On December 16, 2021, the US Office of the Comptroller of the Currency (“OCC”) released draft principles for managing exposures to climate-related financial risks (“Climate Principles”).1 The Climate Principles are targeted at banks with over $100 billion in total assets that are regulated by the OCC.2
The Climate Principles are part of a rapidly unfurling OCC initiative to address the effects of climate change.3 As we discussed in last month’s Legal Update on the OCC’s initial climate change risk management expectations, larger banks will need to promptly implement enhanced governance, strategic planning, risk management, oversight and data reporting practices for climate change.
The OCC will accept comments on the Climate Principles until February 14, 2022, and expects to issue more detailed guidance on climate risk management throughout 2022. In this Legal Update, we provide background on the OCC’s climate risk management initiative and discuss the Climate Principles.
As we explained in last month’s Legal Update, over the past three decades US financial regulators have adopted a series of operational and governance standards for insured depository institutions, including specialized standards for safety and soundness at larger federally chartered banks (“Heightened Standards”),4 which the OCC is now seeking to update to include climate change risks.
In November 2021, the acting head of the OCC issued a call to action on climate change to the boards of directors of OCC-regulated banks.5 Specifically, he outlined an initial series of climate change-related questions that boards should be asking bank management and stated that bank boards should use the exercise to help improve and build up climate risk management and reporting capabilities. He also indicated that the OCC would provide further guidance and expectations on the management of climate-related risk. The Climate Principles discussed here are the first part of that further guidance.
The Climate Principles outline a high-level framework for the management of exposures to climate-related financial risks6 that draws heavily from the Basel Committee’s proposed principles for climate risk management and the OCC’s existing Heightened Standards.7 They are targeted at larger OCC-regulated banks, which are defined as those with over $100 billion in total assets or that have material exposures to climate-related financial risks.8
However, unlike the 18 clearly defined principles of the Basel Committee’s proposal, the Climate Principles are divided into two narratives that contain somewhat disjointed commentaries on risk management. While institutions generally should be familiar with the concepts because they come from the Heightened Standards applicable to large institutions, this approach may complicate efforts to translate the Climate Principles into an institution-specific action plan. Therefore, banks should spend time upfront mapping the discrete expectations in the Climate Principles to existing risk management frameworks on a sentence-by-sentence basis.
The Climate Principles describe actions that bank boards and management should take to demonstrate appropriate governance of climate-related financial risk. Many of these actions are focused on ensuring that the board and management obtain sufficient information on risks and risk management activities. For example, the OCC expects bank management to regularly report to the board on the level and nature of climate-related financial risks.
The second theme of the governance-related principles is that the bank should assign appropriate responsibility and accountability for managing climate-related financial risks. This means that the board should provide credible challenge to management as part of their oversight function, management should establish responsibilities and accountabilities for managing climate-related financial risks, and staff should be held accountable for controlling risks within their lines of authority and responsibility.
The third theme is that the OCC expects climate change to have long-term consequences for banks and, therefore, expects banks to have a comprehensive approach to managing climate-related financial risks. With respect to governance, the OCC indicates that this may mean assessing the potential impact of climate-related risks using a time horizon that is longer than a bank’s typical planning horizon. It also means the bank should consider material climate-related financial risk exposures when setting the bank’s overall business strategy; risk appetite; and financial, capital and operational plans.
The OCC notes that the strategic planning process will be iterative with respect to incorporating material climate-related financial risks and reminds banks that climate-related strategies must align with the bank’s overall strategy and risk management practices and actions must be consistent with the bank’s public communications.
The Climate Principles contain several elements related to core risk management practices. For example, the OCC states that bank management should incorporate climate-related risks into policies, procedures and limits to provide detailed guidance on the bank’s approach to these risks.
Perhaps the most significant element is the expectation that bank management will oversee the development and implementation of processes to identify, measure, monitor and control climate-related financial risk exposures within the bank’s existing risk management framework. The OCC views this process as a comprehensive exercise that cuts across all risk categories and involves all lines of defense. Satisfying the agency’s expectations may require significant enhancements to risk management activities and the development of new resources that are tailored to climate-related financial risk.
Another area the Climate Principles highlight is the need for banks to use climate risk-related data. While the OCC states that it expects banks to aggregate and monitor climate risk-related data, the absence of standardized taxonomies and risk databases means that banks also may need to develop new approaches for defining and collecting relevant information. In particular, some have raised concerns to the OCC regarding the lack of readily available climate risk data.9
The Climate Principles identify scenario analysis as a risk management practice of emerging importance. This is no surprise given the significant emphasis placed on scenario analysis in the OCC’s November call to action. However, the Climate Principles seem to focus exclusively on the “top-down” approach to scenario analysis, which is similar to capital stress testing and focuses on the long-term effect of a scenario on the entire institution. This is in contrast to the November call to action, which emphasized the importance of conducting top-down and “bottom-up” analyses (bottom-up analysis asks more granular “what if?” questions and focuses only on parts of a bank’s portfolio).
The Climate Principles indicate that banks should develop their climate-related scenario analysis capabilities using the same approach that is used for other modeling activities (i.e., sound model risk management practices).10 While expected, this approach appears to discount the benefits of relying on standardized approaches, such as the scenarios developed by the Network for Greening the Financial System.11 It also does not indicate how the OCC’s expectations will align with the climate stress testing contemplated by the Federal Reserve.12
The final part of the Climate Principles is a lengthy discussion on how climate-related financial risks can be addressed in the context of specific risk categories or “stripes.” This discussion largely covers the content of Principles 8, 9, 10 and 11 of the Basel Committee’s proposal and addresses credit, liquidity, interest rate, operational, legal, compliance and reputational risks.
By stating that banks should view climate-related financial risks as being part of the OCC’s traditional risk categories, the Climate Principles appear to indicate that the OCC does not expect climate-related risk to be a standalone risk category in banks’ risk taxonomies. This view is consistent with the acting comptroller’s prior comments that climate risk cannot be reduced to a single metric but may lead to difficulties in assigning the impact of a climate-related risk event to different risk categories (i.e., avoiding double counting of climate risks).
Request for Feedback
The OCC styled the Climate Principles as being in “draft” form and requested feedback on them. In particular, it included 13 questions addressing the following topics:
- Scope of Application of the Climate Principles
- Potential Tailoring of Risk Management Practices
- Challenges to Implementation
- Existing Risk Management Practices Used by Institutions
- Data, Disclosure and Reporting Concerns
- Scenario Analysis Practices and Development Issues
Notwithstanding the “draft” label and the Climate Principles’ status as supervisory guidance,13 the OCC states that it will consider public feedback on the Climate Principles in relation to developing future guidance. Therefore, it may be the case that the Climate Principles remain in draft form and are refined in a piecemeal fashion. However, as indicated in the OCC’s November call to action, this is an issue that the agency will be focusing on as it examines larger banks over the next year. Therefore, OCC-regulated banks should update their climate change processes and procedures to align with the OCC’s expectations and be ready to further revise their climate change management plans to incorporate additional guidance from the agency.
It is worth noting that the Climate Principles and the November call to action emphasize different areas of focus for banks (e.g., the November call to action emphasized business continuity and service provider risks, which are barely mentioned in the Climate Principles).14 Given that banks already struggle with coordinating and prioritizing risk management burdens, hopefully, future guidance will provide a clearer path to satisfying the OCC’s priorities for climate-related risk management.
Banks that are not regulated by the OCC also might consider reviewing the Climate Principles to inform their own risk management activities. As we have seen with the Heightened Standards, the rules for the largest OCC-regulated banks have a way of being applied to certain smaller banks and state-chartered banks by some examiners. This is particularly true for state-chartered banks that have larger and more complex operations that are associated with material exposures to climate-related financial risks.
To discuss any of the issues raised in this Legal Update, please reach out to any of the authors listed above or your Mayer Brown contact.
1 OCC, Bull. 2021-62 (Dec. 16, 2021), https://www.occ.gov/news-issuances/bulletins/2021/bulletin-2021-62.html.
3 The OCC’s actions track with other regulatory initiatives, such as the report on climate-related financial risk that was recently issued by the Financial Stability Oversight Council and reiterated last week. See Press Release, Financial Stability Oversight Council Releases 2021 Annual Report (Dec. 17, 2021), https://home.treasury.gov/news/press-releases/jy0541.
5 OCC, Acting Comptroller Discusses Climate Change Risk (Nov. 8, 2021), https://occ.gov/news-issuances/news-releases/2021/nr-occ-2021-116.html.
6 In contrast to the November call to action’s broad focus on “climate risk,” the OCC appears to have attempted to slightly narrow its focus to “climate-related financial risk,” which would better align the agency with the Financial Stability Oversight Council and traditional notions of safety and soundness. See Press Release, Financial Stability Oversight Council Identifies Climate Change as an Emerging and Increasing Threat to Financial Stability (Oct. 21, 2021).
7 Please see our Legal Update on the Basel Committee’s proposal: https://www.mayerbrown.com/en/perspectives-events/publications/2021/12/climaterelated-financial-risks-bis-issues-consultation-on-principles-for-effective-management-and-supervision.
8 This threshold is part of the OCC’s ongoing journey in defining bank size. In contrast, the OCC’s Heightened Standards apply to banks with more than $50 billion in total assets, and the OCC’s guidelines for recovery planning apply to banks with more than $250 billion in total assets. 12 C.F.R. pt. 30, apps. D and E. See also, OCC, Bull. 2020-94 (Oct. 30, 2020) (providing operational risk management practices to certain banks with $100 billion or more in total assets), https://www.occ.gov/news-issuances/bulletins/2020/bulletin-2020-94.html.
9 E.g., Press Release, All Committee Republicans Ask OCC for Clarity on Potential Climate Supervision Proposal (Nov. 19, 2021), https://republicans-financialservices.house.gov/news/documentsingle.aspx?DocumentID=408202.
11 Press Release, NGFS publishes the second vintage of climate scenarios for forward looking climate risks assessment (June 7, 2021). Please see our Legal Update on the latest NGFS scenario.
13 See 12 C.F.R. pt. 4, app. A. It is unclear why the Climate Principles were issued as supervisory guidance instead of as a safety and soundness guideline. This approach may reflect a recognition by the OCC that existing safety and soundness guidelines and risk management requirements already apply to climate-related financial risks. However, the double-edged sword of supervisory guidance is that it can be highly susceptible to change and reinterpretation because regulators are not bound by the rulemaking process and examiners are not bound by black-letter law.
14 It may be the case that the Climate Principles were issued on an expedited basis to sync up with the final FSOC meeting of 2021. See Press Release, Acting Comptroller of the Currency Issues Statement in Support of the FSOC’s Climate-related Financial Risk Committee (Dec. 17, 2021), https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-139.html.