Federal Reserve And 6 Largest American Banks To Trial Carbon-Based Social Credit Score System And Climate Investing

The U.S. Federal Reserve announced last week that they and six other of the largest banks in the country will pilot a new framework that will allow them to better access the risk of a potential investment, and where these investments stand with their environmental values.

This trial exercise will include Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo. The Federal Reserve has not released too many details on how the simulation operate, but will provide more when the meeting draws near.

According to the Fed’s press release,

[…] Six of the nation’s largest banks will participate in a pilot climate scenario analysis exercise designed to enhance the ability of supervisors and firms to measure and manage climate-related financial risks. Scenario analysis—in which the resilience of financial institutions is assessed under different hypothetical climate scenarios—is an emerging tool to assess climate-related financial risks, and there will be no capital or supervisory implications from the pilot. 

The pilot exercise will be launched in early 2023 and is expected to conclude around the end of the year. At the beginning of the exercise, the Board will publish details of the climate, economic, and financial variables that make up the climate scenario narratives.

Over the course of the pilot, participating firms will analyze the impact of the scenarios on specific portfolios and business strategies. The Board will then review firm analysis and engage with those firms to build capacity to manage climate-related financial risks. The Board anticipates publishing insights gained from the pilot at an aggregate level, reflecting what has been learned about climate risk management practices and how insights from scenario analysis will help identify potential risks and promote risk management practices. No firm-specific information will be released.

Climate scenario analysis is distinct and separate from bank stress tests. The Board’s stress tests are designed to assess whether large banks have enough capital to continue lending to households and businesses during a severe recession. The climate scenario analysis exercise, on the other hand, is exploratory in nature and does not have capital consequences. By considering a range of possible future climate pathways and associated economic and financial developments, scenario analysis can assist firms and supervisors in understanding how climate-related financial risks may manifest and differ from historical experience.

For further clarification, this type of investing is what is known as Environmental, Social, and Governance Investing, or ESG for short.

As explained by Investopedia,

Environmental, social, and governance (ESG) investing refers to a set of standards for a company’s behavior used by socially conscious investors to screen potential investments.

Environmental criteria consider how a company safeguards the environment, including corporate policies addressing climate change, for example. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.

Several financial firms have come out with ESG ratings and scoring systems in recent years. For instance, MSCI has come out with a ratings scheme covering more than 8,500 companies around the world, giving them scores and letter grades based on their compliance with ESG standards and initiatives. Several other companies like Morningstar have also released ESG scores for publicly-traded companies.