Federal regulators urged to address climate risk

The pressure on U.S. financial regulators to address climate risk is growing as investors and regulators overseas — and others at the state level — continue to forge ahead.

"We are seeing great momentum every day from companies, investors and regulators, but it's just not fast enough. We have to accelerate the rate of change," said Steven Rothstein, Boston-based managing director of the Ceres Accelerator for Sustainable Capital Markets, a Ceres initiative advocating for capital market policies to address global climate change.

"I have had hundreds of conversations with regulators at the federal and state level. We have seen a lot more interest and momentum at the state level," Mr. Rothstein said.

Recent examples include the New York Department of Financial Services dictating that New York-based insurers integrate considerations of climate risk into their governance frameworks, risk management processes and business strategies. The agency also signed the United Nation's Principles for Sustainable Insurance.

In Washington state, the insurance commissioner convened an October summit on regulating climate change as a systemic financial risk.

And in November, the Federal Reserve Bank of Richmond is hosting a similar Climate Change Economics summit, and bank regulators are paying closer attention, advocates say. A new report from Ceres warns that more than half of major U.S. banks' syndicated lending is exposed to climate risk, yet that exposure is not fully disclosed.

Summits are helpful, but institutional investors want U.S. financial regulators to see mandatory climate risk disclosure as part of their mandate to protect U.S. market stability and competitiveness. A group of investors with nearly $1 trillion in assets stressed that point in a July letter to all U.S. regulators, including the heads of the Federal Reserve and the Securities and Exchange Commission.

Climate risk "poses a systemic threat to financial markets and the real economy, with significant disruptive consequences on asset valuations and our nation's economic stability," warned the 72 signatories, including the $262.5 billion California State Teachers' Retirement System; $211.2 billion New York City Retirement Systems; $210.5 billion New York State Common Retirement Fund; $56.1 billion Maryland State Retirement & Pension System; and the $3 billion Seattle City Employees' Retirement System.

Another advantage of having a uniform disclosure framework for U.S. companies, said the SEC's investor advisory committee in May, is that it will let the SEC take control "before other jurisdictions impose disclosure regimes on U.S. issuers and investors alike."

That is a real risk, said former SEC Commissioner Robert Jackson Jr., a professor at New York University School of Law and co-director of its Institute for Corporate Governance and Finance. "A failure to act on climate disclosure is going to lead to allowing Europe and others to take the pen," said Mr. Jackson, who sees the confusion caused by European MiFID II rules unbundling trade execution and investment research fees as a warning. "It allowed Europe to take leadership in a way that didn't reflect our investors' needs," he said.

Mr. Jackson does see some room for progress, though. With major asset managers like BlackRock Inc. pressing corporate boards for more transparency on climate and other ESG risks, "the conversation at the SEC is completely different than it was 10 years ago. It's no longer viewed as the object of gadflies," he said.

One "real achievement," Mr. Jackson said, was the September report from a non-partisan market risk subcommittee advising the Commodity Futures Trading Commission on climate change's impact on financial markets. The report called out the U.S. for lagging behind other countries in protecting their financial system from climate change. "It is a striking assessment and indictment of the state of climate risk. I am hopeful that the SEC and CFTC can provide leadership in this area," he said.

Like Mr. Jackson, current SEC Commissioner Allison Herren Lee agrees with many institutional investors that the SEC already has the authority to mandate disclosure of systemic climate risk.

Ms. Lee is pushing for an agency task force to talk with market participants about structuring a mandatory climate risk disclosure regime as more countries, from New Zealand to the European Union, begin requiring it. She cites a recent Swiss Finance Institute survey that found many institutional investors believe climate risk reporting is as important as traditional financial reporting and should be mandatory and standardized. "Voluntary disclosure is not getting the job done," said Ms. Lee, a former SEC enforcement lawyer.

In the meantime, global investors are taking matters into their own hands. In October, 30 of the world's largest investors with a collective $5 trillion in assets, the United Nations-convened Net-Zero Asset Owner Alliance, unveiled concrete portfolio decarbonization targets that follow the Intergovernmental Panel on Climate Change scenario for the next five years on limiting global warming by 1.5 degrees Celsius.

The alliance's 2025 Target Setting Protocol is intended to send "a very loud signal" to companies and governments that movement toward a lower-carbon future is needed immediately, officials said. Alliance steering committee members include representatives from the $410 billion California Public Employees' Retirement System; the 271 billion Danish kroner ($42.6 billion) PensionDanmark; the C$330 billion ($247.9 billion) Caisse de Depot et Placement du Quebec; the €32.7 billion ($38.3 billion) Fonds de Reserve pour les Retraites; and Wespath Benefits and Investments, an agency of the United Methodist Church, with more than $24 billion in assets.

U.S. regulators will have a lot of catching up to other countries to do when it comes to climate risk disclosure mandates. Canada, for example, recently launched a program of COVID-19 relief for companies that comes with climate risk-related strings. Companies will now have to report annually on their climate investments and how they will reduce their environmental footprints, plus show how they support Canada's commitments made under the Paris climate agreement.

The outcome of the American elections could potentially drive more disclosure mandates that mirror those in other countries, said Michael Ferguson, head of North America sustainable finance at S&P Global Ratings, New York. "Certainly the investment community has been clamoring for it. The tools that are at their disposal are quite substantial, but the desire is to have that be more harmonized. We know that climate is a risk."