On October 24, 2023, the US federal banking regulators finalized interagency principles for the effective management and supervision of climate-related financial risks (the "Climate Principles").1 The Climate Principles are targeted at larger banking organizations and are intended to convey consistent supervisory expectations regarding how climate-related financial risks should be managed.
The US federal banking regulators had separately proposed the Climate Principles in 2021 and 2022.2 The Climate Principles mostly follow the proposals, with only a few noteworthy changes.
Importantly, Climate Principles are effective immediately. In this Legal Update, we review the changes made to the draft Climate Principles and discuss what the industry may expect next.
Final Climate Principles
As discussed in our Legal Update on the proposal from the OCC, the Climate Principles outline a high-level framework for the management of exposures to climate-related financial risks that draws heavily from the Basel Committee's proposed (now finalized) principles for climate risk management and the OCC's existing Heightened Standards.
However, unlike the 18 clearly defined principles of the Basel Committee's proposal, the Climate Principles were divided into two narratives that contain somewhat disjointed commentaries on climate risk management. This structure was retained in the final Climate Principles, which contain few substantive changes and some clarifications from the proposals. These changes are:
- Applicability. The Climate Principles are intended for US banking organizations with over $100 billion in total consolidated assets, including holding companies, banks, and thrifts. This includes the combined US operations of foreign banking organizations ("FBOs"), as well as individual US branches or agencies of FBOs, if they satisfy that threshold. However, the preamble muddies this bright line by stating that banking organizations of any size may have material exposures to climate-related financial risks; implying that even smaller organizations may need to implement climate risk management practices.
- De-banking Concern. Consistent with recent public statements in response to concerns around de-banking certain industries, the final Climate Principles expressly state that they neither prohibit nor discourage banking organizations from providing banking services to customers of any specific class or type, as permitted by law or regulation. Even with this change, Federal Reserve Governor Michelle Bowman noted her concern that the likely potential consequence of the Climate Principles will be to "discourage banks from lending and providing financial services to certain industries."3
- Lending. The preamble states that the US federal banking regulators expect banking organizations to manage climate-related financial risks in a manner that will allow them to continue to meet the financial services needs of their communities—including low-and-moderate income and other underserved consumers and communities—and to ensure compliance with fair housing and fair lending laws. The Climate Principles have been revised to include that banking organizations should ensure that fair lending monitoring programs review whether and how the organization's risk mitigation measures potentially discriminate against consumers on a prohibited basis, such as race, color, or national origin.
- Roles and Responsibilities. As we saw in the Federal Reserve's proposal, the final Climate Principles clarify the role of the boards of directors in overseeing the banking organization's risk-taking activities, and the role of management in executing the strategic plan and risk management framework.
- Compensation. The final Climate Principles omit any discussion of compensation practices in relationship to management of climate-related financial risks. However, the preamble states that the US federal banking regulators continue to emphasize that sound compensation programs are important to promoting sound risk management.
- Materiality. In response to concerns that banking organizations might be required to focus on immaterial risks, merely because they are climate-related, the final Climate Principles clarify that organizations should incorporate climate-related financial risks into their risk management frameworks where those risks are material.
As with other supervisory guidance, the Climate Principles do not have the force of law in the United States. Rather, the US federal banking regulators will use the Climate Principles as a common set of expectations when supervising the safety and soundness of banking organizations. This typically is done through non-public processes, meaning that it is likely to remain unclear how the regulators resolve inherent tensions and policy judgments, such as the potential conflict between climate risk management and lending to targeted communities and industries.
Moreover, two FDIC directors and two Federal Reserve governors dissented when voting on the final Climate Principles. A common theme in the FDIC dissents is that climate-related financial risk is like many other types of risk, and that focusing on it in this manner will distract regulators and organizations from the core safety and soundness mandate. Similarly, the FDIC and Federal Reserve dissents touch on the new focus on ensuring that banking organizations continue to lend to underserved consumers and communities, observing that if the Climate Principles are not intended to change these types of lending decisions to reduce climate risk, then there is arguably no point in issuing them.
Impacted organizations should consider reviewing their risk taxonomies to ensure that climate-related financial risks are included and associated control, monitoring, testing and reporting activities are updated to reflect the Climate Principles.
1. Press Release, Agencies issue principles for climate-related financial risk management for large financial institutions (Oct. 24, 2023), https://www.federalreserve.gov/newsevents/pressreleases/bcreg20231024b.htm. The US federal banking regulators consist of the Board of Governors of the Federal Reserve System ("Federal Reserve"), Office of the Comptroller of the Currency ("OCC"), and Federal Deposit Insurance Corporation ("FDIC").
3. Michelle Bowman, Statement on Principles for Climate-Related Financial Risk Management for Large Financial Institutions (Oct. 24, 2023), https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20231024b.htm.
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