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“Imperative” for the SEC to focus on climate risk as systemic risk – Commissioner Lee

Wide-ranging speech from SEC's Allison Herren Lee calls for an "all-hands on deck effort"

There will be a Keynote Interview with Commissioner Lee and RI’s Daniel Brooksbank at RI Digital: USA 2020 on December 2.

There is an imperative for the Securities and Exchange Commission, the US regulator, to focus on climate risk as systemic risk and work with domestic and international peers, Commissioner Allison Herron Lee has said.

In a wide-ranging speech at the Practicing Law Institute (PLI), Lee suggested there could be a role for the Financial Accounting Standards Board (FASB) and that the SEC could look at how credit ratings agencies incorporate climate change into their ratings.

The address was titled Playing the Long Game: The Intersection of Climate Change Risk and Financial Regulation and Commissioner Lee said climate change, unlike other types of risk, is potentially irreversible in terms of the damage it can cause.

“All of these factors increase the likelihood of an overall shock to the global economy with systemic implications. This creates an imperative for the SEC to focus on climate risk as systemic risk, and coordinate with domestic regulators through the Financial Stability Oversight Council, and with international regulators through the Financial Stability Board’s Standing Committee on Assessment of Vulnerabilities, to monitor and address this risk.”

And she cited evidence that climate risks are currently underpriced, “particularly with respect to long-dated assets, utilities, commercial mortgage-backed securities, and potentially municipal bonds, among others”.

She added that underpricing can lead to “abrupt and disruptive re-pricing” as markets discover anomalies. “This reckoning could be triggered by massive climate-related events or significant changes in legal requirements that can render assets and even business models obsolete in a very short timeframe.” She referred to the Bank for International Settlements’ “green swan” phrase.

She said that data was the place to start to deal with these issues and that “all policy should proceed from a foundation and clear-eyed analysis of accurate, reliable data”. 

“The SEC,” she said, “should work with market participants toward a disclosure regime specifically tailored to ensure that financial institutions produce standardized, comparable, and reliable disclosure of their exposure to climate risks, including not just direct, but also indirect, greenhouse gas emissions associated with the financing they provide, referred to as Scope 3 emissions.”

And she said the SEC itself needs to ensure it is cultivating relevant expertise in its hiring and training.

As for credit rating agencies, she noted that many already incorporate climate and other ESG factors into their ratings and asked whether the SECs should encourage increased transparency about how these factors are weighed. “And should our annual examinations of credit rating agencies assess both the transparency of these models and the consistency and accuracy with which they are applied?”

Citing the recent guidance from the International Accounting Standards Board on how climate risks should be reflected within financial statements, Lee asked whether the Financial Accounting Standards Board (FASB), the US standards setter, should “undertake a similar analysis of how climate risks may translate when applying GAAP [Generally Accepted Accounting Principles]?”

“This is an all-hands on deck effort,” she said. 

Her conclusion: “We have all recently witnessed in real time the market consequences of waiting until a crisis is upon us to respond. We need not suffer those consequences when it comes to climate change and ESG if we move thoughtfully and quickly.”