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The US agency charged with regulating the derivatives market is
turning more of its attention to the risk posed by climate threats,
as more companies transition to low-carbon solutions.
The US Commodity Futures Trading Commission (CFTC) announced 17 March the creation
of a "Climate Risk Unit" that would play a "vital role" in
developing new financial products and solutions that will build a
financial system that is resilient to shocks caused by
climate-fueled impacts.
Specifically, this newly created unit, with staff from across
the agency, would ensure that any new financial products and
markets in the climate and broader environment, social and
governance (ESG) arena "fairly facilitate hedging, price discovery,
market transparency and capital allocation."
Derivative markets, which help the global economy manage risk,
play a vital role in discovering prices for everything "from a
barrel of crude oil to a megawatt of solar energy to a tonne of
CO2, helping businesses" while helping policymakers understand the
true costs of climate change," according to the Futures Industry
Association (FIA), a global organization for the futures, options,
and centrally cleared derivatives markets.
With more than $30 trillion now flowing into ESG investments,
the FIA said, "there is clearly demand for these types of
products."
The CFTC's announcement comes a day after Allison Herren Lee,
the acting chair of the US Securities and Exchange Commission,
solicited public comment on its efforts to
improve how publicly traded companies report risk posed by climate
and ESG issues.
The two announcements demonstrate that the Biden administration
is taking its government-wide approach to tackling the climate
crisis -- which has fueled power and water shortages, damaged
properties, and ramped up insurance premiums among other things --
to heart.
"Climate change poses a major threat to US financial stability,
and I believe we must move urgently and assertively in utilizing
our wide-ranging and flexible authorities to address emerging
risks," Acting CFTC Chairman Rostin Behnam, said in a statement
accompanying the agency action.
Front lines
He said the CFTC's unique mission focused on risk mitigation and
price discovery puts the agency on the "front lines" of this
effort.
As part of its charge, the newly created unit will reach out to
exchanges, clearinghouses, industry groups, and market participants
to discuss new and emerging risks pertaining to climate change and
how such risks are being addressed, or ought to be addressed, in "a
fair and equitable manner."
The unit also will coordinate national and international efforts
to write consistent standards, disclosures, and practices as well
as efforts to develop relevant and reliable climate-related market
risk data, the agency said.
Alexandra Thornton, senior director for tax policy at the Center
for American Progress (CAP), said the CFTC's action is "truly good
news" and represents a key part of the all-of-government approach
to move the US economy toward the goal of reducing net greenhouse
gas emissions to zero.
Align with ESG trends
Most analysts and former CFTC regulators tracking climate
finance developments said the CFTC's action was a direct response
to the dramatic increase in ESG and climate-related
investments.
Given the Biden administration's focus on climate, this new
structure to align CFTC internal resources "makes complete sense,"
Scott O'Malia, chief executive officer of the International Swaps
and Derivatives Association, wrote in a March 18 email to IHS
Markit.
"The demand for green investments is growing rapidly, and
CFTC-regulated entities can play an important role in providing
financial solutions to help deploy the trillions of dollars in risk
capital required to transform our economy," O' Malia, a former CFTC
commissioner, added.
Likewise, Cornerstone, an energy policy advisory group, noted
that the CFTC decision to set up a climate risk unit is "certainly
in line with the broader trend we are seeing across all markets and
sectors" as climate risk and overall ESG factors are increasingly
being folded into investment and transactional decisions, and
financial tools continue to grow to keep up with demand.
Behnam's announcement builds on his prior actions to identify
challenges to managing climate-fueled risks to US financial
markets. In 2019, he set up the agency's Climate-Related Market
Risk Subcommittee, which was charged with looking at how to manage
climate risk in US financial markets.
That committee issued a report in September 2020 that
concluded that climate change does pose a risk to all aspects of
the US economy, and thereby its markets.
"The process of combating climate change itself -- which demands
a large-scale transition to a net-zero emissions economy -- will
pose risks to the financial system if markets and market
participants prove unable to adapt to rapid changes in policy,
technology, and consumer preferences. Financial system stress, in
turn, may further exacerbate disruptions in economic activity, for
example, by limiting the availability of credit or reducing access
to certain financial products, such as hedging instruments and
insurance," the report concluded.
Through the use of futures, options and other derivatives, the
FIA emphasized, "companies are able to absorb currency
fluctuations, allow energy companies to mitigate short-term price
volatility so they can invest in future infrastructure, and let
farmers grow their crops without worrying that global trade
disruptions might drive them to ruin."
The paper cited several examples of climate-driven innovations
in the derivatives markets, including the CME Group's E-mini
S&P 500 ESG Index futures, a new risk management tool that was
released in 2019 to align a
growing number of global institutional investors and asset managers
with ESG principles. CME Group is the world's largest derivatives
exchange.
The FIA also pointed to the futures market that has built around
the Regional Greenhouse Gas Initiative (RGGI) in the US that
enables electric utilities across Northeastern and Mid-Atlantic
states to trade carbon allowances under a "hard" emissions cap. The
RGGI futures market, which was built and operated by the
Intercontinental Exchange, has helped provide price discovery and
liquidity, the report said.
CAP's Thornton agreed, saying climate change poses risks to the
entire financial system, of which derivatives are a major part.
"Since derivatives exist on virtually every kind of asset, the
cascading consequences of a climate shock are real and directly
related to the mission of the CFTC to mitigate risk and promote
appropriate price discovery," she said.
The US saw with the 2008 financial crisis that derivatives can
be used to offload risks to others, Thornton said, adding "as the
US and the world transition as quickly as possible to a low-carbon
economy, some assets, especially those related to oil and gas
production, will lose value with ripple effects in the derivatives
markets. That is just one example."
Posted 18 March 2021 by Amena Saiyid, Senior Climate and Energy Research Analyst
