The financial services industry must begin to expand efforts related to ESG (environmental, social, and governance) factors, including impact strategy, assessment, and measurement. COVID-19 amplified ESG awareness and expectations amongst public policy makers, investors, and consumers while simultaneously highlighting racial, social, and economic inequalities. Demand for ESG disclosures, commitments, and actions from regulators and companies is increasing and rapidly evolving; climate change and racial equity are among key priority areas. In financial services, efforts to address climate change and racial equity are beginning to converge as it becomes apparent that certain economically vulnerable communities are more susceptible to and disproportionately affected by climate change risks. Regulators have authority to supervise climate-related financial risks, investors are setting ESG decisioning parameters, and public attention is increasing reputation risk. Financial services firms should anticipate ESG-related developments and regulatory attention across CRA activities (including community development lending and investment), consumer and investor protections (including fair access/fair treatment, responsible banking), and new legislative and/or regulatory requirements (such as disclosure requirements, carbon surcharges).
The Biden Administration has placed an immediate priority on addressing what it characterizes as “converging crises,” including steps to “control COVID-19,” “tackle climate change,” and “advance racial equity.”
For the financial services industry (regulators and institutions), efforts to address these priority areas are indeed converging as it becomes better understood that the impacts of climate change (e.g., increasing numbers of fires, hurricanes, droughts, and floods) and many of the efforts to control it (such as advancing net zero emissions goals and making climate resiliency investments) may disproportionately and adversely affect low- and moderate-income (LMI) geographies and other vulnerable communities, effectively reinforcing existing inequities.
The Consumer Financial Protection Bureau (CFPB) has described the population of low-income and economically vulnerable consumers as diverse by culture, geography, stage of life, and financial status. Frequently, these consumers are unbanked, underbanked, and have thin or no credit files. They may face a variety of obstacles and barriers to obtaining financial services including availability of financial institutions (rural settings); high fee or minimum balance requirements; poor credit histories; lack of required identification; and limited internet access. Similarly, they may be disadvantaged by language barriers, low levels of literacy or numeracy, disability, or other factors that may limit access.
Since COVID-19, the population of “vulnerable” consumers has expanded to include consumers affected by the “economic dislocation” resulting from measures to control the pandemic while also highlighting groups that have experienced “disproportional impact,” including servicemembers; elderly; the housing insecure (consumers at risk of mortgage foreclosure or tenant eviction); small business owners (especially minority- and women-owned businesses); and Black, Brown, and Indigenous communities.
Climate change impacts. Climate change impacts can exacerbate existing vulnerabilities associated with affordable housing, household wealth and savings, economic mobility, education attainment, public health, transportation accessibility, and social capital and community institutions. Features that place LMI and other vulnerable communities at a higher risk of adverse impact from climate change include a higher likelihood that the:
- Communities are located in climate risk zones (e.g., flood zones, isolated rural areas, urban heat islands (limited trees and/or green space))
- Civic infrastructure is aging or poorly maintained
- A large percentage of households are renters, limiting investment in climate risk mitigation measures
- Households may not have access to credit to mitigate risk or repair losses from a climate event
- Households are spending a higher-than-average portion of their income on energy costs.
Approaches under consideration
Policy makers, regulators, institutions, and industry groups are all exploring options for incorporating climate change risks across financial services while simultaneously protecting the financial welfare of disadvantaged individuals. Among the options being considered are:
- Adapting the Community Reinvestment Act (CRA) to:
- Incorporate and incentivize activities that support climate change resilience when meeting the credit and community development needs of LMI communities, such as CRA-eligible credit for:
- Microgrid or battery storage projects in LMI areas with high flood and/or wind risk
- Community solar projects that provide energy to affordable housing or community facilities
- Projects for new or rehabilitated sewer lines, levees, and storm drains that address flooding or sewer issues or reduce stormwater runoff
- Mandate that certain activities, such as affordable housing, must meet sustainability standards
- Incorporate sustainability metrics, including social metrics such as employee and occupant health and wellbeing; diversity, equity, and inclusion; and supply chain management
- Incorporate race, climate, and “environmental justice” metrics to better target CRA assessment areas.
Notably, the Federal Reserve Board added consideration of climate resilience as a qualifying activity in certain targeted geographies as part of its CRA ANPR released last year. The New York Department of Financial Services recently announced that it may provide credit under its own CRA laws to New York State chartered financial institutions engaging in certain climate resiliency activities.
Similarly, consideration of the CRA as a regulatory framework to promote sustainable finance projects, especially climate resiliency, was highlighted by witnesses at a recent Senate Banking Committee hearing, and the subject of multiple articles published by the Federal Reserve Bank of San Francisco in its Community Development Innovation Review.
- Focusing on financial protections for economically vulnerable communities.
Consumer protections. The CFPB has announced (see blog posts here, here, and here) a renewed focus on consumer protection through supervision and enforcement, with a near-term priority on economically vulnerable consumers impacted by COVID-19 and racial equity. The Bureau intends to:
- Elevate and expand fair lending examinations and investigations as well as prioritize fair lending enforcement
- Gauge the health of consumer financial markets, in part, through internal reporting on market metrics such as foreclosures, charge offs, auto loans, and checking account closures
- Analyze data collections, including those for HMDA (Home Mortgage Disclosure Act), CARD Act (Credit Card Accountability, Responsibility, and Disclosure Act) reporting, “Section 1071” small businesses, and PACE (Property Assessed Clean Energy)
- Use its Consumer Complaints Database to enforce consumer financial protection laws (including UDAAP), identify emerging issues, and highlight companies with a “poor track record” of responding to complaints or providing disparate responses to different consumer groups. This data may be shared with the federal banking agencies.
Ensuring that economically vulnerable communities have sufficient and fair access to credit and other financial products and services will most definitely merge with the increasing pressures to address climate change-related risks. Notably, climate change impacts (increased risk of flood, fires, storms, or rising sea levels) are geographically concentrated and can have spillover effects that place additional burden on vulnerable individuals, businesses, and municipalities such as spikes in insurance rates; impaired values, and potentially usability, of properties and infrastructure; and investor abandonment.
Investor protections. The Securities and Exchange Commission (SEC) has stated that both retail investors and asset managers are increasingly looking for disclosures that allow them to allocate capital to sustainable investments; demand has grown dramatically for company disclosures of climate change risk, impacts, and opportunities as well as measures of workforce development and diversity. Recently, and in response to this investor demand:
- The SEC enhanced its focus on climate-related disclosure in public filings and is working toward updating the disclosure requirements.
- The SEC finalized human capital disclosures, though the Acting Chair has released public statements suggesting the agency could require more diversity-specific disclosure (see statements here and here).
- The Department of Labor said it would not enforce rules that could limit ESG-oriented investments and proxy voting by employee retirement benefit plans.
- Implementing new programs or requirements at the federal and state levels, such as:
- Creating a dedicated clean energy grant program under the Department of the Treasury’s CDFI Fund (Community Development Financial Institutions Fund)
- Mandating engagement in greenhouse gas (GHG)-reducing activities and assessing progress through a CRA-style framework
- Imposing costs or surcharges, such as higher interest rates or higher capital requirements, for carbon intensive credit and investment activities
- Imposing a carbon tax on companies (policy discussions raise some concern that vulnerable communities will continue to be disproportionately harmed by permitted, ongoing carbon emissions)
- Improving climate change risk disclosures to better enable investors to evaluate corporate strategies and actions. This would include standardized, reliable, and comparable disclosures.
Recent actions by Treasury
- In early March, the Treasury opened the Emergency Capital Investment Program (ECIP), a new initiative created by the Consolidated Appropriations Act of 2021 and designed to support access to capital in communities traditionally excluded from the financial system and that have struggled during COVID-19. The ECIP will invest up to $9 billion in CDFIs and minority depository institutions (MDIs) in support of their efforts to provide financial products for small and minority-owned businesses and consumers in low-income and underserved communities
- On March 22, 2021, the Treasury and the U.S. Department of Labor jointly announced a financial award to the New York State Energy Research and Development Authority (NYSERDA) for its project to provide clean energy job training to unemployed and low-wage workers, increase participants’ wages, and to evaluate the training’s effectiveness. This is the first time that Treasury has awarded funding through the Social Impact Partnership to Pay for Results Act (SIPPRA) program, which is intended to provide funding to State and local governments for certain projects, including those designed to increase financial stability of low-income families and improve family health and housing.