APRA, ACSI issue new guidance on climate risk

New policy guidance from APRA and ACSI shows boards how to better manage climate risks and opportunities as part of their governance frameworks. Directors are also warned that those who fall short on managing these risks may be targeted by investors.

In April, the Australian Prudential Regulation Authority (APRA) published draft guidance for consultation to assist APRA-regulated entities in managing climate-related risks and opportunities as part of their existing risk management and governance frameworks.

The draft Prudential Practice Guide CPG 229 Climate Change Financial Risks (CPG 229) outlines APRA’s view of sound practice in areas such as governance, risk management, scenario analysis and disclosure. It does not create new requirements or obligations for companies. Instead, it is designed to allow each organisation to adopt an approach that is appropriate for its size, customer base and business strategy. 

Given the unique and long-term nature of the risks, APRA chair Wayne Byres says processes to measure, monitor and manage climate-related financial risks are still developing. “The prudential practice guide doesn’t direct or prevent APRA-regulated entities making any particular business or investment decision,” he says. “Rather, it is aimed at ensuring decisions are well-informed and appropriately consider both the risks and opportunities that the transition to a low carbon economy creates.” 

APRA says CPG 229 is aligned with the recommendations from the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) and was developed in consultation with both domestic and international peer regulators. Consultation is open until 31 July this year.

Governance recommendations

In terms of governance, the draft guidance identifies that the board would be expected to:

• Understand climate risk including through appropriate training.
• Set clear responsibilities for management and hold them accountable.
• Periodically re-evaluate risk and opportunity and incorporate this into business plans and strategy.
• Assess risk and opportunity over both the short and long term.
• Ensure risk management frameworks incorporate climate risk where it is material.

Boards would be expected to have written evidence of management of climate risk, including through policies and board reports. Quantitative metrics to measure risk would be used, such as portfolio exposure to geographic areas. 

Risk management might involve working with clients or investees to improve their risk profiles. Entities may apply limits to exposure or de-invest where they believe risk is too great. Material climate risk exposures, including monitoring and mitigation actions, would be regularly reported to the board and senior management.

The guide says APRA-regulated entities should carry out scenario analysis and develop related capabilities. Qualitative narrative-driven scenario analysis may be used, but more advanced quantitative analysis is preferred. Scenario testing should look short-term, but also focus on long-term exposures on various scenarios (including temperature rises of 2°C vs 4°C by 2100 and an orderly transition to a low carbon economy). It suggests incorporating advice from academics and experts, using robust forward-looking data and documenting the process.

The guide does not propose any mandatory disclosure but encourages additional voluntary disclosure in accordance with the TCFD framework.

ACSI issues warning on votes against directors

Meanwhile, the Australian Council of Superannuation Investors (ACSI) has updated its climate change policy to help companies, particularly those which are highly exposed, improve their approach to climate risk for the long-term benefit of investors. It says it may recommend votes against directors at companies that fall short on managing their climate-related risks from 2022. 

ACSI CEO Louise Davidson AM GAICD says this will be done on a case-by-case basis and will occur after extensive engagement. The focus will be on individual directors most accountable for the oversight of climate change-related risks — for example, chairs, chairs of the risk committee or chairs of the sustainability committee or similar. 

ACSI will initially focus on ASX 200 companies in climate-exposed sectors, including energy, utilities transport, and materials. The updated policy reveals what ACSI and its members expect of companies exposed to material climate-related risks. It advocates disclosure through the TCFD, undertaking scenario analysis, setting Paris-aligned emission targets and aligning policy and advocacy.

Investors have their say on climate policy

The policy also supports an investor “say on climate” and calls on climate-exposed companies to adopt an advisory investor vote on climate reporting at company annual general meetings in 2022. ACSI says commitments for advisory “say on climate” votes have already been secured for the AGMs of Woodside, Santos, Rio Tinto, and Oil Search in 2022. “The vote will allow investors to voice concerns where issues arise and provide further focus, transparency and accountability,” says Davidson. 

The AICD position is that it is preferable for strategy in this area to be set by the board, rather than at the AGM.

Other large investors have also stressed they have climate change risks firmly in their sights. In his 2021 letter to CEOs, for example, BlackRock chair and CEO Larry Fink noted there was no company whose business model would not be profoundly affected by the transition to a net zero economy.

“As the transition accelerates, companies with a well-articulated long-term strategy, and a clear plan to address the transition to net zero, will distinguish themselves with their stakeholders — with customers, policymakers, employees and shareholders – by inspiring confidence that they can navigate this global transformation,” he said. “But companies that are not quickly preparing themselves will see their businesses and valuations suffer, as these same stakeholders lose confidence that those companies can adapt their business models to the dramatic changes that are coming.”

Other developments suggest the focus on climate change risks is only set to accelerate. One is the European Parliament’s vote in March to introduce a carbon levy on imports from countries with weaker emission rules, including Australia.

On 21 April the European Commission released a draft corporate sustainability reporting directive that significantly extends the non-financial reporting directive.

This would extend the scope and the nature of sustainability reporting including to unlisted firms. The commission estimates this would increase the number of entities required to make sustainability disclosures from around 11,600 to approximately 49,000. Reporting standards will be drawn up, with the first set of standards due for adoption by 31 October 2022. The new directive may affect Australian firms trading in the EU.

Another development is the settlement by super fund Rest in November of a lawsuit brought by a member who alleged the super fund failed to provide information related to climate change business risks. Rest subsequently promised to take active steps to consider, measure and manage these risks.

New Zealand has become the first country in the world to introduce legislation requiring certain financial sector participants to disclose the impacts of climate change on their businesses and explain how they will manage the risks and opportunities. 

The UK is also moving ahead with its limited mandatory TCFD disclosure framework. The AICD’s sister organisation, the Institute of Directors, has supported the introduction of mandatory climate reporting and suggested it be extended to more entities.

In an official update to their landmark 2016 legal opinion, lawyers Noel Hutley SC and Sebastian Hartford Davis warned in April that directors who rush to make net-zero pledges without fully examining their organisation’s ability to meet these goals could be guilty of “misleading or deceptive conduct” and vulnerable to regulatory or legal penalties. They added that directors also have a legal obligation to act on climate risk, not just to disclose it, or face accusations of “greenwashing” that could carry real legal consequences.

Similarly, the Australian Securities and Investments Commission recommends that listed companies with material exposure to climate risk consider reporting under the TCFD framework.