Are financial regulators starting to take climate change seriously?

The White House and Treasury Department say climate change is a risk to the financial system. When will they take the next step and limit bank lending to fossil fuel projects?

(Dan Leach via Flickr)
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Justin Guay is director for global climate strategy at the Sunrise Project. This guest essay represents the views of the author, not those of Canary Media.

Financial regulators in the U.S. have opened the door to regulating speculative investments in fossil fuels. While they are still far from taking the aggressive measures needed to avoid a climate-change-driven financial meltdown, banks and other financial institutions should understand that these are the first, not the last, of the climate-related regulatory measures headed their way.

The first signal on this front came from an Oct. 14 White House report outlining a precautionary approach” to mitigating climate risk in the financial sector. Then, last week, the U.S. Treasury Department released a highly anticipated report from the Financial Stability Oversight Council (FSOC), the entity created after the 2008 financial crisis to prevent financial shocks, that declared climate change a systemic risk to the financial system. While this was an important statement, the FSOC report came up short on policy details.

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Looming behind both these reports is the risk that if regulators fail to act, we could see a rerun of the 2008 financial crisis, this time driven by a much more existential problem than bad mortgages. 

Finance policy is climate policy

Just a few short years ago, financial regulation was not regarded as a tool in the climate policy toolkit. That changed last year when Mark Carney, then head of the Bank of England, gave a now-famous speech on climate-induced Minsky moments — sudden and drastic market collapses brought on by speculative activity. He argued that climate change poses clear risks to the stability of the financial system, and we have a duty to rein in those risks. 

For banks, one of the greatest risks is losing money on coal, oil and gas infrastructure forced into early retirement by an inevitable policy response to climate change, referred to as transition risk.” But even without a concerted climate policy push, the U.S. has seen a wave of bankruptcies across the oil and gas industry and the continued decline of the coal industry.

A mounting body of evidence documents the risks that fossil fuel investments pose to the financial system. U.S. financial regulators have the enormous powers of the Dodd-Frank financial reform act at their disposal to deal with such systemic financial risks. Regulators could use this power to force disclosure of risky assets, disincentivize lending to fossil fuels, and even end fossil fuel finance outright. 

Markets can’t self-regulate

The power embodied in the Dodd-Frank act to curb climate risks clearly scares banks and other financial institutions. That’s why leading financial institutions including BlackRock, along with nearly every public company on earth, have championed mandatory rules for disclosure of climate-related risks. They would much rather have disclosure rules than mandates to reduce or eliminate fossil fuel investment. But disclosure rules rest on faith that high-quality information on climate risks will lead the market” to make better investment decisions. In essence, financial institutions and big companies are asking us to trust them that this time around they won’t tank the global economy. 

But as we saw in 2008, the financial system consistently rewards speculative behavior and fails to govern itself. Even industry-led initiatives that purport to back climate action, like the Principles for Responsible Banking or the Glasgow Financial Alliance for Net Zero, led by Carney himself, aggressively resist any and all measures to actually limit lending to fossil fuels. Banks will go to great lengths to engage in the theater of promises, but it is clear that only regulatory action will get them to move beyond merely reporting data. 

Advocates of stronger regulation have offered a menu of potential actions. For instance, the Federal Reserve could force banks that fund fossil fuel assets or are exposed to heightened physical climate risks to hold more capital in reserve to reflect their higher risk profiles. Banks hate that idea because every dollar they hold is a dollar they don’t lend, which means they make less money. But European regulators are now considering capital requirements for fossil fuel lending, potentially signaling a new era in financial regulation. 

A disconnect between Treasury and the White House?

The White House’s report this month made clear that climate change is a systemic risk and therefore a precautionary approach is necessary. Given that, the specific steps the Treasury Department outlined last week in its FSOC report are underwhelming, to say the least. 

Instead of bold measures to disincentivize or outright limit fossil fuel finance, the FSOC proposed cautious, rudimentary steps, including new recommendations for risk disclosure, data collection and enhanced staffing at the FSOC to evaluate climate-related risks. The report also suggests scenario analysis and potentially stress testing at financial institutions to inform future regulatory action. 

But any concrete action to limit fossil fuel finance was omitted from the FSOC report. Instead, it proposed leaving future regulatory actions to a yet-to-be-created Climate-Related Financial Risk Committee. 

This absence of urgency is troubling, especially given that the Biden administration’s climate agenda teeters on a knife’s edge in Congress, thanks to concerted Republican opposition and the unwillingness of Democratic Senators Joe Manchin (West Virginia) and Krysten Sinema (Arizona) to agree to a budget reconciliation bill with robust climate provisions. 

President Joe Biden, who will be joining other world leaders at the United Nations COP26 climate summit in Glasgow next month, is under pressure to bring a set of solid commitments from the U.S. government to match his administration’s pledge to reduce economywide emissions by 50 to 52 percent by 2030. But the Treasury Department has failed to step up to help the White House enter the negotiations with a clear demonstration of U.S. climate leadership for the international community.

Instead, Treasury Secretary Janet Yellen seems to have sought consensus among those on the FSOC, which ultimately led to a weak and indecisive report. Not all members of the FSOC share equal blame for this outcome. Federal Reserve Chair Jerome Powell, a key member of the council, has said that climate change is not a primary consideration for Federal Reserve decision-making. That puts him in direct opposition to advocates pushing the Fed to classify lending to fossil fuel companies as riskier than other loans.

Regulation is a long road. Will Powell be along for the ride?

Climate change has not previously been an issue for the Federal Reserve. But now Powell’s lack of action to safeguard the financial system from the threat of climate change is a driving issue in a suddenly tense renomination battle. That’s a sign of the growing power of the climate movement: If it can’t push regulators to take climate change seriously, it will enlist powerful allies to push for those regulators to be replaced. 

Financial institutions should pay heed to this growing pressure on regulators. Banks need to ask themselves which is more likely: future climate-related regulation or indefinite payouts from their bets on fossil fuels? The answer should be obvious, and for all our sakes, banks need to acknowledge this sooner rather than later.

Justin Guay is director for global climate strategy at the Sunrise Project. He has more than a decade of experience in nonprofit advocacy and foundation strategy development.