Executive Order On Climate-Related Financial Risk: One Small Step For Climate, One Giant Leap For Federal Climate Policy

Vinson & Elkins LLP

Vinson & Elkins LLP

On May 20, 2021, President Biden signed a long-anticipated Executive Order on Climate-Related Financial Risk (the “Executive Order”). The Executive Order establishes a policy “to advance consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk,” addressing such broadly varying actions as potential regulation of climate risk in the U.S. financial system and addressing the Department of Labor’s (“DOL”) Trump-era ESG investing rules. Notably, the Executive Order proposes to use federal procurement and lending programs as a test bed for a variety of climate-related initiatives, from contractor disclosure requirements to agency use of climate data in making award decisions. Contractors and borrowers need to read the Executive Order (and this Alert) in full to understand all its implications, as it is critical to understand the Executive Order in its entirety and how it fits into the federal government’s broader policy goals. As with many other policies issued by the Biden administration, the Executive Order expresses a desire to focus on the transition to a low carbon and climate-conscious economy as an opportunity to create American jobs and enhance the administration’s environmental justice goals. The Executive Order also reiterates the Biden administration’s target of making the United States a net-zero emissions economy no later than 2050.

While there are many steps that remain to implement the actions outlined in the Executive Order, it has the potential to impact businesses across the economy. The Executive Order is significant not only for its breadth, but also for President Biden’s emphasis on the physical risks of climate change and their potential impacts on the financial system. The key provisions and their potential implications are summarized below.

Climate-Related Financial Risk Strategy

What it says: The Executive Order calls upon the Director of the National Economic Council and the National Climate Advisor to develop a government-wide strategy regarding the measurement, assessment, and disclosure of climate-related financial risks to federal programs, the financing needs associated with meeting the 2050 net-zero goal, and the roles that public and private investment can play in meeting these financing needs.

What it means: The stated goal, to achieve net-zero greenhouse gas emissions for the U.S. economy by 2050, was previously announced during President Biden’s Earth Day Summit as the United States’ intended Nationally Determined Contribution under the Paris Agreement (the “NDC”). To meet the NDC, the Biden administration must rely on a combination of legal requirements and financial incentives to put the United States on a trajectory towards net-zero. According to Princeton University’s Net Zero America Report, at least $2.5 trillion in additional capital investments are needed to get the U.S. to net-zero greenhouse gas emissions by 2050. These investments are spread across a wide variety of emissions-reduction pathways, including electricity generation, industrial applications, buildings, and electric vehicles. As we have previously summarized, the 2020 Energy Bill included federal incentives and grant programs to support clean technologies. President Biden’s American Jobs Plan would also commit significant federal dollars to emission-reduction solutions.

These incentives alone will not be enough to mobilize the levels of capital that will be needed to reach the United States’ net-zero goal. However, these commitments by the federal government do not stand in isolation: to date, the six major U.S. banks have each made their own climate commitments, including significant “sustainable finance” commitments, all of which focus at least in part on climate finance. Collectively, the sustainable finance commitments of the six major U.S. Banks — which are not likely to be spent only in the U.S. — total over $5 trillion by 2030.

Assessment of Climate-Related Financial Risk by Financial Regulators

What it says: The Executive Order directs the Treasury Secretary to work with the Financial Stability Oversight Council (the “FSOC”) to integrate climate-related financial risk information into its work to protect the stability of the U.S. financial system. The Executive Order includes a requirement for delivery of a report to the president within 180 days that discusses actions to identify and mitigate climate-related financial risks. The Executive Order further directs the Federal Insurance Office to assess the potential for major disruptions to private insurance coverage in regions of the country that are vulnerable to physical climate risks.

What it means: Many FSOC members have already announced their own plans to explore climate-related financial risks to the U.S. financial system, both through the FSOC and as individual agencies. For example, the SEC is currently seeking public comment on the structure for new climate disclosure requirements. The Federal Reserve announced the creation of a Supervision Climate Committee in March, which will help the Fed identify climate risks to the financial system and develop appropriate approaches to manage these risks. The FSOC itself devoted much of its March 31, 2021 meeting to a discussion of climate-related financial risks and the steps that members intend to take to address those risks.

Pensions and Investments

What it says: The Executive Order directs the Secretary of Labor to identify ways to use existing legal authority to “protect the life savings and pensions of United States Workers and Families from the threats of climate-related financial risk.” The Executive Order also asks the Secretary to consider rescinding or revising two Trump-era rules that limited the ability of ERISA plan administrators to consider climate and other ESG factors when making investment and proxy voting decisions.

What it means: The DOL had already announced that it intends to revisit the Trump-era rules that discouraged investment decisions based on ESG issues and not to enforce those rules until the Department published further guidance. The DOL’s review will likely result in rules that are intended to do the opposite of the Trump administration’s rules, instead encouraging consideration of ESG issues in investment.

Federal Procurement and Lending

What it says: The Executive Order states that “the Federal Government should lead by example” in addressing the risks of climate change “by appropriately prioritizing Federal investments and conducting prudent fiscal management.” The Executive Order envisions that the federal government will do this, in significant part, through federal acquisition and lending programs. In this regard, the Executive Order is one of several Biden administration initiatives that leverage the federal government’s spending power to advance policy goals that reach far broader than the objectives of individual procurements. Other recent initiatives include increasing the minimum wage for federal contractors (Exec. Order No. 14026 (Apr. 27, 2021)), and maximizing the use of supplies and services produced and offered in the United States (Exec. Order No. 14005 (Jan. 25, 2021)).

In fact, the Executive Order is not the first Biden administration executive order to focus on climate change and federal procurement. Section 206 of Executive Order No. 14008, Tackling the Climate Crisis at Home and Abroad (Jan. 27, 2021), called for amendments to the Federal Acquisition Regulation (“FAR”) “to promote increased contractor attention on reduced carbon emissions and Federal sustainability.” The new Executive Order on Climate-Related Financial Risk specifically calls for the consideration of amendments to the FAR to:

  • “require major Federal suppliers to publicly disclose greenhouse gas emissions and climate-related financial risk and to set science-based reduction targets,” and
  • “ensure that major Federal agency procurements minimize the risk of climate change, including requiring the social cost of greenhouse gas emissions to be considered in procurement decisions and, where appropriate and feasible, give preference to bids and proposals from suppliers with a lower social cost of greenhouse gas emissions.”

Section 211 of Executive Order No. 14008 requires each agency head to prepare a Climate Action Plan describing, among other things, “the agency’s climate vulnerabilities” and “the agency’s plan to use the power of procurement to increase the energy and water efficiency of United States Government installations, buildings, and facilities and ensure they are climate-ready.” The new Executive Order on Climate-Related Financial Risk goes further and requires agencies to include in their action plans “actions to integrate climate-related financial risk into their respective agency’s procurement process.”

Finally, the new Executive Order calls on the directors of the Office of Management and Budget and the National Economic Council to develop recommendations for the National Climate Task Force on how to integrate climate-related financial risk into federal lending programs and other federal financial management programs.

What it means: If adopted, requirements for greenhouse gas emissions disclosure and adoption of science-based targets under the FAR would be the first legally required sustainability standards for federal contractors. An existing, Obama-era rule requires federal contractors to disclose if and where they otherwise disclose information on greenhouse gas emissions. See FAR 52.223-22. This rule does not require disclosure of greenhouse gas emissions; rather, it requires contractors to confirm whether they disclose that information publicly and, if so, to provide the link to any such disclosure. The requirements that the new Executive Order contemplate could bring the federal government in line with the current trends in ESG-focused procurement in global corporations, which are increasingly requiring suppliers to meet climate and sustainability requirements.1 It remains to be seen, however, how the FAR Council will define the “major Federal suppliers” that will be subject to any new disclosure and target-setting requirements, what the required scope and format of any disclosure will be, and what guidance will be provided in setting reduction targets.

A requirement that agencies measure and evaluate the “social cost of greenhouse gas emissions” in individual procurements, and give preference to offers from “suppliers with a lower social cost of greenhouse gas emissions,” may well be the most monumental procurement policy changes contemplated by the Executive Order. The Federal Acquisition Regulatory Council (“the FAR Council”) could consider addressing the social cost of greenhouse gas emissions as part of a contracting officer’s evaluation of present responsibility, akin to the evaluation of a contractor’s “satisfactory record of integrity and business ethics.” However, past attempts at broadening the present responsibility determination beyond procurement-related capabilities and controls have been met with concerns about “blacklisting” contractors and requiring the federal acquisition workforce to make determinations that they are not qualified to make.

The FAR Council has a variety of models to draw upon as it considers how to “give preference to bids and proposals from suppliers with a lower social cost of greenhouse gas emissions.” These models include the various existing preference programs for small businesses, the general preference for the acquisition of commercial items, and the inclusion of climate factors within individual procurement evaluation schemes. Again, however, applying any of these models to climate change appears to require technical expertise that the federal acquisition workforce does not currently have. Moreover, the FAR Council will need to consider how any preference for suppliers with a lower social cost of greenhouse gas emissions will coexist with other bedrock procurement policies. For example, it seems clear that any preference established under the Executive Order cannot override the federal government’s preference for the acquisition of commercial items, or for the use of full and open competition, both of which are mandated by statute.

Ultimately, the Executive Order’s direction that the federal government “lead by example” foreshadows new acquisition rules that do more than merely catch up with current trends in ESG-focused procurement for global corporations.

1 Verónica H. Villena and Dennis A. Gioia, A More Sustainable Supply Chain, Harv. Bus. Rev. (March–April 2020) (providing that: “According to the CDP’s 2019 supply chain report, 35% of the program members engaged with their suppliers on climate change in 2018, up from 23% the year before. Additionally, the report noted, ‘as suppliers become more mature in their understanding of sustainability issues and advance their approaches for taking action, there is evidence that they too are improving in their efforts to cascade positive change downwards through their own supply chains.’”).

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