kevin stiroh : climate change and risk management in bank supervision remarks by mr kevin stiroh, executive vice president of the financial institution supervision group of the federal reserve bank of new york, at the conference on “ risks, opportunities, and investment in the era of climate change ”, harvard business school, boston, massachusetts, 4 march 2020. * * * as prepared for delivery introduction good afternoon and thank you for the opportunity to participate in this conference on “ risks, opportunities, and investments in the era of climate change, ” a topic of critical importance for all of us. climate change is already affecting economic and financial outcomes, and projections point to increasingly severe and unpredictable change. 1 in recent years, we ’ ve seen a growing focus of central banks on the financial risks related to climate change. some may argue that this shift was slow in coming, but the change is striking nevertheless. beginning with bank of england governor mark carney ’ s speech in 20152, climate change has emerged as a key issue globally. within the federal reserve, governor brainard detailed how climate change impacts the fed ’ s core objectives around monetary policy, financial stability, financial regulation and supervision, community and consumer affairs, and payments and describes efforts to build capacity to assess these risks. 3 today, i ’ m going to take a more narrow perspective and talk about climate change from the perspective of risk management. i ’ ll discuss how the development of new risks associated with climate change is beginning to change the practice of risk management at financial institutions in terms of governance, risk identification and management, scenario analysis and transparency. i ’ ll also say a few words on why i believe it is appropriate, even critical, for supervisors to focus on this particular risk. before proceeding, i will emphasize that i am speaking for myself and my views do not necessarily reflect those of the federal reserve bank of new york or the federal reserve system. climate change and risk management the discussion of climate change and risk management has introduced a new lexicon for risk discussions. physical risk is the potential for losses as climate - related changes disrupt business operations, destroy capital and interrupt economic activity. transition risk is the potential for loss resulting from a shift toward a lower - carbon economy as policy, consumer sentiment and technological innovations impact the value of certain assets and liabilities. these effects will be felt across business sectors and asset classes, on strategies and operations, and through the balance sheets and income statements of financial firms. at a practical level, risk managers at financial institutions

regulatory capital requirements appropriately reflect their risk. while critically important, capital alone does not define an institution ’ s strength. it is vitally important for firms to continue to invest in strong internal controls and to make sure that advances in the operational infrastructure keep pace with rapid growth, particularly in complex transactions. strong operational controls can help ensure smooth market functioning in times of stress, and when they are weak they can exacerbate adverse market dynamics. an important element of a sound operational control environment is timely and accurate information for senior managers, especially when it is most critical for them to have a clear picture of the firm ’ s exposure. as such, strong operational controls can help reduce some dimensions of uncertainty and therefore help markets function better in conditions of stress. the challenge of ensuring that operational controls keep up with front office advances in the complexity and volume of transactions is particularly evident today in the area of credit derivatives. the rapid growth in the trading of credit default swaps and structured credit products has resulted in considerable back - office backlogs ( unsigned confirmations and master agreements, delays in trade capture into risk management systems, delayed notification of assignments of positions ) that create significant operational risk for market participants. these types of operational problems have arisen more broadly in the otc derivatives market over time and they have gotten worse with the rapid growth in activity by hedge funds. efforts underway to automate matching and confirmation of credit default swap transactions should help address these concerns. but we need to see a stronger collective commitment by the principal dealers in these markets to reduce the outstanding backlog of confirms, shorten confirm times and move larger share of transactions in the more standardized instruments to automated platforms. and we ’ ll act to reinforce that commitment. these considerations are particularly important for the systemically significant financial institutions that stand at the core of the u. s. financial system. these institutions need to have exceptionally high standards in terms of internal controls, capital and risk management and governance. the greater complexity of their risk profile puts more exacting demands on the risk management architecture and requires a higher margin of capital than would be necessary for a business profile with less volatility and more predictability in returns. and the central role these firms occupy in our financial system and the consequences to other firms and to the stability of the financial system should one of them face significant financial or operational difficulties requires that they hold a higher margin of capital above economic capital than would be appropriate for smaller institutions with a similar risk profile. these arguments are compelling