Climate 411

The auction results are in: Washington state’s cap-and-invest program is off to a strong start

By / Bio / Published: March 7, 2023

This blog was co-authored by Delia Novak, Western States Climate Policy Intern, U.S. Region

Today, the Washington State Department of Ecology (ECY) released the results from Washington’s first cap-and-invest auction held last Tuesday, February 28. The results of this auction indicate long-term confidence in the program from covered entities and are an encouraging sign of what’s to come from the Evergreen State. Additionally, the ECY summary report shows that the auction operated smoothly, with oversight and regulatory mechanisms in place to ensure the integrity of the auction and ease of interface for bidders.

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Washington state is holding its first cap-and-invest auction. Here’s what to expect.

By / Bio / Published: February 22, 2023
Photo of the Asgard Pass in Washington state.

Photo Credit: Getty Images

Blog co-authored by Kjellen Belcher, Manager, U.S. Climate

Washington state is getting ready for an exciting development in its new nation-leading climate program, the Climate Commitment Act, which is slated to deliver healthier air, more clean energy jobs and a safer climate future for communities.

After experiencing costly and historic wildfires, heat waves and flooding — all within the past few years — Washington communities are ready for this cap-and-invest program to fast-track the transition to a stronger and more equitable, clean economy. Now, the program will take a major step forward with Washington’s first allowance auction to be held on February 28.

Here’s what you should know about the program and how the allowance auction works. Read More »

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Michigan voters want to see more climate action this legislative session

By / Twitter profile / Published: January 18, 2023

Photo Credit: Steven Kriemadis

This November, Michigan Governor Gretchen Whitmer won her bid for reelection and for the first time in 40 years, Democrats gained a majority in the state house and senate.

With this historic win comes historic opportunity. In the legislative session that started last week, Michigan has the chance to follow through on the climate goals set during Gov Whitmer’s first term with strong policies capable of ensuring a safer climate and healthier communities for decades to come. Recent polling commissioned by EDF Action underscores that voters are ready for state leaders to meet this moment by stepping up action on climate and clean energy.

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As Washington state sets the rules for its ambitious climate program, regulators shouldn’t overlook this policy tool

By / Bio / Published: September 13, 2022

This post was co-authored by Natalie Hurd, Western states climate policy intern at EDF.

Landscape of Washington state

Photo Credit: George Dodd for Getty Images

Washington state is on the cusp of finalizing the rules to launch its ambitious new climate policy. This comes at an important moment of opportunity for states to lean into their climate commitments and increase their ambition. The passage of the Inflation Reduction Act will drive an unprecedented level of investment in fighting climate change and building a clean energy future, making it even easier for states like Washington to meet their climate goals. By enacting ambitious cap-and-invest legislation last year, Washington has taken an important step forward — but now it’s up to regulators to deliver the strongest possible cap-and-invest program.

The Climate Commitment Act (CCA) pairs carbon emission reductions with new tools to tackle local air quality disparities — all in the same policy framework. One of the valuable tools included in the cap-and-invest legislation is an emissions containment reserve (ECR) — a mechanism that guards against long-term uncertainty by ensuring that the program will be made more ambitious if prices for the program become lower than expected. Right now, Washington’s Department of Ecology is making decisions about the details of how to implement the program, including whether or not to include a functional ECR, and EDF has made it clear that Washington should include a well-designed, effective ECR in the state’s cap-and-invest program. Regulators once again have the opportunity to lead the way on the West Coast by including a functioning ECR in Washington’s program design.

What is an emissions containment reserve?

An ECR is a design feature for cap-and-invest programs that was first implemented by the Regional Greenhouse Gas Initiative (RGGI), a multi-state climate program on the East Coast. The primary role of an ECR is to ensure that, when demand for emissions allowances decreases, the overall supply of allowances is reduced. By reducing the supply, the ECR reduces the overall amount of climate pollution allowed under the program. In other words, allowances are reserved from the market and unable to be purchased, to make sure that the overall allowance budget is adjusted so that emissions are further contained. The amount of allowances that can be removed from the supply and placed in the ECR is relatively small ー for example, in RGGI, the size of the ECR is up to 10% of the allowance budget of participating states.

A figure describing how an ECR functions

Figure 1: Overview of an ECR (Adapted from Resources for the Future)

An ECR is activated when the allowance price hits a “trigger price”, which is a set price that would reflect lower-than-expected demand for allowances. In an auction, if demand for allowances is relatively low, the price of allowances at auction will decrease. If the price of allowances decreases enough to reach the ECR’s trigger price, then a predetermined number of allowances will be removed from the overall allowance supply available at the auction. By reducing the supply of allowances when the trigger price is reached, an ECR translates lower demand and lower prices into greater climate ambition.

One reason why demand for emissions allowances and allowance prices might drop, thus requiring the intervention of an ECR, is if regulated entities are able to cut emissions more quickly than expected.. For example, if a policy like a Clean Fuels Standard reduced emissions more swiftly than anticipated, then the entities impacted by that policy would have lower emissions and therefore require fewer emissions allowances than expected. An ECR helps create a supply for emissions allowances that is responsive to how demand for emissions allowances changes over time.

What does Washington’s program currently do?

Despite the added stability and climate ambition that an ECR would bring to Washington’s cap-and-invest program, as imagined in the Climate Commitment Act, the current proposed design for Washington’s program is missing a critical ingredient: an ECR trigger price. Without a trigger price, there is no way for the ECR to be activated, meaning that Washington’s proposed program does not include a functional ECR.

Why should Washington include a functional ECR in their program?

Economic modeling has shown that including an ECR in an emissions market improves performance by making the market more efficient and securing additional emissions reductions. On top of these benefits, an ECR would help ensure that a program like Washington’s will keep running smoothly long-term. For one, the inclusion of a functional ECR can reduce price volatility in the long run, which decreases uncertainty for market participants. Stable market expectations are important to the durability of the program. Cap-and-invest in the state is more likely to be successful going forward if market participants can better anticipate market behavior year-to-year and plan accordingly. In addition, an ECR provides a predictable, rule-based approach for supply adjustments, helping to avoid the need for other less predictable adjustments to supply by the Department of Ecology to keep Washington on track to meet its climate goals.

Finally, an ECR can increase the environmental ambition of the program by reducing the overall supply of allowances if demand for allowances falls, thereby reducing the total climate pollution that can be emitted by regulated entities. This is critical because Washington’s cap-and-invest program serves as a backstop, working alongside a suite of programs and investments that will help drive emissions reductions. As these programs and investments interact, it’s essential that the cap-and-invest program’s overall limit on emissions remains ambitious enough to incentivize continued efforts to address climate change, and an ECR can help do this by reducing the supply of allowances when demand for allowances is low.

Implications for linking with other carbon markets

In addition to enhanced environmental integrity and economic stability, a functional ECR with a trigger price may be an important factor in potential future program linkage between Washington and other carbon markets. Program linkage — or connecting carbon pricing systems across borders — can facilitate quicker reductions in emissions regionally. By establishing an ECR, Washington would set an important precedent for other states, as well as provide a strong example of climate policy. The ECR program design has already spread from its initial inception in RGGI, and Washington now has an opportunity to be a leader for states on the West Coast.

Market-based mechanisms to reduce climate emissions are not the only policies that need to be implemented to address the climate crisis, but they are a critical part of a suite of climate solutions, including sectoral strategies to deliver near-term reductions in climate pollution. In addition to maintaining the strength of its cap-and-invest system, it’s crucial that policymakers in Washington and elsewhere work meaningfully with communities to ensure that these policies are designed and rolled out in an equitable and just way, explicitly addressing the disproportionate burden of pollution that is primarily borne by low-income communities and communities of color. While cap-and-invest programs are only part of the solution, making them as strong and as stable as possible — such as with the implementation of an effective ECR with a trigger price — will help facilitate more ambitious and broad climate action for decades to come.

During the comment period for Ecology’s latest CCA rulemaking, EDF made it clear that Ecology should include a functional ECR with a trigger price in the final rules. Including a trigger price would help the program’s ECR function properly while driving greater reductions in climate pollution when prices are low. By building a strong ECR into its cap-and-invest program, Washington can continue to lead the way with effective, ambitious climate action that’s a model for other carbon markets.

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Climate change creates financial risks. Investors need to know what those are.

By / Bio / Twitter profile / Published: March 30, 2022

Flooding in Baton Rouge, LA in August, 2016. Coast Guard photo by Petty Officer 1st Class Melissa Leake

(This post was co-authored by David G. Victor, nonresident senior fellow at the Brookings Institution. It is also posted here.)

The U.S. Securities and Exchange Commission (SEC) voted recently to move a proposal forward that would require publicly traded companies to disclose the financial risks they face from climate change. These rules aim to bring corporate obligations for the disclosure of climate risk level with the requirements for disclosure of other forms of financial risk. Doing so is long overdue and a critical step to ensuring investors have access to information about the investment risks faced from climate. Those financial harms include “transition risks” stemming from shifts in innovation, technology, and competitive landscape as well as “physical risks”, such as more severe wildfires to more frequent flooding.

Our financial system has always relied on publicly traded companies being transparent about the risks their businesses navigate. This open accounting of business prospects is fundamental to the healthy operation of our economy — reliable information is the bedrock of efficient markets. Publicly traded companies are required to regularly issue disclosure reports that investors — from Wall Street to Main Street — rely on when choosing where to invest their money seeking opportunity and avoiding unwarranted risk.

The consequences of climate change are creating new and growing forms of financial risk that investors need to consider when choosing how to prudently allocate capital. In the last two years alone, the U.S. suffered more than 40 weather disasters that inflicted at least $1 billion in economic damage each. A recent study found that 215 of the world’s largest companies face almost $1 trillion in climate-related risk. These climate risks pose sprawling challenges, disrupting “food supplies, business operations, and economic productivity, while damaging homes and personal property, public infrastructure, and critical ecosystems across the country.” The most recent assessment by the Intergovernmental Panel on Climate Change concluded similarly, finding that “extreme events and climate hazards are adversely affecting multiple economic activities across North America and have disrupted supply-chain infrastructure and trade.”

Disclosure is necessary because climate risk is investment risk, and market participants have a significant interest in understanding the size and scope of that risk. Other countries, from the U.K. to New Zealand to Japan, have taken concrete steps to require that the mounting harms of climate change to their financial systems are proactively identified and understood. Yet in the U.S., companies are not currently required to disclose the financial risks created by climate change. Our existing rules are voluntary and inadequate. One recent study found that only one percent of companies participating in a voluntary set of standards provided sufficient information on their transition plans for the lower-carbon future. Another, jointly conducted by researchers at Brookings Institution and EDF, found similar results, particularly on the disclosure of physical risk. Another study from Brookings, cited by the SEC in its new draft rule, found highly uneven patterns of disclosure about climate risks — especially on physical risks.

An efficient market requires more information. That’s why the investment community has been among the most vocal in calling for the SEC to act. Ninety-three percent of institutional investors believe that climate-related financial risk “has yet to be priced in by all key financial markets globally.” Many of the world’s largest asset managers have called for strong, mandatory climate disclosure rules to improve their ability to prudently manage investments — in their comments to the SEC they also urged (and the SEC heeded) some caution so that disclosure rules stayed in line with the information that the markets most needed to function well. Many of the large publicly-traded American businesses that would be subject to these rules have also expressed support for mandatory SEC climate risk disclosure, including Apple, Walmart, and FedEx. These businesses and many others understand that the U.S. financial system is healthiest when market participants are able to make well-informed decisions.

The proposed rule addresses these barriers by setting forth a range of information requests, all designed to address investor need. Physical risk disclosure, such as disclosure of risks associated with more severe extreme weather or increasing wildfires, is a critical part of the proposal, which requires registrants to disclose “any climate-related risks that are reasonably likely to have a material impact on the registrant’s business or consolidated financial statement.” The extent to which the company uses specific tools to understand the financial risks they face from climate, such as scenario analysis or transition plans, is likewise subject to the proposed rule. Other aspects of a registrant’s climate risk are additionally subject to disclosure, including provisions of information relevant to the company’s specific risk management processes, greenhouse gas emissions, line-item metrics on the effects of climate-related risks on corporate finances, and climate-related targets.

Understanding and responding to the danger climate change poses across the American economy will be complicated. Getting this right will take time and will require a lot of learning. Mandatory climate risk disclosure by the SEC is a necessary early step. It will bring disclosure of climate risk level with other forms of financial risk and will help ensure that investors have access to relevant information for prudent management of the capital they invest. The SEC’s new proposal aims to achieve this end, consistent with the agency’s clear and explicit authority. Commissioners should swiftly move to finalize the proposal and put this much-needed rule into effect.

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How a proposed Department of Labor rule would help protect retirement savings from climate risk

By / Bio / Published: March 14, 2022

Source: pxhere

(This post was co-authored by Alex Song at the Institute for Policy Integrity at at NYU School of Law. You can also read it here.) 

Should retirement plan managers be able to consider climate change and other financially relevant environmental, social, and governance (ESG) factors in their decisions? A recent analysis of public comments found overwhelming support for a proposed rule from the Department of Labor (DOL) affirming their ability to consider these factors.

ESG factors, including climate change, can affect risk and return for all types of investments, not just ESG-labeled funds. For example, a company may have crucial assets that are particularly vulnerable to physical risks from climate-amplified extreme weather or may face transition risks from climate-driven policy or technology changes.

The Trump administration, however, limited retirement plan managers’ ability to consider ESG factors when selecting plan offerings and making other decisions. The DOL proposal would remove these irrational constraints, which would enable plan managers to better protect Americans’ savings.

DOL administers the Employee Retirement Income Security Act (ERISA), which sets forth fiduciary duties of prudence and loyalty for employers who sponsor retirement plans and anyone they contract with to help manage or advise those plans (collectively, “retirement plan managers”). Prudence requires that retirement plan managers carry out their duties with care, skill, and diligence. Loyalty requires that they act solely to benefit participants (the people invested in the plan). DOL’s proposal does not change or conflict with these core fiduciary duties, as some have misleadingly argued. Rather, it ensures that fiduciaries can fulfill their duties effectively in the context of the pervasive financial impacts of climate change. DOL’s proposal explains why retirement plan managers may often need to consider climate risk and other ESG factors and affirms their ability and responsibility to do so.

Environmental Defense Fund, the Institute for Policy Integrity at NYU School of Law, and the Initiative on Climate Risk and Resilience Law jointly submitted comments supporting the proposal, as did the overwhelming majority of the more than 100 other institutions and 20,000 individuals who commented.

Here’s why DOL’s proposal is so important:

  1. Climate change is a risk-return factor for retirement investments.

Climate change is already affecting companies’ bottom lines, and its effects on business operations are projected to accelerate over the next several decades. The National Oceanic and Atmospheric Administration reports that in 2021 alone there were 20 separate billion-dollar weather and climate change disasters in the U.S., causing $145 billion in damages. A wide range of industries will experience large climate-related losses. For example, climate change is expected to decrease labor productivity and agricultural yields, especially in the Southwest, and the real estate brokerage site Redfin estimates that climate-intensified wildfires could wipe out up to $2 trillion in property values in California alone.

These effects are relevant to financial risk-return analyses, especially for retirement investing. Because many retirement funds invest in a diversified portfolio representative of much of the economy, the overall impact of climate change on the economy is relevant to the interests of plan participants, especially in light of the long time horizons inherent in retirement investing. A systematic review of the economic literature on sustainable investing and climate finance found an “encouraging relationship between ESG and financial performance,” observing that ESG funds often outperform regular funds over longer time horizons and provide downside protection during social or economic crises.

  1. The Trump administration’s rules impede retirement plan managers’ consideration of climate risk.

In 2020, under the Trump administration, DOL issued new rules that targeted ESG investment strategies and departed from established ERISA practices. These rules amended longstanding regulations under Section 404(a) of ERISA, and imposed new procedural and documentation requirements that have, in practice, limited the ability of retirement plan managers to consider climate-related risks and other ESG factors in their decisions. As we noted in our July 2020 comment letter to DOL, such interference with fiduciaries’ prudent decision-making processes ultimately harms plan participants whose savings are at stake. In 2021, the Biden administration’s DOL announced that it would not enforce the Trump administration rules, but plan managers still need the clarity and certainty of a new rule.

  1. DOL’s proposal affirms that retirement plan managers should consider all factors relevant to investment risk and return, including climate impacts.

If finalized, the proposal would eliminate the Trump administration’s harmful limitations on fiduciaries’ ability to consider climate impacts when making investment decisions. The proposal affirms that fiduciaries should treat climate and other ESG factors like any other risk-return factor where relevant. Fiduciaries still “may not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to other objectives.” In other words, fiduciaries should consider the financial impacts of climate and other ESG factors, but not their personal policy preferences. Retirement plan managers still have to work in the best interests of their clients, and current and future retirees can rest assured that their financial security is the sole objective.

  1. DOL’s proposal applies the same rational principles to default investments as to investment options generally.

The proposal also reverses a Trump-era bar on designating funds that consider climate or other ESG factors as default investments for plan participants who don’t otherwise specify how to allocate their contributions. Approximately 80% of new ERISA plan contributions are invested in such default funds, known as Qualified Default Investment Alternatives (QDIAs), which only underscores the importance of allowing fiduciaries to consider all relevant risk-return factors when selecting them. By restoring fiduciaries’ discretion to consider climate and ESG factors in QDIA selection where relevant to the risk-return analysis, the proposal will ensure that participants are not unnecessarily deprived of access to financially prudent investment options.

  1. DOL’s proposal reminds retirement plan managers of the potential value of exercising shareholder rights.

Lastly, the proposal corrects distortions to fiduciary decision-making that were introduced by the Trump administration’s proxy voting rule, which included several provisions that discouraged fiduciaries from exercising shareholder rights. Specifically, that rule included a statement that fiduciary duty “does not require the voting of every proxy or the exercise of every shareholder right,” and a “safe harbor” provision for voting on issues “substantially related to the issuer’s business activities or . . . expected to have a material effect on the value of the investment.” This language created incentives for fiduciaries to err on the side of waiving their right to vote on shareholder proposals and board elections. In other words, retirement plans would be less likely to have a say in the management of the companies in which they invest, despite the fact that shareholder voting can be an important tool for managing risk. The proposal correctly recognizes the value of shareholder rights and removes the statements that would have discouraged fiduciaries from exercising these rights to the most beneficial extent.

In sum, DOL’s proposal would protect Americans’ retirement savings by:

  • highlighting the financial relevance of climate change
  • undoing harmful Trump administration rules
  • affirming that fiduciaries should consider ESG factors like climate change when relevant to investment risk-return analysis
  • applying the same rational principles to selection of default investments
  • acknowledging the value of exercising shareholder rights
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