Climate Risk Management Vs. Community Development Lending: NYDFS Wants Its Banks And Mortgage Companies To Do Both – Financial Services

On December 21, 2022, the New York Department of Financial
Services (“NYDFS”) proposed guidance for how the banks
and mortgage institutions it regulates (“New York
Institutions”) should manage climate-related financial risks
(the “Proposed Guidance”).1
The Proposed Guidance would establish extensive obligations for New
York Institutions, which, even if tailored to be proportionate to
size and activities, could create a significant burden. This is
particularly true for mortgage bankers and mortgage servicers,
which historically have not been subject to the same risk
management expectations as banks.

NYDFS will accept comments on the Proposed Guidance until March
21, 2023, and requests that commenters use a specially formatted
spreadsheet from the agency’s website to format submissions. In
this Legal Update, we provide background on the NYDFS’s climate
risk management initiative and discuss the Proposed Guidance.

Background

NYDFS is the primary regulator for many categories of financial
institutions that do business in New York, including New York
Institutions.2 As with the federal
prudential regulators, NYDFS is charged with promoting the safety
and soundness of New York Institutions. In recent years, safety and
soundness principles have been construed as including the
establishment of enterprise-wide risk management systems, although
the risk management expectations for mortgage bankers and mortgage
servicers are not as well-defined or extensive as for banks.
However, this situation may be changing, as evidenced by the
release of model state regulatory prudential standards for nonbank
mortgage servicers by the Conference of State Bank Supervisors.3

In 2020, NYDFS identified climate change as a driver of risk for
the financial institutions that it regulates. This is consistent
with the focus of other regulators, such as the Federal Housing
Finance Agency (“FHFA”), on climate change.4 In October 2020, NYDFS released
initial guidance to New York Institutions on how to manage the
financial risks from climate change. This was followed in November
2021 by climate risk management guidance for New York insurance
companies, which we discussed in an earlier Legal Update. It seemed likely,
however, that NYDFS would revisit the climate risk management
guidance for New York Institutions, particularly given federal and international developments on these
issues.

Proposed Guidance

The Proposed Guidance would expand on the 2020 guidance by
establishing a comprehensive framework for managing climate-related
financial risk. As with guidance from other regulators, the
Proposed Guidance defines climate-related financial risk as
consisting of physical risks and transition risks and states that
New York Institutions should consider the effects of each of these
types of risks on their operational resilience and their safety and
soundness and the particular consequences these risks may pose to
their customers.

The Proposed Guidance identifies two “overarching
themes” to climate risk management: (i) managing
climate-related financial risks while complying with fair lending
obligations in low- and moderate-income (“LMI”)
communities and communities of color, which may be
disproportionately harmed by climate change and natural disasters,
and (ii) taking a proportionate approach to the management of
climate-related financial risks. The first theme is intended to
ensure that New York Institutions manage climate-related financial
risk in a way that minimizes and affirmatively mitigates adverse
impacts on LMI communities and communities of color. This theme may
generate considerable comment given the difficulties financial
institutions can encounter in managing both fair lending and safety
and soundness concerns. It also is notable because NYDFS makes the
point elsewhere in the Proposed Guidance that New York Institutions
cannot assume that insurance will be available or affordable to
mitigate the costs associated with climate change. If climate
change will render some financial products unavailable to financial
institutions, one might wonder why it would not make some financial
products unavailable or cost prohibitive to consumers.

The Proposed Guidance describes the components of prudent climate
risk management as:

  1. Corporate Governance: A New York
    Institution’s governing body and management should establish a
    governance framework that will ensure there is a process in place
    for identifying, measuring, monitoring, and controlling the
    institution’s financial risks associated with climate change.
    This includes appropriate strategy and risk oversight activities as
    well as enterprise-wide policies and procedures and controls.

  2. Internal Control Framework: A New York
    Institution should incorporate climate-related financial risks into
    its internal control frameworks across the three lines of defense,
    to ensure sound, comprehensive, and effective identification,
    measurement, monitoring, and control of material climate-related
    financial risks.

  3. Risk Management Process: A New York
    Institution should identify, measure, monitor, and control
    climate-related financial risks through its existing risk
    management framework, including through appropriate approaches to
    mitigate risks. It appears that climate risk should be embedded in
    an institution’s existing risk categories (e.g., as part of
    credit risk, not a standalone risk).

  4. Data Aggregation and Reporting: A New York
    Institution should develop proportionate risk data aggregation
    capabilities and risk reporting practices that are capable of
    monitoring material climate-related financial risks and producing
    timely information to facilitate board and senior management
    decision-making.

  5. Scenario Analysis: A New York Institution
    should consider using a range of climate scenarios based on
    assumptions regarding the impact of climate-related financial risks
    over different time horizons to assess the resiliency of its
    business model and strategy, identify and measure vulnerability to
    relevant climate-related risk factors, estimate exposures and
    potential impacts, and determine the materiality of climate-related
    financial risks. This expectation may come as a surprise to
    mortgage bankers and mortgage servicers, which historically have
    not been expected to conduct scenario analysis or stress testing as
    part of risk management.

Takeaways

The Proposed Guidance requests comment on a timeline for
implementation of its expectations and how to tailor scenario
analysis activities for smaller institutions. It also asks if there
should be climate-specific reporting and disclosure requirements
for New York Institutions. All of these are issues that have been
raised in relation to the proposed climate risk management
expectations from the federal banking regulators and are likely to
generate similar comments to NYDFS.

The Proposed Guidance is likely to generate new controversy for
its statements that New York Institutions “must manage
climate-related financial risks prudently while continuing to
ensure fair access to capital and credit” and may not
implement risk management practices that “unduly harm or
disadvantage at-risk communities.” While the Proposed Guidance
states that NYDFS will not dictate credit or investment decisions,
the imposition of a fair access requirement arguably could be
viewed as going further than existing fair lending and community
reinvestment requirements if institutions are obligated to make
certain products available.5 As was
seen with the fair access rulemaking by the Office of the
Comptroller of the Currency, this type of supervisory expectation
is not common in the United States and raises a host of regulatory
and policy concerns.

Footnotes

1 NYDFS, DFS Superintendent Harris Proposes
Guidance for New York State-Regulated Banking and Mortgage
Institutions Relating to Management of Safety & Soundness Risks
From Climate Change
(Dec. 21, 2022),
New York Institutions include New York-regulated banking
organizations, New York-licensed branches and agencies of foreign
banking organizations, and New York-regulated mortgage bankers and
mortgage servicers.

2 See, e.g.,
N.Y. Banking L. §§ 14, 44.

3 Press Release,
CSBS Releases Model State Regulatory Prudential Standards for
Nonbank Mortgage Servicers
(July 26, 2021).

4 See our Legal Update on the FHFA action:
See also our Legal Update on the impact of climate change on the
regulated US mortgage industry:

5 See our discussion of climate redlining in
relation to the federal Community Reinvestment Act rulemaking:

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