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.

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