SNW Impact Insight: Climate Change at the Fed

A quick note: To highlight the SNW Impact Strategy through 2019, we will be periodically sharing thoughts and observations from the team responsible for the research and ratings. These pieces are intended to share the context of how the ratings are derived, the philosophy behind ESG and impact ratings, and how the industry is currently positioned. They may feature entities that we do not currently invest in.

Glenn D. Rudebusch, senior policy adviser and executive vice president in the Federal Reserve Bank of San Francisco’s economic research department, outlined the economic impacts of climate change in an Economic Letter released on March 25th. The letter highlighted the likely direct and indirect impacts that will result from rising sea levels, increasing temperatures and changing weather patterns, as well as from resource reallocation to deal with these impacts and to increase climate resiliency in affected communities. This includes both near- and long-term impacts that may yield negative economic outcomes.

Referencing the latest National Climate Assessment released in November 2018, the FRBSF letter provides insight into how markets and central banks may react to climate change. Risks from climate change are of concern to central banks, including the Federal Reserve, as they may require a change in monetary policy. As Rudebusch points out, "Climate-related financial risks could affect the economy through elevated credit spreads, greater precautionary saving, and, in the extreme, a financial crisis. There could also be direct effects in the form of larger and more frequent macroeconomic shocks associated with the infrastructure damage, agricultural losses, and commodity price spikes caused by the droughts, floods, and hurricanes amplified by climate change." These factors, while initially local, may have global carry-on effects. Alongside these direct impacts, adaptation and resilient responses will require the diversion of resources from productive capital accumulation. In combination, as the letter points out, "Climate change is becoming relevant for a range of macroeconomic issues, including potential output growth, capital formation, productivity, and the long-run level of the real interest rate."

With that said, however, Rudebusch points out that the Federal Reserve's statutory mandate of price stability and full employment will restrict the actions the organization can take. The use of policy to support climate change mitigation through the transition to a low-carbon economy, through support for an appropriate pricing of carbon or through other direct actions focused on environmental sustainability are all beyond the remit of the Fed. However, the analysis and policy decisions undertaken by the Federal Reserve can and should take climate change and its effects into consideration as "the volatility induced by climate change and the efforts to adapt to new conditions and to limit or mitigate climate change" are increasingly relevant.

In January, twenty senators sent a letter to the Chairman of the Federal Reserve and to the Comptroller of the Currency urging them to bear in mind that their agencies are responsible for protecting the stability of the U.S. financial system and urging them to ensure that the nation's financial system is ready for climate change. In February, Chairman Powell of the Federal Reserve told legislators that the inquiry about climate change was a "fair question" to ask, and he promised to look into it. These financial risks are increasingly apparent, as what was once considered a long-term issue begins to express itself in more near-term impacts.

Our approach to credit analysis, even outside the holdings in our SNW Impact Strategy, includes an integrated approach to evaluating material and relevant climate and environmental factors in all sectors in which we invest. Our view continues to be that prudently managing risk and being aware of the full spectrum of origins of such risk is a critical responsibility. This includes near-, mid-, and long-term idiosyncratic risks that may affect the ability of issuers to repay their outstanding obligations. We will continue this approach and adjust strategy and positioning as needed.