How should the C-suite respond to the APRA guidance on managing the financial risks of climate change?

More and more financial institutions in Australia are taking action on climate change – not for ideological reasons, but because it’s just good business.

The latest milestone in the quest to tackle climate change is CPG229 Climate Risk as a Financial Risk guidance released by the Australian Prudential Regulation Authority (APRA)[1]. CPG 229 provides guidance for banks, insurers and superannuation trustees to govern and manage climate-related risks and opportunities.

To spark real change and take advantage of the net zero transition, financial institutions must embed climate action into their organisational cultures and the way they do business. Board members and C-level executives have a fiduciary duty to properly incorporate climate into decisions and strategy.

In this article, we’ll set out nine recommendations based on extensive experience supporting financial services companies across the globe with their climate programmes. This spans everything from measuring financed emissions, through to managing climate risk to developing net zero strategy.

Leading from the front to drive organisational change

How can executives ensure that change cascades throughout their organisation?

1. Make climate everybody’s job. Leaders should understand and acknowledge that financial institutions will need to do things differently. Sustainability activities have historically been managed by a separate team and seen by those ‘in the business’ as an extra cost. Tackling climate change should be a business-wide priority, where every function or business unit is clear on the role they have to play. 

2. Quantify the opportunities, not just the risks. Addressing climate change requires a cultural and mindset shift and a recognition that commercial opportunities will exist as the world starts to tackle climate change more broadly. Teams should be incentivised to find and embrace these opportunities.

3. Embrace external concern. A shift in organisational mindset aligns the internal response with the growing expectations of external stakeholders, including investors and customers. Financial services institutions are expected to use their significant influence and market presence to be a force for good.  An obvious consequence of not meeting this expectation being that investors and customers are happy to walk away from those that are failing to act on the climate change appropriately. 

4. ‘Climate’ means people - remember the ‘S’ in ESG. Leaders should ensure their teams take a balanced view of the impacts of decisions, including the social impacts of change.  In the climate sense, this is known as the ‘just transition’ - ensuring that the move to a greener economy benefits everyone. Many thousands of Australians are employed in high-emitting sectors like oil and gas, mining and agriculture – particularly in rural areas. If financial services companies suddenly divest, the ensuing job losses could devastate those communities and impact other portfolios, such as residential mortgages. This ultimately requires a connected climate risk assessment across portfolios.

5. Look at climate as an opportunity to deepen customers relationships. Firms should invest in helping counterparties, customer groups and geographies transition. For example, hydrogen could help decarbonise the oil and gas sector while protecting jobs, but it’s currently very expensive to manufacture. Investment can bring that cost down and generate economies of scale.

6. Set your business up for success. It’s vital financial institutions have the right policies, processes and systems to establish and deliver on credible climate commitments. The critical first step is establishing a strategy to acquire the right climate data, embed it into systems and processes, and use it in risk assessment, strategy and decision-making.

7. Drive transparency as your company’s best defence against greenwashing.  Climate risk data and assessment is continuing to increase in sophistication, and frameworks such as the TCFD2] provide useful ways to disclose.  Companies’ disclosures should be pragmatic, balanced, clear and data-led to avoid greenwashing risk.  Analysis, any supporting assumptions, methodologies and the level of certainty should be clear to investors and other stakeholders.  As key decision makers, it is important to understand and communicate the boundaries of known and unknown then proceed. 

8. Embed climate change scenario analysis into risk management and strategic processes.  Scenarios help with risk identification, because they show how different levels of global warming will impact financial institutions. Balance sheets aren’t static, so as exposures change, businesses need to evolve in response to this. Climate change scenario models help financial services companies view and manage climate risk at a granular level. One example of this is the climate change scenario model that Baringa built and has since been acquired by Blackrock to enhance its Aladdin Climate technology.  

9. Review your risk tolerance and aggregate risk. CPG 229 recognises that climate risk influences and amplifies other risks, so it needs to be properly incorporated into the risk management function, and ultimately how the business wants to manage the emerging opportunities. A change in risk appetite is needed to comprehensively address climate risk. This doesn’t mean new risk appetite statements, rather the impact of climate risk should be evident in how the business will face into the changes needed to address a transitioning world and changing climate.

There’s much work to be done, but there are huge opportunities for financial institutions in Australia to get ahead on the journey of combating climate change. Those that move first will take on risk, but they’ll also reap the greatest rewards.

[2] APRA finalises prudential guidance on managing the financial risks of climate change | APRA

To learn more about how Baringa can help your business tackle climate change, please contact us.