US regulator considers climate stress tests for commodities and derivatives markets

The Commodity Futures Trading Commission (CFTC) is weighing whether to incorporate climate stress tests into its oversight of US commodities and derivatives markets, according to a new consultation paper. The move is among a series of measures being considered by the regulator as it looks to step up its action on climate-related financial risks.

The CFTC is concerned about the implications climate change could have for entities such as clearing organisations, brokers and merchants, as well as to the derivatives and commodities markets themselves. It says the effects could include heightened market volatility and challenges to existing risk management assumptions.

The consultation paper asks for detailed feedback on how stress tests might be deployed, either by the CFTC itself or by the institutions it regulates.

The European Securities and Markets Authority (ESMA) published its own call for evidence in February regarding a new climate stress testing framework for central counterparties, which are equivalent to US derivatives clearing organisations. The ESMA paper noted the absence of literature on climate risk relating to derivatives markets, and the fact that the most commonly-used climate scenarios – those published by the Network for Greening the Financial System – are focused on longer-term time horizons more appropriate for banks and insurers.

The Financial Stability Oversight Council, of which the CFTC is a member, published a landmark report on climate risk in October 2021. The report recommended the use of climate scenario analysis by supervisors across the financial system, but drew a distinction between scenario analysis and stress testing on the basis that the former does not necessarily have regulatory implications.

Earlier this year, Federal Reserve chair Jerome Powell said climate stress scenarios would be an important priority for him in his second term but again drew a distinction with stress tests on the basis that the scenario exercises would not directly lead to an adjustment of firms’ capital requirements.

Although the CFTC consultation paper does not specifically raise the possibility that stress tests could have capital implications, it separately asks for feedback on whether the agency should consider amending its minimum capital and liquidity requirements to better recognise climate-related risks.

The CFTC is also seeking input on how it might enhance disclosures, do more to protect financially vulnerable communities and tackle greenwashing. The consultation is open for 60 days.

The agency has been at the forefront of action on climate-related financial risks under its chair Rostin Behnam. In September 2020, a CFTC subcommittee published the first-ever climate report by a US financial regulator and affirmed climate change as a systemic risk that regulators must act upon.

“My intention is to focus on ensuring that America’s farmers, ranchers, manufacturers, commercial end-users and investors are equipped to manage their risks from increasingly severe and frequent weather events, as well as the transition to a net-zero economy,” said Behnam in a statement last week.