Representatives from across the derivatives industry discussed the role of financial markets in managing climate change risks on an FIA Expo panel on 10 November, agreeing that markets and regulators must work collaboratively to develop market-based solutions.
The panel discussion follows the release of a climate change policy paper from FIA and a report from the climate-related subcommittee of the US Commodity Futures Trading Commission’s Market Risk Advisory Committee, sponsored by Commissioner Rostin Behnam. The CFTC's report provides 53 actionable recommendations on ways financial markets should evolve to address climate risk, including setting a price on carbon, and is the first effort of its kind from a US federal financial regulator.
Speaking on the Expo panel, Behnam said climate change poses a systemic risk to the stability of the US financial system and its ability to support the economy, and emphasized the need for the industry and regulators to work collectively, both in the US and internationally.
"As we continue to see extreme weather events, it is incumbent on all of us to think about how these sub-systemic shocks to regional economies could, if we have corresponding events throughout the year, lead to larger systemic shocks to the financial system," Behnam said. "One of the key tenets of the (CFTC’s) report is about moving quickly, because this is a crisis that we have to address as soon as possible, but being thoughtful, being collaborative and being cognizant that things will change and that we have to adapt in the future."
Behnam highlighted some of the report's recommendations, including stress testing under different climate scenarios, standardized disclosures by firms of climate-related risks and data sharing between regulators.
"Data is key and this weaves into the disclosure theme," he said, "We all have different pockets of data. We need to start working better together, collectively, sifting through the data, sharing data, and thinking about what climate data can tell us as a financial market ecosystem to better address and mitigate climate risk," he said.
Effectiveness of market-based solutions
Dan Scarbrough, president and chief operating officer of IncubEx, an incubator for exchange-traded products with a specific focus in the environmental markets, talked about the rise in market-based solutions over the last 15 years. Those efforts began in large part with the European Union's Emissions Trading System, a cap-and-trade system that became the world’s first major carbon market in 2005.
In North America, in the absence of federal adoption of climate change policy, states took action on their own, creating carbon cap-and-trade markets primarily in the northeastern and western regions.
"What we are seeing now is a proliferation of market-based solutions in new jurisdictions and new asset classes. Not only carbon, but also renewable fuels, renewable energy, things like wind and solar under state RPS (renewable portfolio standard) mandates," he said. "[In the US], the markets have definitely picked up, albeit on a state and regional basis, as opposed to at a federal level."
Speaking about private-sector led initiatives, Bill McCoy, managing director, legal and compliance division at Morgan Stanley, pointed to the Taskforce on Scaling Voluntary Carbon Markets. This private-sector body was recently initiated by Mark Carney, UN special envoy for climate action and former governor of the Bank of England.
The Taskforce convened in September with the aim of developing a blueprint to scale a voluntary carbon market to help meet the climate goals of the Paris Climate Agreement. Both Morgan Stanley and FIA are members of the consultative group of the Taskforce, which plans to publish a final report on its blueprint by the end of January 2021. On 10 November, it released a public consultation document on its plans.
"The aim of the document is to identify the infrastructure solutions that are necessary to scale the voluntary carbon markets," McCoy said. "The document outlines key recommendations, including a proposed set of core carbon principles and exchange-traded core carbon reference contracts, and focuses on areas such as offset legitimacy, market integrity, and demand signaling."
Speaking about the power of markets to bring about change, Pauline Engelberts, the global chief operations officer at ABN AMRO Clearing, said: "Clearing is part of the value chain, and even though we are post-trade we are facilitating large volumes of trades in many of these [environmental] products. The financial markets have so much power to make a change, to shift liquidity and bring liquidity to markets that are needed for the energy transition."
Ending the discussion on an optimistic note, Behnam discussed the opportunities that would arise through collaborative regulatory and industry actions.
"Whether it's through fiscal policy, monetary policy or leveraging the innovation and the expertise of the derivatives market to come up with new products, there are a lot of opportunities for economic productivity, economic growth, job creation, and getting to the core of what we're trying to do – mitigating and attacking climate change as we transition the economy to net zero in the decades to come," he said. "We have to pool our innovation and the entrepreneurial spirit of the derivatives market that's existed for decades to solve the problem."
