New Rules Help Super Funds Understand ESG Risks Better

The Australian Prudential Regulation Authority (APRA) aims to offer draft guidance on how super funds may demonstrate a clear understanding of ESG risks, manage risks, and incorporate ESG concerns into their investment strategy.

The regulator said in response to submissions to its consultation process for enhancing investment governance requirements (SPS 530) that some contained requests for comprehensive guidance on controlling risks related to ESG practices. 

The requests include "Specific reference to ESG risk as a major investment risk to be evaluated at both the idiosyncratic and market-wide level".

According to SPS 530, RSE licensees are required to manage and monitor all known sources of investment risk, and according to APRA, this includes taking into account ESG factors. However, several consultation participants demanded more clarification on how Prudential Practice Guide CPG 229 Climate Change Financial Risks (CPG 229) and SPG 530 interact.

"Submissions noted that the current SPG 530, released in 2013, limited the consideration of ESG factors to the offering of ethically styled investment options as part of the overall investment strategy," APRA said.

In addition, the regulator recognised the growing significance and materiality of ESG financial risk variables within the spectrum of risks addressed by funds, irrespective of investment philosophy.

"Reflecting that these risks are long-term in nature and remain an emerging risk area for many RSE licensees, APRA intends to issue draft guidance on how a prudent RSE licensee can demonstrate it has a clear understanding of ESG risks, reflects ESG considerations in the investment strategy, and manages material ESG risks," APRA said.

"This may include demonstrating, through scenario analysis and stress-testing, the impact of investment decisions and risk management on the investment portfolio and the broader market."

APRA stated that it would also clarify the interaction between CPG 229 and SPG 530, with a focus on stress testing and the fact that ESG risks are not limited to climate change alone.

Concerning stress testing, APRA said that numerous submissions requested further advice on how stress tests should be built and asked for specific example scenarios with realistic time durations to analyse events. In addition, they requested direction on how the tests should be framed in terms of member outcomes and tied to performance test findings.

APRA stated that several submissions questioned if the regulator's expectations would vary for smaller funds "and potentially less-resourced organisations where the costs of full stress testing may be deemed prohibitive or outweigh the benefits."

APRA stated that it is the responsibility of RSE licensees to establish realistic scenarios for their respective funds. However, the regulator would focus on providing guidance on the important aspects licensees should use when developing scenarios.

"APRA encourages RSE licensees to undertake a stress testing programme at least annually, with reporting to the board or relevant sub-committee demonstrating the outcomes of the stress testing, the assumptions and modelling used, and where tolerances are breached, the potential actions that may be taken. APRA expectations about these matters will likely be reflected in draft SPG 530," it said.

Elsewhere, licensees also requested clear guidance on implementing an adequate valuation governance framework.

"Areas identified for guidance include when independent valuations would be considered appropriate, what valuation sources should be used and how results should be reported to the board or relevant sub-committee to provide comfort on the robustness of the valuations and underlying methodology," APRA said.

"Submissions also called for clarification on the expected frequency of regular valuations and when interim valuations should be undertaken."

APRA said it intends to clarify valuation governance, valuation methodology, frequency and monitoring, and the types of valuation risks a fund is expected to consider.

Source: Financial Standard

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