In rapid-fire succession, New Zealand’s key financial regulators have carved out the financial sector’s responsibility for managing and mitigating climate risk. Last week the External Reporting Board (XRB) launched its three-step consultation on climate-related financial disclosure standards for large listed entities, insurers and fund managers. Hot on its heels came yesterday’s missive from the Reserve Bank of New Zealand (RBNZ), which outlined climate change scenario-based stress tests for banks, insurers and non-bank deposit takers, supported by guidance aligned with XRBs standards; and its decision to embed climate risk management into its core functions of financial stability and monetary policy.

Climate-related financial disclosures

From December 2022, when the Climate-related Disclosures standards are due to be launched, companies mandated to report will be held to account by the Financial Markets Authority (FMA) for timely and accurate disclosure of their climate-related risks.

The Governance and Risk Management consultation document (NZCS1), is the first of three consultation documents to be issued between now and July 2022. XRB CEO April Mackenzie advised companies to use the consultation drafts to consider their position and processes for climate risk assessment, target setting, risk management processes and governance frameworks. While the first reporting period isn’t due to commence until 01 January 2023, her advice to reporting entities was clear - get started now; and don’t come at this from a compliance lens.

The standards have been developed in alignment with the Taskforce on Climate-related Disclosures (TCFD) recommendations and will likely align with the international climate related disclosure standards due to be launched by the International Sustainability Standards Board (ISSB) in the first quarter of 2022. The Climate-Related Disclosure Concepts (CRDC) themselves are comparable with a standard accounting conceptual framework. In other words, the nature of information disclosed should be neutral, comparable, verifiable, relevant, timely, complete, free from error and non-complex.

While Ms. Mackenzie emphasized that relevant information should not obscured by insignificant detail, the information disclosed must be sufficient to enable an accurate evaluation of the reporting entity’s overall risk profile, and the quality and robustness of its risk management activities. In this regard, reporting entities will need to make a value judgement on what is deemed to the appropriate level of detail to ensure the disclosure objective is met.

Climate risk stress test

For the Reserve Bank’s part, climate risk has been woven into its stress testing regime. The RBNZ’s inclusion of climate stress tests is based on selected climate change scenarios and is consistent with the TCFD requirement for entities to disclose their strategies for managing the risks across a range of scenarios.

“Intensity and/or frequency of weather events lead to lower profitability and dividend payments for insurers. If sustained, this could lead to higher premiums in the future. Physical and transition risks from climate change will be a focus of our industry stress testing over coming years”, noted Deputy Governor and General Manager for Financial Stability Geoff Bascand during today’s release of the  first General Insurance Industry Stress Test (GIIST) from RBNZ, which includes climate risks.

According to RBNZ’s Governor Adrian Orr, climate risk presents a direct threat to financial stability, hence its focus on climate risk stress tests for insurers and banks. Careful climate risk management via a smooth transition to a low carbon economy will also be key to managing inflation, he says. The regulator is researching how climate impacts on the economy via “transmission mechanisms”. As carbon prices rise, investment in some sectors and withdrawal from others play out on the economy’s growth rate, impacting inflation. With transition gaining pace, “Some of the price pressures we will see will lead to … sustained, higher generalized prices … we are already seeing that in food prices globally and energy prices, transport at present” Adrian Orr noted during yesterday’s online announcement.

The extent that price shocks, not just from the energy sector, eventuate into persistent price instability and inflation, will determine which monetary policy levers are pulled. The RBNZ is still researching how it can leverage monetary policy to counter impacts of climate change.