Climate Risk Management for Financial Institutions
The authors of ‘Climate Risk Management for Financial Institutions’ – a paper presented at the General Insurance Seminar in November 2016 – discuss how financial institutions can play a critical role in managing the potential financial risks posed by climate change.
Financial institutions play a critical role in our economy. They are the front line in managing all financial risks, including those posed by climate change. The stability of our economy and financial system as a whole will depend on how quickly and deeply financial institutions adapt to the risks faced by the Australian economy from climate change.
Climate change is likely to directly impact economic sectors that make up nearly 50% of gross value added in Australia. Further, secondary effects, such as through financial institutions and employment opportunities, will result in an overall impact on the Australian economy that is substantial and material.
Households can be exposed to a variety of climate risks. People’s homes, wages, superannuation, investments, insurance premiums, energy bills and home repair bills will all be adversely affected by climate change. Businesses are similarly exposed through their physical assets, to increased disruption to their own operations and throughout the supply chain, and finally through legal liability.
Since the Paris Conference of the Parties in 2015, the questions faced by Boards have changed rapidly. The ratification of the Paris Agreement on 4 November 2016 has provided certainty that governments will act to address the threat of climate change, and a growing realisation of just how much impact a transition to a low carbon economy will have on the world economy. While the time frames involved may be long and there is uncertainty around the extent of effects, there is little uncertainty about the fact that change will happen, and that financial institutions need to adapt to the evolving business environment in order to protect their enterprise value.
It’s about the customer, and the shareholder
We have passed the point of considering whether or not Boards need to act. Recent legal opinion from leading members of the Australian legal profession suggests that many climate change risks “would be regarded by a court as being foreseeable at the present time”. It is possible that Australian company directors “who fail to consider climate change risks now could be found liable for breaching their duty of care and diligence in the future”.
Boards will need to identify, quantify and manage climate risk exposures across their operations, not only because of these legal issues, but also because of the material impact on their customers and shareholders.
We discuss in our paper how financial institutions can establish and follow an Enterprise Risk Management framework to bring together the multiple ways climate change poses risks to all the company’s stakeholders. This framework facilitates a rigorous cost-benefit analysis to compare adaption and mitigation strategies, and allows the company to actively manage and validate the plan over time.
A link to the full paper is here.
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