Catalyzing a New Era of Climate Action

Despite an increasingly polarized political landscape, one area where there is bipartisan support for governmental intervention is climate change. A Pew Research survey in June of this year found that “a majority of U.S. adults want the government to play a larger role in addressing climate change”, with around two-thirds saying that “the federal government is doing too little to reduce the effects.” Unsurprisingly, given the proliferation of wildfires, hurricanes, drought, extreme heat, and other impacts, most Americans “continue to say they see the effects of climate change in their own communities.”

For those actively focused on climate change, the last few years have been devastating when it comes to U.S. climate policy. Pulling out of the Paris Agreement and the rolling back of regulations have put the country further and further behind the progressive efforts of other regions.

However, 2020 has also brought some glimmers of hope, one being a report published by the Market Risk Subcommittee of the Market Risk Advisory Committee (MRAC) of the Commodity Futures Trading Commission (CFTC) in September. The CFTC, which regulates the U.S. derivatives market, was not the most obvious messenger of the seminal work, Managing Climate Risk in the U.S. Financial System.

Jeff Gitterman recently interviewed Bob Litterman, founding partner and Risk Committee Chairman of Kepos Capital, and chair of the CFTC’s subcommittee, to discuss the process. The subcommittee, a diverse group of participants ranging from agricultural and energy companies, NGOs, academics, and financial services firms, “voted unanimously 34-0 to adopt the report” and its 53 recommendations. This bipartisan consensus was achieved by focusing on where they could secure agreement among the participants.

One of the primary conclusions is the simple statement that climate change “poses a major risk to the stability of the U.S. financial system and to its ability to sustain the American economy.” As a result, the most critical recommendation is that a price on carbon that is “fair, economy-wide, and effective in reducing emissions consistent with the Paris Agreement” is the “single most important step to manage climate risk and drive the appropriate allocation of capital.”

Litterman notes that carbon pricing is “an inevitable policy response” to climate risk and that once appropriate incentives are established, the financial system will go into action. However, the report did not go as far as to suggest what that price should be, as this, and the mechanics of the policy, are the role of Congress.

As a risk manager, Litterman advises that “time is a scarce resource” when you’re managing risk. The longer the U.S. waits to take decisive action, the more likely it is that we face a “disorderly transition” and sudden devaluation of assets. While many would prefer climate action to be driven solely by an intrinsic motivation to steward the Earth, progress to date suggests this will never happen. We agree with Litterman that changing behavior requires changing incentives – whether those be tax credits, regulations, subsidies, or other policy levers – and we are well beyond the time to act. We hope that the work of the CFTC’s subcommittee along with positive signals from the incoming Biden Administration will incentivize climate action underpinned by an exciting new era of U.S. innovation.