Table of contents
Information paper
Climate Change: Awareness to Action
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Current20 March 2019
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Executive summary
Over recent years, APRA has highlighted the financial nature of climate change risks to its regulated entities. APRA has advised that these risks are material, foreseeable and actionable now. Awareness and understanding of these financial risks has clearly increased during this time.
A critical paradigm shift has occurred due to the work of industry, domestic and international supervisors and regulators, as well as other key stakeholders. Climate change is increasingly seen as a material prudential risk. A shift from awareness towards action in response to these risks is underway.
APRA’s climate change survey of 38 large entities, across all regulated industries, highlights the range of activities and strategic responses that entities are adopting to assess and mitigate these risks. This Information Paper provides insights into the responses to APRA’s survey. Regulated entities may compare the results with their own operations and assess their responses to climate change financial risks.
The survey found that a majority of regulated entities were taking steps to increase their understanding of the risk, including all authorised deposit-taking institutions (ADIs), general insurers and RSE licensees surveyed. One third of regulated entities viewed climate risks as material. A wide range of strategic opportunities has been identified. Climate risks are being integrated into risk management frameworks, and more sophisticated financial analysis of scenarios is gaining traction across a range of entities.
As well as outlining the results of APRA’s survey, this paper details some of the recent activity from a range of stakeholders, providing context for the global shift in the response to climate change risks. A coordinated approach to the supervision of these risks is provided through international and domestic agencies which promote consistency, and share knowledge and experiences.
In recognising the global transition towards action, APRA’s supervision activities will be enhanced, as the assessment of climate change risks is integrated into ongoing supervision activities. APRA expects to observe continuous improvement in the awareness and action of regulated entities.
Glossary
Background to climate change financial risks
Climate change and society’s responses to it are now widely recognised as foundational drivers of risk and opportunity within the global economy. This has implications for APRA’s mandate to protect the Australian community by ensuring, under all reasonable circumstances, that financial promises made by APRA-supervised institutions are met within a stable, efficient and competitive financial system. APRA continues to achieve this mandate by promoting awareness and understanding of the financial risks associated with climate change and the need for resilience; promoting financial system stability as well as the interests of depositors, policyholders and superannuation members.
Climate change financial risks include the physical risks which 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, including extreme weather events, have the potential to cause supply chain disruption, resulting in lower productivity as well as lower asset values. Transition risks include risks related to regulatory policy, technological innovation, renewable power and energy advancements and social adaptation and can result in stranded assets. These risks also give rise to liability risks. Liability risks 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.
APRA has advised regulated entities that, while the implications of a changing climate will have a long-term impact and the time horizon for the risks can be uncertain, this does not justify inaction. There is a high degree of certainty that financial risks will materialise, and entities can mitigate the magnitude of the impacts of these risks through action in the shortterm. Entities can also seek a competitive advantage through their preparation for the transition to a low-carbon economy. Similarly, APRA has noted that it is imprudent for entities or regulators to ignore such risks just because there is uncertainty, or even controversy, about the policy outlook. With these factors in mind, APRA continues to encourage regulated entities to consider climate risks within their risk management frameworks, consistent with APRA’s risk management prudential standards.
APRA’s climate change survey
In light of the increasing understanding of climate risks by companies, investors and supervisors, and adoption of the G20 Financial Stability Board Task Force on Climate-related Financial Disclosures (TCFD) framework, APRA undertook a survey of regulated entities in mid-2018. The survey was designed to assist APRA in understanding and assessing industry maturity in responding to climate change risks and to inform APRA’s supervisory approach.
Methodology
The survey responses covered 38 large entities across the ADI, superannuation, and general, life and private health insurance industries. The survey comprised a combination of questions to gain insight and allow for comparability into cross-industry risks, responses, practices and challenges in relation to climate change risks.
The survey aligned with the TCFD recommended framework, allowing the core elements to be broken into themes relating to risk awareness, governance, strategy, risk management, analysis, metrics and targets and disclosure.
The questions that form the survey can be found in Attachment A, and an extract of aggregated answers in Attachment B.
Survey results analysis
APRA’s survey 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.
Risk awareness
A high level of awareness of climate change risks was shown across the ADI, general insurance and superannuation industries. All institutions in these industries were taking steps to improve their understanding of climate-related financial risks. However, less than half of the life insurers and just over half of private health insurers surveyed are taking steps to improve their understanding (Chart A).
Chart A – Organisations taking steps to improve their understanding of climate risks
One third of respondents viewed climate-related financial risks as being material now and a further half stated that the risks will be material in the future. The remaining respondents believed that the climate-related financial risks were not applicable to their business models or that they still had to undertake further analysis (Chart B).
Chart B – Organisations considering climate-related financial risk to be material
Governance
Many respondents identified the board as having ultimate responsibility for climate-related financial risks. Board committees and management groups assisted boards in overseeing the management of the risks. Some of those committees considered climate-related financial risks as part of their environmental, social and governance (ESG) activities. Organisations with a more mature response indicated that they had set up specific climate risk working groups.
The survey responses also included details on key executive and business unit responsibilities for climate-related financial risks. The executives responsible ranged from Chief Executive Officer/Country Head to Chief Risk Officer, Chief Investment Officer, Chief Financial Officer and Chief Technical Officer. The business units responsible for managing climate-related financial risks ranged from investment teams for registrable superannuation entity (RSE) licensees, and pricing, underwriting, actuarial and reinsurance units for general insurers to environmental and social risk teams, sustainability teams, emerging risk teams and project management for other entities.
With regard to governance frameworks by industry, it was observed that:
- The majority of the ADIs surveyed included climate-related financial risks as part of their risk management framework, with the board having ultimate responsibility. The risk management framework cascades down to board sub-committee and management levels. The largest banks are the most advanced in their approach.
- General insurers that indicated climate change risks to be material to their business generally had similar oversight as ADIs in place. A number of the foreign-owned general insurers are guided by their parent’s approach.
- RSE licensees generally indicated that investment teams are responsible for the day-today assessment and management of climate change financial risks. The RSE licensees surveyed had sufficient resources to implement better practices such as a dedicated ESG team or ESG manager with this responsibility. Many RSE licensees indicated that oversight sits with the board, with some delegation of responsibilities to sub-committees. Endorsement of climate change risk management policies by the board is critical for implementation of these principles across the entity’s operations.
- The private health insurers surveyed generally identified board and executive responsibilities in relation to key risks, highlighting corporate social responsibilities and sustainability rather than specific climate-related financial risks.
- The life insurers surveyed generally identified no specific employee responsible for climate-related financial risks, although many acknowledged the role of the CEO and emerging risk teams in managing any emerging risks.
Strategy
Survey respondents identified a number of strategic initiatives that they had implemented, including the development of climate change action plans, climate change position statements and roadmaps that outline the strategy, targets and steps to take to reach their objectives for managing climate change-related risks. Some ADIs reported that they are investing in lending for green technology or introducing green bonds.
The survey responses indicated that entities are considering climate change risks over multiple time periods, on short, medium and long-term horizons. However, there were some entities that were focused on either short-term or long-term horizons only. These narrower perspectives may pose risks to those entities or leave the entities vulnerable to missed opportunities.
A range of influences for survey respondents’ consideration of climate change risks were identified, with investors, customers, the community and regulatory influences being identified across all industries. A number of the respondents indicated that they participate in external working groups both internationally and locally. Other respondents are seeking input from external parties, including academia, consulting firms and specialist experts such as the Bureau of Meteorology to better understand the risks.
ADIs, general insurers and RSE licensees identified opportunities in their responses to climate change risks, including:
- the opportunity to demonstrate industry leadership in relation to climate change responses;
- developing products (including parametric products and other risk transfer solutions); and
- supporting the community in developing resilience and providing education.
Some general insurers indicated that they are improving their capability to respond to the risks by recruiting specialists, undertaking research and analysis, enhancing training and conducting scenario analysis.
Entities observed internal opportunities such as ‘improved risk selection and pricing as a competitive advantage’ and ‘strengthening our technical capabilities to assess and manage climate risks and opportunities and increasing sophistication of tools and capabilities’. These initiatives will create benefits that could put these entities ahead of their peers. Another entity noted that it has ‘taken the opportunity to examine our corporate footprint and report on climate-related measures as part of our social licence to operate in appreciation and recognition of the expectations of its investors, customers, suppliers and the community’.
Investment opportunities were also highlighted among survey respondents. One entity observed that ‘the transition to a low carbon economy presents investment opportunities in areas such as renewable energy production, distribution and storage, energy efficiency, carbon emissions management and waste management’. Another entity noted the ‘opportunity to invest in green technologies and green markets that provide potential for longer term sustainability and growth’. Some RSE licensees were increasing their focus on building exposures to industries and institutions with lower environmental impact.
The strategic opportunities identified by the entities surveyed were generally associated with five key themes identified in Table 1 below.
Table 1 – Strategic opportunities identified
Risk management
Many of the respondents noted that they had embedded climate-related financial risks into their enterprise risk management frameworks. This is reflective of the sophistication of the entities’ risk management frameworks. Life insurers surveyed appeared to have a less developed response to climate risk compared to other entities.
Some risk management initiatives that respondents have undertaken on climate-related financial risks include:
- incorporating climate-related financial risks in risk registers;
- setting out expectations in risk appetite statements;
- incorporating climate risk considerations into existing policy documents, and investment and underwriting procedures;
- undertaking improved due diligence on customers for lending, underwriting and investing;
- integrating climate change considerations into catastrophe models, pricing and engineering tools;
- collecting catastrophe accumulation data;
- developing business continuity plans;
- implementing stress testing and scenario analysis;
- assigning responsibilities to key individuals; and
- producing regular board and management reports on climate-related risks.
The entities that recognised the potential impact of climate change on their business noted the importance of updating business continuity plans. One respondent has extended its risk assessment to its supply chain utilising responsible sourcing processes.
Survey respondents were asked to identify the top five climate-related financial risks to their business (Chart C).
Chart C – Top five climate-related financial risks
The high focus on reputational risk aligns with entity commentary that communities, customers and investors, as well as regulatory expectations, are driving their response to climate risks.
With regard to the risks identified by each industry, it was observed that:
- Four of the seven ADIs surveyed ranked energy risk as their highest climate-related financial risk. One ADI ranked sea level rises as its highest risk. More broadly, most ADIs ranked transition and liability risks higher than physical risks.
- In contrast, general insurers’ key risks related to physical risks, with the majority of the general insurers rating flood among their top two risks.
- Three of the five life insurers rated heat stress as their key risk. Regulatory and flood risks were also rated highly as key risks by the life insurers surveyed.
- Three of the five private health insurers rated reputational risk as their major risk, followed by regulatory risk.
- RSE licensees’ key risks were focused on liability and transition risks rather than physical risks. Reputational, regulatory, board liability and stranded assets were cited as top risks by different RSE licensees. These focus areas may be influenced by both current regulatory and policy focus on the superannuation industry as well as exposures to infrastructure investments giving rise to stranded assets risk.
Metrics and targets
Financial analysis of climate risks can include quantitative analysis of climate change scenarios as well as assessment of potential impacts on investment risk and portfolio allocation, insurance and other risks. The survey indicated that financial analysis on key risks is being undertaken by over 50 per cent of respondents, including investment, insurance, credit, operational and strategic risks (Chart D).
Chart D – Organisations undertaking financial analysis
Scenario analysis is a process for identifying and assessing the potential implications of a range of plausible future states under conditions of uncertainty, which may include both quantitative and qualitative assessments of the impacts of climate change risks on an entity’s business, strategy as well as financial performance. The key challenges observed in undertaking scenario analysis faced by the entities surveyed include limited availability of data, resource constraints and understanding better practices. Other responses included the lack of standardised terminology, regulatory uncertainty, limitation of scientific understanding, and a lack of tools or a clear approach for financial analysis.
Around one third of respondents indicated that they have undertaken scenario analysis and another 40 per cent are considering undertaking scenario analysis in the future (Chart E). The entities that are not undertaking scenarios analysis typically do not view climate-related risks as being a material risk for their business. Even among entities which reported