Financial Institutions Gear Up for Climate-Related Financial Risk Implications under Executive Order 14030

By: Celeste Mitchell-Byars, LEXIS PRACTICAL GUIDANCE

President Biden recently signed Executive Order 14030, Climate-Related Financial Risk (May 20, 2021) (Executive Order)¹ to address the climate-related financial risks of federal programs. The Executive Order directs a number of federal agencies to take action to address climate-related financial risks. This article explores key areas of the Executive Order that could have potential implications for financial institutions.

The Executive Order establishes clear policy objectives to:

• Advance consistent, clear, intelligible, comparable, and accurate disclosures on climate-related financial risk
• Mitigate climate-related financial risks and drivers
• Identify causes of and address disparate impacts on disadvantaged communities and communities of color
• Drive the creation of well-paying jobs
• Achieve a net-zero emissions economy by no later than 2050

This Executive Order is directed to federal agencies in respect of federal programs. However, the Executive Order also highlights that the failure of financial institutions to account for climate-related financial risk threatens the competitiveness of companies and markets, negatively impacts consumers, and hinders the ability of financial institutions to serve their community appropriately and adequately. It stands to reason that financial institutions should expect increased regulatory focus on financial risks arising from climate change, including weather events that increase physical and transition risks.

Summary

Key provisions of the Executive Order and implications for financial institutions are summarized below.

Government-Wide Climate-Related Financial Risk Strategy

The Executive Order calls for development of a government-wide climate-related financial risk strategy (strategy) to address climate-related financial risks. The strategy will focus on:

• Measuring, assessing, analyzing, and mitigating climate-related financial risk to government programs, assets, and liabilities
• Assessing the financing needs associated with achieving net-zero greenhouse gas emission and adapting to impacts of climate change
• Evaluation of private and public investments to meet financing needs while advancing economic opportunities, worker empowerment, and environmental mitigation in disadvantaged communities and communities of color

Achieving net-zero greenhouse gas emission by 2050 is the goal stated in the Executive Order. Significant federal funding is earmarked for emission-reducing solutions, and financial institutions will be relied upon to provide sustainably linked loans and other climate commitments. The assessment of the federal government climate-related fiscal risk exposure will be published upon completion and annually thereafter. Financial institutions should begin assessment of climate-related financial risk as it relates to federal lending programs. Institutions should expect regulatory changes around financial risk and regulatory reporting that impact key risk categories: credit, liquidity, operations, and strategy; changes to risk appetite to include climate-related financial risk; and enhanced risk management, particularly around stress-testing and modeling.

Advancing Equality and Equity

Agencies are asked to undertake analysis of the risk climate change will have not only on the federal government, but on the financial security and viability of consumers, businesses, and the U.S. financial system. Advancing equity to create opportunities for improvement of historically underserved communities is another goal in the Executive Order. According to President Biden, advancing equity requires a systematic approach to embedding fairness in federal government decision-making processes, and working to redress inequities in federal policies and programs that serve as barriers to equal opportunity. Each agency is required under the Executive Order to examine and report on barriers to enrollment, access to federal benefits and service programs, and procurement and contracting opportunities for disadvantaged communities and communities of color.

Financial Regulators Assessment of Climate-Related Financial Risk

The Secretary of the Treasury is directed to work with the Financial Stability Oversight Council to perform climate-related financial risk assessments and provide recommendations on:

• Climate-related financial risks to the stability of the U.S. financial system and approaches to mitigate these risks
• Coordination and information sharing of climate-related financial risk data amongst agencies and executive departments, as appropriate
• Accountability reports on climate-related financial risk policies and programs
• Assessment and integration of climate-related financial risk to federal programs

Further, the Executive Order accounts for the potential of major disruptions in private insurance coverage as a result of climate change impacts. The increase in insurance payouts as a result of weather events, cost of assets, and property damage from extreme weather change, is predicted to have a substantial economic impact on the financial system. The agency is required to perform an assessment of climate-related issues and gaps in the supervision and regulation of insurers.

The financial regulatory agencies are to focus on climate change and financial risk attributed to many other risk areas including operations, credit, liquidity, reputation, and strategy risks. The emphasis of physical and transition risk in the Executive Order, as a component of climate-related financial risk, emphasizes the impact of these events on the financial system. Physical risk is the risk from climate change such that increased extreme weather conditions lead to supply chain disruptions and present physical risk to assets, publicly-traded securities, private investments, and companies. Transition risk is the global shift away from carbon-intensive energy sources and industrial processes.

Life Savings and Pensions

The Secretary of Labor is directed under the Executive Order to identify and recommend actions that can be undertaken by law to protect the life savings and pensions of U.S. workers and families from the threats of climate-related financial risks. The Employee Retirement Income Security Act (ERISA) sets out fiduciary duties and obligations that include responsibility for investing the savings or selecting employee investment alternatives. ERISA imposes these duties and obligations on fiduciaries of ERISA-governed employee benefit plans. The Executive Order provides for rulemaking under ERISA where such rules are designed to protect the interests of plan participants and beneficiaries. The Secretary of Labor is authorized to take actions including suspending, revising, or rescinding rules passed during the prior administration that do not consider ESG factors in investment of savings and pensions. Rulemaking to integrate ESG factors into retirement laws and regulations is a likely result of any action taken by this agency.

Integration of Climate-Related Financial Risk in Federal Lending, Underwriting, and Procurement

The Executive Order requires an assessment and integration of climate-related financial risk into federal financial management and financial reporting, especially as that risk relates to federal lending programs. The lending, underwriting, and procurement functions of a financial institution are likely to undergo changes once regulations are developed. The Executive Order is not intended to discourage lending or underwriting to companies that produce large amounts of carbon emissions. In fact, according to the Executive Order, preference in federal procurement and contracting may be advanced as necessary to companies that provide greenhouse gas disclosures and reduction targets in line with the Executive Order.

Amendments to federal programs and appropriate regulations will require:

• Federal suppliers to publicly disclose greenhouse gas emissions and climate-related financial risk and to set informed reduction targets based on science and behavioral analysis
• Federal agency procurements to consider the social cost
  of greenhouse gas emissions in procurement and give preference to bids and proposals from suppliers with a lower social cost of greenhouse gas emissions where appropriate and feasible
• Federal lending policies and programs, as well as underwriting standards, loan terms and conditions, asset management, servicing, and procurement, to effectively integrate climate-related financial risk into overall processes

Climate-Related Financial Risk Disclosures

The Executive Order directs federal agencies to develop climate-related financial risk disclosure guidelines that reflect behavioral-science insights and are consistent, clear, intelligible, comparable, and accurate. The Executive Order does not contain a mandate for climate-related financial risk reporting. Such information on climate-related financial risk is essential for informed financial decision-making by individuals, businesses, and the government. It can be used to design government policies to better serve the American people. Financial institutions should expect changes to regulations requiring climate-related financial risk disclosures. The proposed changes are directed to be in line with the following components, spelled out in Executive Order 13707, Using Behavioral Science Insights to Better Serve the American People (September 15, 2015):²

• Streamlined forms
• Comprehensible content
• Effective presentation
• Promote public welfare, as appropriate
• Encourage or make it easier for Americans to take specific actions

Environmental, Social, and Governance (ESG) Disclosures

Public companies are currently required under federal regulation to provide material information disclosures including those resulting from ESG matters. While there is no single regulatory standard for reporting on ESG, increasingly ESG disclosures are included in material information reports. ESG disclosures provide reporting on financial risks and impacts associated with climate change, an institution’s use of natural resources, and the effect of its operations on the environment, diversity/inclusion, equity, and community investments and other matters that are material to shareholders. Consistent with current efforts by federal agencies, institutions will be required to disclose the impact of climate change and ESG matters as part of the company’s financial statements.

Greenhouse Gas Disclosure

The Executive Order establishes an Interagency Working Group to determine the social cost of greenhouse gases (carbon, methane, and nitrous oxide), whose recommendations will be used to advance the Administration's goal to reduce greenhouse gas emissions and other regulatory actions. 

Greenhouse gases are proven to deplete the Earth’s protective ozone layer resulting in extreme weather conditions due to climate change. The Interagency Working Group is directed to assess disclosures on the emission of greenhouse gas, particularly as it relates to federal lending programs and procurement. Anticipated changes to the Federal Acquisition Regulations will require federal suppliers to disclose:

• Greenhouse gas emissions and climate-related financial risk
• Greenhouse gas reduction targets

Regulations around climate-related areas are anticipated for financial institutions, both directly to ensure the stability of the U.S. financial system and indirectly through lending and investments in affected sectors. Financial risk reporting for climate-related change faces challenges in light of the lack
of comprehensive and consistent data to analyze climate-related financial risks and equity by categories of race, ethnicity, religion, income, geography, gender identity, sexual orientation, and disability. Policymakers will need to coordinate approaches to mitigating climate-related financial risk; such efforts are currently being standardized in various areas.

Implications for Financial Institutions

Climate change is inevitable and also fundamental to the core of this Executive Order. Key areas of the Executive Order will necessitate changes to laws and regulations by federal financial agencies thereby affecting the financial services industry. Agencies have begun amending policies and performing impact assessments of climate change on the financial system.

• The Federal Emergency Management Agency (FEMA) begun implementing the Federal Flood Risk Management Standards as set out in Executive Order 13690 of January 30, 2015
  (Establishing a Federal Flood Risk Management Standard and a Process for Further Soliciting and Considering Stakeholder Input).³ Executive Order 13690 was reinstated under this Executive Order, providing the go-ahead for FEMA to implement the standards. Federal Flood Risk Management Standard was established to address the increased flood risk as a result of climate change impact of flooding.
• The Securities and Exchange Commission (SEC) is continuing its focus on climate-related disclosure requirements. The SEC created a task force for climate change and ESG. ESG disclosure requirements for public companies are anticipated in late 2021.
• Other financial regulatory agencies, including the Federal Reserve Board, the Office of the Comptroller of the Currency, and many federal agencies have all conducted assessments on the impact of climate change to the financial system broadly and are proposing new goals and policies to advance the objectives of the Executive Order and in particular ensuring equal and equitable access to government programs by all Americans.

It is pertinent that institutions anticipate new or revised regulatory standards around climate-related financial risks and begin establishing a culture of preparedness within the institution, assessing government programs and climate-related financial risk disclosures to include physical and transition risk, incorporating climate-related financial risk into overall risk and controls framework of the institution, identifying and redressing inequities in the institution’s policies and programs to ensure equal opportunity with a focus on disadvantaged communities and communities of color, and enhancing disaster recovery plans and other business continuity controls to mitigate financial risks in areas prone to extreme weather-related events. 

Celeste Mitchell-Byars is a Content Manager and attorney writer for Practical Guidance, focused on Financial Services Regulation.  Ms. Mitchell-Byars has spent more than 20 years in-house at U.S. and foreign financial services institutions advising boards and management in connection with bank regulatory, risk and compliance management, finance, and financial technology. 

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1. 86 Fed. Reg. 27,967 (May 25, 2021). 2. 80 Fed. Reg. 56,365 (Sept. 18, 2015). 3. 80 Fed. Reg. 6,425 (Feb. 4, 2015).