Basel III Regulations - Implications for Insurance and Climate Finance

Fed Chair Jerome Powell said Wednesday that the Fed hasn’t made a decision on next steps on the proposed "Basel III Endgame" regulations, as they continue to analyze “voluminous and very substantive comments” received through the Jan.16th deadline. Powell said that the Fed "would not hesitate" to issue a new version of the proposal is appropriate - and told Congressman Patrick McHenry that he believes a re-proposal is a “very plausible option.

"We do hear the concerns, and I do expect that there will be broad and material changes to the proposal,” Powell said. “I'll add that I am confident that the final product will be one that does have broad support both at the Fed and in the broader world.”

As proposed, Basel III Endgame would affect how U.S. banks price risk, with those holding assets totaling $100 billion or more on their balance sheets estimated to see an average 16% increase in capital requirements. JP Morgan has estimated it would need to reserve 25% more capital on its balance sheet.

Though insurers were not included in the draft regulations, revisions suggested during the comment period include broadening the regulations to capture insurance companies that are subject to prudential regulation and supervision (including minimum capital and liquidity requirements), as well as issuers whose direct or indirect parent insurance holding companies have issued and outstanding unsecured debt securities that are investment grade without credit enhancement. Effectively, insurance companies subject to prudential supervision would be treated substantially similarly to banks for the purposes of risk weighting such exposures, along with a determination by the regulators that insurance companies are subject to such prudential supervision.

Beyond the direct impact on insurers if included as regulated entities, insurers who are advocating - as underwriters and investors - for the transition to a low-carbon economy should be aware of the potential impact of Basel III Endgame on tax equity financing of clean energy projects. The risk weighting for tax equity investments is set to soar from 100% to 400%. The American Council on Renewable Energy estimates the rules could shrink the tax-equity market by 80-90% and therefore "threaten to derail the clean-energy transition." The American Clean Power Association says the proposed legislation is already injecting uncertainty that is negatively impacting the tax-equity market, with projected investments expected to shrink to $10B from a previously projected $25B for this year.

A bipartisan group of more than 100 members of Congress have been receptive to the clean energy communities pushback on the proposed regulations - and the Fed's vice-chair for supervision Michael Barr has indicated a willingness to "analytic,, evidence based revisions that show the risk calibration should be different." Given the pushback from both banks and renewable energy advocates that have found common ground, many analysts believe a significant revision of the proposed regulations is likely.

Source: The Federal Reserve, https://www.federalreserve.gov/newsevents/pressreleases/bcreg20230727a.htm