The Australian Prudential Regulation Authority (APRA) has published a letter to all regulated institutions outlining plans to develop a prudential practice guide focused on climate-related financial risks, as well as a climate change vulnerability assessment. The letter also outlines APRA’s intention to update superannuation Prudential Practice Guide SPG 530 Investment Governance, which includes paragraphs related to ESG investments.
“The effects of a changing climate extend to all sectors of the economy. Those effects are being transmitted directly as well as indirectly, through changing policies, technological developments, investment and consumer preferences. They pose financial risks, as well as provide new business opportunities, to all APRA-regulated entities,” says the letter.
Over the past couple of years APRA has, supported by other agencies of Australia’s Council of Financial Regulators, sought to ensure regulated entities are actively seeking to understand and manage the financial risks of a changing climate just as they would other economic and operational risks. Given the diversity of business models and activities within the regulated sector, the watchdog has not been prescriptive as to how this should be done, nor imposed any particular constraints on specific sorts of business activity, but instead sought to make sure that the effects on businesses from a changing climate – both direct and indirect – have been “actively considered” within entities’ decision making.
The latest letter, following on as it does from the tragic bushfires that so dramatically swept the country, suggests that this approach could now be changing. APRA’s 2018 climate change survey highlighted that many large entities understand the financial risks and opportunities from a changing climate, and described the efforts taken by some entities to embed climate change considerations into risk management frameworks. However, the report also highlighted the need to address the climate data deficit, to quantify the likely impact of the physical, transitional and liability risks of climate change and accurately assess and appropriately price these risks.
“This needs to ultimately be tackled through scenario analysis, stress testing and disclosure of market-useful information. Effective action now on these fronts will promote strong understanding and management of the potential financial impacts of a changing climate on current and future business prospects, allowing well-managed entities to minimise costs and optimise benefits,” says the regulator.
It has also committed to developing and consulting on a climate change financial risk prudential practice guide (PPG). This industry guidance is not intended to establish new obligations, but rather will be designed to assist entities in complying with their existing prudential requirements, including those found in Prudential Standard CPS 220 Risk Management. The cross-industry PPG, relevant to all entities, will set out APRA’s views on better practice and outline prudent practices in this area. The PPG will cover areas relevant to the prudent management of climate change financial risks, aligned with the recommendations of the TCFD, including aspects of governance, strategy, risk management, metrics and disclosure.
Finally, APRA has promised to undertake a climate change financial risk vulnerability assessment. The assessment will begin with Australia’s largest authorised deposit-taking institutions (ADIs). “Beginning with the ADI industry will provide helpful insights on the impact of a changing climate on the broader economy, which will be analysed in conjunction with the Reserve Bank of Australia,” it says. The ADI vulnerability assessment will be designed in 2020 and executed in 2021, with other industries to follow. This timing also aligns with the expected release of international peer regulator guidance on scenario analysis for the banking sector.