Transcript of Question & Answer Session Climate Risks and the Australian Financial System

Moderator

Thank you very much Guy, and as you said at the top of your presentation, it's extremely timely and no doubt very purposeful in terms of what's happening with, as you said, COP26, starting at the end of this month. I guess the first question I'd like to just put to you, and there is one question that's come through, is what tools does the RBA have to manage climate risk? And I guess as a central bank, you clearly don't have direct ways of managing this issue, but it comes back to the philosophy of what the Bank, and many other regulators as you've outlined, are doing in terms of the whole level of disclosure. So it comes back to, I guess, the question that, information is power, is that really the overall philosophy that you're using in terms of trying to manage this risk?

Guy Debelle

Yeah. I'd make a few points in answer to that question, which is a good one, and I'd emphasise the fact that we're working on this collectively with ASIC and APRA who do have tools that can potentially be applied to this. The point I'd make is very much, it is about the information, and what we've seen over the last few years is that a lot of initiatives and very, as I said, well-intended initiatives are really gaining momentum in this, but there's a coordination issue here. And I think that's one role that we, or the CFR group, can play is providing that coordination. As I said, we've seen a number of different taxonomies arise, we've seen a number of different approaches to disclosure arise, and that makes it a real challenge for investors to assess what they're reading.

Whereas, if there was a common approach to this, both locally and at least as importantly, globally, then that makes the challenge a little less, potentially considerably less, and I think that's where we can play an important role in providing some common infrastructure that people can use. A common approach for disclosures, a common approach to assessing scenarios, that both investors can use, companies can use in terms of their disclosures, and banks can use in assessing the risks to their portfolios. Otherwise, if everyone's doing it in a completely bespoke way, then it's not clear that we're going to get any useful outcomes out of that because everyone will be using different information to arrive at different conclusions.

So I think one of our main roles here is to provide that common focus and provide some consistency across all these different initiatives.

Moderator

Yeah. Clarity rather than confusion.

Guy Debelle

Yes.

Moderator

Yep. The number one question that's coming up is climate is a first order risk, but where do you think it ranks on the lists of risks the RBA is monitoring? And I'd add to that, I noticed in the Reserve Bank Bulletin article that the magnitude of the risk that you came up with was not particularly large, but of course this is a long-term issue and potentially an escalating issue. How do you see it in terms of the order of risks that banks face overall?

Guy Debelle

What I'd do here is potentially separate the physical from the transition risk. So the work that you're referring to, when we're looking at the impact of other countries' decisions on Australia's coal exports is just one manifestation of a transition risk. And as you said, for the overall economy the impact is not particularly large, though it is for the coal industry itself and for the communities, as I said, which depend on it. But that's just one manifestation of the risk.

What I would highlight also is the increased prevalence and severity of physical risks, which we've observed, including not all that long ago, here in Australia. So, I mean, I think at some level, it's almost an existential risk, which puts it higher than many other risks that we're thinking about, or puts it right up there, over a horizon which now is not necessarily all that long. In that sense it is a heightened risk, but it is going to play out over a number of years. Although, as I said, we are seeing these physical risks manifest themselves more frequently and more often.

And this is partly what I talked about back in 2019, that we're seeing these events, which actually are now having a macro impact today. The bushfires had a macro impact. Cyclone Yasi had a macro impact back a few years. So we're seeing those sort of events occur more frequently and so it is up there with the risks, but some of the risks do play out over a long period of time and some of the risks are very uncertain and are hard to articulate. So it is up there.

It's also there in a very unpredictable way. We don't know how and when these events are going to manifest, which makes it a particular challenge, and it's harder to articulate some of the risks around them, relative to some of the more straightforward macro risks. We can talk about, say, a slowdown in China, and have a reasonable sense as to how we can translate that through to its impact on the Australian economy. But on the climate front, we don't know how and when, say, some other countries are going to put in place some of these policies, which may have a direct impact on us.

But I would, on that front, note that all our major trading partners on the energy front, all have net zero policies that they've announced. We haven't seen the impact of them yet because they are to put them in place, but that may well start to play out over a fairly short horizon.

Moderator

Yes, I did notice that that was another article in the Reserve Bank Bulletin, so I refer people to go and have a look at those two articles, they are quite relevant to this discussion. And just on that, on the physical risk that you talked about, in terms of the practicality, you've talked about bushfires and cyclones, but the map that you included in that article seemed to be saying that in fact, the southeast Queensland and northern New South Wales area was the most at risk area from coastal inundation. Actually, I'm not sure if the work would go as far as being a little bit more specific about the types of climate risk?

Guy Debelle

Yeah. I mean, we looked particularly at flooding there, but what we are seeing obviously also is with the increased risk of bushfires and houses in bushfire prone areas, that's another manifestation of that as well. But, as I said, that was our first pass at this and others starting to look at that. What I would also highlight is, the insurance industry has had to – they had no choice to – focusing on this for quite a number of years in terms of events that they've actually seen realised, particularly in places like Queensland. And that's obviously been a challenge for communities in those areas, is around insurance and it's because of the realisation of these events, at a much greater frequency and intensity than the insurance industry had factored into its pricing when it originally set those policies. It's a fast-changing area in part, because the events that we are seeing are outside what had been predicted, not many years ago.

Moderator

One of the questions that's come through from Bloomberg is: ‘How significant is the divestment risk that you talk about, and are there any particular sectors, or states, that might be particularly vulnerable?’

Guy Debelle

This one I would just highlight as a risk. It comes up, and as I said, we haven't really seen much manifestation of it. A concern that we may see some announcement of decisions in this space around COP26. I think there is some risk of that. Not saying it is going to occur, but I think there is a risk that people will take … COP26 provides a focal point for announcements of this sort. But that's just a risk that we are monitoring, I mean actively monitoring, in terms of keeping a running list of who is making these sorts of decisions. But to date, they've been small, but we are seeing increased, let me put it, noise around that, whether that noise translates into action, I think, remains to be seen. And I think it'll be something I'd be alert to, even over the next few weeks.

Moderator

And in a similar vein, you did touch on the investment from superannuation funds and we know that a lot of money has been going into unlisted assets, which potentially have a more stranded risk, a greater stranded risk, if I could put it that way. Is that something that you also are focused on?

Guy Debelle

Yes, that's something we're starting to look at. Some of our focus has been on what's disclosed in the traded space, be it bonds or equity, but I think in the unlisted spaces where things like taxonomy comes in, so where it was like, what is a sustainable activity or what isn't a sustainable activity? I mean the challenge obviously always in the unlisted space is valuation, climate is a particular manifestation of that, but it's not only related to climate, it's related to just valuing that sector in general.

But climate does potentially, I think, add another layer of complexity to valuation in that space, it's understanding that. But I suppose the point I would also highlight though, is that be it listed or unlisted the sort of infrastructure we're providing is looking at the economy as a whole. The banks pretty much lend to all parts of the economy, pretty much all sectors of the economy, so even if you've got an asset in the unlisted space I think the information we'll be putting out in the period ahead will provide you with some tools to be able to assess the climate risk of that.

Moderator

Great. Okay. Well, we've actually covered all the questions, most of the questions on climate. You did indicate that you'd be happy to take some broader questions.

Guy Debelle

Sure.

Moderator

If you're open to it, I know Phil Lowe gave us a good update on thinking about a month ago or so, but in the period since then there has been a bit of a strong shift in terms of the global trends, both in terms of quantitative easing policies and also a number of smaller country's central banks are actually raising rates.

Guy Debelle

Yeah.

Moderator

So, I mean, in this globalised world, we don't just see the impact through the exchange rate, but there are broader global impacts that flow through. How has the bank assessed these trends in relation to Australia?

Guy Debelle

Yeah, good question, and that's one we're probably devoting most of our attention to at the moment, is exactly that question. I suppose I would highlight a few things in this space. One is that the circumstances here in Australia, particularly on the nominal side of the economy, both wages and inflation, are quite different from those that we're seeing in other countries. And Phil highlighted some of these in his recent talk.

So, as you mentioned in your introduction actually Phil, we came into this with persistently low wage outcomes in Australia, and much lower than we're seeing in a lot of other comparable countries. And what we've seen over … COVID hasn't changed that picture. A primary focus of our business liaison program is hearing what they're seeing, or what they're seeing and doing on the wage setting front and on the employment front. And while the employment front is very, very positive, a high-level of vacancies as we're coming out of lockdown here in New South

Wales and in Victoria, businesses very much have held on to staff and are looking to pick up more. So, that's a very positive story.

The story on the wage front hasn't really changed in any material way. Yes, there are a few pockets of heightened wage pressure. We're seeing a lot of that here ourselves at the Bank, particularly in our IT area, but also in our audit and risk functions, which are highly in demand. But it's not widespread. At the moment, what we're seeing is the people getting basically somewhere around 2 per cent wage increases is about as high as it's ever been in recent years. And very few people are actually getting more than that. We saw a bunch of companies had wage freezes or wage cuts last year, and what we've seen is, as companies have removed those wage freezes or reversed those wage cuts, they've gone back to paying people 2 per cent again. In a lot of cases, it hasn't been catch up, it's just gone back to 2 per cent. So we aren't seeing those wage pressures that you're seeing in places like the US and the UK.

Now, maybe that changes as we open up over the coming months, but to date we haven't really seen that. And then on the price front is very much the same. We're obviously not quite experiencing some of the energy issues that have been prevalent elsewhere in the world, although that is flowing through to things like the oil price here. But we're also not really seeing so much impact yet, of supply chain disruptions, in terms of influencing prices. Businesses have, by and large, absorbed it in their margins to date.

That's something though we're very attentive to, is seeing how that dynamic plays out in the coming months, and as you said, particularly given what we're seeing elsewhere in the world. But the circumstances we're seeing here, today, in terms of wages and inflation are quite different from those particularly in places like the US where the situation is quite different.

And the final point I'd highlight there is on the labour market. So, notwithstanding whatever's going to be announced on the labour market front in an hour or so, at least up until the end of June, employment of Australians had risen back above its pre-COVID level. In the US, it's still 3 or 4 per cent below its pre-COVID level. So, the labour supply response here has actually been really strong, it hasn't been in places like the US. So again, on the labour market front, there's quite a different dynamic here than there is in other countries, but those issues are very front of mind and something we're going to be paying close attention to, over the period.

Moderator

Great, thanks so much, that's a very good answer. There was, just to finish off, we have 24 seconds left, and somebody has asked, who is your favourite punk rock band?

Guy Debelle

That's a tough question. I suppose I would go with … well, I'm more in the post-punk vein, so I would go probably with The Pixies.

Moderator

The Pixies. There you go. Thanks very much for that. So look, it's been a great session. Thank you very much for your time. Once again, we do really appreciate The Reserve Bank's commitment to being involved with our conference. It is a great avenue for you to talk directly to the investment community and we appreciate it, so thanks so much for that. And if I can just remind people to rate this session on the right-hand side of the panel, and as I pass across to the next things, but if we can just thank Guy.

Guy Debelle

Thanks Phil.