President Biden signed the Executive Order on Climate-Related Financial Risk (Climate Risk EO), a sweeping order that mobilizes the federal government to more actively address climate change risk and sends a clear message that the White House believes that climate change poses a significant financial risk to the US and global economies.
Since taking office, the Biden administration has created increased momentum toward combating climate change, rejoining the Paris Agreement, pushing federal agencies to be more climate-conscious, and hosting a two-day climate summit with other world leaders. On May 20, 2021, Biden’s issuance of the Climate Risk EO, which calls upon the federal government to assess and develop solutions to address climate risk to the financial system, was yet another demonstration of this administration’s focused approach to tackling the climate crisis. According to the White House, the Climate Risk EO will “help the American people better understand how climate change can impact their financial security, strengthen the US financial system, and inform concrete decisions that the federal government can take to mitigate the risks of climate change.” The Climate Risk EO is divided into six sections, which together lay out a framework for federal agencies to take more prescriptive measures to advance the administration’s policy to:
Advance consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk, including both physical and transition risks.
Act to mitigate climate-related risk and its drivers, while accounting for and addressing disparate impacts on disadvantaged communities and communities of color and spurring the creation of well-paying jobs.
In furtherance of these goals, the Climate Risk EO requires multiple federal regulatory and supervisory actors to assess relevant climate-related risk and develop and report on proposed mitigation strategies, including additional regulatory requirements.
As Europe and other parts of the world are already shifting toward a more regulated regime for climate-related risks, President Biden’s Climate Risk EO is a clear indication that US-regulated financial institutions (FIs) should prepare for mandated climate-related risk reporting and management in the near future.
The Climate Risk EO is broken into six sections and contains multiple directives, all in furtherance of the order’s overall objective, which is outlined in the Policy section. Specifically, the Climate Risk EO requires the following:
Climate-Related Financial Risk Strategy: The director of the National Economic Council and the National Climate Advisor must develop, in coordination with the secretary of the Treasury and the director of the Office of Management and Budget, a strategy to: (1) measure, assess, mitigate, and disclose climate-related financial risk to federal government programs, assets, and liabilities; and (2) meet the financing needs associated with achieving net-zero greenhouse gas emissions by 2050 and limiting global average temperature rise to 1.5 degrees Celsius through private and public investment in a manner that fosters a just transition.
Assessment of Climate-Related Financial Risk by Financial Regulators: The Treasury secretary and Financial Stability Oversight Council members should assess climate-related financial risk, including physical and transition risks, to the financial stability of the US government and financial system and, within 180 days of the order (or by November 20, 2021), report on agencies’ efforts to integrate consideration of climate-related financial risks into their policies and programs. The report should discuss the necessity of climate-related disclosures by regulated entities. The Climate Risk EO further requires that the Federal Insurance Office assess climate-related issues or gaps in the supervision and regulation of insurers and, with states, the potential for major disruptions to private insurance coverage in areas most vulnerable to climate change impacts.
Resilience of Life Savings and Pensions: The Labor secretary must review and consider suspending, revising, or rescinding rules imposed by the Trump administration barring consideration of environmental, social, and governance (ESG) factors, including climate-related risks, in decision-making relating to workers’ pensions. The Labor secretary must also assess strategies for protecting US workers’ life savings and pensions from climate-related financial risks and assess how the Federal Retirement Thrift Investment Board has taken ESG factors, including climate-related risk, into account. The Labor secretary is required to submit a report on the above within 180 days of the date of the order.
Federal Lending, Underwriting, and Procurement: Various federal agencies and actors are required to take steps to incorporate climate-related risk into federal financial management. This includes integrating climate-related financial risk into federal lending programs and procurement processes.
Long-Term Budget Outlook: The federal government will exercise fiscal responsibility to respond to the significant financial risk posed by climate change and will annually develop and publish its assessment of climate-related fiscal risk exposure and the steps it is taking to reduce that exposure.
Key Considerations for Financial Institutions
The Climate Risk EO makes clear President Biden’s intent to take concrete steps to mitigate the impact climate change could have on financial markets. Although the directives laid out in the order are targeted at the government and do not lay out specific requirements for FIs, the order is likely a precursor for future climate-focused financial regulations. Below are four key areas on which FIs should focus in advance of anticipated regulations addressing climate-related risks in the financial industry.
Disclosure Requirements: It is likely that financial institutions will face disclosure requirements to provide clear and consistent information on climate risk. Consistent with the US Securities and Exchange Commission’s request for public input on climate-related disclosures issued in March 2021, financial institutions should evaluate their internal-reporting controls and review and enhance their information systems to ensure they have the data required to support new and more detailed reporting requirements.
Investments in Clean Energy: Financial institutions will be expected to invest heavily in clean energy markets to drive liquidity, competitiveness, and, in turn, job growth in clean energy industries to support the country’s efforts to reach net-zero emissions by 2050. The administration will lead this effort but will lean on financial institutions to prioritize investment that aligns with the objectives set forth in the Climate Risk EO.
Insurance: The Climate Risk EO cites the potential for major disruptions to private insurance coverage in regions of the country particularly vulnerable to climate change impacts. With more insurers taking steps to reduce their climate-related risk, including leaving areas that pose a higher risk, this could signal measures to place additional requirements on private insurers to ensure that vulnerable citizens have the coverage they need.
Underwriting Standards: The federal government is considering integrating climate risk into underwriting and loan terms that could have a significant trickle-down effect on a sizable number of financial institutions.
Call to Action
Reports detailing federal agencies’ plans to incorporate climate risk into their programs, including potential requirements for climate risk disclosures, are due on November 20, 2021. Guidehouse can help financial institutions prepare for, and respond to, regulatory requirements aimed at reducing the financial impact of climate change. Guidehouse has a deep bench of financial services and climate and energy professionals with decades of public and private sector experience and a strong understanding of the climate environment in which financial institutions operate. Drawing on this experience, Guidehouse can help FIs and other financial market participants assess and manage climate-related risk by reviewing applicable regulatory requirements to determine gaps; assisting with climate-related disclosures and assessing FIs’ current internal reporting controls; and developing strategies for reallocation of capital and change management support. Guidehouse is well-positioned to make an individualized assessment of your unique circumstances and offer innovative advice and solutions for the challenges associated with the role financial institutions will play in combating the climate crisis.
Special thanks to Henry Darmstadter and Eleanor Gass for contributing to this article.