Why Climate Change Risks Are 'Material' For Big Finance

Fairfax - Clancy Yeates

After a prod from Treasurer Josh Frydenberg, the financial regulator this month reminded superannuation funds that their job was to stay out of political causes, and stick to their knitting: looking after members' interests.
Then, the day after this warning was revealed, the very same regulator, the Australian Prudential Regulation Authority (APRA), upped the pressure on our biggest financial institutions to take more action to deal with climate change risks.

Do those two directions from APRA sound like they might be in conflict? They shouldn't.

Financial businesses are under greater pressure to consider their exposure to climate change risks, which could include fossil fuel assets. Credit: Peter Braig

The pressure put on companies over climate action by many large superannuation funds has attracted plenty of attention lately, with some criticising super funds' role in pushing resources giant Glencore's to cap its coal output.
How the funds managing $2.7 trillion in retirement savings deal with social or environment issues is a debate that is worth having, as the clout of super funds will only grow in years to come. When it comes to climate change, however, the message coming from those who regulate our financial system could hardly be clearer.

They view climate change as a real and present business risk that financiers need to be putting high on the agenda – irrespective of the failure of our political system to really deal with the issue. The sooner more companies start viewing it this way, the better.

In the Reserve Bank’s first meaty comments on the topic, deputy governor Guy Debelle this month warned climate change could cause financial shocks, if companies didn't take these risks seriously in their planning.

Then, last week, APRA released its first survey of how 38 large banks, insurance companies, and superannuation funds are looking at climate risks.
It showed a third of these businesses viewed climate changes as a "material" risk to their businesses right now. More than half thought it would be a material risk at some point in the future.

The most common types of financial risks identified were damage to reputation, flood, regulatory action, cyclone, energy risks, and bushfires.
In a finding that's raised some eyebrows among observers, only about half of the general insurers — who are exposed to flood, bushfire, and cyclones — thought climate change was "material" for them at the moment.

More than 40 per cent of banks and superannuation funds also thought climate risks were material right now, and the vast majority thought they would be material risks in the future.

It's a safe bet those proportions will only rise in years to come, as regulators and investors raise the pressure on financial businesses to put more emphasis on climate change risks.
Emma Herd, who represents institutional investors with about $2 trillion as chief executive of the Investor Group on Climate Change, says the consistent message from regulators is that climate change risks are "material, foreseeable, and actionable."

“The key message for the businesses is don’t get distracted by the political debate. Look at what your regulators are telling you," she says.
Why are the regulators so concerned to see action on climate change?

No doubt part of it is a sense of trying to do their part to help us avoid catastrophic environmental costs for future generations, but their more immediate worries concern financial stability.

APRA board member Geoff Summerhayes, speaking in his capacity as chair of the Sustainable Insurance Forum, last month said climate change was quickly moving from a "purely partisan or moral issue" to one that is "distinctly financial in nature."
Insurance companies are the most immediately affected by more frequent and severe natural disasters. Global insured losses in 2018 were only half of those of 2017, Sumerhayes said, but he added that "2018 was still the fourth most costly year on record".

Banks and financial markets would also be exposed to dramatic changes in the values of trillions in fossil fuel assets. There is a risk many of these assets could become "stranded" as a result of policies to mitigate carbon dioxide emissions, or from advances in renewable energy technology. That risk is especially relevant to big fossil fuel producers like Australia, and it's a reason why banks have been getting more wary about coal financing in recent years.
Longer term, banks' massive mortgage books could also be exposed to risks because of hazards made worse from climate change, such as floods or cyclones.

For several years, regulators have been pushing big financial institutions to collect and publish more data on such climate risks, and run scenarios on how they would fare under various "transition" scenarios.

Now, APRA says it wants to see a move from "awareness to action." It wants banks, insurers and wealth managers to look at climate risks just like any other part of their risk management framework — not as a social responsibility issue.
Bank of England governor Mark Carney, a global leader in this area, last week gave us a taste of where APRA and other local regulators will probably go. Carney said he expected climate risks to be given consideration at board level, and that the United Kingdom regulators would start conducting climate "stress tests" on insurers and banks.

Carney acknowledged these sorts of changes - which are likely coming here as well - won't be enough on their own to move the world to a low-carbon economy. That will be up to governments, and business.
But however dysfunctional our domestic debate is on climate change, it's abundantly clear the financial sector needs to give this issue growing attention.

Links

• Banks need to mitigate climate risk: APRA
• APRA to banks, insurers: Act on climate risk
• Fin services needs to walk the walk on climate risk
• 'Change Now Or Pay Later': RBA's Stark Warning On Climate Change
• Climate Change Poses Financial Stability Risk – RBA
• Climate change-related litigation was once seen as a joke, but it could soon become business reality

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