Despite the recent impacts of extreme weather, understanding and incorporation of climate risk still has a long way to go in Australia.
A new survey shows that Australian entities are failing to integrate climate risk into their risk management frameworks.
Australian entities acknowledge climate risk as a growing concern, but a lack of requirements and understanding has resulted in below-par disclosures.
Climate risks are a major threat to the long-term health of companies and financial systems if not properly managed.
Findings from a new survey published by the Australian Prudential Regulation Authority (APRA) show that while climate disclosures are on the up for companies in the banking, insurance and superannuation industries, climate risk remains a sticking point. The regulator warned that entities must prepare to meet “rapidly increasing expectations” when it comes to measuring and managing climate risk.
The voluntary climate risk self-assessment survey was issued in March this year, with 64 medium to large institutions responding. The goal of the survey was to assess how entities are identifying, assessing and managing climate-related financial risks.
This comes after the APRA released its final prudential practice guide on climate change financial risks in November 2021. The guide does not impose any regulatory requirements or prescribes any specific actions, but acts more as a compass to steer companies in the right direction when managing their climate risk.
The guide covers areas such as governance, risk management, scenario analysis and disclosure of climate-related financial risks.
APRA chair Wayne Byres explains that the guide does not force companies to make any particular investment, lending or underwriting decision, but the APRA wants to ensure that these “decisions are well-informed, and don’t undermine the interests of bank depositors, insurance policyholders or superannuation members”.
A guiding light for climate risk?
Results from the survey reveal that APRA-regulated entities have in general aligned “well” with the guide, especially in the areas of governance and disclosure. However, only a small portion of the survey respondents indicated they have fully embedded climate risk across their risk management framework.
“The survey findings indicate that most survey participants are taking this issue seriously” commented APRA’s deputy chair Helen Rowell. “However, they also underline that this remains a relatively new and evolving area of risk management, especially with regards to setting metrics and targets”, she added.
While four out of five of the boards surveyed claim to oversee climate risk on a regular basis, only 63% of these entities have incorporated climate risk into their strategic planning process.
While fully integrating climate risk into an entity’s framework is a more complicated and lengthy process, the numbers also are not promising when it comes to putting in place mechanisms to manage this risk in the short-term.
Only 68% of these entities say they have publicly disclosed their approach to measuring and managing climate risk, with the overwhelming majority aligning their disclosures with the Taskforce for Climate-related Financial Disclosures (TCFD) framework.
Overall, while it seems that entities are taking more steps to tackle the imminent climate risk issue, they are failing to address the problem at its core, opting for outward-facing targets instead of taking meaningful action. Rowell is “urging” entities to “consider the findings and reflect on their preparedness”.
The results of the survey are not isolated to Australian entities, with regulators around the world also seeing an uptick in climate risk-related disclosures, but not seeing the quantity aligned with quality.
The UK’s Financial Conduct Authority (FCA) has also warned that despite 90% of the UK’s top companies including a TCFD-aligned disclosure in their annual financial reports, the climate risk disclosures are failing to reach the required standard.
Climate risk is a reality today, not in the future
This lack of climate risk integration is despite the fact that 40% of entities responded saying that climate-related events could have a “material or moderate” impact on their direct operations.
Australia knows first-hand the physical impacts of climate change, after experiencing a wave of devastating wildfires and floods that wreaked havoc on the country’s economy.
For example, this year’s floods in Australia were the countries second most costly extreme weather event, resulting in a whopping A$2 billion ($1.4 billion) in payments made by insurers, a significant hit to the industry.
But this is just the tip of the iceberg. The economic cost of climate impacts in the country are expected to nearly triple by 2050 compared to 2017 according to Australia’s national science agency CSIRO.
However, the physical risks of climate change are just one aspect that entities have to deal with as the world moves towards net zero.
Australia has recently agreed a new climate law (currently awaiting approval from the Senate) which ramps up the country’s ambition to lower emissions across multiple sectors to achieve net zero by 2050. The new bill enshrines the country’s emission reduction targets into legislation, which will undoubtedly impact how companies do business going forward.
Already we are seeing how this push towards decarbonisation is impacting the financial sector. Last week, the country saw one of its super ‘industry’ pension funds NGS Super announce it will divest from its oil and gas investments, a trend seen globally that will have significant impacts on financial markets.
These transition risks need to be systematically managed now, or else they could catalyse a global economic crisis according to the European Central Bank. As more sectors and national economies become more and more integrated, the mismanagement of one risk could lead to a domino effect threatening financial stability.
Climate risk disclosures are seen as a key tool to increase transparency and corporate action when it comes measuring and managing these risks. But as the APRA survey shows, a voluntary framework may not be enough to meaningfully address and be proactive on climate risks as entities struggle to adapt to new frameworks and a changing environmental and financial climate.