What US regulators think about the risks of climate change is a lingering puzzle. Fed Chairman Jerome Powell recently offered his perspective in a brief letter, his first public comments on the matter. It was a gem of misdirection and avoidance.
The first thing that is notable about Mr. Powell’s letter is how it strains even to use the term “climate change.” It appears only twice, once in each of the first two paragraphs. After that, he adopts the term “severe weather events,” which not only has the advantage of distancing himself from a term that’s frowned upon by this administration but also neatly drops climate into the box of unknowable things. Such events, he says, are ‘shocks to the financial system that are inherently hard to predict’ and thus beyond the Fed’s purview. You can almost hear Mr. Powell uttering a quiet sigh of relief as he skates over the issue.
But as any bank regulator knows, risk doesn’t behave according to neat categories. So it is with climate risk, no matter what Mr. Powell might wish. By limiting climate risk to severe weather incidents, he overlooks the insidious changes to the physical environment, many too gradual to even be called incidents. But like the frog that doesn’t notice as the pot starts to boil, the effect of gradual changes can be devastating.
The same week Mr. Powell wrote his letter, Houston experienced torrential rain and flooding, just as it did during Hurricane Harvey in 2017. In Mr. Powell’s thinking, hurricanes are unpredictable “shocks” that ultimately do not pose a risk to financial stability. But what about frequent heavy rains? Drawing the line between a shock and a systemic vulnerability, as Mr. Powell wants to do, gets awfully difficult. Both disasters look the same to homeowners and businesses. A responsible bank regulator would be taking these risks more seriously.
In stark contrast to Mr. Powell’s weasely evasions stands Mark Carney, his counterpart at the Bank of England. As Mr. Powell was preparing his letter, Mr. Carney was giving an extensive speech on what banks and companies should do to address climate-related risks.
Mr. Carney underscored the importance of disclosure and sophisticated risk analysis of both physical and transition risks – the changes in asset values likely to occur as the economy shifts to a lower-carbon footing. He also noted the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), particularly its guidance on scenario modeling:
An important question is the form these scenarios should take. Climate scenarios aren’t forecasts, but data-driven narratives that help companies think through different possible futures. The scenarios should be comprehensive, rigorous and challenging. The assumptions and methodologies in the models – such as the assumed global temperature rise, the energy mix, or whether the transition happens smoothly or abruptly – should be sufficiently transparent to allow for comparisons and external challenge. And finally, scenarios should be implemented consistently across the business, linking identification of risks and opportunities to both strategy and disclosure.
Mr. Carney’s speech is a sophisticated and serious discussion, one that reflects both the complexity of guiding financial firms and companies on climate risk and the maturity of the UK market, which has developed a growing infrastructure of advisers and analysts to address these issues. London has also emerged as the global center of climate finance, serving as a hub for green bond issuance and sustainable investment funds.
A more assertive approach to climate risk among regulators is popping up elsewhere, too. Mr. Carney has helped assemble a group of 30 central banks that are committed to embedding climate-risk reviews into their ongoing supervisory work. And no, Mr. Powell’s Fed isn’t part of the effort.
Once there was a time when the Fed chair prudently would call attention to risks that market participants or policymakers were overlooking. Often words alone were sufficient to change behavior, making firmer interventions unnecessary. Previous Fed chairs aired their concern about excessive corporate leverage, complex financial instruments, fiscal imbalances, wayward trade policies, the list goes on.
But on climate risk, Mr. Powell is mum. Has he surrendered the Fed’s regulatory authority to political forces?