The Subcommittee on Climate-Related Market Risk of the U.S. Commodity Futures Trading Commission (CFTC), a federal body regulating the U.S. derivatives markets, has produced Managing Climate Risk in the U.S. Financial System, a first-of-its-kind report from a U.S. financial regulator on the risks posed by climate change to financial markets. The Subcommittee sits under the Committee on Market Risk Advisory, which advises the CFTC and identifies “systemic issues that threaten the stability of the derivatives markets and other financial markets, and makes recommendations on how to improve market structure and mitigate risk.” (A helpful overview of derivatives can be found here).
The report was commissioned by the Committee on Market Risk Advisory to “initiate the critical process of moving toward a climate-resilient U.S. financial system” and to seek to come to a consensus on “complex issues that do not fit neatly into the current regulatory structure.” According to Robert Litterman, Chairman of the Subcommittee and a Founding Partner of Kepos Capital, “[t]his report reflects agreement around a set of fundamental principles beyond pricing carbon, such as the need for collaboration with international efforts to address climate-related financial market risk. Ultimately, these principles coalesce around the need for leadership by the financial regulators to guide an iterative process forward while leaving room for American financial innovation.”
The report and its recommendations to the CFTC were developed based on the insights of the members of the Climate-Related Market Risk Subcommittee. The Subcommittee comprises over 30 cross-sector representatives including, for example:
Why this report is significant
While the findings and recommendations of the report have been identified by other global financial regulators and increasingly urged by institutional investors, the report is significant as it is the first from a U.S. regulatory body to push for an economy-wide carbon price and mandatory climate disclosures, among other recommendations. While acknowledging that not all of the CFTC’s members agree with all of the report’s findings, the Financial Times notes that through this report the CFTC “reached outside its turf to recommend changes in corporate disclosure, investments and central bank asset purchases, the domain of other federal agencies.” Leonardo Martinez-Diaz, Global Director of the Sustainable Finance Center at the non-profit World Resources Institute (and a member of the Subcommittee), points out that the U.S. has “lagged” behind its peers in efforts to address climate-related financial risks, “despite being home to the world’s largest financial markets.” Nonetheless, he underscores that “this report is not landing in a vacuum” coming after recent reports from U.S. legislators and the Federal Reserve highlighting the risks of climate change to markets. What is more, the report “comes at a time when the COVID-19 economic crisis is bound to weaken the financial system’s resilience to shocks, heightening the urgency of addressing the climate risk challenge.”
Key Takeaways
Below are some of the topline findings of the report:
Source: Climate-Related Market Risk Subcommittee of the Market Risk Advisory Committee, U.S. Commodity Futures Trading Commission, Managing Climate Risk in the U.S. Financial System (September 2020)
Source: Climate-Related Market Risk Subcommittee of the Market Risk Advisory Committee, U.S. Commodity Futures Trading Commission, Managing Climate Risk in the U.S. Financial System (September 2020)
Key Recommendations
The report makes many recommendations for both policymakers and financial regulators. A few of the key recommendations highlighted by the report include:
“Investors and financial markets are poised to deliver the low-carbon capital and infrastructure that our global economy requires to address climate risk. We know what we need to do and how to do it. We are impatiently waiting for the appropriate incentives and other policies to reduce emissions to be instituted through legislation. Only then will the awesome power of the financial system be able to address at scale this existential threat.”
Robert Litterman, Chairman, Climate-Related Market Risk Subcommittee, Managing Climate Risk in the U.S. Financial System (September 2020)
“A financial system that is better able to measure and manage these risks will be better positioned to absorb and recover from climate-related shocks, as well as to help investors and entrepreneurs seize opportunities that arise from the transition to net-zero emissions. That will be especially significant in the post-COVID period, when the weakened economy and financial system will be especially vulnerable to any additional disruption. Given the uncertain timing of physical and transition risks, it is imperative that this process begin now. As this report has mentioned repeatedly, policies essential to decisively address climate change lie beyond the purview of financial regulators. Those policies include, first and foremost, effective mechanisms to price carbon appropriately. Financial regulators and other market participants can insistently point to the need to ‘get incentives right,’ and they can warn about the consequences of failing to act. But, ultimately, these critical policies must come from Congress, coupled with an international framework that can facilitate synchronized reductions in greenhouse gas emissions across countries.”
Climate-Related Market Risk Subcommittee of the Market Risk Advisory Committee, U.S. Commodity Futures Trading Commission, Managing Climate Risk in the U.S. Financial System (September 2020)