On October 24, 2023, the Federal Reserve Board (FRB), the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency (together, the “Agencies”) released their final Principles for Climate-Related Financial Risk Management for Large Financial Institutions (the “Climate Principles”). The Agencies stated that the Climate Principles are “intended to explain and supplement existing risk management standards and guidance on the roles of the boards of directors and management.”

The Climate Principles apply to U.S. banking organizations with over $100 billion in total consolidated assets. The Climate Principles also apply to (i) foreign banking organizations (FBOs) with combined U.S. operations of greater than $100 billion in total consolidated assets, and (ii) any U.S. branch or agency of an FBO that individually has total assets greater than $100 billion. Even though only large banking organizations are in the scope of the Climate Principles, the Agencies acknowledged that banking organizations of all sizes may be exposed to climate-related financial risks. Therefore, smaller institutions may want to review their climate risk management program against the Climate Principles, especially given the potential “trickle down” supervisory expectations.

The high-level framework set out in the Climate Principles is intended to assist banking organizations in managing climate-related financial risks (i.e., physical risk and transition risk).[1] The Climate Principles discuss the following six areas: (i) governance; (ii) policies, procedures, and limits; (iii) strategic planning; (iv) risk management; (v) data, risk measurement, and reporting; and (vii) scenario analysis. The Climate Principles also cover a range of specific risk areas (e.g., credit, liquidity, interest rate, operational, legal and compliance, and certain types of nonfinancial risk).

We note that the conclusion of the Federal Reserve’s pilot climate scenario analysis exercise is expected to occur near the end of this year.[2] The ending of the exercise may result in additional guidance regarding climate-risk management.

The Climate Principles Augment Existing Principles, Frameworks, and Standards

The Agencies promulgated the Climate Principles on the grounds that weaknesses in how banking organizations identify, measure, monitor, and control exposure to climate-related financial risks could present safety and soundness concerns. In response to comments received on the proposal regarding the Agencies’ authority to issue the Climate Principles, the Agencies stated that the Climate Principles “neither prohibit nor discourage financial institutions from serving customers of any specific class or type, as permitted by law or regulation” and that “[t]he decision regarding whether to make a loan or to open, close, or maintain an account rests with the financial institution, so long as the financial institution complies with applicable laws and regulations.”[3] In addition, FRB Chair Jerome Powell’s statement accompanying the release noted that “[t]he Federal Reserve is not and will not be a ‘climate policymaker.’ Decisions about policies to address climate change must be made by the elected branches of government.”[4]

The Climate Principles follow other climate-related standards and initiatives within and outside the United States that together reinforce that the public and private sectors are continuing to focus on risks arising from climate change. For those firms familiar with certain other climate-related initiatives, including the framework of the Taskforce for Climate-related Financial Disclosure (TCFD) and the questions of the Climate Disclosure Project (which are also, to some extent, aligned with the TCFD), certain aspects of the Climate Principles should look familiar.[5] In addition, the Climate Principles are similar to the principles of the Basel Committee on Banking Supervision for the effective management and supervision of climate-related financial risks,[6] in that they recognize that climate-related risks will continue to evolve as will risk management practices. Therefore, financial institutions will need to continually monitor risk strategies and methodologies as well as the relevant legal and regulatory landscapes.

Key Takeaways

The Agencies recognize that the incorporation of material climate-related financial risks by banking organizations in their risk management policies, procedures, and practices, will be iterative, as measurement methodologies, models, and data for analyzing these risks continue to change and mature. After performing an initial assessment of current operations and strategies against the Climate Principles, banking organizations will need to continue to monitor regulatory and industry developments to ensure that their systems to identify, measure, monitor, and control exposure to climate-related financial risks are adequate to bolster resiliency and comply with new regulatory requirements and expectations.

ENDNOTES

[1] For purposes of the Climate Principles, “physical risk” refers to “the harm to people and property arising from acute, climate-related events, such as hurricanes, wildfires, floods, and heatwaves, and chronic shifts in climate, including higher average temperatures, changes in precipitation patterns, sea level rise, and ocean acidification.” “Transition risks” include “stresses to institutions or sectors arising from the shifts in policy, consumer and business sentiment, or technologies associated with the changes that would be part of a transition to a lower carbon economy.” The Climate Principles reference the “Report on Climate-Related Financial Risk” issued by the Financial Stability Oversight Council in 2021. (last visited Nov. 3, 2023)

[2] Federal Reserve Board, Pilot Climate Scenario Analysis (CSA) Exercise: Participant Instructions, (Jan. 19, 2023). (last visited Nov. 3, 2023)

[3] See Principles for Climate-Related Financial Risk Management for Large Financial Institutions, 88 Fed. Reg. 74183, 74184 (Oct. 30, 2023). (last visited Nov. 3, 2023)

[4]See Federal Reserve Board, Statement by Chair Jerome H. Powell on Principles for Climate-Related Financial Risk Management for Large Financial Institutions [Press Release], (Oct. 24, 2023). (last visited Nov. 3, 2023)

[5] See Taskforce for Climate-related Financial Disclosures, TCFD Recommendations, TCFD Recommendations (last visited Nov. 3, 2023) (“The recommendations are structured around four thematic areas that represent core elements of how organizations operate: governance, strategy, risk management, and metrics and targets.”). (last visited Nov. 3, 2023)

[6] See Basel Committee on Banking Supervision, Principles for the Effective Management and Supervision of Climate-related Financial Risks, (June 2022) available at Principles for the effective management and supervision of climate-related financial risks (bis.org). (last visited Nov. 3, 2023)

This post comes to us from Morrison & Foerster LLP. It is based on the firm’s memorandum, “Federal Banking Agencies Adopt Climate-Related Financial Risks Guidance,” dated November 6, 2023, and available here.