President Biden met with financial regulators this week to discuss how climate change may adversely affect the financial sector. The meeting comes one month after Biden issued an Executive Order on Climate-Related Financial Risk directing officials to submit reports (by November) on how to address climate change with financial regulations.
The order states that it is the Biden Administration’s policy to:
advance consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk, including both physical and transition risks; act to mitigate that risk and its drivers, while accounting for and addressing disparate impacts on disadvantaged communities and communities of color and spurring the creation of well-paying jobs; and achieve our target of a net-zero emissions economy by no later than 2050.
Leaving aside (for now) whether any of these policies will mitigate climate change, this order is music to the ears of D.C. consultants and lawyers who have been working on climate change disclosure issues for the last few years. In fact, the movement has gathered momentum internationally – the G7 finance minsters have even announced their unanimous support for new mandatory climate risk disclosures. (The ministers are very good at agreeing on aspirations.)
While requiring “accurate disclosure of climate-related financial risk” may sound perfectly reasonable, to the extent that such risks are actually material, they already must be disclosed under current securities laws.
So what gives?
As my coauthors and I outline in a new paper, the securities laws are something of a mess. In particular:
The Supreme Court and regulatory definitions…are quite general and provide little practical guidance to issuers. There is a spirited debate about whether “principles-based” or more “prescriptive,” bright-line rules should govern disclosure by issuers of material information. There is a major effort to redefine what is material, to include information that is directed at achieving various social or political objectives.
Advocates insist that their new rules will promote “accurate” disclosures of risks because they will be “implemented with scientific integrity at the forefront,” but nothing could be further from the truth. Neither the climate science nor humans’ ability to forecast economic outcomes permits the type of disclosures that supporters claim to want.
That’s actually one of the reasons so many public companies are supporting new disclosure rules and turning to consultants. There is no clear and obvious way, based on science, to “advance consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk,” but firms recognize that they will (most likely) be forced to disclose anyway.
At the macro level, there is still significant disagreement over core issues in our best set of climate models. (For a quick overview, check out page 1013.) At a more micro-level, the U.N. Intergovernmental Panel on Climate Change (IPCC) itself acknowledges that their ensemble of models “cannot be taken as a reliable regional probability forecast.” (Again, page 1013).
The reality is that the Earth’s climate has been changing for billions of years, with average temperatures drastically increasing and decreasing for centuries, long before industrialization and human behavior could have influenced temperatures.
It is true that most scientists agree that the Earth has warmed over the past 60 years, and that a portion of that warming is likely due to carbon dioxide emissions. Those facts do not, however, equate to the idea that there is or will be a climate crisis.
For all their improvements over the years, climate models still have not been able to accurately depict historical data. Matters become even more complicated when scientists try to look forward and make educated guesses at how the global climate will change from natural forces and human behavior not just decades in advance, but centuries. Doing so requires a lot of assumptions about science, society, and politics.
Even so, many politicians – and Federal Reserve officials – ignore the legitimate scientific debate among climate scientists about why warming is happening and by how much. Instead, they try to link extreme weather events to potential financial losses, particularly for insurance companies. Yet evidence compiled by the IPCC does not support any significant upward trends in extreme weather events, including tornadoes, hurricanes, droughts, floods, or wildfires.
Despite these facts, Americans are supposed to believe that, somehow, public companies can determine their individual risks associated with (and, presumably, contributions to) climate change, thus enabling better financial disclosures.
If that’s where the story ended, this effort would be exposed as pure fantasy. Unfortunately, things could get much worse.
Federal financial regulators – especially banking regulators – have a great deal of discretion to regulate how financial firms operate, including whom they finance. Even absent the Dodd-Frank Act, which expanded discretion to deal with the ill-defined concept of financial stability, federal regulators could impose their will on banks without regard to any sort of scientific consensus.
If regulators deem, for instance, that lending to fossil fuel companies puts a bank’s reputation at risk, or that doing so constitutes an unsafe or unsound practice, they can force the bank to change its lending behavior and customer base. (Think Operation Chokepoint, a controversial program for which the FDIC was absolved of any statutory violations).
Admittedly, it remains unclear exactly what banking regulators will do, but when a president issues this kind of executive order after openly discussing his desire “to get rid of fossil fuels,” one should worry.
Anyone unaccustomed to the ways of Washington, D.C., might wonder why corporate America is not fighting to head off these efforts. But the companies’ main efforts, so far, have been perfectly rational. They are working with regulators, as they should, to craft “reasonable” rules that mitigate their liability under securities laws.
One important remaining question, though, is whether acquiring protection from this type of liability will expose the companies to other kinds of liability.
If, for example, they disclose their climate-change-inducing activities in accordance with new SEC rules, will those disclosures subject the companies to new lawsuits for causing climate change? Will banking regulators then argue that lending to such companies constitutes an unsafe or unsound practice? Or that such lending increases reputational risk?
Many Americans may not realize it, but banking regulators have the authority to take such actions at their discretion. And they had it long before the 2010 Dodd-Frank Act came along, so the problem is much bigger than simply what the Financial Stability Oversight Council might do.
There is no doubt that Congress has created a highly flawed financial regulatory framework, one that gives federal financial regulators multiple avenues for imposing climate-related regulations. It simply does not matter how much they base these regulations on imprecise metrics and ill-defined concepts.
It will be very interesting to see if corporate executives keep playing ball or if they finally decide to push back.