Climate change risk increasingly important in finance

Speaking at the recent ASIC forum, Macquarie Bank’s managing director and chief executive officer, Mary Reemst, noted that a “long-term mega trend” impacting financial institutions worldwide was climate change and sustainability.

Ms Reemst told the ASIC Forum 2019 that climate change was “creating both risk and opportunity”, adding that while the concept was not a new one, it’s impacts have only recently been formally explored in the finance sector.

She said: “The financial risk posed by climate change are increasingly focused on regulators, supervisors, governments and corporations… Many companies have signed up to the recommendations of The Task Force on Climate-related Financial Disclosures (TCFD) and going forward, we expect to see additional disclosures about climate risk from the corporate sector.”

While the TCFD has developed voluntary climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers and other stakeholders, Ms Reemst noted that in Australia, both APRA and ASIC have been increasingly highlighting the financial risks of climate change.

Indeed, in March of this year, APRA released an information paper called Climate Change: Awareness to Action, which found that the majority of financial institutions now think climate risk has changed as a risk and are taking steps to manage it.

“Climate change is increasingly seen as a material prudential risk. A shift from awareness towards action in response to these risks is underway,” the prudential regulator wrote in its report.

Ms Reemst also highlighted that earlier this year, the governors at the Bank of England and those at France’s central bank issued a joint open letter with the chair of the climate-focused Network for Greening the Financial System (NGFS), warning about the financial risks of climate change.

“If some companies and industries fail to adjust to this new world, they will fail to exist,” they wrote.

Ms Reemst said: “Their message is quite clear – climate change is a financial risk that corporations must take into account in their own businesses. Supervisors will increase their surveillance of these risks and, in particular, there will be increasing focus of disclosure of climate-related risks and how firms manage them.

“For avoidance of doubt, it is incumbent on a financial institution to identify the risks affecting that institution and to develop appropriate risk management.”

International perspectives

Several international regulators have agreed with Ms Reemst at the ASIC Forum last week that regulatory action in the financial space regarding climate change and reporting was ramping up.

Ashley Alder, the chairman of the International Organisation of Securities Commissions (IOSCO) and CEO of the Securities and Futures Commission of Hong Kong, told delegates that sustainability was “a relatively long-range challenge”, and while there were many non-governmental and inter-governmental organisations working in this space to create standards (such as the United Nations), “there isn’t a great deal of regulatory content around this”.

“I actually think that you will be surprised to the degree to which the momentum will increase around the expectation of businesses to describe with more and more precision what risks they are running... not their effect on the environment themselves, but the risks they are running in the context of policy to transition to a lower carbon world,” Mr Alder revealed.

He continued: “Or, to the extent that policy may or may not succeed, the physical risks of climate change upon those businesses. And that is really how this issue of regulation and climate change is currently being positioned; it is being positioned around financial risks, which gets straight into the remit of central banks and also the regulators, the securities regulators, etc.

“It’s a question of gauging what those financial risks might be and as Mark Carney (the governor of the Bank of England) has put it: How do you get better information to price those risks? And that flows right through from asset management to the company businesses themselves to intermediaries, to credit rating agencies, etc.

“So, there is a whole strand around that as well, which I think the financial services industry might be surprised at how fast this will happen,” Mr Alder said.

Likewise, Maureen Jensen, chair and CEO of the Ontario Securities Commission, said that her focus was also on “sustainable investment and sustainable reporting” at the moment.

The Canadian province’s financial regulator continued: “This is another global initiative that is being talked about more and more. It is being driven by large-scale clients and what we’re seeing more and more is that retail clients want to invest in businesses that are focused on sustainable investment.

“So we, together with the Canadian Securities Administrators, are looking at improving the rules that we have on ESG disclosure focusing on risks and while we are not yet on a harmonised position, when we are, it will be published and put into rule books.”

Climate change litigation is growing

The comments come as societies worldwide become increasingly concerned about the impact of the environment on business and the economy, and countries look to transition to a low-carbon economy in the coming decades as part of the Paris Agreement.

Further, a recent Director Sentiment Index undertaken by the Australian Institute of Company Directors found that climate change was the number one long-term issue that company directors want the federal government to address, particularly given that corporate governance practices and the disclosures of companies are coming under increased regulatory scrutiny.

Law firm Ashurst also recently issued a briefing about the potential liability of companies and directors in relation to climate change, outlining that it can have “significant implications for the obligations of companies and their directors, even when it does not pose any direct physical risk to business activities”.

Partners John Briggs and Jeff Lynn commented: “Companies and their directors are expected to consider and understand climate change risks, and ensure they are disclosed and, where appropriate, mitigated.

“Australian regulators, including ASIC and APRA, are increasingly attuned to these obligations and have been vocal in their focus and awareness of climate change and associated liability. However, regulators are not the only ones seeking to ensure that companies and their directors consider and respond to climate risks, climate change litigation is a growing global trend.

“Although the outcome of the federal election indicates that significant new legal transitional risks may not emerge at a Commonwealth level, it’s expected that individual states and territories may play an increased role in renewable energy and emissions reduction requirements,” they said.

“Companies and their directors must monitor these developments and ensure that their practices meet the increasingly well-understood obligations.”

Partner James Clarke noted that several legal proceedings have already been launched in Australia in relation to climate change disclosures and company management and warned that “this trend is expected to continue”.

“While there is an increasing understanding about associated obligations and liabilities, there remains a lack of detailed guidance for companies and directors in how to appropriately respond,” Mr Clarke said.

“Australian courts will most likely consider that climate change risks are foreseeable, and that directors who fail to consider those risks may be liable for breaching their duties of care and diligence. At the same time, key regulators have increasingly strengthened their statements in relation to climate change risks,” he added.

Ashurst advised that business directors consider whether their businesses have an adequate understanding of their exposure to climate risks (both physical and transitional) and that their business and its directors satisfy all governance and disclosure obligations, and “closely follow” regulatory changes now that the federal election is behind us.

[Related: Major banks endorse UN’s responsible banking principles]