Securities Regulation Daily Commissioner Behnam warns of the impact of climate change on financial markets
Friday, February 14, 2020

Commissioner Behnam warns of the impact of climate change on financial markets

By Joanne Cursinella, J.D.

"Certain uncertainties" complicate effective response to the market challenges posed by extreme weather.

In prepared remarks at the 56th Crop Insurance and Reinsurance Bureau Annual Meeting in Florida, CFTC Commissioner Rostin Behnam claimed that the U.S. is facing increasing financial risks due to business interruptions and bankruptcies caused by extreme weather events. Climate change is a risk management challenge that presents uncertain and potentially severe consequences over time, he cautioned. He also discussed some of the measures being taken to address this issue.

The problem. Weather and climate present the greatest, consistent—yet uncertain—risks to the agricultural economy and rural communities, Behnam said. According to one report he cited, Managing the Financial Risks of Climate Change, the average number of extreme weather events per year has more than tripled since the 1980s. Further, according to the National Oceanic and Atmospheric Administration (NOAA), the number of events resulting in losses exceeding $1 billion (USD) each since 1980 has more than doubled in the most recent five years (2015-2019) from an annual average of 6.5 to 13.8 events, Behnam added.

He started to "connect the dots" between climate change and financial market risk, and what role policy makers should and could play to mitigate these more extreme, emerging risks, specifically with respect to financial market participants. Behnam noticed that private financial institutions were beginning to publicize what they perceived as climate-related financial market risk and how to address it. He was also cognizant of the critical role climate has naturally (and obviously) played within insurance and reinsurance markets for decades.

Current initiative. In November 2019, following full Commission approval, Behnam formed a subcommittee within the MRAC, which consists of 37 member-representatives from various types of participants that advise the CFTC on financial markets. According to Behnam, The Climate Related Financial Market Risk Subcommittee includes 35 experts from financial markets, the banking and insurance sectors, as well as the agricultural and energy markets, data and intelligence service providers, the environmental and sustainability public interest sector, and academic disciplines singularly focused on climate change, adaptation, public policy, and finance. The subcommittee chairman has committed to providing a report containing policy recommendations by June of this year, Behnam added.

The "certain uncertainty." As he crafted the charge and mandate of the subcommittee, Behnam said he thought about economic and financial market climate risks very basically, and subsequently stacked hypotheticals and different scenarios on top of each other. He also considered that the International Monetary Fund (IMF) is adding climate-related factors into its existing stress-testing methodology to help government and private-sector leaders prepare for potential financial shocks triggered by climate change.

Focusing on U.S. agricultural commodities, according to a USDA report, agricultural producers reported they were not able to plant crops on more than 19.4 million acres in 2019. Flood-related federal crop insurance payouts for the 2019 growing season were reported as totaling more than $6.4 billion (USD) so far—the costliest on record.

From a financial markets perspective, Behnam asked himself how such physical risks manifest in credit markets and lending relationships between counterparties on a local, regional, or even national level. He concluded that losses have a compounding effect as extreme weather events—especially for the uninsured—can impact both the creditworthiness of the borrowers and the value of the loan collateral, translating to higher probability of default and higher losses in the event of a default.

Feedback loops could also develop between the effects on the real economy and those on the financial markets, Behnam claimed. And, he added, given the lessons from the 2008 financial crisis, specifically the interconnectedness of global financial markets, this begs the question of how, if at all, do local and regional market disruptions resulting from extreme climate events affect market resiliency and stability in an increasingly concentrated banking system?

Need to prepare. The data suggest a likely pattern of more extreme, frequent weather, Behnam said, and we must prepare now by, among other things, beginning the transition to a low-carbon economy. Insurers need to increase their focus on climate risk to investments, and they will need access to reliable data to accurately measure and manage that risk.

In December, the Bank of England published a discussion paper setting out its proposed framework for the 2021 Biennial Exploratory Scenario Exercises to test the resilience of the largest banks and insurers against the physical and transition risks associated with different possible climate scenarios, as well as the financial system’s broader exposure to climate risk.

Meaningful steps. Behnam is encouraged by industry leaders taking meaningful steps to begin to meet the climate risk challenge. But concerning climate, both scenario analysis and stress testing become increasingly difficult exercises because of the uncertainty of climate outcomes. However, Behnam affirmed that we still need a plan to deal with the uncertain but real impacts of climate change on the natural, human, and financial system. Behnam said he is confident that convening the subcommittee will lead to thoughtful, actionable, and data-driven recommendations to move Commission—and perhaps larger U.S. and global financial—policy in the right direction.

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