US bank climate change regulation poised to catch up to global peers

Fitch Ratings expects US financial regulators will expand early-stage efforts to incorporate climate change into macroprudential regulation, given the increased prioritization and stated goals of the new administration.

Greater attention to climate change risks, including incorporation into stress testing, would bring the U.S. closer to regulatory peers in other major developed countries, but is likely to proceed gradually over a two to threeyear period and center on the largest U.S. global systemically important banks.

Regulation that incorporates growing climate-related risks could be supportive of bank credit profiles over the long term. Portfolios incorporating sustainable investments may result in a higher capital and or liquidity requirements for nongreen investments of the portfolio, and lead to more difficult choices on industries or client selection. For some systemic U.S. banks though, the transition to a lower-carbon economy could provide additional revenue streams.

To date, climate-related events have not resulted in material losses for U.S. banks. However, more extreme weather-related physical risks, as well as uncertain transition risks from future policy decisions, can pose complex risks and vulnerabilities to abrupt repricing events.

The U.S. has been a notable laggard among developed market governments in addressing these vulnerabilities.

Under the new administration, U.S. policy trajectory may more closely follow that of global regulatory leaders in this area, such as the Bank of England and the European Central Bank. Last December an asset management advisory committee of the SEC recommended practices to enhance ESG investment product disclosure, including alignment with a sustainable taxonomy developed by the Investment Company Institute ESG Working Group.

Ultimately, a sustained shift in U.S. policy, in conjunction with clear risk quantifications, could accelerate international cooperation on climate risk capital requirements. Incremental steps may include the development of climate-related "best practices" for financial institution risk managers, the refinement of data collection/reporting standards, and climate change risk scenarios in supervisory stress tests. French and UK banks are the first to be stressed for climate change risks but the ECB and a further five countries have also announced plans for similar testing in the near term. We expect this trend to become more mainstream globally.

The new administration has made addressing climate change a top priority. Treasury Secretary appointee and long-time climate policy advocate, Janet Yellen, will likely raise the profile of climate risk among both financial regulators and the general public in her role as Chair of the Financial Stability Oversight Council.

Appointments to other key positions, such as Comptroller of the Currency and Chair of the Securities and Exchange Commission, have yet to be either named or confirmed. However, Democratic control of

Congress make it likely that confirmed nominees will share similar priorities, and further raises the prospect of legislation to embed climate change in prudential regulation. The Chairwoman of the House Committee on Financial Services has urged Treasury to prioritize climate risk at financial regulatory agencies and the Federal Insurance Office.

Under the incoming Senate Banking Committee chair, Democrats may seek to revive the Climate Change Financial Risk Act, which would require the Federal Reserve (Fed) to develop climate change risk scenarios for use in its bank stress tests.

Legislative progress will follow initial steps taken by the Fed, which include a discussion of climate risk in its most recent Financial Stability Report in November 2020. In December 2020, the Fed also joined the Network of Central Banks and Supervisors for Greening the Financial System, and created a Supervision Climate Committee in January 2021 comprised of senior Fed officials.