derivatives tied to instruments. Then, in addition, the
inevitable low-carbon transition could severely impair the
value of financial instruments tied to carbon-intensive
sectors. And both of these types of risks have not only
microprudential implications for individual institutions, but
also pose a broader systemic threat just given the magnitude of
the risk, the types of firms exposed, and the potential speed
with which these losses can materialize.
Senator Warren. Thank you. You know, these risks are real,
and they affect the safety and soundness of our financial
system. The Federal Reserve currently supervises some of the
country's largest banks, including the banks that have been
designated as ``too big to fail.''
So, Mr. Gelzinis, if the health of one or more of these
banks was at risk due to climate change, would the Federal
Reserve be stepping outside its mandate or expanding its
mission if it treated climate change the same way it treats
other risks to the financial system?
Mr. Gelzinis. Absolutely not, Senator. It is clearly within
their mandate.
Senator Warren. Good. In other words, because the Fed's
mandate includes the safety and soundness of the too- big-to-
fail banks, it is within the Fed's responsibility to deal with
climate risk. And by ignoring climate risk, the Fed and other
banking agencies are allowing politics rather than science to
determine the course of their action. Is that a fair statement,
Mr. Gelzinis?
Mr. Gelzinis. Yes. I mean, the risks would violate the very
responsibilities Congress handed down to the regulators.
Senator Warren. And the biggest banks seem to realize what
is happening, so they have started to brag about how great they
have been doing to solve this problem all on their own. Last
month, for example, JPMorgan committed to achieving net-zero
carbon emissions by 2050.
Now, I appreciate that commitment. I do. But we also know
that JPMorgan has financed close to $270 billion in fossil fuel
projects since 2016 and has yet to announce any clear steps as
to how it will wind down its significant participation in oil
and gas drilling, in fracking, and in other contributions to
climate change.
So let me ask: Mr. Gelzinis, is voluntary self- regulation
from big banks sufficient to protect our financial system from
climate risks?
Mr. Gelzinis. So, Senator, when you were warning about a
potential housing crash in the early 2000s, financial
regulators and Wall Street executives at the time hailed the
merits of self-regulation and cast aside the warnings of
``alarmists'' since bank risk models and decisionmaking was so
advanced that crises, you know, really were a thing of the
past. Then the predictable catastrophe struck, and it was not
those banks that caused the crash or regulators who were asleep
at the wheel who suffered the consequences. It was communities
across the country and the Government that picked up the tab.
So financial firms simply do not have the incentive to
self-insure against these risks, particularly against the worst
outcomes, partly because of their near-term focus on quarterly
profits and partly because they do not bear the full cost of
the risks that, you know, their activities are placing on the
system.
So I guess my fear is that, you know, similar to 2008,
while the music is playing, financial firms will get up and
dance while they can still make short-term profits. They will
continue to overengage in climate-risky activities until
catastrophe strikes yet again and we relearn the painful lesson
of self-regulation.
So, anyway, that is just why I think it is so vital for
financial regulators to step in here and ensure the financial
system is resilient.
Senator Warren. Right, and it is a powerful reminder of
this analogy. You know, we need to take seriously the threat
that climate change presents to our financial system, and that
means using our regulatory tools to mitigate that threat. And
every day that the Fed and other regulators refuse to do their
jobs and ignore these risks, they put both our planet and our
economy at risk.
Thank you. Thank you for being here. And thank you, Mr.
Chairman.
Chairman Brown. Thank you, Senator Warren.
The Senator from Minnesota, Senator Smith, is recognized
for 5 minutes.
Senator Smith. Thank you, Mr. Chair, and thank you to all
the panelists.
I am finding this conversation quite interesting, and I
want to just start with a point here. I hear some of our
panelists saying that it is so important, even some of my
Republican colleagues saying how important it is that we
address this from a public policy perspective, which I, of
course, agree with. And so I would like to invite my colleagues
on both sides of the aisle to join in the work that we have to
do to address climate change from a public policy perspective.
I am excited about the work that I am doing around a clean
electricity standard, which would be a great example of the
kind of thing that we could do to address climate change and
get us to the clean green economy that I think that we know
that we need.
But let me turn to the topic here of this conversation, and
I am going to direct this question I think to Mr. Gelzinis, and
then, Ms. Waite, I have a question for you afterwards I would
like to try to get to.
Recently, our Republican colleagues sent a letter to Chair
Powell questioning the need for assessing climate- related
risk, saying, and I quote, ``Financial regulation does not and
should not seek to guard against every type of unforeseen
event.''
So, Mr. Gelzinis, is climate change an unforeseen event?
Mr. Gelzinis. No. It is a high-impact, high-probability
event.
Senator Smith. And will climate change affect asset
valuations in the market?
Mr. Gelzinis. Absolutely. It already is. And because of
climate change's nonlinear effect, it is only going to get
worse?
Senator Smith. And is this a small risk, as some of our
panelists have been posing? Or is it big?
Mr. Gelzinis. No, it is a massive risk that impacts a wide
range of asset markets, a wide range of financial institutions.
Senator Smith. And isn't it the job of the SEC to protect
investors and to maintain a fair and orderly efficient market?
And wouldn't understanding that climate risk be an important
part of their job, therefore?
Mr. Gelzinis. Absolutely. Climate change intersects with
each aspect of that mission that you just outlined.
Senator Smith. And isn't it the job of the Federal Reserve
to promote the soundness of financial institutions? And
wouldn't that include understanding climate risk?
Mr. Gelzinis. Absolutely. Both the safety and soundness of
individual firms, which are undoubtedly exposed to these risk--
think, you know, a $20 billion bank in the oil patch or, you
know, a $50 billion bank overly exposed to coastal real estate,
but also given the magnitude, the stability of the banking
system and financial sector as a whole.
Senator Smith. Well, thank you for that. I think it is just
important to clarify and understand what it is that we are
talking about here. And so I appreciate that.
Let me turn to Ms. Waite. You in your work at the
foundation are talking about mobilizing private capital to
address climate risk, and I want to just get your take on this.
How would standardized climate risk disclosures support more
efficient deployment of private capital to address the climate
crisis? What impact would that have on how we are efficiently
deploying private capital?
Ms. Waite. So thank you for your question, Senator. Both
investors and lenders rely on information to make decisions. So
having this climate disclosure that the tons of carbon dioxide
equivalent for each financial assets class disclosed--measured,
disclosed, and reduced, that would enable investors and lenders
to make better decisions to manage away from the carbon-
intensive assets toward the low-carbon ones.
Senator Smith. Now, I think heard one of the panelists here
today saying that some attempt to assess climate risk would--
first of all, that--he kept using the word ``fantasy,'' but
what he seemed to be saying was that assessing climate risk
would in some way distort the market. Could you explain--what
do you think about that view?
Ms. Waite. To the contrary, it would actually help protect
the market and make better decisions so that we support those
activities and financing those activities that do not put our
financial system in danger. So it is actually the contrary.
Actually, the market has spoken. One out of every $3 now
invested in sustainable funds, investors are calling out for
the ESG, ETFs have doubled in 2020 alone. Over 100 financial
institutions or banks and asset managers are now measuring and
disclosing the carbon emissions of their loans and investments.
So this is happening.
Now, it is the regulators' opportunity and job to actually
step in and make sure that all institutions are doing this so
that the entire system can work for this transition.
Senator Smith. Well, thank you. I could not agree more. I
appreciate all of you being here, and thank you very much, Mr.
Chair.
Chairman Brown. Thank you, Senator Smith.
Senator Cortez Masto from Nevada is recognized for 5
minutes.
Senator Cortez Masto. Thank you, Mr. Chair. I appreciate
this conversation.
Let me start with Mr. Keohane and then follow through.
Isn't it really true that at this juncture it is the investors
that are demanding to know how companies are confronting the
risks and opportunities posed by our changing climate and
environment? Isn't that true that is what is happening today,
right?
Mr. Keohane. Yes, that is true. That is exactly right,
Senator.
Senator Cortez Masto. And so really it is the investors
demanding--no matter what we want to say here as politicians in
this room, it is the investors that are demanding to know this.
Aren't they entitled to have this information?
Mr. Keohane. Well, I certainly think so, Senator. As an
economist, I think, you know, the free and transparent flow of
information is critical to well-functioning markets and to
investor choice. And I would say the only reason that
disclosure would result in reallocation of capital away from
fossil fuel companies is because investors might think there is
a pretty big risk associated with investing in fossil fuel
companies.
But nobody is demanding that reallocation. It would be the
result of investors making free and informed choices.
Senator Cortez Masto. Thank you. Now, I am from Nevada, and
our hospitality industry and tourism industry has been so
devastated. Can you explain how investments in hospitality and
tourism might be affected by physical and transition risk due
to the extreme weather events brought on by climate change?
Mr. Keohane. Well, Senator, I would be happy to get back to
you with specifics around your State and hospitality. I will
say in general that it is the shifting risks and uncertainties
that have to do with climate change that present this risk.
What we see--maybe one point I will draw on in this regard that
the CFTC report I cited makes very clear. It is not only a
question of risk to the entire economy, risk, you know, to big
banks. It is also a question of concentrated geographical risk,
what the report called ``sub-systemic risk,'' whether that is
agricultural lenders, whether that is commercial real estate
and small banks in coastal areas, or whether that is something
like the hospitality industry in places that rely heavily on
it.
So it is those concentrated risks that mean there can be
vulnerability and, I think Greg used the word,
``microprudential'' issues associated with particular sectors
or regions that are vulnerable to climate risk, and that is
where there is a need for greater information and disclosure
and regulation.
Senator Cortez Masto. Thank you. And let me ask Mr.
Gelzinis and Ms. Waite, do we actually have the modeling
technologies we need to adequately evaluate the climate-
related risk?
Mr. Gelzinis. I will go first. I think they are certainly
improving, but we will not get there if we do not get the
underlying data that needs to fit into those models, which is
another reason why disclosure is so important. And we certainly
will not get there if regulators are not building up their own
capacity.
Senator Cortez Masto. Right. Ms. Waite, what do you think?
Ms. Waite. I agree, and I would also add that in order to
get the models in shape, the regulators have to request and
demand the data. So the tons of CO2 for each financial asset
class has to be disclosed for models to be built that actually
gives a better sense of what is happening in the real economy
through investments made by lenders and other investors.
Senator Cortez Masto. Thank you. Thank you for this
incredible conversation today.
Mr. Chairman, I yield the remainder of my time.
Chairman Brown. Thank you, Senator Cortez Masto.
Senator Warnock from Georgia is recognized for 5 minutes.
Senator Warnock. Thank you so very much, Mr. Chairman, for
having this important and timely hearing on how we can address
the impact of climate change on our financial system. I am
grateful for all the panelists.
I wanted to talk more about the climate-related impact on
housing, particularly among communities of color. As you know,
many Black and brown communities were once forced to purchase
homes in less desirable neighborhoods and an unlawful practice
that is known as ``redlining'' is a way in which that
continues. These same communities are at higher risk of losing
their homes to flooding caused by climate change. I think folks
knew for a long time prior to Hurricane Katrina what happened
in the old 9th Ward was predictable. We knew that when a storm,
the right storm, came through that those folks were in an
incredibly vulnerable position. And, again, communities of
color were forced into these areas.
A recent report examined nearly 40 metropolitan cities and
concluded that homes purchased in these redline areas were 25
percent more likely to suffer from climate-related flood damage
compared to homes in non-redlined areas. Not only did the
findings in this report confirm the racial disparities within
our housing market, they also confirmed that these unjust
lending practices have now presented significant concerns to
our financial system.
And so my question is for Mr. Gelzinis, Dr. Keohane, and
Ms. Waite. How can Congress and Federal regulators-- what can
we do to lessen the climate-related economic impact on
historically disadvantaged communities and also on our overall
financial system? What should we be doing in terms of public
policy right now to take this issue seriously?
Mr. Gelzinis. Great. Thank you, Senator. I just want to
reiterate your point that it is all too clear that climate
change just simply magnifies and exacerbates the racial
injustice that is already embedded in our economic systems. So
the same communities of color that were historically redlined
now face the most severe physical risks like the flood risk
that you mentioned, but also temperatures. Redlined parts of
major metropolitan areas are several degrees warmer than other
neighborhoods due in part to the lack of green space there.
So in terms of policies, I think the Community Reinvestment
Act is critical, and climate resilience and adaptation
mitigation efforts should be integrated into the Community
Reinvestment Act. I think the Community Development Financial
Institution Fund that Treasury, the appropriation there could
be increased and green criteria added as well to make sure
community finance, particularly in communities of color, are
helping finance the transition.
Then it is outside the scope of my work, but I would just
note that public finance and fiscal policy have a huge role to
play here as well. And if disproportionate harms go to
communities of color, then disproportionate funding needs to go
to those communities of color as we build this new economy.
Senator Warnock. Yes, Ms. Waite.
Ms. Waite. So I will mention two things. The first is that
the Federal Housing Finance Authority can do a lot. Fannie
Mae's remarkably successful Multifamily Green Mortgage Program
accounts for just over 20 percent of their multifamily
mortgages. So the FHFA can expand these commitments to
addressing climate change and climate resiliency.
The second is to really ensure that the existing CRA,
Community Reinvestment Act, explicitly calls out climate
resiliency and climate change mitigation efforts. The other
thing would be to create a new CRA mirror-like mandate on banks
and other lenders so that they must lend a certain percentage
of their assets into climate infrastructure in disadvantaged
communities and communities that are likely to be impacted by
climate change.
Mr. Keohane. I will just basically echo what my colleagues
on the panel have said, Senator. I think it is critical that we
make more investment, both public investments with Government
funds but also help leverage private investment, into investing
in those communities, communities of color that have been
historically burdened, that are more vulnerable to climate
change, as you have said, but also have been historically
burdened by pollution and toxic chemicals.
So I think there is a huge amount of need there to direct
funds and to make investments in coastal infrastructure and
resilience, as my colleagues have said.
Senator Warnock. Thank you very much. We have seen more
recently financial regulators take more seriously the impact of
climate on our larger financial system, but as you point out,
we have got to do much more. So thank you for your insights.
Chairman Brown. Thank you, Senator Warnock.
Senator Toomey, before I close, do you have comments or
another question or two?
Senator Toomey. Mr. Chairman?
Chairman Brown. Yes?
Senator Toomey. Yeah, if you are going to make a closing
statement, I would just make a brief statement.
Chairman Brown. Sure.
Senator Toomey. Would you like me to do that now?
Chairman Brown. Yeah, sure. Please proceed. Thank you.
Senator Toomey. Thanks for doing this hearing. Let me just
say, you know, I believe that climate change is real. I think
human activity is an important cause. But as Dr. Cochrane
reminded us, climate change is not some unforeseen risk. It
does not pose a risk to our financial system. And financial
regulators who have no legal authority to regulate climate and
have no expertise regarding climate change should not attempt
to regulate a non-risk to our financial system.
Let us be clear what this is really all about. This is
about undermining the independence of regulators so that they
can be pressured to allocate credit as the political left would
like it to be allocated. Now, if people get their way on this
and we start to have a political allocation of capital, that
will result in slower economic growth, fewer jobs, lower wages,
and a diminished standard of living. That is why this is a bad
idea.
Thank you, Mr. Chairman.
Chairman Brown. Thank you. I will close in a moment. I have
one more question. But we have heard about a lot of complex
topics in this hearing. It is a big, complicated issue, of
course. But to be clear, the Fed and other agencies cannot just
care about what partners on Wall Street or professors at
business schools or people at think tanks think is important.
They have to look at factors outside the movement of money
between and among banks. Look at something like cybersecurity.
The Fed is not staffed with computer programmers, but we all
agree it is part of their job--and several have said that in
this hearing--to take on cyber risk.
I want to end by bringing us back to why all this matters
in people's lives. It is what I try to do at every hearing, on
Tuesday with housing and again today, what it means when
somebody is foreclosed on, what it means to a family.
We know what climate can mean to paychecks and savings and
communities. In Ohio, the combination of wetter springs and
heavier rains and hotter summers has increased algae blooms
across Lake Erie. It is the shallowest of the Great Lakes, and
it is the most vulnerable in that way. Fewer tourists rent
cottages or charter fishing boats, less money going to small
business and supporting local communities in places like
Sandusky, local economies and communities in places like
Sandusky and Clinton and Lorain and Toledo. I hear it in
conversations with people at Put-in-Bay on Lake Erie. It means
less and less money in their pockets every summer.
So I will close with asking Ms. Waite and Mr. Gelzinis and
Dr. Keohane, could each of you just briefly, very briefly, talk
about the moment you realized that climate change is going to
affect people's jobs and local economies, and probably sooner
than we think? Think back to the moment you first thought that
and describe it briefly to us. Ms. Waite, if you would start?
Ms. Waite. Yes, thank you, Senator, Chairman, for the
question. I remember quite clearly in August 2005 when
Hurricane Katrina hit, and that cost exceeded $150 billion.
That was the first time I recognized that this was going to be
extremely important for the economy and for the financial
system.
Chairman Brown. Thank you, Ms. Waite.
Mr. Gelzinis. So for me personally, Mr. Chairman, it was
really a compounding effect of the increasingly severe and
frequent extreme weather events around us and really coming to
understand that decarbonization was going to fundamentally
restructure the economy. So I think when you have an issue as
wide-ranging and of that magnitude, anyone working in public
policy should ask: Does this issue intersect with my work? And
the answer here was quite clearly yes.
Chairman Brown. Dr. Keohane.
Mr. Keohane. Thank you, Chairman. I have devoted my career
to working on climate, but I guess if there was one particular
instance that made me really realize the nature of extreme
weather, it was Superstorm Sandy. I live in New York City. The
city shut down, and then we saw the devastation out on Long
Island and in New Jersey, which Senator Menendez referred to.
So that was for me a moment where it really hit home.
Chairman Brown. Thank you very much, Mr. Keohane.
Senator Ossoff has appeared, and he will have the last 5
minutes for questions. Senator Ossoff from Georgia, please
proceed.
Senator Ossoff. Thank you, Chairman Brown, and thank you to
our panel.
Mr. Gelzinis, what do you assess to be the most significant
risks to financial stability or the financial system that are
associated with climate change?
Mr. Gelzinis. So the issue that I think, you know, would
really be catastrophic is a simultaneous or near-simultaneous
transition and physical risk event. So let us say,
unfortunately, policymakers or regulators delay taking the
necessary legal and regulatory steps to decarbonize; climate
change continues to get worse; and then we have a brutal string
of natural disasters and extreme weather events over, let us
say, 18 months across the country, starting to erode the
resilience of financial institutions. And then that spurs
public action to rapidly decarbonize the economy and make up
for the lost time that occurred before, devaluing a whole host
of carbon-intensive assets that financial institutions had not
started to wean down and bolster their resilience to, and so
you would have both physical and transition effects impacting
the financial system at the same time, potentially
destabilizing it.
That is the thing that would scare me the most.
Senator Ossoff. Thank you. Could you please unpack in a
little bit more detail the chain of events and financial
instruments, mechanisms, asset classes, relationships that in
such a high-stress event could cause there to be systemic risk
to the stability or solvency of major financial institutions?
Mr. Gelzinis. Yes, there are multiple ways that this could
play out. So, first off, any risk to a systemically important
financial institution, a too-big-to-fail bank, automatically
becomes a macroprudential concern or a financial stability risk
concern, because if one of those big banks failed, it is going
to bring down the rest of the system with it.
But you could also have correlated stress across a range of
financial institutions, so let us say you had, you know, a
range of $70 billion to $300 billion banks that were overly
exposed to carbon-intensive sectors that led to, you know, as
former Bank of England Governor Mark Carney noted, a ``climate
Minsky moment'' where the carbon bubble bursts. There are rapid
sell-offs and fire sales, impaired assets. Creditors start to
run from the institutions that they think are exposed to those
risks but may not have the transparency to know which
institutions they are, so they pull out from a lot of
institutions. And then that creates the first and second order
effects that we know occur with, you know, financial crises and
would impact financial institutions that were not even exposed
to that climate-related shock in the first place.
Senator Ossoff. Thank you. And in what ways and for what
reason do you believe that markets are not currently accurately
pricing such risks?
Mr. Gelzinis. So I would say two things about that,
Senator. So the first is institutional investors, when they are
polled on this, all--I think it was over 90 percent said that
they do not think that these risks are being appropriately
priced in because they do not have the data and the information
to price them in.
The second point I would make is that even if risks were
priced in, there would still be an important role for financial
regulators to play around tail risks. So if you think about
what it means to price in a risk, it means you have, you know,
a weighted distribution of probabilities, and oversimplifying
here, but you pick the median expected outcome and price it
based on that. So financial regulators would still have a role
to play in some of the tail scenarios that could play out with
both the physical and transition risk that, you know, climate
change poses.
Senator Ossoff. I want to return to the previous question
briefly, and I think one of the things I am trying to unpack
here is whether we are talking about addressing risks to
financial stability resulting from shocks associated with
climate change or whether we are talking about economic policy
and macroprudential policy as a means of mitigating and
combating climate change, both of which I think could have
merit as policy strategies.
But can you please unpack for me again, with a little bit
more specificity, how, for example, a series of severe weather
events or climate-associated shocks could cause such stress in
financial markets or such a precipitous reduction in the value
of certain assets that it could pose a threat to systemic
financial stability?
Mr. Gelzinis. Sure. So one example that I would use is go
back to Hurricane Andrew in the early 1990s. Insurance
companies were looking--you know, they did not have advance
catastrophe risk models at the time. They were kind of
ballparking prices based on what they had always priced that
risk at. Then all of a sudden, something happened that they
were not expecting, and it wiped out 16 insurance companies. At
the time we did not really have global interconnected insurance
companies like AIG, but imagine if, you know, some sort of
climate event on a much larger scale, if we had a couple
hurricanes in the Southeast, wildfires raging in the West, and
droughts and pests reducing crop yields in the Midwest. If that
erodes the resiliency and drives losses at systemically
important interconnected financial institutions like an
insurance company or a major Wall Street bank, then the risk
factor would be very similar to the financial crises we have
seen in the past in terms of runs, fire sales, and a credit
contraction for the real economy.
Senator Ossoff. Thank you. I appreciate that. I am sadly
out of time. Something I would like to address to all the
panelists for the record, you mentioned crop yields, and I
think that one of the things I would like to unpack a bit more
is the impact on price stability and the impact on political
stability that could result from effects on agriculture from
some of the modeled climate scenarios. But, alas, I do not have
the time right now, and I see Mr. Cochrane is shaking his head,
eager to address that question for the record. So you will all
have the opportunity to do that.
I thank you again for being here today, and I yield back,
Mr. Chairman.
Chairman Brown. Thank you, Senator Ossoff.
Thanks to the witnesses for being here today and providing
testimony. For Senators like Senator Ossoff who wish to submit
questions for the record, those questions are due 1 week from
today, on Thursday, March 25th. For witnesses, you have 45 days
to respond to these questions.
Thank you all for your participation and your civic-
mindedness. The Committee is adjourned.
[Whereupon, at 12:12 p.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN SHERROD BROWN
Today, the Banking and Housing Committee is holding its first-ever
hearing on the risk climate change poses to our economy.
That also makes it the first time our Committee will consider all
the economic opportunities that exist by addressing climate change.
More than ever, people in Ohio and around the country are
experiencing how climate change affects their lives--from devastating
hurricanes to raging wildfires, from harmful algal blooms in Lake Erie,
to landslides in Cincinnati, to erratic farming seasons across the
Midwest.
People aren't stupid. They see what's happening, and they know it
threatens not only their air and their water, but their livelihoods and
their homes.
And they also know that there are all sorts of opportunities, in
communities in every state that come with taking climate change
seriously.
They see the wind turbines across the Great Plains made with
American steel. They see people installing solar panels made in Toledo
at one of the biggest solar energy manufacturers in the country.
We can't have a 21st Century economy built on a 19th Century
model--that doesn't make environmental sense. It also doesn't make
economic sense.
If we want an economy that creates jobs and improves infrastructure
in all communities, and allows our businesses and our workers to
compete around the world, then instead of running from these
opportunities, we have to seize them.
I want to be clear: it's not the role of this committee to vilify--
or even prop up--any specific technology or any source of energy. The
work of coal miners in Belmont County, Ohio has every bit as much
dignity as the work of a battery manufacturer in Fremont, Ohio.
We show those workers no respect if we don't plan now for how we're
going to protect their communities from flooding and drought and
economic upheaval, and protect their retirement and kids' college
savings from risky investments.
On this Committee, we're charged with looking at anything that
could hurt the stability of our economy.
This is a set of issues my Democratic colleagues have talked about
for a long time.
And a lot of what we'll talk about today got a jump start last year
when now-Acting CFTC Chairman Rostin Behnam created his Climate-Related
Market Risk Subcommittee.
The Subcommittee put out an important report, ``Managing Climate
Risk in the U.S. Financial System.''
And just yesterday he announced he's establishing a Climate Risk
Unit (CRU) in CFTC to focus on the role of derivatives in
understanding, pricing, and addressing climate-related risk.
I would like to ask unanimous consent to enter the CFTC
subcommittee report, ``Managing Climate Risk in the U.S. Financial
System,'' into the record for this hearing.
Being on the lookout for risk is our job here.
We can't always predict what it might be--it could be the business
decisions of a few bad actors in a particular industry. Or we might be
forced to act because of events beyond our borders.
In this case, though, we can predict something that's going to hurt
the economy. We know that climate change threatens the country's
financial stability.
And the financial sector, and the government agencies that oversee
it, are going to have to reckon with the consequences of decades of
risky investments in industries that fuel natural disasters, and
threaten people's paychecks and their retirement security.
For years, the biggest corporations have fought government action
on climate change because CEOs could make a lot of money in the short
term by endangering our planet in the long term. And then these
corporations and these CEOs expect workers and their families to foot
the bill.
We can't protect the economy--and the people who make it work--if
we don't start by identifying the risks.
We know far too little about how much climate-related risk is
sitting on the books of banks and insurance companies.
It's not a surprise that Wall Street is trying to hide just how
heavily they've invested in corporate polluters. This lack of
transparency about the largest U.S. banks' significant investments in
long-term fossil projects here and abroad hides potential financial
risks.
Those are risks that workers and families investing their pensions
and 401Ks are going to pay the price for.
We need to know where Wall Street is investing people's hard-earned
savings. And if it's invested in shrinking industries that threaten
their jobs and their communities, we need to know about it.
That means looking at stronger transparency rules, and it means
looking at whether the tools financial watchdogs already have can help
us shine a light on these risks.
While some large banks and other companies have voluntarily
disclosed some of their investments, not enough of them have, and they
aren't moving fast enough.
We needed this years ago.
Look around--climate-related disasters are already here, and
they're already grinding local economies to a halt, forcing people out
of work, and destroying their communities.
The second polar vortex in a decade to cripple Texas is not far
behind us, and we're approaching what some are predicting will be an
above-average hurricane--those are economic risks.
Persistent drought leaves the Mountain West dealing with wildfires
that rack up multibillion dollar economic losses year after year, in
fire seasons that are so constant they've ceased to be seasons--that's
an economic risk.
Farmers in the Plains states lost an entire planting season because
of wet fields or flooding that once would have been shocking, but now
is all too common--that's an economic risk.
A three-day downpour flooded more than 100,000 homes in Houston,
forced hundreds of thousands of people out of their homes, and ground
commerce to a standstill at one of the three busiest ports in the
country--with effects like that, it's hard not to think that the only
way you could fail to see an economic risk, is if you're being paid not
to see one.
It's also not enough to just think about the climate risks to
companies' balance sheets or stock prices--the financial industry, and
our government, has to take into account the risks to people's
livelihoods, the communities they live in, the food they eat, and the
investments they've made for their retirements.
As we look for opportunities, we need to make sure that American
industry-steel and aluminum, paper and autos-can access the capital
they need to reduce or eliminate emissions.
And when we increase transparency across the financial sector and
take into account the clear economic costs of climate change, then
lenders, industry, and workers will be rewarded by making these capital
investments.
Today we'll hear from five witnesses who will share their insights
and expertise on those risks, and the opportunities we all have to
protect and rebuild our economy. I hope my colleagues will keep an open
mind.
Every day that we delay is another missed opportunity to invest in
new industries and technologies, to make our businesses more
competitive, and to create jobs in communities that are so often left
behind.
And if we don't tell people the truth and take this seriously, we
know who is going to pay the price.
It's never CEOs. It's never the corporate boards. It's never
senators.
It's going to be the ranchers in North and South Dakota, and the
line cook in New Orleans, and the kindergartner with asthma in Las
Vegas, and the steel worker in Cleveland.
It's their jobs and their savings and their futures on the line.
And it's our job to be on their side.
______
PREPARED STATEMENT OF GREGORY GELZINIS
Associate Director, Economic Policy, Center for American Progress
March 18, 2021
Chairman Brown, Ranking Member Toomey, and Members of the
Committee: Thank you for the opportunity to testify before the
Committee on this critical issue. My name is Gregory Gelzinis. I am an
Associate Director for Economic Policy at the Center for American
Progress, where I research, and advocate for, policies that would
create a safer, more stable, and less predatory financial system-one
that is well-positioned to support long-term economic growth.
The coronavirus pandemic has proven to be a terrifying reminder
that our collective livelihoods can be upended by catastrophic
exogenous shocks, seemingly at a moment's notice. It is incumbent on
policymakers to use this experience as a catalyst towards addressing
the impending exogenous shock that will likely disrupt our lives on a
much greater scale: climate change. The climate crisis has profound
implications for life and health, as it challenges our very ability to
sustain a habitable planet. Climate change is also going to have a
fundamental impact on every sector of our economy, including the sector
we are here to discuss today: the financial sector.
The increase in frequency and severity of extreme weather events
and long-term environmental shifts threatens an array of real assets
and financial assets. From commercial and residential real estate
exposures along the coast to agricultural lending in the Midwest,
climate change could severely impair the value of physical collateral,
disrupt supply chains, limit economic activity, increase financial
uncertainty, and strain profitability. These effects would reduce real-
estate and commodity values, lower corporate equity prices, and limit
the ability of businesses and households to repay debt.
In addition, the financial system is exposed to transition-related
risks. If policymakers take the legal and regulatory actions necessary
to meet emissions and temperature targets, financial institutions whose
balance sheets don't align with the transition could face significant
losses. Financial instruments tied to carbon-intensive sectors could
face a severe repricing as policies restrict and raise the costs of
emissions. Under certain scenarios, financial institutions could adjust
to these transition effects abruptly, bursting the carbon bubble and
creating what former Bank of England Governor Mark Carney has coined a
``climate Minsky Moment.''
Climate change does not only present risks to individual
institutions. It also poses a systemic threat due to the potential
magnitude of the physical and transition-related risks, the wide array
of financial institutions and markets exposed to these risks, and the
speed with which these possibly correlated risks could materialize.
These risks aren't theoretical. In just the past two years we've
seen arguably the first climate bankruptcy in PG&E and witnessed energy
companies, like BP and Total, write down the value of stranded assets,
as energy price assumptions are re-calibrated.
The financial sector is finally starting to adjust to these risks
and recent net-zero commitments from the largest Wall Street banks are
a welcome development, although such commitments have been light on the
details and lack near-term plans to meet those long-term goals. But it
iscritical for regulators to step in and account for these risks in the
supervision and regulation of the financial system. We can't let Wall
Street write the rules and rely upon the disproven strategy of self-
regulation, especially as these firms continue to finance the very
drivers of the climate crisis that put their own balance sheets, as
well as those of responsible firms, at risk.
Financial regulators have broad responsibilities under existing law
to mitigate these climate related risks. Markets regulators have a
responsibility to protect investors, to promote transparency, and to
foster healthy markets for securities and derivatives. Prudential
regulators have a statutory mandate to ensure the safety and soundness
of financial institutions and to promote the stability of the financial
system. Climate change clearly falls within these mandates and a
failure to mitigate climate-related risks would violate the duties
Congress bestowed upon the financial regulators.
Thankfully, over the past few months a bipartisan collection of
U.S. financial regulators have acknowledged that climate change falls
within their remit. Even though the U.S. is several years behind its
international peers, recent actions and announcements by the White
House, Treasury Department, Fed, SEC, CFTC, FHFA, FDIC, and state-level
regulators signal that momentum is building.
Like many economic variables, these risks won't be easy to model or
quantify, given the inherent uncertainty climate change entails. But
the potential magnitude of the risk demands regulators employ a
precautionary principle and safeguard the financial system from the
worst outcomes. Integrating climate change into corporate and financial
disclosure requirements, fiduciary obligations, stress testing,
supervision, capital requirements, and systemic risk oversight would
bolster the resilience of the financial system and position it to serve
as a source of strength to the economy during the low-carbon
transition. If regulators fail to act with sufficient speed or refuse
to use their full panoply of tools, it is imperative for Congress to
insist that they do so. The stakes are too high.
Climate Change Poses Significant Risks to Financial Institutions and
Markets.
Climate change has fundamental implications for every sector of the
economy, including the financial sector. Physical risks and transition
risks are the two primary transmission channels through which climate
change could impair financial institutions and markets. Physical risks
stem from the increase in frequency and severity of extreme weather
events and long-term environmental changes.\1\ Transition risks refer
to the potential impact that climate policy interventions, clean energy
technological advancements, and shifts in consumer and investor
sentiment can have on carbon-intensive financial exposures.
Transition risks
In order to stabilize global temperatures and mitigate the chances
of catastrophic climate impacts on the planet, climate policymakers
must take legal and regulatory steps to drastically decrease greenhouse
gas (GHG) emissions. The Paris Agreement, signed by the U.S. and 190+
other parties in 2015, aims to limit global temperatures to well-below
2 degrees Celsius above preindustrial levels, and ideally 1.5 degrees
Celsius.\2\ The Intergovernmental Panel on Climate Change's special
report in 2018 underscored the imperative to keep warming to 1.5
degrees Celsius, given the severe consequences associated with even 2
degrees of warming.\3\ The scientific projections suggest that global
emissions must reach net-zero by 2050 to plausibly hit the 1.5 degree
Celsius temperature target.\4\ Achieving these climate goals requires a
fundamental restructuring of the economy. This low-carbon transition
isn't several decades away. In many respects, it has already begun. But
further robust policy changes are required in the near-term to hit
these targets and avoid catastrophic impacts on communities and the
economy. Emissions must decline by at least 45 percent from 2010 levels
by 2030 to remain on track.\5\ The U.S. presently derives roughly 20
percent of its energy from clean sources, while 80 percent is derived
from fossil fuels.\6\ President Biden has committed to put the U.S. on
a path to achieve 100 percent clean energy by 2050.\7\
If climate policymakers implement the legal and regulatory actions
necessary to meet these emissions and temperature targets, financial
institutions whose balance sheets don't align with the transition could
face significant losses. Financial instruments tied to carbon-intensive
sectors, e.g., fossil fuel companies, fossil-driven utilities,
transportation, agriculture, chemical production, and mining and
metals, could face a severe repricing as policies restrict and raise
the costs of emissions. Companies engaged in high-carbon activities
would face increased costs and the potential for fully or partially
``stranded assets''.\8\ For example, the implementation of rigorous
energy efficiency standards and other policy interventions that limit
emissions would severely diminish the value of hydrocarbon reserves.
Fossil fuel companies would have to write down the value of those
stranded assets on their balance sheets, impairing their financial
condition and reducing their ability to meet their financial
obligations. This dynamic would create losses for their equity
investors, creditors, and counterparties. Moreover, bank loans to
fossil fuel companies are often secured by hydrocarbon reserves.
Transition-related risks can therefore increase the likelihood of the
loan's default, as well as the loss to the bank if the loan defaults,
since the collateral would lose value.\9\ This risk is not theoretical,
as companies are beginning to face the prospects of transition-related
write-downs. For example, British Petroleum wrote down $17.5 billion in
assets in June 2020 after lowering its long-term fossil fuel price
assumptions and Total SE took a $7 billion hit on Canadian oil sands
assets in July 2020.\10\
The magnitude of potential financial losses and the prospect for
broader stability issues in the banking system increase if the
transition is ``disorderly''. Under such a scenario, policymakers slow-
play the actions necessary to meet emissions and temperature targets,
before eventually taking more aggressive and rapid actions to make up
for lost time. Financial losses in the energy sector alone could reach
$1-4 trillion, depending on the extent to which the transition is
disorderly.\11\ Taking a broader view of transition-related risks, an
estimate from IRENA suggests an abrupt and disorderly transition could
cause upwards of $20 trillion in financial losses.\12\ Technological
advancements and changes in investor sentiment could also quickly
trigger many of these dynamics in advance of any actual legal or
regulatory changes.
In either an orderly or disorderly scenario, financial institutions
whose holdings and exposures are not aligned with a low-carbon economy
could face severe losses, increasing risks to the economy, communities,
and public funds. Research suggests that the direct and indirect
exposures to carbon-intensive sectors could propagate stress throughout
the financial system and disrupt financial stability.\13\ These
transition-related risks impact credit, market, reputational,
operational, and liquidity risks.\14\ If financial institutions do not
adjust to these transition-effects in a timely manner, the
crystallization of losses could occur abruptly, bursting the carbon
bubble and creating what former Bank of England Governor Mark Carney
has coined a ``climate Minsky Moment''.\15\
A survey of institutional investors suggests the financial system
is not reflecting these risks in asset prices, as 93 percent responded
that the implications of climate change had yet to be priced into
markets.\16\ Research surrounding the projected physical impacts of
climate change and scenario analyses probing transition-related impacts
support this view held by institutional investors.\17\. There are
several reasons that investors have yet to price the impacts of climate
change into valuations for a range of assets. These include a lack of
granular, comparable, and reliable corporate disclosure of climate-
related risks; backwards-looking pricing models that are not fit for
purpose when analyzing forward-looking risks; and the temporal mismatch
between shortterm corporate thinking and medium-to-long term climate
risk materialization.\18\
It's important to note that the low-carbon transition also provides
incredible opportunities for financial institutions to finance clean
energy projects and an array of green assets. It's going to take both
public and private finance to fund the decarbonization of the economy
and banks and companies that are safeguarded from transition-related
risks will be best positioned to take advantage of these opportunities.
Physical risks
The current concentration of greenhouse gases in the atmosphere is
significantly higher than it has been at any point in the last 800,000
years.\19\ To maintain stable temperatures, energy coming into the
planet must be balanced by energy leaving it. Greenhouse gases,
particularly carbon dioxide, allow energy into the atmosphere, but trap
energy as it attempts to leave-skewing the balance and increasing
global temperatures. To this point, the earth has warmed by 1 degree
Celsius, above pre-industrial levels. As a result, sea-levels are
rising at an unprecedented rate-driven by melting ice sheets and the
expansion of seawater as ocean temperatures rise.\20\ Not only are sea-
levels rising, but oceans are becoming significantly more acidic.\21\
These environmental changes are driving more frequent and severe
extreme weather events across the globe. The physical impacts of
climate change have severe implications for life and health, and the
overall ability to sustain a habitable planet. And, directly relevant
to this hearing, they also pose risks to various economic sectors and
the real and financial assets tied to them.
Under severe warming scenarios, the physical impacts of climate
change could drive at least $2 trillion in losses to GDP annually (in
today's dollars) by 2100, or loosely speaking, the economic equivalent
of the 2008 financial crisis every 5 years.\22\ Even under more
moderate warming pathways, macroeconomic impacts could be severe.\23\
The real-estate sector faces some of the most acute physical risks.
Improved flood data, for example, shows that over 14 million properties
could be at risk from 100-year floods.\24\ The outdated FEMA maps
estimate that only 8.7 million are at risk.\25\ Zillow mapped flood
risk data onto its real estate data and estimated that roughly $900
billion in homes face serious risk from rising sea-levels, and that was
prior to the publication of the aforementioned research on flood
risk.\26\ Climate change is already impacting agriculture.\27\ Climate
change erodes the quality of soil, increases invasive species and crop
diseases, and leads to more frequent droughts and floods.\28\ These
physical impacts drive down crop yields and drive commodity price
volatility. The fishing sector is also impacted by warmer and more
acidic oceans.\29\ The physical risks of climate change also impact the
retail and tourism sectors and will have effects on a wide range of
businesses and industries in affected geographic areas.\30\
The impact of sea-level rise, warming global temperatures, and more
frequent and severe floods, hurricanes, droughts, wildfires, and other
natural disasters could drive up losses for insurance companies, banks,
private funds, investment companies, pension funds, and other market
participants invested in exposed assets.\31\ These risks threaten to
reduce the value of a range of real assets and financial instruments
tied to commercial and residential real-estate, agricultural lending,
commercial and industrial lending, municipal and corporate bonds, and
commodities. Physical risks can impair physical property, disrupt
supply chains, limit economic activity, increase financial uncertainty,
and strain profitability, which reduce real-estate and commodity
values, lower equity prices, and limit the ability of borrowers to
repay debt.\32\ They can also directly damage and reduce the value of
collateral that secures credit extended in some of these markets. In
addition to the credit and market risks posed by the physical effects
of climate change, they threaten to significantly increase claims for
an array of property and casualty insurance business lines. Some may
argue that many of these real assets and financial assets are or could
be insured, protecting the financial institution or investor from
losses.
Insurance companies, however, may, and in some cases have already
started, to reduce the availability of insurance in certain geographies
and business lines.\33\ That would leave other financial actors
increasingly exposed to physical-risk losses. Even if insurance
companies stay in these impacted markets or geographies, the difficulty
in modeling the non-linear effects of climate change could leave
insurance companies themselves overly exposed to physical risks.\34\
Similarly, given the non-linear nature of the risks, the credit default
swap and debt markets will continue to have difficulty accurately
pricing these risks, which can impact single issuers, geographic
regions, or whole industries. Rapid re-pricings of debt securities may
also impact equity and options holdings of the underlying issuers. Put
simply, financial instruments tied to the fates of companies and
municipalities, which may be held by public or private fund investors,
pensions, and even individuals, may suffer significant losses.
These risks are not theoretical, and they are not far off in the
distance. They are already here. Severe weather events have caused $106
billion in damage a year on average over the past 5 years,
significantly higher than the 1980-2019 average of $43.9 billion.\35\
Based on the projected intensification of these events, they could
trigger trillions of dollars in losses for financial institutions and
investors exposed to these assets in the coming years and decades.\36\
Many have labeled the wild-fire driven bankruptcy of the utility
company PG&E in 2019 as the first climate-related bankruptcy, initially
wiping out around $20 billion in market capitalization (roughly 85
percent of the late 2018 level).\37\ Even if policymakers are
successful in limiting warming to 1.5 degrees Celsius above pre-
industrial levels, extreme weather events will be substantially more
severe and frequent than they are today and long-term environmental
shifts will continue to progress. Today, the world has warmed about 1
degree Celsius above pre-industrial levels and the destructive impacts
are clear. Another 50 percent increase in warming will meaningfully
exacerbate the physical impacts of climate change-and that's under the
best-case scenario. It's worth underscoring that low- and moderate-
income communities and communities of color are likely to be the
hardest hit by physical risks and the least able to financially bear
the resulting costs. Meanwhile, it is these very same communities that
disproportionately suffer the consequences of the industrial pollution
produced by the very drivers of the climate crisis.\38\
Financial regulators have a statutory responsibility to mitigate
climate-related risks to financial institutions, investors, and
the stability of the financial system.
A few years ago, it was a common refrain among some financial
regulators that climate change fell outside their core mandates. To be
clear, financial regulators are not being asked to set climate policy.
That is the responsibility of Congress and other executive agencies.
Financial regulators are simply being asked to do the jobs Congress
assigned--to protect the financial system and broader economy from
damaging financial risks.
Thankfully, many financial regulators--both Democrats and several
Republicans appointed by President Trump-now acknowledge that climate-
related financial risks fall squarely within their statutory
mandates.\39\ It is rapidly becoming a broadly bipartisan issue. But
the original refrain, and the idea that efforts to get financial
regulators to focus on climate-related risks are ``the left'' pushing a
social engineering project, still appears in some corners.\40\ It is
therefore worth briefly clarifying how the aforementioned climate-
related financial risks intersect with the mandates and authorities of
various regulators. The specific policies that financial regulators can
and should implement to mitigate climate-related financial risks are
discussed in greater detail in Section IV of this testimony.
Markets regulators
The Federal securities laws were created to ensure that investors
and the public have essential information about companies so as to
promote the efficient allocation of capital and protect investors. As
Congress explained when adopting the Securities Act of 1933,
Whatever may be the full catalogue of the forces that brought
to pass the present depression, not least among these has been
this wanton misdirection of the capital resources of the Nation
. The bill closes the channels of such commerce to security
issuers unless and until a full disclosure of the character of
such securities hasbeen made.\41\
The Securities and Exchange Commission (SEC) was established in
1934 to promote the effective implementation and oversight of the new
rules. Its mission is to protect investors; maintain fair, orderly, and
efficient markets; and facilitate capital formation.
Information about companies and their risks is essential to
facilitating the efficient allocation of capital and protecting
investors. The climate-related financial risks outlined above intersect
with that mission in several important ways. The Commission has broad
authority to require disclosures by issuers to ensure that investors
and the broader public have the information necessary to accomplish
those statutory goals.\42\ Over the years, corporate issuers and their
allies have sought to constrict the Commission's disclosure framework
to a narrowly defined ``materiality'' framework that is essentially
tied to whatever the company itself (or its management) believes to
have a significant impact on the company's finances. But the SEC's
statutory authority is not limited to that constricted view.\43\
Rather, the disclosure obligation must center the needs of investors
and the public interest-as its statutory authorization makes clear.
Corporations should not be deciding what information investors or the
public require to make prudent capital allocation decisions or protect
the public interest.\44\ The physical and transition risks associated
with climate change have implications for the ongoing operations of
companies in every sector of the economy, both positive and negative.
Understanding a company's direct and indirect greenhouse gas emissions,
energy consumption, fixed-asset and supply chain exposure to extreme
weather disruptions, and other climate-related factors are necessary
for investors to make prudent capital allocation decisions. Investors
have made it very clear that they want this information. A lack of
transparency could drag on economic growth with overinvestment in
certain sectors or companies, and underinvestment in others.
Whether and to what extent the SEC requires comprehensive,
reliable, and comparable information from issuers of securities will
have profound impacts on whether and how companies and investors are
efficiently allocating capital and assessing risks. For example, much
of the corporate debt securities markets are currently exempt from SEC
disclosure obligations. If a large fossil fuel company sells billions
of dollars in debt securities that are not due for 15 years or more,
what are the climate-related risks of those securities?
The SEC also oversees registered investment advisers and investment
companies. A broad range of investors are looking for fund products
that both limit their climate-related exposures and direct investment
towards green climate solutions.\45\ The SEC has a statutory
responsibility to ensure that funds holding themselves out as ``green''
are not misleading investors, but these investors (as well as banks,
insurance companies, pension funds, and others) can only manage their
portfolios to meet these ``green'' expectations if they are getting
comprehensive, reliable, and comparable information from the companies
in which they invest.\46\ To go back to the example above, how can an
investment adviser assess the risks to its funds holding of a fossil
fuel company's debt securities if the party best positioned to identify
and disclose them hasn't done so?
Furthermore, as climate risk impacts the price outlook for various
investments, entities with a fiduciary obligation overseen by the SEC
must increasingly take such risks into account when providing
investment advice to meet those obligations, regardless of their
investment strategies.\47\ Put simply, fiduciaries cannot ignore these
risks. Climate change impacts other institutions under the SEC's
jurisdiction, including broker-dealers, credit rating agencies, and
auditing and accounting firms.\48\ Broker-dealers are exposed to market
risk posed by transition and physical risks, credit rating agencies
will need to update their rating methodologies to ensure climate
related risks to fixed-income issuances are factored in, and auditing
and accounting firms will be increasingly essential to ensure that
climate risks are accurately accounted for and company disclosures are
reliable. If the SEC fails to integrate climate-related risks into its
core regulatory framework, it will fall short of its statutory mission.
Investors will be exposed to risks that were not sufficiently disclosed
to them, capital will be inefficiently allocated, our markets will be
anything but orderly, and it will serve as a drag on capital formation
due to a loss of investor confidence in the resilience and transparency
of markets.
The SEC's recent announcement under Acting Chair Allison Herren Lee
that the agency's Division of Examinations team is focusing on
companies' disclosures and compliance with the agency's 2010 climate
risk-related guidance\49\ and investment advisers' claims and practices
regarding sustainable investing is a great step towards ensuring
accountability under the existing rules. So, too, was the announcement
of the SEC's creation of a Taskforce on Climate and ESG within the
Division of Enforcement. However, the SEC's expectations for companies,
investment advisers, broker-dealers and other essential market
participants need to be modernized to reflect the magnitude of the
risks and impacts of climate change on seemingly every aspect of our
economy.
The Commodity Futures Trading Commission (CFTC) is the primary
derivatives regulator in the U.S. and is responsible for promoting the
integrity, resilience, and vibrancy of derivatives markets. The agency
has authority to impose disclosure requirements, margin and capital
rules, risk management standards, and other safeguards on the firms and
products under its jurisdiction.\50\ The physical and transition risks
caused by climate change could impact the value and volatility of
commodity prices and drive losses at the market participants exposed to
these assets, including through derivatives. For example, chronic
droughts and an increase in crop diseases in the Midwest could impact
corn prices and rising temperatures in the Mississippi Delta could
impact rice yields. Moreover, the clean energy transition necessary to
stabilize global temperatures will have a considerable impact on fossil
fuels and metals commodities. Increased risk and volatility in these
and other commodities markets could impact futures commission
merchants, central counterparties, and other market participants. The
CFTC also oversees swaps dealers and major swaps participants. Credit
default swaps on a basket of energy companies or a commercial mortgage-
backed security index, for example, could be affected by climate-
related risks. The 2008 financial crisis showed the costs of an
underregulated derivatives market, and it is imperative for the CFTC to
appropriately account for climate-related risks in its regulatory and
supervisory framework.
Prudential regulators and the Financial Stability Oversight Council
The prudential banking regulators, the Federal Reserve Board (Fed),
Federal Deposit Insurance Corporation (FDIC), and Office of the
Comptroller of the Currency (OCC) have a statutory responsibility to
ensure the safety and soundness of the banking organizations under
their respective jurisdictions and to promote the overall stability of
the banking system. The banking regulators play a critical function in
our economy. Reducing the chances and severity of banking crises,
protecting depositors and the public funds that stand behind insured
deposits, and ensuring our banking system is supporting productive
economic investment instead of speculation all help to orient our
economy towards long-term, sustainable, and equitable growth. When
these regulators fall short, we've all-too-recently seen the resulting
economic devastation that bank failures, fire-sales, runs, and a
contraction of credit can have on businesses and households across the
country. Congress has afforded banking regulators broad writs of
authority to execute this critical mission in several statutes,
including the Federal Deposit Insurance Act, the Bank Holding Company
Act, the International Lending Supervision Act, and most recently, the
Dodd-Frank Wall Street Reform and Consumer Protection Act, among
others.\51\ Through these statutes, regulators have significant
authority to use supervisory tools, capital and liquidity requirements,
stress testing, recovery and resolution planning, risk management
requirements, and other prudential tools that they deem appropriate to
address any risks to individual institutions--microprudential risks--as
well as risks to the overall functioning of the banking system--
macroprudential risks.
Climate change poses microprudential risks to banks, including
credit, market, liquidity, reputational, and operational risks. All
banks, large and small, receive special public privileges due to the
inherent fragilities of the banking business model and the key role
banks play in providing credit, offering payment services, and most
importantly, issuing deposits. These privileges include deposit
insurance and access to the Fed's discount window, but also come with a
regulatory and supervisory framework to mitigate moral hazard and the
externalities failures can impose. Even though the failure of a $10
billion bank won't create a systemic crisis, regulators still have a
responsibility to ensure the safety and soundness of the bank, since it
still receives these public privileges, and its failure could still
have a harmful impact on the local or regional economy. Individual
banks are exposed to varying degrees of climate-related risk depending
on the types of assets they hold and the geographic location of those
assets. For example, a bank with a high concentration of coastal
commercial real-estate exposure could face severe losses from rising
sea-levels. A bank that finances agricultural loans could face losses
if droughts, floods, and pests decrease the crop yield for a farmer who
then can't meet her financial obligations. Moreover, a bank in the oil
patch that focuses on reserve-based lending to oil and gas exploration
and production companies could face losses if hydrocarbon reserves are
devalued as a result of the clean energy transition, increasing both
the likelihood of default on the loan and the loss to the bank if the
loan does, in fact, default.
The prudential regulators not only have a responsibility to
mitigate climate-related risks for individual institutions. They must
also address the macroprudential risks created by climate change-that
is, the risks to the overall functioning of the banking system and
broader financial sector. As Federal Reserve Board Governor Lael
Brainard has noted, ``Climate change could pose important risks to
financial stability. That is true for both physical and transition
risks.''\52\ Climate change is a systemic threat due to the potential
magnitude of the physical and transitionrelated risks it poses, the
wide array of financial institutions and markets exposed to these
risks, and the speed with which these possibly correlated risks could
materialize.\53\ Climate-related shocks could impair the normal
functioning of the financial system and inflict damage on the broader
economy. A physical or transition shock could cause severe losses at a
systemically important financial institution or correlated losses
across a string of financial institutions, leading to fire sales of
impaired assets, creditor runs from distressed institutions, and
second-order counterparty losses and contagion at institutions that may
not have been directly exposed to the initial shock.\54\ These first-
and second-order effects could create vicious feedback loops, undermine
confidence in the financial system, and ultimately trigger a credit
contraction and a broad increase in the cost of financial
intermediation.
SEC Acting Chair Allison Herren Lee has cautioned that climate-
driven financial stability disruptions ``can also spread in ways that
are less predictable because climate risk is unique in terms of its
scope, breadth, and complexity.''\55\ In a particularly troubling
financial stability scenario, a physical shock could trigger a near-
simultaneous transition shock. After delaying robust and orderly
decarbonization, a brutal string of natural disasters could spur
policymakers to take aggressive and disorderly steps to stabilize
global temperatures. In short, climate-related shocks could be
immediately amplified by and transmitted throughout the financial
system, disrupting the normal functioning of the system and leading to
spillover effects on the real economy.\56\ Another macroprudential
concern short of a systemic crisis is that physical and transition
risk-related losses could chronically erode the resilience of financial
institutions over time and leave the system vulnerable to other shocks.
In addition to the macroprudential responsibilities and authorities
afforded to the prudential banking regulators, the Dodd-Frank Act
created a new financial stability watchdog-the Financial Stability
Oversight Council (FSOC). Although the United States is notable for
having many financial regulatory agencies, before the 2008 financial
crisis, no one regulator or regulatory body was responsible for looking
out across the financial system and addressing systemic risks.
Financial regulators focused on their respective jurisdictions, while
significant risks built up across jurisdictions and outside of any one
regulator's purview. Risky financial activities and products sprouted
in the cracks of the financial regulatory infrastructure as regulatory
arbitrage, intentionally exploiting its fragmentation. The FSOC was
structured to mitigate some of these regulatory design flaws. It is
chaired by the secretary of the U.S. Department of the Treasury and
brings together the heads of all eight federal financial
regulators,\57\ and a voting member with insurance expertise, around
one table.\58\ The FSOC's goal is to improve coordination across
agencies and tackle emerging financial sector risks and vulnerabilities
before they trigger or amplify another financial crisis. Climate change
has implications for every part of the financial system and, in turn,
every financial regulator. It is the exact type of cross-cutting risk
that the FSOC was designed to address. The FSOC can use its research
and coordinating functions to drive better climate-related risk
analysis, monitoring tools, and risk-mitigating policies at primary
regulators. When necessary, it can also use its powerful statutory
tools to directly address certain climate-related risks and push
primary regulators to act.
It's important to note that the banking regulators and FSOC are not
supposed to focus solely on the microprudential or macroprudential
risks to which financial institutions are exposed. They also have a
responsibility to mitigate risks created or exacerbated by financial
institutions that could then drive losses elsewhere in the financial
system. For example, Section 165 of the Dodd-Frank Act directs bank
regulators to develop macroprudential regulations to ``prevent or
mitigate risks to the financial stability of the United States that
could arise from the material financial distress or failure, or ongoing
activities, of large, interconnected financial institutions . . . ''
(emphasis added).\59\ That principle is embedded throughout the Dodd-
Frank Act.\60\ In the context of climate change, prudential regulators
and the FSOC have a statutory mandate to mitigate climate-related risks
created or exacerbated by financial institutions' ongoing activities.
Notably, financial institutions that are major financiers of carbon-
intensive activities are facilitating increased GHG emissions and
intensifying climate change. Exacerbating the climate crisis will
increase both the physical and transition risks of climate change and
inflict larger losses on the financial system. With respect to physical
risks, higher GHG emissions lead to higher global temperatures, which
in turn cause more frequent and severe extreme weather events and
damaging environmental changes.\61\ The more significant the physical
effects of climate change, the more likely and severe the financial
system's associated losses will be. Furthermore, increased emissions
today drive up projected warming pathways and increase the likelihood
that a rapid and disruptive transition is required to stabilize global
temperatures.\62\
Other Regulators
This testimony focuses primarily on markets regulators, prudential
banking regulators, and the FSOC, but climate change has implications
for other state and federal regulators as well. Credit unions, which
receive a distinct charter and are regulated by the National Credit
Union Administration (NCUA), face similar microprudential risks as
banks. The NCUA, likewise, has similar tools to promote the safety and
soundness of credit unions. As mentioned earlier, the physical effects
of climate change-particularly sea-level rise-poses significant risks
to the commercial and residential real-estate markets. The Government
Sponsored Enterprises (GSEs), Fannie Mae, Freddie Mac, and the Federal
Home Loan Banks, have significant exposure to these markets. In fact,
there is increasing evidence that banks are off-loading substantial
flood risk to Fannie and Freddie.\63\ The Federal Housing Finance
Agency (FHFA) is the prudential regulator for the GSEs and has broad
authority to ensure their ongoing safety and soundness. Similarly, the
Public Company Accounting Oversight Board (PCAOB), the Municipal
Securities Rulemaking Board (MSRB), and the Financial Industry
Regulatory Authority (FINRA) each have important roles to play. For
example, to the extent that the SEC requires companies to make climate
related estimates and disclosures, the PCAOB will have an essential
role in ensuring that those estimates and disclosures are comparable
and reliable. The Consumer Financial Protection Bureau could help
consumers hold banks accountable on issues of sustainability,
effectively empowering them to ``vote with their deposits'' by making
it easier to seamlessly switch their bank accounts, something that is
surprisingly challenging to do today.\64\
Finally, the insurance sector is arguably the most acutely exposed
to the physical risks of climate change, since the core business model
for property and casualty insurers involves guaranteeing the value of
physical assets. Insurers' investments are also exposed to physical and
transitionrelated risks. Insurance is primarily regulated at the state-
level, meaning state insurance regulators have a critical role to play
in mitigating these risks. But the FSOC and Federal Insurance Office
(FIO) must closely monitor such risks and use their own tools to
address them, when necessary.
The U.S. is behind its international peers in addressing climate-
related financial risks, but there are recent signs of
progress.
International regulators have acknowledged the severity of climate-
related risks and the need for financial regulators to act urgently to
mitigate such risks. The Network for Greening the Financial System
(NGFS) was established in December 2017 by eight central banks as a
coordinating body for those central banks and supervisors committed to
tackling climate-related financial risks. Since then, the NGFS
membership has expanded to 83 members and 13 observers, representing
about 75 percent of global GDP and the vast majority of the world's
systemically important financial institutions.\65\ The NGFS has put out
multiple research reports, sample supervisory guidance, model stress
testing scenarios, and more over the past several years.\66\ Many NGFS
members have begun, in turn, to adapt their core regulatory and
supervisory frameworks accordingly. The Basel Committee on Banking
Supervision published the results of its climate-related stock take of
how member jurisdictions are approaching climate-related risks.\67\ Of
the 27 jurisdictions surveyed, 24 had conducted climate-related
research, 23 had raised the issue directly with banks, and 6 had issued
supervisory guidance (with 5 more in the process of doing so).\68\ Some
jurisdictions have advanced mandatory climate disclosure frameworks and
have implemented, or are in the process of implementing, climate-
related stress testing and scenario analysis regimes.\69\ In many
jurisdictions, this activity has been driven by regulators under
existing authority, while legislative bodies in certain jurisdictions
have set comprehensive frameworks.\70\
The U.S. has made little progress on addressing climate-related
risks, while U.S. financial institutions are lagging their
international counterparts in curbing climate-risky activities. The
tide is shifting, however, and recent actions are cause for optimism.
In September 2020, the CFTC Climate-Related Market Risk Subcommittee,
established by Commissioner Rostin Behnam, published the first
official-sector commissioned report in the U.S. on climate-related
financial risks.\71\ In November 2020, the Fed included climate-related
risks in both its Supervision and Regulation Report and Financial
Stability Report, before ultimately joining the NGFS in December.\72\
This was welcome news, as Governor Lael Brainard has been talking about
the need for the Fed to focus on climate change for years.\73\
Additionally, the Fed recently created a Supervision Climate Committee
to evaluate and mitigate the microprudential risks posed by climate
change.\74\ SEC Acting Chair Allison Herren Lee has taken steps over
the past two months to better integrate climate-related risk in the
Commission's disclosure, examination, and enforcement functions.\75\
FDIC Chair Jelena McWilliams announced that focusing on climate
change's impact on the financial sector was recently added to the
agency's performance goals for the first time.\76\ FHFA Director Mark
Calabria recently issued a fairly comprehensive public request for
information regarding how the agency should integrate climate-related
risks into its core functions.\77\
The Biden administration has also signaled that addressing climate-
related financial risks would be a key priority within the all-of-
government approach to the climate crisis. A recent executive order
directed the Treasury Secretary to ensure the U.S. was present at
international fora working on climate-related financial risks and the
executive order reinforced the Paris Agreement's goal to align capital
flows with a 1.5-degree Celsius warming pathway.\78\ Secretary Yellen
has repeatedly emphasized the importance of this issue for multiple
Treasury core functions, including the Secretary's role as Chair of the
FSOC. She has even committed to establishing a ``climate hub'' at the
Department.\79\ Certain state-level regulators have also started to
make real progress on this issue. The New York Department of Financial
Services, in particular, has taken some nation-leading steps on this
front.\80\ The California Department of Insurance, under Dave Jones'
leadership, also made notable progress during his tenure.\81\
The U.S. is behind our international counterparts. The building
momentum, though, suggests the next few years could be a ``leapfrog
moment'' for our country, as Sarah Bloom Raskin, former Treasury Deputy
Secretary and a global leader on climate-related financial issues, has
characterized the present opportunity for action.\82\
Financial regulators have the tools to advance a robust policy agenda
to mitigate climate-related financial risks.
The U.S. is moving beyond merely the identification and evaluation
phase of this effort, but not fast enough. A bipartisan set of
regulators acknowledge that climate change poses risks to the financial
system and, therefore, falls within their statutory remit. We cannot,
however, fall victim to the calls for self-regulation of these risks.
It is welcome news that large U.S. banks are making net-zero
commitments and that more companies are utilizing myriad voluntary
disclosure frameworks, but many of these commitments do not set clear
short-term goals and rely too heavily on promises of future emission
offsets. In any event, these developments do not absolve regulators of
their responsibility to ensure that firms are resilient to these risks
and that investors have the information they need to appropriately
allocate capital. The U.S. has tried selfregulation in the past, and
that hands-off approach has proven catastrophic for workers, small
businesses, and communities across the country. Private financial
institutions do not have sufficient incentives to voluntarily self-
insure against climate-related risks, especially tail risks. It is
therefore critical for regulators to step in and ensure these risks are
accounted for in regulatory and supervisory frameworks. Moreover, the
absence of climate-related safeguards provides a hidden subsidy to the
banks exposed to, and exacerbating, these risks. Banks that are not
creating or exposed to these risks bear those costs.
Regulators have the tools to mitigate these risks.\83\ The question
now is how urgently will regulators move to mitigate these risks and
what specific safeguards will they employ? If regulators pursue a
robust climate finance agenda, the U.S. financial system will be
wellpositioned to handle future climate shocks and to take advantage of
the significant opportunities that the transition to a low-carbon
economy presents. Meanwhile, the public will be spared the high costs
of future bailouts and will benefit from a stable financial system.
One of the most important lessons policymakers should have learned
from the 2008 financial crisis is the importance of deploying a
precautionary principle when regulating the financial system. As
Professor Hilary Allen describes it, ``This principle is essentially a
more sophisticated version of the old adage, `better safe than sorry,'
counseling regulators to err on the side of regulating an activity when
the outcome of that activity is uncertain, but potentially irreversible
and catastrophic.''\84\ In the run-up to the 2008 crisis, many
policymakers assumed financial crises were a thing of the past and did
not cast a skeptical eye towards the development of new complex
financial products and systemic interconnections.\85\ A laissez-faire
deregulatory approach, the opposite of the precautionary principle,
dominated the three decades leading up to the crisis and set the stage
for the resulting catastrophe. Regulators must have humility about
their ability to predict the precise causes and complex effects of
financial crises, which are high impact and low probability events that
carry substantial inherent uncertainty. Regulators must act to ensure
the financial system is resilient to extreme, but plausible, tail risk
scenarios. The severe and lasting economic and social damage wrought by
instability in the financial system warrants this type of precautionary
approach to regulation-one that favors proactive and robust safeguards
in the face of uncertain, but potentially catastrophic, risks.
Certainty regarding the near-term private costs of regulation and
uncertainty regarding the precise value of social benefits from such
regulation-which nevertheless are likely to be great in magnitude-
should not unduly hamstring regulators. Climate-related financial risks
are a special case that warrant a particularly proactive approach.\86\
Climate change is itself a high impact and high probability phenomenon.
It will certainly have significant negative effects on the planet,
economy, and financial system. There is no doubt about the likelihood
of climate change and no doubt about the general magnitude of its
damaging impacts under various warming scenarios. It is also clear that
the transition to a low-carbon economy, which is necessary to stabilize
global temperatures, is going to impact financial institutions and
markets. There is significant uncertainty, however, regarding the
timeline of climate-related financial stability risks, the precise
magnitude of the economic value at risk, and the exact manifestation of
those risks on a range of financial assets, markets, and institutions.
The answers to many of these questions hinge on the level of emissions
going forward and the resulting warming pathway, as well as the future
actions taken by policymakers, technological advancements, and shifts
in market sentiment. The uncertainty is fueled by difficulties modeling
climate change and its impacts, including its non-linear nature, the
existence of tipping points, and the interactions with complex
environmental systems.\87\ It is clear, however, that climate-related
risks could have a catastrophic impact on financial institutions and
markets, and ultimately disrupt financial stability.
This policy effort will be an iterative process. Given the urgency
of the issue and the magnitude of the risk, it is important for
regulators to not let the perfect be the enemy of the good and to act
with urgency. As Fed Governor Lael Brainard recently stated, ``Despite
the challenges, it will be critical to make progress, even if initially
imperfect, in order to ensure that financial institutions are resilient
to climate-related financial risks and well-positioned for the
opportunities associated with the transition to a more sustainable
economy.''\88\ Regulators should advance a comprehensive and vigorous
agenda to mitigate climate-related financial risks-an agenda that
embodies the precautionary principle.
Markets regulators\89\
Disclosure
The SEC should establish a mandatory climate risk disclosure
framework.\90\ Investors need reliable, consistent, and comparable data
on climate-related risks. The myriad voluntary disclosure frameworks
that have developed over the past several years have helped get the
ball rolling on this important issue, but only a mandatory standardized
regime can provide the reliable, consistent, and comparable information
necessary for investors to make prudent decisions when they allocate
capital. The disclosures should include both specific line-item
requirements and additions to the narrative-based disclosures in the
management discussion and analysis, such as those called for by the
Task Force on Climate-related Financial Disclosures.\91\
The line-item disclosure should at least include clear metrics
regarding the exposure of corporate assets, facilities, supply chains,
services, and products to water stress, natural disasters and
environmental shifts, water insecurity, heat stress, and additional
physical risk-related factors.\92\ Companies should also be required to
disclose metrics regarding their energy consumption, scope 1, 2, and 3
emissions, and their transition-related emissions targets. For
financial institutions, the Commission should require disclosure of the
emissions financed by the firm.\93\ Moreover, the management discussion
and analysis should include transition plans and the board and
management strategy for addressing climate-related risks. This is not a
comprehensive list of all of the necessary elements of a corporate
climate risk disclosure framework, but the aforementioned metrics
should be core components. Additionally, climate disclosures should not
be considered in a vacuum. Investors have been asking for a broad array
of ESG information, much of which intersects with how companies are
thinking about their climate risk. SEC Acting Chair Lee recently spoke
to the interconnected nature of ESG factors, saying, ``We know climate
presents heightened risks for marginalized communities, linking it to
racial justice concerns.''\94\ Lee also pointed out the risk to
investors from companies that make public commitments regarding carbon
neutral policies, but secretly donate to political candidates with
anti-climate justice records. It's important that climate risk
disclosure be part of a comprehensive ESG disclosure regime.
Restoring the Application of Securities Laws
The SEC must also ensure that this framework applies to all large
companies and offerings. Over the past several decades, and
particularly since the passage of the Jumpstart Our Business Startups
(JOBS) Act, ever larger companies and offerings are proliferating
outside of the SEC's disclosure and accountability framework. That
should be reversed.\95\
Efforts to promote the disclosure and accountability of the public
markets could include limiting the application of Rule 506 and
requiring additional disclosure requirements on issuers making use of
the exemption, as well as eliminating or modifying Rule 144A.\96\
Without restoring the primacy of the public capital markets, the SEC's
efforts to promote transparency will be severely undermined-and climate
risks will continue to be insufficiently identified, assessed, and
addressed.
Restoring Rights
For years, long term investors have engaged with companies and
their management teams to promote better identification, assessment,
and management of risks, including climate risks. Oftentimes, investors
have used shareholder proposals and their powers to vote to hold
companies and their executives accountable. Unfortunately, these tools
have been undermined in recent years. The SEC should promote investor
engagement, including through easing submissions for shareholder
proposals and expanding the ability of investors to shape corporate
action, such as by reducing dual class share structures and adopting
universal proxy ballots. Investors can and must be empowered to protect
their interest in corporate sustainability.
Fiduciary Requirements
The SEC and Department of Labor should require investment
fiduciaries to develop and implement policies and procedures that
clearly outline how the adviser identifies, evaluates, and addresses
climate-related risks and opportunities. SEC Acting Chair Allison
Herren Lee has suggested the Commission could pursue this type of
requirement under existing law and that there is precedent for
requiring ``policies and procedures around a specific topic of
particular importance.''\97\ This type of sustainable investment policy
would help provide clarity to investors as to how fiduciaries are
integrating climate-related considerations into the advice they are
providing, without dictating outcomes that fiduciaries would be
required to follow.\98\ Relatedly, the SEC could require investment
advisers and broker dealers to ascertain the climate-related
preferences of investors and factor those preferences into their
investment decisions.
Additional tools
Capital markets regulators have an array of additional tools that
could be used to mitigate climate-related risks to the firms and
markets under their jurisdiction.\99\ The SEC should (i) require credit
rating agencies to disclose how they are integrating climate-related
risk into their rating methodologies and ensure they are applying those
models consistently; (ii) enforce existing accounting standards with
respect to climate-related risks and expand those standards to more
fully integrate the risks; (iii) ensure that auditors have the skills
and knowledge necessary to audit for compliance with accounting
standards as they relate to climate risks; and (iv) establish and
enforce a clear taxonomy that promotes standardized labeling for
``green'' or ``ESG'' funds and securities to prevent greenwashing.\100\
In addition, the CFTC should adapt its margin and capital requirements
to account for climate-related risks to specific entities and markets
under its jurisdiction.\101\
Prudential regulators
Stress Testing
The Federal Reserve should establish climate-related stress tests
for the largest banks in the country.\102\ The stress tests would probe
how bank balance sheets would be impacted by hypothetical severely
adverse climate scenarios over the next 15-30 years. The time horizon
of the climate-related stress tests should be much longer than the
nine-quarter horizon for the annual macro stress tests to allow
regulators to explore how the worst effects of climate change could
impact bank balance sheets. The scenarios should include both physical
and transition risks. Banks should then be required to submit detailed
remediation plans that outline how they plan to adjust their balance
sheets and financing activities over time to mitigate their exposure to
these risks. Unlike the annual macroeconomic bank stress tests, these
tests should not quantitatively set capital requirements. The inherent
difficulties in projecting losses over such a lengthy time horizon make
these stress tests ill-suited for setting bank-by-bank capital
requirements immediately.
Even though the quantitative results of the tests shouldn't
directly set capital requirements, it is critical for the stress tests
to have teeth and not become a box checking exercise of little value.
Regulators should therefore include a qualitative objection component
in the climate-related stress tests. If the remediation plans are
inadequate in scale or granularity, or if climate change is
insufficiently integrated into banks' internal controls, governance,
risk management, or capital planning processes, the Fed should invoke
the qualitative objection and restrict banks' planned capital
distributions today. The climate-related stress tests would provide
transparency regarding banks' climate-risk exposure, force banks to
embed climate risk into their core business functions and require them
to provide regulators with actionable plans to adjust their balance
sheets over time to limit climate-related risks.
Conducting several iterations of the climate-specific stress tests
should improve regulators' understanding of climate-related variables,
scenario design, and modeling. Ultimately, near-term climate-related
variables and shocks should be introduced into the severely adverse
scenario of the nine-quarter annual macroeconomic stress tests, the
Comprehensive Capital Analysis and Review (CCAR). These annual stress
tests directly feed into banks' capital requirements, as regulators use
both static and dynamic tools to ensure capital adequacy.\103\ Adding
climate variables and shocks to these tests would help integrate
climate considerations into the bank capital framework.
Banks have pushed back against the creation of climate-related
stress tests.\104\ They have argued that there is significant
uncertainty around climate-related shocks and their effects, and that
they'd be tough to model. It is true that there is substantial inherent
uncertainty around climate-related risks and potential warming and
transition pathways. But stress tests are not designed to predict the
future. They are used to test bank balance sheets against extreme, but
plausible, scenarios. That's a threshold the Fed should be able to
meet. There are certainly data, modeling, and scenario decisions that
the Fed will have to weigh carefully. Those challenges are by no means
insurmountable given the purpose and role of stress testing. Moreover,
banks have lamented the long time horizon of the scenarios as it
relates to assumptions regarding bank balance sheets. It is certainly
true that a bank's balance sheet could look very different in 2045 than
it does in 2021. Stressing a bank's 2021 balance sheet against longer-
term risks, however, demonstrates just how significantly a bank may
have to adjust its balance sheet over time to avoid catastrophic
climate-related losses. The Fed could then ensure banks are, in fact,
adjusting their balance sheets over time to avoid these long-term
risks. It's also important to note that while the most severe climate-
related risks may take decades to materialize, there are potential
risks in the more immediate future-particularly with respect to
transition risks. In order to hit 2050 emissions and warming targets,
rigorous action is required in the near-term. Those legal and
regulatory developments, or technological advancements and shifts in
investor sentiment, could crystallize transition-related losses in the
short-term and should be included in CCAR at some point soon.
The arguments banks are making against climate-related stress tests
rhyme with the arguments they deployed against the initial stress tests
in 2009, the Supervisory Capital Assessment Program, and the annual
macroeconomic tests that were developed in the wake of the crisis,
CCAR.\105\ For 12 years banks have fought tooth and nail with the Fed
over what constitutes appropriate or realistic scenarios, models, and
assumptions. One particular example is instructive. In CCAR, the Fed
included an assumption that bank balance sheets would grow during the
stress testing time horizon. This was a prudent assumption, since
regulators want banks to be capitalized enough to serve as a source of
strength during a downturn and historical evidence suggested that there
would be pressure on bank balance sheets to expand as businesses and
households sought liquidity. While it may be prudent from a
microprudential standpoint to assume banks could keep a static balance
sheet or shrink to conserve capital during a stress period, that would
lead to a severe contraction in credit if a range of banks all took
that approach. After years of pressure from banks, the Fed relented and
watered down the balance sheet growth assumption and changed it to
assume a flat balance sheet.\106\ Then, in early 2020, the global
financial system experienced a real-life stress test due to the COVID-
19 shock and bank balance sheets grew significantly.\107\ Banks were
not pushing the Fed to adopt a flat balance sheet because it was more
realistic or grounded in historical evidence. They did so because a
flat balance sheet assumption weakened the stress tests by reducing
required capital. Similarly, when it comes to climate-related stress
tests, banks will continue to advance arguments that seek to reduce the
severity of projected losses or the procedural consequences of the
stress tests. Regulators must see the arguments for what they are.
Supervision
Banking regulators should clearly define climate-related
supervisory expectations for banks. As Governor Lael Brainard stated
recently, ``Supervisors have a responsibility to ensure that financial
institutions are resilient to all material risks-including those
related to climate change-both currently and into the future.''\108\ It
is critical for banks to integrate climate risk into their governance,
risk management, internal controls, capital planning, and self-run
scenario analyses. The banking regulators should integrate these
expectations into supervisory guidance, supervisory manuals, and the
supervisory ratings systems.
Governance: The board of directors and senior management should
clearly assign responsibilities for climate-related risks within the
bank's governance structure. This issue requires attention at the
highest levels of the bank to ensure that climate-related factors are
being appropriately integrated throughout the bank's core business and
risk functions.
Risk Management: Banks should have the policies and procedures in
place to identify, evaluate, report, and mitigate climate-related
risks. Both the physical and transition-related risks associated with
climate change pose serious credit, market, liquidity, reputational,
and operational risks for many banks. It is vital for banks to account
for all of these risks in their core risk management frameworks.
Internal Controls: It is important for banks to have the policies
and procedures in place to effectively monitor the integration of
climate-related factors into core risk and business functions. Strong
internal controls can help the bank evaluate the effectiveness of
climate-related risk management, governance, capital planning, model
use, compliance, audit and other functions, and address any clear
deficiencies in a timely manner.
Capital Planning: As part of the normal capital planning process,
in which banks evaluate their capital needs and determine how to manage
their capital resources, banks should take climate-related risks into
account.
Scenario Analyses: While the Fed should establish supervisory
stress tests, banks should be expected to conduct their own company-run
stress tests and scenario analyses. The Fed will only use a handful of
the thousands of potential climate-related scenarios that could play
out. It's important for banks to think through and attempt to model a
wide range of potential scenarios.
Capital Requirements\109\
Banking regulators should use capital requirements to address both
the microprudential and macroprudential risks posed by climate change.
Banking regulators should first focus on the credit and derivative
exposures that face the most pronounced transition-related risks:
fossil fuel assets and infrastructure. Bonds, loans, and derivative
transactions for companies that derive a meaningful portion of their
revenue from the extraction, exploration, transportation, storage,
exporting, or refining of oil, natural gas, or coal should be the top
priority. The risk-weights should be calibrated based on several
factors, including: (i) the extent to which the company generates
revenue from fossil fuel-related activities; (ii) differentiation in
transition risk intensity among oil, gas, and coal exposures; and (iii)
the length of the exposure. Regulators could also incorporate
additional variables, such as treating financing for new and existing
fossil fuel reserves and infrastructure differently, but should not
spend years trying to over-engineer the risk-weights and adding
needless complexity. Next, banking regulators should use the
information gleaned from enhanced corporate climate risk disclosure and
climate-related stress testing to make additional transition risk
adjustments to the risk-weighted capital framework. Financial
instruments tied to other carbon intensive sectors are also susceptible
to transition risks, including the utility, transportation, mining,
chemical production, and metal and mining, building materials, and
agricultural sectors.\110\ In addition, regulators could use stress
testing and engagement with climate scientists and climate economists
to improve modeling approaches regarding the physical risks of climate
change and increase risk-weights for the most exposed assets
accordingly.
In order to bolster big banks' resilience to the systemic risks
they are inflating, and to require them to internalize these external
costs they are placing on others, banking regulators should also
implement a macroprudential climate risk contribution capital
surcharge. This additional riskweighted and leverage capital buffer
should apply to bank holding companies with more than $100 billion in
assets and nonbank financial companies designated by the Financial
Stability Oversight Council (FSOC) as systemically important. The
climate capital surcharge should be calibrated based on a firm's
climate risk contribution score, which would measure the bank's level
of financed GHG emissions, including emissions from its lending,
underwriting, trading, and off-balance sheet activities.
The capital surcharge that applies to global systemically important
banks (G-SIBs) provides a useful conceptual example of how bank capital
requirements can be used to mitigate a financial externality.\111\ The
basic formula for the expected losses that a bank places on the
financial system and broader economy is a function of the bank's
probability of default, or its likelihood of failure, and its loss-
given default, or the losses that would be placed on the financial
system or economy if it failed. The failure of a large, complex, and
interconnected bank would have a much greater negative impact on the
financial system and broader economy than the failure of a smaller
bank.\112\ Thus, the loss-given default of a larger bank is much higher
than that of a smaller bank. Assuming the probability of default is
generally equal, the expected loss of a large systemic bank is higher
than that of a small bank. The G-SIB surcharge was designed to bring
the expected loss for systemic banks in line with those of smaller
banks by lowering their probability of default through raising their
capital requirements. When the G-SIB surcharge rule was finalized,
former Federal Reserve Chair Janet Yellen stated, ``A key purpose of
the [G-SIB] capital surcharge is to require the firms themselves to
bear the costs that their failure would impose on others''.\113\ The
Fed also noted that a related goal of the G-SIB surcharge was to
``create incentives for SIFIs to shrink their systemic footprint, which
further reduces the risks these firms pose to financial
stability.''\114\
Using the expected loss framing, financing emissions is effectively
contributing to an increase in the probability of default, and expected
loss, of the financial system as a whole. Banks that are major
financiers of carbon-intensive activities are facilitating increased
GHG emissions and intensifying climate change. Exacerbating the climate
crisis will increase both the physical and transition risks of climate
change and inflict larger losses on the financial system. With respect
to physical risks, higher GHG emissions lead to higher global
temperatures, which in turn cause more frequent and severe extreme
weather events and damaging environmental changes.\115\ The more
significant the physical effects of climate change, the more likely and
severe the financial system's associated losses will be. Furthermore,
increased emissions today drive up projected warming pathways and
increase the likelihood that a rapid and disruptive transition is
required to stabilize global temperatures.\116\ Firms should be
required to internalize these costs and the capital surcharge would
disincentivize risky carbon-financing activities.
Community Reinvestment Act
The banking regulators should also look to their obligations under
the Community Reinvestment Act to help drive mitigation and adaptation
efforts in low- and moderate-income communities, and communities of
color. Regulators should use race and environmental justice metrics to
better target CRA assessment areas.\117\ Regulators should also clarify
the types of adaptation and mitigation activities that qualify for
credit under the CRA, including energy efficient affordable housing,
community solar projects, and green infrastructure.\118\ It is also
vital for regulators to strengthen the overall enforcement and
accountability of the CRA to ensure it is meeting the needs of these
communities, as intended by the statute.
State insurance regulation
State insurance commissioners should require insurance companies
operating in their state to disclose their fossil fuel investments and
underwriting activities. This disclosure would improve regulators',
investors', and the public's understanding of insurers' exposure and
contribution to the climate crisis. Regulators should ensure companies
set targets and pathways to reduce those high-emissions activities. The
FIO should issue a data call to collect this information from the
insurance industry if state insurance commissioners do not use their
authorities to act.
Commissioners should establish climate-risk stress tests and
scenario analyses to help quantify climate-related risks on an
industry-wide and company-by-company basis-and create stronger risk
management rules and supervision based on the results. The stress tests
should gauge the short- and medium-term resiliency of insurers' balance
sheets in the face of both physical and transition risks. Longer term
scenario analyses could complement the stress tests by probing how
insurance companies plan to shift their asset allocation and business
practices to align with different warming scenarios over a longer time
horizon. The FIO should evaluate these stress testing frameworks and
make recommendations to state insurance regulators on best practices
around scenario design and supervisory models, where appropriate.
Climate-related risks should also be integrated into the risk-based
capital (RBC) framework for insurers. The RBC requirements are meant to
ensure the resilience of insurers and are calculated based on the
riskiness of their assets and underwriting activities. Increasing the
loss-absorbing capital required for assets and underwriting activities
that are most exposed to climate-related risks would help promote the
stability of the sector. This policy should focus on insurers' fossil
fuel investments and underwriting, which both expose insurers to
transition-related losses and increase the physical risks that will be
borne by others in the future. In addition, regulators should require
insurers to include climate-related risks in their Own-Risk and
Solvency Assessments.
Financial Stability Oversight Council
As a start, the FSOC should embed a focus on climate change and
climate-related capabilities into its operating structure. Chartering a
Climate Risk Committee to handle the portfolio of ongoing climate-
related work would be a good initial step toward this end. Relatedly,
the FSOC should work with the director of the Office of Financial
Research (OFR) to establish a Division of Climate Risk Analysis. The
OFR should spearhead the FSOC's data collection, analysis, and research
priorities on climate-related financial risks, working with member
agencies on their needs. These recommendations would complement
Secretary Yellen's important commitment to establish a ``climate hub''
at Treasury. FSOC member agencies should then make it an early priority
to coordinate on the development of agency-specific commitments to
integrate climate-related risks into their respective core functions.
These clear and actionable goals could be developed after consultation
with the public through an agency request for information and announced
in advance of the U.N. Climate Change Conference (COP26) in November
2021, which features a robust private finance agenda.\119\
Over the long term, the FSOC should use its statutory authorities
to address any identified gaps with respect to climate-related
financial risks. The FSOC's Section 120 authority to issue
recommendations to primary regulators could help pressure regulators to
act where they have the existing authority to do so. Primary regulators
have substantial authority to use disclosure requirements, stress
testing, capital frameworks, supervision, fiduciary obligations, and
more to mitigate climate-related risks and align the financial system
with the low-carbon transition. These tools have the power to improve
the resilience of the financial system to climate-related shocks and to
facilitate the decarbonization of the economy. The FSOC should stand
ready to push unwilling regulators to act, or go further, when
necessary.
Furthermore, the FSOC should integrate climate-related risk as a
factor into its designation guidance.\120\ There are currently two
statutory standards under which a nonbank financial company can be
designated as systemically important. If a firm's material financial
distress could destabilize the financial system, it can be designated
under the first standard. That standard is agnostic to the cause of the
material distress, so there is not an obvious climate-related
intersection. Under the second standard, designation can occur if ``the
nature, scope, size, scale, concentration, interconnectedness, or mix
of the activities'' of the nonbank financial company could threaten
financial stability.\121\ Under this standard, therefore, the FSOC
could evaluate a firm's contribution to climate-related financial risks
through its carbon-financing activities. Financing high-emission
activities intensifies climate change and increases physical and
transition risk-related losses for financial institutions and the
economy in the future, exacerbating systemic risk. It is unlikely that
the FSOC would designate any firm solely based on climate-related risk
considerations, but the council could reasonably add these
considerations to the calculus under the second standard.
Separately, the Federal Reserve should apply robust climate-related
prudential regulation to nonbank financial companies that are
designated as systemically important under either standard, regardless
of whether climate considerations are factored into the decision to
designate them. Depending on the former primary regulator of the
designated company, it may or may not have faced climate-related
financial regulation previously. As the new primary prudential
regulator, the Fed is responsible for bolstering the resilience of
designated nonbank financial companies, and it is important that these
systemic firms can weather climate-related shocks, among other risks.
Role of Congress
Congress has an important role to play in ensuring our financial
system is resilient to climate-related shocks and is positioned to
support the low-carbon transition. First, stringent congressional
oversight of the financial regulators will prove crucial. As outlined
in this testimony, financial regulators have wide-ranging authority
under existing law to address climate-related risks. Through letters,
hearings, investigations, and other mechanisms, Congress can press
regulators to act with appropriate speed and to deploy their full suite
of tools to rigorously address these risks. Several members of this
Committee have been pushing regulators for years, which is one of the
reasons progress has been made in the past few months.
Second, if regulators fail to act swiftly enough or refuse to
implement a robust agenda around climate financial risks, Congress
should step in and insist they do so. In advance of the 2008 financial
crisis, regulators refused to use the tools at their disposal to
address the risks financial institutions were creating and the risks to
which the financial system was exposed. Several important provisions in
Dodd-Frank did not create new authorities per se-they required
regulators to implement policies that could have been implemented under
precrisis law. If regulators again fail to check a build-up of risk in
the financial system, Congress should direct them to do so in advance
of another catastrophe. Several important bills, including those
authored or cosponsored by members of this Committee, have been
introduced in the past few years. Some notable recent bills include:
The Climate Risk Disclosure Act, introduced by Senator
Warren and Representative Casten, would direct the SEC to
develop a comprehensive mandatory climate risk disclosure
framework.\122\
The Climate Change Financial Risk Act, introduced by
Senator Schatz and Representative Casten, would require the Fed
to establish a climate-related stress testing framework.\123\
The Addressing Climate Financial Risk Act, introduced by
Senator Feinstein and Representative Casten, would direct the
banking regulators to develop climate-related supervisory
guidance, direct the FSOC to update its nonbank designation
guidance to include climate risk, require a report from the
Federal Insurance Office on climate risk, among other
provisions.\124\
Finally, Congress could consider additional policy measures or
adjustments to financial regulators' mandates to more intentionally
align private capital flows with explicit climate-related targets.
Regulators have broad responsibilities to bolster the resilience of the
financial system to climate-related risks and, if used appropriately,
those authorities will ensure the financial system serves as a source
of strength for the economy as it decarbonizes. But the ``risk''
framing is somewhat of a constraint and Congress could more directly
mobilize private capital to achieve climate-policy ends. For example,
banks could be given green-finance mandates as one of the obligations
that comes with the special public privileges they are afforded.\125\
Conclusion
Climate-related risks are building in the financial system and
financial institutions themselves are exacerbating these risks. It is
incumbent on U.S. financial regulators to step in and perform the jobs
Congress assigned to them. Integrating climate-related risks into the
regulatory and supervisory framework through mandatory disclosure,
stress testing, supervision, capital requirements, fiduciary
obligations, and more would bolster the resilience of the financial
system, mitigate the risks created by financial institutions, and
position the financial system to support the low-carbon transition.
These risks are not theoretical, and they are not far off in the
distance. They are here. Regulators have a chance to address these
risks head on, before catastrophe strikes. It is critical to learn the
lessons of the 2008 crisis, move urgently, and avoid a climate-driven
financial crisis.
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PREPARED STATEMENT OF NATHANIEL KEOHANE
Senior Vice President, Climate, Environmental Defense Fund
March 18, 2021
Introduction
Climate change is one of the defining challenges of our time. Its
impacts become more visible every year, not only in hotter
temperatures, rising seas, and melting glaciers but also in extreme
weather: wildfires, heat waves, hurricanes, floods, droughts. The
economic consequences of these impacts loom large, amounting to
hundreds of billions of dollars every year to the United States alone
from current emissions.
As the world's second-largest emitter and largest historical
emitters, the United States has an obligation to lead the world in
addressing climate change by taking action across the U.S. economy. To
help reduce the risk of catastrophic climate change, in line with the
latest climate science and with the objectives of the Paris Agreement
on climate change, the U.S. should achieve net zero emissions across
the entire economy--the point at which we emit no more carbon pollution
than we can remove from the atmosphere--by no later than 2050,
including an interim target of cutting emissions at least 50 percent
below 2005 levels by 2030. A range of recent analyses demonstrate the
these goals are achievable with well-designed government policies and
investments to reduce greenhouse gas emissions from sectors including
electric power generation, transportation, industry, buildings, and
fossil fuel production; manage forests, croplands, and rangelands to
store carbon; and increase the resilience of natural and physical
infrastructure, especially in coastal areas. \1\
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\1\ See National Academies of Sciences, Engineering, and Medicine,
Accelerating Decarbonization of the U.S. Energy System (Washington, DC:
The National Academies Press, 2021), https://doi.org/10.17226/25932; E.
Larson, C. Greig, J. Jenkins, E. Mayfield, A. Pascale, C. Zhang, J.
Drossman, R. Williams, S. Pacala, R. Socolow, EJ Baik, R. Birdsey, R.
Duke, R. Jones, B. Haley, E. Leslie, K. Paustian, and A. Swan, Net-Zero
America: Potential Pathways, Infrastructure, and Impacts, interim
report (Princeton University, 2020). https://perma.cc/Z2ZT-BHLM;
Environmental Defense Fund, ``Recapturing U.S. Leadership on Climate:
Setting an Ambitious and Credible Nationally Determined Contribution''
(Environmental Defense Fund, 2021), https://perma.cc/3UXP-2EPM.
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The good news is that study after study has shown that the
investments needed to put the U.S. economy on a path to net zero
emissions will also help to strengthen the nation's economy, ensure
good jobs, and enhance America's competitiveness in the global clean
energy economy.
In addition to the massive aggregate economic damages mentioned
above, there is a growing realization that climate change poses a
significant risk to the U.S. financial system as well--both potentially
to the financial system as a whole, as well as to specific types of
financial institutions in particular sectors and regions. In this
context, policy makers and financial and prudential regulators have a
range of tools available that could help to significantly mitigate the
risk to the financial system, particularly by ensuring greater
transparency around the nature, magnitude, and distribution of climate
risk and requiring that regulatory bodies and private companies more
thoroughly incorporate climate change into their risk management and
decision making. In addition, in light of the enormous and growing
demand from private investors for sustainable and climate-friendly
investing, policy makers and regulators can take steps to reduce the
barriers to such investing.
With this context in mind, my testimony makes three main points.
First, climate change poses significant risks to the U.S. financial
system. In detailing these potential risks, I draw extensively on a
recent report published by the Climate-Related Market Risk Subcommittee
of the Commodity Futures Trading Commission's Market Risk Advisory
Committee, of which I was a co-author.
Second, financial regulators have a clear responsibility to address
climate risk under their foundational duties and authorities. I put
special emphasis on the importance of mandatory climate risk
disclosure, and also discuss a range of other recommendations related
to incorporating climate risk into risk management practices of
regulated firms, increasing the relevant expertise of regulators, and
improving data availability.
Third, there is significant demand--and opportunity--to channel
private capital into low-carbon and climate-friendly investment. In
addition to noting the rising demand among private investors for such
opportunities, I highlight the single most important thing policy
makers could do to ensure that private capital flows more efficiently
to low-carbon opportunities: namely, implementing a fair and effective
price on carbon across the U.S. economy.
Climate-Related Risks to the U.S. Economy and the Financial System
Economic damages and financial risk
The impacts of climate change on the U.S. financial system were the
focus of the Climate-Related Market Risk Subcommittee of the Market
Risk Advisory Committee of the Commodity Futures Trading Commission, on
which I served. Along with the other subcommittee members, I was a co-
author of the subcommittee's report, Managing Climate Risk in the U.S.
Financial System, which was the first of its kind to be released under
the auspices of a U.S. financial regulator. \2\ The report was
unanimously approved by the subcommittee's 34 members--experts
representing banks, asset managers, agribusiness, the oil and gas
sector, academia and environmental organizations. In this section, I
draw extensively on that report to discuss climate-related risks to the
U.S. financial system.
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\2\ Commodity Futures Trading Commission (CFTC), Managing Climate
Risk in the U.S. Financial System, Report of the Climate-Related Market
Risk Subcommittee of the Market Risk Advisory Committee (2020), https:/
/perma.cc/UT9M-FG2Y.
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The report conveys a stark message to financial institutions,
regulators, and policy makers: climate change poses serious risks that,
if ignored, will undermine the financial system's ability to support
the American economy.
Other reports have clearly documented the economic damages from
climate change. The science has improved tremendously over the past
decade, to the point where we can clearly link severe weather events
like hurricanes, wildfires, floods, and drought to a warming planet.
One recent study calculated $1.75 trillion in damages from severe
weather events since the 1980s. \3\ The National Oceanic and
Atmospheric Administration (NOAA) estimates that the United States has
already experienced over $500 billion in direct economic costs from
extreme weather events since 2015. \4\ Climate change is driving more
frequent and damaging extreme weather events; 22 high-cost events were
recorded in this past year alone, with each causing over $1 billion in
direct economic damage. \5\
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\3\ Marcy Lowe and Rebecca Marx, Climate Change-Fueled Weather
Disasters: Costs to State and Local Economies (Datu Research, 2020),
https://perma.cc/N459-SDH4.
\4\ Nat'l Oceanic and Atmospheric Admin., Billion-Dollar Weather
and Climate Disasters: Summary Stats, https://perma.cc/57XB-638E (last
visited Jan. 27, 2021).
\5\ Id.
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Peer-reviewed economic research suggests that by the end of the
century, total economic damages to the United States from climate
change could amount to roughly 1 percent of U.S. GDP annually for each
1 degree Celsius of global mean temperature rise. \6\ Given expected
economic growth rates, that amounts to a few trillion dollars per year
in damages by the end of the century in real terms. Those damages would
be felt across the economy--reducing crop yields in agriculture,
threatening infrastructure, damaging coastal real estate, reducing
labor productivity, and increasing heat-related mortality.
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\6\ Solomon Hsiang et al., Estimating Economic Damage from Climate
Change in the United States, Science 365:1362 (2017), https://perma.cc/
UN9D-PRYS.
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But even very large economic damages do not necessarily translate
into risk to financial institutions. One of the main contributions of
the CFTC report is to explore the potential financial risks in detail.
Pathways for climate-related risk to financial institutions
At the macro--or ``systemic''--level, the report discusses how
climate impacts could conceivably contribute to a financial crisis by
propagating throughout the economy and undermining the value of
financial assets, as previously hidden risks are suddenly taken into
account.
The report also highlights the possibility that climate-related
risks may well produce ``sub-systemic'' shocks, defined as those that
affect financial markets or institutions, or a particular sector, asset
class or region, but without threatening the stability of the financial
system as a whole. For example, climate-related extreme weather events
could pose a risk to financial market operations, via liquidity
disruptions (as could occur in agricultural commodity futures markets,
say, as a result of price volatility triggered by drought or other
extreme weather events in major agricultural states) or by threatening
the operation of financial market utilities (the flooding of a vault of
the Depository Trust and Clearing Corporation (DTCC) during Superstorm
Sandy provides a cautionary tale). \7\
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\7\ CFTC, Managing Climate Risk in the U.S. Financial System, 30.
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Financial institutions that hold assets likely to be particularly
vulnerable to climate change could also be at risk--especially where
the impacts of climate change are relatively concentrated. The report
highlights examples of risks to various types of financial institutions
or asset classes:
Banks with international loan portfolios in climate-
vulnerable regions. \8\ A scenario analysis conducted by 10
major international banks found that water stress resulting
from climate-induced drought could lead to increased loan
default losses or credit downgrades for bank portfolios. \9\
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\8\ CFTC, Managing Climate Risk in the U.S. Financial System, 33.
\9\ Laurence Carter and Stephen Moss, Drought Stress Testing:
Making Financial Institutions More Resilient to Environmental Risks
(U.N. Environment Programme Financial Initiative, 2017), https://
perma.cc/3BRF-CDPV.
Regional and community banks in coastal areas and other
climate-vulnerable regions. \10\ Regional and community banks
held 30 percent of commercial real estate loans in 2019. \11\
These loans tend to be geographically concentrated and make up
nearly a third of the loan books of small banks (Figure 1). As
a result, climate-related disasters that affect commercial real
estate in a particular region--such as a severe hurricane
season--can have a disproportionate impact on local financial
institutions.
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\10\ CFTC, Managing Climate Risk in the U.S. Financial System, 33.
\11\ Federal Deposit Insurance Corporation, 2019 Risk Review
(Washington, DC: Federal Deposit Insurance Corporation, 2019). https://
www.fdic.gov/bank/analytical/risk-review/full.pdf.
Agricultural banks. \12\ Nearly half of all agricultural
loans are held by lenders with at least one-quarter of their
portfolio concentrated in farm-related areas, such as operating
loans or real estate loans (Figure 2). Many of these lenders
also have correlated risks because of loan concentrations in
particular geographies or related agricultural businesses.
Following severe flooding in the spring of 2019, for example,
lenders in the Midwest reported to the Federal Reserve Bank of
Chicago that 70 percent of their borrowers were moderately or
severely affected by extreme weather events. That year, the
portion of the region's agricultural loan portfolio reported as
having ``major'' or ``severe'' repayment problems hit the
highest level in 20 years. Such occurrences are likely to
become more frequent and severe as climate impacts continue to
grow. A credit-stressed agricultural lending system would
decrease farmers' access to affordable credit and increase the
difficulty in recovering from climate-related shocks.
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\12\ CFTC, Managing Climate Risk in the U.S. Financial System, 35.
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Municipal bonds. \13\ Municipal bonds, used to help finance
local governments and held by a wide variety of mutual funds,
banks, insurance companies, households, and non-profit
organizations, could also be at risk in climate-vulnerable
regions. An analysis by BlackRock estimated that in roughly the
next decade, municipalities issuing more than 15 percent of the
S&P National Municipal Bond Index could face climate-related
GDP losses of 0.5 to 1 percent annually--with that figure
rising to 40 percent of municipalities suffering losses of 3
percent or more by the end of the century. \14\ These impacts
could have significant implications for the ability of
municipalities to service their obligations--raising the
financial risk to bondholders.
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\13\ CFTC, Managing Climate Risk in the U.S. Financial System, 36.
\14\ Ashley Schulten et al., Getting Physical: Scenario Analysis
for Assessing Climate-Related Risks (BlackRock Investment Institute,
2019), https://perma.cc/3J5C-7DK6.
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
Table 1 on the previous page, taken from the CFTC report, presents
a comprehensive list of assets exposed to climate change. It reveals
the breadth of climate risk, including assets like mortgage-backed
securities, real estate investment trusts (REITs), utility debt,
insurance equities, and bonds; and sectors including agriculture,
airlines, automobile manufacturers, hospitality, power generation, and
concrete and steel.
Who bears these risks? Some risk is borne by regular investors--
those without the information, analytical resources, or access to
proprietary data to allow them to identify and respond to hidden risks
from climate change. .Some risk is borne by the regional financial
institutions and the people who depend on them: small businesses with
commercial real estate mortgages, farmers needing loans from
agricultural credit institutions, and so on. In other words, this isn't
just about big banks on Wall Street; this is about everyday
transactions on Main Street: the home mortgages, commercial real estate
loans, farm credit, and small business loans that underpin the U.S.
economy--and that depend on a stable financial system.
How likely are those risks? The scary answer is: We don't know. The
report shows a range of scenarios for how climate change could threaten
the U.S. financial system, but we don't know when or how those
scenarios could occur--because we are not requiring businesses and
financial institutions to assess, measure, manage, and disclose those
risks. Recent research from the Brookings Institution, aptly titled
``Flying Blind,'' makes the same point: investors don't know the actual
climate risks to their portfolios. \15\ Members of the financial
community who ignore climate change--whether they are banks, investors
or regulators--do so at their own peril.
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\15\ Parker Bolstad et al., Flying Blind: What do Investors Really
Know About Climate Change Risks in the U.S. Equity and Municipal Debt
Markets? (Brookings Institute, 2020), https://perma.cc/8LNV-BEGK.
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That's precisely why measuring and managing climate risk should be
an essential part of the actions regulators take to protect the
financial system. I now turn to the role of regulators.
The Duties and Authorities of Financial Regulators To Respond to the
Risks of Climate Change
Climate change and the foundational duties and authorities of financial
regulators
Effective financial regulation relies upon multiple and overlapping
federal and state regulatory regimes and regulators, each working to
achieve a diversity of statutory goals and objectives. Those duties and
obligations vary, but generally require agencies to ensure ``market
efficiency and integrity, consumer and investor protections, capital
formation or access to credit, taxpayer protection, illicit activity
prevention, and financial stability.'' \16\ These broad statutory
obligations require financial regulators to ensure a variety of
safeguards are present. Transparent and fairly enforced market rules
support market integrity. Reducing information asymmetries, ensuring
accurate and comprehensive information, and requiring robust disclosure
improves efficiency. Preventing losses to the American taxpayer is
likewise of crucial importance. And financial stability, considered in
the context of systemic risk and synergistic events, is core to
regulatory responsibility.
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\16\ Marc Labonte, ``Who Regulates Whom? An Overview of the U.S.
Financial Regulatory Framework'' (Congressional Research Service,
2020), https://perma.cc/NXT4-V3RU, ii.
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Climate change is highly relevant to the various statutory
obligations for financial regulators identified above: market
efficiency and integrity can only be maintained when market
participants are aware of climate risks to regulated entities and
investments; taxpayer losses can only be prevented when the effects of
climate change are considered; and financial stability can only be
maintained when systemic risks like climate change are proactively
addressed. More generally, risk identification, reduction, and
allocation guide regulatory oversight and should extend to
consideration of climate impacts. For these reasons, financial
regulators should take proactive action to consider how the
consequences of climate change implicate their statutory duties and
authorities.
The consequences of climate change increasingly implicate these and
other statutory duties of financial regulators. Put simply: Asserting
that financial regulators have an obligation to regulate climate risk
is not based on a reinterpretation of the duties of those regulators.
Those duties remain the same. What is ``new'' is the magnitude of the
risk posed by climate change.
The need for mandatory disclosure of climate-related financial risk
As described above, financial regulators have long required
requisite levels of transparency and accountability from regulated
entities. Safeguards to ensure accurate and comprehensive information
are necessary to the U.S. economy and convey critical benefits across
stakeholders. Duties and authorities under federal securities law
serves as one pressing example, with the SEC statutorily obligated to
protect investors, facilitate capital formation, and maintain fair,
orderly, and efficient markets. \17\
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\17\ National Securities Markets Improvement Act of 1996, Pub. L.
No. 104-290, 110 Stat. 3425 (adding 15 U.S.C. 77b(b) to the Securities
Act of 1933 and 15 U.S.C. 78c(f) to the Securities and Exchange Act of
1934).
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To discharge these core duties, the SEC requires, among other
things, that regulated entities disclose material risks. As
demonstrated in section 2, climate change increasingly poses a material
risk to a broad swath of the economy. The consequences of climate
change are already creating significant and foreseeable financial
harms, and disclosure is necessary to ensure investors are aware of the
physical and transition risks that corporations they invest in may
face, as well as the potential implications of that exposure.
Although climate related financial risks are growing, current
disclosure regimes in the United States have not kept pace. SEC
guidance in 2010 was important and pathbreaking but has proven
insufficient, with resulting disclosures lacking in specificity,
submitted with boilerplate language, or missing entirely. \18\ In the
absence of effective regulation, voluntary standards and frameworks
have emerged. Although these efforts, including those by the Task Force
on Climate-related Financial Disclosures (TCFD) and the Sustainability
Accounting Standards Board (SASB) have been critical to advancing
climate risk disclosure, they are insufficient. Recent study has found
that although climate risk disclosure has increased, ``[m]ore firms are
disclosing more general information that is essentially of no utility
to the marketplace.'' \19\ In addition, disclosure varies across
sectors and some sectors that are particularly vulnerable to climate
impacts, such as agriculture, are lagging in their assessment and
disclosure of climate risks. \20\
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\18\ Sustainability Accounting Standards Board, The State of
Disclosure 2017: An Analysis of the Effectiveness of Sustainability
Disclosure in SEC Filings (2017), https://perma.cc/USC8-2HN2, p. 2.
\19\ Parker Bolstad et al., ``Flying Blind'', 3.
\20\ Agricultural lenders cite their largest risks as commodity
prices, production costs, farmland values and global market issues.
U.S. Bd. of Governors of the Fed. Reserv. Sys., Div. of Banking
Supervision and Regul., SR 11-14: Supervisory Expectations for Risk
Management of Agricultural Credit Risk (2011), https://perma.cc/LT4G-
2D6T.
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To address this vulnerability, the SEC should take action to
strengthen mandatory climate risk disclosure. Doing so furthers the
Commission's statutory duties and provides benefit not only to
investors, but to regulatory companies, the market, and the American
public. First, investors benefit generally when risks are disclosed,
insofar as ``investors can only price the risks that they are aware
of,'' and understanding climate risk exposure ``requires more granular
data than is currently disclosed in financial reporting.'' \21\ Useful
climate risk information thus serves an investor's interest in
effectively allocating capital on the basis of a robust understanding
of reward and risk. Second, companies benefit in at least three ways:
``the improved ability: (i) to identify, assess, manage, and adapt to
the effects of climate change on operations, supply chains and customer
demand; (ii) to relay risk and opportunity information to capital
providers, investors, derivatives customers and counterparties,
markets, and regulators; and, (iii) to learn from competitors about
climate-related strategy and risk management best practices.'' \22\
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\21\ Madison Condon, Market Myopia's Climate Bubble, 2021, Utah L.
Rev. (forthcoming 2021) (manuscript at 6-7), https://papers.ssrn.com/
sol3/papers.cfm?abstract-id=3782675.
\22\ CFTC, Managing Climate Risk in the U.S. Financial System, 87.
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Third, strengthened climate risk disclosure benefits markets
themselves, and climate risk disclosure is relevant to facilitating
capital formation and maintaining fair, orderly, and efficient markets.
As noted above, prices that incorporate all information about a
corporation's financial prospects improve investors' ability to
distribute capital to its highest value use. Without sufficient
disclosure, widespread mispricing can occur, an outcome that puts
market structures at risk, where in the absence of accessible and
accurate information the likelihood of a sudden shift in price
correction may occur. Financial experts have warned that consequent
``sharp changes in valuations'' of corporate entities could in turn
lead to cascading instability across the financial sector. \23\
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\23\ Mark Carney, Gov., Bank of England, Chair, Fin. Stability
Bd., Resolving the Climate Paradox, Arthur Burns Memorial Lecture
(Sept. 22, 2016), https://perma.cc/6GPS-VWVU.
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Fourth, climate risk disclosure also conveys crucial benefit to the
American public: transparent disclosure of climate risk and
incorporation of that information supports public planning; better
understanding of physical climate risk and thoughtful resilience
planning can reduce damage; and strengthened climate risk disclosure
has the potential to support mitigation efforts. \24\
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\24\ Benedikt Downar, Jurgen Ernstberger, Stefan Reichelstein,
Sebastian Schwenen, and Aleksandar Zaklan, ``The Impact of Carbon
Disclosure Mandates on Emissions and Financial Operating Performance'',
(Stanford Steyer-Taylor Center for Energy Policy and Finance, 2020),
https://law.stanford.edu/publications/the-impact-of-carbon-disclosure-
mandates-on-emissions-and-financial-operating-performance/.
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For these reasons, the consequences of climate change should be
brought level with other forms of financial risk and mandatory
disclosure rules strengthened. Boilerplate filings are not adequate,
and disclosure should drive comparable, specific, and decision-useful
information from regulated entities. These three tentpoles of
strengthened disclosure necessarily overlap, but each conveys
particular meaning: comparability enables benchmarking and risk
relational across companies; specificity encourages granular analysis
particular to that entity; and decision-useful design, meant to broadly
contemplate not only investment determinations but also, for example,
ownership, engagement, and proxy voting-related decisions, is crucial.
\25\
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\25\ Madison Condon et al., Mandating Disclosure of Climate-
Related Financial Risk (NYU Institute for Policy Integrity and
Environmental Defense Fund, 2021), https://perma.cc/2USW-MMXF, p. 11.
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The SEC has recently taken positive and important steps to consider
where and how climate change implicates its statutory duties and
obligations, including focusing staff attention on the subject and
requesting public input on climate risk disclosure. \26\ These efforts
should lead to mandatory comparable, specific, and decision-useful
climate risk disclosure.
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\26\ Acting Chair Allison Herren Lee, Public Input Welcomed on
Climate Change Disclosures, U.S. Securities and Exchange Comm'n (Mar.
15, 2021), https://perma.cc/U9VA-RZW3.
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Additional recommendations for incorporating climate risk into
financial regulation
As described above, climate change implicates multiple financial
regulators and a variety of statutory obligations and duties. In this
context, a few additional examples of specific agencies actions are
identified below. These actions are described here to highlight the
varying ways in which climate change interacts with regulatory
responsibility and identify a few potential priorities, without
representing an exclusive list.
Add climate risk expertise
First, the Treasury Department and the Financial Stability
Oversight Council (FSOC) should act swiftly to add climate risk
expertise. The consequences of climate change as a systemic risk could
be explicated through these bodies, and FSOC may additionally serve as
an entity well-suited to convene an interagency working group to
consider climate scenario analyses. Such action would have precedent:
FSOC has previously created interagency working groups to better
understand potential risks of specific activities and actions to
financial stability. \27\
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\27\ Press Release, Dep't of Treasury, Financial Stability
Oversight Council Releases Statement on Review of Asset Management
Products and Activities (Apr. 18, 2016), https://perma.cc/M9T9-M9J5.
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Likewise, the Federal Reserve should continue efforts to improve
its internal expertise on climate risk. In its 2020 Financial Stability
Report, the Federal Reserve classified climate change as a ``near-term
risk to the financial system that will likely increase financial shocks
and financial system vulnerabilities.'' \28\ Similarly, the Fed has
recently stated that ``Federal Reserve supervisors are responsible for
ensuring that supervised institutions operate in a safe and sound
manner and can continue to provide financial services to their
customers in the face of all types of risks, including those related to
climate change.'' \29\
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\28\ https://www.federalreserve.gov/publications/2020-november-
financial-stability-report-near-term-risks.htm
\29\ ``Supervision and Regulation Report'', Board of Governors of
the Federal Reserve System, November 2020, https://
www.federalreserve.gov/publications/files/202011-supervision-and-
regulation-report.pdf.
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Require bank and nonbank financial firms to incorporate climate
risk more broadly
Under its supervisory authority, the Federal Reserve should require
financial institutions to incorporate consideration of climate-related
financial risk into existing risk management and governance frameworks.
As recommended in the CFTC report, the Fed should also begin to explore
incorporating climate risk into stress testing, for example through a
pilot climate risk stress testing program in conjunction with financial
institutions--following the lead of other jurisdictions such as the
U.K., and drawing on the work of the Central Bank and Supervisors
Network for Greening the Financial System (NGFS). \30\
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\30\ CFTC, Managing Climate Risk in the U.S. Financial System, 44-
45 and 51-52.
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Promote broader availability and consistency of climate data
To inform these stress tests and help ensure consistency in
reporting, regulators should work with a range of stakeholders to
support the widespread public availability of consistent, comparable,
and reliable climate data and analysis, including via open source
platforms, and to develop standardized, consistent, broadly applicable
climate scenarios. \31\
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\31\ See discussion of data needs and scenario analysis in CFTC,
Managing Climate Risk in the U.S. Financial System, Chapters 5 and 6.
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Opportunities for Moving Private Capital to Address Climate Change
The role of the private sector in promoting climate-friendly and
sustainable investment
Over the past five years, private capital has increasingly flowed
towards climate-friendly assets, as part of a broader shift to take
environmental, social, and governance (ESG) factors into account in
investing. Between 2016 and 2018, ESG investing (often referred to as
``sustainable'' investing) in the US grew by more than 38 percent. \32\
Sustainable investments now account for approximately one third of all
assets under professional management in the US, totaling $17.1 trillion
as of November 2020. \33\ These trends are driven in large part by
increasing demand: 85 percent of investors across all age groups
express interest in sustainable investing. This number rises for
younger populations: 95 percent of millennials have a stated interest
in sustainable investing and 89 percent actively expect their financial
advisors to assess a company's ESG profile before making an investment
recommendation. \34\
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\32\ US SIF, Sustainable Investing Basics, https://perma.cc/2E9F-
PTEN.
\33\ US SIF, The US SIF Foundation's Biennial ``Trends Report''
Finds that Sustainable Investing Assets Reach $17.1 Trillion (Nov. 16,
2020, 3:24 PM), https://perma.cc/DM2C-YBCX.
\34\ MSCI, Swipe to Invest: The Story Behind Millennials and ESG
Investing 7 (2020), https://perma.cc/ZSQ6-PQ6N.
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Much of the rising demand in ESG and sustainable investing is
driven by a particular focus on climate change, motivated by an
interest in helping to combat the physical and transition risks
presented by climate change as well as the opportunities to generate
value from low-carbon and climate-friendly investment. The Climate
Action 100+ initiative, designed to support transition to net-zero
business strategies, continues to grow, with nearly 550 investors and
$52 trillion in assets under member management. \35\ These trends
highlight the immense momentum driving private capital towards climate
solutions.
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\35\ ``Climate Action 100+'', Ceres, https://www.ceres.org/
initiatives/climate-action-100.
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Asset managers and banks also understand that climate change poses
short-, medium-, and long-term financial risks. As BlackRock CEO Larry
Fink succinctly wrote in 2020, ``climate risk is investment risk.''
\36\ BlackRock is not alone; investors increasingly allocate private
capital to climate-friendly assets to minimize risk and maximize
returns. \37\ Indeed, these same underlying forces have prompted
leading financial institutions to commit to achieving net zero finance
emissions by 2050. JPMorgan, Morgan Stanley, Goldman Sachs, and
Citigroup among others have all pledged to slash their financed
emissions over the coming decades. These commitments portend even more
climate-aligned capital allocation in the future. However, more action
is needed.
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\36\ Larry Fink, Larry Fink's 2020 Letter to CEOs: A Fundamental
Reshaping of Finance, BlackRock (Jan. 14, 2020), https://perma.cc/8TA7-
VGUM.
\37\ Jon Hale, Morningstar, Sustainable Funds U.S. Landscape
Report: More Funds, More Flows, and Impressive Returns in 2020 (2021),
https://perma.cc/9SFJ-7NE5.
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Banks and asset managers can begin reducing financed emissions in
the immediate term by engaging with companies in carbon-intensive
sectors such as oil and gas and transportation. In oil and gas, firms
can monitor, for example, methane emissions, flaring intensity, capital
expenditures, lobbying, and governance to track progress and allocate
investment to those that perform well. By establishing time-bound
climate benchmarks with consequences for high impact sectors, investors
can accelerate the deployment of private capital to climate solutions.
\38\ Banks and asset managers should also direct financing towards
activities that simultaneously reduce greenhouse gas emissions and
build the underlying asset's climate resilience. For example, private
investments in climate-resilient agricultural production can reduce
agriculture's greenhouse gas emissions while reducing production risks
from severe weather impacts. \39\
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\38\ Ben Ratner and Erin Blanton, Five Key Climate Metrics for the
Oil and Gas Sector's Next Five Years, World Economic Forum (Nov. 2,
2020), https://perma.cc/U3RL-KMXF.
\39\ Maggie Monast, Financing Resilient Agriculture: How
Agricultural Lenders Can Reduce Climate Risk and Help Farmers Build
Resilience (Environmental Defense Fund, 2020), https://perma.cc/BF4G-
A55W.
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The role of government policies in channeling private capital into
climate solutions
Carbon pricing
The most important step that government could take to help channel
private capital into low-carbon investment is to implement policies
that put a fair and effective price on carbon emissions. Every ton of
carbon dioxide and other greenhouse gases imposes a cost on society as
a whole. Using the U.S. government's current central estimate of the
social cost of carbon--the estimate economic damages from a ton of
carbon dioxide emitted today, calculated into the future and discounted
back to today--is $51 per ton. \40\ Given total U.S. CO2 emissions of
more than 5 billion tons, that implies an annual cost on the order of a
quarter of a trillion dollars per year. Moreover, there are strong
reasons to think that the current estimate of the social cost of carbon
is too low. \41\ In the absence of effective government policies,
however, that cost is not reflected in market prices--and therefore is
missing from the financial returns to investors.
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\40\ United States Government Interagency Working Group on Social
Cost of Greenhouse Gases, Technical Support Document: Social Cost of
Carbon, Methane, and Nitrous Oxide Interim Estimates under Executive
Order 13990 (February 2021), https://www.whitehouse.gov/wpcontent/
uploads/2021/02/
TechnicalSupportDocument_SocialCostofCarbonMethaneNitrousOxide.pdf.
\41\ K.D. Daniel, R.B. Litterman, and G. Wagner, Declining CO2
price paths, Proceedings of the National Academy of Sciences 116(42)
(2019), 20886-20891; R.L. Revesz, P.H. Howard, K. Arrow, L.H. Goulder,
R.E. Kopp, M. Livermore, and T. Sterner, Global warming: Improve
economic models of climate change, Nature, 508(7495) (2014), 173.
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As a result, without a price on carbon, private markets will fail
to direct capital efficiently. In the words of the CFTC report:
Without an effective price on carbon, financial markets lack
the most efficient incentive mechanism to price climate risks.
Therefore, all manner of financial instruments-stocks, bonds,
futures, bank loans-do not incorporate those risks in their
price. Risk that is not quantified is difficult to manage
effectively. Instead, it can build up and eventually cause a
disorderly adjustment of prices. \42\
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\42\ CFTC, Managing Climate Risk in the U.S. Financial System, 4.
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For this reason, the CFTC report recommends that
The United States should establish a price on carbon. It must
be fair, economywide, and effective in reducing emissions
consistent with the Paris Agreement. This is the single most
important step to manage climate risk and drive the appropriate
allocation of capital. \43\
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\43\ CFTC, Managing Climate Risk in the U.S. Financial System, 9.
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Supporting climate-focused and sustainable investing
While interest in ESG and sustainable investing is increasing, the
data underlying ESG products remains inconsistent in terms of quality
and availability. ESG investing remains relatively opaque, with no
shared industry definition on ``sustainability.'' As a result, ESG-
branded products can contain companies that perform poorly on climate,
and comparability between ESG rating systems is difficult to achieve.
\44\ More generally, investors face difficulties engaging companies on
decarbonization strategies when they lack relevant climate information.
Strengthened mandatory disclosure by the SEC, as described above, could
help address these issues, driving more private capital to climate-
friendly assets.
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\44\ Dane Christensen et al., ``Why is Corporate Virtue in the Eye
of the Beholder? The Case of ESG Ratings'', 96 The Acct. Rev.
(forthcoming 2021), https://perma.cc/Q8X3-5QUV.
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Government policies should also acknowledge the relevance of ESG
factors, including climate-related factors, to investors and allow them
to be better integrated into retirement planning. Demand for
sustainable retirement funds is high; 74 percent of employees feel that
having socially responsible investment options in their 401(k) plans is
important. Roughly 2/3rds of all millennials would increase their
retirement plan contribution if they knew their investments were doing
social good. Retirement plans are a significant vehicle for individual
investors to realize their goals: while only 14 percent of Americans
are directly invested in individual stocks, over half have access to
401(k) plans. \45\ Yet despite clear interest in sustainable
investment, less than 3 percent of 401(k) plans include an ESG option
and only .1 percent of 401(k) assets are ESG-aligned. \46\
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\45\ https://www.pewresearch.org/fact-tank/2020/03/25/more-than-
half-of-u-s-households-have-some-investment-in-the-stock-market/
\46\ Greg Iacurci, Climate Funds Hold Less Than 1 percent of
401(k) Money. Here's Why, CNBC (Dec. 14, 2020), https://perma.cc/D892-
JMEN.
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Promoting better integration of ESG and climate-focused factors in
the $6.6 trillion 401(k) market would provide millions of Americans
with access to funds that generate superior long-term returns, align
with their values, and protect the planet. The Department of Labor
(DOL), under the Employee Retirement Income Security Act (ERISA),
oversees minimum standards for retirement plans in the United States,
and should consider rulemaking and/or other actions that could support
climate-aligned investment by better integrating ESG and sustainability
factors in ERISA plans. In particular, DOL should consider formally
acknowledging existing evidence that climate-related risks are
financially material, in order to clarify existing regulations for plan
fiduciaries and reduce uncertainty that can hinder the inclusion of
climate-relevant factors into plan offerings.
Conclusion
Climate change poses significant risks to the U.S. financial
system--but well-designed policies can help to manage and mitigate
those risks. As policy makers consider how to address the challenge of
climate change and position the U.S. economy for robust, inclusive
growth in coming decades, they have a range of tools available. Given
the central importance of accurate, consistent, and up-to-date
information, regulators should put particular importance on mandatory
climate risk disclosure, as well as incorporating climate risk into
risk management practices of regulated firms, increasing the relevant
expertise of regulators, and improving data availability. In addition,
well-designed policies can help remove barriers that limit the flow of
private capital into low-carbon and climate-friendly investment
opportunities, responding to the significant and growing demand from
investors. In that respect, the most important step policy makers can
take would be to implement a fair and effective price on carbon across
the U.S. economy.
______
PREPARED STATEMENT OF MARILYN WAITE
Climate And Clean Energy Finance Program Officer, The William and Flora
Hewlett Foundation
March 18, 2021
Climate Urgency
The year 2020 marked a turning point in planetary systems--it was
the warmest year on record, with Death Valley in California reporting a
maximum temperature of 130 degrees F in August. \1\ The United States
experienced 22 separate billion-dollar weather and climate-related
disasters, exacerbating the economic toll of COVID-19 and costing $95
billion in damages in a single year./2/
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\1\ Laura Newberry. L.A. Times, Aug 16, 2020. ``Death Valley Hits
130 Degrees, Thought To Be Highest Temperature on Earth in Nearly a
Century''. https://www.latimes.com/california/story/2020-08-16/death-
valley-hits-130-degrees-thought-to-be-earths-highest-temperature-in-
more-a-century
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As climate change pushes towards higher average global
temperatures, we will continue to see a variety of sectors hurt: from
grounded planes in Arizona because it's simply too hot to take off, to
a dwindling food supply because heavy rain and snow storms in the
Midwest blanket agricultural land. In an Economic Brief from the
Federal Reserve Bank of Richmond, researchers explained that rising
temperatures could reduce overall growth of U.S. economic output by as
much as one-third by 2100./3/ The impacts of climate change are deep
and widespread, with no one industry exempt.
In 2018, the Intergovernmental Panel on Climate Change (IPCC)
outlined the impacts of climate change at 2.7 degrees F (or 1.5 degrees
C). The report, which involved 91 authors and drew upon 6,000 research
papers, emphasized the time-sensitive nature for mitigating climate
change--we must accelerate action over the next decade to avoid
significant loss of human, economic and ecosystem life.\4\ In order to
avert unprecedented upheaval, the global average temperature increase
from pre-industrial levels must stay at or below 1.5 degrees C. To
remain within this limit, the global economy must cut annual global
greenhouse gas emissions 45 percent below 2010 levels by 2030 and reach
net zero (also known as becoming carbon neutral) by 2050. At the global
level, this means that, in aggregate, all sources of anthropogenic GHG
emissions that currently total up to 55 GT of CO2 equivalent (CO2e) per
year must reach zero. For the United States, which represents about 15
percent of the world's GDP and GHG emissions, this equates to roughly 6
GT of CO2e annually.\5\
If warming is allowed to increase to 4 degrees C in the business-
as-usual scenario, global economic losses from climate change are
conservatively estimated to be $23 trillion per year-three to four
times the scale of the 2008 financial crisis and more than three times
the predicted contraction of global GDP due to COVID-19.\6\ That
estimate is conservative partly because it does not account for the
effects of wildfires and other extreme events.
But we have choices. Another modelled estimate finds the economic
cost of failing to cut emissions adds up to a burden of between $150
and $792 trillion by 2100, whereas the net benefit of climate change
mitigation, on top of avoiding those losses, could be between $127 and
$616 trillion by 2100.\7\
In short, it's cheaper to solve the climate crisis than to allow it
to persist.
According to a comprehensive study by Princeton University, the
U.S. must invest an additional $250 billion each year, compared to
business-as-usual, for the next ten years at a minimum to reach net
zero by 2050. These investments would target energy supply, industry,
buildings, and vehicles and could create 1 million new jobs.\8\
Climate-Related Financial Risks
The impacts of climate change to the financial system manifest in
multiple ways and can be grouped in both physical and transition risks.
Physical risk includes damage to properties and assets from the
changing climate and related extreme weather events. Physical risks,
whether acute or chronic, can lead to increased capital costs (e.g.,
damage to facilities), reduced revenues from lower sales/output, write-
offs and early retirement of existing assets (e.g., damage to assets in
``high-risk'' locations), and increased operating costs (e.g.,
inadequate water supply for hydroelectric plants or to cool nuclear and
fossil fuel plants). Physical risks include both demand and supply-side
shocks to the financial system. For instance, rising sea levels may
decrease demand for coastal real estate; saline intrusion of wells may
impact drinking water supplies.
Transition risks are losses arising from the transition from a
fossil fuel-based economy to a clean energy economy. The risks include
credit risk (loan defaults from stranded assets, technology
substitution of existing products and services with lower emissions
options) and market risk (such as impairment of capital market assets),
and can result in reduced demand for products and services and
repricing of assets. Transition risks also capture the indirect effects
of climate change, such as higher prices of raw materials, which may
lead to less competition among firms, which in turn may lead to greater
unemployment, which could result in greater insecurity. Taken together,
once risks have manifested at the institutional and retail level, they
reach the financial markets, through the classic market, credit,
liquidity and operational risks.\9\
Worth special attention is the creation of stranded assets. This
term describes an asset, such as a piece of equipment or a resource,
which falls in value or can no longer produce revenue as a result of
technological developments, market shifts or changing societal
habits.\10\ For example, by the early 20th century, the market for
whale oil and oil lamps all but disappeared with the advent of electric
lighting. The whaling industry's ships and the existing stock of oil
lamps therefore became stranded assets. Today the term is often used to
describe oil and gas resources that remain in the ground but appear as
assets on a firm's balance sheet. Yet stranded assets are not only a
problem for companies involved in fossil fuel extraction; businesses
that use fossil fuels as production inputs, or are otherwise energy or
carbon intensive could also be heavily impacted by climate legislation,
technological breakthroughs, and a shift in demand as the global
economy transitions away from fossil fuels.
In some sectors, such as coal, the stranding of assets has already
begun due to the relative cost competitiveness of renewables. For
example, globally, power generation from wind and solar installations
are now less expensive to operate than coal-with almost 30 percent of
new coal plants estimated to enter the market cash flow negative from
their first day of operation.\11\ Furthermore, investors and
governments alike could find themselves with $630 billion worth of
stranded assets if the current global pipeline of new coal plant
construction was to proceed.\12\ If investing continues along a
business-as-usual path, and the financial system fails to incorporate
climate risks into its decision-making framework-businesses will
inevitably end up with stranded assets across numerous sectors.
As the financial system and the real economy will both be
devastated if the planet warms much more, and with real losses already
manifesting in some sectors and asset classes, the challenge goes far
beyond just protecting the financial system from climate risk.
Investors and policymakers must choose if and why they should finance
and back assets that are fundamentally unworkable, inconsistent with
international agreements such as the Paris Agreement, and are likely to
be stranded. In the case of coal, it would be wise for policymakers to
plan now for the retirement of coal assets over the coming 10 years to
minimize the financial risk of a disorderly energy transition.\13\ The
financial system, through new market rules, must integrate a shift from
the single materiality of risk management to the double materiality of
risk and impact management; this double materiality includes financial
materiality and environmental and social materiality.\14\
Role of Finance in Solving Climate Change
Finance is absolutely essential. There will not be a transition to
a low carbon economy without a way to finance the vast number of
infrastructure, retrofit, new technology research, and various other
projects needed. We saw annual climate investment flows rise to $579
billion, on average, over the 2-year period of 2017-2018, with
increases concentrated in low-carbon transport, North America, and East
Asia. Nevertheless, this figure is not enough to maintain a well-below
2 degrees C of warming target. Estimates of the global investment
required to achieve that goal range from $1.6 to 3.8 trillion annually,
for supply-side energy system investments alone.\15\ However
policymakers as well as businesses know that investments are not only
associated with costs, they also bring returns and benefits. Therefore,
while climate change is a significant crisis, it is also a significant
opportunity to create jobs, wealth, and long-term economic prosperity-
especially in the context of the ongoing U.S. economy's recovery from
COVID-19.
In 2018 alone, the U.S. advanced energy industry generated $238
billion in revenue, which is roughly equal to that of aerospace
manufacturing and double that of the biotech industry. The market for
climate-smart technology is expected to grow significantly over the
coming decade, estimated to be worth $23 trillion by 2030. Clean energy
installations are also a steady source of state and local taxes-for
example, wind farms paid $761 million to state and local governments in
2018 in addition to $289 million to farmers and landowners who leased
their land to wind turbine operators. Investing $4 billion annually
into reforestation and sustainable forest management could support an
estimated 150,000 jobs per year, which is three times as many jobs as
the logging industry provides.\16\
At the Hewlett Foundation, we've taken a lead on committing
significant resources to climate initiatives--and for the first time in
2018-2023, we dedicated $75 million to Climate Finance and Investment
grantmaking. This falls within our broader commitment of $600 million
for climate-focused grantmaking across four key geographies (the United
States, China, India and Europe) within five sectors including
Electricity, Transportation and Cities, Industry, Finance/Investment,
and Technology, Innovation and R&D.
In developing our Climate Finance Strategy, we studied the
financial system to better understand where capital was allocated, who
owned or controlled it, and what the barriers were to financing more
zero emissions energy, transportation, industry, and land use projects.
What we found was nearly $250 trillion worth of commercial capital
available globally in five primary capital pools including: Asset
Owners, Retail Bank Deposits, Development Finance Institutions (DFI)/
Multilateral Development Banks (MDB), Private Equity and Venture
Capital. Broadly speaking, each of these pools of capital seek
different risk/return profiles, comply with different regulations in
different markets, and perform distinct functions in the global capital
markets.\17\
The data clearly show that the problem is not lack of capital.
Moreover, recent responses to COVID-19 have mobilized trillions from
national budgets and the capital markets have re-bounded since March
2020, shifting trillions of dollars from retail and institutional
investors to listed companies. Yet an estimated one-third of fixed
income and public equity assets are still linked to climate change
causing industries.\18\ Therefore, the real challenge is moving those
trillions to low-carbon investments. Numerous factors hold back this
investment-entrenched beliefs, thinking, and processes associated with
traditional methods of investment decision-making hamper action. For
some investment professionals, false perceptions about investing in
climate-friendly projects or technologies are common. For others, a
lack of data or tools makes it too challenging to apply the
consideration of the impacts and risks associated with climate change
to their portfolio.
Through interviews, research and analysis, we identified eight key
barriers that inhibit the expansion of opportunities to access and
mobilize finance for climate-friendly activities. These include:
1. Limited Sources of High-Risk Capital
2. Pricing of Perceived Risks
3. Deal Size Preferences
4. Lack of Transparent Data
5. Policy Uncertainty
6. Timing of Climate Risk Impacts
7. Lack of climate-friendly investment guidelines
8. Short-term investment horizons
Limited Sources of High-Risk Capital: Early-stage investments
provide the bridge between the research and development of a technology
and scaling up. Typically, Venture Capital (VC) funds fill this gap and
are an integral resource for early-stage investments and helping
companies scale. Yet VC cleantech investments are heavily skewed
towards late-stage projects concentrated around energy efficiency,
transportation and smart grid. As such, 87 percent of VC cleantech
investments went to late stage projects in 2016.
Pricing of Perceived Risks: Risks that apply to climate-friendly
investments are often perceived by investors in vastly different ways.
This results in a wide variation in pricing and capital availability.
For example, energy efficiency projects are universally identified as
critical to solving climate change; yet the inability to finance these
projects based on the strength of their energy savings has limited
their deployment. Investors' opinions, not always data, sometimes lead
to an over reliance on the financial strength of the project hosts,
which can lead to requiring credit enhancements or complicated
structures to satisfy investors' concerns over the durability of energy
savings.
Deal Size Preferences: The market for larger, centralized projects
with vetted technologies initiated and supported by utilities,
governments, corporations and other long-term credit worthy
counterparties is well known and quite active. Yet, smaller,
distributed projects-including solar photovoltaic, energy efficiency,
electric vehicles, and others at the residential, small commercial and
industrial sectors often have challenges accessing sufficient levels of
long-term capital. This typically occurs because large institutional
investors, such as pension funds, traditionally participate in utility
scale deals on a significantly grander scale-where deals are worth $50
million or more. This preference for large deals means that relatively
smaller projects worth $10,000, $100,000, or even $1,000,000 often get
left out.
Lack of Transparent Data: A lack of consistent, transparent, and
available data that reports the technical performance, energy
production, and environmental impact of climate projects and other
important factors limits the ability of potential investors to evaluate
past performance of similar projects. This often results in higher risk
premiums, which increase interest rates and return requirements and
simultaneously decreases the number of interested investors. An
inability to thoroughly assess projects increases hesitation among
investors as they are further unable to evaluate and reduce perceived
risk premiums for climate-friendly projects.
Policy Uncertainty: Further dissuading long-term investment in
climate-friendly activities is the uncertainty associated with policies
around climate change. Governments' shifting and sometimes unclear
commitments to climate-related policy or regulations help to fuel
investors' unease with entering the sector.
Timing of Climate Risk Impacts: Many professionals making
investment decisions do not view climate change as a significant short-
term risk that requires the adjustment of investment and credit
considerations. The indefinite timing and magnitude of climate change
impacts are often cited as key impediments to investors' ability to
consider the financial risks of climate change in near term decision
making and portfolio allocation methods.
Lack of Climate-Friendly Investment Guidelines: There is no unified
definition for climate/ green/sustainable investments; or for climate
finance activities that provide direct funding towards reaching climate
goals and reducing GHG emissions. Practically speaking, this means that
investors cannot easily compare different investment opportunities
labeled `green' or climate friendly. For example, securities can only
be listed on the Bloomberg Barclays MSCI Green Bond Index if they fall
within at least one of six MSCI-defined eligible environmental
categories: Alternative Energy, Energy Efficiency, Pollution Prevention
and Control, Sustainable Water, Green Building, and Climate
Adaptation.\19\
Short-Term Investor Horizons: Many investment decisions are focused
on near-term risks and returns. For example, the hold period for
investments is typically five to seven years, and therefore investors
minimize risks further off into the future. There is also the
expectation by many investors for maximum returns over each period they
hold an investment. This pressure can lead investment managers to
``chase'' quarterly returns and not properly or fully analyze risk.
We structured our approach in the Climate Finance Strategy to
foster and select projects that address one or more of these barriers.
What we have learned from this work is that there are limits to what
any one lender, asset owner or asset manager can do within its four
walls and financial supply chain to enact the changes necessary to
protect the financial system from climate-related downfall and support
the low carbon economic transition. Fortunately, there are a number of
actions that financial regulators and policymakers can take to
safeguard the planet and people and provide adequate market rules to
curb climate change.
Financed Emissions Disclosure
Step one is to mandate more information, but not just any
information. Financial institutions must be required to measure and
disclose the carbon emissions of their financial portfolios.\20\ This
list includes, but is not limited to sovereign bonds, listed equity,
project finance, mortgages, commercial real estate, corporate debt:
bonds, business loans, indirect investments, and auto-loans.
An open access, open source, widely used methodology for measuring
and disclosing financed emissions comes from the Partnership for Carbon
Accounting Financials (PCAF). PCAF is an international, industry-led
initiative that enables financial institutions (FIs) to measure and
disclose GHG emissions financed by loans and investments. A group of
banks and investors launched PCAF during Climate Week in New York in
September of 2019. Currently, over 100 FIs have joined and committed to
assess and disclose their portfolio's GHG emissions, representing more
than $25 trillion of assets under management (AUM).\21\ The members of
PCAF have harmonized an approach to assess and disclose the greenhouse
gas (GHG) emissions of their loans and investments, accompanied by an
emissions factor database.
There is global precedent for mandating financed emissions
disclosure. For example, in March 2021, The European Banking Authority
(EBA) issued a draft standard on the prudential disclosures on ESG
risks, stating that European financial institutions should disclose the
carbon footprint and scope 3 emissions\22\ of their collaterals by June
2024.\23\ The European Central Bank (ECB) published, in Section 7.2 of
its final guide on climate-related and environmental risks for banks,
that financial institutions are ``expected to disclose the
institution's financed scope GHG emissions'' and references the use of
PCAF by a number of financial institutions in line with the GHG
Protocol.\24\
Corporate disclosure of climate-related risks and opportunities
will help investors fulfill their fiduciary obligations to integrate
material climate considerations into their investment actions.
Investors need consistent, comparable data, in a machine-readable
format, so that they can efficiently and effectively aggregate and
analyze climate-related financial disclosures. The Securities and
Exchange Commission must update existing disclosure requirements to
require that reporting companies disclose this data.
Enabling Community-Focused Lenders to Lead
Communities of color in the country bear the brunt of environmental
degradation and pollution, and similar to the impacts of COVID-19, are
likely to be disproportionately impacted by unabated climate change.
The National Academy of Sciences found that the largest environmental
health risk factor in the U.S., fine particulate matter (PM2.5), is
disproportionately caused by consumption of goods and services mainly
by the non-Hispanic white majority, but disproportionately inhaled by
Black and Hispanic minorities.\25\ Due to the increased air pollution
burden, higher likelihood of living in climate risk zones (such as
flood zones, isolated rural areas, and urban heat islands), higher
likelihood of living in areas with aging and poorly maintained
infrastructure, low-income groups, communities of color, and some
immigrant populations are highly vulnerable to the health impacts of
climate change.\26\
In addition to living in communities disproportionately affected by
pollution and vulnerable to climate change, both rural and urban low-
income households spend three times as much of their income on energy
than non-low-income households, a phenomenon known as energy
burden.\27\ In 2015, an estimated 17 million households received an
energy disconnect/delivery stop notice and 25 million households had to
forgo food and medicine to pay energy bills.\28\ To help low or
moderate income (LMI) households mitigate the effects of climate change
and access renewable energy technologies, community-focused lenders and
other community-based financing schemes can be leveraged.
There are over 100 minority depository institutions (MDIs), over
1,000 community development financial institutions (CDFIs), over 5,000
credit unions, and over 5,000 deposit-taking banks that are poised to
serve climate-impacted communities in the United States. However, the
federal government has a critical role to play in ensuring the
successful alignment of these institutions with solving climate change.
There are a number of existing federal programs that need to be updated
in the short-run to align financial incentives with the clean energy
transition. For example, the creation of a dedicated clean energy grant
program as a part of the CDFI fund would be beneficial. There is
precedence for this approach, with CDFI Funds already having dedicated
grant program award `buckets' to efforts outside of traditional awards,
such as the Healthy Foods Financing Initiative and Disability Funds
Financial Assistance.\29\ This approach would ensure that more CDFIs
focus on financing clean energy, which in turn boosts innovation and
impact. As such, dedicated clean energy awards could be structured to
assist CDFIs to fund solar and energy efficiency loans.\30\
Credit unions are another powerful source of financing that can be
deployed to help communities access funds for everything from home
solar to energy efficiency retrofits and electric vehicles. However,
what they lack is the technical assistance and the patient capital to
be able add the `clean energy asset class' to their loan books. A key
challenge is access to secondary capital for loss absorption. Unlike
banks, which have different instruments available to them, secondary
capital for credit unions has historically been provided by
philanthropic organizations or as loans--with demand significantly
outstripping supply.\31\
The National Credit Union Administration (NCUA) should expand
access to secondary capital, including equity, for credit unions
engaging in climate mitigation and green opportunity financing, and
allow credit unions to service small businesses for climate mitigation
related lending, similar to the current rule for low-income lending. At
the same time, we see the need for an injection of long-term, low-cost
capital to enable rapid scaling of credit union's lending capacities in
the communities most impacted by COVID-19 and climate change.
Therefore, Treasury should provide direct investment of secondary
capital into credit unions to support the lending needed for economic
recovery and long-term climate change mitigation.\32\ Note that this
approach is not without precedent either. In 2010, Treasury made an
investment of $70 million to secondary capital for CDFI-certified
credit unions-where every dollar invested resulted in $60 worth of
loans over the intervening years.\33\
Some credit unions such as the Clean Energy (Federal) Credit Union
and Inclusiv (a network of community development credit unions) are
already focusing on clean energy and seeing success. For example, in
its first three years of operations the Clean Energy Credit Union has
reported zero delinquencies and has sold loan participations across the
U.S. including Texas, Oklahoma, and Montana. As a low-income designated
cooperative bank, they are already teaching other credit unions the
value of this asset class. Similarly, Inclusiv offers green lending
training for all community-focused lenders along two tracks:
commercial/project finance and residential/consumer loans. Importantly,
these existing lenders are financially stable-meaning they pass the
regulatory tests set by the FDIC and NCUA on an annual basis.
A Bank Mandate for Climate-Mitigating Lending
An important way to unlock trillions of dollars with zero public
spending is through mandates, a series of incentives and penalties for
lenders to meet climate change mitigation lending amounts. The
Community Reinvestment Act (CRA) provides a precedent for such action.
The existing CRA can be strengthened to explicitly provide credit for
climate and clean energy loans. A new mandate that requires banks to
invest a certain percentage of their assets into climate friendly
infrastructure can also be instated.
The CRA seeks to ensure that banks meet the credit needs of their
entire service territory, including low- and moderate-income
neighborhoods. The OCC, FDIC and Federal Reserve Board enforce the CRA
by evaluating depository institutions according to size-differentiated
rubrics; large banks are scored on the basis of lending, investment and
service and receive one of four grades: outstanding, satisfactory,
needs to improve, and substantial noncompliance.\34\
While the CRA has been largely beneficial to LMI communities, up
until now it has not focused on addressing environmental justice.
Incorporating sustainability metrics for LMI communities into the CRA
would drive new investments and loans to help mitigate disproportionate
negative impacts and increase LMI community access to the benefits of
clean energy. The CRA should explicitly include climate-friendly
investments as allowable activities; this would provide banks and
financial regulators with better data on how many investments are being
made and in what areas, which in turn will also likely increase these
types of investments./35/ The following specific changes to the
existing CRA would enable more climate capital in underserved
communities that can serve both wealth-building and climate resiliency
purposes: 1) extend CRA coverage to non-banks, including credit unions,
which would expand access to credit in banking deserts,\36\ 2) measure
financial institution performance by outcomes, including carbon
emission levels and other criteria for climate justice, 3) create a
stronger focus on geographic racial and ethnic disparities due to the
disproportionate impact of climate change on zip codes with high
concentrations of people of color, and 4) mandate that affordable
housing (including mixed income units) be sustainable and energy-
efficient for CRA credit.
In addition to CRA modifications, the following interventions would
also create climate resiliency and wealth creating opportunities for
LMI communities: fostering a municipal green bond market that meets the
Principles of Environmental Justice\37\ and climate-focused New Markets
Tax Credits.\38\
The CRA is estimated to mobilize about $300 billion annually to LMI
communities. Climate is another area of underinvestment and thus
warrants a CRA-style mandate. Congress can instruct financial
institutions (FIs), especially SIFIs, to lend and invest in GHG-
reducing activities across financial asset classes. The FIs would be
rated and these ratings would be taken into account for regulatory
approvals, including mergers and acquisitions. In addition, FIs that
fail to meet minimum thresholds for decarbonization could incur fees.
The Nation's Balance Sheet
During the 2020 economic disruption provoked by the COVID-19
pandemic, the Federal Reserve made 83 percent of the oil and gas
industry's mostly below investment grade debt eligible for cheap
refinancing.\39\ Coal, oil and gas companies received nearly $3.9
billion in government aid.\40\ The financial regulators, including the
Fed, thus ignored sound risk management by failing to incorporate
climate-related financial risks. The Fed is prohibited from making
investments into companies that are insolvent or likely to become
so,\41\ yet by extending corporate bond purchases to `junk bonds,' the
nation's balance sheet has been put in peril. Fossil fuel energy
companies make up 13 percent of the lowest-rated, riskiest kind of
corporate debt.\42\ This climate change-causing sector also
disproportionately relies on heavily leveraged loans, collateralized
loan obligations, and other low-rated debt.\43\
Climate risk should be incorporated into Dodd Frank Act stress
tests in order to have a more accurate picture of financial stability.
However, the Federal Reserve and other financial regulators should not
wait on the results of such tests to enact climate finance regulations.
To lead to material shifts away from the dirty economy towards a clean
one, a `precautionary' financial policy approach is required. This
approach takes into account that climate related financial risks are
different from others--they are endogenous and systemic, irreversible,
pervasive, and have a high level of uncertainty in terms of very
specific points of impact.\44\
The business of risk analysis is generally based on forward-looking
projections that build on past data and as such, the future is
conceived as a replication of the past. Climate impacts, which are
multidimensional, non-linear, and attached to underlying socio-economic
realities, do not work that way-they exist in the realm of uncertainty,
whereby the future is ``unknowable and unpredictable.''\45\
Taking a precautionary approach to climate financial policy,
policymakers at all levels of government can enact regulations to limit
the financing of climate change causing activities and incentivize
climate change solving ones. Therefore, the country's bank, the Federal
Reserve, and other financial regulators should ensure that the
financial system is working for climate mitigation. Tools include a
differential interest rate for carbon intensive lending, different
capital requirements for carbon intensive lending, and a corporate
equity and bond purchasing policy that is negatively screened for
carbon. Not only should policymakers such as the SEC and OCC instruct
banks and asset managers to measure and disclose their financed
emissions, but The Federal Reserve itself should also measure and
disclose the greenhouse gas emissions that it is financing through its
operations, starting with its emergency lending portfolio in response
to the coronavirus crisis.\46\ Asset managers and insurance companies,
through a designation as non-bank SIFIs by the FSOC, can also come
under supervision and regulation by the Federal Reserve.\47\ The
Federal Reserve can also take the following measures: 1) require banks
that own coal, oil and gas assets to retire them, 2) limit banks'
ability to own and run nonfinancial businesses, and 3) implement higher
risk-weighted bank capital requirements for assets that are sensitive
to the price of carbon such as fossil fuels, deforestation, and
internal combustion engine vehicles.\48\ On the latter, the minimum
ratios of capital to assets, known as risk-based capital, should
reflect the potential for losses due to physical and transition climate
risks. Risk weights could be increased for loans and investments in
climate change-driving assets, such as the financing of the industries
that account for most global industrial greenhouse gas emissions in
coal, oil, gas, and agribusiness tied to deforestation.\49\
Fiduciary Duty
The market has spoken when it comes to the financial benefit of
incorporating environmental, social and governance (ESG), including
climate impact factors, into investment decisions. The majority of ESG
funds outperform non-ESG counterparts and ESG ETFs doubled in 2020.\50\
ESG, including climate mitigation strategies, are preferred by
investors for a number of reasons, including that this information
allows for better decision making, better management and mitigation of
risks, and ultimately the generation of risk-adjusted returns.
Sustainable investing assets now account for $17.1 trillion-or 1 in 3
dollars-of the total US assets under professional management. This
represents a 42 percent increase over 2018.\51\
Investment in climate change causing industries, such as fossil
fuels, poses a long-term risk to generating strong returns for a
diversified portfolio. In the last ten years, the S&P energy sector
gained just 1 percent as low oil prices, high operational costs and
changing consumer preferences spurred selling. However, in the same
time period, the broader market gained 212 percent. Investors and
lenders now require higher hurdle rates for climate change-causing
industries since they produce a lower return on investment capital. If
we look at hurdle rates, coal projects need 40+ percent whereas
developed market solar and wind need just 10+ percent.\52\ Policymakers
should therefore protect worker's savings and maximize returns by
instructing ERISA fiduciaries to incorporate ESG risks and
opportunities, explicitly climate considerations, into investment
options.
Climate change is always material. Fiduciaries, as those
responsible for acting in their client's best financial interest, would
be unfit should they not consider such an important and pervasive risk
as climate change. Climate pollution is not like other sources of air,
water and land point-source contaminants--GHG emissions are omnipresent
and impacts are widespread, including in transportation, energy, real
estate, food production, water and wastewater infrastructure. By
neglecting climate factors, investors will likely misprice risk and
poorly allocate assets; this is in part why globally there are over 730
policies across 500 policy instruments that support or require the
incorporation of ESG issues in the fiduciary process.\53\
Policymakers at all levels of government, including state pension
fund regulators, the SEC, FINRA, and the Department of Labor (DOL),
should modernize fiduciary duty definitions to align with ESG,
including climate risk and impact. Climate specific fiduciary
regulations should include retirement fiduciaries (including pension
plans), investment advisers registered with the SEC, broker-dealers and
other financial intermediaries (subject to federal securities laws),
asset managers that are not registered with the SEC, and non-profit
asset owners. Trustee boards and investment committees should
demonstrate the consideration of climate and ESG impacts in the
investment process and through the investment policy. DOL should (1)
issue guidance that explicitly calls out climate factors as
``pecuniary'' and therefore important considerations for ERISA
fiduciaries and (2) issue a rule to clarify that climate factors are
material and require ERISA plan fiduciaries adopt and implement
sustainable investment policies. FINRA should enact reforms to the KYC
rules to include seeking information about customer ESG-related
preferences. The SEC should at a minimum (1) implement a rule under
Section 203(c)1(C) under the Investment Advisers Act of 1940 requiring
the Form ADV to require investment advisers to adopt and implement
sustainable investment policies that incorporate climate risk and
impact and (2) implement a rule under the Investment Company Act to
require a fund to disclose on its prospectus and statement of
additional information how the fund identifies, assesses, and addresses
key climate issues, votes and otherwise engages with companies of
portfolio securities consistent with sustainable investment policies,
and has been audited for compliance with the policies.
Unlocking Consumer Finance
Demand deposits are a bedrock of the financial system. Banks
leverage consumer deposits to make loans and purchase assets; these
accounts also create a customer relationship that results in fees for
bank services and other product sales such as credit cards and auto
loans. Domestic demand deposits in FDIC-insured banks and savings
institutions are roughly at $15 trillion.\54\ If only 1.7 percent of
these deposits were mobilized annually for climate solutions, the
nation would surpass the additional investment amount needed to reach
net zero by 2050 and avert a climate-induced financial crisis. Only 1.7
percent of capital sitting in our everyday bank accounts.
Unfortunately, it is currently cumbersome for consumers to align
their deposits with a people and planet-friendly economy. Opening a new
account and closing an old account is ``rarely easy and is usually
hard.''\55\
Switching bank accounts should be as easy as switching broker
dealers and telephone providers. U.S. consumers now own their phone
numbers, allowing them to easily choose a provider that suits their
needs. This was enabled by the 1996 Telecommunications Act that
required all carriers to offer mobile number portability (MNP). MNP
allows consumers to contact a new carrier, who then transfers the
account and service by contacting the consumer's current carrier. After
receiving consumer complaints about transferring brokerage accounts,
FINRA helped establish the Automated Customer Account Transfer Service;
implemented in 2006, this allows consumers to transfer accounts and
common assets such as cash or stocks from one broker-dealer to another,
usually within a week.\56\
Allowing retail and institutional consumers to own their bank
account number and developing a system that allows for seamless
switching would also enable consumers to have full rights and choice.
There is international precedent and best practice for government
enabling consumer switching. The United Kingdom implemented the Current
Account Switch Service (CASS) in 2013 to provide seamless and quick
switches in current accounts.\57\ The current barriers to switching
accounts include the following processes: 1) needing to gather several
pieces of information that one may not immediately have, such as the
login details for current accounts and a driver's license number 2) the
tediousness of needing to input information in poorly designed print or
online forms, 3) the multiplicity of needing to switch direct deposit,
linked cards, linked apps, and auto-pay, and 4) the lack of incentive
or deadline to finish the process.\58\
With 93 percent of households in the U.S. having a bank account and
7 in 10 supporting government action to solve climate change,\59\
democratizing the ability to switch to climate-friendly bank accounts
is a policy imperative. There is a growing movement of depository
institutions, such as those listed in the Bank for Good campaign,\60\
that are limiting their exposure to climate risk and supporting the
real economy in clean energy lending. Numerous examples of consumer
behavior leading to significant market shifts include hundreds of
millions moved to Black owned banks and Bank of America and other banks
announcing that they would no longer charge a monthly fee for debit
card holders after intense consumer pushback.\61\
In order to enhance consumer choice in banking, policymakers can
enact a number of changes, including: 1) reducing transactions costs
through account portability rules, 2) mandating transparency for
consumers around a bank's ESG practices, including the carbon footprint
of loans and investments, and 3) lowering costs associated with closing
and switching accounts. For the third change, the CFPB could set
standards for lenders and third-party platforms that facilitate
switching accounts, including eliminating the need to hold funds in two
accounts at the same time.\62\
Conclusion
All sectors of the economy will be impacted by climate change if
the financial system does not work for the low carbon transition. These
impacts will be especially acute in energy, transportation, and
agriculture across the United States.\63\ Climate change, if left
unabated, is expected to transform the regions of the U.S. in some of
the following ways:
West and Northwest: changed precipitation patterns
(including drought) and snow pack, increased risk of wildfires.
Great Plains and the Midwest: increased frequency and
severity of flooding and drought.
Northeast and Mid-Atlantic: increased storms and sea level
rise.
South and Southwest: decreased precipitation levels,
leading to less water resources for agriculture, industry and
households.
Southeast: warmer temperatures with more extreme heat
waves, increased sea level rise, increased hurricane intensity
and associated impacts to coastlines.
Hawaii: increased sea level rise, loss of coral reefs, and
increased drought.
Puerto Rico: increased sea level rise, loss of coral reefs,
increased frequency and intensity of hurricanes.
Alaska: declined sea ice, earlier breakup of river ice in
the Spring, and thawing of permafrost.
In order to avert economic disaster, the financial system must
incorporate climate risk and impact into the market rules. The
following changes will enable the system to finance less of the GHG
emitting activities and more of the GHG reducing activities, all while
supporting millions of new well-paid jobs that do not harm communities
and help build wealth: mandating annual carbon accounting for financial
institutions and reduction targets to reach net zero, providing patient
capital to community-focused lenders to scale climate-friendly loans,
adjusting capital requirements and risk weights for banks based on
carbon emissions, implementing a climate-friendly grading system for
SIFIs modeled after the CRA, and mandating the incorporation of ESG,
including climate impact, into investment management.
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF JOHN H. COCHRANE
Senior Fellow, Hoover Institution, Stanford University
March 18, 2021
Chairman Brown, Ranking Member Toomey, and Members of the
Committee: Thank you for the opportunity to testify today.
I am John Cochrane. I am an economist, specializing in finance and
monetary policy. My comments do not reflect the views of my employer or
any institution with which I am affiliated.
Climate change is an important challenge. But climate change poses
no measurable risk to the financial system. This emperor has no
clothes. ``Risk'' means unforeseen events. We know exactly where the
climate is going over the horizon that financial regulation can
contemplate. Weather is risky, but even the biggest floods, hurricanes,
and heat waves have essentially no impact on our financial system.
Moreover, the financial system is only at risk when banks as a
whole lose so much, and so suddenly, that they blow through their
reserves and capital, and a run on their short-term debt erupts. That
climate may cause a sudden, unexpected and enormous economic effect, in
the next decade, which could endanger the financial system, is an even
more fantastic fantasy.
Sure, we don't know what will happen in 100 years. But banks did
not fail in 2008 because they bet on radios not TV in the 1920s. Banks
failed over mortgage investments made in 2006. Trouble in 2100 will
come from investments made in 2095. Financial regulation does not and
cannot pretend to look past 5 years or so, and there is just no climate
risk to the financial system at this horizon.
Sure, a switch to renewables might lower oil company profits. Oil
stockholders may lose money. But ``risk'' to the ``financial system''
cannot mean that nobody ever loses any money! Tesla could not have been
built if people could not take ``risks.'' Yes, we are in a transition
to a decarbonized economy, but the transitions from horses to cars, and
from trains to planes, from typewriters to computers did not cause even
blips in the financial system. Companies and industries come and go all
the time.
So why is there a push for regulators to force financial firms to
``disclose'' absurdly fictitious ``climate risks,'' and change
investments to avoid them? These proposals aim simply to defund the
fossil fuel industry before alternatives are in place, and to steer
funds to fashionable but unprofitable investments and away from
unfashionable ones, by regulatory subterfuge rather than above-board
legislation or transparent environmental agency rulemaking. This goal
isn't a secret. For example, The Network of Central Banks and
Supervisors for Greening the Financial System (NGFS), which the Federal
Reserve recently joined, \1\ states plainly its goal is to ``mobilize
mainstream finance to support the transition toward a sustainable
economy.'' \2\
---------------------------------------------------------------------------
\1\ https://www.federalreserve.gov/newsevents/pressreleases/
bcreg20201215a.htm
\2\ https://www.ngfs.net/en
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But financial regulators are not allowed to ``mobilize'' the
financial system, to choose projects they like and de-fund those they
disfavor. Thus regulators must pretend that they are dispassionately
finding ``risks'' to the financial system, and oh, just happen to
stumble on climate.
The climate focus proves the dishonesty. There are plenty of
genuine risks to the financial system that our regulators largely
ignore. Imagine a new pandemic, one that kills 10 percent not less than
1 percent, and that lasts years with no vaccine. Suppose China invades
Taiwan, or a nuclear weapon goes off in the Middle East. Another
financial collapse can come. Imagine a global sovereign debt crisis.
Suppose that the US Treasury runs out of room to borrow, is downgraded
or defaults, and financial institutions no longer accept Treasury
collateral. Imagine a massive cyberattack--all the accounts at Citibank
are wiped out by North Korean hackers, and people rush for cash
everywhere. These would indeed be financial system catastrophes. Yet of
all of these large, obvious and quite plausible risks, our financial
regulators want to focus on just one, a fictitious climate ``risk.''
Why? Obviously, the end justifies the means.
Some advocates are a bit more honest: They recognize there is no
financial risk due to climate itself, but climate regulation could come
along and ``strand'' assets or hurt companies. The Godfather would be
proud: Nice business you've got there, it would be a shame if something
should happen to it. But think about it. This view posits that our
environmental regulators are so bone-headed, so ignorant of basic cost-
benefit analysis, that they might suddenly and dramatically not just
wipe out industries and millions of jobs, but do it in a way that
causes colossal bank failures like 2008. And if we go down this path,
here too, why just climate-related risk? There is lots of political and
regulatory risk. Regulate and disclose tech exposure, in case the FTC
breaks up big companies. Regulate steel exposure, always on the edge of
tariffs one way or another. Uber could be outlawed by labor legislation
tomorrow. An honest list of all the ways Congress or the agencies might
plausibly destroy industries would make good reading. But we're not
doing that, are we? The reason is obvious.
Climate is really important. Climate is too important to let
financial regulators play with it, inspired by what's fashionable at
Davos cocktail parties. Climate needs clear-headed, science-based,
steady, and transparently-enacted policy, with explicit cost-benefit
analysis. Underhandedly funding and defunding financial regulators'
momentary enthusiasms will repeat corn ethanol, switchgrass, an
absurdly expensive rail line from Merced to Bakersfield that comes
online just as all cars and trucks are electric, and other
counterproductive feel-good policies. The US leads the world in carbon
reduction today because of natural gas produced by fracking, which no
regulator ``mobilized.'' Climate answers may include nuclear power,
geoengineering, carbon capture and storage, hydrogen fuel cells,
genetically engineered foods, zoning reform, a carbon tax, and other
approaches, which financial regulators will never even envision let
alone implement.
Financial regulation is really important. Financial regulation is
too important to be eviscerated on the altar of de-funding fossil fuel
and subsidies to pet projects. Once regulators cook up fantasy
``climate risks,'' the books remain cooked, and financial regulation
loses whatever any ability to perceive and to offset genuine risks.
Once financial regulators demand funding of today's fashionable green
projects, the political allocation of credit will expand.
Financial regulation and the financial system are in peril, and not
because of climate. Contemplate the abject failure sitting in front of
us. Despite 12 years of Dodd-Frank regulation, stress tests, and armies
of embedded regulators, despite centuries of experience, ARS, H1N1,
Ebola, Aids, 1918, and many federal pandemic plans, financial
regulators failed to consider that a pandemic might come along. We made
it through the last year by one more massive bail-out, not by
regulatory prescience. The financial system remains far too leveraged
and far too reliant on an even larger bailout that may not come in the
next crisis. And now they want to soothsay climate?
We need to get financial regulation back to its job: making sure
that run-prone financial institutions have adequate capital to
withstand all sorts of shocks, which none of us, not least the
regulators, can pretend to foresee. It's boring. You don't get invited
to Davos to talk about it. Industry hates being told to get more
capital. But that's its job and there is plenty to do.
Don't let the EPA regulate banks, and don't let our financial
regulators dream up climate policy. You will get bad climate policy,
and an even more fragile and sclerotic financial system if you do.
PREPARED STATEMENT OF BENJAMIN ZYCHER
Resident Scholar, American Enterprise Institute
March 18, 2021
Thank you, Chairman Brown and Ranking Member Toomey, for this
opportunity to offer my views on the topic of the financial system and
anthropogenic climate change, one now receiving substantial attention
from policymakers and many interested observers. The Statement below
makes a number of observations that I hope will prove of interest to
this Committee. I begin with a summary of my arguments, and then
proceed to discuss them in more detail in the ensuing sections:
1. Climate Uncertainties and Choices Among Crucial Assumptions.
2. The Evidence on Climate Phenomena and the Effects of Climate
Policies in the EPA Climate Model.
3. Observations on the Materiality of Climate ``Risks.''
4. Additional Observations and Conclusions.
Summary
Neither the Federal Reserve or any other bank regulator,
nor banks or other financial institutions, are in a position to
evaluate climate phenomena, whether ongoing or prospective,
with respect to which the scientific uncertainties are vastly
greater than commonly asserted.
The range of alternative assumptions about central
parameters is too great to yield clear implications for the
climate ``risks'' attendant upon the allocation of financial
capital among economic sectors.
Those central parameters include the choices among climate
models, the assumed sensitivity of the climate system to
increases in the atmospheric concentration of greenhouse gases
(GHG), the assumed future increase in that GHG concentration
through, say, 2100, and the analytic assumptions underlying
calculations of the effects of aerosol emissions on cloud
formation, about which surprisingly little is known. That short
list is far from exhaustive.
If the Federal Reserve and the financial institutions opt
to use the same (or similar) sets of assumptions about central
parameters, a very real danger would arise of more-or-less
homogeneous predictions inconsistent with historical, ongoing,
and prospective climate phenomena. If the Federal Reserve and
the financial institutions opt to use sets of assumptions that
differ in important dimensions, the ensuing predictions about
future climate phenomena (risks) would vary substantially,
yielding very large uncertainties in terms of policy
implications.
It is reasonable to hypothesize that financial institutions
will have powerful incentives to undertake climate analysis
driven not by the actual evidence and the peer-reviewed
literature on climate phenomena. Instead, they will be driven
to undertake such analysis, whether in response to regulatory
directives or to political pressures, under assumptions and
methodologies insulating them from adverse regulatory actions
and litigation threats.
It is reasonable to hypothesize also that the aggregate
benefits (that is, positive ``risks'') of increasing GHG
concentrations, as reported by the National Oceanic and
Atmospheric Administration and in the peer-reviewed literature,
will be excluded from such analytic efforts.
It is reasonable to hypothesize further that such analyses
will exclude the risks of climate policies, prominent among
which are the large and adverse implications of artificial
increases in energy costs. Such policy risks are likely to be
greater when implemented by bureaucracies insulated from
democratic accountability.
Anthropogenic climate change is ``real'' in that increasing
atmospheric concentrations of GHG have yielded effects that are
detectable. But they are much smaller than commonly asserted;
and there is no evidence in support of the ubiquitous
assertions of a climate ``crisis,'' whether ongoing or looming,
and no evidence in support of the even more extreme
``existential threat'' argument. Moreover, the available
analysis suggests that the financial risks of anthropogenic
climate change in the aggregate are much smaller than many
assert.
The mainstream climate models have a poor track record in
terms of predicting the actual temperature trend of recent
decades, having consistently overstated that trend by a factor
of over two.
Application of the Environmental Protection Agency climate
model suggests strongly that climate policies, whether
implemented by the U.S. Government alone or as an international
cooperative policy, would have temperature effects by 2100 that
would be virtually undetectable or very small. Such policies
cannot satisfy any plausible benefit/cost test.
Because the perceived ``climate risks'' confronting the
financial sector are dependent upon crucial choices among
alternative assumptions, the evaluation of such ``risks'' would
be largely arbitrary given that the ``correct'' assumptions are
very far from obvious. This means that a requirement, whether
formal or informal, that climate ``risks'' be incorporated into
the business decisions of financial institutions would weaken
the materiality standard for disclosures by those institutions.
``Materiality'' always has meant the disclosure of information
directly relevant to the financial performance of the bank or
other institution. When ``risk'' analysis becomes an arbitrary
function of choices among assumptions complex, opaque, and far
from obvious, the traditional materiality standard inexorably
will be diluted and rendered far less useful for the investment
and financial markets, an outcome diametrically at odds with
the ostensible objectives of those advocating the evaluation of
climate ``risks.'' Moreover, the ``risks'' of anthropogenic
climate change are far from the only such mass-geography
``risks.'' A bias toward focusing only on climate ``risks''
would distort the allocation of capital.
Because the uncertainties attendant upon the future effects
of increasing atmospheric concentrations of GHG are so great, a
top-down policy approach for the evaluation of any attendant
``risks'' is itself very risky. A wiser approach would entail
allowing market forces to make such ``risk'' determinations in
a bottom-up fashion, thus avoiding an obvious politicization of
the allocation of capital.
Proposals that the Federal Reserve enforce a mandate that
financial institutions evaluate climate ``risks'' represent a
blatant effort to distort the allocation of capital away from
economic sectors disfavored by certain political interest
groups pursuing ideological agendas. This would represent the
return of Operation Choke Point, a past attempt to politicize
access to credit, one deeply corrosive of our legal and
constitutional institutions.
Protection of those institutions is consistent only with
formal policymaking by the Congress through enactment of
legislation, rather than with powerful pressures, whether
formal or informal, exerted by the Federal Reserve or other
regulatory agencies. This institutional protection would
preserve the traditional roles of the private sector and of the
government, respectively, as part of the larger permanent
objectives of maximizing the productivity of resource use under
free market competition, and preserving the political
accountability of the policymaking process under the
institutions of democratic decisionmaking as constrained by the
constitution.
Climate Uncertainties and Choices Among Crucial Assumptions
Notwithstanding ubiquitous assertions that climate science is
``settled,'' that a crisis is upon us or looming large, and that
government policies must address the ``existential threat'' posed by
anthropogenic climate change, in reality the uncertainties attendant
upon the prospective effects of increasing atmospheric concentrations
of greenhouse gases (GHG) are very substantial. Moreover, no evidence
supports the ``crisis'' narrative, as discussed below. These realities
are illustrated by the ranges of various estimates published by the
Intergovernmental Panel on Climate Change (IPCC) in its most recent
Assessment Report, by the wide range of temperature paths projected by
the mainstream climate models, and by the scientific literature more
generally. \1\
---------------------------------------------------------------------------
\1\ See, e.g., Figure 2.5 in the IPCC Fifth Assessment Report
(2013), on alternative paths for future temperature changes, at https:/
/www.ipcc.ch/report/ar5/syr/synthesis-report/. On the wide range of
temperature projections yielded by the mainstream climate models, see
Figure 2 in the testimony of John R. Christy before the U.S. House
Committee on Science, Space, and Technology, March 29, 2017, at https:/
/science.house.gov/imo/media/doc/Christy%20Testimony-1.pdf?1. On the
general state of scientific uncertainty in the context of climate
phenomena, see e.g., Judith Curry, ``Uncertainty About the Climate
Uncertainty Monster,'' Climate Etc., May 19, 2017, at https://
judithcurry.com/2017/05/19/uncertainty-about-the-climate-uncertainty-
monster/.
---------------------------------------------------------------------------
The evaluation of climate ``risks'' to the financial system would
require choices among the available climate models, choices among
alternative assumptions about the path of future atmospheric
concentrations of GHG, choices among assumptions about the effect of
increasing GHG concentrations upon the climate system, that is, the
``sensitivity'' of the climate system, and deeply problematic
assumptions about the effects of aerosol emissions on cloud formation,
about which little is known. \2\
---------------------------------------------------------------------------
\2\ See, e.g., Judith Curry, ``The Cloud-Climate Conundrum'',
Climate Etc., June 2, 2016, at https://judithcurry.com/2016/06/02/the-
cloud-climate-conundrum/.
---------------------------------------------------------------------------
Let us note that the mainstream climate models have found it very
difficult to predict the historical and current climate record; as an
example, the models have been unable to explain the warming observed
from 1910-1945. \3\ That period of warming cannot have been the result
of increased atmospheric concentrations of GHG, in that such
concentrations had increased only from about 278 ppm in 1750 to about
295 ppm by 1910. \4\ Another example: Every climate model predicts that
increasing atmospheric concentrations of GHG should result in an
enhanced heating effect in the mid- and upper troposphere over the
tropics. The satellites have been unable to find that effect. \5\ In
the latest iteration of the suite of climate models, to be applied in
the next IPCC Assessment report, the average predicted tropospheric
temperature increase for 1979-2019 is 0.40 degrees C per decade. The
actual record as measured by the satellites: 0.17 degrees C per decade.
\6\ The climate models on average have overstated the temperature
record by a factor of more than two.
---------------------------------------------------------------------------
\3\ See the HadCRUT5 reconstructions of temperature anomalies at
https://crudata.uea.ac.uk/cru/data/temperature/. Interestingly enough,
the Russian climate models from the Institute for Numerical Mathematics
(models INM-CM4 and INM-CM4.8) do the best job of predicting the past
and the present. See http://www.glisaclimate.org/node/2220 and https://
www.researchgate.net/publication/329748540-Simulation-of-the-modern-
climate-using-the-INM-CM48-climate-model.
\4\ See the NOAA reconstruction of carbon dioxide emissions and
concentrations for 1750-2019 at https://www.climate.gov/sites/default/
files/CO2-emissions-vs-concentrations-1751-2019-lrg.gif.
\5\ The tropics for the most part are water, and emissions of
additional GHG would warm the earth slightly, resulting in an increase
in ocean evaporation. In the climate models, as the water vapor rises
into the mid troposphere, it condenses, releasing heat. This seems
straightforward, but efforts to demonstrate this phenomenon with
satellite measurements have proven very difficult. See Ross McKitrick
and John R. Christy, ``Pervasive Warming Bias in CMIP6 Tropospheric
Layers,'' Earth and Space Science, Vol. 7, Issue 9 (September 2020), at
https://agupubs.onlinelibrary.wiley.com/doi/10.1029/2020EA001281; and
Ross McKitrick, ``New Confirmation That Climate Models Overstate
Atmospheric Warming'', Climate Etc., August 25, 2020, at https://
judithcurry.com/2020/08/25/new-confirmation-that-climate-models-
overstate-atmospheric-warming/.
\6\ See the Coupled Model Intercomparison Project, Phase 6, at
https://pcmdi.llnl.gov/CMIP6/. See also, e.g., the recent presentation
by Professor John R. Christy at https://www.youtube.com/
watch?v=D2Cd4MLUoN0.
---------------------------------------------------------------------------
Consider only the effect of varying assumptions about the future
path of atmospheric GHG concentrations. IPCC in the latest (2013)
Assessment Report uses four such alternative paths: Representative
Concentrations Pathways 2.6, 4.5, 6, and 8.5. \7\ The following table
illustrates the range of temperature effects (anomalies) by 2100 under
the four RCPs.
---------------------------------------------------------------------------
\7\ The figures (2.6, etc.) are not temperature effects; they are
theoretical calculations of ``radiative forcings'' in watts per square
meter. For an introduction, see G.P. Wayne, ``The Beginner's Guide to
Representative Concentration Pathways'', Skeptical Science, August
2013, at https://skepticalscience.com/docs/RCP-Guide.pdf.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Neither the Federal Reserve or any other bank regulator, nor banks
or other financial institutions, are in a position to evaluate the
strengths and weaknesses of alternative RCP assumptions, or of the
other crucial parameters underlying climate projections in the context
of GHG emissions. \8\ The IPCC in the 2013 Assessment Report provides a
range of estimates for the equilibrium sensitivity of the climate
system, from 1.5 degrees to 4.5 degrees, with a mean of 3 degrees. \9\
Many of the more extreme or ``alarmist'' assertions of the effects of
anthropogenic climate change assume RCP8.5 and a climate sensitivity of
4.5 degrees (or even higher). The numerous estimates reported in the
peer-reviewed literature do not support that assumption, instead
supporting an assumption of 2 degrees or even less; the range estimated
from the actual data is 1.5 to 2.3 degrees C. \10\
---------------------------------------------------------------------------
\8\ Note that RCP8.5 is a popular assumption among those
advocating strong climate policies, but it is a scenario essentially
impossible. Under RCP8.5, atmospheric concentrations of GHG rise at
almost 12 parts per million (ppm) through 2100 as an annual average;
the average for 1985-2019 was about 1.9 ppm, and the single largest
increase was about 3 ppm in 2016. See the data reported by NOAA at
https://www.esrl.noaa.gov/gmd/ccgg/trends/global.html. See Kevin
Murphy, ``Reassessing the RCPs,'' Climate Etc., January 28, 2019, at
https://judithcurry.com/2019/01/28/reassessing-the-rcps/; and Judith
Curry, ``Is RCP8.5 An Impossible Scenario?'', Climate Etc., November
24, 2018, at https://judithcurry.com/2018/11/24/is-rcp8-5-an-
impossible-scenario/.
\9\ The equilibrium sensitivity of the climate system is the
temperature increase that would result from a doubling of atmospheric
concentrations of GHG, after the climate system were to ``finalize''
all attendant adjustments.
\10\ See Patrick J. Michaels and Paul C. Knappenberger,
Lukewarming: The New Climate Science That Changes Everything,
Washington, DC: Cato Institute, 2016; and the recent presentation by
Professor John R. Christy at https://www.youtube.com/
watch?v=D2Cd4MLUoN0.
---------------------------------------------------------------------------
Again: Neither the Federal Reserve or any other bank regulator, nor
banks or other financial institutions, are in a position to sort
through such enormous complexities; government agencies and
international bodies wholly dedicated to doing so find the task
daunting. Instead, the Federal Reserve and financial institutions will
be driven to adopt assumptions (or to retain consultants who will do
so) minimizing the degree to which their analyses might subject them to
political attacks, adverse regulatory actions, and litigation. This is
very different from an objective effort to evaluate climate phenomena
and a reasonable range of prospective effects of increasing GHG
concentrations, that is, climate ``risks.''
Instead, for example, they will have powerful incentives to use the
Environmental Protection Agency climate model, used by most federal
agencies to evaluate climate trends and the effects of climate
policies; since that is the U.S. Government model, it would be
difficult to attack a financial institution for choosing it. \11\ For
the earlier suite of climate models (CMIP-5), the EPA model provided
predictions close to the average of those models under a given set of
underlying assumptions, equilibrium climate sensitivity in particular.
For the new suite (CMIP-6), the EPA model provides predictions cooler
than the average of those models, not because the EPA model now is
providing predictions more consistent with the historical evidence, but
because the CMIP-6 models have incorporated a range of climate
sensitivity assumptions and estimates higher on average than those in
the CMIP-5 iteration. That range of climate sensitivity values in CMIP-
6 also is wider than that in CMIP-5, meaning that the uncertainty of
the climate models is increasing. \12\
---------------------------------------------------------------------------
\11\ This is the Model for the Assessment of Greenhouse Gas
Induced Climate Change (MAGICC), at www.magic.org.
\12\ Private communication with Professor John R. Christy, March
14, 2021. See CMIP-5 at https://pcmdi.llnl.gov/mips/cmip5/; and CMIP-6
at https://pcmdi.llnl.gov/CMIP6/.
---------------------------------------------------------------------------
Again, the Federal Reserve and the financial institutions will have
powerful incentives to choose among assumptions on future emissions and
atmospheric concentrations, climate sensitivity, and other crucial
parameters so as to insulate themselves from political attack, adverse
regulatory actions, and litigation. They thus will be led toward
analytic homogeneity, yielding a very real danger of an artificial
``consensus'' among financial institutions regardless of the actual
evidence, and perhaps largely inconsistent with it. Any such consensus
would be an artifact of the political pressures to which the financial
institutions would be subjected; it would have nothing to do with
``science.''
If, implausibly, the Federal Reserve and the financial institutions
were to opt to use models and/or sets of assumptions that differ in
important dimensions, the ensuing predictions about future climate
phenomena (risks) would vary substantially or hugely, yielding very
large uncertainties in terms of policy implications. What would the
Federal Reserve do under that condition, how would financial
institutions respond, and--again--what would such decisions have to do
with ``science''?
Those political pressures will weigh against consideration of the
benefits of increasing atmospheric concentrations of GHG, as reported
by the National Oceanic and Atmospheric Administration (NOAA), and in
the peer-reviewed literature. Examples are planetary greening,
increased agricultural productivity, increased water use efficiency by
plants, and reduced mortality from cold. \13\ Nor will such analysis
include the possible adverse impacts of government climate policies,
which as a core imperative must have the effect of increasing energy
costs artificially, notwithstanding common assertions that alternative
energy sources are competitive in terms of costs. \14\ More narrowly,
government policies that lead financial institutions to incorporate
climate ``risks'' into their decisions on lending and other parameters
are likely to yield important distortions in capital markets, one of
which is a weighting of climate ``risks'' above those posed by other
important natural phenomena.
---------------------------------------------------------------------------
\13\ On the carbon dioxide ``greening'' effect see NOAA at https:/
/www.nasa.gov/feature/goddard/2016/carbon-dioxide-fertilization-
greening-earth. On the agricultural productivity effects, see, e.g.,
Goudriaan and Unsworth at https://acsess.onlinelibrary.wiley.com/doi/
abs/10.2134/asaspecpub53.c8. On water use efficiency by plants, see,
e.g., http://www.co2science.org/subject/w/summaries/wateruse.php. On
the beneficial impacts of moderate warming on mortality, see https://
www.thelancet.com/journals/lancet/article/PIIS0140-6736(14)62114-0/
fulltext.
\14\ See Benjamin Zycher, The Green New Deal: Economics and Policy
Analytics, American Enterprise Institute, 2019, at http://www.aei.org/
wp-content/uploads/2019/04/RPT-The-Green-New-Deal-5.5x8.5-
FINAL.pdf?x91208.
---------------------------------------------------------------------------
The Evidence on Climate Phenomena and the Effects of Climate Policies
in the EPA Climate Model
The available body of evidence does not support the ubiquitous
assertions that a climate ``crisis'' is upon us or looming large. This
means in the context of this hearing that the asserted climate
``risks'' threatening the U.S. financial system are far less obvious
than often assumed.
That anthropogenic climate change is ``real''--that increasing GHG
concentrations are having detectable effects--is incontrovertible, but
that does not tell us the magnitude of the observable impacts, which
must be measured empirically. Temperatures are rising, but as the
Little Ice Age ended no later than 1850, it is not easy to separate
natural from anthropogenic effects on temperatures and other climate
phenomena. \15\ The latest research in the peer-reviewed literature
suggests that mankind is responsible for about half a degree of the
global temperature increase of about 1.5-1.7 degrees C of global
warming observed since 1850. \16\
---------------------------------------------------------------------------
\15\ On the surface (land/ocean) temperature record, see UK Met
Office, Hadley Centre/University of East Anglia Climatic Research Unit,
``Tim Osborn: HadCRUT4 Global Temperature Graphs,'' https://
crudata.uea.ac.uk/timo/diag/tempdiag.htm. On the Little Ice Age, see
Michael E. Mann, ``Little Ice Age,'' in Encyclopedia of Global
Environmental Change, Volume 1: The Earth System: Physical and Chemical
Dimensions of Global Environmental Change, ed. Michael C. MacCracken,
John S. Perry and Ted Munn (Chichester, England: John Wiley & Sons,
2002), http://www.meteo.psu.edu/holocene/public-html/shared/articles/
littleiceage.pdf.
\16\ See, for example, Ross McKitrick and John Christy, ``A Test
of the Tropical 200- to 300 hPa Warming Rate in Climate Models'';
Nicholas Lewis and Judith Curry, ``The Impact of Recent Forcing and
Ocean Heat Uptake Data on Estimates of Climate Sensitivity,'' Journal
of Climate 31 (August 2018): 6051-71, https://journals.ametsoc.org/doi/
pdf/10.1175/JCLI-D-17-0667.1; and John R. Christy and Richard McNider,
``Satellite Bulk Tropospheric Temperatures as a Metric for Climate
Sensitivity,'' Asia-Pacific Journal of Atmospheric Sciences 53 (2017):
511-18, https://link.springer.com/article/10.1007/s13143-017-0070-z.
For a chart summarizing the recent empirical estimates of equilibrium
climate sensitivity as reported in the peer-reviewed literature, see
Patrick J. Michaels and Paul C. Knappenberger, ``The Collection of
Evidence for a Low Climate Sensitivity Continues to Grow,'' Cato
Institute, September 25, 2014, https://www.cato.org/blog/collection-
evidence-low-climate-sensitivity-continues-grow.
---------------------------------------------------------------------------
The ``crisis'' assertions are unsupported by the evidence reported
in the peer-reviewed, official, or scientific literature. There is
little trend in the number of ``hot'' days for 1895-2017; 11 of the 12
years with the highest number of such days occurred before 1960. \17\
NOAA has maintained since 2005 the U.S. Climate Reference Network,
comprising 114 meticulously maintained temperature stations spaced more
or less uniformly across the lower 48 States, 21 stations in Alaska,
and two stations in Hawaii. \18\ They are placed to avoid heat island
effects and other such distortions as much as possible; the reported
data show no trend over the available 2005-20 reporting period. \19\ A
reconstruction of global temperatures over the past one million years,
using data from ice sheet formations, shows that there is nothing
unusual about the current warm period. \20\
---------------------------------------------------------------------------
\17\ For the reconstruction of the NASA data, see John R. Christy,
``Average per Station (1114 USHCN Stations) 1895-2017: Number of Days
Daily Maximum Temperature Above 100 F and 105 F,'' drroyspencer.com,
http://www.drroyspencer.com/wp-content/uploads/US-extreme-high-
temperatures-1895-2017.jpg.
\18\ For the Climate Reference Network program description, see
National Centers for Environmental Information, ``U.S. Climate
Reference Network,'' https://www.ncdc.noaa.gov/crn/.
\19\ For a visualization of a prototypical station, see Willis
Eschenbach, ``NOAA's USCRN Revisited-No Significant Warming in the USA
in 12 Years,'' Watts Up with That?, November 8, 2017, https://
wattsupwiththat.com/2017/11/08/the-uscrn-revisited/. For the monthly
data and charts reported by the National Oceanic and Atmospheric
Administration (NOAA), see National Oceanic and Atmospheric
Administration, ``National Temperature Index,'' https://
www.ncdc.noaa.gov/temp-and-precip/national-temperature-index/time-
series?datasets%5B%5D=uscrn¶meter=anom-tavg&time-
scale=p12&begyear=2005&endyear=2020&month=8.
\20\ See R. Bintanja and R.S.W. van de Wal, ``North American Ice-
Sheet Dynamics and the Onset of 100,000-Year Glacial Cycles,'' Nature
454, no. 7206 (August 14, 2008): 869-72, https://www.researchgate.net/
publication/23171740--Bintanja-R-van-de-Wal-R-S-W-North-American-ice-
sheet-dynamics-and-the-onset-of-100000-year-glacial-cycles-Nature-454-
869-872. NOAA published the underlying data at R. Bintanja and R. S. W.
van de Wal, ``Global 3Ma Temperature, Sea Level, and Ice Volume
Reconstructions,'' National Oceanic and Atmospheric Administration,
August 14, 2008, https://www.ncdc.noaa.gov/paleo-search/study/11933.
For a chart showing the temperature record over one million years, see
Institute for Energy Research, ``Temperature Fluctuations over the Past
Million Years,'' https://www.instituteforenergyresearch.org/wp-content/
uploads/2020/03/temperature-flucturations.png.
---------------------------------------------------------------------------
Global mean sea level has been increasing at about 3.3 mm per year
since satellite measurements began in 1992. The tidal-gauge data before
then show annual increases of about 1.9 mm per year, but that
comparison does not show an acceleration because the two datasets are
not comparable. The tidal gauges do not measure sea levels per se; they
measure the difference between sea levels and ``fixed'' points on land
that in reality might not be fixed due to seismic activity, tectonic
shifts, land settlement, etc. Accordingly, the data are unclear as to
whether there is occurring an acceleration in sea level rise; it is
reasonable to hypothesize that there has been such an acceleration
simply because temperatures are rising, as noted above, and such
increases should result in more melting ice and the thermal expansion
of water. But because rising temperatures are the result of both
natural and anthropogenic causes, we do not know the relative
contributions of those causes to any such acceleration. \21\
---------------------------------------------------------------------------
\21\ As a crude approximation, the data suggest that about two-
thirds of such sea level increases are due to ice melt, and one-third
to thermal expansion of water. See Judith Curry, ``Sea Level and
Climate Change,'' Climate Forecast Applications Network, November 25,
2018, https://curryja.files.wordpress.com/2018/11/special-report-sea-
level-rise3.pdf. Curry cites research from Xianyao Chen and colleagues,
the central finding of which is that ``global mean sea level rise
increased from 2.2 plus/minus 0.3 mm/year in 1993 to 3.3 plus/minus 0.3
mm/year in 2014.'' See Xianyao Chen et al., ``The Increasing Rate of
Global Mean Sea-Level Rise During 1993-2014,'' Nature Climate Change 7
(June 26, 2017): 492-95, https://www.nature.com/articles/nclimate3325.
Whether the trend from a 21-year period can yield important inferences
is a topic not to be addressed here. For a different empirical
conclusion from the tidal gauge record, see J.R. Houston and R. G.
Green, ``Sea-Level Acceleration Based on U.S. Tide Gauges and
Extensions of Previous Global-Gauge Analyses,'' Journal of Coastal
Research 27, no. 3 (May 2011): 409-17, https://meridian.allenpress.com/
jcr/article-abstract/27/3/409/28456/Sea-Level-Acceleration-Based-on-U-
S-Tide-Gauges?redirectedFrom=fulltext. For an example of temporary
rapid sea-level rise in the 18th century, see W.R. Gehrels et al., ``A
Preindustrial Sea-Level Rise Hotspot Along the Atlantic Coast of North
America,'' Geophysical Research Letters 47 (2020), https://
agupubs.onlinelibrary.wiley.com/doi/epdf/10.1029/2019GL085814. For
further reported evidence of an acceleration, see Hans-Otto Portner et
al., Special Report on the Ocean and Cryosphere in a Changing Climate,
Intergovernmental Panel on Climate Change, 2019, https://www.ipcc.ch/
srocc/.
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The Northern and Southern Hemisphere sea ice changes tell different
stories; the arctic sea ice has been declining, while the Antarctic sea
ice has been stable or growing. \22\ U.S. tornado activity shows either
no trend or a downward trend since 1954. \23\ Tropical storms,
hurricanes, and accumulated cyclone energy show little trend since
satellite measurements began in the early 1970s. \24\ The number of
U.S. wildfires shows no trend since 1985, and global acreage burned has
declined over past decades. \25\ The Palmer Drought Severity index
shows no trend since 1895. \26\ U.S. flooding over the past century is
uncorrelated with increasing GHG concentrations. \27\ The available
data do not support the ubiquitous assertions about the dire impacts of
declining pH levels in the oceans. \28\ Global food availability and
production have increased more or less monotonically over the past two
decades on a per capita basis. \29\ The IPCC itself in the Fifth
Assessment Report was deeply dubious about the various severe effects
often asserted to be looming as impacts of anthropogenic warming. \30\
---------------------------------------------------------------------------
\22\ See Patrick J. Michaels, ``Spinning Global Sea Ice,'' Cato
Institute, February 12, 2015, https://www.cato.org/blog/spinning-
global-sea-ice. It appears to be the case that the Antarctic eastern
ice sheet--about two-thirds of the continent--is growing, while the
western ice sheet (and the peninsula) may be shrinking. No agreed
explanation for this phenomenon is reported in the literature.
\23\ For the historical data reported by the NOAA, see National
Ocean and Atmospheric Administration, ``Historical Records and
Trends,'' https://www.ncdc.noaa.gov/climate-information/extreme-events/
us-tornado-climatology/trends.
\24\ For data on global tropical cyclone activity, see Ryan N.
Maue, ``Global Tropical Cyclone Activity'', updated March 16, 2021, at
http://climatlas.com/tropical/.
\25\ For the reported U.S. wildfire data, see National Interagency
Fire Center, ``Total Wildland Fires and Acres (1926-2019),'' https://
www.nifc.gov/fireInfo/fireInfo-stats-totalFires.html. On the decline in
global area burned over past decades, see Stefan H. Doerr and Cristina
Santin, ``Global Trends in Wildfire and Its Impacts: Perceptions Versus
Realities in a Changing World,'' Philosophical Transactions of the
Royal Society of London, Series B, Biological Sciences 371, no. 1696
(2016), https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4874420/pdf/
rstb20150345.pdf.
\26\ See US Environmental Protection Agency, ``Climate Change
Indicators: Drought,'' https://www.epa.gov/climate-indicators/climate-
change-indicators-drought; and US Department of Commerce, National
Climatic Data Center, ``Divisional Data Select,'' https://
www7.ncdc.noaa.gov/CDO/CDODivisionalSelect.jsp.
\27\ See R.M. Hirsch and K.R. Ryberg, ``Has the Magnitude of
Floods Across the USA Changed with Global CO2 Levels?,'' Hydrological
Sciences Journal 57, no. 1 (2012): 1-9, https://www.tandfonline.com/
doi/full/10.1080/02626667.2011.621895?scroll=top&needAccess=true&.
\28\ See CO2 Science, ``Ocean Acidification Database,'' http://
www.co2science.org/data/acidification/results.php. See also Alan
Longhurst, Doubt and Certainty in Climate Science, pp. 214-25, https://
curryja.files.wordpress.com/2015/09/longhurst-print.pdf.
\29\ See Food and Agriculture Organization of the United Nations,
World Food and Agriculture Statistical Pocketbook 2018, 2018, Charts 28
and 46, http://www.fao.org/3/CA1796EN/ca1796en.pdf. See also Kevin D.
Dayaratna, Ross McKitrick, and Patrick J. Michaels, ``Climate
Sensitivity, Agricultural Productivity and the Social Cost of Carbon in
FUND,'' Environmental Economics and Policy Studies 22 (2020): 433-48.
\30\ Julie M. Arblaster et al., ``Long-Term Climate Change:
Projections, Commitments and Irreversibility-Final Draft Underlying
Scientific-Technical Assessment,'' in Working Group I Contribution to
the IPCC Fifth Assessment Report (AR5), Climate Change 2013: The
Physical Science Basis, September 23-26, 2013, p. 12-78, http://
www.climatechange2013.org/images/uploads/WGIAR5-WGI-12Doc2b-FinalDraft-
Chapter12.pdf.
---------------------------------------------------------------------------
If we apply the Environmental Protection Agency climate model,
under sensitivity assumptions higher than those reported in the recent
peer-reviewed literature, net-zero U.S. GHG emissions effective
immediately would yield a reduction in global temperatures of 0.104
degrees C by 2100. That effect would be barely detectable given the
standard deviation (about 0.11 degrees C) of the surface temperature
record. \31\ The entire Paris agreement: about 0.17 degrees C. Net-zero
emissions by the entire Organization for Economic Cooperation and
Development: 0.21 degrees C. A 35 percent reduction in global GHG
emissions implemented immediately and maintained strictly would reduce
global temperatures in 2100 by about half a degree. \32\ Note that GHG
emissions in 2020 fell by about 6.4 percent as a result of the COVID-19
economic downturn. \33\ Can anyone believe that even larger GHG
reductions are plausible politically? Is there a believable benefit/
cost model that would justify such policies?
---------------------------------------------------------------------------
\31\ See https://agupubs.onlinelibrary.wiley.com/doi/pdf/10.1029/
1999JD900835.
\32\ Author computations using MAGICC 5.3. The MAGICC model can be
found at http://www.magicc.org/.
\33\ See https://www.nature.com/articles/d41586-021-00090-3.
---------------------------------------------------------------------------
Observations on the Materiality of Climate ``Risks''
It is clear that those in support of the proposition that banks and
other financial institutions evaluate the ``risks'' of anthropogenic
climate change to the financial system view such analyses as
``material'' in terms of disclosures to investors. \34\ Several
problems are attendant upon that premise, in substantial part for the
reasons discussed above. Any such projections of climate phenomena and
resulting ``risks'' to the financial system--far into the future--are
very far from trivial methodologically. Which climate model(s) should
financial institutions use? Which assumptions about future emissions,
about the sensitivity of the climate system, about policies to be
adopted internationally, about the climate effects of those policies,
ad infinitum, should financial institutions incorporate into those
models? Are those financial institutions--even very large ones--in a
position to do such analysis in a credible fashion? If not, whom should
they retain to do that analysis for them, and how should they evaluate
the differences among the available alternative providers of such
analyses?
---------------------------------------------------------------------------
\34\ See the Federal Reserve Financial Accounting Manual for
Federal Reserve Banks at https://www.federalreserve.gov/aboutthefed/
files/BSTfinaccountingmanual.pdf. The Securities and Exchange
Commission final rule for materiality disclosure requirements for banks
is at https://www.federalregister.gov/documents/2020/10/16/2020-20655/
update-of-statistical-disclosures-for-bank-and-savings-and-loan-
registrants.
---------------------------------------------------------------------------
The reality is that a ``climate risk'' disclosure requirement would
be deeply speculative, and the level of detail and the scientific
sophistication that would be needed to satisfy such a requirement is
staggering. Such ``disclosures'' and supporting analysis and
documentation would take up thousands of pages, with references to
thousands more, and the premise that this ``disclosure'' requirement
would facilitate improved decision making by investors in the financial
sector is difficult to take seriously.
If climate ``risks'' are deemed material in terms of disclosure
requirements, why not others that are uncertain or speculative? Climate
``risks'' are hardly the only ones potentially relevant to the
financial system but difficult to incorporate into business decisions.
What about massive volcanic eruptions? Asteroid impacts? Powerful
earthquakes? Tsunamis? The potential problem of mass contagion is one
with which we are far more familiar now than was the case only a bit
more than a year ago. The use of bioweaponry by terrorists, nuclear
war, gamma ray storms, and on and on. Is climate ``risk'' the most
important? If that is the hypothesis, what is the basis for it? Why are
those others, and many more, not worthy of incorporation into financial
decisions? What distortions would result from attention only to climate
change and not others?
Because the perceived ``climate ``risks'' confronting the financial
sector are dependent upon crucial choices among alternative
assumptions, the evaluation of such ``risks'' would be largely
arbitrary given that the ``correct'' assumptions are very far from
obvious. This means that a requirement, whether formal or informal,
that climate ``risks'' be incorporated into the business decisions of
financial institutions would weaken the materiality standard for
disclosures by those institutions. ``Materiality'' always has meant the
disclosure of information directly relevant to the financial
performance of the bank or other institution. When ``risk'' analysis
becomes an arbitrary function of choices among assumptions complex,
opaque, and far from obvious, the traditional materiality standard
inexorably will be diluted and rendered far less useful for the
investment and financial markets, an outcome diametrically at odds with
the ostensible objectives of those advocating the evaluation of climate
``risks.''
Additional Observations and Conclusions
The available analysis suggests that the financial risks of
anthropogenic climate change, at least in the aggregate, are much
smaller than many assert. Consider the predictions from the central
integrated assessment models, one of which is the Dynamic Integrated
Climate and Economy Model, for which William D. Nordhaus won the Nobel
Prize in Economics in 2018. \35\ Under DICE, global gross domestic
product (GDP) in 2100 varies by about 3 percent across policy
scenarios, including no climate policies at all, a figure that is both
very small and almost certainly not statistically significant given the
vagaries of economic forecasting and the number of years remaining
before the end of this century. (I exclude here Nordhaus' ``Stern
discounting'' policy scenario, as it assumes a discount rate
effectively equal to zero, a fundamental analytic error. \36\) Per
capita consumption varies only by about 1.3 percent across policy
scenarios, also a very small number and almost certain not to be
statistically significant.
---------------------------------------------------------------------------
\35\ See William Nordhaus and Paul Sztorc, ``DICE 2013R:
Introduction and User's Manual,'' Yale University, Department of
Economics, October 2013, Figure 4 and Table 1, http://
www.econ.yale.edu/nordhaus/homepage/homepage/documents/DICE-Manual-
100413r1.pdf. See also Benjamin Zycher, ``The Climate Left Attacks
Nobel Laureate Willian D. Nordhaus,'' monograph, American Enterprise
Institute, July 2020, at https://www.aei.org/wp-content/uploads/2020/
07/The-Climate-Left-Attacks-Nobel-Laureate-William-D.-Nordhaus.pdf.
\36\ See, e.g., David Kreutzer, ``Discounting Climate Costs,''
Heritage Foundation, June 16, 2016, at https://www.heritage.org/
environment/report/discounting-climate-costs. See Nicholas Stern, The
Economics of Climate Change: The Stern Review (Cambridge, UK: Cambridge
University Press, January 2007), https://www.cambridge.org/us/academic/
subjects/earth-and-environmental-science/climatology-and-climate-
change/economics-climate-change-stern-review?format=PB.
---------------------------------------------------------------------------
Proposals that the Federal Reserve enforce a mandate that financial
institutions evaluate climate ``risks'' represent a blatant effort to
distort the allocation of capital away from economic sectors disfavored
by certain political interest groups pursuing ideological agendas. This
would represent the return of Operation Choke Point, an attempt to
politicize access to credit, one deeply corrosive of our legal and
constitutional institutions. Protection of those institutions is
consistent only with formal policymaking by the Congress through
enactment of legislation, rather than with pressures, powerful but
informal, exerted upon and by the Federal Reserve and other regulatory
agencies. Because the uncertainties attendant upon the future effects
of increasing atmospheric concentrations of GHG are so great, a top-
down policy approach for the evaluation of any attendant risks is
itself very risky. A wiser approach would entail allowing market forces
to make such ``risk'' determinations in a bottom-up fashion, thus
avoiding an obvious politicization of the allocation of capital. It is
reasonable to hypothesize that the market in its atomistic fashion has
decided that it is the sum of decisions by financial institutions and
investors that is the more reliable gauge of the highly uncertain
business implications of evolving climate phenomena. So as to drive the
appropriate responses from businesses, it is not necessary that all
investors make such difficult judgments; it is necessary only that
marginal investors do so. Financial institutions are not charities, and
they are not government. The campaign for evaluation and disclosure of
climate ``risks'' by the Federal Reserve and financial institutions is
a clear effort to use private-sector resources for ideological
purposes, in the context of the unwillingness of the Congress to enact
such policies explicitly. The proper course in the context of climate
phenomena is the preservation of the traditional roles of the private
sector and of the government, respectively, as part of the larger
permanent objectives of maximizing the productivity of resource use
under free market competition, and preserving the political
accountability of the policymaking process under the institutions of
democratic decisionmaking as constrained by the constitution.
Thank you, Chairman Brown and Ranking Member Toomey, for this
opportunity to offer my views on this prominent topic. I will be very
pleased to address any questions that you or the other Members of this
Committee may have.
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR CORTEZ MASTO FROM GREGORY GELZINIS
Q.1. How are financial firms considering the increase of
migration due to extreme climate change? How would a financial
institution that has long served its community plan for a
possible fire, tornado or flood wiping out the town and
uprooting and dispersing residents?
A.1. Unfortunately, regulators and the public have little
information on how financial firms are considering the
potential effects of climate change on their balance sheets and
operations, including the effects of climate-driven migration.
It is critical for regulators to compel the production of this
information and also ensure, through supervision and other
prudential means, that financial firms are adequately
integrating these risk factors into their governance, risk
management, internal controls, and capital planning processes.
The damage caused by an extreme weather event can impair
the value of physical assets and cause losses for the financial
instruments tied to those assets. Migrations following extreme
weather events or those driven by long-term environmental
shifts can further reduce the value of real and financial
assets in the region, e.g., a commercial loan to a small
business that loses a large portion of its customer base or a
mortgage in a housing market with depleted demand. Migration
could also limit financial firms' ability to derive future
business from the impacted region, reducing their
profitability. These and other physical risks could threaten
the safety and soundness of individual firms and further
economically disrupt the communities they serve. Beyond this
type of microprudential concern, physical risks could
ultimately destabilize the broader financial system and inflict
harm on the economy as a whole. Financial firms will not
sufficiently address these risks on their own. Regulators must
step in to improve the resilience of the financial system to
these climate-related risks.
Q.2. We know that the insurance sector is particularly
vulnerable to the physical impacts of climate change. We've
seen fires, floods, tornadoes and other extreme weather events
cause wide-scale devastation.
Have insurance commissioners identified specific Federal
actions to mitigate large-scale losses?
How are State insurance commissioners ensuring that
insurance firms consider and plan for risks?
A.2. The business model for property and casualty insurance
companies, which guarantee the value of physical property
against an array of perils, is acutely exposed to the physical
risks of climate change. The increase in frequency and severity
of floods, wildfires, hurricanes, and other extreme weather
events threatens to drive unprecedented claims for insurers in
impacted geographies and business lines. It is critical for
state insurance commissioners to ensure the resiliency of these
institutions. An increase in insurance company failures could
threaten state guarantee funds, policyholders, counterparties,
and the broader economy. Moreover, the less prepared an
insurance company is for climate-related risks, the more likely
it will rapidly pull back from certain geographies and business
lines after a climate-related shock. That may help limit the
future solvency risk of the insurance company, but it will
increase the risks borne by businesses, households, and other
financial firms that rely on insurance for risk mitigation.
State insurance commissioners have generally refrained from
identifying federal financial regulatory actions that could
help mitigate climate-related risks to the financial system,
given that insurers are predominantly regulated at the state
level. A few state insurance regulators have taken initial
steps, however, to identify and mitigate climate-related risks
to insurers within their jurisdiction, but too few states have
taken action on this front. California and New York have been
two of the leading states. In 2016, CA Insurance Commissioner
Dave Jones launched the Climate Risk Carbon Initiative to
tackle climate-related insurance risks. \1\ The effort included
enhanced climate risk disclosure and stress testing, among
other measures. In 2019, the New York State Department of
Financial Services (NYDFS) was the first U.S. financial
regulator to join the Network for Greening the Financial
System. Since then, NYDFS has issued a circular and proposed a
guidance document that outlines climate-related supervisory
expectations for insurers. \2\
---------------------------------------------------------------------------
\1\ California Department of Insurance, ``Climate Risk Carbon
Initiative,'' available at http://www.insurance.ca.gov/0250-insurers/
0300-insurers/0100-applications/ci/index.cfm.
\2\ New York State Department of Financial Services,
``Superintendent Lacewell Announces Proposed DFS Guidance To New York
Insurers On Managing The Financial Risks From Climate Change,'' Press
Release, March 25, 2021. Available at https://www.dfs.ny.gov/reports-
and-publications/press-releases/pr202103252.
---------------------------------------------------------------------------
It is important for state insurance commissioners across
the country that are lagging behind to pick up the pace of
action. Climate risk disclosure, stress testing, supervisory
guidance, and integrating climate considerations into the risk-
based capital framework would improve the resiliency of the
insurance sector. Moreover, despite the potential lack of
support for federal action among most state insurance
commissioners, the Federal Insurance Office (FIO) and Financial
Stability Oversight Council (FSOC) have a vital role to play on
this issue. The FIO and FSOC should push states to act and use
their own federal tools to mitigate these risks, where
appropriate.
Q.3. At the Securities and Exchange Commission, Acting
Commissioner Lee has suggested improvements to disclosure
related to investments
Do investors know the actual climate risks to their
portfolios?
A.3. A survey of institutional investors suggests the financial
system is not reflecting these risks in asset prices, as 93
percent responded that the implications of climate change had
yet to be priced into markets. \3\ Research surrounding the
projected physical impacts of climate change and scenario
analyses probing transition-related impacts support this view.
\4\ There are several reasons that investors have yet to price
the impacts of climate change into valuations for a range of
assets. These include a lack of granular, comparable, and
reliable corporate disclosure of climate-related risks;
backwards-looking pricing models that are not fit for purpose
when analyzing forward-looking risks; and the temporal mismatch
between short-term corporate thinking and medium-to-long term
climate risk materialization. \5\
---------------------------------------------------------------------------
\3\ asset-allocation-finds-new-report-by-bny-mellon-investm.
\4\ Felix Suntheim and Jerome Vandenbussche, ``Equity Investors
Must Pay More Attention to Climate Change Physical Risk,''
International Monetary Fund, May 29, 2020, available at https://
blogs.imf.org/2020/05/29/equity-investors-must-pay-more-attention-to-
climate-change-physical-risk/; See for example, De Nederlandsche Bank,
``An energy transition risk stress test for the financial system of the
Netherlands,'' (2018), available at https://www.dnb.nl/media/pdnpdalc/
201810-nr-7-2018-an-energy-transition-risk-stress-test-for-the-
financial-system-of-the-netherlands.pdf and Irene Monasterolo,
``Assessing climate risks in investors' portfolios: a journey through
climate stress-testing,'' U.N. Principles for Responsible Investment,
March 2, 2020, available at https://www.unpri.org/pri-blog/assessing-
climate-risks-in-investors-portfolios-a-journey-through-climate-stress-
testing/5526.article.
\5\ Madison Condon, ``Market Myopia's Climate Bubble,'' Boston
University School of Law, Law and Economics Research Paper Forthcoming
(2021), available at https://papers.ssrn.com/sol3/papers.cfm?abstract-
id=3782675.
Q.4. Is it possible for investors to know the actual climate
---------------------------------------------------------------------------
risk in their portfolios?
A.4. Investors need reliable, consistent, and comparable data
to evaluate the climate-related risk in their portfolios. The
myriad voluntary disclosure frameworks that have developed over
the past several years have helped get the ball rolling on this
important issue, but only a mandatory standardized regime
implemented by the SEC can provide the information necessary
for investors to make prudent decisions when they allocate
capital. The disclosures should include both specific line-item
quantitative requirements and additions to the narrative-based
disclosures in the management discussion and analysis, such as
those called for by the Task Force on Climate-related Financial
Disclosures. \6\
---------------------------------------------------------------------------
\6\ Task Force on Climate-related Financial Disclosures,
``Implementing the Recommendations of the Task Force on Climate-related
Financial Disclosures,'' (2017), available at https://assets.bbhub.io/
company/sites/60/2020/10/FINAL-TCFD-Annex-Amended-121517.pdf; Alexandra
Thornton and Andy Green, ``The SEC's Time To Act'' (Washington: Center
for American Progress, 2021), available at https://
www.americanprogress.org/issues/economy/reports/2021/02/19/496015/secs-
time-act/.
---------------------------------------------------------------------------
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR CORTEZ MASTO FROM NATHANIEL KEOHANE
Q.1. How does extreme weather events due to climate change pose
risks to the hospitality and tourism sector? How should
communities that rely on tourism and hospitality jobs plan for
climate change impacts?
A.1. Extreme weather events caused by climate change can have
severe consequences for local recreation and tourism
industries, ranging from skiing to national park visitation to
urban excursions. The scope and magnitude of these impacts on
residents and out-of-state visitors--and the businesses that
support them--are likely to grow in the future. They will also
put increasing pressure on the budgets of the federal, state,
and local agencies charged with managing park and recreation
lands and facilities. \1\
---------------------------------------------------------------------------
\1\ Van Houtven et al., 2020. Climate Change and North Carolina:
Near-term Impacts on Society and Recommended Actions. RTI
International. Available at: https://www.edf.org/sites/default/files/
content/NC-Costs-of-Inaction.pdf.
---------------------------------------------------------------------------
Nevada in particular is already experiencing the effects of
a changing climate. The state's average temperature is
increasing, with 8 of the 10 warmest years since 1895 having
occurred since 2000. Annual average temperature increases of 4-
6 degrees Fahrenheit are projected across the state by 2050.
Under a high-emissions scenario, most of central and northern
Nevada could see increases of 10-12 degrees by the end of the
century. \2\
---------------------------------------------------------------------------
\2\ Nevada Climate Initiative, 2020. State Climate Strategy.
Available at: https://climateaction.nv.gov/wp-content/uploads/2021/01/
NVClimateStrategy-011921.pdf.
---------------------------------------------------------------------------
Reno and Las Vegas are already experiencing particularly
severe warming, due to the urban heat island effect--in which a
city's built infrastructure prevents heat from dissipating as
temperatures cool overnight.
Nevada is also likely to experience increased droughts,
snow loss, and flooding due to climate change. By 2050, 5-10
percent more of total precipitation could fall as rain rather
than snow--with even higher numbers in the Tahoe basin and
northwestern part of the state. Peak runoff rates are projected
to rise more than 25-50 percent above the state's historical
rates by 2050, particularly around many mountain ranges and the
Las Vegas Valley. \3\
---------------------------------------------------------------------------
\3\ Ibid. Both projections are 2050 estimates, under an RCP8.5
(i.e., high-emission) climate scenario.
---------------------------------------------------------------------------
These climate impacts stand to have significant
implications for Nevada's tourism, recreation, and hospitality
sectors. For example:
Shorter snow seasons and less reliable snowpack
could affect Nevada's ski season and reduce associated
tourism in an industry that generates hundreds of
millions in annual revenue. \4\
---------------------------------------------------------------------------
\4\ For example, a study from Patrick Tierney at SF State found
the ski industry contributed $564 million to the local Tahoe area
economy during the 2013-14 winter season. Meanwhile, a report from
Tourism Economics found that outdoor recreation accounted for $966
million of visitor spending in Nevada in 2018.
Higher temperatures in the summer, coupled with
increased dust caused by drought, can deter visitors
and reduce the time available to be safely outside. By
2050, Great Basin National Park, for example, is
projected to experience 58 days per year of
temperatures over 90 degrees--up from the current
average of 19. \5\
---------------------------------------------------------------------------
\5\ Kahn, 2016. ``The Future of National Parks is Going to be a
Lot Hotter.'' Climate Central. Available at: http://
assets.climatecentral.org/pdfs/NationalParks-daysabove.pdf.
Increased temperatures and heat waves are expected
to lead to greater energy demand for air conditioning
and cooling, placing additional cost pressures on local
businesses. In Clark County, where Las Vegas is
located, increased annual energy expenditures could
reach between 15-20 percent by end-of-century under a
pessimistic climate scenario (RCP8.5). \6\
---------------------------------------------------------------------------
\6\ Hsiang, S., Kopp, R., Jina, A., Rising, J., Delgado, M.,
Mohan, S., Rasmussen, D.J., Muir-Wood, R., Wilson, P., Oppenheimer, M.
and Larsen, K., 2017. Estimating economic damage from climate change in
the United States. Science, 356(6345), pp.1362-1369. Available at:
https://science.sciencemag.org/content/sci/356/6345/1362.full.pdf.
The labor supply of Nevada workers heavily exposed
to outdoor temperatures is expected to decline between
1-2 percent by end-of-century under a pessimistic
climate scenario (RCP8.5). Many of these jobs support
tourism and recreation across the state. \7\
---------------------------------------------------------------------------
\7\ Ibid.
More severe droughts have the potential to
adversely affect a wide variety of water-based
recreational activities as well as the golfing
industry, which supports more than a billion of annual
revenue and 4,000 jobs. \8\
---------------------------------------------------------------------------
\8\ Repetto, 2012. Economic and Environmental Impacts of Climate
Change in Nevada. Demos. Available at https://www.demos.org/research/
economic-and-environmental-impacts-climate-change-nevada#Climate-
Change's-Impact-on-Tourism-in-Nevada.
Increased severity and frequency of droughts will
likely result in more wildfires across the state. This
would affect the state's extensive parks and recreation
---------------------------------------------------------------------------
lands by reducing visitation and associated revenue.
Increased flash flooding could cause disruptions in
downtown areas of Reno and Las Vegas, while road
closures due to flood and landslide risk can disrupt
travel plans throughout the state. \9\
---------------------------------------------------------------------------
\9\ Nevada Climate Initiative, 2020. State Climate Strategy.
Available at: https://climateaction.nv.gov/wp-content/uploads/2021/01/
NVClimateStrategy-011921.pdf.
Many ski areas and mountain communities have responded to a
changing climate by expanding their traditional tourist
offerings--for example, by expanding their summer and
traditional ``mud season'' offerings to include hiking,
mountain biking, and adventure parks as a way to generate
revenue during the off season. However, these solutions only
offer short-term revenue patches, and they must be complemented
by longer-term policy and investment decisions.
The most important way to protect such communities from the
impacts of climate change is to enact policies that reduce
emissions of carbon dioxide, methane, and other heat-trapping
greenhouse gases that are responsible for climate change. While
there is no substitute for Federal action on climate, state
initiatives are essential to making critical near-term
reductions, helping mitigation of greenhouse gas emissions and
offering a roadmap for ambitious Federal action. For example,
Nevada Governor Steve Sisolak recently announced new rulemaking
to promote low- and zero-emissions vehicles, complementing the
state's latest renewable portfolio standard requiring 50
percent carbon-free electricity by 2030.\10\ \11\ Most
recently, the Nevada Climate Initiative issued its inaugural
State Climate Strategy in December, outlining several policy
options to meet the state's 2050 decarbonization goals--
including an enforceable cap on emissions. \12\
---------------------------------------------------------------------------
\10\ EDF, 2020. ``Nevada Governor Sisolak Takes Important First
Step Toward Transportation Electrification.'' Available at https://
www.edf.org/media/nevada-governor-sisolak-takes-important-first-step-
toward-transportation-electrification.
\11\ Morehouse, 2019. ``Nevada Passes Bill for 50 percent
Renewables by 2030, 100 percent Carbon Free by 2050.'' Utility Dive.
Available at https://www.utilitydive.com/news/nevada-passes-bill-for-
50-renewables-by-2030-100-carbon-free-by-2050/553138/.
\12\ EDF, 2020. ``Nevada's State Climate Strategy Signals Need for
More Ambitious Policies to Curb Pollution.'' Available at https://
www.edf.org/media/nevadas-state-climate-strategy-signals-need-more-
ambitious-policies-curb-pollution.
---------------------------------------------------------------------------
In addition, communities can plan for climate change
impacts by making investments in stormwater management systems
and other climate-resilient infrastructure; integrating
projections of future climate impacts into land use planning
and zoning (e.g., increasing green space can help reduce the
``heat island'' effect mentioned above that exacerbates
warming); and, especially in semi-arid regions like Nevada,
integrating projections of climate impacts into long-range
planning for water infrastructure and use. \13\
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\13\ Several such policy options are outlined in Nevada Climate
Initiative, 2020. State Climate Strategy. Available at: https://
climateaction.nv.gov/wp-content/uploads/2021/01/NVClimateStrategy-
011921.pdf.
Q.2. At the Securities and Exchange Commission, Acting
Commissioner Lee has suggested improvements to disclosure
related to investments.
Do investors know the actual climate risks to their
portfolios?
A.2. Investors in general do not currently know the actual
climate risks to their portfolios--because the information
needed for them to do so is not widely available with the
consistency, quality, and specificity required. This conclusion
emerges clearly from the report by the Climate-Related Market
Risk Subcommittee of the Commodity Futures Trading Commission,
of which I was a member. \14\
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\14\ Commodity Futures Trading Commission (CFTC), Managing Climate
Risk in the U.S. Financial System, Report of the Climate-Related Market
Risk Subcommittee of the Market Risk Advisory Committee (2020), p. v,
https://perma.cc/UT9M-FG2Y (``The existing disclosure regime has not
resulted in disclosures of a scope, breadth, and quality to be
sufficiently useful to market participants and regulators.'').
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Climate change poses significant physical and transition
risks for companies across economic sectors and geographic
locations. \15\ In light of that fact, the SEC promulgated its
2010 guidance confirming that climate-related risks should be
disclosed in the same manner as other financial risks to
companies, \16\ and well over 1,000 companies have signed onto
the TCFD voluntary framework for additional climate disclosure.
\17\
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\15\ CFTC, Managing Climate Risk in the U.S. Financial System, 11.
\16\ Commission Guidance Regarding Disclosure Related to Climate
Change, Securities Act Release No. 9106, Exchange Act Release No.
61,469, 75 Fed. Reg. 6290 (Feb. 8, 2010).
\17\ Parker Bolstad et al., ``Flying Blind: What Do Investors
Really Know About Climate Change Risks in the U.S. Equity and Municipal
Debt Markets?'' (Brookings Institute, 2020), p. 2, https://perma.cc/
8LNV-BEGK.
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However, a large proportion of companies are not making
disclosures that would allow investors to meaningfully assess
climate risk. A 2017 KPMG study of the annual financial reports
of nearly 5,000 companies found that only 28 percent
acknowledged financial risk of climate change at all. \18\
Among the 250 largest companies, the rate of acknowledgment was
higher but still under 50 percent. \19\
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\18\ KPMG, ``The Road Ahead: The KPMG Survey of Corporate
Responsibility Reporting 2017'', p. 30, https://assets.kpmg/content/
dam/kpmg/be/pdf/2017/kpmg-survey-of-corporate-responsibility-reporting-
2017.pdf.
\19\ KPMG, ``The Road Ahead'', p. 31.
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Furthermore, many reports that do reference climate risk
have considerable limitations. Only 2 percent of the companies
in the KPMG study that acknowledged climate risks quantified
those potential risks in financial terms; a similarly low
percentage modeled potential impacts using scenario analysis.
\20\ The TCFD's 2020 status report found that only 17 percent
of companies discuss their process for integrating climate
change into risk management, while only 7 percent of companies
discuss their resilience strategies. \21\
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\20\ KPMG, ``The Road Ahead'', p. 31.
\21\ TCFD, 2020 Status Report, p. 11-12, https://www.fsb.org/wp-
content/uploads/P291020-1.pdf.
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In order for disclosures to be sufficient, they must be
specific to the company, comparable to other companies, and
useful in making decisions on investment, ownership,
engagement, and proxy-voting. \22\ Without broad access to
specific, comparable, and decision-useful disclosures,
investors are not able to reliably assess climate risks to
their portfolios. At a system level, this lack of information
has created the danger of a ``climate bubble'' through
mispricing of risky assets. \23\
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\22\ Madison Condon et al., ``Mandating Disclosure of Climate-
Related Financial Risk'', NYU Institute for Policy Integrity and
Environmental Defense Fund, 2021, p. 11, https://perma.cc/2USW-MMXF.
\23\ Madison Condon, ``Market Myopia's Climate Bubble 2021'' Utah
L. Rev. (forthcoming 2021), https://papers.ssrn.com/sol3/
papers.cfm?abstract-id=3782675.
Q.3. Is it possible for investors to know the actual climate
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risk in their portfolios?
A.3. It is certainly possible to greatly improve the quantity
and quality of climate risk information available to investors
by ``deploying new analytical tools, regulatory incentives, and
business practices.'' \24\
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\24\ Parker Bolstad et al., ``Flying Blind'', 4.
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Tools for climate risk analysis are advancing rapidly. The
Paris Agreement Capital Transition Assessment (PACTA), for
example, aggregates corporate climate risk information to allow
financial institutions to assess both asset-specific and
portfolio-wide alignment with various climate scenarios. To
date, over 3,000 financial institutions globally have used the
PACTA tool. \25\ The Climate Action 100+ Net Zero Benchmark and
Transition Pathway Initiative, along with ESG ratings products
from firms like MSCI and Sustainalytics, also provide investors
with increasingly robust resources to model climate risk.
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\25\ 2 Degree Investing Initiative, ``PACTA/Climate Scenario
Analysis Program,'' https://2degrees-investing.org/resource/pacta/.
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These tools can improve with enhanced corporate climate
risk disclosure. Over the past three years, a growing consensus
of investors have called for TCFD-aligned disclosure to better
evaluate portfolio-wide climate-related financial risks. \26\
That the number of companies reporting in line with the TCFD
continues to increase annually suggests that enhancing climate
risk analysis is achievable. \27\ Additionally, the
proliferation of downscaled climate projections can help make
investor analysis of company-specific physical risks more
sophisticated. \28\
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\26\ The Yale Center for Business and the Environment, Investors
Push the Pace of Climate Risk Financial Disclosures (2018), p. 2,
https://www.erm.com/globalassets/documents/publications/2018/yalecbe-
erm-investors-push-the-pace-on-climate-risk-financial-disclosures.pdf.
\27\ TCFD, 2019 Status Report, p. 5, (``Overall, the Task Force
found signs of progress in implementing the recommendations among
companies traditionally engaged on climate-related issues. These
companies demonstrate that disclosing climate-related information
consistent with the TCFD recommendations is possible and is a journey
of continuing improvement.'').
\28\ See, e.g., U.S. Climate Resilience Toolkit, Energy Data
Gallery, https://toolkit.climate.gov/topics/energy/energy-data-gallery
(last updated Sept. 24, 2019); Nat'l Aeronautics & Space Admin., NASA
Earth Exchange (NEX) Downscaled Climate Projections (NEX-DCP30),
https://www.nccs.nasa.gov/services/data-collections/land-based-
products/nex-dcp30 (last visited Apr. 14, 2021); U.S. Geological
Survey, Regional Climate Change Viewer, http://
regclim.coas.oregonstate.edu/visualization/rccv/index.html (last
visited Apr. 14, 2021); Bureau of Reclamation et al., Downscaled CMIP3
and CMIP5 Climate and Hydrology Projections, https://gdo-
dcp.ucllnl.org/downscaled-cmip-projections/#Welcome (last visited Apr.
14, 2021); Conservation Biology Inst., Adapt West-A Climate Adaptation
Conservation Planning Database for North America, https://
adaptwest.databasin.org/ (last visited Apr. 14, 2021).
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Regulators can facilitate wider adoption of best practices
through many avenues, including mandating climate risk
disclosures, building climate expertise, requiring financial
firms to consider climate risk, and facilitating availability
and consistency of climate data. \29\ Leading investors
including BlackRock, the world's largest asset manager, have
called for mandatory climate risk disclosure, noting that
``consistent, high-quality and material public information.will
enable both asset owners and asset managers to make more
informed decisions about how to achieve long-term returns.''
\30\ Through regulatory action, corporate initiative, and
technological innovation, investors can determine portfolio-
wide climate risks with increasing accuracy.
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\29\ CFTC, Managing Climate Risk in the U.S. Financial System; see
particularly the Key Recommendations summarized on pages vi-ix.
\30\ Larry Fink, ``To Our Shareholders,'' (Jan, 26, 2021), https:/
/www.blackrock.com/corporate/investor-relations/larry-fink-chairmans-
letter.
Additional Material Supplied for the Record
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