A legacy podcast from Lawrence Baxter’s prior academic career, exploring climate and regulatory issues
before his transition into executive coaching

 

 

Q: Clearly, this has been the focus of the Biden administration. A sort of all-government approach to climate change. But why specifically is climate change relevant to financial regulation? Can you summarize what financial regulators have started to do in this space?

 

00:17 Baxter: As you said its Earth Day today, and there’s a lot more excitement all around the dangers and impending catastrophes that climate change is presenting. Not only are all the environmentalists, all the scientists, synergized about this, but the financial markets are paying close attention, as are the regulators, for the simple reason that to achieve very rapid stretch goals, the market’s where the money is, and the money is going to be, what produces the incentives under the sanctions, to shape how climate change is addressed. So let me give you some examples. The Biden administration has just announced that it plans to cut greenhouse gas emissions by fifty to fifty-two percent by 2030. That is a huge goal that has to be given because climate change is coming on much faster, and we’ve been asleep at the switch for a number of years for political reasons.  

 

1:07 Baxter:But to get there is not going to be easy, even if you marshal financial markets as a whole. So, the financial markets consist not only of investors and traders and retail buyers and sellers and stock, but of course, the regulators as well.  The Federal Reserve System regulates essentially the big banks, and big bank holding companies, and there are other regulators I will mention in just a moment. They have an ability to influence the reaction of those who fund — for example the fossil fuel industry. So various actions can be taken by regulators. For example the Fed, how they can apply stress tests which make banks show how they will do as climate change presents great and great threats.

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1:50 Baxter:At this stage, I’m speaking hypothetically. They can also focus on whether the banks are managing their risks properly. For example, if banks are lending a lot of money in areas that are highly likely to be hit by widespread flooding or damaging storms that stem from climate change. Another thing that regulators can do is look at the concentration of funding or lending — it’s not only lending, but mostly lending by big banks. If, for example, there’s a very heavy concentration of real estate in certain areas, the same kind of concern arises, or there may be a heavy concentration in lending to energy companies or fossil fuel industries. And the question there is, you know is, what is the exposure? There are other technical things that I won’t go into, because we don’t have time here, but they can apply various other techniques to shape how the financial markets react.

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2:43 Baxter:The problem is that we don’t have unity in the country, and no unified record of the success of those widespread government-sponsored activities. They’re very powerful, but they’ve often gone wrong. For example, everyone probably remembers Sola Engrow, I think it was, which was solar energy fund that ended up losing the government over five hundred million dollars because there was a degree of misleading activity there, but it wasn’t only misleading, it was a failed enterprise. And that triggered political divisions in the country, deep skepticism about government agencies should be dabbling in this.

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3:23 Baxter:There are other, easy-to-illustrate examples of how this could go wrong.  So, let’s say, for example, the regulators decide to place pressure on banks, they’re not to fund certain types of investments. Only the ones that are highly provocative. Not to fund hydrogen fuel cell investment, because electric and lithium battery is going to take over. There’s deep division in the motor industry about which is actually the best way to go. In fact, just yesterday— Bosche, the German company that has made huge investments in electric and battery and energy as alternatives to traditional fuels, was very critical of government actions to that extent, because, as their CEO pointed out, that has the effect of suppressing what may well be much better alternatives, like hydrogen cell technology—that is developing, but may be starved of finance.

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4:14 Baxter:Now, it may be that government agencies get this right, but none of us have gotten it right yet. So, the government agencies like the Fed, and others I’m about to mention, are entering an absolute thicket of controversy. Having said that, one thing that the Fed, and another agency I think you’re going to raise, which is the Federal Oversight Council— the one thing they do have a direct concern for is stability of both individual banks, and the financial system, so they are on much firmer ground there. And the Federal Reserve System and some of its economists have produced a paper that basically urges the banking regulators to pay attention to these risks they believe are very real.

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4:57 Baxter:In reacting to danger, the bank regulators are on much firmer ground. In promoting alternatives, it gets much more tricky.  What have the other agencies done? Well, we have the Commodities Futures Trading Commission, and the SEC, that, Jim and Elizabeth talked about earlier, both market regulators, and the PFTC, the Product and Futures Trading Commission — actually lead the way — way ahead of all the other regulators as well. When Commissioner Behnam, who’s the acting chair at the moment, commissioned a sub-committee to look into climate change.

 

5:27 Baxter:Quantity futures trading commission regulates derivatives activities, in the form of exchange trade derivatives, like futures and options, and over-the-counter derivatives like large-scale swaps. And Commissioner Bennon was worried about so much of this derivative activity, leveraging risks, not being well understood, and its price discovery function. So, he commissioned a sub-committee that produced a superb report, one of the best we have by any government agency, uh, in the United States. So, the CDFC, since then, has actually created, under acting commissioner chairman Behnam, a climate risk unit. And to drive home the point, this now is a unit of the CDFC cross divisional staff, and they are going to delve deeper into how derivatives either help or endanger us, to the extent that they’re a very big component of the financial system, much bigger and volatile than anything else.

 

6:23 Baxter: The SEC has launched a project to compose much-improved disclosures by companies — that they have to be much more candid about the climate risks that they face. But it’s also a very complicated process. There are a number of questions that we have to go through. We don’t have the right metrics yet, we don’t know which will be effective, and which won’t —or which goes back to Jim’s statement, about how a lot of this goes outside of the regulatory system. Fossil fuel industry moving away from the reach of the regulators. The Federal Reserve System, as I mentioned, has now begun to acknowledge the scale of the problem, and is acting has rejoined an international network of central banks. And I think we’ll see a lot of action there, but a lot of it will be over a considerable amount of time. Then, as you’ve probably seen with headlines, the big asset managers have said that they will impose selection standards that relate to climate change. We run into the problem of greenwashing, in which a lot of institutions say they’re doing this, but when you dig deeply, and you discover that it’s words only, or companies are simply lying to them about what they’re doing. But at the same time, it’s being tackled, I think, on a big scale for the first time.

 

7:35 Baxter: The Treasury Secretary announced yesterday that she was going to expect the FSOC to be coordinating this massive action between the big agencies. So, I think we got the attention of government as a whole. Question is, solving these issues is much, much more complicated. But it is a vast difference from just a year ago, where there was a resolute refusal by government to  address the problem.

 

Thank you, Lawrence. I did want to ask you about the Financial Stability Oversight Council, but we’ve got several questions and run out of  time. 

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