Agency Guidelines Confirm That Climate-Related Financial Risk Is Real
- The U.S. Department of the Treasury's Office of the Controller of the Currency, Federal Reserve Board and Federal Deposit Insurance Corp. have issued joint guidelines on climate-related financial risk for large financial institutions.
- The guidelines encourage large financial institutions to develop their own procedures to identify, measure, monitor and control for climate-related financial risks and ensure that their public statements are consistent with internal strategies, risk appetite statements and risk management frameworks.
- The guidelines also describe how climate-related financial risks can be addressed in various risk categories, including credit, liquidity, operational, legal and compliance, along with other financial and nonfinancial risks.
The U.S. Department of the Treasury's Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board) and the Federal Deposit Insurance Corp. (FDIC) (collectively, the Agencies) on Oct. 24, 2023, issued joint guidelines (Guidelines) for large financial institutions (i.e., those with consolidated assets of more than $100 billion in total consolidated assets) regarding the steps they should take to mitigate climate-related financial risk. See 88 Fed. Reg. 74183 (Oct. 30, 2023).
The Agencies have confirmed that large financial institutions could be affected by both the physical risks and the transition risks associated with climate change, and that they need to have a high-level framework for the safe and sound management of these risks. The Agencies confirmed that their Guidelines are intended to neither prohibit nor discourage financial institutions from providing banking services to customers of any specific type or class.
Assessing Climate Risks
Climate risks for the financial sector have been a topic of discussion among federal agencies since 2021 when the Biden Administration issued an executive order on climate-related financial risk. (See Holland & Knight's previous alert, "The Financial Sector and Government Contractors in the Environmental Bull's-Eye," May 28, 2021.)
The Guidelines encourage large financial institutions to develop their own procedures to identify, measure, monitor and control for climate-related financial risks and to be sure that their public statements are consistent with their internal strategies, risk appetite statements and risk management frameworks.
The Guidelines emphasize that sound compensation programs are important in promoting sound risk management. The Guidelines also focus upon the following areas:
- Governance: The Guidelines provide that the boards of individual financial institutions should oversee their risk-taking activities and hold management accountable for adhering to the risk-management framework. The board should evaluate climate-related risks across various scenarios and planning horizons, and management should regularly report to the board on the level and nature of risks.
- Policies, Procedures and Limits: Management should incorporate climate-related financial risks into its policies, procedures and limits.
- Strategic Planning: The board should consider the potential impact of material climate-related financial risk upon the institution's financial condition, operations and business objectives, including risks to underserved communities.
- Risk Management: Management should develop processes to identify, measure, monitor and control exposures to climate-related financial risks. Tools include exposure analysis, heat maps, climate risk dashboards and scenario analysis.
- Data, Risk Measurement and Reporting: Management needs to incorporate climate-related financial risk information into its internal reporting, monitoring and escalation processes.
- Scenario Analysis: Scenario analysis involves forward-looking assessments of the potential impact on the financial institution of changes in the economy, changes in the financial system or the distribution of physical hazards from climate-related financial risks.
The Agencies emphasize that the management of climate-related risks should be integrated within financial institutions' risk management framework designed to develop and implement appropriate strategies to identify and mitigate emerging risks. The Guidelines describe how climate-related financial risks can be addressed in various risk categories, including credit, liquidity, operational, legal and compliance, as well as other financial and nonfinancial risks.
If you have questions about the Agencies' Guidance or need assistance in complying with the Guidance, feel free to reach out to the authors or other members of Holland & Knight's Environmental Team.
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.