January 28, 2021

Treasury Pauses Disastrous OCC Rule Limiting Climate Risk Policies By Banks After Casten Led Members of Congress Calling for its Reversal

Washington, D.C. – The Office of the Comptroller of the Currency (OCC) today announced it has paused publication of a rule finalized under the Trump administration that would serve to limit banks' ability to account for climate-related financial risks and discourage banks from adopting risk-based policies prohibiting lending to certain lines of business.

Today's reversal comes after Congressman Sean Casten (IL-06) led Senators Sheldon Whitehouse (D-RI), Brian Schatz (D-HI), Sharrod Brown (D-OH), and Merkley (D-OR) Kathy Castor (D-FL), Nydia M. Velázquez (D-NY), Cynthia Axne (D-IA), Bill Foster (D-IL), Madeleine Dean (D-PA), Jared Huffman (D-CA), Steven Lynch (D-MA), and Jesús G. "Chuy" García (D-CA) in a letter expressing their opposition to the rule earlier this month. In the letter, the lawmakers point out that the rule would make it much more difficult for banks to consider climate-related risks to the oil and gas industry – risks that experts say put banks and the entire financial system in danger.

Casten said, "Forcing banks to prop up a failing industry isn't just bad for our financial system, it's antithetical to free-market capitalism. When Adam Smith wrote about the power of market capitalism's ‘invisible hand' to adequately ensure a fair and efficient exchange of goods and services, he probably didn't envision the U.S. government forcing banks to loan to a sector that's seen coal demand down 45%, natural gas prices are down 40%, oil prices are down 45%, and shale producers chew through $342 billion of free cash flow since 2010. Under the OCC rule, Smith's invisible hand would function as a marionette puppet's pulled by the strings of big oil and gas at the expense of our entire economy.

"Right now, climate risk is a massive problem for our entire financial sector, and it's just going to get worse. As we all remember from 2008, a crisis in the financial sector is a crisis that spreads to the rest of the nation. If we don't take sufficient action to safeguard our financial system against climate risk, we risk triggering an economic disaster even greater than the last at a moment when we simply cannot afford it.

"I'm glad to see the Biden administration pause this disastrous rule, but our work mitigating climate risk is far from done. During my first term I introduced two common-sense bills that will require companies to be transparent about their exposures and enable the fed to assess risks the financial system faces.

In December, Casten gave a floor speech explaining the consequences of exposing our financial system to catastrophic financial risk.

Casten and U.S. Senator Elizabeth Warren (D-Mass.) introduced H.R. 3623 the Climate Risk Disclosure Act of 2019 to require public companies to disclose critical information about their exposure to climate-related risks. The legislation would help investors appropriately assess climate-related risks, accelerate the transition from fossil fuels to cleaner, and more efficient energy sources, and reduce the risks of both environmental and financial catastrophe. The bill passed out of the House Financial Services Committee in July of 2019.

In November, Casten and U.S. Senator Brian Schatz (D-HI), introduced the Climate Change Financial Risk Act of 2019. The legislation would direct the Federal Reserve (Fed) to conduct stress tests on large financial institutions to measure their resilience to climate-related financial risks.

Full text of the members' comment letter is below and linked here.

Brian P. Brooks

Acting Comptroller of the Currency

Office of the Comptroller of Currency, Treasury

RE: Docket ID OCC-2020-0042, RIN 1557-AF05

Dear Acting Comptroller Brooks:

We write in opposition to the Office of the Comptroller of the Currency (OCC) notice of proposed rulemaking for the so-called "Fair Access to Financial Services" rule. The proposed rule would hinder banks' efforts to limit their exposure to the risks associated with extending credit to certain lines of business, and to the extent that it would hobble banks' efforts to limit their exposure to climate-related risks in the fossil fuel industry, could undermine financial stability.

In making it more difficult for banks to establish risk-based policies prohibiting lending to certain lines of business, this proposal will create a chilling effect that will dissuade banks from implementing prudent risk assessment approaches. Markets function best when capital is allocated based on full information and sound risk judgments. But this proposal would limit the ability of banks to consider all relevant information, and could instead force institutions to lend to projects despite potential credit, operational, and reputational risks associated with them. That would be bad for the health and stability of our financial system.

The rule was proposed in response to a letter sent to the Acting Comptroller by congressional Republicans alleging that decisions made by a number of large financial institutions to stop lending to new oil and gas projects in the Arctic were "discriminatory."[1] The members also sent identical letters to the Chair and Vice Chair of the Federal Reserve and the Chair of the Federal Deposit Insurance Corporation. Notably, only OCC decided to initiate a rulemaking in response to the letter's allegations.

The proposed rule would make it more difficult for banks to limit their exposure to any number of financially risky projects or sectors. This comment will focus only on the rule's primary purpose: to make it more difficult for banks to manage financial risks stemming from exposure to the fossil fuel industry.

Specifically, the proposed rule would make it substantially more difficult for banks to consider climate-related risks to the oil and gas industry. While the proposal acknowledges that "climate change is a real risk," it essentially concludes that banks' existing risk management practices are flawed and insufficient, and do not justify the decisions of several major banks to stop lending to new Arctic oil and gas projects.

We disagree.[2] Over the past several years, economists, central bankers, financial regulators, asset managers, investors, insurance analysts, credit rating analysts, investment bankers, real estate professionals, and scientists have produced an enormous volume of research warning that climate change and the failure to plan for an orderly transition to a low-carbon economy are capable of destabilizing the financial system and threatening significant economic losses. Of particular relevance to this rulemaking, many of these warnings focus on the risk of a "carbon bubble," i.e., that as demand for fossil fuels decline, fossil fuel assets will become stranded, thereby posing a significant risk to the balance sheets of the financial institutions that financed or invested in those assets.

One recent economic paper reports that "economic literature combined with industry practices suggest the presence of persistent market inefficiencies for fossil fuel reserves, so these assets are likely to be stranded and mispriced, i.e. a carbon bubble exists ...."[3] Another paper finds that "the magnitude of ... stranded assets of fossil fuel companies (in a 2 degrees C economy) has been estimated to be around 82% of global coal reserves, 49% of global gas reserves, and 33% of global oil reserves."[4] That's 82% of global coal reserves gone, wiped off balance sheets; 49% of global gas reserves, gone; and 33% of global oil reserves gone. The market value of fossil fuel reserves that can't be burned is "around $20 trillion," according to the World Bank.[5] A study done by the European think tank CEPS predicts that "fossil fuel companies altogether would see their market value fall by half."[6]

Government policies to reduce carbon pollution are not the only forces that may lead to stranded assets. The economics of renewable energy and other low carbon technologies are also reducing demand for fossil fuels. For example, demand for coal has fallen by 40% in the United States as lower cost energy sources have taken its place in the economic dispatch order on our power grid. Americans are choosing to use cheaper, cleaner energy sources. While that is economically disruptive to established incumbents, their failure to compete is no basis for regulatory intervention.

Economists studying stranded assets warn that high-cost producer regions like the U.S. could "lose almost their entire oil and gas industry."[7] And because the risk is systemic, the consequences could extend well beyond the fossil fuel industry, potentially causing over a five percent decline in U.S. GDP and millions of lost jobs.[8] This data contradicts OCC's assertion that banks' decisions to stop lending to new Arctic oil and gas projects are not the product of quantitative risk management practices. High-cost production projects, such as those in the Arctic, will be the first to be stranded. Exploration in an untested and environmentally sensitive petroleum play—in a historically volatile oil price environment—is a logical place for a bank to apply prudent risk management to its business selection.

Central banks are also increasingly concerned about the risks associated with a carbon bubble. The Bank of England warned in an official statement, "investments in fossil fuels and related technologies . . . may take a huge hit."[9] The Bank for International Settlements also warns of stranded fossil fuel assets in its recent report on climate-related economic risks.[10] And a recent report from 34 central bank presidents cautioned that "estimates of losses […] are large and range from $1 trillion to $4 trillion when considering the energy sector alone, or up to $20 trillion when looking at the economy more broadly."[11]

This makes the risk of a carbon bubble not just a risk to fossil fuel investors, but a systemic risk that could result in trillions of losses to the broader economy. A stress test of European financial institutions revealed that some were alarmingly exposed to fossil fuel assets and could be at risk should these assets plunge in value.[12] Indeed, the Bank of England has become so concerned about systemic risk associated with stranded fossil fuel assets that it included climate scenarios in its 2019 stress test of insurance firms[13] and plans to do the same for the UK's largest banks.[14]

American regulators are also beginning to take climate-related financial risks seriously. Last month, Federal Reserve Chair Jerome Powell said that the Fed was incorporating climate risk into "all that we do," including bank regulation.[15] This followed Fed Governor Lael Brainard's warning in the Fed's biannual financial stability report about climate-related shifts in asset values and "abrupt tipping points and significant swings in sentiment."[16] Earlier this month, Powell told members of the House Financial Services Committee that banks should be incorporating climate risk analysis into their decision-making.[17]

Moreover, the Climate-Related Market Risk Subcommittee of the Commodity Futures Trading Commission released a report earlier this year warning of stranded assets and that "[i]nstitutional investors already appear to be screening potential investments for direct carbon emissions and demanding compensation for associated transition risks,"[18] highlighting yet another rationale that banks would have to reduce their exposure to oil and gas projects.

There is no doubt that climate change poses significant financial risk to fossil fuel assets and that regulators around the world are beginning to focus on these risks. OCC's proposal runs counter to the overwhelming sentiment among economists and financial experts that financial institutions need to do more to avoid climate-related financial risks, not less. Simply because a risk to a type of project is difficult to precisely quantify does not mean that it should be ignored, or that it cannot serve as the basis for a decision to stop lending to such projects.

Banks are required to understand the full range of risks on their balance sheets that inform their lending decisions. Banks currently have significant exposure to climate-related risks, beyond even those posed by fossil fuel assets; these risks will likely be exacerbated as climate change accelerates. It is in a bank's own interest to fully assess the impact of new financing decisions, like lending to oil and gas exploration, on their existing portfolios.

An egregious example mentioned in the proposed rule describes bank lending based on accounts receivable, and states that it "would be impermissible for the bank to categorically deny access to this service to firms in a particular sector, given that the risks…would not change based on the sector in which the firm operates." This conclusion is wholly incorrect and demonstrates one of the many underlying issues with this proposal. Any rule that hinders the ability for a bank to consider sector-specific risks in its business decisions will lead to banks taking on risks they are not well-positioned to evaluate.

Given the proposal's requirement that banks provide financial services to all industries "on proportionally equal terms," it could force banks to extend credit to a project type or line of business when the weight of the risk-based evidence places the project or business outside of the bank's risk tolerance or expertise. This proposal would cause a chilling effect on the development of prudent risk management approaches, and would inhibit banks' ability to consider a broad range of risks, including climate-related financial risks. It runs counter to the OCC's mission and would undermine the safety and soundness of the banking system. Indeed, this proposal places fossil fuel politics over bank safety and financial stability. For these reasons, we oppose this proposal and call for it to be withdrawn

[1] Letter from congressional Republicans to Financial Regulators (June 16, 2020), available at https://www.sullivan.senate.gov/imo/media/doc/06-16-20%20AK%20Delegation%20Letter%20to%20the%20Federal%20Reserve,%20OCC,%20and%20FDIC%20Re%20Anti-Arctic%20Bank%20Policies.pdf

[2] President Trump has made deregulation and "cutting red tape" a mantra. Much of this deregulation at the Environmental Protection Agency and other agencies has been done at the behest of President Trump's political donors in the fossil fuel industry. Now, in response to pressure from an oil state's congressional delegation (and presumably from the oil and gas industry itself), a Trump-selected acting regulator has finally found a situation where he believes government action is necessary. If ever there were a perfect example of the stranglehold the fossil fuel industry exerts over the Republican Party, this proposal is it, as it flies in the face of the Republican Party's claimed commitment to ideals of free enterprise and limited government.

[3] Thomas Lee, "Fossil Fuel Stranded Assets: Efficient Market or Carbon Bubble." Penn Wharton Public Policy Initiative (April 12, 2017), https://publicpolicy.wharton.upenn.edu/live/news/1807-fossil-fuel-stranded-assets-efficient-market-or

[4] Battiston, et al., "A climate stress-test of the financial system," Nature Climate Change (March 27, 2017), https://www.nature.com/articles/nclimate3255

[5] Vladimir Stenek, "Carbon Bubbles & Stranded Assets," The World Bank (June 3, 2014), http://blogs.worldbank.org/climatechange/carbon-bubbles-stranded-assets

[6] Jorge Núñez Ferrer and Pavel Kiparisov, "Can the Carbon Bubble become a serious Financial Bubble," CEPS Energy Climate House, http://ceps-ech.eu/sites/default/files/Carbon%20Bubble%20background%20briefing%20paper.pdf

[7] Mercure, et al., "Macroeconomic impact of stranded fossil fuel assets," Nature Climate Change (June 4, 2018), https://www.nature.com/articles/s41558-018-0182-1

[8] Id.

[9] Paul Fisher, "Confronting the challenges of tomorrow's world," Bank of England (March 3, 2015), https://www.bankofengland.co.uk/-/media/boe/files/speech/2015/confronting-the-challenges-of-tomorrows-world.pdf?la=en&hash=DA7050DCC625A7127875DA88665B67094914CB2B

[10] Bolton, et al., " The green swan: Central banking and financial stability in the age of climate change," Bank for International Settlements (Jan. 2020), https://www.bis.org/publ/othp31.pdf

[11] "A call for action: Climate change as a source of financial risk," Network for Greening the Financial System (April 2019), available at https://www.banque-france.fr/sites/default/files/media/2019/04/17/ngfs_first_comprehensive_report_-_17042019_0.pdf

[12] Battiston, et al., "A climate stress-test of the financial system," Nature Climate Change (March 27, 2017), https://www.nature.com/articles/nclimate3255

[13] Mathew Carr and Lisa Pham, "Bank of England Climate Tests Weigh Disorder in Stock Market," Bloomberg (Aug. 2, 2019), https://www.bloomberg.com/news/articles/2019-08-02/u-k-insurers-to-weigh-stock-market-disorder-caused-by-climate?sref=St6YrHy8

[14] "Discussion Paper: The 2021 biennial exploratory scenario on the financial risks from climate change," Bank of England (Dec. 2019), https://www.bankofengland.co.uk/-/media/boe/files/paper/2019/the-2021-biennial-exploratory-scenario-on-the-financial-risks-from-climate-change.pdf?la=en&hash=73D06B913C73472D0DF21F18DB71C2F454148C80

[15] Christopher Condon, "Fed's Powell Says Central Banks Must Help Address Climate Change," Bloomberg (Nov. 12, 2020), https://www.bloomberg.com/news/articles/2020-11-12/feds-powell-says-central-banks-must-help-address-climate-change?sref=ygM2vgD8

[16] In first for Fed, U.S. central bank says climate poses stability risks, Reuters (Nov. 9, 2020), https://uk.reuters.com/article/usa-fed-stability-climate/in-first-for-fed-us-central-bank-says-climate-poses-stability-risks-idUKL1N2HV2KX

[17] Oversight of the Treasury Department's and Federal Reserves' Pandemic Response, House Financial Services Committee (Dec. 2, 2020), available at https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=407031

[18] Litterman, et al., Managing Climate Risk in the U.S. Financial System, Commodity Futures Trading Commission, pg. 20, https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf