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Making sense of the CFTC Report on Managing Climate Risk in the US Financial System

By Caroline Abramo


This ground-breaking report was issued September 9, 2020. Here at Pana LCE, we have taken a keen interest in interpreting the report’s findings on many of key areas that impact our investments. In this article, we have highlighted those that have the most financial bearing on our investments. The opportunity for the companies we are investing in is unprecedented, and this framework will support investment decisions to add climate impact companies to any portfolio. Pana LCE is focused on private investments and are already instituting this transparency, facilitating the transition of our portfolio companies from the private to the public markets.

Key Conclusions of the CFTC Report

1. Transparency: Price of Carbon

This report begins with a fundamental finding – that financial markets will only be able to channel resources efficiently to activities that reduce greenhouse gas emissions if an economy-wide price on carbon is in place at a level that reflects the true social cost of those emissions. Addressing climate change will require policy frameworks that incentivize the fair and effective reduction of greenhouse gas emissions.

In the absence of such a price, financial markets will operate sub-optimally, and capital will continue to flow in the wrong direction, rather than toward accelerating the transition to a net-zero emissions economy. At the same time, policymakers must be sensitive to the distributional impacts of carbon pricing and other policies and ensure that the burden does not fall on low-to-moderate income households and on historically marginalized communities.

This report recognizes that pricing carbon is beyond the remit of financial regulators and recommends that the United States Congress should establish a price on carbon. It must be fair, economy-wide, and effective in reducing emissions consistent with the Paris Agreement. This is the single most important step to manage climate risk and drive the appropriate allocation of capital.

2. Governance: The Task force on climate related financial disclosures (TCFD) framework.

Companies must disclose GHG emissions in a transparent and consistent way. This is at the core of Governance. The disclosure by corporations of information on material, climate-related financial risks is an essential building block to ensure that climate risks are measured and managed effectively. Disclosure of such information enables financial regulators and market participants to better understand climate change impacts on financial markets and institutions. Issuers of securities can use disclosure to communicate risk and opportunity information to capital providers, investors, derivatives customers and counterparties, markets, and regulators. Issuers of securities can also use disclosures to learn from peers about climate-related strategy and best practices in risk management. Investors can use climate-related disclosures to assess risks to firms, margins, cash flows, and valuations, allowing markets to price risk more accurately and facilitating the risk-informed allocation of capital. Demand for disclosure of information on material, climate-relevant financial risks continues to grow, and reporting initiatives have led to important advances. Investors and financial market actors have long called for decision useful climate risk disclosures, and in 2019, more than 630 investors managing more than $37 trillion signed the Global Investor Statement to Governments on Climate Change, which called on governments to improve climate-related financial reporting. Disclosure frameworks have been developed to enhance the quality and comparability of corporate disclosures, most notably, the Task Force on Climate-related Financial Disclosures (TCFD).

Also, in 2010, the U.S. Securities and Exchange Commission (SEC) published Commission Guidance Regarding Disclosure Related to Climate Change, which provides public companies with interpretive guidance on existing SEC disclosure requirements as they apply to climate change.

3. Corporate Responsibility metrics – Stakeholder Activism

This is alluded to but a key area of work and practice by Activist and Long /Short managers. The idea is that climate has to be a key financial metric and that we must move away from short term shareholder models and company managements must be compensated on this metric. There already is some valuation benefit given to “green” companies but this is not transparent or consistent.

4. Regulatory Oversight

The report finds that, in general, existing legislation already provides U.S. financial regulators with wide-ranging and flexible authorities that could be used to start addressing financial climate-related risk now. As such, The CFTC already has the jurisdiction to monitor corporate reporting on climate.

This is true across four areas:

1. Oversight of systemic financial risk

2. Risk management of particular markets and financial institutions

3. Disclosure and investor protection, and the

4. Safeguarding of financial sector utilities.

Presently, however, these authorities and tools are not being fully utilized to effectively monitor and manage climate risk. Further rulemaking, and in some cases legislation, may be necessary to ensure a coordinated national response.

5. Data and analytical tools to measure and manage climate-related financial risks remain a critical constraint. To undertake climate risk analysis that can inform decision-making across the financial system, regulators and financial institutions need reliable, consistent, and comparable data and projections for climate risks, exposure, sensitivity, vulnerability, and adaptation and resilience. Demand will likely grow for public and open access to climate data, including for primary data collected by the government. Public data will enable market participants to, among other things, compare publicly available disclosure information and sustainability-benchmarked financial products. At the same time, proprietary data and analytical products can introduce innovations that improve climate risk management. A key challenge will be how best to balance the need for transparency through public data on one hand, with the need to foster private innovation through proprietary data, on the other.