Articles, Newsletters and Advisories
The Legal Intelligencer
(by Ben Clapp)
In September, the Market Risk Advisory Committee of the U.S. Commodity Futures Trading Commission (CFTC) issued a significant, yet perhaps under-publicized, report titled “Managing Climate Risk in the U.S. Financial System.” The report identified several key findings, including that: climate change “poses a major risk to the stability of the U.S. financial system and to its ability to sustain the American economy;” “financial markets will only be able to channel resources efficiently to activities that reduce greenhouse gas emissions if an economywide price on carbon is in place at a level that reflects the true social cost of those emissions; and “disclosure of information on material, climate-relevant financial risks … has not resulted in disclosures of a scope, breadth, and quality to be sufficiently useful to market participants and regulators.” CFTC, Managing Climate Risk in the U.S. Financial System at i-iv (Sept. 2020). The report recommends that the U.S. establish a price on carbon that is consistent with the Paris Agreement’s goal of limiting global temperature rise this century to less than two degrees Celsius above pre-industrial levels.
The report is particularly notable for its blunt assessment of the risks posed by climate change to the underpinnings of the U.S. economy, and its conclusion that comprehensive federal climate change legislation is required to mitigate these risks. (For those wondering at the unlikelihood of a report such as this being published by a federal agency in a presidential administration that has demonstrated a marked tendency toward deregulation, the report was not voted on by the commissioners of the CFTC and has been characterized as representing the perspective of private sector committee members.) Other federal agencies have been reluctant to take additional steps to address climate change investment risks. The Securities and Exchange Commission, for example, resisted calls to incorporate prescriptive climate change disclosure requirements when adopting final rules modernizing Regulations S-K, choosing instead to retain the principles-based materiality standard currently governing climate change disclosures. See Commissioner Allison Herren Lee, SEC, Regulation and ESG Disclosures: An Unsustainable Silence (Aug. 26, 2020)
The future of federal climate change regulation in the U.S. remains murky. Obviously, much depends on the results of the upcoming election, but even in the event of a shift in the balance of power to the Democratic party, it may be several years before climate change legislation is enacted, and the scope of such legislation is far from certain. Notably, however, even in the absence of federal action on climate change, private sector initiatives—in particular those of global investment firms, institutional investors, and insurers—to compel greenhouse gas intensive industries to reduce emissions and to disclose the climate change-related impacts of their operations, continue to gather momentum.
In the United States, a watershed moment occurred in January 2020, when BlackRock, Inc., the world’s largest asset manager, announced that it was asking the companies that it invests in to meet certain standards for disclosing the risks posed by climate change. Letter from Larry Fink, chairman and CEO, BlackRock, Inc. to CEOs (Jan. 2020) (BlackRock letter). BlackRock’s goal is “to ensure that companies are effectively managing the risks and opportunities presented by climate change and that their strategies and operations are aligned with the transition to a low-carbon economy—and specifically, the Paris Agreement’s scenario of limiting warming to two degrees Celsius or less.” See BlackRock, Our Approach to Sustainability (July 2020) (Sustainability Report). BlackRock believes that climate change presents a “defining factor in companies’ long-term prospects,” requiring a “fundamental reshaping of finance.” To that end, the asset manager has called for a global price on carbon and requested that the companies it invests in disclose their climate-related risks, including their greenhouse gas emissions and the expected impact of those emissions, the impact of climate change on their own facilities, and the “transition,” or business risk associated with operating under a scenario where the Paris Agreement’s goals are fully realized. The latter requirement is especially challenging for companies with greenhouse gas-intensive operations, as it requires an evaluation of how future operations and financial results will be impacted by legislation designed to fundamentally alter, and even restrain, the industries in which these companies operate. In July, BlackRock announced that it had placed 244 companies on watch and taken “voting action” against 53 companies, including 37 energy companies, for, in BlackRock’s opinion, failing to take sufficient action to incorporate climate risk into their business models or disclosures. Sustainability Report at 11.
BlackRock is not alone in its efforts to leverage its influence in financial markets to combat climate change. Numerous financial institutions, including Goldman Sachs, have echoed BlackRock’s call for a global price on carbon. Investment banks, such as Morgan Stanley, Citigroup, and Bank of America, have committed to publicly disclosing the greenhouse gas emissions from projects and investments that they finance. In early October, JP Morgan Chase announced that it would adopt “a financing commitment that is aligned to the goals of the Paris Agreement,” see press release, “JP Morgan Chase Adopts Paris-Aligned Financing Commitment” (Oct. 6, 2020). In so doing, the investment bank intends to evaluate the carbon intensity of its investments and establish intermediate emission targets for 2030.
The movement extends beyond Wall Street. More than 500 institutional investors, with more than $47 trillion in assets under management, belong to the Climate Action 100+ initiative, which has the goal of ensuring that the world’s largest corporate greenhouse gas emitters take necessary action on climate change. The organization has a focus list of 100-plus companies (oil and gas, mining and minerals, transportation, industrials), that face investor pressure to create long‑term energy transition plans and quantitative targets for reducing emissions. Insurers, recognizing that climate risk equals insurance risk, have taken similar steps. For example, Swiss Re has announced it will stop providing insurance to, and investing in, the top 10% most carbon-intensive oil and gas companies by 2023, see press release, “Swiss Re takes further steps towards net-zero emissions” (Feb. 20, 2020). In addition, some major U.S. insurers, such as The Hartford, Chubb and AXIS Capital, are starting to restrict, or eliminate, insurance coverage for coal and tar sands companies, see Axis Capital, Thermal Coal and Oil Sands Policy (effective Jan. 1, 2020); press release, The Hartford Announces Its Policy on Insuring, Investing in Coal, Tar Sands (Dec. 20, 2019); Chubb, Chubb Coal Policy.
Some of these efforts, BlackRock’s in particular, have been met by a fair degree of cynicism from climate activists. In early October, five Senate democrats sent a letter to BlackRock chairman and CEO Larry Fink, asserting that the asset manager’s proxy voting record was inconsistent with its professed goal of incorporating climate change risk into its investment stewardship, including BlackRock’s failure to vote in favor of initiatives identified as key objectives by Climate Action 100+. The letter requests that BlackRock respond to several pointed questions that appear aimed at forcing BlackRock to provide more transparency on what, precisely, the firm aims to do in support of its climate change strategy.
The impact of these private sector initiatives can only be assessed over time. It is clear, however, that there is a growing certainty in the financial sector that climate change poses a serious risk to the U.S. financial system and the global economy as a whole. The current focus on requiring more robust climate change disclosures reflects investors’ desire to assess such risks sooner rather than later so that they can take appropriate actions. If investment firms, institutional investors, and insurers conclude that limiting global temperature rise to two degrees Celsius above pre-industrial levels will significantly limit their long-term exposure to risk, it is reasonable to conclude that these entities will determine that limiting the flow of capital into carbon-intensive industries, or declining to insure projects occurring within those industries, is the prudent course of action, thereby accelerating a transition to a low-carbon economy.
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Reprinted with permission from the October 29, 2020 edition of The Legal Intelligencer© 2020 ALM Media Properties, LLC. All rights reserved.