Policymaking on climate risk shifts into higher gear

WASHINGTON — Banking policy analysts are eagerly awaiting the first concrete example of climate risk guidance from a U.S. financial regulator, which some experts say will begin an iterative process leading to more prescriptive rules.

Observers predict the "supervisory expectations" to be unveiled by the Office of the Comptroller of the Currency by yearend will serve as a cautious first step by bank regulators, focusing on defining climate risk, providing model examples of risk management steps banks have already taken and recommending basic standards.

But the OCC's guidance may just be the prelude to more formal requirements down the road, many say, such as climate-related stress tests or a new supervisory rating on bank examinations for climate risk management.

"You're going to see more explicit peer learning and education resources for the banks on both climate scenarios and climate disclosure, building out common scenarios,” Lauren Compere, a managing director at Boston Common Asset Management, said of the OCC's upcoming guidance.

But as other regulators develop their own standards, future iterations could include more formal assessments of a bank's physical risk related to extreme weather events and risks tied to consumers making the transition to a more climate-conscious economy.

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“What I think this is all going to lead to ... is an expectation that the banks are assessing and disclosing both physical and transition risk,” Compere said. “I think it’s going to lead eventually to climate stress testing. We’re going to see that more and more, and I think it’s going to eventually link to ratings on climate risk.”

Climate risk management standards from the OCC and others could also aim to provide incentives for financial institutions to finance projects aimed at mitigating the effects of climate change, said Bao Nguyen, a partner at Skadden and a former senior official at the OCC.

“If banks participate in the Chesapeake Bay regional cleanup, and that benefits a lot of minority fishermen on the Eastern Shore, I think the agencies would definitely think about giving that [Community Reinvestment Act] credit since it goes to ... the administration's top priorities [of] climate change, environmental protection, and diversity, inclusion and minority advancement,” said Nguyen.

The issuance of climate guidance will eventually involve all the prudential bank regulators, experts said, but for now the spotlight rests squarely on the OCC.

Acting Comptroller Michael Hsu first mentioned the upcoming guidance on Oct. 21, the same day that the Financial Stability Oversight Council released a long-anticipated report on climate risk to the financial system.

He offered more details earlier this week in a speech in which he also recommended steps that bank boards can take to query senior managers about banks' internal climate risk assessments.

"We expect to issue framework guidance by the end of this year, to be followed next year with detailed guidance for each risk area," Hsu said Monday. "The detailed guidance will build on a range-of-practices review that will launch this week, industry and climate groups’ input, and lessons from other jurisdictions."

Many say central to the OCC's guidance may be the message that banks must start now to get a handle on how they could contribute to and be impacted by climate change in the future.

“They should be working on this now,” said Peter Dugas, executive director at Capco. “We've gotten enough from various speeches and congressional testimony and statements made by various regulators. Bank should be thinking about this yesterday and not two months, six months, eight months from now.”

The OCC is preparing its guidance just as the Federal Reserve moves ahead with conducting exercises known as "scenario analysis" to assess banks' climate risks.

Some see the OCC potentially taking on a more active role on climate risk policy with the leadership of the Fed somewhat in limbo and Federal Deposit Insurance Corp. Chair Jelena McWilliams — a Trump appointee — having reservations about the rapid development of climate policy without sufficient data to back it up.

For now, few analysts expect any dramatic changes to national bank policy resulting from the OCC guidance in the near term. The agency's first steps are expected to instruct banks in broad strokes how they should think about and integrate climate risk into their broader risk management practices.

“I would expect that the agency will take an iterative approach to climate risk guidance, beginning with standards that are relatively high level and focused on only the largest banks, but growing more detailed and becoming more broadly applicable over time," said Jeremy Newell, a partner at Covington.

Advocates for robust climate regulations also have measured expectations, even as they push regulators to move quickly to incorporate climate risk into the financial system’s supervision.

“Clearly, the regulators are still trying to figure this out themselves, and the role of guidance to the banks is to help them think through these issues,” said Todd Phillips, director of financial regulation and corporate governance at the Center for American Progress.

Still, others said banks should expect the coming guidance to have heft, particularly if regulators continue to frame climate change risk as a matter of safety and soundness.

“What this industry really needs to be doing — and hopefully this is where Hsu is headed — is educating chartered institutions on climate risk, instructing them that they need to take these risks seriously and that the agency itself views them as posing potential threats to safety and soundness,” said David Arkush, managing director of Public Citizen's climate program.

Over time, analysts predict that initial guidance could be built up and expanded to other areas, such as reform of the anti-redlining Community Reinvestment Act.

Some advocates support expanding CRA to include green investments but argue that such a reform is no panacea for addressing climate risk.

“I think that they should include climate incentives here and give banks credit for giving loans to [low-to-moderate income] communities that have been affected by climate change or will be affected by climate change in the future, to help them mitigate those future changes,” Phillips said. “At the same time, CRA is not safety and soundness.”

The scope of the OCC's yearend guidance is still anyone's guess.

While most environmental advocates prefer an approach that covers as many financial institutions as possible, Hsu has said the early framework will be directed at “large banks.”

“We want supervisory guidance that applies to all banks, large and small,” said Phillips. “And we want to see guidance coming out from all three of the banking agencies.”

But others say the nation’s largest banks — of which the OCC supervises the majority — are best suited to receive, implement and experiment with the coming guidance. Indeed, many of the biggest institutions have already announced high-profile moves such as curtailing loans for new fossil fuel exploration or new coal fired power plants.

“It's well suited for [the OCC] to primarily focus on large financial institutions, because they have the level of maturity that will help them to be able to effectively use technology [with] mature compliance programs that can help to integrate those new requirements into their programs,” said Dugas.

Another significant question for the OCC to answer in early guidance will be what relationship climate risk has to the myriad other risks that banks are already expected to manage, including credit risk, operational risk, reputational risk and legal risk.

Advocates hope that the national bank regulator will “start mapping climate-related risks onto those categories, and explaining how those risks should be treated,” Arkush said.

“Obviously, the regulators and the banks should be looking at all relevant risks, and climate is a huge, huge category,” Arkush said. “So really, in some ways, what you're doing here is ending the carveout of climate-related risk from supervision.”

To that end, one of the most critical things that national banks can do in the meantime is hire personnel capable of examining an institution’s current risk practices and looking for ways that climate risk may need to be applied to different portfolios and business lines.

Acting Comptroller Hsu “wants banks to know that the effort to start building out the internal processes to assess this kind of risk should begin now,” Nguyen said. “While the specific details are not all figured out yet, we know that the process is going to be risk-based, risk-oriented, and in the early stages that's all about banks getting the right people and processes in place.”

With time, analysts expect the OCC’s early climate policymaking to give way to a more robust interagency effort.

“The Fed has been doing a lot of economic research on this, but it hasn’t gotten into the hands of the FDIC and OCC yet,” Nguyen said. “I expect that Mike is not going to try and do anything super aggressive without first coordinating with the Fed and the FDIC.”

That kind of coordination will be critical to ensuring a smooth transition toward more explicit climate risk management, Compere said.

“There really needs to be alignment across the financial regulatory system here in the U.S.,” Compere said. “Having common expectations around disclosure and assessment — it’s really important to standardize and harmonize what is going to be expected across the financial system.”

But some climate advocates are wary of the potential for agency coordination to slow the rollout and even weaken the strength of the climate guidance to come.

“I’m willing to assume there are some places where the coordination argument has more force,” said Arkush. “But in general, if some regulators of some segments of the banking industry are not willing to do what needs to be done, the ones that are willing to do it with respect to their jurisdiction — it's better to have some of the banks protected, and some of the financial system protected, than none.”