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Managing climate change-related risks in the financial system

By Patrick IbbotsonJessica Dorricott

• 18 September 2020 • 7 min read
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Amidst the spectre of wildfires on the west coast for another season and with some election battle lines being drawn around climate change policy, an expert subcommittee of the United States, Commodity Futures Trading Commission, has reported on risks posed by climate change to the stability of the US financial system.

While Australia has benefitted hugely from high carbon intensive industries, coal in particular, the transitional costs of, for example, a sudden reduction in coal exports will be significant. One message for Australia from the report is the necessity of planning for that eventuality.

What is the subcommittee?

The Climate-Related Market Risk Subcommittee is a Market Risk Advisory Committee of the US Commodity Futures Trading Commission established to identify and examine climate change-related financial and market risks.

The US Commodity Futures Trading Commission is an independent agency of the US Government that regulates the US derivatives markets[1].

The Subcommittee has diverse membership including large financial firms JPMorgan Chase, Citigroup and BNP Paribas, oil giants ConocoPhillips and BP, and Allianz insurance.

Report findings

The report recognises that climate change poses major and complex risks to the stability of the US financial system and to its ability to sustain the US economy. Climate change is already impacting or is anticipated to impact nearly every aspect of the US economy. No doubt Australia could draw similar conclusions about the impacts of climate change on infrastructure, agriculture, residential and commercial property and human health and labour productivity.

The report considers in detail the physical and transition risks associated with the impact of climate change on the U.S economy. Physical risk is the risk that arises from the material, operational, or programmatic impairment of economic activity and the corresponding impact on asset performance from the shocks and stresses attributable to climate change. Transition risk is the risk associated with the uncertain financial impacts that could result from a transition to a zero carbon economy.

Transitional risks are real and demand a balanced response to climate change. However, the report emphasises that the longer governments wait to address climate change the more rapidly physical and transition risks are likely to increase in parallel. The physical impacts of climate change will intensify while the magnitude of the response needed to arrest further climate change grows. The public and private sectors must progress both climate mitigation and adaptation simultaneously to effectively manage both physical and transition risks.

The report notes that uncertainty about the impacts of climate change leads to financial system vulnerability. Climate change is expected to affect multiple sectors, geographical areas, and assets in the US, possibly simultaneously and within a relatively short timeframe. Climate and non-climate-related risks could also interact with each other, amplifying these systemic shocks.

The report notes that climate change could also lead to ‘sub-systemic’ shocks, those events that affect financial markets or institutions in a particular sector, asset class, or region of the country, but without threatening the stability of the financial system as a whole.

The Subcommittee has called on US financial regulators to move urgently and decisively to measure, understand, and address climate-related risks by working with financial institutions and the market. There is also a role for the financial community to address the risks by providing new financial products, services, and technologies to help the US economy better manage climate risk and help channel more capital into technologies essential for the transition to a low carbon economy.

Key recommendations

The Subcommittee has made 53 recommendations, the primary recommendation being the need to establish a price for carbon consistent with the Paris Agreement.

The Subcommittee has made a number of recommendations around systematic risk oversight, including federal financial regulators joining and actively engaging in international financial forums, including G7 and G20, to exchange information regarding the monitoring and management of climate-related financial risks.

To undertake climate risk management companies need reliable, consistent and comparable data and methodologies. In order to facilitate this the Subcommittee recommends that financial regulators, in coordination with the private sector, should support:

  • the availability of consistent, comparable and reliable climate risk data and analysis to advance the effective measurement and management of climate risk
  • the development of US-appropriate standardised and consistent classification systems or taxonomies for physical and transition risks, exposure, sensitivity, vulnerability, adaptation, and resilience, spanning asset classes and sectors, in order to define core terms supporting the comparison of climate risk data and associated financial products and services.

The Subcommittee made a number of recommendations around mandatory climate risk disclosures. Mandatory disclosure will allow companies to:

  • identify, assess, manage, and adapt to the effects of climate change on operations, supply chains and customer demand
  • to relay risk and opportunity information to investors, markets, and regulators
  • to learn from competitors about climate-related strategy and risk management best practices.

The Subcommittee has also recommended that the US government should consider integration of climate risk into fiscal policy as current and ongoing fiscal policy decisions have implications for climate risk across the financial system.


The report is non-partisan and without a ’green agenda’. While its conclusions and recommendations reflect numerous reports from other government and non-government organisations, its tone, findings and recommendations are telling given the nature of the US Commodity Futures Trading Commission.

Of particular note is the emphasis on transitional risk. Clearly transitioning to a low carbon economy will come with costs but the emphasis in the report is that those costs will be greater if there is delay or if the transition is sudden. By delaying the transition, the dichotomy that some draw between economic outcomes (jobs) and environmental outcomes becomes more acute. It does not need to be that zero sum game.

This transitional focus is significant for Australia. For example, our economy has benefited hugely from coal. The Reserve Bank of Australia published ’The Changing Global Market for Australian Coal‘ in 2019, which observes:

For most of the past decade, coal has been Australia’s second largest resource export, after iron ore, and since 2015 has averaged around one quarter of annual resource export values and 14% of total export values. In 2018, the value of coal exports was $67 billion, equivalent to 3.5% of nominal GDP.

The growth in coal exports from the The Changing Global Market for Australian Coal

The RBA report observes that while our domestic consumption of coal has fallen by around 11% since the mid-2000s our economy has become increasingly dependent on coal exports and observes ”Given the size of Australia’s coal exports, changes in export volumes and prices can have a significant effect on Australia’s GDP and terms of trade”.

The transitional cost to Australia of a sudden reduction in coal exports would be significant. The US Commodity Futures Trading Commission report emphasises the risk of not diversifying our economy. Whatever view you take on the climate science, what will matter is when the countries who buy our coal change their purchasing behaviour.

The RBA report considers this point in terms of both thermal and metallurgical coal and observes:

The International Energy Agency’s (IEA) World Energy Outlook 2018 report presents long-term projections of thermal coal demand under different electricity generation scenarios. Under the IEA’s scenario framed around government policies currently in place (‘current policies’), global thermal coal demand is expected to increase moderately over the next 20 years, but still comprise a declining share of global electricity generation. An alternative IEA scenario (‘new policies’), where a range of policies currently under consideration are implemented (which the IEA suggests moves countries towards meeting their Paris Agreement obligations), would see coal-powered generation broadly unchanged over coming decades.

Different demand scenarios for thermal coal from the The Changing Global Market for Australian Coal

If we need to plan for the sustainable development scenario we may regret not having started earlier.

The mission of the Commodity Futures Trading Commission is to promote the integrity, resilience, and vibrancy of the US derivatives markets through sound regulation

Want to know more on climate change related risks in the financial system?

Get in touch with the Planning & Environment team

By Patrick IbbotsonJessica Dorricott

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