APRA provides guidance on managing the financial risks of climate change
APRA has released draft guidance on how entities can manage the financial risks arising from climate change and the transition to a low carbon economy
What you need to know
- In response to industry requests for greater clarity of regulatory expectations and examples of good practice, APRA has released a draft of Prudential Practice Guide CPG 229 Climate Change Financial Risks (CPG 229) for consultation
- APRA expects that the responsibility for understanding, assessing and mitigating climate risk rests with the board of directors and senior management
- APRA also expects that institutions will begin to develop capabilities in climate risk scenario analysis and stress testing, as well as the means of regularly disclosing climate risk information to interested stakeholders
What you need to do
- Consider the guidance set out in CPG 229 and how it applies to your organisation, noting that it is still in draft form
- Review existing governance and risk management practices, and investigate the feasibility of scenario analysis and climate risk disclosures
Background
On 22 April, APRA released for consultation a draft of its proposed prudential practice guide (PPG) relating to financial risks related to climate change, CPG 229 (Draft Prudential Practice Guide).
CPG 229 does not impose new requirements in relation to climate risks. Rather, it is intended to support compliance with APRA’s existing risk management and governance requirements (in particular, Prudential Standards CPS 220 Risk Management (CPS 220), SPS 220 Risk Management (SPS 220), CPS 510 Governance (CPS 510) and SPS 510 Governance (SPS 510)) and provide guidance to assist an institution to manage climate risks.
Overview
The table below summarises the key points in CPG 229:
Guidance | Comments |
Overall objectives | The three key objectives of CPG 229 are for entities to:
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The financial risks of climate change | APRA has categorised the financial risks of climate change into three areas:
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The impact on existing risks | CPG 229 stresses the need to recognise and manage the interaction between climate risks and business activities, as well as the compounding effect climate risks can have on existing financial risks, including:
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Governance |
The ultimate responsibility for good governance rests with an entity's board of directors (see prudential standards CPS 510 and SPS 510). APRA therefore considers it prudent practice for the board to seek to understand and regularly assess the financial risks arising from climate change that affect the institution, now and into the future. The board may delegate certain functions of the management of climate risks but, as with other risks, needs to maintain mechanisms for monitoring the exercise of this delegated authority. Board-level engagement is important to ensure that work on climate risks holds sufficient standing within an institution, and gives the board the requisite institution-wide insights to strategically respond to the risks. APRA also expects that a prudent board should understand and be able to discuss climate risk at meetings, even if that requires training. Periodic reviews of climate risks and opportunities (both short and long-term) should also be enshrined in meeting agendas. Furthermore, an institution's senior management should also shoulder climate risk responsibilities, including managing risk exposures, reviewing frameworks and providing recommendations relating to climate risks to the board so they stay informed. Finally, senior management should also ensure that there are adequate resources and skills allocated to climate risk throughout the entity. |
Risk management |
Under CPS 220 and SPS 220, the board of an APRA-regulated institution is ultimately responsible for both the institution’s risk management framework, and for the oversight of its operation by management. The monitoring and management of all material risks also falls on senior management. APRA considers it prudent for climate risks to be considered within an institution’s existing framework, including the board approved risk appetite statement, risk management strategy and business plan. An institution should include the management of climate risks within its written risk management policies, management information, and board risk reports. Where climate risks are material, this may require updating existing risk management policies and procedures. When monitoring these risks, institutions are encouraged to utilise both a qualitative and quantitative approach, including developing appropriate metrics. Data should be used from both publicly available and proprietary sources, and potentially from external experts where necessary (including academics, specialist consultants, and scientific bodies). Finally, robust risk reporting procedures also help facilitate well-informed decision-making. The board and senior management can also use these reports to understand and review the activities exposed to climate risk and make executive decisions appropriate to the institution. |
Scenario analysis | A part of prudent climate risk management involves institutions developing capabilities in climate risk scenario analysis and stress testing, or to have access to external scenario analysis and stress testing capabilities, to inform their risk identification in both the short and long term. Climate risk scenario analysis and stress testing is a developing area and APRA expects approaches to evolve and mature over time.
Scenario testing should be tailored to each institution's size, market exposures and geographical locations. It should involve both short-term assessments in line with business planning cycles, as well as longer term assessments that factor in scenarios such as future global temperature rises, transitions to a lower-emission economy (both orderly and disorderly), and natural disasters and catastrophes. Scenario testing should be communicated with the board and senior management to inform business planning and strategy setting, as well as setting and reviewing the institution’s overall climate risk management approach. |
Disclosure |
The disclosure of climate risk information allows interested stakeholders to assess an institution’s resilience. There is increased demand from investors and other stakeholders for disclosure on climate-related risks, a lack of absolute certainty in relation to climate risks’ future impacts should not be considered a reason to avoid disclosure of exposure to these risks. |
Next steps
APRA is requesting industry feedback on CPG 229 by 31 July 2021, with the intention of finalising the standard by the end of 2021. It will then be available as a formal APRA prudent practice guidance document
Author: Dominic Tran, Senior Associate
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