The Federal Reserve proposes a weather risk guide for large financial institutions (2023)

On December 2, 2022, the Board of Governors of the Federal Reserve System (Federal Reserve)PublishedProposed Principles for Managing Climate-Related Financial Risks for Large Financial Institutions (the Proposal). The proposal is pushing large financial institutions[1]consider how best to identify, measure, monitor and control the different risks related to climate change at different time horizons. It also establishes that large financial institutions must monitor microprudential risks, including credit, market, liquidity, operational, and legal and compliance risks, as well as other financial and non-financial risks that may arise from climate change.

The proposal aims to help boards and senior management of financial institutions to integrate climate-related financial risk mitigation into their broader risk management frameworks, in line with sound and safe practices and with the rules and regulations. Federal Reserve guidelines for responsible corporate governance.

Large financial institutions are defined as those with assets greater than $100 billion that are subject to Federal Reserve regulation, including US operations of non-US banking organizations. The Federal Reserve's guidance is based on the premise that climate change is an emerging risk to the safety and soundness of financial institutions and to the financial stability of the United States.

Principles of climate risk management

The proposal addresses both the physical aspect[2]and transition risks[3]associated with climate change. The proposal serves as an overarching framework covering six key aspects of climate-related financial risk management: (i) governance; (ii) policies, procedures and limits; (iii) strategic planning; (iv) risk management; (v) data, risk measurement and reporting; and (vi) scenario analysis.

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guide:The board of directors of a financial institution must understand the impact of climate-related financial risks on the institution, oversee risk-taking, allocate resources to support climate-related risk management, and assign responsibilities. Management must implement policies consistent with the strategic direction of the Board; oversee the development and implementation of processes to identify, measure, monitor and control climate-related financial risks; and periodic reporting to the Board of Directors.

Policies, Procedures and Limits:Management should integrate weather-related financial risks into the financial institution's policies, procedures, and limits, consistent with the strategy and risk appetite established by the board.

strategic planning:The board and management of a financial institution must consider climate risk when determining the overall business strategy, risk appetite and capital plan. The board and management should also consider how weather-related financial risks impact other operational and legal risks and stakeholders.

Risk management:Management should oversee the development and implementation of processes to identify, measure, monitor and control exposure to weather-related financial risks within existing risk management frameworks, develop processes to measure material climate-related financial risks climate, communicate these risks to internal stakeholders and include them. in the financial institution's risk management system, including internal controls and internal audit.

Data, risk measurement and reports:Management should incorporate climate-related financial risk information into internal reporting, monitoring and escalation processes, as well as monitor developments in data, risk measurement, modeling and reporting methodologies and integrate them into climate-related financial risk management. the weather.

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scenario analysis:Management should develop and implement forward-looking analytical frameworks for climate-related scenarios that are appropriate to the financial institution's size, complexity, operations, and risk profile. These frameworks should include clearly defined objectives that reflect a financial institution's overall climate-related financial risk management strategies. The proposal suggests that the scenario analysis framework can serve multiple purposes, e.g. B. Estimate climate-related risks and potential losses under a variety of scenarios, including extreme but plausible scenarios. The proposal notes that these scenario analyzes differ from traditional stress test models, which focus on the potential impact of temporary shocks on short-term economic and financial conditions. (The Federal Reserve reportsAnnouncedin September 2022, which conducted a pilot climate scenario analysis exercise with the six largest financial institutions in the US in early 2023).

Note that if the US Securities and Exchange Commission (SEC) March 2022 on climate risk disclosures, which will require SEC registrants to disclose the climate scenario analysis that the registrant uses to assess the impact of climate-related risks. The proposal does not address significant additional disclosure requirements that the SEC's scenario analysis rule could impose on financial institutions.

management of risk areas

The proposal also directs management to be aware of how weather risk assessment and mitigation relates to other types of traditional risks, such as: B. Credit risk, liquidity risk, other financial risks (for example, risk and compliance risk (for example,., fair loans) and other non-financial risks.

Evaluate Governors

the suggestion wassupportsby six of the seven Federal Reserve governors.

Governor Michelle Bowman issued aExplanationHowever, who gave preliminary approval for the proposal's publication, with the aim of gathering public opinion, said that based on the comments received, he would decide on an additional vote to finalize the proposal. He specifically noted that the Federal Reserve "should consider the costs and benefits of any new expectations ... [and] additional trade commitments."

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Governor Christopher Waller issued a briefExplanationcontradictory because it contradicts the premise that "climate change risks pose a serious risk to the safety and soundness of large financial institutions and to the financial stability of the United States." He said that the stress tests of existing financial institutions are sufficient to determine the resilience of financial institutions in the face of severe macroeconomic shocks.

US banking regulators online

The proposal comes just over two years after the US Federal Reserve first acknowledged the impact of climate risks on financial stability in its annual report.Financial Stability Report(More information on the November 2020 report can be found hereblog post). Since then, President Jerome Powellconsistentthat climate risk mitigation comes from the "assigned legal mandates" of the Federal Reserve. In fact, the suggestion comes from theClimate Report October 2021of the Federal Stability Oversight Council (FSOC report), whose voting members include the heads of the Federal Reserve, the SEC, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the Commodity Futures Trading Commission (CFTC) and five other financial regulators. The FSOC report urged all member agencies to promote consistent, comparable and actionable disclosures that enable investors and financial institutions to incorporate climate-related financial risks into their investment and lending decisions.

According to the Federal ReserveBoard Memorandum, the proposal is essentially similar to those issued by the OCC in December 2021 (cf.on here) and the FDIC in March 2022 (cf.on here). In fact, the Federal Reserve noted that its staff developed the proposal in consultation with staff at the OCC and the FDIC and "intends to work with those agencies to promote consistency in the supervision of large banks through guidance." end between agencies".

The proposal includes some notable changes from the OCC and FDIC principles:

  • guide: The Federal Reserve sought to clarify the roles of directors versus management to allay directors' concerns and better align with the broader concept that directors have an oversight and input role, while management's role is Implement risk controls and report relevant information to the Board of Directors.
  • management of risk areas: The proposal omits a sentence included in the OCC and FDIC versions that says the agencies "will develop these risk assessment principles in later guidance." The preamble to the proposal references the Principles and "any further guidance on climate-related financial risks," which stops short of the OCC and FDIC statement that "there will be" development of future guidance, and the proposal is limited by its terms to "Financial Risk."

In particular, given Governor Bowman's objection that the proposal would impose a number of new obligations on affected financial institutions, the proposal does not address costs. The Federal Reserve is not subject to any legislation that would have led agencies like the SEC and CFTC to perform a cost-benefit analysis in publishing the proposed rules, but the proposal would clearly require extensive compliance obligations.

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the suggestion wasPublishedto the Federal Register on December 8, 2022, and comments must be received by February 6, 2023.

Interact with global regimes in managing climate-related financial risks

The proposal reflects the approach taken in many countries to address threats to the stability of the financial system and the safety and soundness of regulated institutions by introducing measures related to managing climate-related financial risks. In the UK, the Bank of England was the first central bank to set prudential expectations for banks and insurers to address weather-related financial risks, covering governance, risk management, scenario analysis and disclosure. . In the UK, climate change risk management has been included as a central part of the supervisory approach and is part of the normal supervision that banks and insurers are subject to. In Europe, the European Central Bank has an advanced weather-related financial risk management programme, which includes comprehensive weather risk resilience testing. Therefore, global banks should review the proposed principles in light of their broader framework and commitments related to climate-related financial risk management.

closing remarks

1The proposal defines "financial institutions" to include state member banks, bank holding companies, savings and loan holding companies, foreign banking organizations with respect to their operations in the US, and nonbank systemically important financial institutions ( SIFI) regulated by the Federal Reserve.(I turn)

2The proposal defines physical hazards as damage to people and property from acute weather events, such as hurricanes, wildfires, floods, and heat waves, and chronic climate changes, including higher average temperatures, changes in precipitation patterns, increased sea ​​level and ocean acidification.(I turn)

3The proposal defines transition risks as burdens on institutions or sectors resulting from changes in policy, consumer sentiment, and changes in business or technology associated with changes that would be part of a transition to a low carbon economy.(I turn)

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