Climate Risk Management Principles Finalized By US Banking Regulators – Financial Services

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:

1. 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.




2. 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




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.




4. 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.




5. 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.




6. 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.

Next Steps

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.

Footnotes

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”).

2. See our December 21, 2021, March 31, 2022, and December 15, 2022 Legal Updates on these
proposals.

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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