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Australian, French and Canadian financial regulators back action on climate risk

by Joel Kenrick

The last few weeks have seen speeches on climate risk by the Australian Prudential Regulation Authority, Deputy Governor of the Bank of Canada, and a joint report by the French Treasury, central bank and prudential regulator. They join others including the Financial Stability BoardBank of EnglandEuropean Systemic Risk BoardDutch Central Bank and Swedish Financial Supervisory Authority

Australia regulator APRA: climate risks important and explicit part of our thinkingGeoff Summerhayes, one of three members of the Australian Prudential Regulation Authority (APRA), said 'climate risks will become an important and explicit part of our thinking' in a major speech to the Insurance Council of Australia Annual Forum. Reflecting on global developments over the last 12 months including the Paris Agreement he offered 'observations about why climate-related risks are likely to be relevant and important, not only for insurers but for all APRA-regulated entities' and said the APRA wants to be explicit that 'Some climate risks are distinctly ‘financial’ in nature. Many of these risks are foreseeable, material and actionable now. Climate risks also have potential system-wide implications that APRA and other regulators here and abroad are paying much closer attention to.' Echoing the FSB TCFD he concluded that 'It could be the case that, just as we would expect to see more sophisticated scenario-based analysis of climate risks at the firm level, we look at these risks as part of our system-wide stress testing.' (Australia's new horizon: Climate change challenges and prudential riskAPRA, 17 Feb).

APRA: Climate change a 'here and now' financial risk: ABC Radio said the speech was the first time Australia's financial regulators had explicitly addressed the financial risk created by global warming, and that the 'APRA now views climate change as a 'here and now' risk [..] due to three main influences: the Paris climate agreement, recommendations by the G-20 Financial Stability Board, as well as a legal opinion issued late last year. APRA says it expects big companies to carefully consider these risks, warning that company directors could be liable if they fail to do so.' (Climate change a financial risk, says APRA, 17 Feb, ABC AM). 'The Climate Institute's CEO John Connor described the speech as a "huge" development. "APRA has never gone out there like this before," he said. "It's an antidote to the hyper partisan political culture war on climate policy; our regulator's moved to the front foot in managing climate risks." The Climate Institute and the Investor Group on Climate Change wrote jointly to the Council of Financial Regulators two years calling for regulatory action on the financial risks from climate change.'(Climate change change could threaten entire financial system, APRA warns, 17 Feb, ABC).

The market and legal system are moving ahead of politicians: In the SMH Michael Pascoe called the speech a 'climate change bombshell' that shows that 'never mind the politicisation of energy and carbon policy – the market and legal system is moving rapidly to instil the discipline and punishment the government isn't game to discuss. The policy vacuum will be filled by the personal liability of company directors and the disclosure requirements of financial regulators.The climate bombshell the politicians didn't touch, 20 Feb, The Sydney Morning Herald). In Business Insider, Kate Mackenzie of the The Climate Institute puts the speech in context of recent papers on this issue, including a memorandum of opinion on director liability in Oct 2016, The Actuaries Institute on managing risks in the financial sector, and the Climate Change and Good Governance report for the Australian Institute of Company Directors (The bank regulator is finally putting climate change on the risk agenda for Australian companies, 20 Feb, Business Insider). See also Climate change a 'material' risk for the financial system: APRA, 17 Feb, Sydney Morning HeraldThe legal opinion shaking up the nations's boardroomsABC), Apra says companies must factor climate risks into business outlookThe Guardian.

Bank of Canada warns of cost of climate change: 'The deputy governor of the Bank of Canada touted the case for pricing carbon during a speech in Montreal on Thursday, warning that climate change and actions to address it will have "material and pervasive effects on Canada's economy and financial system." (Deputy governor of Bank of Canada warns about climate change, touts pricing carbon, 2 Mar, CBC News). 'Canada’s economy is already taking a hit from global warming, including more frequent droughts and forest fires plus a burst of carbon-tax-induced inflation, a top Bank of Canada official says.' (Climate change will have ‘pervasive effects’ on economy, Bank of Canada deputy governor says, 2 Mar, Globe & Mail). The speech was given at the Finance and Sustainability Initiative (Thermometer Rising—Climate Change and Canada’s Economic Future, 2 Mar, Bank of Canada).

French Treasury invoke Tragedy of the horizon': The French Treasury, in collaboration with the Banque de France (French central bank) and the Autorité de Contrôle Prudentiel et de Résolution (the Prudential Supervision and Resolution Authority) have published report 'Assessing climate change-related risks in the banking sector' (pdf) have backed the 'tragedy of the horizons' remarks of Mark Carney, stating that although the horizon for the materialization of physical risk is usually believed to extend beyond the usual risk assessment horizon 'these risks can also have immediate or short-term effects. Even though the bulk of the risks falls beyond the horizon of other risks and the exercise is to be considered from a forward-looking perspective, the assessment of climate-related vulnerabilities and their manifestation in terms of financial risk categories are already important issues as of today.' (French Treasury the latest to warn of the ‘tragedy of the horizon’ for investors, 22 Feb, Responsible Investor ($)). 

French banks up to 15% exposure to climate vulnerable sectors: The French Treasury report finds that 'a mapping of French banks’ exposures to climate-related risks suggests 1%-15% exposure in vulnerable sectors/regions (for physical risks as well as for transition risks); this is a conservative estimate and effective (loan-level) sensitivity is difficult to assess.' The report states that transition risks can be analyzed through two complementary perspectives:

  • The macroeconomic level: where 'an abrupt transition, for instance through the sudden introduction  of a high carbon price, would have a substantial impact on macroeconomic variables (inflation, GDP growth, household consumption).
  • Sectoral sensitivity tests: 'to assess various scenarios impact on banking exposure, different channels should be explored': 'connect carbon price evolution... to credit/market risks' and 'better analyze ... who will eventually bear the brunt of rising carbon prices'. 'Scenario-based analysis of transition risks could thus be performed [by banks] in two steps: ... assess, at a portfolio level for specific sectors, their clients' exposures to transition risks by assessing the potential impact of climate policies' ... 'as a second step, based on carbon prices scenario draw up ... banks could assess their portfolio ... and then predict losses in case of sudden transition. ('Assessing climate change-related risks in the banking sector', p. 12).
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