US needs to update fiduciary duty and corporate disclosure rules, and put a price on carbon, Litterman-led report tells financial regulators

Pioneering climate risk group gives its feedback

Establishing a price on carbon is the “single most important step” the US must take to tackle climate risks and “drive the appropriate allocation of capital” –  so says the long-awaited report by the Bob Litterman-led Climate-Related Market Risk Subcommittee (CRMRS), commissioned by the US Commodity Futures Trading Commission (CFTC).

Putting a price on carbon is one of 53 recommendations put forward by the 34-strong subcommittee, which was set up to advise financial regulators in the US on climate risks. Members include former California Insurance Commissioner Dave Jones, Ceres President Mindy Lubber, UK green finance leader Ben Caldecott, Head of Stewardship at Vanguard Adrienne Monley and Herve Duteil, Chief Sustainability Officer for BNP Paribas Americas.

Its report, Managing Climate Risk in the US Financial System, is the first to be commissioned by a US regulator, and has been interpreted as an attempt to close the gap with Europe and China on sustainable finance.

‘A fundamental flaw in the economic system lies at the heart of the climate change problem — the lack of appropriate incentives to reduce GHG emissions. No discussion of climate related financial risk management can begin without focusing on this market failure’ – Bob Litterman

Risk veteran Litterman, most famous for developing the widely-adopted Black-Litterman portfolio optimisation model while at Goldman Sachs, is a well-known champion for carbon taxes. 

“A fundamental flaw in the economic system lies at the heart of the climate change problem – the lack of appropriate incentives to reduce GHG emissions. No discussion of climate-related financial risk management can begin without focusing on this market failure,” he says in his foreword. 

Given the uncertainty around the appropriate price for a tonne of carbon, the report states that the US should err on the side of caution when setting a price, ensuring that it “reflects the true social cost of those emissions”. 

Earlier this year, RI reported that Swedish pension giant Alecta uses an $870 carbon price in its 1.5°C scenarios. 

The report identifies “political inertia” as the “primary obstacle” to introducing a federal carbon price in the US, and says the decision “is beyond the remit of financial regulators” and sits squarely with Congress. 

But, it argues, US regulators are not doing enough with the powers at their disposal.  

Existing legislation provides them with “wide-ranging and flexible authorities that could be used to start addressing financial climate-related risk now”, the expert group states, observing that “these authorities and tools are not being fully utilised to effectively monitor and manage climate risk”.

One of the report’s key recommendations is that US financial regulators should incorporate climate-related risks into their mandates and “develop a strategy for integrating these risks in their work, including into their existing monitoring and oversight functions”. 

“US financial regulators must recognise that climate change poses serious emerging risks to the US financial system, and they should move urgently and decisively to measure, understand, and address these risks”, it stresses, warning that a “sudden revision of market perceptions about climate risk could lead to a disorderly repricing of assets, which could in turn have cascading effects on portfolios and balance sheets and therefore systemic implications for financial stability”. 

The experts also call out the US’ reluctance to participate in many of the international initiatives attempting to tackle climate risks, urging it to join groups like the Central Banks and Supervisors Network for Greening the Financial System. Federal Reserve Chair Jerome Powell had said previously that the central bank was looking to join. 

Another key recommendation of the report is that US financial regulators should follow the lead of other jurisdictions by performing its own climate stress tests, and assist the financial institutions they regulate to follow suit. 

Corporate disclosure is described in the report as “an essential building block” to managing climate risk, and says more needs to be done to increase the scope and quality of reporting by companies. It suggests that the Securities and Exchange Commission could update its 2010 Commission Guidance Regarding Disclosure Related to Climate Change in “light of global advancements in the past 10 years”.

The report also cites “policy uncertainty” around the types of financial products US firms can offer employees through their employer-provided retirement plans as a limiting factor – last month investors slapped back proposed changes by the US Department of Labor (DOL) on how fiduciaries of employee pension plans should treat ESG.

It recommends that the US Government address this by clarifying existing regulations on fiduciary duty, particularly around the “appropriateness of making investment decisions using climate-related factors—and more broadly, ESG factors that impact risk-return”. 

“The central message of this report is that US financial regulators must act on the serious

emerging risks climate change poses to the US financial system”, committee representatives from Ceres, Environmental Defense Fund, OSClimate, The Nature Conservancy and World Resources Institute said in a joint statement.