Climate &
Systemic Risk

The financial sector’s role in managing risk and accelerating the transition to net-zero

A special report from FP Analytics, the independent research division of Foreign Policy Magazine

Climate change poses profound risks to nearly all aspects of society, including the financial sector and wider global economy. As global temperatures climb, climate patterns continue to change, and extreme weather events—including floods, fires, droughts, extreme heat, and storms—are becoming more frequent. These climatic shifts are placing pressure on political and economic systems as populations, governments, and businesses struggle to respond. Beyond the direct human costs of climate change, rising global temperatures are already negatively impacting economic activity, reducing output and employment, and hurting commercial profits around the world. 

“Climate change is an emerging and increasing threat to America’s financial system that requires action.”

Janet L. Yellen, U.S. treasury secretary and head of the Financial Stability Oversight Council - Oct. 21, 2021
Average global surface temperatures have risen at an unprecedented rate over the past 150 years. Already severe, the impacts from climate change are only projected to worsen as the climate continues to warm. The extent of damage caused by climate change, however, hinges upon the rate and magnitude of warming that occurs and humanity’s capacity to manage it. A best-case scenario, according to the Intergovernmental Panel on Climate Change (IPCC), demands substantial reductions in greenhouse gas emissions to limit this warming to less than 1.5°C, compared to pre-industrial levels, with the goal of achieving net-zero carbon emissions by around 2050. This target, set by the Paris Climate Agreement, will require a whole-of-society effort, in which the financial, and the private sector more broadly, must play an essential role.

Failure to transition will generate significant and widespread economic and financial risks. An economic forecast from Swiss Re projects a loss in global gross domestic product (GDP) of between 4.2 and 18.1 percentage points by mid-century, depending on different warming scenarios. As a result, limiting increases in global temperature is essential to mitigating those losses and maintaining stability of the global economy. However, even under best-case warming scenarios, climate change will continue, with unpredictable consequences for economic growth, the financial system, and the conduct of financial and monetary policy—the impacts of which are already being felt. Though the magnitude and severity of climate-related risks are uncertain, avoiding the most costly and destructive outcomes depends on immediate action from private-sector and government actors alike. This FP Analytics report outlines the varied financial risks posed by climate change, and the ways in which regulators and the private sector are acting to mitigate these risks and accelerate the transition to net-zero. Through an evaluation of the quickly-evolving regulatory landscape around climate risk and insights gleaned from expert interviews, this analysis highlights the ways in which policymakers and private sector actors alike can further minimize sector risk and strengthen economic resilience in the face of climate change.

Climate-Related Risks: Understanding Impact on Business and Finance

Climate change presents significant new business and financial risks to the private sector. Climate-related risks to business range from physical climate impacts such as extreme weather events to climate-focused policies and regulations that can impact commerce. Though these risks are complex and nuanced, they can be grouped into three categories: physical, transitional, and liability. These risks are set to affect households, communities, and multiple sectors of the economy across the globe—damaging property, impeding business operations, impacting income, and altering the value of assets— necessitating greater preparedness to safeguard against these risks and attendant losses.

Simulated GDP Changes in 2050 Under Different Warming Scenarios

Select one of the four warming scenarios to see the regional projected GDP impact.

Below 2° Celsius Increase

World map - below 2 degrees celsius increase




North America


South America




Middle East & Africa





2°C increase

World map - 2 degrees celsius increase




North America


South America




Middle East & Africa





2.6°C increase

World map - 2.6°C increase




North America


South America




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3.2°C increase

World map - 3.2°C increase




North America


South America




Middle East & Africa





Source: Swiss Re

Physical Risk

Physical risks represent the potential economic costs and financial losses associated with long-term changes in climate patterns and increasingly frequent and severe climate-related weather events. These chronic and acute risks can affect physical assets, disrupt economic activity, and harm human health. While the physical impacts of climate change are inherently localized in nature, varying within and across countries, impacts such as forced migration and supply chain disruptions transcend borders and are being felt worldwide. Physical risks are spread unevenly across sectors, but economic interconnections mean that direct physical risks and impacts can have reverberating impacts and spill over to other sectors. Certain industries, including agriculture and forestry, real estate, health care, critical infrastructure, energy, tourism, and finance, are more vulnerable to physical risks than other sectors. The insurance sector, for example, is particularly exposed to extreme weather events, which have jumped 83 percent over the past 40 years. The severity of these climate-related physical risks will only intensify as temperatures rise.

Number of Weather-Related Disasters by Cause from 1990 to 2019

As temperatures continue to rise, climate-related natural disasters are becoming more frequent.

Source: Munich Re

Economic Losses from Natural Catastrophes Between 1990 and 2020, Adjusted for Inflation

Costs associated with natural disasters are also on the rise, impacting recovery costs and insurance losses, shown in USD billions and adjusted for inflation.

Source: Swiss Re. Note: Prices are inflated to reflect 2020 prices.

Nettle Beach bay on the French Caribbean island of Saint Martin shows a damaged tourism complex after the island was hit by Hurricane Irma in 2017. Helene Valenzuela/AFP VIA GETTY IMAGES

Transition Risk

Transition risk arises from the uncertain scope and pace of an economic transition to a net-zero emissions economy. Sources of transition risk include changes in policy, regulation, consumer preferences, and investor behavior by governments, companies, and consumers. These changes may result in declines in asset prices, income, and profitability for sectors that generate high-levels of carbon emissions, such as energy, transportation, construction, and manufacturing. While the energy transition will result in financial losses and stranded assets for some businesses, decarbonization will generate new opportunities in other sectors, such as electric vehicle manufacturing, renewable energy, and efficiency-related technologies.

Although physical and transition risks are often considered separate, these risks are deeply interconnected. Changes in carbon emissions directly impact the degree and rate of warming, and thus the level of physical risk. For example, a strong and immediate transition to a net-zero world would increase transition risks in the short-term but help to mitigate physical risks in the future. In contrast, delayed and weak action to address climate change would ease the transition risks in the near term but lead to even greater, potentially catastrophic, physical risks. Delayed actions, followed by strong actions made in an effort to “catch up,” may lead to both high transition and physical risks. Scenario analysis of dynamic risks over near- to medium-term time horizons could help firms anticipate and manage changing risks to their operations and asset portfolios.

Climate Scenarios and Risks

A transition is necessary to contain global temperature increases and will decrease exposure to physical risks. The strength, speed, and clarity surrounding a transition to net-zero will determine the extent of warming as well as the level of exposure to physical and transition risks.

Source: NGFS or OliverWymen

Electricity pylons are seen in front of the cooling towers of a coal-fired power station in Weisweiler, Germany on Jan. 26, 2021. INA FASSBENDER/AFP VIA GETTY IMAGES

Liability Risk

Liability risk involves the costs and losses that may be incurred if climate-related legal action is taken against corporations that have failed to sufficiently disclose climate risk, adapt their business to a net-zero future, or mitigate their impact on the climate. As of 2021, nearly 1,900 climate-related litigation cases have been filed worldwide, 1,400, or 74 percent, of which have been filed in the United States. While the majority of this litigation has been against governments, such legal action increasingly targets companies. The full range of allegations is diverse, including product liability, greenwashing, fraud, human rights abuse, and procedural failure. In addition to the firms that are directly targeted, liability risk may profoundly impact the insurance sector, as insurance companies have underwritten commercial liability insurance policies for high-emitting industries, such as oil and gas producers, which are particularly vulnerable to climate-related litigation.

Climate-Related Litigation Outside the U.S. Since 2000

A rising tide of litigation displays the private sector’s exposure to liability risk.

Source: Grantham Research Institute, the Sabin Center at Columbia Law School

Police stand by as climate activist groups protest in Washington, DC, on Feb. 24, 2020. The U.S. Supreme Court was hearing a case on Dominion Energy’s proposed $7.5 billion Atlantic Coast Pipeline crossing the Appalachian Trail. MARK WILSON/GETTY IMAGES

The magnitude, breadth, and complexity of climate impacts stemming from many of these risks are systemic in scale, posing severe threats to the financial sector. Economic shocks originating from a physical or transitional risk can negatively affect asset valuations, household wealth, corporate profits, and economic growth. These impacts are far-reaching and can be transmitted to financial sector firms through loan portfolios, asset holdings, or insurance policies. Certain aggressive climate mitigation or adaptation scenarios may lead to tighter financial conditions, further escalating the associated risks. Particular risks and conditions—such as the abrupt repricing of large classes of assets or the creation of asset bubbles—have an acute potential to disrupt financial market functioning and ultimately financial stability. 

The imperative of managing these economic and financial risks is beginning to drive businesses and financial institutions to adapt operations in support of a net-zero future and develop strategies to mitigate their exposure to climate-related risks. The private sector is demonstrating this commitment through a variety of activities, including committing to net-zero goals, reducing carbon footprints, and disclosing climate risks. Due to the complexity of climate risks and their long-term horizons, however, these voluntary mitigation efforts by the private sector may not sufficiently manage climate risk at the company level. Fiscal, financial, and monetary policy are necessary to help mitigate private-sector exposure to climate-related risks and support the decarbonization of the global economy.

Carbon Pricing: An Economy-Wide Lever That Could Mitigate Climate Risk

Carbon pricing represents a powerful policy mechanism to curb greenhouse gas emissions and facilitate deep decarbonization of the global economy. Carbon pricing involves assigning a monetary value to carbon dioxide and other greenhouse gas emissions, the crux of rising global temperatures. When emissions are not priced, the associated costs are externalized in the form of future climate impacts such as extreme weather events. Carbon pricing ties these emissions and their climate impact back to the emitting source(s) and makes carbon-intensive practices and investments reflect the true costs to society. A strong price signal for carbon could accelerate adoption of more efficient, less emissions-intensive processes and practices and toward low-carbon, climate-resilient alternatives. 

Long an issue of debate, carbon pricing is gaining traction in countries around the world, but implementation remains far from universal. As of 2021, 45 national governments and 35 subnational jurisdictions have implemented a carbon price initiative, which covers less than 22 percent of global greenhouse gas emissions. These carbon-pricing mechanisms generally involve either a carbon tax or an emission trading system (ETS). The two policies are not mutually exclusive and are used in tandem in certain jurisdictions such as Sweden and British Columbia. It is important to note that most carbon-pricing initiatives are sector-specific, only applying to high-emitting sectors such as energy, utilities, and industrials. Global prices for carbon are also not uniform across initiatives and can vary greatly among jurisdictions. For example, carbon prices range from less than $1 per ton in Poland to more than $130 per ton in Sweden.

Global Carbon Pricing Initiatives

Hover over a country to reveal implemented national and subnational carbon pricing initiatives

Source: World Bank

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National & subnational jurisdictions with carbon pricing

icon - price tag with leaf in place of price


The average global price of carbon is ~$3 per ton of CO2

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Percent of GHG emissions priced globally

The Two Primary Mechanisms Used to Price Carbon

Carbon Tax +

A carbon tax directly sets a price on greenhouse gas emissions. Carbon taxes are usually levied on carbon dioxide emissions and their emitters, though other greenhouse gases, such as methane or nitrous oxide, may also be targeted. To date, 35 jurisdictions across the globe have implemented a carbon tax.

Emissions Trading System (ETS) +

Carbon can also be priced through an ETS, otherwise known as a “cap-and-trade program.” An ETS limits the total amount of carbon emissions for certain sectors within a given year. Under an ETS, governments issue a limited number of permits that allow the holder the right to emit one ton of greenhouse gas, generally carbon dioxide. These emission allowances can be directly allocated to firms, sold through auction markets, or traded between firms. Through the buying and selling of permits, a market price for allowances is created, which essentially prices one ton of emissions. Currently, 30 ETS programs have been initiated worldwide at either the national or subnational level.

Despite these efforts, the cost of carbon remains too low to reduce emissions effectively. Prices for carbon emissions currently average about $3 per ton, which is far less than most estimates of its true cost. For instance, although the United States lacks a national carbon-pricing initiative, the country has estimated the cost of carbon at more than $50 per ton using a cost-benefit analysis known as the “social cost of carbon (SCC).” The SCC provides a dollar measure of the economic damages resulting from the emission of one additional ton of carbon dioxide into the atmosphere. The United States first introduced an SCC estimate under the Obama administration in order to guide federal climate regulations, such as fuel economy standards, and to inform investment decisions. A proposed alternative to the social cost of carbon, target-consistent carbon pricing, sets emission prices based on the minimal price level required to reach the Paris climate goals. Unlike the social cost of carbon, target-consistent pricing does not rely on long-term projections, which are uncertain, and instead bases carbon pricing around desired policy outcomes. Using a target-consistent approach, the High-Level Commission on Carbon Prices estimated that carbon pricing would need to be set between $40 and $80 per ton in 2020 and between $50 and $100 per ton by 2030 to align emissions with the standards set in the Paris Agreement. However, only 3.76 percent of emissions are covered by a carbon price above $40 per ton, which is woefully insufficient. 

The failure to appropriately price carbon hinders meaningful progress toward national and global climate goals, which translates into direct risk to the financial sector and global economy writ large. Without strong and methodologically rigorous carbon pricing integrated into commercial models, the private sector will fail to account for the true costs of future commercial operations and face mounting real-world costs from physical, transitional, and liability risks. As countries fall further behind their climate goals, and the effects of climate change become more pronounced, governments could pursue policies to rapidly transition to a low-carbon world to avoid a climate catastrophe. Abrupt policy changes could result in financial shocks if the prices of carbon-intensive assets are rapidly devalued.

Headshot of Robert Litterman

Robert Litterman

Founder and Chairman of the Risk Committee at Kepos Capital LP

“We have to put a price on carbon. That’s the fundamental flaw in our risk management: we’re not pricing the risk.”

The corporate universe is unanimous that we should price carbon. The CFTC subcommittee, which represented all of the major participants in the financial system ranging from banks and insurers and investment managers, asset owners, corporations, including oil companies, insurance companies, data companies, and exchange, academics, NGOs–we had a very diverse group—all agreed. We don't have incentives to reduce emissions. When we don't have incentives to reduce emissions, you can't expect people to reduce emissions. Incentives are so key. What are incentives? They're things that change behavior. So, if you want to change behavior, you're going to change incentives. And in a market economy, that's prices and wages.

In 2020, Dr. Litterman served as the Chairman of the Climate-Related Market Risk Subcommittee of the U.S. Commodity Futures Trading Commission, which produced a report entitled Managing Climate Risk in the U.S. Financial System.

The absence of a robust market price for carbon has led many companies to begin independently placing a monetary value on each ton of carbon emitted through their operations and investments. This process of internally pricing carbon can assist firms in preparing for the imposition of compulsory carbon-pricing schemes and can allow investors to get a clearer picture of firms’ ability to compete in a net-zero world. Internal carbon prices generally take one of two forms: a shadow price or an internal fee. Shadow pricing applies a hypothetical cost to carbon emissions that companies can use to price carbon risk and inform decisions about capital investments. It is the most popular form of internal pricing and has been used by large fossil fuel companies, including BP and Shell. Alternatively, an internal fee, used by companies such as Microsoft, internally charges business units for their emissions. Unlike shadow pricing, internal fees generate revenue that can be channeled toward investments in carbon-reduction efforts. 

Both schemes can serve as vital risk-mitigation tools, particularly for high-emitting firms. As of 2020, more than 2,000 companies worldwide have disclosed their use or planned use of internal carbon pricing to the CDP (a nongovernmental organization that runs the global environmental disclosure system)—an increase of nearly 25 percent from 2019.  Predictably, these internal carbon-pricing initiatives are highly concentrated in sectors that are vulnerable to carbon-pricing transition risks, including fossil fuels, energy, and finance. However, fewer than 15 percent of companies disclosing carbon-pricing risk to the CDP have implemented a carbon price so far, leaving many companies vulnerable to sudden shifts in carbon-pricing regulations. The median internal carbon price was $25 per ton in 2020—lower than most current carbon price estimates. As a result, major global companies may face up to $283 billion in carbon-pricing costs by 2025 if countries significantly ramp up carbon-pricing efforts, according to S&P Global.

Impact on earnings (USD billions) for certain sectors sector in 2025 under a high-carbon-price scenario

Source: Adapted from SPG Global Trucost

Note: Data featured is from the Trucost index, which covers 31 countries and approximately 70 percent of global stock market capitalization.

Existing regulation or the expectation of future regulation around emissions clearly drives internal carbon-pricing initiatives among firms. However, such internal pricing does not appear adequate to adapt to rapid shifts in climate pricing and sudden changes in policy, which could occur in the near future. Momentum for carbon-pricing regulation is building as countries begin to ramp up efforts to meet their Nationally Determined Contributions to the Paris climate goals. Beyond national carbon initiatives, worldwide carbon prices will jump well beyond the level accounted for in voluntary schemes if the European Union applies a carbon-border adjustment through its trade policy, or if a price floor agreement can be reached among major carbon-emitting countries. Either way, companies must begin to understand their carbon footprint and its associated costs in the face of this rapidly shifting landscape around carbon-pricing regulation.

Climate-Related Risk Disclosure: From Voluntary to Mandatory Reporting

To achieve deep decarbonization, governments and private-sector actors need information and data on the risks that climate change poses to specific sectors, business models, and individual companies. Investors are leading this charge, demanding increased transparency from publicly traded corporations and financial institutions regarding their emissions and exposure to climate-related risks. Despite investor demands, this information is not widely available. Only 9,526 companies of the more than 43,000 publicly listed companies worldwide disclosed climate risk according to the CDP in 2020. Although publicly traded companies are legally required to file annual disclosures on financial performance, securities regulators historically have not required climate-related risk disclosure, but investor pressure to mandate disclosure of climate risks is mounting. 

Climate disclosures generally refer to public statements in which a company details the estimated financial impact of climate change on its operations and financial health under different warming and transition scenarios. In addition to the transparency they can provide, these disclosures provide valuable information for businesses and investors that can help frame and direct decision-making around future strategy and investment. Currently, however, reporting on climate risk by corporations is largely voluntary and often undertaken through measures such as the widely endorsed Taskforce for Climate-Related Financial Disclosure (TCFD) framework. Created by the Financial Stability Council, the TCFD is an industry-led initiative offering standardized guidance to assist corporations in understanding and disclosing climate risk. The taskforce specifically details eleven recommendations in the areas of governance, strategy, risk management, and metrics and targets.

Taskforce on Nature-Related Financial Disclosures (TNFD): A New Frontier for Environmental Risk

The natural world forms the foundation of the global economy, with an estimated value of more than $100 trillion per year. However, the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES) estimates that as much as 70 percent of land, 50 percent of freshwater, and 40 percent of ocean ecosystems have been significantly altered by human activities, leading to their degradation. The loss of diversity in species and ecosystems directly impacts human societies, including through the interdependency of climate- and nature-related risks. Climate change exacerbates the drivers of nature loss, which in turn decreases climate resilience. Damage to the natural world and the decline of certain ecosystem services pose a grave risk to the global economy and financial system. 

Nature-related risk accounts for both the dependency of businesses on nature and the potential risks that certain economic activities pose to it. In recognition of these dependencies and impacts, the international Taskforce on Nature-Related Financial Disclosure (TNFD) was formed to explore a risk-management and -disclosure framework for nature-related risk. The new framework will aim to provide firms with the tools to determine exposure to nature-related risk and will help to support a global shift in financial flows toward nature-positive outcomes. The TNFD framework is expected to launch in 2023 and will be structured around the same four pillars as the TCFD, though it will be far more complicated. Unlike the measurement of climate-related risks, which are strictly related to six greenhouse gas emissions, measuring nature-related risk will require quantifying the impact of a business’s operations on ecosystems and biodiversity. Nature is incredibly complex, and understanding a firm’s impact on biodiversity will involve developing metrics for specific elements of nature, such as pollinators, water use, and soil health, and their interaction. While daunting to disclose, nature-related risk is becoming better understood and is anticipated to be a key component of ESG standards in the future. Addressing nature-related risks and transitioning to a world that enriches biodiversity, maintains soil, purifies water, and stores carbon could generate up to $10.1 trillion in annual business value and create nearly 400 million jobs by 2030, according to the World Economic Forum.

Support for the voluntary disclosure framework has steadily grown among firms, institutions, and regulators since its inception in 2017. By 2021, 2,700 firms, institutions, and governments from 89 jurisdictions had pledged support for the TCFD, up from just 282 in 2017. Supporting the framework, however, does not require businesses to implement climate-related disclosures, thus lessening the significance of such widespread support. According to the most recent TCFD report, only 52 percent of 1,651 disclosures from public companies explicitly reported climate-related risks and opportunities in 2020. This marked a 10 percent increase from 2019, but implementation among public companies is far from complete. Disclosure across various sectors, including technology, remains weak. 

Limited implementation of the framework is due in part to the intensive nature of implementation, which requires the collection and analysis of emissions-related data across all areas of a company’s operations. Gaps in data collection, collation, and analysis are major initial barriers to implementing the TCFD, especially for financial institutions. Banks are particularly dependent on data from counterparties to disclose exposure to climate risks that will affect their own performance. Addressing these gaps requires companies to devote resources and to train personnel in the technical components of the TCFD framework. Implementation of the TCFD also requires buy-in across a company, beginning with leadership, according to a case study on Verizon’s implementation efforts.

Even among companies that do disclose climate risk, the vast majority fall short of disclosing on all TCFD recommendations. For example, only 13 percent of companies disclosed the resilience of their strategies and operations under different climate change scenarios. The quality of these disclosures is also often lacking, with many reporting only non-material climate risks. Low rates of disclosure may reflect the iterative nature of the framework and the complexity of the undertaking, with future iterations anticipated to improve as companies develop additional metrics and collect more data. However, the evolutionary nature of the process also means that most disclosures are not comparable, as companies are independently producing metrics to understand their unique risks. More likely, companies may be hesitant to disclose certain risks altogether when investors or regulators could perceive these risks as damaging, underscoring the limitations of voluntary disclosures and the need for greater harmonization of reporting requirements. 

The unreliable nature of voluntary guidelines is driving many countries toward compulsory climate reporting to produce widespread, comparable, and credible disclosures. Mandating climate disclosure represents a critical step in mitigating private-sector exposure to climate change while also helping to ensure that the Paris Climate goals are met. Information provided by climate disclosure will be necessary to redirect investments from high-emissions industries toward more sustainable alternatives, providing information on emissions and exposure to carbon pricing. One study from the Banque de France, for example, found that mandatory climate reporting prompted French investors to cut stakes in fossil fuel companies by 40 percent.

Headshot of David Carlin

David Carlin

Climate Risk and TCFD Lead at UNEP Finance Initiative

“Mandatory disclosures are critical to improving both the quality and usefulness of disclosures.”

The TCFD really is a de facto standard now. There's a large number of firms that see TCFD as a necessary and expected thing for them to be doing, and I think that that's really good. On the flip side, I would say there still isn't enough really strong disclosures around quantitative scenario analysis, nor is there adequate standardization in terms of metrics, even in terms of emissions disclosures.

Mandatory disclosures are critical to improving both the quality and usefulness of disclosures. With mandated reporting, reports become significantly easier to compare because there's more people submitting because they're required to, greater standardization, and also minimum standards for what the outputs will look like. I think a way to improve disclosures as well as a to make them a more useful tool is to set expectations around quality and detail.

Despite the benefits, mainstreaming TCFD recommendations into required disclosures will create complex accounting challenges that many businesses, asset managers, and banks will have to address in the near term. For governments, mandating climate disclosure may require a reworking of the TCFD recommendations to ensure comparability across sectors and countries as well as feasibility. At COP26, progress to enhance comparability and harmonization of standards was made with the creation of the International Sustainability Standards Board (ISSB). This new entity—which sits under the International Financial Reporting Standards Foundation, the organization responsible for the production of international accounting standards—is tasked with standardizing sustainability-reporting guidelines, using the four pillars of the TCFD, for companies across 37 countries.

Governments around the world are beginning to mandate climate-risk reporting

While the European Union remains at the forefront of sustainability reporting, financial hubs, including Hong Kong and London, will soon be subject to climate-related disclosures—and the U.S. will likely follow suit. This major shift coincides with the endorsement of mandatory climate-risk reporting by G7 finance ministers and central bank governors, signaling a growing consensus among major economies around compulsory reporting.



France became the first country to require disclosure of climate-related risk in 2016, after passing the French Law for Energy and Green Growth. The law requires large institutional investors and asset managers to report climate risks and explain their plans for transition.


In 2021, the Swiss Financial Market Supervisory Authority amended disclosure rules to require insurers and banks to report climate-related financial risks, based on TCFD.

United Kingdom

TCFD-aligned disclosures will be mandatory across the economy by 2025, with many requirements in place by 2023.

European Union

In April 2021, the European Commission issued a proposed Corporate Sustainability Reporting Directive that would amend existing reporting requirements to require sustainability reporting, including climate-related risk disclosure.

People pick grapes under voltaic louvers in the vineyards of Tresserre, France on Sept. 28, 2021. Dynamic agrivoltaics is a technology that protects agricultural crops from climatic hazards. LIONEL BONAVENTURE/AFP VIA GETTY IMAGES


The United States

In March 2021, the Securities and Exchange Commission (SEC) launched a public consultation requesting input on climate change disclosures, including TCFD.


In October 2021, the Canadian Securities Administrators (CSA) published a Proposed Instrument that would impose mandatory climate-related risk disclosures. The Proposed Instrument is open for public consultation until January 2022.


The Banco Central Do Brasil plans to require banks to make disclosures in line with TCFD by July 2022.

A tour guide steers his boat next to an iceberg at the seashore of King’s Point on July 3, 2019 in Newfoundland, Canada. JOHANNES EISELE/AFP VIA GETTY IMAGES

Asia and the Pacific

New Zealand

In April 2021, New Zealand became the first country in the world to introduce mandatory TCFD disclosure for financial institutions. The “comply or explain” mandate will force about 200 large financial institutions to make climate-related disclosures in 2022.


The Financial Services Agency, Japan’s financial watchdog, will reportedly require around 4,000 blue-chip companies listed on the Tokyo Stock Exchange to make disclosures in accordance with TCFD in April 2022. Mandatory TCFD requirements will eventually apply to all publicly listed companies on the exchange.


The Singapore Exchange Regulation, the regulatory arm of the Singapore Exchange, will require mandatory climate disclosures for listed companies beginning in 2022.

Hong Kong

The city has announced its intention to make TCFD mandatory for public companies by 2025.

Smoke billows from a coal fired power plant as a in a neighborhood in Shanxi, China November 26, 2015. KEVIN FRAYER/GETTY IMAGES

Accelerating Change Through Financial Regulation

Despite progress, voluntary risk management tools remain inadequate to cope with climate change. As a result, financial regulation and monetary policy will be key to managing climate-related risks and ensuring financial stability as the world transitions to net-zero. Around the world, central banks are taking up this challenge. 

Spearheading this charge are members of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), which comprises 100 market and monetary authorities. NGFS members, such as the Bank of England, are actively integrating climate-related risks into supervision and financial-stability monitoring. While the exact policies implemented by NGFS members vary, consensus among major financial regulators is clear: central banks cannot afford to ignore climate-related risks. 

Although the authority of central banks is limited by strict legal frameworks, managing climate-related risks falls squarely within the mandate of central banks to maintain price stability. Climate change and its associated policy responses are expected to impact the prices of assets and goods, such as food and fuel, affecting inflation and portending significant implications for financial stability. Given these price and stability risks, central banks have an essential role to play in mitigating climate change. 

Managing these risks will require central banks and supervisors to gather information and data to better understand the size, scope, and likelihood of climate-related risks. This information can be collected through mandating disclosures as well as conducting stress and scenario testing for climate change. Like mandatory climate disclosure, countries around the world are beginning to stress test banks for climate change. While Banks and other financial institutions already undergo stress and scenario testing, which were introduced after the 2008 financial crisis to test banks’ resilience against economic shocks, climate scenario testing differs significantly from annual financial stress tests. Climate stress testing acts as a theoretical exercise that puts banks through various climate scenarios that span decades into the future. These exercises help banks understand their potential losses resulting from climate impacts, and central banks comprehend the threat level of climate-related risks to the overall financial system. The European Central Bank, the Banque de France, and the Bank of England are among the few central banks that have conducted climate stress tests for their respective financial sectors thus far. Within the next few years, a range of other countries may stress test for climate change, including the United States, according to statements made by current Federal Reserve governors.

Headshot of Mark Zandi

Mark Zandi

Chief Economist of Moody’s Analytics

“Climate-risk scenarios are about designing and thinking about different possibilities about how climate change is going to affect the macro economy, industries, financial markets, the system more generally, and then trying to assess what that means for you as an institution.”

Right now, they're not using the stress scenarios as a way to require banks to change pricing or capital levels or anything. There might be some teeth to these risks in the climate-risk scenarios, where they're used to actually impact capital levels and pricing. And if that's the case, then that's probably the best way for the central banks and regulators to impact exactly what kind of lending is getting done. So far, the first step is just “Let's do a scenario, see what kind of results we get.

Only after understanding these risks can central banks begin correcting misalignment that may exist between current regulation and climate-related risk concerns. Shifting regulation to reflect climate concerns could involve a variety of measures, including strengthening capital requirements, liquidity coverage ratios, or countercyclical capital buffers. Central banks can also contribute to decarbonization directly through policies such as green quantitative easing or green-targeted lending operations. Greening these monetary policy tools would tilt the economy’s allocation of capital in support of a net-zero transition. Although decarbonization will help mitigate the threat of climate change to price stability, opponents suggest that central bank policies that offer clear benefits to certain sectors or actors over others would violate the principle of market neutrality, under which central banks aim to minimize possible distortionary effects when intervening in financial markets. However, the current market is not neutral—markets continue to favor carbon-intensive assets due to their failure to fully price environmental harms such as carbon emissions. As a result, financial markets do not accurately reflect the price of carbon-intensive assets, which can affect the allocation of capital by central banks.

While direct support for decarbonization by financial regulators may be controversial, some central banks are working to ensure their activities are coherent with a net-zero government policy, regardless of market neutrality concerns. Certain central banks, such as the Banque de France, have a secondary objective to align monetary policy with national economic and industrial policy, provided that it does not interfere with price stability. Central banks with this policy-coherence objective can help to ensure that their activities are in lockstep with net-zero government policy.

Financial regulation will be critical in mitigating climate risks and transitioning to a net-zero world. While changing central bank policies are directly targeted toward the financial sector, these changes will reverberate throughout the economy. As financial sector actors face increasing pressure from regulators and investors to decarbonize their balance sheets and minimize exposure to climate risk, businesses failing to account for climate-related risk and transition their business toward net-zero may find it difficult to obtain loans or hold certain insurance policies. It is important to recognize, however, that the toolkits of central banks and market regulators are not sufficient to tackle climate change alone. Green monetary policy is not meant to be a substitute for government-led environmental regulation and carbon pricing, which will have comparatively more impact in mitigating climate risk and facilitating a net-zero transition. Green monetary policy can, however, complement government action, providing powerful short-term signals to financial markets that can begin to shift banks’ balance sheets toward net-zero.

Promising Financial Regulation and Monetary Policies to Facilitate a Net-Zero Future

Integrating Climate-Related Risks into Capital Requirements +

The adjustment of bank capital requirements around climate exposure can also serve as a powerful tool for central banks to limit future climate-related financial losses and support economy-wide decarbonization. Capital requirements dictate the level of equity that banks must maintain to fund their assets, thereby restricting the overall amount of debt that banks can retain. Strong capital requirements are critical to ensuring that banks can weather economic shocks and continue to provide credit and payment services to households and businesses. Integrating climate risk in capital requirements can be achieved through adjusting the risk weights that determine the debt-to-equity ratio that banks must hold based on their credit exposure to climate risks. 

Regulators could pursue a number of pathways. For example, regulators could apply a lower risk weighting for green investments, which would allow banks to hold less capital to buffer against potential losses. This “green supporting factor” could help spur investment in low-carbon sectors, but previous supporting factors, such as the small-to-medium enterprise supporting factor, have had mixed success in boosting lending. Alternatively, risk weights for carbon-intensive holdings could be increased, forcing banks to cover these climate exposures with additional loss-absorbing capital and less debt. More commonly known as the “brown penalizing factor,” this type of adjustment to capital requirements could improve banks’ resiliency against transition-related risks.

Aligning Central Bank Asset Purchases with a Net-Zero Transition +

Aligning monetary policy tools such as quantitative easing (QE) with environmental sustainability goals can contribute directly to a transition to a low-carbon economy. QE is a cyclical policy instrument aimed at providing temporary stimulus to the economy through the purchase of large quantities of assets, including government and corporate bonds, to lower borrowing costs, boost spending, and support economic growth. QE is a powerful tool that has been utilized by 30 central banks to collectively pump over $25 trillion into the global economy since 2008. These operations aim for “market neutrality,” but corporate bond purchases made through QE easing programs, including recent purchases made during the pandemic, are not market-neutral and often favor large carbon-intensive companies. For example, analysis of the European Central Bank’s (ECB) balance sheet reveals that more than half of the €241.6 billion in corporate bonds held by the ECB at the end of July 2020 had been issued by companies in carbon-intensive sectors. 

Continuing large-scale purchases in this manner may carry unintended consequences for financial stability and climate change. The continued support of fossil fuel companies by central banks may perpetuate climate risk and promote the continued use of fossil fuels, undermining national efforts to reach global climate goals. To better align monetary policy with the goal of combatting climate change, the NGFS included a proposal to green QE programs as well as other monetary policy tools in a 2021 toolkit for central bankers. Green QE would recalibrate QE purchases to favor green assets, such as green bonds, and would exclude carbon-intensive financial assets in future asset purchases by central banks. In 2019, Sweden’s Riksbank became the first central bank to adopt such an approach in its asset purchases. Riksbank now applies a sustainability approach to its corporate bond purchases and foreign currency reserve management. Other central banks, including the ECB, have reportedly considered this approach. However, the effectiveness of greening asset purchases is not clear; research suggests that gains from greening QE may be short-lived and may have a limited impact in reducing carbon emissions.

Greening Central Bank Lending Through Targeted Longer-Term Refinancing Operations +

Central banks can also encourage bank lending to green projects and companies through Targeted-Longer-Term Refinancing Operations (TLTROs). First introduced by the ECB in 2014, TLTROs offer banks longer-term loans, at favorable rates, in order to boost lending to the real economy. These favorable rates are conditional and depend on banks’ lending patterns. A green TLTRO would offer cheaper central bank loans to banks lending to green activities. The TLTROs deployed by the ECB have positively impacted bank loan supply and are not associated with excessive risk-taking. However, these operations, when considered alongside strong market incentives to decarbonize bank balance sheets, may result in the rise of excessive levels of toxic debt, especially since “green activities” are still in a nascent stage of development. Despite these concerns, several central banks, including the ECB and the Bank of Japan, are considering green TLTROs to incentivize additional green lending.

Fostering A Market for Green Assets through Green Taxonomies +

Beyond requiring disclosure of climate-related risks, securities regulators can play a critical role in facilitating the creation and growth of green asset markets through a green taxonomy. Green taxonomies are classification tools that establish market clarity around green economic activities, including sectors and financial products. Taxonomies for climate-friendly and other sustainable activities are currently being developed by the European Union and 11 other jurisdictions around the world. By establishing standards around sustainable activities, green taxonomies can avert greenwashing, a common marketing ploy by companies that falsely conveys that a product or practice is sustainable. Green taxonomies thus allow market participants to invest in sustainable assets with more confidence. Such classification schemes can help investors, companies, and financial institutions to make informed climate decisions regarding their objectives, operations, and investments.

The Path Forward: Making Net-Zero Commitments a Reality

As pressure builds to decarbonize the global economy, governments will continue to explore and implement new regulations and other policies to reduce emissions. This rapidly changing regulatory landscape will create new incentives and potentially devastating risks for businesses. While transitioning to a lower-carbon economy presents significant economic and financial risks, decarbonization also creates vast opportunities for organizations that are focused on climate change mitigation and adaptation solutions. For example, firms that successfully green their operations may experience cost savings, develop new products and services, gain access to new markets, and build resiliency along their supply chains. Harnessing these opportunities can also benefit the entire global economy, creating up to 18 million jobs and potentially improving livelihoods around the world. However, if this transition is hurried and unequitable, it could create unnecessary economic hardship for communities and workers and risks to business.

For the private sector, mitigation of climate-related risks must go beyond understanding exposure. Greening firm operations and products will be essential for mitigating climate-related risks in the long-term. The financial sector is particularly prone to climate-related risks and is expected to play a crucial role in financing the global economic transition to net-zero. Despite the global need for green financing and the risk of continued reliance on fossil fuels, fossil fuel financing has not slowed down: between 2016 and 2020, the world’s largest commercial and investment banks increased their financing of fossil fuels. Beyond fossil fuel investments, equity holdings of the largest asset management groups are misaligned with Paris climate targets, with companies underinvesting in green technologies for climate-critical sectors. Failing to align investments and loan portfolios with a net-zero future will leave financial institutions vulnerable to climate-related risks and less able to weather a transition. 

At COP26, over 450 financial institutions from 45 countries pledged to align their financing activities to achieve net-zero emissions by 2050. At least 300 other companies, members of the RE100 Initiative, have also committed to completely transition their energy usage to renewable sources. But many private-sector companies have yet to embrace any sort of commitment to shrink their environmental footprints, with most narrowly focused on passively mitigating long-term climate risk and meeting compliance standards in the short term. Failure on the part of companies to take bold action will undercut the energy transition and will fail to protect them from climate-related risks. 

Garnering additional net-zero pledges and making current pledges a reality will require companies to design and implement a governance framework that more accurately accounts for the costs presented by climate change and enables data-driven strategy and operations adjustments to advance toward a net-zero future. Moreover, it will demand adherence and action in the absence of compulsory measures from government authorities. Without clear direction from governments, the private sector must take the initiative and begin utilizing key mitigation tools, including internal carbon pricing and disclosure, to help make net-zero a reality. Financial regulators are well positioned to facilitate the transition. Failure to do would pose existential risks to firms’ commercial viability and to broader economic stability the world over.

Written by Miranda Wilson. Edited by Allison Carlson and Phillip Meylan. Copyedited by David Johnstone. Art direction and design by Sara Stewart. Creative direction by Lori Kelley. Development by Wes Piper and Andy Baughman. Illustration by Nicolas Ortega for Foreign Policy.

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