APRA encourages entities to perform stress-test for climate-related risks

The “weight of money” is driving the transition to a low carbon economy, and “commercial imperatives such as investment, innovation and reputational factors, is increasingly driving that shift, rather than scientists or policymakers,” according to Geoff Summerhayes, executive board member of the Australian Prudential Regulation Authority (APRA).

Revisiting and expanding on the themes he first raised in a landmark speech earlier this year, Summerhayes this week spoke about APRA’s evolving view on the macro-prudential risks of climate change, and APRA’s work to engage with regulated entities on climate-change related risks. Summerhayes noted that APRA has established an internal Climate Change Financial Risk Working Group to develop their supervisory response.

“The group is responsible for updating APRA staff on relevant developments, and providing training and high-level guidance for supervisors,” he said. “To aid APRA’s understanding of the risks, the group is also developing a cross-industry heat map through the lens of prudential standard CPS220, identifying the key climate-related risks across each of the industries we regulate. APRA supervisors have begun to ask questions of regulated entities. Initially, these have related primarily to awareness: is the entity aware of APRA’s comments about climate related risks? Has it investigated or planned to investigate the issues raised? And if it has investigated them, is action required?”

Summerhayes said APRA will increasingly expect more sophisticated answers, “especially from well-resourced and complex entities.”

“Externally, APRA has commenced discussions with Treasury, as well as fellow regulators ASIC and the RBA, on the sustainability and financial risk dimensions of the economy related to climate change,” Summerhayes said. “Through the creation of an interagency initiative, we intend to focus on information-sharing and improving our understanding in this area. Through such initiatives as I’ve just described, APRA intends to gain insights in areas such as how exposed regulated entities are to physical, transitional and liability risks, and whether they’re taking steps to protect themselves and their customers. Information on these metrics remains limited, and while that is slowly changing, recent global developments may be about to accelerate the process.”

Summerhayes specifically addressed the FSB’s Taskforce on Climate-Related Financial Disclosures (TCFD) recommendations in his speech.

“The Task Force on Climate-Related Financial Disclosures report sets out clear expectations that companies and investors conduct scenario exercises to analyse these risks,” he said. “To date, APRA hasn’t conducted any stress tests specifically related to climate risk, but in the future we will consider doing so. In the meantime, we encourage entities to perform their own stress tests that consider such scenarios. APRA’s risk management standard CPS220 requires entities to test for key risks, so if factors related to climate change are key business risks, it makes sense to test for them.”

APRA is planning a survey of regulated entities to “gain a better understanding” of emerging best practice, and will also conduct an industry-wide review of climate-related disclosures. APRA has “no immediate plans” to introduce climate-risk specific prudential standards, and will use CPS-220 as the standard for general risk management expectations, Summerhayes said.

“So whether due to regulatory action or – more likely – pressure from investors and consumers, Australia’s financial sector can expect to see more emphasis on disclosure around climate risk exposure and management,” he said.

APRA has liaised with international peers to make sure the supervisory response to climate risk is aligned with global best practice. Summerhayes noted that he attended the Sustainable Insurance Forum meeting in late October in Kuala Lumpur. SIF is a network of leading insurance regulators and supervisors and has developed capacity-building tools and guidance for supervisors. Summerhayes also pointed out that the International Association of Insurance Supervisors (IAIS) “has signalled its intention to share the SIF’s guidance with all insurance supervisors globally,” and that the IAIS is reviewing the TCFD to consider whether to adopt the guidance. APRA is an IAIS member.

Summerhayes also emphasised that climate change and society’s response to climate change is already starting to shape the global economy.

“Shifts in market sentiment have increased the risk of asset value volatility, and the potential for stranded assets,” he said. “Institutions that fail to adequately plan for this transition put their own futures in jeopardy, with subsequent consequences for their account holders, members or policyholders. So while the debate continues about the physical risks, the transition to a low carbon economy is underway, and that means the so-called transition risks are unavoidable: changes to market sentiment, new financial or environmental regulations, or the emergence of new technologies with the potential to prompt a reassessment of the value of a large range of assets, and consequently the value of capital and investments. But that doesn’t mean these risks are unmanageable, or that the impacts on businesses and the wider economy need be negative.”