In a high-profile meeting of the CFTC’s Market Risk Advisory Committee, policy makers, market participants, and academics explored the impacts of climate change on the world economy, and responses being taken by regulators and business alike.
The CFTC’s Market Risk Advisory Committee (MRAC), under the sponsorship of Commissioner Rostin Behnam, recently met to consider the difficult, politically sensitive, and often controversial issues and risks surrounding climate change. Specifically, the committee examined market participant approaches to managing and mitigating climate-related market risks, as well as regulatory responses and policy initiatives being taken in response to a growing array of climate related threats. Other agenda items included an update on interest rate benchmark reform and remark from Steven Majoor, Chair of the European Securities and Market Authority (ESMA).
The commissioners weigh in climate-related financial risks. While each of the five commissioners expressed some support for MRAC’s work on climate-related risks, Commissioner Behnam was the most vociferous, stating, "Worldwide economic costs from natural disasters have exceeded the 30 year average of $140 billion in 7 of the last 10 years. In 2018, the total cost was $160 billion. Our commodity markets and the financial markets that support them will suffer if we do not take action to mitigate the risk of contagion. As most of the world’s markets and market regulators are taking steps towards assessing and mitigating the current and potential threats of climate change, we in the U.S. must also demand action from all segments of the public and private sectors, including this agency."
Chairman Giancarlo expressed his full support for MRAC’s activities in exploring the topic. Meanwhile, in Commissioner Quintenz’s more tempered remarks, he noted that the meeting provided an opportunity to remind everyone of the valuable economic purpose derivatives markets serve. He then turned his attention to recent EPA reports which found significant declines in greenhouse gas emissions, and lauded the shale revolution which has led to the dramatic growth in natural gas production in the past decade. Commissioner Berkovitz, for his part, insightfully observed that political systems often do not immediately respond to emerging trends, while market forces are more responsive.
Market participants respond. One of the panels focused of market participants’ management and ongoing efforts to mitigate climate-related financial market risks, including key risk management, governance, and disclosure considerations. Some highlights include the following:
- Blackrock’s Kristen Walters spoke about the difficulties in measuring the risks associated with climate change, and how the firm is developing a tool kit to do just that. In the firm’s report, Getting Physical—Scenario analysis for assessing climate related risks, it is noted that many climate-related risks are not priced in to asset valuations, as they may appear distant and uncertain, and may also lead to discounting of risks that are already biting.
- Nancy Meyer of the Center for Climate and Energy Solutions, a non-profit organization that works with 34 major companies on climate change matters, discussed the guidance provided by the Task Force on Climate-related Financial Disclosures (TCFD), which provides a framework for climate-related financial disclosure. That framework includes elements of risk management, strategic planning, and sustainability/ESG reporting.
- Matthias Graulich, the chief strategy officer with Eurex Clearing AG, told the committee that climate-related issues are very much on top of minds in Europe, as reflected in the recent European Parliament elections. In the election, the Green Party attracted 20 percent of the electorate up from 10 percent. Graulich also described efforts how the financial markets are used to reduce carbon emissions via carbon allowance certificate trading.
- Dr. Stefano Giglio, Professor of Finance at the Yale School of Management, observed there are great opportunities to pursue a global derivatives market tied to climate change risk, but also pointed to three key obstacles. First, he noted it’s hard to specify the right target of a hedge. Second, there are barriers to market participation and development given very long time horizons and counterparty risks involved. Lastly, he noted the limits to quantitative analysis of risks given complex predictions, model uncertainty, and the lack of data on extreme scenarios.
Regulatory response and policy initiatives. Another panel focused on current domestic and international policy initiatives and supervisory approaches related to climate risks, as well as the potential impact of climate change on the future stability of the global financial system. Some of those highlights include:
- Stacy Coleman, Secretariat of Financial Stability Board’s (FSB) Taskforce on Climate-related Financial Disclosures, provided an update on TCFD’s recent progress. She noted that while the disclosure of climate related information has increased over the past three years, it is still not sufficient for investors. In particular, investors need information on the potential financial impact of climate-related issues on companies. She noted more needs to be done.
- Sarah Breeden, a representative of the Bank of England, observed that physical risks arising from damage to property, land and infrastructure from climate and weather-related events such as heatwaves, droughts, floods and rises in sea level have increased by a factor of five in recent decades. She also noted that the Bank of England is a clear supporter of the disclosure of financial risks from climate change in line with standards set out by the TCFD, and supports the position that disclosure is critical if the financial system is to be able to weigh risks and investment accordingly.
- Dave Jones, a former California insurance commissioner provided an extensive overview of Climate Risk and Insurance Regulation. He also discussed the recent National Association of Insurance Commissioners (NAIC) survey which sought to determine how insurers are addressing climate risk in underwriting, reserving and business operations. With 1000 insurers questioned (representing over 70 percent of U.S. insurance market), the survey found 69 percent of insurers consider impact of climate change on investment portfolios and 60 percent of insurers altered investment strategy in response to climate risk considerations.
It is also worth noting that in 2010, the SEC issued guidance regarding disclosure related to climate change, but has taken no further action in this area since that time. Meanwhile, at the MRAC meeting, the committee also voted to establish a new Climate-Related Financial Risk subcommittee. Further details regarding the subcommittee will be published in the Federal Register. Commissioner Behnam also indicated that MRAC may issue a report on climate-related risks which could be shared with other financial regulators and agencies.
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