How the Financial System Can Help Solve the Climate Crisis - And Create Prosperity to Boot

As the sponsor of one bill that was passed by the House Financial Services Committee and another that was under consideration prior to the pandemic, U.S. Rep. Sean Casten, D-Illinois, is a leading Congressional voice on how the financial industry can usher in a prosperous era fueled by clean energy.  In an interview in a recent edition of The RMA Journal, a portion of which is excerpted below, he says the way forward involves stressing the considerable economic benefits—and not necessarily the environmental ones. The article, part of a special report on climate change and the financial industry, is available here.  

RMA JOURNAL: You have introduced bills in Congress regarding climate risk stress tests [the Climate Change Financial Risk Act of 2019 (H.R. 5194)] and climate risk disclosures [the Climate Risk Disclosure Act of 2019 (HR 3623)]. Could you briefly describe what they would require?

CASTEN: The stress test would require bank regulators to consider whether climate change presents a systemic risk. I would submit that it does. When you have hundreds of billions of dollars in property that’s going to be lost to flooding, and you consider all the related insurance policies and mortgages, that is a systemic risk. For its part, the climate risk disclosure bill essentially would create a standard accounting for disclosing climate risk. Currently, firms produce wildly different reporting both for their exposure to a changing climate and their contribution to it. A standard set of disclosures would protect investors. If you are deciding whether to invest in a real estate investment trust with assets in Miami Beach or one with assets in Denver, those are fundamentally different from a climate risk perspective. But we don’t currently treat them as distinct. What if you want to invest in something that is going to hedge the higher climate risk in Miami? Standardized reporting would allow for a way to quantify the hedge to make sure it offsets the risk.

RMA JOURNAL: When you questioned Fed Chair Jerome Powell during his testimony before the House Committee on Financial Services in February, you noted two types of climate risks that could affect banks and the financial system: physical and transitional. Can you briefly describe those here?

CASTEN: “Physical risk” describes the risk of asset loss due to climate-related impacts. Floods wash away your home. Hailstorms damage your vehicle fleet. Wildfires destroy your property. Those are all tangible and fairly easy to understand. “Transitional risk” is more about what happens as capital markets anticipate or respond to those changes. Some transitional risks are just about capital leaving markets—for example, when an auto insurer sees an increase in claims for hail damages and quietly removes that rider from their policy, vehicle owners are left holding that risk as the “smart money” leaves the market. But that capital migration creates local challenges, even when it might lead to net economic gain. For example, a grid that embraces clean energy has cheaper and cleaner power, and more jobs for solar manufacturers. But it will be disruptive to coal plants and coal communities who no longer have a competitive resource to sell and cannot readily relocate to or retrain for those new growth areas.

RMA JOURNAL: You also noted to Chairman Powell the more than $700 billion in banking assets tied to fossil fuel, and their exposure to transitional risk. What scenarios concern you regarding fossil fuel and transitional risk?

CASTEN: An obvious example would be the mortgages and insurance associated with coastal property exposed to the risk of sea-level rise. A 30-year mortgage on such property signed today might be insurable, not because the risk is low in year 20, but because the insurance is renewed every year. A scenario where that insurance is not renewable (or at least not cost-effectively renewable) between now and the date that the mortgage is fully repaid would cause significant ripple effects on the ability to refinance and/or resell those mortgages, putting the residual unpaid principal and underlying equity at risk.

RMA JOURNAL: How big of a part can the financial system play in addressing the overall climate crisis—in the U.S. and internationally?

CASTEN: The financial system is virtually the entire game when it comes to responsibly addressing the climate crisis. All of the possible solutions to getting to a zero-net CO2 world exist between one of two poles. At one extreme are deep sacrifices in our quality of life and access to useful energy. At the other extreme is a complete overhaul of our energy system to provide us with the same level of useful energy but without fossil input. One extreme is economically disastrous while the other leads to cheaper, cleaner, and sustainable energy that can be a source of growth. But that more responsible extreme will require massive capital investment. The U.S. energy sector alone has a total depreciated capital value of slightly over $8 trillion. The replacement cost is far, far higher. But within that $8 trillion is a massive diversity of public and private investments, from coal mines and gas wells to power plants and oil refineries to transmission wires and gas stations. Deploying the capital needed, at the pace required to avoid climate catastrophe, requires an all-hands-on-deck effort that is all going to be routed through the international financial system. Let’s get working.