Report Warns of Climate Risks

CFTC Task Force Spotlights Potential Climate Shocks to US Financial System

Chris Clayton
By  Chris Clayton , DTN Ag Policy Editor
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The August wind storms that blasted through Iowa last month shocked the state's agricultural businesses and other industries as grain bins were crushed at major elevators, and other businesses and farms were destroyed. (DTN file photo)

OMAHA (DTN) -- A new report released by a Commodity Futures Trading Commission subcommittee calls for the United States to set a price on carbon as a key step needed for financial regulators to mitigate the risks climate change poses to the country's financial system.

The call to set a price on carbon came from an array of more than two dozen global companies representing finance, agriculture and even energy sectors who were on the task force that wrote the CFTC report. The CFTC's Market Risk Advisory Committee was led by Democratic CFTC Commissioner Rostin Behnam, who has served on the CFTC since 2017. The subcommittee voted 34-0 to release the report and the dozens of recommendations for financial markets to deal with climate risks.

CENTRAL FINDING

A central finding of the report is that climate change poses systemic risk to the U.S. financial system. Multiple sectors, geographies and assets in the U.S. are affected, sometimes simultaneously. The spillover effect has the potential for "systemic shocks" to the financial system. A rapid change in market perceptions about climate risks could cascade through financial portfolios and balance sheets, destabilizing the country's financial system, the report spelled out.

"U.S. financial regulators must recognize that climate change poses serious emerging risks to the U.S. financial system, and they should move urgently and decisively to measure, understand and address these risks," the CFTC report stated.

Agricultural risk and markets were highlighted throughout the report, which included members representing Cargill, Bunge, Dairy Farmers of America, CME Group and the agricultural analytics group Gro Intelligence as members. "It is exciting and necessary for the financial system to take this crucial step toward addressing climate change and becoming part of the solution," said Sara Menker, CEO of Gro Intelligence, in a news release about the report.

Despite the 196-page report being issued by the CFTC committee, a spokesperson for the commission noted the report reflects the work of a climate-related subcommittee and does not necessarily reflect the views of CFTC, "or its staff or the U.S. government." CFTC Chairman Heath Tarbert credited Behnam for putting together the report, but Tarbert also noted the report points to risks in changing the economy too quickly to try to reduce greenhouse emissions. Tarbert pointed to brownouts in California to make his point.

GET THIS RIGHT

"The subcommittee's report acknowledges that 'transition risks' of a green economy could be just as disruptive to our financial system as the possible physical manifestations of climate change, and that moving too fast too soon could be just as disorderly as doing too little too late," Tarbert said. "This underscores why it is so important for policymakers to get this right. The brownouts and power rationing taking place in California today underscore the potential implications of flawed climate policy -- we must avoid introducing similar dynamics in our derivatives markets."

The CFTC report called for financial regulators within the U.S. to work together, and work internationally with financial regulators in the G7 or G20, among others, to ensure climate risk is part of the global financial agenda.

Financial institutions should also look at developing climate risk stress tests, which should include agricultural lenders and community banks, the CFTC report stated.

NEED POLICIES AND INCENTIVES

Yet, financial markets need policies and incentives that focus on reducing greenhouse-gas emissions to mitigate the financial risks, the CFTC subcommittee report stated. The report's fundamental finding is that financial markets can only channel resources into practices that reduce greenhouse gas emissions "if an economy-wide price on carbon is in place at a level that reflects the true social costs of those emissions."

A key recommendation is that the U.S. should establish a price on carbon. "It must be fair, economy-wide and effective in reducing emissions consistent with the Paris Agreement," the CFTC stated. "This is the single most important step to manage climate risk and drive the appropriate allocation of capital."

U.S. agricultural commodity giant Cargill participated in the report as well. The commodity company credited the CFTC subcommittee for writing the report, noting the executive summary calls for policies that are "flexible, open-ended and adaptable to new information about climate change and its risks" and dialogue with the private sector. Agriculture, Cargill cited, has a "history of innovation and adaptability." Cargill added, "Agriculture is how we can mitigate greenhouse gas emissions, capture carbon and provide other ecosystem services for society as a whole. In addition, a healthy and vibrant agricultural sector is necessary for a safe, sustainable and affordable food system."

MORE FEDERAL FUNDING

As Cargill pointed to the potential for agriculture to capture carbon, more federal funding is going to develop platforms for those markets. The University of Illinois on Wednesday announced it had received $4.5 million from the U.S. Department of Energy's Advanced Research Projects Agency-Energy (ARPA-E) program to develop a program to calculate carbon credits on the farm.

According to the news release, the University of Illinois is developing technology that would help farmers determine if certain practices sequester more carbon in the soil. It would allow farmers to reduce their farm emissions and potentially earn carbon credits.

Last November, USDA's Foundation for Food and Agriculture Research gave $10.3 million in funding to the Ecosystem Services Market Consortium to establish a platform for a carbon market. There's also a Senate bill that would require USDA to help farmers become certified for such markets.

MAJOR CONCERN FOR REGULATORS

A major concern for regulators is what is not known about climate risks, the CFTC stated. Climate change can exacerbate other vulnerabilities in the financial system such as how leveraged corporations may become. This is more unsettling now because of stressed businesses due to COVID-19, the CFTC stated.

Climate change will change how markets operate. Financial regulators are likely to increasingly want companies and governments to disclose more information on climate risks, exposure, vulnerabilities, adaptation and resilience. The public as well will want more access to that data to allow those trading in markets to "among other things, compare publicly available disclosure information and sustainability-benchmarked products." Markets will adapt as companies also develop proprietary products to provide innovations or improvements to risk-management tools. The challenge will be balancing the need for transparency with the need for private innovation as well.

SEPARATE REPORT RELEASED

Just last week, the group Environmental Defense Fund released a separate report spotlighting how agricultural lenders could help address climate risk in agricultural finance and on farms. That report noted climate risk is a blind spot for agricultural lenders and poses greater financial risks. Crop insurance operates as a "shock absorber" for farmers and bankers, but it's not enough to handle the broader, long-term risks.

"That's the crux of the shift we need to make on resilience," said Maggie Monast, director of working lands for Environmental Defense Fund. "These reports make the case, as the phrase goes, that an ounce of prevention is worth a pound of cure. It's hard from a human-nature perspective to prepare for disasters, and you have to incur some costs now to reduce costs later. That's really the overall argument that we're making by building better resilience in agriculture that it will reduce overall long-term costs."

INCREASING EXTREME WEATHER EVENTS

Behnam, the commissioner who led the task force, was formerly lead counsel for Democrats on the Senate Agriculture Committee under Sen. Debbie Stabenow of Michigan. Behnam spoke last February about the uncertain costs of climate risks to agriculture in a speech to the crop insurance industry. He noted then that the number of costly extreme weather events each year across the country continues to increase.

"We are facing increasing financial risks as a result of potential bank loan losses due to business interruptions and bankruptcies caused by extreme weather events," Behnam said to the crop insurers in February. Behnam added that losses from extreme weather events become compounded for the uninsured, as well as others who can see their creditworthiness change and increase the risk of people and businesses defaulting on loans.

Cargill letter on CFTC Climate Report: https://www.cftc.gov/…

CFTC report: Managing Climate Risk in the U.S. Financial System https://www.cftc.gov/…

Chris Clayton can be reached at Chris.Clayton@dtn.com

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Chris Clayton