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How the Fed and Wall Street view of climate change is evolving under pressure

Key Points
  • Some of the country's biggest investors wrote a letter to Federal Reserve Chair Jerome Powell this week demanding regulatory action related to climate risks. 
  • Morgan Stanley recently announced it will be the first Wall Street bank to disclose the impact its loans have on carbon emissions. 
  • Climate change may prove to be an even bigger risk to markets than coronavirus.

In this article

Sandbags surround the New York Stock Exchange in New York on Oct. 30, 2012, after Hurricane Sandy. The storm was a stark reminder of the rising risks of climate change.
Victor J. Blue | Bloomberg | Getty Images

As the Federal Reserve Bank works to shore up the U.S. economy amid an unprecedented global crisis, top institutional investors and climate advocacy groups sent Fed Chair Jerome Powell a warning this week about another global risk that has no short-term fix: the climate crisis.

"There will never be a vaccine for climate," said Steven Rothstein, managing director at investor climate advocacy group Ceres.

Ceres, along with 72 other signatories, including investors managing close to $1 trillion in assets, nonprofits and public officials, wrote a letter to Powell urging the Fed chair and other regulators to enact regulatory requirements to address the systemic market risks posed by climate change.

The letter followed a report released on June 1 that outlined 51FFca recommendations for the Federal Reserve and other financial regulators to address climate change.

"The pandemic has exposed that the U.S. is particularly vulnerable to shocks that hit our collective well-being like those related to health and climate; that financial markets cannot perform the work of assuring collective well-being; and that the magnitude of a crisis is determined not just by the impact of precipitating events, but by the fragility of the system it attacks," wrote Sarah Bloom Raskin, former U.S. Deputy Secretary of the Treasury and former member of the Federal Reserve board of governors, in the report. 

The top recommendations include uniform regulations for financial institutions to measure and disclose the impact their loans and investments have on emissions, and integrating climate into risk assessments to prevent economic downturns and manage financial stability.

Late last year the Bank of England became the first central banker to create a stress test for climate. At the time, Mark Carney, the Bank of England's governor, said climate change "will affect the value of virtually every financial asset." 

Currently, there is minimal to no regulation in place for U.S. banks to measure or even acknowledge their impact on climate change and extreme weather events.

The coronavirus pandemic has expanded the concept of extreme risk from just five months ago, when most individuals and companies would not have been able to imagine the shutdowns that results from Covid-19.

"A scenario no one would bother putting into a stress test and now we're living in it, and there's a parallel to be drawn with the climate," said Dan Saccardi, senior director and banking expert at Ceres. "It may not be that extreme that quickly, but it's not far-fetched to imagine the typical risk, and there should be some real meaningful policy with the economic transition. ... We can plan for it [climate change], be proactive and be prepared." 

What the Fed has said about climate change

Earlier this year, Powell said that while the U.S. response to climate change is ultimately in the hands of elected officials, the Fed has a role to play to stabilize U.S. banks and financial markets.

"The public has every right to expect and will expect that we will ensure that the financial system is resilient and robust against the risks of climate change," Powell said at a news conference following the Fed's January meeting.

Powell also indicated the Fed may join the Network for Greening the Financial System, an international consortium devoted to climate risks. "We've been looking at joining in one form or another. ... We probably will do that at some point," Powell said. More than 30 central banks from around the world, including the European Central Bank and the People's Bank of China, are part of the network, which launched in 2017.

Powell on systemic risks climate change could pose to the economy

In a May 2019 response to a letter from U.S. senators, including Sen. Brian Schatz, D-Hawaii, concerned about climate and markets, Powell wrote, "As I have commented previously, although addressing climate change is a responsibility that Congress has entrusted to other agencies, the Federal Reserve does use its authorities and tools to prepare financial institutions for severe weather events."

Powell continued: "Some potential risks are difficult to quantify, and especially if they materialize over such a long horizon that methods beyond near-term analysis and monitoring are appropriate. Accordingly, we rely on ongoing research by academics, our staff and other experts to improve our understanding and measurement of such longer-run or difficult-to-quantify risks."

A Federal Reserve research paper from last March indicated that "in coming decades, climate change — and efforts to limit that change and adapt to it — will have increasingly important effects on the U.S. economy. These effects and their associated risks are relevant considerations for the Federal Reserve in fulfilling its mandate for macroeconomic and financial stability."

What Wall Street is doing about carbon

With mitigating risks and stabilizing the economy on the forefront of concerns, major Wall Street banks already have taken steps to improve their policies on climate and allocate funds toward clean energy, infrastructure development and supporting climate action.

This week, Morgan Stanley became the first investment bank to say it would measure and disclose how its loans and investments impact climate change, joining the Partnership for Carbon Accounting Financials, or PCAF, which is developing a standard of measuring impact across other financial firms. 

"They are at a place where they are feeling, both from their clients, shareholders and regulators, the need to disclose what that risk is," said Brian O'Hanlon, principal for global climate finance at the Rocky Mountain Institute, one of the 72 signatories on the letter addressed to Powell. Joining PCAF, which is the largest organization dedicated to carbon accounting, will help Morgan Stanley to disclose the links between financing made to clients and carbon emissions, as well as the emissions its operations generate.

Although Morgan Stanley is the first major U.S. bank to join PCAF, other Wall Street banks are taking steps in the right direction. According to the Rocky Mountain Institute, which teams with JPMorgan Chase, Goldman Sachs, Bank of America and Wells Fargo to launch the Center for Climate-Aligned Finance. Each of the banks has committed large sums to spur the transition to a low-carbon economy, with Goldman Sachs putting forth $750 billion by 2030 to address climate change in their operations, investments and financing. 

Bank of America CEO Brian Moynihan said earlier this year at the Davos World Economic Forum, "There is a huge opportunity, whether it is green bonds or different types of financing for solar installations or wind installations." And as more companies seek carbon neutrality, that will drive demand for new technology, he said.

Bank of America has committed $300 billion to sustainable investments over the next decade.

Powell: Climate change operates on longer cycle than a typical economic forecast

The world's largest money manager, BlackRock, expects climate change will lead to a fundamental reshaping of finance the likes of which the world has never seen, and a significant reallocation of capital is set to take place "sooner than most anticipate," according to its CEO Larry Fink. "Climate change has become a defining factor in companies' long-term prospects," he wrote in an early 2020 letter to investors.

BlackRock and Bank of America are among the major financial players that have taken steps in recent years to limit exposure to coal operations.

The climate crisis is a business opportunity as well as a serious risk for large banks.

"There are significant business opportunities to invest in green energy, low-carbon producing products, not just talking about solar. ... There are thousands of opportunities, trillions of dollars to be made, and it's critical for the banks to look at these opportunities," Ceres' Rothstein said. 

Even with some banks already taking steps in the right direction, building resilience and adaptability to prevent another global crisis are key and require urgent action. 

"We appreciate what several of the large banks are doing in different ways, but we have to move forward faster and in a more unified way. It has to be consistent disclosure across all the banks, and we hope that all institutions, banks, insurance companies, investors come up with a Paris aligned plan and get us to a plan that reaches the goals the U.N. has set out," Rothstein said.