Today's announcement follows recent announcements of portfolio decarbonisation roadmaps by a number of Australia's largest superannuation funds, who have in turn followed a lead from European banks, asset owners and managers. The momentum among mainstream investors to achieve a net zero portfolio or financed emissions has important implications for the real economy. The pressure is on Australian businesses to accelerate their integration of climate risk governance into strategy and risk management – particularly in high-emitting sectors such as energy, resources and construction materials, and those with physical vulnerabilities such as agriculture and infrastructure. 

Overview of developments in Europe and Australia

Regulatory and investor expectations on climate risk governance and disclosure continue to ratchet higher – even in the face of COVID-19 pressures. Australian institutions, many of whom are accustomed to being viewed as market leaders on climate risk governance and disclosure, are finding that leading practice in prior years will not immunise them from negative scrutiny in the current reporting season. Following significant proxy pressure their northern hemisphere counterparts, Australian institutions are faced with a potential wave of investor pressure to increase and accelerate portfolio decarbonisation commitments.

The drivers behind this step-change in expectation include a number of recent developments in Europe, which are continuing to lift the bar on climate change commitments and standards of climate risk governance in the financial services sector. But a few examples from recent months include:

• In March, the EU joined other jurisdictions like the UK, New Zealand and California in legislating a requirement that its economy be operating on a net zero emissions basis by 2050. In September, it flagged the acceleration of its 2030 interim emissions reduction target from 40% to 55% (as against 1990 baseline). In September, China joined the net zero club, announcing a target of emissions neutrality by 2060, followed in October by announcements from South Korea and Japan (both targeting net zero before 2050).
• In June, the Network for Greening the Financial System (NGFS) issued guidance providing ‘a common starting point’ for climate change stress-testing by its 66-member central banks and supervisors. The scenarios range across the spectrum from a disorderly transition to a 1.5°C economy (relatively, higher transition risk), to a ‘hot house world’ of runaway climate change (higher physical risk). The variables and assumptions are consistently aligned across the suite of models and are, in some cases, significantly more aggressive than those contained in existing bank stress-testing programs. For example, carbon prices under the disorderly transition to 1.5°C scenario range up to US$700/t by 2050.
• Also in June, the European Commission passed the final version of the EU Green Finance Taxonomy. This 'dictionary' of industrial activities that qualify as 'green' has already been applied by asset management giants such as Storebrand, has been flagged for application in COVID stimulus fund raising by jurisdictions including France and Germany, and forms the basis of the European Commission’s ongoing consideration of prudential reform proposals that would embed a ‘green supporting factor’ and/or ‘brown penalising factor’ into capital regulatory requirements.
• In July, the Bank of England Prudential Regulation Authority wrote to the CEOs of all regulated entities in the UK, requiring that they integrate plans for climate risk portfolio assessment and management prior to the end of 2021 – including portfolio stress-testing and scenario analysis, applying reasonable proxies and assumptions where data limitations would otherwise prevent them from doing so.
• In early October, the Joint Committee of the European Supervisory Authorities closed its consultation on the EU Sustainability Disclosure Regulation (2019/2088), which proposes Regulatory Technical Standards on the content, methodology and presentation of entity and product-level sustainability disclosures. These proposals include a requirement for European asset managers, pension funds and insurers to publish the 'principal adverse sustainability impacts' of their investment decisions (against a list of 32 designated factors) and their degree of alignment with the objectives of the Paris Agreement.
• In mid-October, a coalition of 137 CDP-member institutional investors worth a collective US$20 trillion in funds under management sent a letter to 1,800 high-emitting investee companies across global markets, seeking their commitment to implement Science-Based Targets (ie reducing emissions consistent with a trajectory to limit global warming to 1.5°C above pre-industrial averages, and to achieve net zero emissions prior to 2050).

With the significance of European asset owners, asset managers, banks and (re)insurers in global capital markets, it is not surprising that these developments would compel a response across global capital markets. Australian equity issuers, investors and debt providers are not immune from heightened regulatory, investor and competitive pressures within our own jurisdiction:

• ASIC has flagged climate-related risk for its annual report review program.
• APRA has foreshadowed a program of climate risk stress-testing of regulated entities.
• AASB/AuASB Guidance is presenting report preparers and auditors with the fresh challenge of integrating material climate risk variables into financial statement accounting estimates.
• Both offer document and annual report disclosures are under intense scrutiny following a number of climate-related duties-based legal claims filed in Australia and abroad.
• Leading superannuation funds such as HESTA, Unisuper, Cbus and Aware (First State Super) have announced roadmaps to net zero portfolio / financed emissions – and this will likely set a benchmark for finance sector climate risk assessment and disclosure that other capital market participants will now be under pressure to clear.

In addition, in today's announcement, one of Australia's Big 4 banks, ANZ, announced updates to its climate change policy that will significantly strengthen its ambition to reduce greenhouse gas emissions across both operations and lending portfolios. Whilst the bank has not set hard targets to reduce financed emissions (as have other international banks including Barclays, Morgan Staley and ING), the announcement flags that 2030 targets will be set for lending to the power generation and commercial property sector by 2021. Other notable lending policy changes include:

• finance for the construction of new large-scale office buildings to be limited to NABERS / Green Star 5 star-rated projects;
• a program of specific engagement with commercial borrowers on their climate-risk transition plans, and reduced exposures to customers without a diversification strategy or specific, time bound, public transition plans;
• inclusion of references to climate risk in agriculture-related lending guidance documents used by front line bankers; and
• no banking of new business customers with material exposure to thermal coal mines or coal-powered utilities (>10% revenue, installed capacity or generation), with engagement with existing customers with thermal coal exposure to 'seek specific, time bound and public diversification strategies by 2025'. By 2030, all direct lending to the power generation sector will be limited to gas and renewables by 2030.

What are the implications for the real economy?

The implications of these capital market developments for companies in the real economy cannot be underestimated. Australian companies – particularly those in emissions-intensive sectors – are likely to come under pressure to accelerate their own climate risk governance ambitions to ensure access to competitive finance and insurance. Those who are able to demonstrate Paris Agreement-aligned strategic pathways will benefit from the growth in green finance markets, from transition bonds to sustainability-linked loans.

This pressure is only set to compound with the announcement of a new 'Net Zero Company Benchmark' of expectations for investee companies by the US$45 trillion institutional investor coalition on climate change, the Climate Action 100+. The Benchmark echoes the recent step-change in European developments by setting elevated expectations on strategic alignment with the goals of the Paris Agreement and a net zero emissions future for its 'significant emitter' target investees – which include a number of Australian listed companies in the energy and resources, aviation and industrial sectors. The pressure on those companies to meet the heightened standards will very quickly set a new bar of expectation for their mid-cap and junior counterparts.

Recommended next steps

With already limited bandwidth consumed with the immediate social and commercial implications of COVID-19, many energy and resource sector boards are finding the step-change in climate risk governance and disclosure expectations a significant challenge. Those who have remained abreast of this dynamic area are struggling to understand the additional assurance measures that may be required. Nervousness around the magnified focus on forward-looking disclosures, and the need to integrate material climate variables into financial statement valuations under new accounting guidance, is being compounded by an increase in shareholder class action and regulatory enforcement on climate risk disclosures.

MinterEllison's leading Climate Risk Governance team specialises in climate change risk (and opportunity) through a finance and liability lens. We would be delighted to assist you to navigate this dynamic governance, strategy and finance landscape with confidence.