APRA releases its finalised prudential guidance on the management of climate change financial risks
10 December 2021
What you need to know
- Following extensive consultation, APRA has released the final version of Final CPG 229, with this forming part of APRA's broader portfolio of work on climate change risks.
- Final CPG 229 does not create any new regulatory requirements or obligations for institutions but rather, it provides broad guidance to support better-informed decision making by APRA-regulated institutions in managing climate change financial risks within their existing risk management approach.
- APRA has maintained a principles based approach to the guidance, despite receiving feedback from numerous stakeholders requesting more prescription and guidance for addressing climate related risks.
- The drafting of Final CPG 229 affirms the links between this guidance and existing prudential guidance, including those relating to risk management governance and disclosure.
What you need to do
- Take steps to understand the specific climate-related risks that impact your institution's business operations and consider your tolerance for such risks. This may include clearly articulating what targets are in place around items such as lending activities and other opportunities to support the climate transition such as sustainable financing.
- Review your existing governance, risk management and other arrangements to determine whether these are adequate for managing climate-related risks.
- Consider and adopt the guidance provided in Final CPG 229 in a manner that is proportionate to the size, business mix and complexity of your institution's business, including, if required, by incorporating climate change scenario analysis and stress testing, determining the appropriate level of capital adequacy and ensuring climate risk information is disclosed to interested stakeholders.
Background
On 26 November 2021, APRA released Final CPG 229 on the management of climate change financial risks. The finalised guidance reflects only minor changes to the draft version circulated for consultation in April 2021 (Draft CPG 229) and is accompanied by a Response Paper. Both documents can be accessed here.
As outlined in a previous Financial Services Update, CPG 229 does not impose new requirements in relation to climate risks but rather, it provides broad guidance in respect of how APRA-regulated institutions can manage such risks in the context of the existing risk management and governance prudential requirements. The guidance is a direct response to requests from industry for greater clarity of regulatory expectations in respect of climate-related risks and it relevantly provides examples of better industry practice to support more informed decision making in this regard.
The submissions received from industry on Draft CPG 229 were generally supportive of the guidance. The majority of the feedback provided relates to articulating targets, scenario analysis, capital adequacy, disclosure and risk management.
In response to the consultation, APRA has sought to clarify guidance in some areas of CPG 229, though it has maintained a principles-based approach in Final CPG 229 so as to ensure that the guidance is able to adapt to the evolving external environment and compliments to existing prudential requirements.
What has changed?
Following the consultation on Draft CPG 229, the following key changes have been made to the prudential guidance:
| Topic | Changes |
|---|---|
| Governance | Final CPG 229 has been revised to remove the materiality threshold relating to the climate risks that are to be addressed by an APRA-regulated institution. Accordingly, APRA's expectation is that all climate risks are managed within an institution's overall business strategy and risk appetite, while the board will be required to demonstrate its ongoing oversight of these risks. The finalised guidance is also expressly linked to Prudential Standards CPS 510 (Governance), which reaffirms the complimentary nature of this standard with the existing board responsibilities for the sound and prudent management of an institution's business operations. However, APRA has refrained from making a direct connection between climate risk and remuneration, noting that boards should maintain the discretion to design a remuneration framework that is appropriate to their institution providing that this meets the requirements of Prudential Standard CPS 511 (Remuneration). |
| Risk management | In light of the submissions received on Draft CPG 229, APRA has revised CPG 229 to incorporate guidance on setting targets to assist businesses in managing climate-related risks and opportunities. This revision reflects APRA's recognition that setting targets for climate-related metrics is a valid approach to quantifying business expectations, and holding businesses and individuals accountable. Specifically, Final CPG 229 notes that a prudent institution may identify specific climate-related levels, thresholds, quantities or qualitative outcomes that it wants to achieve, over a defined time horizon, to assist in dealing with the climate risks that arise in the context of its business. APRA has further noted that, in setting these targets, institutions should consider how their chosen metrics align with broader net zero commitments and Paris Agreement-aligned targets. The finalised guidance is also expressly linked to Prudential Standards CPS 220 (Risk Management) to reiterate obligations under this standard without creating additional obligations. Moreover, while APRA has broadly retained its guidance on risk identification and risk monitoring, it has provided further background on how institutions can assess scope 3 emissions. |
| Capital adequacy | APRA's view remains that institutions will need to consider the interactions between climate-related risks and capital adequacy, noting that it expects institutions to take steps to continue to monitor their capabilities in this area. However, it has revised Final CPG 229 to recognise different avenues for considering and recording climate change risks on capital adequacy. On this note, APRA has acknowledged respondents' concerns relating to the potential difficulties with capturing these risks within the ICAAP, including that shorter time horizons of the ICAAP may be inconsistent with the longer time horizons of climate change financial risks. The ICAAP is, however, still expressly referenced in CPG 229 as a viable option for institutions in meeting the capital adequacy requirements. |
| Scenario Analysis and Stress Testing | Numerous stakeholders raised concerns with regards to the lack of prescription in Draft CPG 229, with it being noted that increased prescription would improve comparability between institutions and assist those institutions that are concerned that they may lack adequate capabilities or resources to address climate-related risks. Yet, while APRA noted that it recognised the value in achieving increased comparability between the scenario analyses conducted by different institutions and also in providing best practice case studies, it has not prescribed key design features for scenario testing or otherwise provided any case studies in Final CPG 229 at this stage. APRA considers that doing so would limit institutions and constrain innovation in an area that is still emerging. APRA has, however, amended CPG 229 so as to make it clear that where institutions voluntarily disclose the outputs of their scenario analysis, they should disclose the key design features influencing the results and be capable of explaining why the scenarios used were appropriate for assessing the specific climate-related risks faced by the business. It has also made minor changes to its guidance on specific scenarios so as to align with international standards and the current understanding of potential future climate trajectories. |
| Disclosure | Although various respondents requested APRA to mandate, or at least expect, disclosures to be made in line with international peer jurisdictions, APRA has not made any substantive amendments to the disclosure guidance that was set out in Draft CPG 229. APRA has, however, strengthened Final CPG 229 so as to highlight that best practice for institutions would be to make disclosures in line with the Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD) framework. |
| Matters specific to superannuation | APRA also received submissions in respect of aligning CPG 229 with existing provisions in Prudential Standard SPS 530 Investment Governance (SPS 530) and Prudential Practice Guide SPG 530 Investment Governance (SPG 530), including on how climate change financial risk should be considered by RSE licensees in investment decision making. No updates have been made to CPG 229 in this regard, though APRA has flagged that this feedback will be considered as part of its proposed enhancements to SPS 530 and SPG 530. |
What now?
APRA has announced that it will be rolling out a climate change financial risk survey, with this intended to assist APRA in understanding the alignment between the management of climate-related risks, Final CPG 229 and the TCFD recommendations.
APRA has also been undertaking a Climate Vulnerability Assessment (CVA) with Australia's five largest banks to provide insights into the potential financial exposure of institutions, the financial system and economy to the physical and transition risks of climate change. The findings from this first assessment will be aggregated and shared more broadly early in 2022.
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Authors: Elena Lambros, Partner(Ashurst Risk Advisory); Silvana Wood, Partner; Jonathan Gordon, Partner and Luke Whitcher, Director(Ashurst Risk Advisory)
