RBNZ releases guidance on managing climate-related risks for prudentially regulated entities

On Wednesday, 26 March, 2024, the Reserve Bank of New Zealand – Te Pūtea Matua (RBNZ) released its guidance on managing climate-related risks (Guidance).

We welcome RBNZ's efforts to harmonise the Guidance with NZ CS 1 and provide more illustrative examples of strategy disclosures. The previous draft of the Guidance could have led to confusion and conflicts for climate-reporting entities.

We recommend that all entities prudentially regulated by the RBNZ (banks, licensed insurers, licensed non-bank deposit takers and designated financial market infrastructures) review this Guidance.

The Guidance informs the supervisory and monitoring approach of RBNZ in relation to the climate-related risk management practices of its prudentially regulated entities. It is intended to sit alongside Part 7A of the Financial Markets Conduct Act 2013 (FMCA), the Aotearoa New Zealand Climate Standards (NZ CS) and existing guidance from the External Reporting Board (XRB) and the Financial Markets Authority – Te Mana Tātai Hokohoko (FMA).

WHO IS THE GUIDANCE FOR?

The Guidance is relevant to prudentially regulated climate-reporting entities that are subject to the FMCA Part 7A climate disclosures.

The Guidance does not make any recommendations relating to climate disclosures, as that remit is left to the XRB and FMA.

RBNZ has consulted with the XRB and the FMA to ensure that the Guidance does not unnecessarily repeat or contradict any standards or other guidance issued by XRB or the FMA.

WHAT DOES THE GUIDANCE SAY?

The Guidance is structured around the four key pillars of climate related disclosures: Governance, Strategy, Risk Management, and Metrics & Targets.

Governance

• An entity's governing body should be responsible for effective climate-related risk management. If a governing body delegates these risk-management functions, it should ensure that the management team responsible have the requisite skills and expertise.
• Climate risk should be included in an entity's broader risk management framework, instead of being managed separately. From this framework, management can establish tools and metrics to monitor exposure, develop and implement appropriate policies to limit any exposure, and report to the governing body on material climate risks.
• The Guidance recommends the World Economic Forum's guiding principles for climate-related governance, namely being climate accountability, subject command, board structure, materiality assessment, strategic integration, incentivisation, exchange and reporting & disclosure. These principles are consistent with the FMA and RBNZ's findings in their 2023 Governance Thematic report. You can find our client update on this report here.

Strategy

• Entities should develop capabilities in scenario analysis and stress testing, proportionate to their size, business mix and complexity.
• Scenario analysis allows entities to systematically explore the effects of a range of plausible, but uncertain future events on their business. Entities should consider the outcomes of this analysis when setting their business strategies. Further guidance can be found in the XRB's here.
• Stress testing subjects financial institutions to severe but plausible scenarios (and sensitivities) that are deliberately chosen for their potential to threaten the viability of the business model. RBNZ expects entities to develop their own internal stress testing capabilities over time.

• Entities should develop a climate transition plan to ensure its business model and strategy can thrive in low-emissions, climate resilient economy and include these plans in their regular strategy reviews. RBNZ will pay close attention to risk related parts of entities transition plan and expect an entity to demonstrate effective management of risks associated with real economy transition.
• The XRB is expected to release its transition planning guidance this month. Entities can also refer to guidance from the UK's Transition Plan Taskforce.
• Examples of climate-related risks – Some helpful examples of climate-related risks are included here.

Risk management

• Distinguishing climate-related risks – RBNZ notes that the uniqueness of climate-related risks warrants specific analytical consideration within an entity's risk management framework. Climate risks are uncertain and unprecedented in nature, and traditional risk assessments that rely on historical data are insufficient to predict its impacts. In situations where data is limited and uncertain, scenario analysis is one of the few tools to assist an entity in assessing impacts from climate-related risks.
• Risk identification – In its risk assessment, an entity should identify higher or lower exposures to physical and transition risks in different parts of its business model. For example, certain types of insurance might be vulnerable to extreme weather events, which could affect insured customers and cause changes in policies on whether the business is sustainable in the long run.
• Development of specific policies, procedures and operations – Following risk assessment, entities are encouraged to mitigate identified risk through changes in its operations. In conjunction with the RBNZ's cyber resilience guidance published in April 2021, entities should ensure business continuity during or following severe weather events by having adequate response and recovery plans.
• Financial resources – Pertaining to RBNZ's liquidity requirement, registered banks are expected to identify climate-related risks and whether they materially impact their liquidity risk profile. The Guidance largely defers to RBNZ's published Solvency Standard for Insurers in terms of how climate risk is calculated for the purpose of complying with the Standard, however it does note that in the context of always managing capital and solvency to always exceed regulatory minimums licenced insurers should also consider the implications of climate change on future capital and solvency positions. Including implications on claims (severity and frequency), reinsurance (availability and pricing), market dynamics (insurability and affordability) and government/regulatory changes or interventions. More generally, registered banks and licensed insurers when managing capital and solvency should always consider how climate change which implications such as claims, reinsurance, market dynamic, and government regulatory changes or interventions.
• Reporting and evaluation – Governing bodies and senior management of entities should regularly be informed on risk exposures, and take into account entity's risk appetite and management approach when making important decisions.

Metrics and targets

• Measuring and monitoring – Entities should incorporate both qualitative and quantitative approaches when measuring metrics, and also ensuring that metrics are tailored to that entity's size, business complexity and data availability. RBNZ noted issues with climate related data (noting availability, comparability, consistency and that the quality is improving over time) but emphasised the need to make progress with whatever data is currently available.
• Industry-specific metrics – the Guidance added reference links to external providers that provide industry-specific metrics (see Helpful links and resources below).

WHERE TO FROM HERE?

RBNZ will update the Guidance to reflect the evolving nature and maturity of climate-related risk management practices, as well as any future changes to key legislation (such as the Deposit Takers Act 2023 or Insurance (Prudential Supervision) Act 2010).

We note that, as part of its own stress testing programme, RBNZ will soon release the results of its stress testing of transitional and physical climate-related risks for the five largest banks. See more information on RBNZ's climate stress test programme here.

RBNZ has reiterated that the Guidance does not have an effective date, is non-binding and is voluntary for each entity to apply. RBNZ did not negate the possibility of developing climate-specific standards in the future, and states that the development of potential standards will be subject to the same consultation and implement procedures as existing RBNZ standards.

Please get in touch if you have any questions about climate-related disclosures.

Helpful links and resources

• Managing climate-related risks. Guidance for prudentially regulated entities
• Individual submissions on The Guidance
• Responses to individual submissions on The Guidance
• Aotearoa NZ Climate Standards
• NGFS - Guide for Supervisors Integrating climate-related and environmental risks into prudential supervision
• PCAF Insurance-Associated Emissions
• PCAF Financed Emissions
• IFRS – Appendix B – Industry Based disclosure requirements
• Net Zero Banking Alliance Commitment Statement and Guidelines for Climate Target Setting
• Basel Committee on Banking Supervision consultation on 'Disclosure of climate-related financial risks