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Blog Posts — June 11, 2021

Taking Temperature Part 2: US Enters Climate Financial Regulation Era

webinar1 last week discussed the evolving climate-related financial regulatory landscape in the US, where a series of recent government and agency initiatives may result in new disclosure and oversight rules for investors and companies after years of slow progress. The debate was a follow-up to a webinar on investors’ climate action last February. 

Since late 2020, the US government, the Federal Reserve, the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) have taken steps that may pave the ground for legislation and regulation to drive climate action within financial markets. As it has happened in other regions, particularly Europe, policymakers could end up setting responsible-investing guidelines for professionally managed assets and disclosure rules on climate-change risks, opportunities and impact. 

In a report last September, the CFTC called on financial regulators to address climate risk without delay and to help promote the role of financial markets as providers of climate solutions. The SEC in March launched a Request for Comment on Climate Change Disclosure “with an eye toward facilitating the disclosure of consistent, comparable, and reliable information on climate change.” The same month the Fed created a Financial Stability Climate Committee to identify and address climate-related risks to financial stability. Last month, the Biden Administration issued an executive order calling for the entire federal government to start to account for — and mitigate — those same risks. 

“We are very excited to see the attention from the Fed, from the White House, from federal agencies, on climate-related regulation and policies,” Nina Chen, Director of Sustainability and Climate Initiatives at the New York Department of Financial Services (NYFDS), said during the webinar. “We are really thirty years late in mitigating climate change, so I would say now is definitely the time to act.”

The US rejoined the 2015 Paris Agreement last February, a move that heralds the new government’s engagement with climate action. The European Union (EU), meanwhile, has advanced on an action plan on sustainable finance that seeks to reorient capital flows towards a ‘green’ economy and to mainstream ESG into risk management. The EU has introduced a Climate Benchmarks regulation and a Sustainable Finance Disclosure Regulation (SFDR), and is working on a taxonomy of sustainable activities. 

‘Lots of interest’

The NYFDS is the first US financial regulator to have established a set of holistic expectations for managing financial risks from climate change, Chen explained, and has provided guidance for New York insurers, banks and non-depositary mortgage companies to include and disclose those risks. The agency is putting special focus on smaller companies, which may have less experience but are equally key to driving change, she added.

Greg Hershman, Senior Specialist for U.S. Policy at the Principles for Responsible Investment (PRI), described a marked change in American policymaking, with the government “looking at every single piece where climate risk may exist across the financial system and trying to attack it.” The PRI has been busy engaging with policymakers on this topic, he said at the event.

“There’s definitely a lot of interest from officials, within not just the Administration but at the SEC and the Fed, of learning best practices and seeing what others are doing,” said Hershman. “All of these groups know that none of this happens in a vacuum. They know that others have thought about these things as well, and they are looking to what has worked and has not worked in Europe, and what others are doing around the world.”

The risk of greenwashing

Stan Dupre, Founding Partner at 2° Investing Ventures, pointed out that reducing portfolio exposure to carbon-intensive companies as a risk-management strategy, and contributing to climate goals are two distinct things. “The idea that an investor should have an impact in the real economy to help solve climate issues is becoming more mainstream,” he said. 

However, he warned about the possibility of US regulation failing to curtail impact-washing. He said that unless an investor is able to change the activities of a company through their influence, they are not creating an impact in the real economy. “In other words, as an investor you can be exposed to a green company, or you can only have brown companies in your portfolio and have an impact by changing their behavior”, Dupre said. 

Dupre explained that the European Commission defines sustainable investment on the basis of a portfolio’s exposure to green activities or its reduction of exposure to brown activities. This, he said, is at odds with scientific findings on which investor activities have an impact in the real economy. 

“One fear I have is US policymakers potentially importing this flaw in the regulation,” Dupre said. “That is my main concern about the regulatory field right now.”

Investors must lead

The conversation led to the question of whether regulation is enough to bring change in the asset-management industry, or if, instead, change should flow ‘from bottom-up.’

“Regulation is great, it is driving the market; but it shouldn’t be a reason to stop thinking,” said Rodolphe Bocquet, Global Head of Sustainable Investment at Qontigo. “Investors should really figure out what they want to have as an impact and how to bring that impact.” It is thus important to offer customer-centric solutions to the market that enable investors to reach their objectives, he added. 

From net zero to net positive

Viola Lutz, Head of Climate Solutions at ISS ESG, focused on the various commitments towards net-zero carbon emissions that have sprung from states, corporations and investors, and said such efforts may not be enough. In order to meet global temperature targets by 2050, governments will have to promote ‘negative’ emissions strategies including carbon removal, she told the audience.

“The math at the moment is not working out,” Lutz said. “Carbon capture and storage, and even less so carbon removal, are not that much on the agenda. I do think, yes, we will see this come more on the agenda.”

“What we see if you aggregate all announced pledges, is that we are actually far away from reaching net zero by 2050,” she added. This “gives you an idea of the potentially future coming regulatory activity that can be expected.” ISS ESG is a leading provider of sustainability data and analytics.

More rules or a carbon tax?

Another topic of discussion was the possibility that a tax on carbon emissions be introduced in the US, as is the case in other jurisdictions.

The PRI’s Hershman noted that, historically, penalizing polluting businesses with such taxes has been a contentious proposition in the US, although political resistance to the idea may be ebbing. He called the introduction of a US tax “inevitable.”

Qontigo’s Bocquet said carbon tax policies must be improved or reconsidered altogether. Currently, he noted, only a small share of global emissions is covered by a tax, and “ridiculously low” prices can’t “drive a shift in the business model and the allocation of capital to reach the decarbonization pathways that we need to be on.”

Finally, the NYDFS’ Chen said efforts must be simultaneously focused on more regulation and on a US carbon tax.

“Both are needed,” she said. While regulation is pushed forward by agencies, a carbon tax would have to be passed by Congress, she said. “It’s different people. I don’t think one can substitute the other.” 

Change ahead

To conclude, ISS ESG’s Lutz said US investors can expect more regulation as officials’ response to climate change gathers pace.

“This is a pretty big journey,” she said. “I very much agree we are several decades too late, but we can still manage the targets. Given the persistent gap between rhetoric and action, more regulation might yet follow.”

Overall, momentum is building in the US for new climate-related policies governing financial investments. Policymakers’ actions will add to pressure from asset owners and public opinion in shaping investors’ policies and expectations in the immediate future. It remains to be seen if change occurs as forcefully as it has happened in Europe.

1 ‘Taking temperature, Part 2: Upcoming Climate Change Regulations,’ Responsible Investor, Jun. 2, 2021.