Banking on a sustainable future

Capital providers need to support all sectors that harbour emissions reduction ambitions - not just the deep green industry. By Josh Frydenberg.

From the industrial revolution to the digital age, financial markets have been affected by significant structural change. Each time it drives a reassessment of risk and value and, in turn, asset allocation.

Climate change is no different.

Markets are moving as governments, regulators, central banks and investors are preparing for a lower-emissions future. It’s a long-term shift, not a short-term shock.

The world signalled its ambition when more than 190 parties committed in Paris to keep the rise in average global temperatures to below two degrees.

This has been followed by 129 countries committing to reaching net zero emissions by 2050. Markets are responding as participants make their own judgments as to what this new dynamic means for their existing portfolios and their future investment decisions.

In particular, they are increasingly focusing on the physical risks to their investments of climate-related events and the transition risk to their investments as consumer preferences, technological and regulatory settings change.

As a result, trillions of dollars are being mobilised globally in support of the transition. For example, in Australia, in the last 12 months alone, one of our leading banks coordinated more than 50 transactions worth $100 billion in climate finance related activities.

Increasingly, institutional investors are themselves committing to the net zero goal, like BlackRock, Fidelity and Vanguard, three of the biggest fund managers in the world. For them, there is an alignment between the commercial opportunities and the environmental outcomes.

Australia’s interest lies in our markets functioning effectively so the financial system remains stable, investors are able to make informed and timely decisions, and capital can be accessed at the lowest possible cost.

Historically, Australia has relied heavily on imported capital to fund our economy. Whether it’s in the form of foreign investment, the stock of which currently stands at $4 trillion, or in the form of wholesale funding of our banking system, with around 20 per cent sourced offshore.

When it comes to Commonwealth government bonds, close to half are held by foreign investors. Reduced access to these capital markets would increase borrowing costs affecting everything from interest rates on home loans and small business loans, to the financial viability of large-scale infrastructure projects. Australia has a lot at stake.

We cannot run the risk that markets falsely assume we are not transitioning in line with the rest of the world. Were we to find ourselves in that position, it would increase the cost of capital and reduce its availability, be it debt or equity.

Australia is addressing these challenges on two fronts.

Firstly, government regulators have focused on the disclosure of material financial risks, and promoting a best practice framework following the recommendations of the Taskforce on Climate-related Financial Disclosure. APRA has also been developing guidance on governance, risk management and vulnerability assessments for our largest financial institutions. This is designed to assist them to effectively assess and manage any material climate risks they face.

The Reserve Bank of Australia, like its counterparts around the world, is also factoring in the impact on the macroeconomy of more frequent climate-related events. As deputy governor of the Reserve Bank Guy Debelle has said, these are not simply temporary and cyclical events, but a trend change that has first-order economic effects.

Internationally, Australia is an active participant in the work under way through the G20 and other forums to develop consistent and effective climate disclosure frameworks. These actions are designed to ensure markets are fully informed and, therefore, able to effectively price and manage these risks.

Secondly, just as Australia is making progress in strengthening our regulatory and financial frameworks, so too we are making progress in meeting our emissions reduction targets. Emissions are down by more than 20 per cent since 2005, putting our 2030 target of a 26 to 28 per cent reduction clearly in sight.

The equivalent of 3 million cars have been taken off the road for 15 years. The transition is under way as $35 billion of renewable energy investments have been made in Australia since 2017.

One in 4 Australian households have solar panels, the highest rate on a per capita basis anywhere in the world. Our technology investment road map will guide $20 billion in government funding and is expected to leverage $80 billion in total investment by 2030.

Snowy 2.0 in NSW, Battery of the Nation in Tasmania and new interconnectors around the country will create a more reliable, affordable and lower emissions energy system.

Partnerships with Japan, Germany, Singapore, and the United Kingdom will also drive new energy investments particularly in hydrogen, where we have a comparative advantage.

As recently as last week in a joint statement by the US and Australia’s foreign and defence ministers, our commitment is to “make low emissions technologies globally scalable and commercially viable,” which can “make achievement of net zero emissions by 2050 possible”.

These new investments are generating more jobs, particularly in our regions, as our economy has simultaneously grown by more than 40 per cent since 2005 while, in the same period, our emissions have reduced by 20 per cent.

To go the next step and achieve net zero will require more investment across the economy. An economy-wide transition is needed, as in the words of the former governor of the Bank of England, Mark Carney this “isn’t about funding only deep green activities, or blacklisting dark brown ones”.

The transition requires a broad-based approach, which sees investment in emissions reduction strategies across all sectors, be it agriculture, mining, manufacturing, and others.

For example, the resources industry, where the value of Australia’s nickel and copper and lithium exports are forecast to increase by $11.1 billion over the next five years, driven by demand for lower-emission technologies like electric vehicles.

It is wrong to assume that traditional sectors, like resources and agriculture, will face decline over the course of the transition. To the contrary, many businesses in these sectors are at the cutting-edge of innovation and technological change.

Iconic Australian companies, like BHP, which have been around for more than a century are investing in renewables to power their mines, as they pursue their own goal of net zero operational emissions by 2050.

Another major Australian miner, Fortescue, has committed over $1 billion to produce renewable green hydrogen to fuel future steel making activities. When I talk to these and other large Australian companies about how they are positioning for the future, they not only expect to be around in 2050, but to be bigger and stronger.

There is a message here for business: opportunities will abound and it will be those businesses that recognise these trends and put plans in place to adapt that will have the most promising futures.

At the same time, there is a message to Australian banks, super funds and insurers. If you support the objective of net zero, do not walk away from the very sectors of our economy that will need investment to successfully transition.

Climate change and its impacts are not going away. It represents a structural and systemic shift in our financial system, which will only gain pace over time.

For Australia, this presents risks we must manage and opportunities we must seize. That work is well under way, but there is still more to do.

This piece first appeared in The Age and has been republished with permission.