12/12/2019

The world is rapidly transitioning to a low carbon economy.  This is forcing companies to respond to these developments or risk being left behind.  It is also forcing directors to adopt a more proactive approach to considering and disclosing foreseeable climate-related risks to the companies they oversee. 

Why is climate change risk an important issue that boards need to proactively manage?

Ken Hayne warned this week, in his speech to the Centre for Policy Development’s Roundtable on Climate and Sustainability, that directors have a legal duty to act on climate change risk, include it in corporate strategies and report on it to shareholders. 

These remarks further reinforce an increasing body of thought, initially aired by Noel Hutley in his widely quoted opinion piece on director liability and climate risk, that a director’s duty of care, skill and diligence could be breached by directors who fail to properly consider and disclose foreseeable climate-related risks to their business.

The fact that Hayne’s remarks are now relatively mainstream shows how far things have come in the three years or so since Noel Hutley’s opinion piece made national headlines. 

Ken Hayne: “International opinion is now firmly behind the need for all entities with public debt or equity to respond to climate change issues in their governance, their strategy, their risk management and their metrics and targets and, importantly, to record their responses to the issues in their financial reports.” 

What are the climate-related risks that directors should consider?

Climate change is a recent and significant entrant in the risk register for companies. Directors who are mindful of their legal duty to act in the best interests of the company need to actively consider all foreseeable climate-related risks, or risk breaching their directors’ duties.

The climate-related risks that directors should actively consider include:

  • Reputational risk – companies that engage in or support carbon intensive activities risk a loss of social licence and reputational damage.  Activist shareholders, even when motivated by profit, can target companies with environmental issues because it perpetuates the negative spin.  The 2019 Australian AGM season saw 8 of the ASX 50 face ESG-related activist shareholder resolutions (up again from last year).  Successfully managing climate risks create opportunities for companies to avoid shareholder activism of this nature. 
  • Stranded asset risk – companies with a business model that is dependent on carbon intensive activities run the risk that their assets will suffer from unanticipated or premature write-downs, devaluations, or conversion due to environment-related risks. This is likely to be of concern to directors of financiers who fund mining projects or directors of superannuation funds who invest in carbon intensive companies.
  • Physical risk – flooding, cyclones and fires are examples of primary climate-related risks that can wreak damage on companies which have a financial exposure to these events.
  • Litigation risk – the possibility of a company being sued for loss or harm suffered because of its adverse impact on the environment, cannot be ignored.  Although Australia does not have a history of extensive climate change-related litigation, Volkswagen recently settled a lawsuit, on a no admissions basis, agreeing to pay up to A$127 million to Australian customers. This lawsuit followed allegations that Volkswagen engaged in misleading or deceptive conduct due to the installation of car software which represented its vehicles to be emitting fewer emissions than they were.
  • Regulatory risk – new laws may be introduced that impose greater compliance or economic burdens on brown asset companies, to a point where their financial viability is threatened.  You need look no further than the financial services industry to see how this can emerge as a risk following a sustained period of regulatory and community scrutiny.  In addition, obtaining regulatory approvals for activities that have an environmental impact, such as mining licences, may be subject to longer timeframes and rejections may become more frequent based on environmental concerns.

What guidelines do directors need to be across to help them mitigate risk?

Know your Australian law disclosure obligations

The reporting of financial information by Australian companies is regulated by the Corporations Act 2001 (Cth), the ASX Listing Rules, and the Australian Securities and Investments Commission Act 2001 (Cth).  Directors will need to ensure they comply with their obligations under these laws to appropriately report climate change-related financial disclosures.

For example, ASX Listing Rule 4.10.3 (in conjunction with Guidance Note 9) requires that a company’s annual report include a corporate governance statement that discloses the extent to which the company has followed the recommendations of the ASX Corporate Governance Council.  Council Recommendation 7.4 denotes that any exposure to economic, environmental or social sustainability risks that a reasonable person would expect to materially affect share prices should be disclosed.  Financial risk reporting by prudentially regulated entities is additionally governed by the Australian Prudential Standards, as published by the Australian Prudential Regulation Authority (APRA).

Be aware of international governance principles and guidelines

In January 2019, the World Economic Forum released a set of principles to help boards navigate the risks and opportunities that climate change poses to business. Boards could improve their structures, processes and risk management frameworks to support their ability to assess the risks and opportunities that climate change poses to their company.

Familiarise yourself with the TCFD recommendations

In June 2017, the Financial Stability Board Task Force on Climate-Related Financial Disclosures (TCFD) released recommendations for voluntary climate-related financial disclosures. These recommendations provide a framework for investors and companies to appropriately assess and price climate-related risk and opportunities.

Although the recommendations of the TCFD are non-binding, they have been embraced by Australia’s regulators as the preferred market standard for voluntary climate change-related disclosures.  ASIC has this year strongly encouraged listed companies with material exposure to climate change to consider reporting voluntarily under the TCFD framework.

Keep abreast of Australian regulatory changes

The TCFD recommendations have not yet led to any change in Australia’s laws. However, since their publication, APRA and ASIC have become increasingly focussed on the disclosure of climate change-related risks, culminating in the release by ASIC of Report 593: Climate Risk Disclosure by Australia’s Listed Companies in September 2018. The report includes high-level recommendations encouraging listed companies to adopt a proactive approach to emerging risks, including climate change risk. It also notes that directors need to disclose meaningful and useful climate risk related information to investors.

ASIC has also published updates to the following regulatory guides on 12 August 2019:

Regulatory Guide 228 – Prospectuses: Effective disclosure for retail investors; and Regulatory Guide 247 – Effective disclosure in an operating and financial review.

The updated guidance encourages companies to, amongst other things, incorporate types of climate change risks developed by the TCFD into the list of common risks that may need to be disclosed in a prospectus (refer to Table 7 of RG 228). It also highlights climate change as a systemic risk that could impact an entity’s financial prospects for future years and that may need to be disclosed in an operating and financial review (OFR), and reinforces that disclosures made outside the OFR (such as under the voluntary TCFD framework or in a sustainability report) should not be inconsistent with disclosures made in the OFR (refer to RG 247.66).

In August 2019, ASIC also updated ASIC information sheet (INFO 203) to include climate change risks as a relevant consideration for directors when determining key assumptions that underlie impairment calculations of a company.

In the coming year, ASIC has indicated that it will investigate climate change-related disclosure practices of select listed companies and continue to participate in discussions with industry and other stakeholders on these issues.

October 2019 also saw ASIC release its Director and officer oversight of non-financial risk report, where it found that boards’ oversight of non-financial risks was less mature than required. It’s not hard to see how climate risk will be relevant here.

APRA has also increased its scrutiny of how banks, insurers and superannuation trustees are managing the financial risks of climate change to their businesses. While APRA expects these climate risks to be assessed within existing prudential risk management standards CPS 220 and SPS 220, it has signalled that it wants to see continuous improvement in how regulated entities disclose and manage the financial risks of climate change to their businesses in the future.

Are there opportunities in managing the risks around climate change? Can climate change have a positive impact on your company?

On the opportunities side of the ledger, climate change offers companies new sources of revenues, particularly if they can successfully commercialise products or services that facilitate the global transition to a low carbon economy.  Companies with strong sustainability credentials will also be more attractive from a credit perspective, particularly for ESG investors or asset managers with ESG mandates. 

Boardrooms will need to pay attention to the temperature gauge

There is a prominent and rapid shift in the way that Australia is perceiving climate change risk. In the wake of this, directors are giving serious consideration to climate change risks when discharging their duty to act in the best interests of a company.  Pressure from shareholders, activist groups, and society for companies to pay greater heed to climate change, accompanied by the new regulatory guidance on climate change related risks disclosure, will only increase the impetus for directors to consider these risks in the future.

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