Climate Change – Setting The Scene

Climate change is no longer viewed solely as an ethical or environmental issue, but as one with clear financial and prudential implications. APRA’s Geoff Summerhayes emphasises that discussions have shifted towards understanding the quantifiable impacts, risks and probability distributions associated with climate change. To limit global warming to below two degrees Celsius, global emissions must be reduced by around 800 gigatonnes of CO₂—equivalent to roughly 25 years of current annual emissions.

Scientific advances, including satellite technology and decades of interdisciplinary research, have deepened understanding of both the causes and impacts of climate change. These developments have transformed climate change from an aspirational challenge to one requiring coordinated and practical responses from policymakers, regulators, businesses, and economists. The focus has evolved from long-term ambition to near-term implementation, with prudential regulators increasingly engaged in assessing financial stability risks arising from climate-related factors.

Three Key Recent Developments

• Paris Agreement
  The Paris Climate Agreement established a global commitment to limit temperature increases to between 1.5 and 2 degrees Celsius. Ratified by 131 countries—including Australia—it covers over 80 per cent of global emissions. The agreement provides a binding framework for ongoing emission reductions, monitoring, and policy adjustments. It also signals a clear global shift towards low-carbon economies, influencing domestic, state and city-level policy development and business adaptation.
• FSB Taskforce On Climate-Related Financial Disclosures
  The Financial Stability Board’s Taskforce on Climate-related Financial Disclosures (TCFD) aims to improve transparency of climate-related financial risks. Its framework promotes voluntary, practical disclosure standards across industries to help investors and regulators better assess risk. The initiative seeks to enhance governance, scenario analysis, and decision-making processes within financial markets. The report underscores the importance of consistent, comparable and decision-useful information to enable informed investment and lending decisions.
• Legal Opinion On Directors’ Duties
  A legal opinion issued by barrister Noel Hutley SC for the Centre for Policy Development and the Future Business Council highlights that Australian company directors could be personally liable if they fail to consider and disclose foreseeable climate-related risks under the Corporations Act. It asserts that neglecting such duties could constitute a breach of due care and diligence obligations. This opinion has prompted discussions among directors, investors, and regulators on integrating climate considerations into governance frameworks.

Importance And Immediacy Of Transition Risks

APRA distinguishes between physical risks—arising from direct climate impacts such as natural disasters, supply chain disruption, or resource scarcity—and transition risks, which stem from policy, market, and technological changes linked to the shift towards a low-carbon economy. The latter pose particular concern for financial institutions due to potential asset repricing, stranded assets, and reallocation of capital.

Australia’s financial system, including its large superannuation sector and exposure to carbon-intensive industries, faces significant systemic risk from abrupt or disorderly transitions. APRA highlights that comprehensive disclosure and monitoring are essential for identifying vulnerabilities. Transition risks are expected to have greater long-term impact on financial stability than physical risks, given their link to evolving regulation, market sentiment, and technological shifts.

Scenario Analysis As The New Normal

Scenario analysis is identified as a critical tool for assessing climate-related financial risks. APRA encourages entities to model potential outcomes under different climate scenarios and time horizons, including the Paris-aligned 2°C transition pathway. This approach moves beyond static metrics, embedding forward-looking analysis into risk management and governance practices.

Scenario-based thinking enables institutions to test resilience under varying market, regulatory, and physical risk conditions. It also supports transparency for investors and regulators seeking to understand how firms identify and manage material risks. APRA notes that institutional investors increasingly view climate risk management as a core indicator of effective corporate governance and long-term value creation.

Conclusion

Climate-related financial risks are now an explicit focus within APRA’s prudential framework. The regulator expects all supervised entities to incorporate climate considerations into governance, risk management, and scenario analysis processes. APRA will not prescribe specific approaches but will promote consistent expectations and encourage improvement where necessary.

Summerhayes concludes that climate risks should be managed alongside other prudential concerns such as social licence and operational resilience. Regulators, firms, and governments share responsibility for addressing these emerging risks, which, if ignored, could have material financial and reputational consequences. APRA’s stance reflects the growing global recognition that climate change represents a foreseeable, actionable and financially material prudential risk.