On October 21st, the Financial Stability Oversight Council (FSOC) issued its Report on Climate -Related Financial Risk¹.  The report covers several broad themes along with some 35 specific recommendations directed at U.S. financial regulators that set forth necessary actions to identify and address climate-related risks to the financial system and promote the resilience of the financial system to those risks.  The specific recommendations, focused on risk measurement, quantification, and disclosures.

In our view, the recommendations rightly avoid restricting lending practices—an approach more in line with European regulations with their emphasis on impact or “double materiality.”  But also, FSOC’s initiative should serve to accelerate ESG integration practices among asset owners and investors and lead to a reduction in investor confusion and misunderstanding regarding sustainable investing.

The Financial Stability Oversight Council (FSOC), which was established in 2010 pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, is charged with identifying and responding to emerging threats to U.S. financial stability.  In this capacity, FSOC has been monitoring climate-related financial risks that are now viewed as an emerging threat to the financial stability of the United States.  FSOC notes that 2020 was a “historic year of extremes” for the United States, based on data provided by the National Oceanic and Atmospheric Administration’s (NOAA’s) National Centers for Environmental Information (NCEI).  According to a report issued by AON, economic losses from natural disasters were estimated at $268 billion in 2020².  Refer to Chart 1. 

Chart 1:  United States Billion-Dollar Climate and Weather Disaster Events

Notes of Explanation:  Event counts and total cost estimates reflect weather and climate disaster events with costs exceeding on billion in CPI-adjusted 2020 dollars.  Source: NOAA NCEI, “Billion-Dollar Weather and Climate Disasters.”

The efforts of the FSOC should benefit asset owners and investors in the following three ways:

  1. While asset owners, investment managers, investors and others have already begun to factor relevant and material ESG risks generally and climate risks in particular into investment decisions, such efforts are likely to be stepped up and accelerated.  
  2. FSOC Council members, which include 10 voting member entities and two non-voting member organizations³, including the Securities and Exchange Commission (SEC), are expected to coordinate and speed up deliberations related to the recommendations made by FSOC.  This should be beneficial as regulations applicable to the various constituencies supervised by these entities are likely to converge and be more consistent.  Such actions would serve to address the confusion and misunderstanding that has arisen in the marketplace as well as in the minds of sustainable investors4
  3. FSOC’s acknowledges the interconnectedness of the global financial system and advocates in favor of working with their international counterparts.  Especially relevant for financial firms with operations overseas, a cooperative effort is more likely to lead to harmonized rules and regulations and diminish the potential for divergence that may already be emerging between Europe’s impact oriented regulatory direction and the U.S. ESG risk-oriented approach.

¹ Full report at:  FSOC Report on Climate-Related Financial Risk (treasury.gov)

² Source:  AON. Weather, Climate & Catastrophe Insight: 2020 Annual Report 

³ The Council is composed of ten voting members who head the U.S. Department of the Treasury, the Board of Governors of the Federal Reserve System (Federal Reserve Board or FRB), the Office of the Comptroller of the Currency (OCC), the Consumer Financial Protection Bureau (Bureau or CFPB), the Securities and Exchange Commission (SEC), the Federal Deposit Insurance Corporation (FDIC), the Commodity Futures Trading Commission (CFTC), the Federal Housing Finance Agency (FHFA), and the National Credit Union Administration (NCUA), along with the independent member with insurance expertise, plus five nonvoting members. Two of the nonvoting members head the Office of Financial Research (OFR) and the Federal Insurance Office (FIO). The other three nonvoting members are a state insurance commissioner, a state banking supervisor, and a state securities commissioner designated by their peers.

4 Refer to https://sustainableinvest.com/rapid-growth-in-esg-funds-calls-for-adoption-of-standards/

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