The Climate Change Ball is in the Financial Industry’s Court

And it's time they start taking action.

Don’t you love a great sports analogy? As often as they are used, it really is time for the financial industry to step up to the plate, take the shot, and be part of the climate change solution.

I take current reports on the financial industry’s potential impact on climate change and the impact of climate change on the financial industry to illustrate how importance it is for the lenders and financiers to take climate action, however big or small, today!

The financial industry’s climate & economic impact

“A study authored by the Sierra Club and the Center for American Progress shows that eight of the biggest U.S. banks and 10 of its largest asset managers combined to finance an estimated 2 billion tons of carbon dioxide emissions, based on year-end disclosures from 2020, or about 1% less than what Russia produced.” See https://www.bloomberg.com/news/articles/2021-12-14/wall-street-may-trigger-climate-financial-crisis-green-insight.

That does not include Scope 3 emissions, which would have greatly increased the financial industries total carbon dioxide emissions.

The report notes that insurer Swiss Re wrote in May that the global economy risks losing more than 18% of current GDP by 2048 if no action on the climate crisis is taken. For perspective, the U.S. economy contracted by about 4.3% during the Great Recession. See https://www.bloomberg.com/news/articles/2021-12-14/wall-street-may-trigger-climate-financial-crisis-green-insight.

Bloomberg writer Tim Quinson further states “To mitigate climate-related financial risks posed by Wall Street’s exposure to high carbon-emitting industries, the report states that regulators including the Securities and Exchange Commission and Labor Department should at least take the following steps:

• Require all financial institutions disclose all emissions embedded in their portfolios and attributable to businesses for whom they provide services.

• Ensure that investment fiduciaries keep their commitments to clients and the public, including those related to how they invest and vote their shares.

• Incorporate climate risk into the supervisory ratings they assign to banks.

• Administer climate-related stress tests to identify the banks’ potential losses from climate change (Moody’s Investors Service estimates that banks globally have $22 trillion of exposure to carbon-intensive industries).

• Require that banks fund riskier investments with more equity capital and less debt.

• Implement climate-risk surcharges on “global systemically important banks.”

• Adjust deposit insurance premiums to reflect climate-related risks.

• Proactively address racial and economic justice issues that intersect with such climate-risk related reforms.”

That a long list for the regulators to tackle. While regulation is needed, an approach that involves the finance industry’s own tested standards and requirements would go along way to a bipartisan agreement in Washington and high private sector adoption.

How an interpretation can catalyze an industry

The tip of the melting iceberg is up for interpretation. The SEC requires publicly traded companies, including those eight biggest U.S. banks, to disclose material risks as part of their public disclosures. What is material used to only include financial risks traditional to the business sector like cash on hand, liabilities, and accounting. However, in a changing climate, it is hard to ignore the expensive climate risks plague the companies and individuals banks are invested in.

Since the Biden administrations push to combat climate change the regulatory agencies scrambled to increase climate enforcement and communicate with the regulated:

• SEC Chair Gary Gennsler states that his staff is working a rule for further climate risk disclosures See https://www.sec.gov/news/public-statement/gensler-amac-2021-07-07.

• President Biden issues an executive order on Climate-Related Financial Risk directing the Secretary of the Treasury Janet Yellan to assess the risks climate change poses to the American financial system with a sight on future regulatory actions. See https://www.whitehouse.gov/briefing-room/presidential-actions/2021/05/20/executive-order-on-climate-related-financial-risk/.

• Commodities Futures Trading Commission ('CFTC') established its Climate Risk Unit. The Climate Risk Unit is focused 'on the role of derivatives in understanding, pricing, and addressing climate-related risk and transitioning to a low-carbon economy' while addressing the 'industry-led and market-driven processes in the climate—and the larger ESG—space.' See https://www.cftc.gov/PressRoom/PressReleases/8368-21

• The SEC announces a Climate and ESG Task Force in the Division of Enforcement.

• In September of 2021, SEC sends out letters reminding publicly traded companies that it is selectively reviewing company disclosures for climate risk disclosures. See https://www.sec.gov/corpfin/sample-letter-climate-change-disclosures.

The business case for unlocking the financial industry’s climate impact potential

Will there be increased enforcement of ESG disclosures and material risks? I think so. Even if the Democrats lose ground in the senate and the house in the midterm elections, a very real possibility as inflation harkens back to Bill Clinton’s “it’s the economy stupid,” the regulatory agencies will still have the power to interpret what is material to encompass climate risk disclosures.

It is also in the financial industry’s best interest. By creating standards that fit within their operations and actually make their portfolios more resilient, they can influence what the regulators require and look for. Getting ahead of the rule making process will pay dividends in the future.

What are the rules and standards that need to be addressed by the financial institutions? An interesting development is a new collaboration among major global banks through the Office of the Comptroller (OCC). See https://www.americanbanker.com/news/occ-outlines-climate-risk-standards-for-big-banks. Major banks like Bank of American and Wells Fargo are beginning to ask the question “what standards should we apply when assessing climate risk in our portfolios?” The answer could help both the private and public sector avoid some of the major climate change risks on the horizon.

Another important regulation for the financial industry to think about is H.R.1187 - Corporate Governance Improvement and Investor Protection Act. This bill, while a low chance of passing, highlights the questions and problems the financial industry should address in the climate change space. The bill seeks to do the following:

• to address various areas of corporate disclosures including: ESG disclosures, shareholder political transparency, accountability in pay, climate risk disclosures, disclosure of tax havens and offshoring, workforce investment, preventing and responding to workplace harassment, cybersecurity disclosure, governance through diversity, disclosure of the use of forced labor, and other matters, and

• focuses on the 'sectors of **finance**, insurance, transportation, electric power, mining, and non-renewable energy’. [emphasis added]

• While the details are yet to be finalized, the finance industry may have to account for all the companies for which it invests in or loans money to.

The finance industry will not only want to figure out how to track the emissions of the companies they are invested in, but also how to disclose and use that information to build resiliency in their own operations.

Extreme weather events are expensive

Specifically impacting the financial industries borrowers and investors are extreme weather events. Those events that are hard to predict but can be the tail risk that dooms a portfolio. These extreme weather events are becoming more frequent and increasingly expensive.

Flood damage alone is predicted to hit $13.5 billion in the U.S. next year.

The total damage of extreme weather will build upon the $99 billion already incurred by American taxpayers in 2020. In 2021 alone, one in three Americans were affected by extreme weather. According to the U.S. Climate-Related Financial Risk: Executive Order 14030 A ROADMAP TO BUILD A CLIMATE-RESILIENT ECONOMY, October 14, 2021. “Climate-related disasters from extreme weather cost an additional $600 billion in physical and economic damages over the last five years.”

When supply chain efficiency is reduced and agriculture is no longer predictable, the foundation of the economy begins to erode.

Hail Mary or one-percent improvements

We heard at COP26 that the likelihood of a hotter planet in the future is likely and the worst-case scenarios are becoming more probable than ever before. The finance industry can make a major impact, but realistically, major change takes time. Whether we can initiate a Hail Mary pass by increasing tech innovation and supporting business adoption will happen remains to be seen. Today, the finance industry can start with small improvements, 1 percent improvements at a time, to reduce exposure to fossil fuels, adopt a disclosure framework, and begin to hold companies lent to accountable for disclosing their climate impacts.

I hope for rapid innovations and adoption of climate change practices, but in case that is slower than expected, let’s make progress where possible. The ball is still in your court financial industry.