Australian financial regulator to double down on climate risk with new guidance and stress testing

APRA says scenario analysis, stress testing and disclosure key to addressing ‘climate data deficit’

One of Australia’s key financial regulators is devising climate risk guidance for the financial industry and a ‘climate vulnerability assessment’ for the country’s largest banks, it announced in a letter to regulated entities on Monday. 

The Australian Prudential Regulation Authority (APRA), which oversees most superannuation funds, as well as banks, insurers, building societies and credit unions, said the measures were part of ongoing supervisory focus on climate and an effort to address what it called the “climate data deficit”. 

The letter, from Executive Board Member Geoff Summerhayes, said the regulator was developing a cross-industry, TCFD-aligned prudential practice guide (PPG), which would include aspects of governance, strategy, risk management, metrics and disclosure. It will outline best prudent practice rather than establish new obligations for regulated entities.

It urged institutions to be coordinated and “proactive in taking steps to assess and mitigate climate change financial risks now, and not delay action until further guidance or scenario analysis from APRA is released”.

APRA also said it would undertake a “climate change financial risk vulnerability assessment”, starting with the country’s largest authorised deposit-taking institutions (ADIs) and later expanding to other industries.

It said the assessment would involve entities estimating the potential physical impacts of a changing climate, including extreme weather events, on their balance sheet, as well as the risks that may arise from the global transition to a low-carbon economy. The ADI vulnerability assessment will be designed in 2020 and executed in 2021.

The move comes on the back of devastating wildfires in Australia in recent months, which are estimated to have caused some $4.5bn of economic damage.

Additionally, APRA will build on its 2018 climate change survey by conducting deeper supervisory assessments of 38 large entities across the ADI, superannuation, general, life and health insurance industries, due to be completed in mid-2020. 

It said the original 2018 survey had “highlighted the need to address the climate data deficit, to quantify the likely impact of the physical, transitional and liability risks of climate change and accurately assess and appropriately price these risks. This needs to ultimately be tackled through scenario analysis, stress testing and disclosure of market-useful information.”

“Effective action now on these fronts will promote strong understanding and management of the potential financial impacts of a changing climate on current and future business prospects, allowing well-managed entities to minimise costs and optimise benefits.”

The regulator said it was also updating its ESG guidance in mid-2020, in response to industry views. The updates will apply to APRA’s Prudential Practice Guide SPG 530 Investment Governance, which aims to assist superannuation funds forming and implementing an investment strategy and includes guidance on ESG considerations.

APRA’s first public statement in relation to its prudential regulatory approach to climate risk back in 2017 was welcomed by investors, and the regulator has since been ramping up scrutiny on regulated industries.

Australia’s finance sector last year launched the Australian Sustainable Finance Initiative, inspired by Europe’s High-Level Expert Group on Sustainable Finance (HLEG) and tasked with developing a sustainable finance roadmap for Australia to help catalyse the transition to a more “resilient and sustainable economy”. Unlike its European counterpart, ASFI has no backing from government. 

APRA is officially observing the work of one of the initiative’s five working groups, focusing on creating a more sustainable financial system.