Is the sky really falling? Acting Supervisor Takes Key Questions on Climate Change to Banks | Holland & Knight LLP


Canadian singer-songwriter Joni Mitchell lamented the toil of deforestation in 1970: “They took all the trees, put them in a tree museum / And they charged people a dollar and a half just for them. see “. More than 50 years after his environmental anthem, another voice of environmental awareness would resonate from a source Mitchell could never have imagined in 1970: a federal banking regulator in Washington, DC, who also bemoans the crisis of change. climate with a voice that is meant to change the national debate on climate awareness and action.

On November 8, 2021, Acting Comptroller of the Currency Michael J. Hsu, in a speech at the Office of the Comptroller of the Currency (OCC) headquarters, proposed some of the most sweeping regulatory proposals on banking and change climate to date. Framed as “Five Climate Questions Every Board Should Ask“, the Interim Controller set out a framework for boards of directors and bank examiners to assess a bank’s readiness to adapt to climate change as well as the bank’s own risk assessment regarding impact of climate change on its operations, the operations of its suppliers and the risks of borrowers. Assuming that the framework set out in this speech is ultimately more formalized in agency directives or even regulations, it represents a potentially substantial regulatory burden even if it is environmentally necessary.

Interim Controller Hsu’s questions cover several different aspects of banking operations, from macroeconomic issues to counterparty risk, to specific bank concerns, and more.

Question 1: What is our global exposure to climate change?

In order to answer this question, the OCC suggests that bank managers “need to develop a framework, a risk taxonomy, metrics, data, scenarios, and a solid understanding of the first and second order impacts that risks. physical and transitional may have on the bank’s wallet. In addition, “Understanding your exposure to a given risk is essential to effectively monitoring and managing that risk. By asking this question about climate change exposure directly and repeatedly to senior executives, boards will engage and support them in developing frameworks, collecting data, and building the necessary teams and systems. to effectively manage the risks associated with climate change. “

The question calls on banks to develop a company-wide framework for assessing exposure to climate change. OCC may seek banks to take action such as appointing a climate change risk manager as the OCC did in July 2021. The OCC can also expect banks to present to the board periodically the impact of climate change on the bank.

Question 2: Which counterparts, sectors or localities deserve our increased attention and focus?

In this question, the OCC links climate change to counterparty risk, explicitly noting that “climate change is going to have a significant impact on the creditworthiness of certain borrowers and sectors”. The OCC identifies two types of risks that banks must take into account: physical risks and transition risks. Physical risks include the increased frequency, severity and volatility of extreme weather and long-term changes in global weather patterns and their associated impact on the value of financial assets and the creditworthiness of borrowers. Transition risks relate to adjusting to a low-carbon economy and include associated changes in government policy, technology, and consumer and investor sentiment.

Counterparty risk assessment goes far beyond abstract and macro notions of the impact of global climate change. On the contrary, the statement of the Interim Monitor calls on banks to identify “the borrowers and sectors most likely to see deterioration in financial terms. their repayment capacity or in their collateral values in scenarios of potential physical and transition risks [as] a critical first step to prudently manage climate risk. “(emphasis added). This call to integrate climate risk into the repayment capacity and valuation of collateral is potentially a game changer in lending. This policy may require that banks adopt higher product pricing policies for credit if the borrower, collateral, or industry is more weather-exposed. The OCC may consider that banks should already do this, but requiring it will require a review substantial bank credit risk modeling, data collection and underwriting analysis.

Question n ° 3: To what extent are we exposed to a carbon tax?

A carbon tax puts a price on emissions of carbon dioxide and other greenhouse gases, encouraging individuals, businesses and governments to produce less. Even though Acting Controller Hsu acknowledges that the United States is unlikely to see a carbon tax in the foreseeable future, he views the anticipation of such a tax as “the risk of transition equivalent to the scenario.” extremely unfavorable ”in the CCAR [Comprehensive Capital Analysis and Review]. In addition, Acting Controller Hsu suggests, “More important than the estimate itself, the exercise of establishing a number will require processes, data and calculations that will further strengthen the risk measurement practices of transition. These capabilities can, in turn, enable more refined assessments of more complex and likely transition risks in the future. “

Some banks and analysts may scoff at the idea of ​​using a tax that the OCC recognizes is highly unlikely to materialize as an indicator of transition risk as an unnecessary supervisory burden. Some might argue that it makes just as much sense as requiring a bank that provides only secured loans for airplanes, ships and rolling stock to conduct an assessment of fluctuations in the residential real estate market; it would have no rational connection with the activities of the bank. Nevertheless, the Interim Controller considers the resilience of the carbon tax as an appropriate indicator of the “severely adverse” scenario under the CCAR.

The reference of the OCC to the CCAR is particularly notable. The Federal Reserve Board describes CCAR as “an annual Federal Reserve exercise to assess whether the largest bank holding companies operating in the United States have sufficient capital to continue to operate during times of economic and financial crisis and whether they have strong capital planning processes that take into account their unique risks. This may signal a requirement to impose CCAR-type stress tests on a bank’s ability to withstand changes in climate-related risks.

Question # 4: How vulnerable are our data centers and other critical services to extreme weather conditions?

Business continuity planning (BCP) has long been at the center of prudential supervision. According to the OCC in its bulletin of November 14, 2019,, “Business continuity management is the process by which management oversees and implements resiliency, continuity and response capabilities to protect employees, customers and products and services. Disruptions such as cyber events, natural disasters or man-made events can interrupt operations and can have a wider impact on the financial industry. The Interim Supervisor’s question in this area suggests that banks should assess the impact of “extreme weather” on a bank’s business continuity, including the bank premises and third-party vendors that the bank relies on. for his services. According to the speech of the Interim Controller, “assessments and risk mitigation measures that take into account all climate scenarios can encourage consideration of changes in data center strategies or business continuity plans.”

This area would require banks to review, revise and expand the scope of their BCP policies to anticipate disruptions caused by climate change events.

Question 5: What can we do to position ourselves to seize the opportunities of climate change?

Banks will understand that not all of Acting Controller Hsu’s remarks were gloomy and stormy. In this area, he notes that: “Renewable energies, carbon capture, electric vehicles, charging stations – these are the most obvious banking opportunities arising from climate change. Changes in agriculture, water infrastructure, consumer preferences and investor sentiment will also create opportunities. “He suggests that” strong climate risk management capabilities can enable the same prudent risk-taking in climate-related business opportunities. “

This focus area may force banks to reassess their investment portfolios and may offer increased opportunities for joint ventures and community development investments.

And after?

It remains to be seen how the OCC decides to implement the Acting Controller Hsu’s climate change monitoring initiative. Codifying the above points into OCC regulations is probably too aggressive and may anger conservatives and moderates in Congress to trigger the overturning of these regulations under the Congressional Review Act. The most likely approach is for the OCC to publish a surveillance bulletin outlining the agency’s surveillance expectations and incorporate the guidance into OCC review manuals covering topics such as management. risk, BCP, public welfare investments, evaluation of guarantees and others. By incorporating the above points into scattered sections of the many OCC review manuals, the OCC would be able to integrate the concepts broadly into the review process without targeting a single stand-alone document for review. industry.

Whatever form the OCC’s prudential approach takes, the message to the industry is clear: climate change must become a factor in bank decision-making processes. At a minimum, bank boards should start the conversation about how to incorporate some of the OCC’s suggestions into their operations. Of course, the degree of integration will depend on the risk profile and the specific operations of each bank. This may mean starting the conversion at the board level to lay the groundwork for a climate change review working group, identify partnerships for the bank with other climate change focused stakeholders to take advantage of synergistic opportunities offered by banks, establish a climate change risk management committee or even just ask outside advisers or consultants to make presentations to the board to present issues.


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