Australia’s superannuation funds will be required to face stress tests to assess their preparedness to deal with the financial impacts of climate change and the transition to a low-carbon economy.

The Australian Prudential Regulation Authority (APRA) this week wrote to all regulated institutions, including super funds, outlining plans to develop a prudential practice guide focussed on risks from a changing climate. The guide will include a climate change vulnerability assessment.

APRA said its risk assessments would begin next year with the nation’s deposit-taking institutions, such as banks and credit unions. The second phase would be insurance companies and superannuation funds.

APRA wants these institutions to estimate the potential physical impacts of a changing climate, including increased extreme weather events, on their balance sheets.

APRA executive board member Geoff Summerhayes said in his letter that the effects of a changing climate extended to all sectors of the economy.

“Over the past couple of years, APRA has, supported by other agencies of the Council of Financial Regulators, sought to ensure regulated entities are actively seeking to understand and manage the financial risks of a changing climate, just as they would other economic and operational risks,” he said.

APRA’s 2018 climate change survey showed that many large entities understood the financial risks and opportunities from a changing climate, and described efforts taken by some entities to embed climate change considerations into risk management frameworks.

APRA plans to conduct “deeper” supervisory assessments of each entity that participated in APRA’s 2018 climate change survey. These assessments are due to be completed mid-2020.

“However, this work (the climate change survey) also highlighted the need to address the climate data deficit, to quantify the likely impact of the physical, transitional and liability risks of climate change and accurately assess and appropriately price these risks,” he wrote.

“This needs to ultimately be tackled through scenario analysis, stress testing and disclosure of market-useful information.”

Geoff Summerhayes, executive board member at APRA

“This needs to ultimately be tackled through scenario analysis, stress testing and disclosure of market-useful information.”

He added: “Effective action now on these fronts will promote strong understanding and management of the potential financial impacts of a changing climate on current and future business prospects, allowing well-managed entities to minimise costs and optimise benefits.”

Regulators and supervisors around the world are developing responses to the climate data deficit. In particular, insights gained through climate-related scenario analysis are being considered, including through the Central Banks and Supervisors Network for Greening the Financial System (NGFS).

Many industry participants have indicated they would like APRA to provide more information on better industry practice in relation to climate-related financial risks, as well as greater clarity on regulatory expectations.

APRA plans to develop and consult on a climate change financial risk prudential practice guide (PPG) which would cover all industries.

APRA office logo

APRA plans to develop and consult on a climate change financial risk prudential practice guide (PPG) which would cover all industries

The vulnerability assessment will involve entities estimating the potential physical impacts of a changing climate, including extreme weather events, on their balance sheet, as well as the risks that may arise from the global transition to a low-carbon economy.

The scenarios that will form the basis of the vulnerability assessment will be consistent with practices being developed and utilised by peer regulatory authorities internationally, according to the APRA letter.

The authority will co-ordinate this work with the corporate regulator, the Australian Securities and Investment Commission (ASIC), and the Reserve Bank of Australia to ensure consistency in the application of scenario analysis.

The regulator will also seek input from Australia’s Commonwealth Scientific and Industrial search Organisation (CSIRO) and the Bureau of Meteorology.