After years of ambiguity, the prudential regulator has stated clearly that banks, insurers and superannuation funds have a duty to calculate the financial risks associated with climate change.

The Australian Prudential Regulation Authority (APRA) last week put the financial services industry on notice that it is worried about the financial risks climate change poses, declaring it an “important and explicit part” of the agency’s thinking.

On February 17, 2017, APRA member Geoff Summerhayes told the Insurance Council of Australia Annual Forum that the regulator now views climate risks as “foreseeable and material” to financial institutions and expects businesses to systematically monitor, disclose and discuss the risks.

“To be blunt … if entities’ internal risk-management processes are not starting to include climate risk as something that has to be considered – even if risks are ultimately judged to be minimal or manageable – that seems a pretty reasonable indicator there might be something wrong with the process,” Summerhayes said. “Similarly, if you’re an investor and you’re not already asking questions about how the companies you invest in approach these issues, perhaps you should be.”

Summerhayes added financial institutions could expect APRA to place greater emphasis on stress testing for organisational and systemic resilience in the face of adverse shocks, both at the firm level and system-wide.

The prudential regulator’s focus will also include the exposure of asset owners and managers.

Physical and transition risks

“This is an important consideration, given the size of Australia’s superannuation sector and its heavy weighting towards carbon-intensive equities and a relatively resource-intensive domestic economy,” Summerhayes said.

Consistent with the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures, APRA has adopted the terminology of physical and transition risks in relation to climate change.

Physical risks stem from the direct impact of climate change on our physical environment – through, for example, resource availability, supply-chain disruptions or damage to assets from severe weather, Summerhayes explained.

Transition risks stem from the much wider set of changes in policy, law, markets, technology and prices that are part of the now agreed-upon transition to a low-carbon economy.

Warm reaction

“We make no apologies for expecting regulated entities to rise to this challenge with us,” Summerhayes asserted. “These are shared responsibilities. When things go wrong, it reflects badly on all of us – regulators, entities, governments and the entire financial ecosystem.”

A variety of organisations have welcomed the move, including the Australian Council of Superannuation Investors (ACSI), the Actuaries Institute and the United Nations Principles for Responsible Investment (PRI).

The Australian arm of the PRI said in January that its top priority for 2017 was advocating for APRA to clarify its position on long-term fiduciary duty, particularly in relation to environmental, social and governance (ESG) issues and risks.

ACSI chief executive Louise Davidson welcomed the clarification Summerhayes’ speech provided.

“We are pleased to see APRA make such an explicit statement on the importance of including an assessment of climate risk in the investment process,” Davidson said. “ACSI agrees that climate change risk cannot be categorised as ‘non-financial’ but is in fact a real financial risk for investors.”

Davidson also called for greater policy certainty, consistent with the international commitments Australia has made under the Paris Agreement.

“Maintaining the current policy framework is no longer an option,” she said. “It does not provide the long-term certainty and structural reform needed, nor does it meet the international commitments we have made. Investors need a long-term climate-change policy framework to ensure an orderly transition to a low-carbon future.”

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