March 22, 2021

New Unit Signals CFTC Targeting ESG Issues and Financial System's Climate Risks

Kelly Carrero, Donald McGahn II, Brian Rabbitt, Joshua (Josh) Sterling, Jayant Tambe

Jones Day

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In Short

The Situation: The Commodity Futures Trading Commission ("CFTC") has established a new unit dedicated to addressing climate risk in the financial system, providing yet another example of financial services regulators prioritizing climate and ESG policy during the Biden administration.

The Result: The CFTC is now poised to wade into the policy discussion over climate and ESG issues. Given the CFTC's stakeholder model of engagement, the time is ripe to consider how to best engage with the agency to advocate for specific climate risk approaches, priorities, and desired outcomes.

Looking Ahead: The CFTC may also undertake specific climate risk data collection efforts that will require firms to produce information. The agency could also take a more active approach to fact-finding and regulation in the wake of severe weather events that impact energy markets. It remains to be seen whether the CFTC will join the Securities and Exchange Commission ("SEC") in considering ESG issues through an enforcement lens.

On March 17, 2021, Acting Chairman Rostin Behnam of the Commodity Futures Trading Commission ("CFTC") announced the formation of the Climate Risk Unit ("CRU"), which will be comprised of staff from across all functions in the agency. The CRU will focus "on the role of derivatives in understanding, pricing, and addressing climate-related risk and transitioning to a low-carbon economy." Alongside recent climate-related initiatives by the Securities and Exchange Commission ("SEC"), the CRU's formation demonstrates that financial services regulators plan to prioritize climate policy during the Biden administration.

What Will the CRU Do?

The CFTC's press release is short on detail, and unlike the SEC's recent announcement of a climate and ESG enforcement task force, notably did not indicate whether the CFTC Division of Enforcement will have a role in the CRU. While greater details on the CRU's composition and projects will undoubtedly come soon, the press release did highlight the following avenues of engagement with derivatives market participants and other stakeholders. Specifically, the CRU may:

Engage in a dialogue regarding emerging climate change risks and the impact of increasingly frequent extreme weather events and how such climate-related market risks may be addressed in a fair and equitable manner;
Work to better understand the derivatives and related products that are being developed to address climate-related market risks and facilitate the transition to a net-zero economy, and how such products interact with the CFTC's regulatory framework;
Increasingly participate in forums that are working to develop consistent standards, taxonomies, disclosures, and practices across derivatives products and markets, as well as related clarity on regulatory, capital, and accounting standards;
Coordinate efforts to support the development of relevant and reliable climate-related market risk data resources; and
Evaluate whether tools such as climate finance labs or regulatory sandboxes would enhance development of climate-related market risk tools, products, and services.

These efforts and others by the CRU will likely draw on the findings and recommendations of a September 2020 CFTC report on managing climate risk in the financial system. That report was authored by the CFTC's Climate-Related Market Risk Subcommittee, a group of industry participants and other experts. The Subcommittee was sponsored by Acting Chairman Behnam, indicating that the Report will likely drive many of the CRU's next steps.

What Does the Establishment of the CRU Mean?

By taking this action early in the Biden administration—even before the President has nominated a new Chairman for the agency—the CFTC is signaling that climate will be a leading priority for the foreseeable future.

The CFTC is doing a full-court press on climate risk in the financial system, with the goal of linking its efforts to regulate the derivatives markets with global efforts to promote climate mitigation, de-carbonization, and other climate-related priorities in the financing and lending markets. The derivatives markets will need to be fully compatible with those other markets in how they define and measure climate-related activity and risks, so that derivatives trading by financial institutions and other market actors can closely correspond with these actors' other efforts to "green" their conduct. As a result, the CRU appears likely to focus considerably on harmonizing derivatives markets with emerging standards in cash markets, so that the CFTC can credibly carry out future, climate-focused mandates.

Closing Thought: Climate and Weather

As part of the broader federal response to climate change, the CRU also gives the CFTC considerable resources and flexibility to utilize in analyzing the impact of extreme weather events on derivatives markets. This potential for a "ripped from the headlines" approach to fact finding, regulation, and even enforcement may well pull into its scope events like California wildfires and the unusually cold February 2021 weather in Texas, given their impact on energy and power markets. The CFTC generally stays out of those markets although it does retain investigatory and enforcement power over them in some key respects.

Accordingly, firms should bear in mind the potential interest of the CFTC in their hedging and other derivatives market activities around severe weather events.

Four Key Takeaways:

The CFTC has a stakeholder model of engagement with market participants and constituencies; indeed, they invited as much in their press release. So the time is ripe to consider how to best engage with the CFTC to advocate for specific climate risk approaches, priorities, and desired outcomes.
It is not yet clear exactly how the CFTC will begin to tackle this new self-created climate risk mandate. More industry dialogue, including through the CFTC's Market Risk Advisory Committee and other similar forums, can be expected. But the CFTC may also undertake specific data collection efforts that will require financial and non-financial firms to produce information to the agency. Many of the usual concerns about voluntary cooperation will be implicated, and firms will want to think through carefully whether and to what degree they accommodate the CFTC in light of their own commercial and proprietary interests.
Neither the Commodity Exchange Act nor any other statute specifically authorizes the CFTC to regulate climate. Likewise, the CFTC's regulations do not identify the manner in which the agency may do so. Therefore, the CFTC will be proceeding down the climate regulation path based on its general authority to conduct investigations and undertake fact finding. This suggests the CFTC ought to tread lightly and be deferential.
Even if the CFTC does proceed circumspectly, companies may have well-founded arguments that specific requests for information go beyond the CFTC's legal authority and accordingly should be pared back or abandoned. Firms should bear these arguments in mind when the CFTC requests information from them, seeks to adopt climate-related rules, and brings climate-related enforcement actions.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.