Climate Change, A Financial Risk

So, we find ourselves in 2022. We have already experienced two tumultuous decades in the global financial markets. We have already witnessed Australia successfully, to a point, navigate the global financial crisis which was largely due to conservative lending strategies and the strength of our natural resources exports into Asia. In 2018 and for the first time, every day Australian’s observed the very public fallout of the misconduct in the Financial Services Royal Commission. Although the Commission exposed some extremely negligent processes and behaviours, these findings led to both substantial and positive changes in conduct, culture and customer-centricity.

Now in 2022, (admittedly, a few years behind other developed nations), the Australian economy now faces the real challenge of assessing and managing climate change and sustainable investments. Australia’s resilience has continually been tested by natural disasters triggered by significant changes to our climate. The memories of Australians have been scarred by the events of “Black Saturday” in Victoria in 2008 as bush fires devastated the Victorian regional communities. Over the last decade, bush fires have continued to wreak havoc across the states and territories. The continual flooding in Queensland and Northern New South Wales this summer has served as a grim reminder of how quickly entire communities are overwhelmed in what has been two decades of unprecedented natural disasters.

The commercial & financial markets in Australia have taken a leadership position to address the nation’s accountability to achieve lower carbon emissions by 2035 as Australia strives to achieve net-zero by 2050. So, what is the role of the Australian financial institutions in a time when embracing the impacts of climate risk and a need for sustainable investments is no longer optional but essential as the market attempts to navigate the continuing economic impact of climate change?

What keeps you up at night?

I spent time reaching out to my c-suite network in the risk and compliance community and I wanted to know two things: ‘What is it about climate risk and sustainability that keeps them awake at night, and how concerned are they by increased “greenwashing activity?” These insights coupled with my own research have given me the opportunity to peek through the looking glass into the future and in turn, better understand the key concerns and financial impacts attributed to climate change.

“The economic transition (and associated risks) requires an urgent strategic, long term and non-partisan (domestically and globally) roadmap. A map that sets out a clear action plan that considers proactive industry transition that minimizes the impact to economic growth and the coordination between a monetary and fiscal policy which considers socioeconomic impacts.”

The Australian Banks are currently scenario planning and stress testing an increasing number of credit loss portfolios and stranded assets ascribed to climate change. The latest weather-related catastrophe reveals the scope of the perils Australia faces both today and in the future. Today you only need to study the devastation of the NSW town of Lismore in which a significant number of its residents and small business owners simply couldn’t afford the insurance premiums associated with living in a ‘flood zone’. The climate crisis is “weighting the odds” in ways that would discourage insurers from offering coverage for certain events, particularly flooding and cyclone-related damage. How do towns like Lismore, their residents and small business owners survive? Are they not the epitome of stranded assets? In 2021 the Government announced its intention to establish a reinsurance pool for cyclones and related flood damage, to commence from 1 July 2022 and will be backed by a $10 billion Government guarantee (ARPC). However, is this enough?

The Australian financial services regulators are developing a broader ESG, Sustainability and Climate Risk policy which will steer the financial services market’s strategic approach to tackling climate change. However, the move into green energy investment is not as simple as it sounds and although there is a push for increased carbon trading, and further investment in green bonds and ESG linked derivatives, the banks have both historical and profitable clients who are responsible for significant carbon footprints. The same banks are continually criticised for financing these organisations to help them transition to decarbonisation, but the banks are also providing assurances they are holding their clients accountable for their commitments. On the flip side, if the banks cease financing these organisations which would invariably lead to the demise of some of Australia’s preeminent businesses, the economic impact would be catastrophic. This is a real ‘Catch 22’ situation and a solution-based approach to climate risk requires a skill set that is largely embryonic even in the most progressive global financial markets.

“The challenge of managing client portfolios whilst diversifying into green energy investments has presented the bank with a new set of risks that bring a socioeconomic impact that we have not had to tackle in recent years”.

One of the key risks is the scarcity of talent with the appropriate depth and breadth of experience to properly assess the financial impacts of climate risk in the Australian market. Fortress Australia has been locked down for nearly two years and although the borders have finally reopened, there is a nervousness, (which I have not witnessed in the past) to simply up sticks and relocate to Australia. Therefore, there has been a reliance to upskill locally and, in some cases, simply ‘rebadging’ to tackle the issue of climate change. However, outside academia, we simply don’t have the depth of knowledge required to properly assess the financial risk.

“What are my key challenges? Staffing is my biggest, the opportunities are enormous but finding and holding on to staff with the requisite experience and literacy from a sustainability and climate perspective is a real challenge. The rapidly changing environment (political, regulatory, societal etc) and how we can stay ahead of the curve? Finally, how do we navigate picking the winners and losers (there will be both).”

Twelve months ago in London, ESG was a secondary topic of conversation, now it’s the primary topic of conversation. Here in Australia, we’ve seen a significant uptake in ESG and Climate Risk consulting activity across the legal and professional services firms. Not since the Royal Commission and outside of cyber has the professional services community ramped up its offerings in a specific functional discipline. However, there is currently a dearth of talent in Australia and that needs addressing quickly. The impacts of climate change coupled with pending regulatory scrutiny require the Australian financial institutions to add climate risk to the core of their everyday activities whilst continuing to tackle regulatory change, safeguard operational rigour and ensure the financial stability of the economy.

Greenwashing

All Australian businesses are now facing the significant challenge of Greenwashing. When greenwashing, companies like to project an eco-friendly image which is simply untrue. Sometimes the disguise is hard to detect but in other cases, the message strays so far from the truth that you can only question the ethics of the PR & Marketing teams behind the ‘greenwash’.

“All deals the bank are involved in (in any capacity) require sign-off by Head of Sustainable Finance to help ensure we do not participate in or lead any that could be perceived to be engaging in greenwashing.”

The process of eliminating greenwashing from a business involves key stakeholder groups, marketing groups and activist groups, all of whom will be assessing the institutions’ supply chain and 3rd party providers. Most concerning is the propensity for some companies to outsource high emission activities to less developed economies that either have no choice or willingly accept the damage to the climate as a consequence of generating revenue for their broader economy.

“These activities are occurring at a company and sovereign level (e.g., developed economies outsourcing high emission activities to less developed economies). We are tracking the impact of all our material supply chains to fully appreciate the risk of ‘green washing’ and from a reporting perspective ensuring data is appropriately reviewed and a ‘look through approach’ is taken. The risk of greenwashing will increase, and I expect more such issues to be identified as investor expectations with regards to ESG continue to increase followed by customer expectations.”

A need for talent by proxy

We’ve observed in the UK and other developed European markets a big push from the global Investment management groups for financial institutions to include a patron of Climate Risk and broader ESG activities as a key member of their board. We also observed the consequences if these expectations are resisted, with board members simply being removed and replaced. As a result, the role of the “Proxy Advisor” has now become a key contributor to boards that require continued momentum in addressing sustainability and climate change. The ‘Proxy Advisors’ provide services to shareholders (in most cases an institutional investor of some type) with research and data, as well as recommendations on management and shareholder proxy proposals that are voted on at an organization's annual and special meetings. These activities have yet to occur regularly in the Australian market but if we follow the trends, these noteworthy changes will be taking place in the boardrooms of Australian businesses within the next twelve to eighteen months.

With the board pushing the agenda and financial markets embracing climate change, there is a real need for experienced talent in climate risk. Unearthing this talent with the relevant experience and skills in financial services, coupled with the appropriate functional expertise across credit risk quantification & stress testing, regulatory policy, risk strategy and governance narrows the talent pool considerably. As a global search firm, we have had to leverage our international networks to their capacity and explore regions that weren’t immediately obvious to uncover the talent we require for our Australian clients. Now that the borders are open again, it is more important than ever to broaden our global search parameters to provide access to a talent pool that can support Australia in addressing our own sustainability.