Climate Change: Financial Services in the Cross Hairs


Climate Change: Financial Services in the Cross Hairs

The Taskforce on Climate Related Financial Disclosures (TCFD) of the Financial Stability Board (FSB) has released its recommendation to disclose climate related financial risks in mainstream financial statements. Deloitte’s Climate Risk Actuary Sharanjit Paddam and Sustainability Partner Shailesh Tyagi look at the detail and considers what it means to Australian companies, what we should do and why.

The FSB Reports into the G20 which is clearly concerned about how best to mitigate the global risks of climate change. And while the TCFD disclosure recommendations are presently voluntary, we expect that investor and competitive pressure will lead companies to adopt these standards.

The Final TCFD Recommendations Report was released on 29 June 2017. It recognises the multi-faceted and pervasive impact of climate change on all organisations. It reflects the fact that climate change presents risks and opportunities for companies and that these can (and most likely will) have financial impacts.

In fact Aviva, AXA, BHP, Shell, Dow Chemical, HSBC, ICBC, Swiss Re, Unilever, and many others have already issued statements supporting the recommendations and are expected to adopt the standards. BlackRock, the world’s largest asset manager, is also asking the companies it invests in serious questions on how they assess and manage climate risk.

So increasingly the response to climate change is from companies, not government; and is being driven by stakeholders and hard-nosed investors.

In February 2017, Geoff Summerhayes of APRA stated that climate risks need to be considered as part of prudential risk management in the financial sector and calls like this from regulators are expected to continue.

NSW Barrister, Noel Hutley SC also recently found that company directors who fail to properly consider and disclose foreseeable climate-related risks to their business, could be in breach of their statutory duty of care and diligence under the Corporations Act.

So what are the risks of climate change? The FSB’s Taskforce considers climate risks in two categories:

  1. Risks related to the transition to a lower-carbon economy; and
  2. Risks related to the physical impact of climate change.

Transition risks arise from:

  • Policy changes, such as restrictions on GHG emissions
  • Technological changes, such as cheaper renewable energy sources
  • Reputation risks, community or consumer pressure.

These may result in changes in economic activity in certain sectors, such as lower tourism due to the loss of the Great Barrier Reef (see our Deloitte Access Economics recent report here). This potential loss will have implications for industries relying on those sectors, such as airlines.

Banks, insurers and superannuation funds that invest in industries exposed to transition risk, such as coal mining, also carry an investment risk that these assets will suddenly drop in value.

For financial institutions, this investment risk is likely to be the most significant risk from climate change in the short to medium term. In the longer term, lower economic activity due to transition to a lower-carbon economy may also become significant – e.g. reduced bank lending to tourism and mining industries as customers.

Physical risk

Physical risk is also important for insurers, banks and other financial institutions that invest in property. Increased natural disasters, such as cyclones, bushfires and coastal inundation may result in increasedmaintenance costs, increased insurance costs and loss in the value of property assets that are no longer accessible or useable.

A local Australian example was the properties in Narrabeen, a suburb of Sydney that experienced severe coastal inundation during May 2016. Another recent example is the fall in gross state product in Queensland following Cyclone Debbie, when business activity fell, and companies were unable to ship goods to overseas markets.

For insurers

Physical risk may lead to increased demand and prices for property insurance in the short-term, but in the longer term insurance may become unaffordable and then unavailable, threatening the top line of insurers as well as raising reputational issues. While insurers can reprice the risk on an annual basis, in the longer term it is this loss of business which needs to be assessed and managed.

For banks

Things are perhaps worse for banks since home loans are written for longer periods with no annual repricing. Higher insurance and maintenance costs may lead to serviceability issues on loans as household budgets are stretched. Increased coastal inundation (which is not usually covered by insurance), may result in higher defaults and losses.

What can companies do? To consider and disclose climate risks Boards of Directors need to ask their companies to:

  1. Identify and measure climate risks and opportunities to the company across all of its operations, including lending, underwriting, investments and business strategy;
  2. Review how these risks are assessed and managed within the overall risk management framework for the company;
  3. Develop a strategy to manage climate risk and any opportunities on the company’s business, strategy and financial planning;
  4. Undertake scenario testing, including a 2 degree C or lower scenario, and assess the impact on the company’s business;
  5. Develop metrics and targets to measure the company’s performance in line with its strategy and risk management process;
  6. Measure and disclose greenhouse gas emissions and the related risks;
  7. Ensure and document appropriate governance and controls for the company’s management of climate risks and opportunities, including regular oversight by the Board; and
  8. Consider the disclosure of the above items to all stakeholders in line with the TCFD recommendations.

Each of these programs will need both strategic and tactical responses from the company.

For example, while most insurers have a strong capability in modelling catastrophes, these models only have a one year time horizon. Significant changes to existing models, or new models entirely, will be required to assess climate change which is likely to act on a longer time horizon.

Under the Taskforce’s climate disclosures recommendations, companies must undertake scenario testing, to measure the impact on their financial position, and to set strategies to mitigate any adverse impacts and seize commercial opportunities.

The warning for Australian banks is that they have higher concentrations of residential lending assets than any other developed nation.

For everyday Australians, our homes are exposed to weather events, our insurance costs will increase with increasing extreme weather, and our superannuation is exposed to fossil fuel investments. Investors and customers are expecting Australian financial institutions to lead the charge for the management and disclosure of climate risk. Those that seize this opportunity stand to gain a compelling competitive advantage.

Sharanjit Paddam is a Principal in Deloitte Actuaries & Consultants and convenes the Actuaries Institute’s Climate Change Working Group, and Shailesh Tyagi is our subject matter expert on climate risk assessments and was part of the TCFD scenario analysis working group from Deloitte.

This article was first published in Asia-Pacific Banking & Finance.

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