For nearly 20 years, policy responses to the challenge of climate change have largely focused on the physical regulation of carbon emissions — either directly, or through various forms of carbon pricing. It is only in the last three to four years that policymakers have begun to focus on what we can call the financial regulation of climate risk through the creation of a new agenda for banks, investment funds, insurance companies and financial regulators.

Australia has begun to play its part in staking out this new policy terrain and now faces both the challenge and the opportunity of rapid catch-up to (and beyond) the international best-practice frontier in both policy and corporate action. This paper surveys the policy and politics of the emerging international debate about climate risk for the finance system, assesses the potential implications for Australia, and frames some key questions for Australian policymakers in responding to them.

The new approach to the financial regulation of climate risk can be traced to two events. The first was the landmark speech of Bank of England Governor Mark Carney in September 2015, showing how the worst impacts of climate change will be felt beyond the typical planning horizons of the finance sector and thus will create a “tragedy of the horizon”. The second was the Paris climate accord, agreed in December of the same year. The agreement firmly and for the first time placed a key responsibility upon the finance sector to shape the transition to a low- and eventually no- carbon economy.

For the finance sector, the Paris Agreement can be seen as a form of ‘regulatory overhang’. In other words, the transition to a low-carbon economy, once
it passes into the regulations and laws of countries, will drastically reduce the value of high-emitting assets such as coal mines, power stations, gas plants and oil rigs. These assets, now worth trillions of dollars, would then become ‘stranded’ — devalued or even worthless.

Australia is disproportionately exposed to such stranded asset risk. It has a highly carbon-intensive economy, and its national emissions have been rising since 2013. The further Australia departs from an emissions pathway that is compatible with the Paris Agreement, the greater the need for a late,
sharp policy adjustment, with all the attendant risks of serious damage to the finance sector and the economy. Yet Australia also stands disproportionately to benefit from a successful low carbon transition. It has a world-class solar and wind energy resource base, mineral resources critical to battery production,
and a large and sophisticated funds management industry on hand to provide financial services products to realise these opportunities.

With the risks and opportunities in front of Australia set out, it is important to understand the very rapid progress that has been made around the world on the sustainable finance policy agenda in recent years. Australia can draw on this experience in its own reform process.

Financial policy and regulatory reform to address climate change has its roots in the last financial crisis and a growing determination by international policymakers to avoid climate being the cause of any future crisis. This expressed itself initially in the processes of the G20 group of nations, culminating in the report of the Taskforce on Climate-related Financial Disclosures (TCFD) to the 2017 G20 Leaders’ Summit. With the arrival of a new US administration in 2017, progress on climate issues became all but impossible in the G7 and G20 groups.

Rather than the agenda collapsing, however, it found new and even more energetic and ambitious expression in two venues, in particular:

• The Network for Greening the Financial System (NGFS), founded in 2017, brings together central banks and financial supervisors around the world to “contribute to the development of environment and climate risk management in the financial sector, and to mobilise mainstream finance to support the transition toward a sustainable economy”. From an initial founding coalition of eight central banks and financial supervisors, the network grew in 18 months to 35 members, including the Reserve Bank of Australia. Its ambitious workplan includes examination of micro — and macro — prudential policy as well as measures to assist in scaling up green finance. All measures offer the unprecedented prospect of central banks and financial supervisors deploying their mandates in the service of the low carbon transition, potentially including penalties for high-carbon activities.
• The comprehensive European policy reform agenda initiated by the European Commission’s High-Level Expert Group on Sustainable Finance (HLEG) in late 2016, and the Commission’s response to that group’s final report in early 2018. The HLEG’s reform agenda is broad and ambitious and more than can be enacted by a commission whose mandate concludes this year, but important downpayments have been or will be made to reform sustainability benchmarks, disclosure regulations and investor duties, and to define a ‘taxonomy’ of sustainable activities. These activities will also have a large impact beyond Europe’s shores, both since they apply to businesses operating in the vast EU capital market and because they offer a best practice example for others to copy.

In addition to these two key developments, related national efforts in China and the UK are influential:

• China, because of the speed and impact of reforms such as compulsory liability insurance for environmental pollution and mandatory disclosure of environmental information. The potential size of China’s green finance sector gives these reforms an international resonance beyond their domestic impacts.
• The United Kingdom ran its own HLEG-style process, reporting in March 2018. Government is yet to respond, but the process signals a pro-green finance direction at odds with fears that the UK would turn in a deregulatory direction once freed from European Union frameworks.

Further, both Canada and New Zealand have embarked on their own expert panel processes in order to push sustainable finance reform.

In conclusion, Australia has numerous positive reform examples to draw on. With the recent announcement of the Australian Sustainable Finance Initiative, the ingredients are there for Australia to make significant progress, and quickly. Key industry players are aligned; domestic regulators have done solid groundwork; a well-defined set of international best practices now exists, and in international fora such as the NGFS best practice can rapidly be transmitted and catch-up occur.