APRA emphasises "compounding effect" of climate change

Financial risks of climate change can interact and compound other institutional risks including credit risk, market risk, and liquidity risk, APRA has emphasised in a new practice guide.

APRA has released a draft guide for Prudential Practice Guide CPG 229 Climate Change Financial Risks (CPG 229), designed to assist banks, insurers and superannuation funds in managing climate-related risks and opportunities as part of their existing risk management and governance frameworks. The guide outlines better practice for identifying, managing and disclosing financial risks of climate change in line with the Task Force on Climate-related Financial Disclosures (TCFD).

APRA states that it is prudent practice for boards of regulated entities to "seek to understand and regularly assess the financial risks arising from climate change that affect the institution, now and into the future," and that the board should be able to provide evidence of its ongoing oversight of risks that they deem to be material.

APRA has developed CPG 229 in response to requests from industry for greater clarity of regulatory expectations and examples of better industry practice.

Better practice consists of five pillars - identifying and measuring risks to understand potential impacts on business model, monitoring risks through regulator updated metrics, considering scenario analysis to inform understanding of long-term risks and opportunities, evidencing plans to manage risks through mitigation plans, including through engaging customers and counterparties, and reporting relevant information to board and senior management, and considering external market disclosures.

The guidance covers APRA's view of sound practice in areas such as governance, risk management, scenario analysis and disclosure, but APRA states that it does not create new requirements or obligations.

"Since the Australian government became a party to the Paris Agreement, APRA has been raising awareness of climate-related risks to the financial sector," says APRA Chair Wayne Byres. "Given the unique and long-term nature of the risks, however, processes to measure, monitor and manage climate-related financial risks are still developing.

"The prudential practice guide doesn't direct or prevent APRA-regulated entities making any particular business or investment decision. Rather, it is aimed at ensuring decisions are well-informed and appropriately consider both the risks and opportunities that the transition to a low carbon economy creates."

Emma Herd, CEO of the Investor Group on Climate Change (IGCC) says the guide will "go a long way to consolidating the accelerating action across the financial sector to address the systemic financial risks created by climate change."

"The draft APRA guidance sends a clear message to directors and trustees that climate risk is financial risk," Herd says. "It means assessment, disclosure and management of an organisation's climate risk exposure is clearly identified as being consistent with proper risk management practices and regulator expectations.

"We note that the guidance has been developed in consultation with other Australian financial regulators through the Council of Financial Regulators and APRA's international peers, which should give it further authority in the market."

The guide is a "significant step forward," says Nicolette Boele, executive manager of policy and standards at the Responsible Investment Association Australasia (RIAA).

"We would hope, as in New Zealand, this guidance becomes mandatory, so that all financial institutions are pricing and valuing companies within the portfolios they manage, as well as realigning portfolios to contribute to a lower carbon world," Boele says. "Encouragingly, this last year has seen various leading super funds and investment managers announce net zero strategies, however there remains a gap between investment strategy and consumer expectations that their money doesn't contribute to further climate change.

"The Australian investment community has a pivotal role to play in helping to achieve the Paris Agreement on climate change and needs to remain competitive in global capital markets that are rapidly shifting capital towards a lower carbon economy."

The guide is out for consultation, and APRA is seeking stakeholder feedback on the draft CPG 229 by 31 July 2021. Subject to feedback, the final PPG is expected to be released before the end of 2021.

Read more: APRAParis AgreementWayne ByresTask Force on Climate-related Financial DisclosuresTCFDEmma HerdNicolette BoeleResponsible Investment Association AustralasiaInvestor Group on Climate Change