US President Joe Biden’s May 20, 2021, executive order laid out an aggressive, whole-of-government plan to address climate change risk, including a set of directives that will have a major impact on the operations of the federal government and on the regulation of financial markets participants. While the effects on regulation of banks and financial services companies are somewhat clearer, state-regulated insurance companies face a murkier, less well-defined future. This On the Subject reviews recent developments in climate change risk management in the United States and in Europe, and outlines some of the challenges that lie ahead.
MAY 20 EXECUTIVE ORDER
On May 20, 2021, US President Joe Biden issued his Executive Order on Climate-Related Financial Risk (EO) that sketched out a whole-of-government approach to addressing climate change risk, both for federal government operations and also for the regulation of many financial markets participants, including insurers. The EO sets deadlines for submission of two major reports: first, within 120 days from the date of the EO, a plan to develop a comprehensive strategy with respect to government programs (e.g., the underperforming federal flood insurance program), assets and liabilities; and second, a late-November 2021 deadline for the Financial Stability Oversight Council (FSOC) to submit to the president a comprehensive climate change risk assessment and progress reports from federal regulatory agencies on integration of climate change-related risk into banking, securities and asset-management regulatory frameworks.
The initial focus of the EO is on disclosure. It seeks to promote “consistent, clear, intelligible, comparable and accurate” disclosure of climate-related financial risk, including physical and transition risks, by the federal government as a whole and by financial entities regulated by the government—and apparently also for insurers. As many readers will appreciate, insurer solvency and market conduct are most definitely not directly regulated by federal government regulators. But as those who know the history of the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 will also recall, the creation of the Federal Insurance Office by that legislation positioned the proverbial camel’s nose very close to, if not under, state insurance regulators’ tents. (See more on the FIO and climate change, below.)
The EO also seeks to advance two other Biden administration climate change aims: correcting environmental inequities imposed on many communities, and creating well-paying jobs. And for those fortunate enough to have pensions or retirement savings, the EO tasks the US Secretary of Labor to consider threats to them from climate change.
The EO addresses federal lending, underwriting and procurement activities, seeking to ensure that climate change-related risks are considered in government financial management and financial reporting. Future budgets will include assessments of the government’s own climate risk exposure. “Major” federal government suppliers will need to begin disclosing greenhouse gas emissions (GHGs), climate change-related financial risks and “science-based” reduction targets for GHGs.
As to federally regulated financial institutions—and mindful of systemic risk/stability issues—the EO assigns to the FSOC under the direction of Treasury Secretary Yellen (who also chairs the FSOC), the task of ensuring that every federal financial services regulatory body has integrated climate change-related risks into its regulatory and supervisory activities. Here again, the focus is on disclosure enhancements by regulated entities, but emphasis is also placed on examining approaches to improving mitigation with new or revised regulatory standards.
As to the insurance industry in particular, the EO instructs Secretary Yellen to:
“(i) direct the Federal Insurance Office to assess climate-related issues or gaps in the supervision and regulation of insurers, including as part of the FSOC’s analysis of financial stability, and to further assess, in consultation with States, the potential for major disruptions of private insurance coverage in regions of the country particularly vulnerable to climate change impacts; and
(ii) direct the Office of Financial Research to assist the Secretary of the Treasury and the FSOC in assessing and identifying climate-related financial risk to financial stability, including the collection of data, as appropriate, and the development of research on climate-related financial risk to the U.S. financial system.”
The development and publication of the EO come at a fascinating moment in the evolution of climate change-related financial risk analysis and planning in America and globally. As the “Fact Sheet” that accompanied the May 20 EO put it:
“Today, President Biden took action to address the serious threat that the climate crisis poses to our economy. Extreme weather related to climate change can disrupt entire supply chains and deprive communities of food, water, or emergency supplies. Snowstorms can offline entire power grids. Floods made worse by rising sea levels destroy homes and businesses. As the United States builds a modern and equitable clean energy future that creates millions of good-paying jobs and advances environmental justice, the agency actions spurred by the President’s directive today will help safeguard the financial security of America’s families, businesses, and workers from the climate-related financial risks they are already facing.”
The International Energy Agency (IEA), an entity that for almost half a century has focused on fossil fuels, has just published what some commentators have termed a “stunning” report entitled “Net Zero by 2050.” The IEA’s lengthy take on what will be required to move the global energy sector to net zero by 2050, the narrow pathway that policymakers and participants in the world economy will need to travel, the hundreds of milestones to reduce and then eliminate investment in oil, gas and coal-fired plants and projects that the IEA believes will need to happen, is sobering to consider.
Among other global milestones in the IEA’s pathway:
Starting now, no more approvals of unabated coal fired power plants and no approvals for new oil or gas fields, or coal mines or extensions of existing mines
By 2030, spending $820 billion per year on electric grid upgrades (up from $260 billion per year today)
By 2030, spending $90 billion per year to reach an installed base of 40 million electric vehicle (EV) charging stations
By 2030, boosting annual EV battery production from 160 gigawatt hours today to 6,600—i.e., building the equivalent of 20 lithium-ion battery gigafactories each year
By 2030, 60% of passenger cars sold are electric; by 2035, 50% of heavy-truck sales are electric
By 2050, coal falls to 10% of power production, with 20% of that in plants with carbon-capture technology.
Translating these global milestones into country-specific achievements and company-specific mandates will likely be a complex, expensive and messy exercise, particularly in countries still building coal-fired generation capacity with 40- or 50-year operating lives and in developing economies that will struggle to finance investment in green technology. Deploying (and financing the deployment of) new clean technology that will not have a positive environmental impact for some time also will be a huge challenge.
Indeed, the Organisation for Economic Co-operation and Development (OECD) has estimated that in the near-term (up to 2030) annual investment of $6.9 trillion (approximately 8% of global gross domestic product in 2020) will be required just to keep global warming to 2° C. above pre-industrial levels. The IEA’s own estimate of necessary energy-sector investment is $5 trillion by 2030, up from an annual average of $2.3 trillion in recent years.
In the United States, an even bigger challenge is political, hence (in part) the Biden administration’s climate change mantra (reasserted in the EO) about the positive job creation aspects of setting out on this multi-decade crusade. But like it or not, the United States is beginning the journey. It is fascinating to observe the US government’s climate change about-face, now in progress and visible on a daily basis. (See, for example, https://www.epa.gov/climate-indicators, now updated for the first time in four years.) Given this history, it is uncertain whether the United States will continue on the journey and at what pace.
Not surprisingly, the IEA’s report has already been criticized or rejected, at least in part, by multiple countries and non-governmental organizations (e.g., OPEC), and there will certainly be continuing reverberations in the weeks and months ahead. Such dissents from the prevailing climate change orthodoxy in Europe and now in Washington, DC, are to be expected. In the United States, apart from climate-change skeptics in Congress, we may see state-by-state opposition as well. Recent press reports forecast that state Republican attorneys general in Arizona, Kentucky, Louisiana, Missouri and West Virginia could be expected to file suits seeking to challenge aspects of the Biden administration’s developing climate change policies. Indeed, state treasurers from 15 states wrote to John Kerry, the US Special Presidential Envoy for Climate, this week to decry the Biden administration’s “bullying” of banks and other financial institutions to curtail lending and investment in fossil fuel companies and projects. The treasurers threatened to withdraw funds from banks that cave to the Biden administration’s pressure tactics.
IS “CONSISTENT, CLEAR, INTELLIGIBLE, COMPARABLE AND ACCURATE” DISCLOSURE OF CLIMATE-RELATED FINANCIAL RISK POSSIBLE?
When it comes to climate-related financial risks, the world today is filled with multiple, proliferating, climate change regulatory frameworks and models, metrics, data sources and stress-testing scenarios. During the six weeks leading to the release of the EO, following months of climate change regulatory announcements by government officials in Washington, DC, and in capitals around the world, news cycles were inundated with press releases from financial institutions, fund managers and others discussing sustainability plans, new targets to reduce GHG emissions, claims about green investment funds, green investment commitments, green investment measurement tools and the like. Developers of climate change frameworks, purveyors of environmental and climate change data and metrics, scenario experts and others have continued to bombard the public all with their new and improved products.
In one recent article, discussing which of 33 sustainability certifications might be right for a young graduate, Trish Kenlon, founder of Sustainable Career Pathways, observed:
“The world of corporate sustainability reporting is not for the faint of heart. The organizations that comprise the infamous alphabet soup of reporting frameworks and standards each provide their own approach to the reporting of sustainable value creation and disclosure of climate-related risks, which makes deciding what reporting-related certification to pursue incredibly difficult.”
Ms. Kenlon concluded that “we’re not likely to have one single framework that everyone uses anytime soon (if ever)” and offered the following advice to the graduate on which certification to pursue: the one that your future employer uses!
CLIMATE CHANGE DATA
As a noted asset manager put it last month in announcing its new sustainability scoring approach:
“As demand for ESG-driven investing has accelerated, so too has the number of data providers–each with varying information, reporting components and levels of transparency. This has created significant confusion and subjectivity for investors to assess the magnitude and direction of individual companies’ ESG-related issues. Concerned by the numerous ESG methodologies and data sets available, investors have expressed the need for a more transparent and disciplined framework that focuses only on the ESG-related business issues that could impact the financial condition of a company–and ultimately their portfolio’s investment return.”
Leaders within financial and other institutions are well aware of this surfeit of information. The head of sustainable finance at a leading investment bank, speaking to the proliferation of climate metrics, was quoted earlier this month as follows:
“My mantra tends to be: if we could have better data on fewer things that matter more […] Companies feel like they’re asked for too many different things by too many different people, and that the list is changing […] investors feel, to some degree, that they get a lot of noise and not a lot of signal.”
Central bankers apparently get it, as well. In early May 2020, in a speech delivered at the Delphi Forum, Benoît Coeuré, head of the Bank for International Settlements (BIS) Innovation Hub, reviewed the Innovation Hub’s 2021 initiative, which involved teaming up with the international G-20 forum on a TechSprint addressing green/sustainable finance generally and how to help financial institutions and investors “better collect, verify, and analyse data to understand whether their loan decisions and investments improve (or worsen) environmental outcomes.” He continued:
“This is a topical theme. Data and information availability has been highlighted as a major impediment to addressing climate change in recent years. The large number of standards and disclosure frameworks for corporate sustainability and climate-related issues, as well as different definitions and taxonomies, make it difficult to compare climate-related, green and sustainability information available to market participants. When firms make information public, they often do so across different reports, making such information difficult to locate, collate and analyse.”
AFTER THE MAY 20 EXECUTIVE ORDER
Federal government activity in line with the EO should lead to centralized and standardized US financial regulatory efforts to make sense of the many competing frameworks for climate change risk analysis, sources of information about climate change, the data that is analyzed, and the metrics that should be used by everyone, regulators and regulated entities alike. Indeed, in commenting on the EO, Secretary Yellen promised that:
“FSOC will work with Council members to improve climate-related financial disclosures and other sources of data to better measure potential exposures… [and] will work with regulators to share perspectives, identify common impediments, and find solutions to those impediments. A critical task is pulling together individual agency perspectives to assess how climate risks may impact the stability of the entire financial system.”
Presumably, Secretary Yellen will look to her staff, perhaps principally to John Morton, Treasury’s “climate counselor” appointed in April 2020 to lead the coordination efforts. What remains unclear, however, is exactly what this new structure and lineup of largely federal players may mean for the future of climate change regulation for insurers at the state level.
Keep in mind that US insurance regulators have exactly one non-voting representative on the FSOC (although there is a legislation pending to enable the representative to vote). At the same time, the National Association of Insurance Commissioners (NAIC) is moving slowly to develop a position on climate change regulation and the New York Department of Financial Services (DFS) remains the only US financial services industry regulator, state or federal, that has developed a more or less comprehensive climate change regulatory framework.
It is a leap, however, from having a framework, to guiding regulated entities in making sense of the existing jumble of climate change data and metrics—a jumble soon to be augmented with competing climate change models being developed by modelling companies and perhaps also by others, including possible state and federal agencies.
Although there are many uncertainties, this new initiative probably also means that the odds have improved for greater convergence between US regulatory standards and processes, on the one hand, and the rest of the world on the other. Such alignment could help avoid an outcome in which differing approaches—with each country or region pursuing its own favored goals, methods and requirements—create gaps and inconsistencies and increase risk.
In fact, Secretary Yellen committed Treasury to “engage fully with our global partners through the G-7, G-20, and Financial Stability Board [to] promote a strong and consistent global approach.” How quickly this happens and how far any such convergence might extend is of course subject to a host of factors and variables, including US political developments. While it would appear that the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), along with others, may be well placed to help guide US regulators, even experienced central bankers understand how much work banks have yet to do.
Recently, a task force co-chaired by senior regulators from the European Central Bank (ECB) and the Federal Reserve concluded:
“[T]hat [bank regulators] still need an enhanced toolbox that can better measure climate risks. This is why the ECB is encouraging banks to enhance both the quantity and the quality of their climate-related disclosures, and to become more transparent about their overall exposures to climate-related risks. Banks are still in the early stages of incorporating climate change into their risk frameworks; risk identification and risk limits around climate-related goals do not yet actually feature in their risk management processes. This needs to change. Euro area banks need to drastically improve their capacity to manage climate-related and environmental risks and start acknowledging how these risks can drive others, including credit, market, operational and liquidity risks.”
Clearly, US bank regulators are playing catch-up, but the distance between them and European bank regulators should shorten considerably as 2021 progresses. That said, the picture for US insurers is less clear.
STATE REGULATORS AND CLIMATE CHANGE
In late May 2021, the International Association of Insurance Supervisors, working with the UN-sponsored Sustainable Insurance Forum, published its revised “Application Paper on the Supervision of Climate-Related Risks in the Insurance Sector” that offers insurance regulators worldwide a mix of advice, illustrations, examples and recommendations with respect to constructing or upgrading a climate change insurance regulatory framework. However, apart from the New York DFS, it is not apparent that any state that has sought to develop a climate risk regulatory framework for insurers.
The DFS’ work on its framework continues; industry and interested-party comments on New York’s proposed framework are due by June 23, 2021. There is one state—Connecticut—with legislation pending (S.B. 1047) that would require insurers to report to the state Insurance Department on fossil fuel-related investments and premium income, and would in turn require the Insurance Department to prepare an annual climate change report for the state legislature. It is unclear, however, whether this bill will advance over insurer opposition in the few weeks remaining in the state’s 2021 legislative session.
In addition, submission of climate change disclosures by insurers will be required again in 2021 by a number of states (California, New York and Washington State, among others). What’s more, the NAIC’s Climate and Resiliency Task Force recently decided not to make any changes in the NAIC’s disclosure survey. Insurers again have the option of submitting the FSB’s Task Force on Climate-related Financial Disclosures (TCFD) survey in place of the NAIC survey.
With a little more than 150 days until the start of the biggest climate change summit of the year (the United Nations Climate Change Conference of the Parties, or COP26) in Glasgow, Scotland, on November 1, 2021, there’s an old joke about how few working days (70? 80?) will be left to delegates to prepare after eliminating weekends, national and religious holidays, vacations (allowing for national differences), a sick day or two, preparing for and attending other conferences, etc. For US government officials engaged in the US whole-of-government climate change assessment exercise called for by the EO, there will be even fewer days to prepare for COP 26. Meanwhile, many US insurers will be engaged in the same climate change disclosure process as in years past, while also monitoring the final steps in the New York DFS process to adopt a climate change regulatory framework. Whether there will be any progress to report from the NAIC on climate change remains to be seen.