Council of Financial Regulators Climate Change Activity Stocktake 2021

Prepared by CFR Working Group on Financial Implications of Climate Change

This stocktake paper outlines the recent activities and planned further work of the Council of Financial Regulators Working Group on Financial Implications of Climate Change in relation to climate change risks. Further details are contained in the Appendix.

Key issues

The CFR agencies have taken steps to improve the ability of Australian corporates and financial institutions to manage the financial risks associated with climate change and to provide high-quality comparable disclosures on these risks. A focus in 2020/21 has been the Climate Vulnerability Assessment (CVA), run by APRA on behalf of other CFR agencies. This assessment aims to measure the potential financial risks to large banks, the financial system and economy posed by both physical and transition climate risks using scenario analysis. The other important aspects of this exercise are to understand how banks may adjust their business models and implement management actions in response to the different scenarios, and improve banks' climate risk management capabilities.

CFR agencies have continued to build their understanding and knowledge about how to measure and manage the financial and operational risks associated with climate change. This has included targeted supervisory and regulatory engagement with institutions, collaboration with expert bodies, contributing to international forums and producing publicly available reports. Climate-change related issues have gained increasing prominence in the international forums in which CFR agencies participate.

Background

The Council of Financial Regulators Working Group on Financial Implications of Climate Change was established in 2017. The Working Group brings APRA, ASIC, RBA and Treasury together to consider and coordinate actions in relation to understanding and managing climate risks. As per the terms of reference, the Working Group reports to the CFR, as needed, on international developments, emerging regulatory gaps and risks to the financial system in relation to climate change.

Summary of activities in 2020/21

Activities of the working group members since the last report to CFR can be grouped under four broad themes.

First, using scenario analysis to measure the exposures of financial institutions and the financial system to climate related risks. APRA, on behalf of the CFR agencies, is currently conducting a climate vulnerability exercise for Australia's five largest banks. The CVA is the working group's priority for 2021. The RBA has also undertaken analysis of the effects of climate change on the banking and insurance sectors.

Second, setting supervisory expectations for the management of climate-related risks, including around governance, strategy, risk management, scenario analysis and stress testing, and disclosures. APRA released a draft Prudential Practice Guide (PPG) on Climate Change Financial Risk for consultation, which is currently being reviewed following the consultation period closing at the end of July 2021. The PPG is designed to assist entities in developing frameworks for the assessment and monitoring of climate-related financial risks.

Third, improving the quality, consistency and breadth of climate risk disclosures, which in turn improve investors' ability to assess financial risks associated with climate change. ASIC is continuing its surveillance of climate risk governance and disclosure practices of listed companies. Treasury is increasing efforts to understand the implications of emerging global frameworks and standards for Australian entities, including via engagement in international discussions on efforts to improve quality and standardisation of disclosures.

Fourth, monitoring the development of taxonomies used to define what is a ‘sustainable’ activity or financial product. CFR agencies are using their involvement in international groups, for example Treasury and RBA participation in the G20 Sustainable Finance Working Group (SFWG), as a way to learn about and – where needed – seek to influence the development of taxonomies and other approaches to align investments with sustainable goals. The issue of taxonomies is also important for establishing standards that allow investors to assess the sustainability credentials of specific projects and financial products. ASIC and APRA participated as observers on the Steering Committee of Australian Sustainable Finance Initiative (ASFI), which is looking to explore the implementation of a sustainable finance taxonomy in Australia in 2021/22.

Priorities for 2021/22

The working group has identified three priority areas for 2021/22.

First, complete the CVA and consider next steps to take in measuring and understanding the climate risk of regulated entities. The participating banks have commenced their assessment, and APRA plans to publish results in 2022. The experience gained from this CVA may be applied to similar future activities in the insurance and superannuation sectors, as well as inform future banking-sector activities. APRA is also considering further methods of measuring the climate risk exposures of its regulated entities, which may include launching an annual climate risk self-assessment survey.

Second, identify and strengthen the building blocks that will be needed to facilitate high-quality and comparable climate-related disclosures, including high-quality data and consistent scenarios. CFR agencies will consider how the CVA scenarios can be drawn on more broadly to inform disclosures. It is hoped that the CVA exercise will provide useful benchmark scenarios that can be used by other companies looking to provide high-quality consistent disclosures. Further surveillance work is planned by ASIC on climate-change related disclosures and governance practices by Australia's large listed companies, focussing on the Task Force on Climate-Related Financial Disclosure (TCFD) reporting framework. ASIC will continue work on ‘greenwashing’, examining the extent of potential harms to financial consumers in Australia from greenwashing practices, and determining what interventions (if any) are necessary in light of those harms.

CFR agencies will also consider how international developments in standards for climate-related disclosures, including moves to mandate disclosures in some jurisdictions, may affect Australia. This includes the possibility that a dominant standard for climate-related disclosures emerges that is not well suited to the Australian context, which could undermine the ability of markets to price climate-related risks accurately. ASIC will continue to engage with the International Financial Reporting Standards (IFRS) Foundation proposals to develop a globally consistent and comparable sustainability reporting baseline, through its participation in the International Organisation of Securities Commissions (IOSCO) Sustainable Finance Taskforce. Treasury and the RBA will continue to support the work of the IFRS Foundation through their participation in the G20 SFWG. CFR agencies will consider possible impacts for Australian firms and markets, and principles that should guide any response to international regimes, noting that any policy decisions are a matter for Government.

Third, examine the implications of emerging sustainable finance taxonomies, including for investment flows, and consider possible Australian approaches to these developments. A few countries have made significant progress towards developing sustainable finance taxonomies, and there is a push for the development of internationally consistent approaches. CFR agencies will consider these developments and potential implications for Australia, including the risk that a dominant taxonomy emerges that is not well suited to Australia's need to finance the transition to lower carbon emissions. CFR agencies will continue to engage with relevant international groups, including the G20 SFWG, to understand and influence the development of common global taxonomies. The working group may also consider how emerging international approaches to defining sustainable investments, such as taxonomies, could be adapted to meet Australian needs, and engage with relevant industry initiatives on this topic.

Appendix – Update of recent agency activity

Measuring the climate-risk exposures of financial institutions and the financial system

Measuring and understanding the nature of climate-related risks to the financial system falls within the mandates of all CFR agencies. APRA has a mandate to maintain the safety and soundness of financial institutions: climate change poses risks to the balance sheets of financial institutions, and therefore measuring the extent of these risks is relevant to APRA's mandate. The macroeconomic implications of climate change, for example its impact on output and inflation, are relevant for the RBA's conduct of monetary policy. The implications of climate change for financial markets, financial institutions, and the balance sheets of companies and households, are also relevant for the RBA's financial stability mandate. Promoting greater understanding and measurement of climate risk exposures falls under ASIC's role to maintain, facilitate and improve the performance of the financial system. Treasury is responsible for analysing policy issues from a whole-of-economy perspective, including the financial system. Climate change, and mitigation efforts, will have repercussions for the financial system and the economy, and as a result understanding how climate-risk exposures are being measured and managed is a component of Treasury's mandate.

Alongside other Australian CFR agencies, APRA is conducting a CVA of large banks in Australia. The CVA has been designed with the following three key objectives:

• measure the potential financial risks to ADIs, the financial system and economy posed by both physical and transition climate risks;
• understand how ADIs may adjust their business models and implement management actions in response to the different scenarios; and
• improve ADIs' climate risk management capabilities.

APRA recently published an Information Paper outlining the objectives and key design features of the CVA, as well as providing a comparison to similar work being undertaken by international regulatory peers. With the design process concluded, the participating banks have now commenced their assessment, and APRA expects to publish aggregated results from the CVA in 2022. The experience gained from this CVA may be applied to similar future activities in the insurance and superannuation sectors, as well as inform future banking-sector activities.

The RBA has conducted analytical work on the impact of major trading partners' net zero targets on Australian exports,[¹] as well as the implications for Australian gas demand from the increase in the cost-effectiveness of renewable energy generation.[²] The RBA has also published analysis on the effect of climate change on the banking and insurance sectors,[³] and continues to highlight the long-term financial stability risks of climate change in its Financial Stability Review.[⁴] The RBA has also made progress towards quantifying the risks to Australian agricultural exports posed by climate change by incorporating weather conditions into the RBA's macroeconomic model. RBA staff prepared an information paper on climate change, the economy and financial stability for the Board in June. The Treasurer released the 2021 Intergenerational Report on 28 June, which contained a chapter on the environment that discussed the impacts on the economy from climate change.

Looking ahead, once APRA's CVA is complete there will be significant value in doing an ex-post evaluation exercise to understand what has been learned from the exercise and what additional work would be valuable to get the most out of future scenario analysis of financial institutions. It will also be beneficial to understand how useful this exercise has been for other institutions looking for information and benchmark scenarios for their own disclosures.

The RBA is planning to undertake further analysis of the impact of climate related risks on the Australian economy and financial system, which could include an evaluation of the potential impact of carbon border adjustment mechanisms on Australian exports.

Working group members are involved in discussions about how to understand and measure the climate related exposures of financial institutions and the financial system in a variety of international groups:

• APRA and the RBA are members of the Network for Greening the Financial System (NGFS), which is leading international progress on the development of common climate scenarios to assess financial sector risks. An updated version of the NGFS climate scenarios was published in June 2021, incorporating an expanded set of macroeconomic variables and provide additional country and sector-level granularity. APRA and the RBA have also been contributing to a paper on cross-country case studies, due to be published later in 2021.
• The RBA chairs the Executives' Meeting of East Asia and Pacific Central Banks (EMEAP) Monetary and Financial Stability Committee (MFSC), which has discussed how central banks in the region are using the NGFS scenarios and implications of climate change for financial stability.

Related to this is international work to address the challenges of data gaps:

• The FSB Standing Committee on Assessment of Vulnerabilities (SCAV) is preparing a report on the availability of data to monitor and assess climate-related risks to financial stability. The RBA is a member.
• The RBA and APRA are involved in the NGFS Bridging the Data Gaps workstream, which has recently published a draft progress report.

Setting supervisory expectations

Setting supervisory expectations sits within the mandates of APRA and ASIC. APRA's mandate is to enforce prudential standards and practices to ensure that financial promises made by institutions that it supervises are met. Climate risks may affect the balance sheet of financial institutions, and as a result APRA is required to set supervisory expectations for financial institutions to ensure that these risks are managed appropriately. ASIC's regulatory role involves promoting fair and efficient markets and confident and informed investors. This may involve issuing regulatory guidance in relation to climate change-related disclosures.

Australian regulators are setting supervisory expectations for the management of climate-related risks, including around governance, strategy, risk management, scenario analysis and stress testing, and disclosures.

• APRA is encouraging regulated institutions to consider climate risks within their governance and risk management frameworks via the draft Prudential Practice Guide CPG 229 Climate Change Financial Risks. This guidance is aimed at ensuring decisions of APRA-regulated entities are well-informed and appropriately consider both the risks and opportunities arising from a transition to a lower emissions economy. APRA has also developed internal training modules to support APRA staff in incorporating climate risk assessments into their regular supervisory activities.
• ASIC has clarified the application of its existing regulatory guidance to the disclosure of climate change related risks and opportunities, including Regulatory Guide 228 Prospectuses: Effective disclosure for retail investors and Regulatory Guide 247: Effective disclosure in an operating and financial review. ASIC continues to encourage listed companies and their directors, officers and advisors to consider both physical and transitional climate risks to the company, develop and maintain strong and effective corporate governance practices, comply with the law where it requires specific disclosure of climate-related risks and, where those risks are material, consider providing further and more detailed voluntary disclosure under the recommendations developed by the TCFD.[⁵]

The CFR agencies are also engaged in international discussions about supervision of climate-related risks, including the following:

• APRA is involved in the FSB Standing Committee on Supervisory and Regulatory Cooperation (SRC) working group on climate risk, which has recently published a stocktake and summary report, and is developing principles and recommendations for supervisors.
• APRA has become a member of the Basel Committee on Banking Supervision's task force on climate risks (TFCR). The TFCR has recently published an analytical report on transmission channels and measurement methodologies, and is moving to identify potential gaps in the Basel framework.
• APRA has also provided strategic advice and secretariat support to the UN Sustainable Insurance Forum (SIF), and contributed to the SIF's joint work with the International Association of Insurance Supervisors on climate risks in the insurance sector.

In the year ahead, APRA will review submissions on the Prudential Practice Guide CPG 229 Climate Change Financial Risks, and publish a final version of the guidance before the end of 2021. APRA is already considering further methods of measuring the climate risk exposures of its regulated entities, which may include launching an annual climate risk self-assessment survey. Such a survey could provide APRA with visibility of the adoption of its prudential practice guide on climate change financial risks, inform supervisors of climate risk challenges among regulated entities, and allow comparison of domestic climate risk alignment to international peers.

Improving the quality, consistency and breadth of climate risk disclosures

Efforts to improve the quality, consistency and breadth of climate risk disclosures also sit across several CFR agencies. ASIC's role is to maintain, facilitate and improve the performance of the financial system and the entities in it, which extends to promoting fair and efficient markets, and confident and informed investors. This intersects directly with standards of climate change-related disclosure and governance by market participants. Treasury provides analysis and policy advice on issues that may affect the Australian economy. As a result, understanding the role of disclosures and climate risk reporting within Australia's established legal framework, which may have implications for investment decisions, falls within Treasury's mandate. Similarly, the implications of disclosures and climate-risk reporting for efficiency of financial market pricing and ability of financial institutions to manage these risks places understanding these issues within the RBA and APRA's financial stability mandates.

Domestically, ASIC continues to reinforce key messages and existing guidance on climate change-related disclosure and governance, including encouraging voluntary TCFD disclosures. ASIC also continues to progress its surveillance work to monitor climate risk governance and disclosure practices of listed companies in Australia.

ASIC proposes another round of surveillance of climate change-related disclosure by large listed companies representing a continuation of ASIC's ongoing monitoring of developing market practices in this area.

Treasury has formed a team to focus on issues around the financial risks of climate change. In collaboration with Treasury's international posts, it is reviewing recent international trends in these matters, including approaches to disclosure, improving data quality and standards and the development of sustainability taxonomies. It will consider potential impacts on climate risk governance and reporting in Australia, and is actively engaging on these issues through its participation in domestic and global forums.

The CFR climate change working group plans to consider the potential implications for Australian entities and members of the CFR of the moves to mandatory TCFD disclosures abroad, noting that any policy decisions around disclosure that require legislative change are a matter for Government.

Internationally, ASIC is involved in the IOSCO Sustainable Finance Taskforce working groups on sustainability disclosures by issuers and asset manager disclosures and greenwashing. IOSCO has voiced support for the IFRS Foundation proposal to create a new International Sustainability Standards Board (ISSB) to drive greater consistency in sustainability reporting and recently published a Report to this effect. ASIC is also involved in the IOSCO Sustainability Technical Experts Group (TEG) which is providing input to preliminary work by the IFRS Foundation's Technical Readiness Working Group towards the development of climate change and sustainability reporting frameworks in anticipation of the possible formation of the ISSB. The FSB's TCFD continues to monitor implementation of its 2017 recommendations, which provide a framework for companies and other organisations to develop more effective climate-related financial disclosures. To assist with this process, APRA and ASIC have recently provided responses to an FSB cross-country survey on climate-related disclosures by banks and other firms in Australia.

Planned work in this area in the next year includes continued ASIC engagement at the international level through membership of the IOSCO Sustainable Finance Taskforce and its TEG. Treasury will also investigate opportunities to promote Australian perspectives and expertise in the development of the IFRS' proposed baseline standards, through engagement with the Australian Financial Reporting Council and others.

Consideration and engagement on sustainability taxonomies

Issues raised by the international push to develop and implement taxonomies and other alignment approaches are relevant to the mandates of several working group members. ASIC's mandate includes promoting fair and efficient markets and confident and informed investors, two outcomes that would be supported by improvements in the consistency and or compatibility of taxonomies. The development and implementation of sustainable finance taxonomies will have implications for investment in Australia. Therefore it is important for Treasury to understand the issues associated with the development of domestic or global taxonomies in order to provide sound policy advice on the appropriate strategic direction for Australia. The RBA and APRA are also monitoring developments in this area, because consistent, widely-recognised taxonomies are an important foundation for the efficient pricing of climate risk in financial markets, which supports the stability of financial markets and the ability of financial institutions to manage these risks.

The CFR working group has met with ASFI, who are looking to establish a project to explore the implementation of a sustainable finance taxonomy in Australia, with involvement from industry and regulators. ASFI also recommends that Australia, through a relevant public authority, joins the International Platform on Sustainable Finance (IPSF). ASIC and APRA have been observers at ASFI's steering committee, and expect to join a newly formed advisory committee.

Improving the consistency or compatibility of taxonomies is also topic under discussion in the international forums that CFR agencies are engaged in:

• The RBA and Australian Treasury are members of the G20 SFWG, which is developing a multiyear sustainable finance work plan, covering enhancing compatibility in sustainability reporting, and improving compatibility, interoperability and transparency of frameworks to align investments with sustainability goals.
• IOSCO's Sustainable Finance Taskforce is examining issues related to taxonomies as part of its workstream focussed on asset managers and greenwashing and recently published a Consultation Report. ASIC is participating in this work.

Looking ahead, RBA and Treasury will continue to participate in the work of the G20 SFWG, and highlight the need for taxonomies that have appropriate coverage of transition financing. Australian Treasury is considering further options to influence developments in this area, which could include involvement in the IPSF. CFR agencies will also continue to monitor the development of taxonomies overseas and the potential impact on Australia entities, including the risk that a dominant taxonomy emerges that is not well suited to Australia's need to finance the transition to lower carbon emissions. The working group may also consider how broader international approaches to defining sustainable investments could be adapted to meet Australian needs, and engage relevant industry initiatives.

ASIC's domestic surveillance on potential greenwashing intersects with this work. The lack of an agreed set of definitions (both domestically and internationally, whether through taxonomies, labels, standards or other certifications) allows market participants to set their own definitions in many respects and ASIC's work is examining the extent to which this is (if at all) causing harm to financial consumers. ASIC will continue this, and will determine what interventions may be necessary in light of this work.

The RBA has been involved in international discussions on scaling up green finance and the implications for central bank operational frameworks as participants in an NGFS workstream. The RBA has also undertaken internal analysis of developments in green financing to anticipate any potential financial market implications.

Footnotes