The rising importance of climate change at financial institutions

Banking organizations have no shortage of economic factors to navigate as geopolitical tensions continue and domestic monetary policy undergoes normalization. But banks in the United States and Canada also are staring down a new strategic imperative: addressing the impacts of climate change.

Climate change may not be on their radar yet, but it should be. Organizations need to educate their leadership teams, understand what may be necessitated by regulatory initiatives related to climate change, build or find talent to meet these new proposed requirements, assess the impact of climate change on their organization, and place a greater emphasis on sustainability in their broader corporate strategy.

New climate change regulations

Since December 2021, the United States’ Office of the Comptroller of the Currency (OCC), U.S. Securities and Exchange Commission (SEC) and Federal Deposit Insurance Corporation (FDIC) all have proposed principles for monitoring climate change-related risks, for evaluating banks’ exposure to climate change, and ultimately—in the case of the SEC—for requiring companies to disclose climate change-related risks and their financial impact.

Similar initiatives are underway in Canada, where the Office of the Superintendent of Financial Institutions (OSFI) has issued a draft guideline on climate-related risks and required disclosures that federally regulated financial institutions (FRFIs) are required to make. This guideline was developed from consultations with FRFIs and other stakeholders and the final version is expected to be completed by early 2023. The guideline requires FRFIs to describe the institutions’ processes for identifying, assessing and managing climate-related risks (among other required disclosures). FRFIs are expected to implement disclosures required by this guideline effective for fiscal periods ending on or after Oct. 1, 2023, but may choose to voluntarily adopt disclosure expectations earlier.

While the initial U.S. proposals focus on larger banking organizations (those with assets in excess of $100 billion, in the case of the FDIC and OCC proposals) or public companies (in the case of the SEC proposal), the reality is that if principles or rules are put in place for these larger participants, they may, in time, trickle down to smaller banking organizations—whether due to regulatory initiatives or investors’ increasing focus on climate change.

The FDIC and OCC draft principles largely focus on an institution’s efforts to provide its leadership team with the necessary guidance to create a framework for managing climate change-related risks across the organization.

While that is significant, it’s the SEC’s proposal that has garnered the most attention. Totalling more than 500 pages, the proposal lays out a comprehensive and substantial change to public company reporting. The SEC’s fact sheet covering the proposal states the rule would “require a domestic or foreign registrant to include certain climate-related information in its registration statements and periodic reports, such as on Form 10-K, including:

• Climate-related risks and their actual or likely material impacts on the registrant’s business,,strategy, and outlook;
• The registrant’s governance of climate-related risks and relevant risk management processes;
• The registrant’s greenhouse gas (GHG) emissions, which, for accelerated and large accelerated filers and with respect to certain emissions, would be subject to assurance;
• Certain climate-related financial statement metrics and related disclosures in a note to its audited financial statements; and
• Information about climate-related targets and goals, and transition plan, if any.”

Both the FDIC and OCC have indicated they will elaborate further on their proposals in 2022 based on the feedback the agencies receive from interested parties. The SEC’s proposed rule includes a phased-in compliance schedule based on a registrant’s filing status. If the SEC’s proposed rules are adopted effective in December 2022, the rule would go into effect in fiscal year 2023 for all disclosures for large accelerated filers that file in 2024. One exception is some GHG emissions metrics, which would need to be disclosed in fiscal year 2024.

Canada’s federal government noted in its 2022 budget that “as federally regulated banks and insurers play a prominent role in shaping Canada’s economy, OSFI guidance will have a significant impact on how Canadian businesses manage and report on climate-related risks and exposures.”

Taking action

As society continues to adapt to climate change-related pressures, the focus on responsible, sustainable business practices will only grow. This means the time to put off considering the impact of climate change on your organization is over.

For those institutions newer to evaluating the evolving climate change paradigm, here are two practical steps to take now:

• Educate: While these regulatory proposals are not yet finalized, banking organizations should not simply wait to see how things shake out. Institutions need to understand what is in each proposal, assess how climate change risk considerations factor into their current practices and policies, and identify practices and policies that may need to change.
• Understand: Reporting on climate change-related metrics or incorporating climate change into risk assessments is not new. European banks have been disclosing such information—for example, how climate change affects their policies, procedures and finances—for years. While European banks are indeed much more mature in this arena, it may be informative for midsize and smaller U.S. banks to review the public filings of global or super-regional banks in the United States to glean insight into how domestic institutions are addressing climate risks.

If your institution is further along in incorporating climate change considerations, here are some additional steps to take.

• Build expertise: While established institutions likely have baseline skill sets and knowledge surrounding climate change risk analysis and reporting, what may become the final rule from the regulatory agencies would require more. Organizations may need to upskill their teams, hire new talent, work with a trusted external advisor for assistance, or some combination of all of these.
• Assess: With the appropriate team or advisor in place, an enterprise risk assessment looking at exposure to climate change, specifically financial and transition risks, will be critical. If finalized, the proposed rules put forth by the OCC, FDIC and SEC would require consideration of the impact of these risks on the organization over time, together with approaches to mitigation.
• Strategize: Whether your organization develops a stand-alone strategy for climate change impacts or incorporates these issues into an existing risk strategy, formally aligning efforts to these priorities will allow your institution to achieve its goals in a more cohesive way.

Many consumers, customers and investors are increasingly focusing on the effects of climate change. As this continues, so will banking regulators’ attention to the issue. To remain compliant with evolving rules, banking organizations need to be prepared to adapt.