A recent Treasury consultation paper sought input on the architecture of the scheme but the basic commitment is made: climate risk disclosure will be mandatory. 

There are two drivers for this. The first is climate change itself, which poses a fundamental risk to Australia’s economy, society and institutional stability if global warming is allowed to exceed 1.5 degrees above the long-term global average. The second driver is investors. Recognising that climate change transition and physical risk pose significant risk to earnings, investors are seeking transparent, consistent and decision-useful information about climate risk because they need to know that companies and governments can manage that risk.

The starting point is the draft disclosure standard prepared by the International Sustainability Standards Board, which ISSB has indicated will come into force in January next year. For ease and consistency of reporting and to attract international capital, the Australian framework needs to be consistent with international baselines, including in the disclosure of material Scope 3 emissions, but there’s a case for Australia to go further than ISSB and others in the disclosure framework for physical risk.

Unlike transition risk, physical risk is not limited to a particular window of time and will escalate even if the Paris temperature agreement goals are met. The consequences of physical risk are not limited to particular sectors, but will broadly, profoundly and irreversibly affect every aspect of Australia’s society and economy. The latest update from the Network for Greening the Financial System scenarios for climate risk make it clear that, “For all scenarios and time scales, physical risks outweigh transition risks.”^[1]

And yet, around the world, quantitative disclosures are more common for transition risks than physical risks, as has been observed by the TCFD, the ECB, and others. The breadth and duration of the risk, Australia’s particular vulnerability to physical risk and its reliance on international investment are powerful arguments in favour of setting world leading practice in this area. One way to do that is to establish from the outset that not all physical risk is able, at this time, to be directly quantified in balance sheets and so there’s a need to direct firms to disclose not only their direct risk (to assets and operations), and their cascading risk (second- and third-order effects on supply and value chains), but also their contextual risk (the effects of physical risk on material macro-economic factors like GDP, productivity, inflation etc) and risk that could be deemed unmanageable – beyond the capacity or scope of the entity to manage, mitigate or transfer. One example of the last is a risk identified by the IPCC’s Sixth Assessment Report Working Group II chapter on Australasia, which raised the high risk in Australia that beyond 1.5 degrees of warming, “Climate hazards overwhelm the capacity of institutions, organisations, systems and leaders to provide necessary policies, services, resources, coordination and leadership.”

The questions the Treasury is grappling with include the coverage of the disclosure standards (for example the inclusion of private companies and government entities) and whether to exempt climate disclosures from the requirement that applies to other official forward-looking statements: that they be made on “reasonable grounds.” A so-called “safe-harbour” provision would be a mistake for Australia. There is no safe harbour from the physical risks of climate change, as XDI’s Gross Domestic Climate Risk ranking indicates. Protecting boards that fail in their fiduciary duty to satisfy themselves they have reasonable grounds to draw the conclusions they have drawn on climate physical risk essentially transfers this risk to shareholders, investors, insurers, and ultimately the public.

There’s a strong case for Australia to adopt physical risk disclosure requirements of greater detail and breadth than emerging international standards have so far included. ISSB has acknowledged there is more work to do on physical risk. Australia is reliant on international investment and has elevated vulnerability to climate change impacts. Australia needs a world-leading framework for physical risk disclosures underpin investment confidence, ensure that investment is climate resilient and safeguard the community.