U.S. Can Learn From Others on Managing Climate Finance Risks

The U.S. is a latecomer to climate finance regulation, but the White House seems determined to move fast.

On Thursday it issued a new executive order on climate-related financial risk that requires a swathe of agencies and regulators, from the Federal Reserve to the Federal Retirement Thrift Assessment Board, to consider climate risk in their oversight work. Some departments, like Veterans Affairs, must also consider it in procurement decisions.

The executive order requires some tight turnarounds, with a report on government financial risks due in just 120 days, and recommendations from the Treasury Secretary on financial risk due in 180 days. But move fast it should—the climate crisis gets worse and more urgent as time passes, and after four years of the Trump administration using federal regulation to dampen climate action, there’s ground to make up.

There is an upside to this tardiness, however. The U.S. can now draw lessons from other countries, particularly the European Union, which is several years into developing and deploying a wide-ranging sustainable finance agenda. 

The executive order begins by setting out three objectives: to identify climate risks, mitigate them, and support the government’s goal of zeroing out emissions by 2050—all while addressing disparate impacts on disadvantaged communities and communities of color.

In practice, the order focuses on risk assessment and disclosure. That might be so that regulators and agencies can work within their existing mandates. But there are some specific things the U.S. can and must do.

The executive order’s ultimate effect will depend upon how financial regulators and government departments interpret and implement it—especially the offices that are overseeing and coordinating a lot of it: the Treasury, the Office of Management and Budget and White House panels such as the National Economic Council.

Firstly, they should be clear about the function of climate risk analysis and disclosure. It’s necessary but it’s unlikely, on its own, to redirect capital in the ways that U.S. climate envoy John Kerry suggested before it was released. In contrast to Kerry’s remarks, disclosure alone doesn’t tend to move markets. Europe’s sustainable financial measures are explicitly in support of its environmental goals.

Devising more intricate and precise measurements of either emissions or climate impact risks can be fascinating rabbit holes, but will waste precious time. Numerous methodologies already exist. Few are perfect, but the U.S. could limit itself to improving existing systems rather than starting from scratch.

Secondly, take an international comparative approach. Financial regulatory frameworks vary a lot around the world, but the U.S. can and should support a convergence on the underlying notions of what is and is not climate-aligned. 

Unfortunately Kerry has already shown an aversion for one of the main European climate finance regulatory benchmarks: the taxonomy of which assets count as sustainable. In March he told the Financial Times that the U.S. was unlikely to adopt this EU system, despite appeals from France. The Network for Greening the Financial System—a coalition of central banks which the Fed belatedly joined last year, after most of other developed economies had already signed on—has also suggested that “global comparability and consistency” would be a good thing. 

The EU taxonomy became the subject of fierce lobbying from industry and member states—a fate that the U.S. could avoid. A system that at least maps to it would be helpful. Lengthy disputes over which activities are green or not will make for an unbearably slow transition. It’s also increasingly clear that weak definitions and rules—say, allowing natural gas to be counted as clean—are self-defeating, because investors are skeptical of greenwash.

The U.S. should be clear on what its goal is. The big tension is always the same: are you protecting climate from finance, or finance from climate? Considering both is sometimes called “double materiality.” Focusing on protecting finance might seem like a politically safer option, but it’s not necessarily correct.

“The main thing for the U.S. administration to avoid would too much emphasis on disclosure, stress testing and scenario analysis and not enough on policies that will actually shape the net-zero carbon transition,” says Josh Ryan-Collins, an academic at University College London who has argued that financial regulators could be proactive in reducing climate and environment harm, even from within a narrow risk-based mandate.

Clarity from the administration could help avoid fights over “market neutrality” in the role of the Fed, one of the most powerful entities covered by the executive order. Neutrality has been cited as a reason for central banks to ignore climate factors in their asset purchasing programs. But several analyses of such programs have shown this isn’t true. Asset purchase programs, including the Fed's Covid corporate bond buying, often inadvertently skew towards the most polluting companies and sectors. It makes little sense for central banks to actively support the accumulation of risks they are simultaneously trying to manage and avoid.

The EU has been explicit about its goal for a financial system that supports its environmental goals. While the U.S. administration is more hampered by Congressional politics and the need to work with existing mandates, signals from the White House would at least help to resolve these questions in day-to-day decisions among regulators. 

The executive order will require many federal officials to get up to speed on climate change. A frank appraisal of what has already happened would not only save time, it would also allow the U.S. to skip over some old debates and enact a coherent and effective approach.

Kate Mackenzie writes the Stranded Assets column for Bloomberg Green. She advises organizations working to limit climate change to the Paris Agreement goals. Follow her on Twitter: @kmac. This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

©2021 Bloomberg L.P.

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