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The Australian Prudential Regulation Authority (APRA) has issued a letter to all APRA regulated entities wherein it has advised the entities to understand and manage the risks of a changing climate which poses financial risks, as well as provides new business opportunities.
Risks from Climate Change
- Financial risks – Climate changes trigger financial risks which include the physical risks that cause direct damage to assets or property as a result of rising global temperatures, as well as transition risks which arise from the transition to a low-carbon economy.
- Physical risks- This includes extreme weather events, have the potential to cause supply chain disruption, resulting in lower productivity as well as lower asset values.
- Transition risks- This includes risks related to regulatory policy, technological innovation, renewable power and energy advancements and social adaptation and can result in stranded assets.
- Liability risks- Liability risk stem from the potential for litigation if entities and boards do not adequately consider or respond to the impacts of climate change and may include the potential breaching of directors’ duties.
The implications of above-mentioned risks might have a long-term impact and the time horizon for the risks can be uncertain, this does not justify inaction for entities.
What are the strategic opportunities that Climate change could offer?
- New and innovative products for customers - Innovative products – with a focus on low carbon products and services; Risk transfer solutions, including mortgage lending products, insurance products and parametric products; Green investment options
- Investment strategies- Responsible investments (including renewables, green technologies and bonds)
- Services to customers and the community- Educating customers and industry, including providing research and sharing experiences with customers and the broader community
- Internal control initiatives - Updating internal tools and procedures (including pricing tools and catastrophe models
APRA, which is a regulatory authority that supervises institutions across banking, insurance and superannuation, is known for developing and enforcing a robust prudential framework that promotes prudent behaviour among the regulated entities in Australia.
On Monday, 24 February 2020, APRA released a letter in which it outlined the plans to develop a prudential practice guide focused on climate-related financial risks, as well as a climate change vulnerability assessment to promote strong understanding and management of the potential financial impacts of a changing climate on current and future business prospects.
Although, APRA has not been prescriptive as to how it will access the climate change risks, nor imposed any particular constraints on specific sorts of business activity but it has called for voluntary frameworks to assist entities with assessing, managing and disclosing their financial risks associated with climate change.
APRA has highlighted that the impacts of a changing climate extend to all sectors of the economy and they are being transmitted directly and indirectly via changing policies, investment, technological developments as well as through consumer preferences. Therefore, it is important for the institutions to make sure that the effects on businesses from a changing climate are being considered while taking decisions.
Earlier in 2016, APRA had considered the risks posed to APRA-regulated entities by a changing climate and noted the need to promote awareness and understanding of the risks among regulated entities as well as within APRA. This reflected developments such as Australia’s commitment to the Paris Agreement in 2016, the G20 Financial Stability Board establishing the TCFD in late 2015, and the Hutley opinion.
In its recently released letter, APRA has informed that over the past couple of years it has sought to ensure regulated entities are actively seeking to understand and manage the financial risks of a changing climate and has undertaken a survey of regulated entities in mid-2018, to assist APRA in understanding and assessing industry maturity in responding to climate change risks and to inform APRA’s supervisory approach.
The survey responses covered 38 large entities across the ADI, superannuation, and general, life and private health insurance industries 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 it also confirmed that many entities have moved from an initial phase of establishing a governance structure to strategically considering climate risks. Such entities assume a more granular risk management approach, which considers the risks posed to the business model and underlying products, while also assessing the business opportunities available.
What action is APRA taking to tackle these risks?
- Enhanced Supervision- Supervisory Assessment of strategic response to climate change
- Continued industry engagement- Supporting Australia’s sustainable finance roadmap
- Domestic regulatory coordination- Council of Financial Regulators working group; supporting the development of climate change analytical tools
- Peer Agency Cooperation internationally- SIF-IAIS support of TCFD implementation including Issues paper; FSI Insight Paper on Supervisory practices for insurance and climate change
Vulnerability assessment
In collaboration with international and local stakeholders, APRA intends to undertake a climate change financial risk vulnerability assessment which will begin with Australia’s largest authorised deposit-taking institutions (ADIs) that will provide helpful insights on the impact of a changing climate on the broader economy.
Update SPG 530
In order to assist a registrable superannuation entity licensee for the formulation and implementation of an investment strategy, APRA also intends to update Prudential Practice Guide SPG 530 Investment Governance (SPG 530). Further APRA also intends to consult on specific changes to Prudential Standard SPS 530 as part of APRA’s response to the postimplementation review.
After observing all the financial risks and opportunities that climate change poses, it is clear why APRA is stressing its regulated entities to get serious about this thing. APRA has assured that it will continue to engage with entities and support industry-led initiatives to encourage coordination and has requested the entities to be proactive in taking steps to assess and mitigate climate change financial risks now and not delay.
