Climate-Related Financial Risk Management Final Interagency Guidance Rules Issued – Now What’s Next?

By Douglas A. Thompson

On October 24, 2023, the Federal Reserve (Fed), Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC) issued the joint agency climate-related financial risk management guidance for large institutions. As many will recall, this guidance has been pending for approximately two years, since the OCC first published in December 2021 (with the other agencies following in 2022). For the release, the Fed Chairman, several Fed Governors, and several other agency directors all issued statements. Institutions not subject to the guidance may glean valuable insights from both the principles and the various statements. Key questions may include: (1) Is the guidance the final word (or will more be coming and from where)? and (2) What should other banks and financial institutions (not $100B banks) be doing? The likely answer to both: stay tuned and be proactive.

Interagency Guidance Overview:
The guidance focuses on mitigation and management of climate-related financial risks, including physical and transition risks, which according to the Fed Staff’s September 25, 2023, Board Memorandum “can manifest as traditional micro-prudential risks, including as credit, market, liquidity, operational, and legal risks.”

According to the Memorandum, clarification in the final guidance includes “appropriate roles of boards and management to better align with existing interagency guidance on board effectiveness and governance” but “excludes discussion of compensation practices, which was referenced in the Board's proposed guidance, because the agencies believe the issue is covered in existing interagency guidance.” The guidance also clarifies that in addition to applying to institutions with over $100B in total consolidated assets supervised by the agencies, foreign banking institutions with combined US operations of greater than $100B also are covered. Fed Staff Board Memorandum weblink:
https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20231024b2.pdf

The Principles for Climate-Related Financial Risk Management for Large Financial Institutions Final Interagency. Federal Register Notice & Summary weblinks:
https://www.federalregister.gov/documents/2023/10/30/2023-23844/principles-for-climate-related-financial-risk-management-for-large-financial-institutions
https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20231024b3.pdf

The Principles Note: “Weakness in how financial institutions identify, measure, monitor, and control climate-related financial risks could adversely affect financial institutions’ safety and soundness.” The Principles provide a high-level overview of the variety of supportive and constructively critical comments received covering topics such as: the contours of agency authority, the scope of burdens for institutions of all sizes, accountability and action relating to institution public comments regarding climate action (including net zero GHG emissions goals), social justice and equity (including support for promoting fair lending initiatives and underserved community programs), increased governance, and materiality of risks assessments, among other things. The Principles require institutions to develop and incorporate monitoring and mitigation of material climate-related financial risks, both transition and physical risks across six areas: (1) governance, (2) policies, procedures, and limits, (3) strategic planning, (4) risk management, (5) data, risk measurement, and reporting, and (6) scenario analysis. Ultimately, “the principles are designed to help financial institutions’ boards of directors (boards) and management make progress toward incorporating climate-related financial risks into risk management frameworks in a manner consistent with safe and sound practices.” 

The guidance also notes that each institution should tailor its risk management activities and risk scenario analysis frameworks “in a manner commensurate to the financial institution’s size, complexity, business activity, and risk profile.”

Objectives for Financial Institutions: The Principles provide examples of potential objectives that robust assessment of climate-related financial risks may promote:

(a) “exploring the impacts of climate-related financial risk on the financial institution’s strategy and business model;”
(b) “identifying and measuring vulnerability to relevant climate-related financial risks factors including physical and transition risks;”
(c) “estimating climate-related exposures and potential losses across a range of scenarios, including extreme but plausible scenarios;” 
(d) “identifying data and methodological limitations and uncertainty in climate-related financial risk management;” 
(e) “informing managements’ assessment of the adequacy of the institution’s climate-related financial risk management framework.”

According to the Principles, all of these assessments should be made through the lens of traditional sound risk management including focus on credit risk, liquidity risk, other financial risk, operational risk, legal and compliance risk, and other nonfinancial risk.

On-Going Debate, Future Focus, and Bright Line Limits: While the agencies jointly issued the principles with strongly supportive leadership statements, two Federal Reserve governors issued dissenting vote comments. Governors Michelle Bowman and Christopher Waller separately commented declining to support the guidance. Governor Bowman expressed concern regarding “unclear expectations and unintended consequences.” She also criticized the potential pitfalls and limited benefit of long-range horizon scenario analysis, citing its departure from the customary Comprehensive Capital Analysis and Review two-year horizon and other shorter horizons.
https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20231024b.htm

Governor Waller expressed his view that he does not “believe the risks posed by climate change are sufficiently unique or material to merit special treatment relative to other risks.” 
https://www.federalreserve.gov/newsevents/pressreleases/waller-statement-20231024b.htm

That said, other regulators expressed views that the principles do not go far enough and that additional rules will be forthcoming. Acting Comptroller of the Currency Michael Hsu commented that institutions cannot be complacent about emerging risks, including climate-related financial risk: “We have learned through hard-earned experience that it is better to address risks as they emerge, rather than after they’ve caused damage. This philosophy underpins prudent risk management, safety and soundness, and these Principles.”
https://www.occ.gov/news-issuances/news-releases/2023/nr-occ-2023-119b.pdf

Consumer Financial Protection Bureau (CFPB) Director Rohit Chopra, a member of the FDIC Board, issued a comment with even more urgency: “We are already seeing certain cracks in the [financial] system, such as the recent mass cancellations of homeowner’s insurance policies due to climate-related risks. Banks, in particular, play an essential role for the functioning of society, and it is critical that they be able to meet the changing financing needs of their communities, and serve small businesses and households in times of stress or in the wake of a catastrophic event.” Chopra concluded that he hopes “future guidance and rules can embrace simplicity and bright line limits where appropriate.”
https://www.consumerfinance.gov/about-us/newsroom/statement-of-cfpb-director-rohit-chopra-member-fdic-board-of-directors-on-the-final-guidance-regarding-climate-related-risks/

Risk Management Takeaways for Non-Covered Institutions: 

1. Digest the Guidance and keep abreast of continuing climate-risk focus. Across the U.S. and around the globe, numerous government entities, regulators, and non-governmental organizations continue to develop new rules and approaches. Some are coalescing into alignment. Many are not. Depending on your institution’s business strategy, customers and risk footprint, some regions may be critically important to your risk management approach.
2. Be proactive. It is more likely than not, that at least some aspects of this guidance ultimately will impact your institution. Either through future expansion of rules scope or simply because of changes in regulator outlook and perspectives. Initiating meaningful dialogue with key stakeholders sooner should help prepare you and your institution for such potential eventualities. It also may help formulate business strategy and risk management approaches.   
3. Analyze your climate-related financial risk profile and potential exposures. The architecture at the largest institutions is going to be much more substantial and costly because of those institutions’ complexity and global reach. Consider your business strategy and goals and whether potential climate-related financial risk (either transition risk or physical risk to your operations and to your customers) may materially adversely impact your strategy and success. 
4. Assess your messaging and key information systems. As noted above, many of the commenters focused on accountability for public messaging institutions provide regarding commitments to environmental, social and governance (ESG) progress – whether it be net zero greenhouse gas emissions commitments or sustainability goals or social justice and community engagement. Are the institution’s words outpacing its actions? How can the institution credibly demonstrate incremental progress toward goals? Does the institution’s data and reporting systems provide adequate support? 
5. Begin to imbed consideration of climate-related financial risk across the institution. Socialize these risk considerations among the institution’s compliance and risk management teams. Assess leveraging their business unit focus to percolate up key potential risk considerations. Consider how to develop and empower key stakeholders to identify and take action regarding key climate-risk and ESG related initiatives. 

While many financial institutions are not yet covered by the new Interagency guidance, institutions of all shapes and sizes should anticipate increased focus on climate risk and sustainability issues. In time, there may be a waterfall of these principles to smaller institutions. Given the sense of urgency expressed by several regulators, including the OCC and CFPB, we may expect these concepts to be incorporated in some manner going forward, whatever an institution’s profile. We also can expect various states and other agencies to continue to develop climate-risk related rules, such as the recent California Climate-Related Financial Risk Act (SB261) and the pending SEC rules, which Commissioner Gensler recently discussed at the U.S. Chamber’s Center for Capital Markets Competitiveness. Watch this space.