Improving the agriculture industry's climate resilience is essential to protect the sector's long-term productivity and profitability. Two new reports take a deep dive into managing climate risk in the financial system as well as the overall risks agricultural lenders specifically face.

The climate-related market risk subcommittee of the Commodity Futures Trading Commission’s (CFTC) Market Risk Advisory Committee (MRAC) released a report Sept. 9 titled "Managing Climate Risk in the U.S. Financial System," which the climate subcommittee voted unanimously 34-0 to adopt.

The report is the first of its kind from a U.S. government entity and was initiated by CFTC commissioner Rostin Behnam to examine climate-related impacts on the financial system in June 2019, when the MRAC convened to examine climate change-related financial risks. At that meeting, Behnam pointed to the critical importance of undertaking this effort, highlighting ongoing work by private market participants and government entities across the globe, including more than 40 central banks and supervisors like the European Central Bank, World Bank and the People’s Bank of China.

“As we’ve seen in the past few weeks alone, extreme weather events continue to sweep the nation, from the severe wildfires of the West to the devastating Midwest derecho and damaging Gulf Coast hurricanes. This trend — which is increasingly becoming our new normal — will likely continue to worsen in frequency and intensity as a result of a changing climate,” Behnam said. “Beyond their physical devastation and tragic loss of human life and livelihood, escalating weather events also pose significant challenges to our financial system and our ability to sustain long-term economic growth. Now, with this report in hand, policy-makers, regulators and stakeholders can begin the process of taking thoughtful and intentional steps toward building a climate-resilient financial system that prepares our country for the decades to come.”

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The report's executive summary stated, “The central message of this report is that U.S. financial regulators must recognize that climate change poses serious emerging risks to the U.S. financial system, and they should move urgently and decisively to measure, understand and address these risks. Achieving this goal calls for strengthening regulators’ capabilities, expertise and data and tools to better monitor, analyze and quantify climate risks. It calls for working closely with the private sector to ensure that financial institutions and market participants do the same, and it calls for policy and regulatory choices that are flexible, open-ended and adaptable to new information about climate change and its risks, based on close and iterative dialogue with the private sector.”

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John Hartmann, global sustainability lead for Cargill Agricultural Supply Chain, served on the MRAC climate-related market risk subcommittee. He welcomed the report’s call for policy and regulatory choices that are “flexible, open ended and adaptable to new information about climate change and its risks, based on close and interactive dialogue with the private sector.” He added that mitigating greenhouse gas emissions, capturing carbon and providing ecosystem services for society as a whole all offer ways the agriculture sector can innovate and adapt to find solutions.

The report, which presents 53 recommendations to mitigate the risks to financial markets posed by climate change, stated that climate risks may also exacerbate financial system vulnerability that has little to do with climate change, including vulnerabilities caused by a pandemic that has stressed balance sheets, strained government budgets and depleted household wealth.

Existing statutes already provide U.S. financial regulators with wide-ranging and flexible authorities that could be used to start addressing climate-related financial risk now. Regulators can help promote the role of financial markets as providers of solutions to climate-related risks. In addition, financial innovation is required not only to efficiently manage climate risk but also to facilitate the flow of capital to help accelerate the transition to net-zero carbon emissions and increase economic opportunity.

“Capital allocation recommendations state that efforts should aim to facilitate an orderly transition, where possible, avoiding adding financial strain on already stressed sectors, including agricultural producers and commercial and industrial companies, among others,” Hartmann said of the report. “We believe the future path should generate positive incentives that realize the potential of nature and agricultural-based climate change solutions and avoid adding financial strain to agricultural producers.”

In addition to the absence of an economy-wide carbon pricing regime in the U.S., other barriers are holding back capital from flowing to sustainable, low-carbon activities, the report notes.

“The United States should establish a price on carbon,” the CFTC report said. “It must be fair, economy-wide and effective in reducing emissions consistent with the Paris Agreement. This is the single most important step to manage climate risk and drive the appropriate allocation of capital.”

Ag lenders’ role

The Environmental Defense Fund (EDF) also released a report that not only details the risks agricultural lenders face from climate change but also points out the opportunities that they have to support the long-term profitability of those who work the land.

In a foreword written by Dick Wittman, a farmer and longtime conservationist, he said the report offers “fresh thinking about how the agricultural finance sector can better understand and mitigate climate risks and be a partner in advancing conservation. The sector needs innovation in lending products and program delivery to better understand the relationships between conservation and financial success. This will, in turn, affect how lenders price credit and reward risk mitigation.”

The EDF report asserts that climate risks pose a blind spot for lenders that have not proactively assessed their own risks. The hesitancy to act is concerning, given that agriculture is on the front lines of climate change. The report also notes that those in the financial sector beyond agricultural lenders have already been making strides to incorporate climate risk into their decision-making process.

Given the financial risks that the changing climate imposes – such as reduced farm earnings and credit quality, especially in agricultural regions where lenders and related businesses tend to be concentrated – crop insurance is not enough. Crop coverage offers a "shock absorber" for participating farmers and their lenders, but it is insufficient to protect farmers, lenders or the broader agricultural economy from climate risk over the long term, the report asserts.

EDF also believes that current loan offerings don't value resilience. The report notes, for example, that short-term financial products such as annual operating loans don't integrate the value of farmer investments in practices like no-till, cover crops and extended crop rotations. The disconnect between these practices – which have shown measurable financial benefits in terms of both cost savings and risk reduction – and agricultural lender policy undermines long-term profitability and resilience for both farmers and financiers.

Among the recommendations included in the report is for lending institutions to assess their own exposure to climate risk and then adopt and implement strategies to monitor and mitigate climate risk. Organizations must gain valuable insight from farmers on the financial impacts of conservation practices and their role in managing risks in order to find strategies that will minimize costs and maximize the benefits of adopting conservation practices.