The Biden administration is using legal ambiguity and the runaway power of the administrative state to impose their climate change agenda unilaterally. Ambiguities in the Dodd-Frank Act are being exploited to justify expanding the regulatory powers of so-called independent financial regulatory agencies in ways never intended by Congress. Self-serving interpretations of ill-defined concepts like “systemic risk” are being used to justify new financial regulations that will penalize greenhouse gas-intensive activities by executive order, without congressional hearings or new authorizing legislation.
Following the last housing bubble-driven financial crisis, the Dodd-Frank Act ushered in new financial regulations designed to mitigate financial “systemic risk.” By oversight or design, the act never defined systemic risk notwithstanding the 39 times the term appears in the 849-page legislation.
The act required the Federal Reserve to impose new regulations to mitigate the systemic risk created by “systemically important financial institutions” and allowed that, by virtue of their corporate structure, activities or practices, other financial institutions could be sources of system risk if so deemed by the Financial Stability Oversight Council. By never objectively defining the term systemic risk, the act created ambiguity the council can exploit to designate institutions, activities or practices as a source of systemic risk — a designation that requires federal financial regulatory agencies to promulgate new regulations to mitigate the risk.
The Biden administration capitalized on this to argue that climate change poses a systemic risk to the financial sector. An October report by the council “identified climate change as an emerging and increasing threat to U.S. financial stability,” and recommended that “members take new actions on climate change data, disclosure, and scenario analysis,” as a prelude to imposing new regulations to discourage bank and capital market investments in greenhouse gas-intensive activities.
In order to regulate something, one must first measure it. The administration plans to use greenhouse gas emissions data that will be produced by the Securities and Exchange Commission’s proposed requirement that all public companies disclose their emissions (using the GHG Protocol) in their mandatory periodic SEC filings. Using these data, the financial regulatory agencies will invoke Dodd-Frank powers to craft new bank capital requirement surcharges to discourage emission-intensive loans, design investment fund rules to cap the emissions of the securities mutual funds may hold, and take other regulatory actions to forestall investments in emission-intensive activities — all in the guise of mitigating financial system systemic risk.
Congress never granted the executive branch or independent financial regulatory agencies the power to regulate non-financial firms using federal financial regulations. Can this “Operation Climate Change Choke Point” plan for waging war against fossil fuels using financial regulations be stopped? Maybe, but not quickly.
The systemic risk provisions of the Dodd-Frank Act apply to federally regulated banks, financial institutions and to nonbank financial institutions designated to be “systemically important.” by the council. The latter must be nonbank companies ‘‘predominantly engaged in financial activities.’’ The council’s report on climate change risk argues that the companies emitting greenhouse gases are the source of systemic risk. However, these companies are predominately nonfinancial in nature and consequently not subject to the provisions of the Dodd-Frank Act.
The Biden administration might counter this argument by claiming that they have not designated emission-intensive firms as systemic, but instead have determined that firms involved in emission-intensive activities pose a heightened credit risk as a consequence of climate change transitional risk. Transitional risk is the risk that a firm’s revenues or costs could be negatively impacted by future government policies or regulations, or because of diminished demand as a consequence of changing consumer preferences. This ambiguous concept of transitional risk is conjectural and not based on specific historical experiences. It could be applied to any firm to justify any political goal.
The claim mirrors the claims of “reputational risk” that were used to discourage bank lending to gun shops, payday lenders and legal purveyors of pornography in “Operation Choke Point” conducted by the Federal Deposit Insurance Corporation and the Department of Justice under the Obama administration. Using climate change transitional risk to choke off lending to firms involved in legal but politically disfavored activities is a clear abuse of regulatory power.
Should the administration succeed in imposing “Operation Climate Change Choke Point” on emission-intensive companies, there are at least three avenues that could be used to overturn the new rules. The probability of successfully overturning regulations once they are imposed is anyone’s guess, and the time frames required to rescind these rules could prove crucial. The longer the rules are in force, the larger the push-back from climate-change consultancies profiting off the rule and from companies that incurred significant costs to comply.
The quickest way to overturn any new climate change systemic risk regulations would be for Congress to pass a disapproval resolution using its powers under the Congressional Review Act. If 30 senators sign a petition to consider disapproval, debate on the motion is limited, and the resolution would receive a Senate vote. If the resolution also passes the House, the president’s signature is required to vacate the regulation. In addition, the Congressional Review Act can only be used to overturn a regulation within a short period after the final regulation is published in the Federal Register or delivered to Congress.
After the midterm elections, the 118th Congress could pass new legislation that overturns any new emissions-focused financial regulations imposed by the administration. Again this legislation would have to be signed by the president before becoming law. Clearly, both congressional approaches face long odds of success under President Biden.
A systemic risk determination can also be challenged under the Administrative Procedures Act and there is precedent for this slow form of judicial redress. In 2014, the council designated Metlife Inc., a systemically important nonbank financial institution. Metlife fought the designation using the Administrative Procedures Act and successfully prevailed when the court found the determination to be arbitrary and capricious.
The Biden administration’s plan to penalize emission-intensive activities using the powers of the independent financial regulatory agencies is an abuse of power facilitated by poorly drafted legislation and independent federal agencies that are only weakly accountable to Congress. It’s time for congressional members to reassert their authority and neuter the administrative state’s abuse of power.
Paul Kupiec is a senior fellow specializing banking and financial industry issues at the American Enterprise Institute.