APRA urges institutions to heed climate risks and shift to carbon economy

Financial institutions and businesses are jeopardising their futures if they fail to take into account climate change risks and the transition to the low carbon economy, the Australian Prudential Regulation Authority has warned.

Speaking at the Centre for Policy Development public forum on building a sustainable economy, executive board member of APRA, Geoff Summerhayes, stressed the importance of recognising existing climate-related financial risks and the opportunities for businesses that move ahead of the market and possible regulatory change in adapting to the low-carbon economy.

Mr Summerhayes said that APRA shares the view of the international network, the Sustainable Insurance Forum, that climate change and society’s responses to it are starting to affect the global economy.

“APRA is not a scientific body, and I can’t say with 100 per cent conviction to what extent scientists’ predictions of increasing temperatures, rising sea levels, more frequent droughts and more intense storms will impact the Australian economy. But what I can tell you with absolute certainty is that the transition to a low carbon economy is underway and moving quickly. The weight of money, pushed by commercial imperatives such as investment, innovation and reputational factors, is increasingly driving that shift, rather than scientists or policymakers.”

“As money seeps from carbon-intensive assets, the flow into green investments, though still more a stream than a torrent, is gaining in volume and velocity.”

Mr Summerhayes exemplified the potential impact of increasingly frequent extreme climate events with the impact of Cyclone Debbie earlier this year, an event that has cost the insurance industry $1.6 billion.

“APRA’s concern here goes beyond the impact more frequent and damaging natural disasters may have on insurers’ balance sheets and their capacity to pay claims. It also flows through to insurers’ ongoing ability to keep premiums affordable and available in high-risk areas.”

“This type of scenario has consequences. Banks, credit unions and other lenders may take a hit, as they juggle a rise in poorly performing loans with a reduction in property values, negative customer equity or properties becoming unsellable. With loan terms of 30 years, the banking sector is already exposed to this risk. “

However, Mr Summerhayes said that APRA has “no immediate plans to introduce new prudential standards related to climate risk”, and will continue to rely on APRA's risk management standard CPS-220 for setting out general risk management expectations.

“For now, our focus is on raising awareness rather than prescribing additional prudential standards, though consideration may be given to updating prudential guidance.”

Mr Summerhayes noted that with the transition to a low carbon economy under way, there were also 'transition risks' - 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.

At the same time, there were opportunities for the financial sector in enabling the transition as investment patterns shift and providing economic resilience to extreme climate events.

Internationally, climate risk disclosure has become increasingly important, and APRA is planning a survey of regulated entities to gain a better understanding of emerging best practice, as well as an industry-wide review of climate-related disclosures. It will also consider conducting stress tests for the sector specifically related to climate risk.

Summing up, Mr Summerhayes said that understanding of the economic impacts of climate change and the transition to the low-carbon economy was still developing among regulators, and so far APRA was only asking entities to consider climate change in their risk management frameworks.

“But over time, as risks become more apparent, that is likely to change,” he said, and urged regulated entities to “more effectively plan ahead, so they float with the transitional current rather than fighting against the rising tide. “

Geoff Summerhayes full speech is available here

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