JONES DAY TALKS® - Financial Regulators and Asset Managers Warm to Acknowledging Climate Risks

Jones Day partners Lanier Saperstein and Jay Tambe talk about The New York Department of Financial Services’ recent guidance on Climate Change and Financial Risks, and BlackRock CEO Larry Fink’s annual January letter to corporations, which addressed similar issues.

The conversation focuses on how regulators and asset managers are addressing investors’ concerns relating to climate change, including the risks of potential climate-related damage to physical property, and the economic benefits of moving toward carbon-neutral investment options.

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Dave Dalton:

The interest in ESG investing has accelerated in recent months, as evidenced by the attention it's getting from regulatory and enforcement bodies, and also from heavy hitters in the asset management community. Jones Day partners Lanier Saperstein and Jay Tambe are here to talk about the ESG guidance from the New York State Department of Financial Services, which outlines the department's expectations for how financial institutions under its purview should manage climate change risk.

Dave Dalton:

And Lanier and Jay will also comment on the January letter sent by BlackRock CEO, Larry Fink, and in case you didn't know, BlackRock is the world's largest asset manager, about how seriously his firm is taking sustainable investing. You don't want to miss this one. Take notes. I'm Dave Dalton. You're listening to Jones Day Talks.

Dave Dalton:

Jones Day partner Lanier Saperstein represents financial institutions in both litigation and regulatory matters. Among many other matters, he has managed a broad range of issues relating to the Bank Secrecy Act, anti-money laundering, the Office of Foreign Assets Control's programs, the Anti-Terrorism Act, and alleged fraud claims under federal and New York law. Lanier is an adjunct professor at Fordham Law School, where he teaches banking-related courses. He has written extensively on matters impacting financial institutions and his writings have been cited in dozens of prominent law journals.

Dave Dalton:

Jay Tambe leads Jones Day's financial markets practice. He advises financial institutions on litigation concerning securities, derivatives, credit default swaps, collateralized debt obligations, and other financial products. Many of his cases involve cross-border disputes and he is experienced in the navigation of international discovery and judgment enforcement. Jay routinely provides pre-litigation advice on documentation and risk mitigation and is a frequent speaker on complex financial products. Lanier, Jay, thanks for joining us today.

Lanier Saperstein:

Thanks, Dave. Glad to be here.

Dave Dalton:

Okay, there are a number of recent developments relating to ESG investing and reporting that we'd like to cover during this conversation. Lanier, let's start by talking about an action by the New York State Department of Financial Services. Late last year, DFS issued a guidance letter on ESG. But before we get into the specifics of what was in that letter, give us some background or an overview of the New York Department of Financial Services, what it is, what it does, just some background for people who maybe aren't so familiar.

Lanier Saperstein:

Sure. The DFS is the primary regulator for all New York licensed and New York's chartered banks, as well as a host of other New York-based financial actors. DFS also supervises insurance companies operating in New York.

Lanier Saperstein:

Now, some of our non-US listeners may be wondering why there is a New York regulator. The U.S. has a dual banking system. There are federally-chartered banks that are supervised by the federal regulators, and there's also state-charted and licensed banks largely supervised by their respective state regulators. In fact, the DFS regulates more financial institutions than the OCC, which is one of the principal federal banking regulators. But not only does the DFS regulate a lot of entities, it also has enforcement powers, and that's something unique amongst regulators, so the DFS is an important actor.

Dave Dalton:

Okay, so let's talk a little bit. We'll go over to Jay in a second, but let's talk about some of the specifics in this letter. I guess the letter noted that financial risks from climate change are unprecedented, and DFS expects that banks will begin integrating climate change risk in their government's frameworks. I guess also, they said, they should develop disclosure policies and work with the task force for climate-related financial disclosures on a framework. Is that basically what this gets to, Lanier? Are those broad strokes with the DFS guidance?

Lanier Saperstein:

Yeah. It is guidance, right? They're not, right now, mandating any action. Essentially, what the DFS is saying is that financial institutions should start thinking about climate risk and should start thinking about incorporating climate risk into the financials, as well as the financial disclosures. I would expect over the ensuing months or year that DFS will come out with something that's a bit more than guidance, inching the industry towards a more fulsome and complete disclosure regime.

Dave Dalton:

Over to Jay Tambe for a moment. Jay, why now? Why would DFS, late 2020, decides now is the time to bring out a guidance letter on ESG? Is it just because that's where momentum appears to be going, or what maybe prompted this at that point?

Jay Tambe:

I think, certainly, momentum is part of the rationale behind why the DFS acted when it did. What we have noticed is really starting in Europe, and more recently expanding broadly to the US, is a greater focus, awareness, on ESG issues, and in particular, on the environmental, the E part of ESG. In many ways, both investors and regulators in Europe have been focused and have prescribed regulations around environmental targets, environmental disclosures.

Jay Tambe:

We're beginning to see a movement by U.S. investors, very, very broadly, into ESG issues, and again, environmental issues in particular. So you can view the department's guidance letter as recognizing, acknowledging, the importance of environmental issues to issuers, to investors, to financial market participants, and really beginning the process of engaging with financial institutions and regulated entities on appropriate disclosures, on measurement, and on addressing the concerns of investors who are very focused on these environmental issues.

Dave Dalton:

Absolutely, absolutely. Now, Lanier, as far as we know, is this the first action of its kind by a U.S.-based regulator?

Lanier Saperstein:

Yeah, it is, and I'll also add that, in May of this... Well, I guess, in May of last year, the DFS hired its first Director of Sustainability and Climate Initiatives, Dr. Nina Chen, who has an impressive background, including a PhD from MIT. So the DFS clearly is focused on ESG, and as Jay said, right now, in particular, the E, the environmental aspect of ESG.

Dave Dalton:

We'll stay with you one more minute, Lanier, and then we'll move back to Jay. You'd written in a Jones Day commentary late last year, and we'll post that at jonesday.com, it'll be an attachment with this podcast, you said that DFS is a major regular enforcement agency with an established history of weighing in on these sorts of issues. Cite some examples, what have they done prior that gives this sort of action on DFS some credibility, I guess?

Lanier Saperstein:

Yeah, the DFS is really seen as a leader in terms of regulatory innovation, in a number of critical areas. And I date myself. Many years ago, there was an ad on TV saying, "When EF Hutton talks, others listen," and I think that really happens with the DFS, so when the DFS speaks, other regulators listen, as well as investors.

Lanier Saperstein:

So the DFS is taking a lead in a number of areas, including cybersecurity, FinTech charters. Jay and I teach a class together and I bang on often about the fact that the DFS sued the OCC, arguing that the OCC's FinTech charter program violated the dual banking system, so the DFS certainly is not shy about stating its position. The DFS also took the lead in compliance officer certification. That really has caught on more widely, so the DFS really is an important player in this space.

Dave Dalton:

Okay, Jay, is this a harbinger of things to come this year? Later in 2021, will other regulators move toward ESG-related oversight?

Jay Tambe:

Absolutely. I think we see what the DFS is doing here as only the beginning of a series of regulatory moves by state and federal regulators, frankly, in providing greater guidance and definition on ESG-related issues generally. We see a strong push from investors in emphasizing ESG principles and ESG criteria in making investment decisions.

Jay Tambe:

And I think we see a strong push from legislators and regulators on making climate change and social and governance issues more prominent in the financial markets. I think it's only a matter of time, therefore, that you're going to see in the US, more regulation and more prescriptive and proscriptive regulation about ESG-related issues, and so this is a very important first step by the DFS in setting out this guidance letter, but we fully expect many other regulators to follow suit.

Dave Dalton:

Certainly a trend and a story to watch. All right, Jay, let's stay with you. You talked about investors a moment ago. Big news, in January, BlackRock CEO, Larry Fink, sent his annual letter to chief executives and he said his firm would avoid investments in companies that, I'm quoting, "that present a high sustainability-related risk." Now, BlackRock is the world's largest asset manager, a little more than 8.5 trillion U.S. Dollars under management. Jay, I think I know the answer before I'm going to ask this question, but this is a big game-changer. How big is this?

Jay Tambe:

Look, certainly in terms of making headlines, BlackRock has made headlines and Mr. Fink has made headlines. The devil is always in the details, however, and one of the challenges that's presented, I believe, to companies, to regulators, to investors, is, how exactly do you measure high sustainability-related risk, and who is going to do that measurement? What are the standards, and what exactly are companies supposed to do?

Jay Tambe:

When it comes to financial disclosures and accounting disclosures, we have plenty of guidance. We have decades, if not longer, of experience in understanding exactly how you measure financial performance, how you account for assets and liabilities. Now, what Mr. Fink, BlackRock, and other investors are frankly asking issuers to do is to account for something that may be a lot harder to define and a lot harder to measure.

Jay Tambe:

So you can log the principles behind Mr. Fink's letter and the focus on ESG issues. It is a difficult transition, in my view, to make from those aspirations of focusing on high sustainability, proper governance, proper social issues, to actually measuring and delivering on those aspirations. So it is a game-changer, but to carry the analogy further, it's a game-changer in the sense, the rules of the game are yet to be written.

Dave Dalton:

Sure. So Jay, what needs to happen? I mean, over time, do industry groups get together and come to an agreement, or is this something that's legislated? But what needs to happen to make this clear and understandable and implementable? Is that a word? I mean, how do we get to the point where this is something that everybody adheres to and understands?

Jay Tambe:

There are a couple of ways of, I think, looking at the ESG movement generally. One is, you could look at it and say, "Well, these are incremental, marginal changes." That's the incorrect way of looking at the ESG movement. I frankly think what ESG captures, what the ESG statements now being issued by the likes of BlackRock and State Street and others capture is almost a fundamental review and analysis of what the role companies is going to be in modern finance.

Jay Tambe:

Most famously, you have the letter from the Roundtable, the Business Roundtable, which discussed obligations of companies and responsibilities of companies, not just to shareholders, but to stakeholders. It's in that context of the broader reshaping off the corporation's relationship with, not just its customers, not just its employees, not just its shareholders, but its place in society as a whole, and being seen as a vehicle for change and for effecting policy, whether it be environmental policy, social policy, or governance policy. That's the broader framework under which these discussions, these kinds of letters, have to be examined.

Jay Tambe:

And so, what will it take? It will take a lot of conversation. There will need to be consensus built around what the rules of the game are. And the rules, in some part, can be legislated, they can be regulated, but ultimately, they are rules that have to be accepted by all the principle actors in the financial markets. And so, they have to be accepted and acceptable, therefore, to-

Jay Tambe:

...issuers, to regulators, to legislators, to investors, and so it'll be a series of conversations to get to consensus around what the rules of the game are going to be.

Dave Dalton:

This reminds me a little bit of the discussion, controversy, the situation around green bonds that I remember reading about last year, what exactly constitutes a green bond? What benchmarks do you have to meet in order to qualify for that kind of categorization, I guess? Is this similar? And I know that's a very narrow part of all this, Jay, but are the arguments and the discussions similar to get us to this point?

Jay Tambe:

You can think of the discussion and controversy around green bonds as one of the flavors of the conversation we're going to have more broadly about ESG, an important one, because certainly, if you look at transactions that are occurring today that are driven by or focused on addressing environmental issues, certainly, green bonds, sustainable finance, falls into that bucket. And we've already seen the challenges that are presented in bridging the gap between aspirations and principles, and then actually effecting and implementing those aspirations and principles in reducing carbon output, in more sustainable energy production, and the like.

Dave Dalton:

Let's go back to Lanier for a second, staying with Mr. Fink's letter to CEO's for a second. He'd written that the evidence on climate risk is compelling investors to reassess core assumptions about modern finance. What was your reaction when you read that, Lanier?

Lanier Saperstein:

I agree, and I think helpful, at least for me, when I think about it in concrete terms, and we can do that by looking at the insurance industry, right? The insurance industry has been, I think, focusing on these issues longer because the cost of climate change and climate-related damage often falls on the insurance industry, first, at least, and the insurers have to price that risk.

Lanier Saperstein:

And let me give you a local example. I now live in New York. And anyone trying to buy flood insurance after Hurricane Sandy hit the East Coast, and in particular, New York City, knows that, as the risk of flooding increases, so do your insurance premiums. And in fact, in September, which was about a month before the DFS released its open letter to its supervised financial institutions, the DFS published an insurance circular directed to all New York domestic and foreign insurance companies operating in New York. And in that circular, the DFS cited a study that estimated single and multifamily residential homes in New York City with a reconstruction value of $334 billion are at high risk of storm surges.

Dave Dalton:

334 billion, with a B?

Lanier Saperstein:

With a B, yeah. And so, the insurance industry is really at the forefront of this because they have to be, right? They are the first line in sustaining these costs. Now, Jay raises a good point, right? Now, we move to the financial industry. It gets a little harder to both price the risk and come up with the rules for investing and disclosing with respect to environmental risk, and that's something that is going to be over the ensuing months or years, certainly going to be something that's hashed out.

Lanier Saperstein:

But what we are seeing in the financial industry, and Dave, you referred to it, at least in part, is that it's borne out by the numbers. And we see investors putting their money into investments that are linked to the environment and climate change. So for example, Bloomberg reported that inflows into ESG exchange-traded funds have increased to 22 billion, again, with a B, this... in 2020, excuse me, and that was three times the total in 2019. PricewaterhouseCoopers estimates that ESG funds could experience a threefold increase in assets by 2025.

Lanier Saperstein:

You mentioned, Dave, green bonds. Well, green bonds have exploded since 2005. I was looking at the data as I was preparing for this podcast, and green bonds essentially went from zero in 2005 to over 500 billion in 2019. So the investors are going in this direction, and I think the financial industry and the regulators, certainly, will be doing likewise.

Dave Dalton:

Staying with Lanier, this is the first time, I guess it was a headline-grabber, but was this the first time an asset manager with this much influence made carbon neutrality a central component of their ongoing strategy?

Lanier Saperstein:

Certainly, one of the first. BlackRock is a big, big investor, and so, obviously, got a lot of attention, but there have been some others. State Street, for example, which is the world's third largest asset manager, sent a similar letter to its board of directors, and so they are very involved in this space as well.

Lanier Saperstein:

We've also seen statements from other senior financial institutions, or at least ahead of those institutions. So for example, Karen Frank, the CEO of Barclays, said, "Sustainability is not a trend, it's something that is the next evolution in investing." Anne Simpson of CalPERS, which is a massive pension fund, said, "Anyone who's not thinking about climate change, or its impact on workers, or worrying about the health and safety, any investment strategy that does not consider those factors will be flawed."

Lanier Saperstein:

So certainly, a lot of companies are thinking about this, and a few, with BlackRock being one of the leaders, have really put this into a more sort of formalized approach, or at least, trying to.

Dave Dalton:

So Jay, I think it would be reasonable to expect that other investment funds that maybe haven't started down this road will follow BlackRock's lead.

Jay Tambe:

I think so, and I'm not sure it's entirely fair to call it BlackRock's lead because the fact of the matter is that what BlackRock and Mr. Fink have focused on has been the focus of other asset managers, at, or about, the same time. There are any number of pension funds that have made it clear to their asset managers that they are placing an emphasis on sustainability and ESG principles, and so we expect this to be part of a broader trend that's going to gather, I think, more strength in the coming quarters and years to where they will come out publicly, the way BlackRock has, and emphasize what their interests and principles are when it comes to ESG investing.

Dave Dalton:

Okay, we're going to wrap this up with a couple of broader questions. Let's go back to Lanier. Talk about the practical takeaways from Mr. Fink's letter from a corporation standpoint, or one of your client's standpoint. What do they need to do, having seen this now?

Lanier Saperstein:

I think financial institutions should identify a person or a group of people within the organization who will lie awake at night, thinking about these issues, and in fact, turning back to the DFS letter, that is what the DFS wants its regulated or supervised entities to do. And in the DFS letter, it says it expects all regulated organizations to, "designate a board member, a committee of the board, as well as a senior management function, as accountable for the organization's assessment and management of the financial risks from climate change," so I would start there.

Jay Tambe:

If I could add to that, maybe a natural and understandable reaction to respond to letters like the letter from Mr. Fink, by providing wholehearted support and agreement. But for issuers, for other financial industry actors, I think it's not just a question of whether or not they agree with and are broadly of a similar mindset as BlackRock and other institutional investors.

Jay Tambe:

But the question is, when they do sign on to those principles, do they have the necessary staff, the necessary processes and controls internally, to identify how they're going to achieve their ESG goals, how they're going to satisfy those ESG principles, how they're going to measure them, how they're going to report on them, and frankly, how their following of those ESG principles, how their adoption of those ESG principles, is going to square with their legal obligations to their shareholders, to their employees, and to their customers?

Jay Tambe:

As I said earlier, there are a number of ESG conversations that are occurring, but one of the important places where the ESG conversations need to occur is in the legal sphere where legal duties and obligations need to be better understood and defined. And to move from the truly aspirational to implementation, I think you need to have, and the financial markets need to have, more clear legal guidance and more clear demarcation of what the regulators expect and what companies are required to provide, as opposed to merely the aspirational support and backing of different actors.

Dave Dalton:

Jay, this is a heavy lift. There's a lot going on, both internally for corporations, and for regulators, and for industry-focused groups, maybe for the media. This could take a while to unpack. Could it?

Jay Tambe:

We expect it to be a long road, indeed. There are clearly strong market forces that are either pulling or pushing the financial industry as a whole in the direction of greater adherence to ESG principles. I think the care that needs to be taken by the lawyers, by the legislators, by the regulators, is that we do it in a way that makes sense, in a way that is predictable, in a way that is possible to implement, without exposing issuers or other financial actors to undue risk.

Dave Dalton:

Real good. Hey, let's leave it right there. Lanier, Jay, this has been a great discussion. Let's do this again soon. Honestly, why don't we see how things unravel over the end of 2021, have another look? Lot of evolving storylines under this headline, so there's a lot to watch, a lot to anticipate, and I think it's an exciting time to be in your space. Kind of like you're practicing right now, it's probably a very interesting, compelling time. So thanks for everything you're doing.

Jay Tambe:

Great. Thanks a lot, David.

Dave Dalton:

Thanks for being here today.

Lanier Saperstein:

Great, thanks.

Dave Dalton:

Take care. Bye. You can find complete biographies and contact information for Lanier and Jay at jonesday.com. While you're there, go to our insights page. You'll find more podcasts, publications, white papers, newsletters, commentaries, client alerts, and other useful information.

Dave Dalton:

And be sure to subscribe to Jones Day Talks. You can do that at Apple Podcasts and wherever else podcasts are found. We have a number of ESG-related podcasts following in the next couple of months. We'll talk about the European Banking Authority's guidance on ESG-related investments, and we're also going to take a hard look at the green bond market. As always, we thank you for listening to Jones Day Talks. I'm Dave Dalton. We'll talk to you next time.

Speaker 4:

Thank you for listening to Jones Day Talks. Comments heard on Jones Day Talks should not be construed as legal advice regarding any specific facts or circumstances. The opinions expressed on Jones Day Talks are those of lawyers appearing on the program and do not necessarily reflect those of the firm. For more information, please visit jonesday.com.