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A Changing Climate for Regulators

Our national elections have rightly dominated headlines for the past month, including where climate policy is concerned. President-Elect Biden has declared his intent to rejoin the Paris agreement on his first day in office; in talks about staffing his administration, according to the New York Times, Biden’s top advisors frequently evaluate even candidates for lower-level roles based on the question: “is the person climate-ambitious?” But as welcome as such news may be, a simultaneous shift on climate policy is underway that may be no less important–and has nothing to do with the elections.

For the first time ever, in a biannual risk report put out earlier this month, the Federal Reserve highlighted “how climate change . . . is likely to increase financial shocks and financial system vulnerabilities that could further amplify these shocks.” The Fed’s discussion of climate change was specifically called out in the report’s table of contents and again in its text, with a highlighted two-page spread appearing within the section titled “Near-Term Risks to the Financial System.” The report followed remarks by Chair Jerome Powell a few days earlier that the Fed is “very actively in the early stages” of getting up to speed with the “science and art” of incorporating climate change into financial regulation, an effort in which the US had previously lagged other central banks around the world.

Perhaps even more promising, last week the Fed’s Governor, Randal Quarles, revealed that the Fed has “requested membership” to the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), after attending recent meetings of the global organization behind the scenes. Days later, Powell confirmed the report. Other than the Reserve Bank of India, the US would be the last major, global central bank to join the NGFS, which was founded 3 years ago to support the goals of the Paris climate agreement.

Among the many possible corollaries of the Fed’s NGFS membership could be a clear definition of green bonds, which would in turn allow the Fed to establish more of a market for climate-friendly investments and possibly even buy such debt itself. Such a move could add major momentum to efforts to “green” the economy.

Another step many other NGFS members have taken is to require the banks they oversee to report on climate exposures. Indeed, in the same week as the Fed’s announcement, the U.K. treasury took that concept a step further, when it made climate change impact disclosures mandatory for a wide swath of businesses, including all listed companies, banks, large private businesses, insurers, asset managers and regulated pension funds. By 2025, according to the new U.K. rules, all such organizations must disclose in alignment with the Task Force on Climate-related Financial Disclosures (TCFD).

Back on this side of the Atlantic, while the timing of the Fed’s announcements may bear some connection with the election, we are encouraged that neither move appears at all politically motivated. Instead, one of the United States’ most important agencies seems finally to have begun grappling with the reality of the climate crisis. The impact of the changes that follow could become a major step forward in the fight against climate change. At the very least, the signal sent by the Fed seems clear: climate risk is now very much relevant to its overall responsibility for risk measurement, management and mitigation in the financial system.