On 12 December 2022, The Australian Department of the Treasury (Treasury) released a Consultation Paper regarding the introduction of mandatory climate-related financial risk disclosure in Australia (Consultation Paper), that could require companies to reveal more of the financial risks they face due to climate change in an attempt to provide more certainty to investors.
The release of the Consultation Paper comes amid growing pressure from investors for Australia to introduce mandatory reporting requirements in line with similar developments occurring in New Zealand, the United Kingdom and the European Union. Whilst not yet mandatory, a large number of Australian Securities Exchange (ASX)-listed companies have been disclosing climate-related financial risks and opportunities in line with the recommendations of the Taskforce on Climate-Related Financial Disclosures (TCFD). Recent data set out in a research report published by the Australian Accounting Standards Board (AASB) and the Auditing and Assurance Standards Board (AUASB) noted that 96.8% of the ASX 100 reported climate-related disclosures in 2021.
In addition, Australian regulators have released guidance that incorporates climate-related disclosures:
- Australian Securities and Investments Commission (ASIC) has published the Regulatory Guide 228 Prospectuses: Effective disclosure for retail investors, and Regulatory Guide 247: Effective disclosure in an operating and financial review. This ASIC guidance incorporates physical and transitional climate-related risks, as identified by the TCFD, into the list of examples of common risks that may need to be disclosed in a prospectus, and highlighted 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.
- The ASX Corporate Governance Principles and Recommendations provide that ASX-listed entities should consider whether they have a material exposure to climate change risk by reference to the TCFD, and if they do, to consider making climate-risk related disclosures in line with TCFD recommendations.
- Australian Prudential Regulation Authority has released the Prudential Practice Guide: CPG 229 Climate Change Financial Risks, which outlines prudent practices in relation to climate change financial risk management. Specifically, the guide provides guidance, sets out examples of better practice and aims to assist institutions in managing climate-related risks and opportunities.
2022 has also seen the release of the International Sustainability Standards Board’s (ISSB) draft global standards for climate and sustainability-related financial disclosures. There is an expectation that Australia will look to align Australian corporations’ obligations in respect of climate risk disclosure with these.
Purpose of the Climate-related Financial Disclosure Consultation Paper
The purpose of the Consultation Paper is two-fold: it is intended to canvas initial views on requirements for the design and implementation of “standardised, internationally-aligned requirements for climate-related financial risks and opportunities” across Australia; it also seeks input on other matters relevant to climate disclosure, including changes to allow Australia’s financial reporting bodies to stay abreast of international standards and priorities.
The proposed climate-related financial reforms and final design requirements will be guided by the following principles:
- Support Australia’s net zero emissions goal, adaptation to climate change and broader efforts to promote sustainable finance nationally and globally.
- Improve the quality and quantity, as well as comparability, of disclosure.
- Ensure climate-related financial risk disclosure is clearly understood.
- Align with international reporting practices.
- Ability to scale up disclosure requirements as well as allowing flexibility in order to accommodate future developments.
- Ensure climate disclosure requirements are proportionate to the risks they address.
Notably, the Consultation Paper forms one part of a broader sustainable finance framework being developed by Treasury. Public consultation on the broader framework and its measures will open in 2023.
Key proposals in the Consultation Paper and questions for feedback
The Consultation Paper seeks submissions on the costs and benefits of Australia aligning with international practice on climate-related financial risk disclosure, including mandatory reporting for certain entities. It also seeks inputs on a number of more specific policy and technical questions, with inputs to be considered against the reform principles. Below, we consider some of the key proposals and areas of feedback set out in the Consultation Paper.
A phased approach to mandatory reporting
A fundamental question is whether Australia should take a phased approach to mandatory climate-related financial disclosure requirements (similar to other jurisdictions including New Zealand and the United Kingdom), with first reports for initially covered entities due for financial year 2024-25.
The Government proposes a phased approach, with disclosure requirements to initially apply to:
- large, listed entities covered by the Corporations Act 2001 (Corporations Act), and
- large financial institutions (such as banks, insurers, credit unions and superannuation funds).
The Government has proposed that reporting requirements gradually expand to smaller listed entities, which could include both companies and schemes.
Feedback is sought on which entities should be subject to initial reporting obligations, including whether large entities which are unlisted and are not financial institutions should also be initially covered, and what size thresholds should be used to determine whether an entity is ‘large’.
We expect that the Government’s proposed phased approach to mandatory climate-related reporting with an initial focus on large entities will be favoured by a number of stakeholders, particularly given that smaller entities may take more time to comply with reporting requirements and will benefit from an opportunity to observe how larger entities approach reporting obligations.
What will the regulatory framework for required disclosures look like?
Another fundamental question is the appropriate design of the regulatory framework for mandatory climate-related financial risk reporting. The Consultation Paper envisages that the framework for climate-related financial risk reporting should be consistent with the existing regulatory framework for financial reporting, under which, the Corporations Act and regulations made under that Act establish reporting rules, and covered entities report to ASIC and the ASX (as relevant).
It is proposed that legislation will likely set out (at a minimum) the details of covered entities; the location for any reporting requirements (for example, in annual reports); and requirements to follow prescribed standards when making climate-related financial disclosures. The Consultation Paper proposes that more prescriptive details about the content of disclosures will be set out in climate standards (for example, TCFD), and notes that there are at least two possible options for the position of overarching obligations within the regulatory framework, as follows:
- overarching obligations for climate disclosure (governance, strategy, risk management, targets and metrics) could be incorporated in legislation (for example, the Corporations Act), with more specific obligations contained in standards and guidance; or
- current requirements to disclose any material risks as part of an operating and financial review could be expanded, with overarching obligations for climate disclosures set through regulatory guidance or standards (for example, by adjusting ASIC regulatory guidance so that it directs affected entities to apply ISSB standards once finalised).
The Consultation Paper seeks feedback on key considerations that should inform the design of the new framework. In our view, while both proposed options for overarching climate-related financial disclosure obligations would work, incorporating new requirements into legislation, such as the Corporations Act, may be a preferable approach, particularly as it would allow reporting obligations to be consolidated in one location. This could make any future amendments to the regulatory framework for mandatory climate-related financial risk reporting more efficient.
Approaches to assessing materiality and assuring climate risk
The Consultation Paper asks for inputs about what considerations should apply to judging whether a risk is sufficiently ‘material’ to require disclosure, in circumstances where assessing materiality of climate and sustainability risks is an evolving area. The TCFD and AASB currently provide guidance on how to judge the materiality of climate risks, and materiality guidance will be included in ISSB standards when finalised. The Consultation Paper asks for input on the appropriate reference point for materiality (for instance, whether it should align with ISSB guidance).
Views are also sought on what level of assurance should be required for climate disclosures, who should provide assurance (for instance, financial report auditors), and whether assurance providers should be required to comply with independence and quality management standards.
In our view, it will be important for a high level of assurance to be required for climate disclosures, so as to safeguard the integrity of the reporting scheme.
Requirements for reporting emissions, transition plans, and use of offsets, and how these obligations should interact with other reporting obligations
(a) Emissions reporting
With respect to emissions reporting, the Consultation Paper seeks inputs on the appropriate requirements for requiring scope 1, 2 and 3 emissions reporting, and the potential interaction between any new disclosure obligations and existing national emissions reporting frameworks such as the National Greenhouse and Energy Reporting Scheme under the National Greenhouse & Energy Reporting Act 2007 (Cth), Corporate Emission Reporting Transparency Initiative (CERT) and the Climate Active Carbon Neutral Standard, noting the need to ensure consistency and minimise duplication for entities that also report emissions under these schemes.
We expect that avoiding duplication of emissions reporting obligations will be an important aspect of the reforms, particularly for entities who are already subject to reporting obligations under the National Greenhouse and Energy Reporting Scheme.
(b) Corporate transition plans and use of offsets
Importantly, with respect to disclosure of corporate transition plans, the Consultation Paper acknowledges the growing international focus on the need for transparency and comparability in how businesses report on their decarbonisation commitments. It seeks inputs on how to ensure covered entities provide transparent information about how they are managing climate-related risks, including what transition plans they have in place, and any use of offsets to meet their published targets.
It also notes the need to consider how the regime for mandatory climate risk reporting should interact with the misleading or deceptive conduct prohibitions and civil penalties in the Corporations Act, to ensure that entities have appropriate incentives to provide accurate, comprehensive, and timely disclosures without taking on disproportionate liability risk.
The Corporations Act provides that representations about future matters are deemed to be misleading if made without reasonable grounds. This is echoed in ASIC’s disclosure guidance (in Regulatory Guide 247), and was recently emphasised in ASIC’s Information Sheet 271 on avoiding greenwashing risk. The Consultation Paper seeks views on the appropriateness of these ‘reasonable grounds’ requirements in the context of climate reporting, and whether there are other tests or measures that could be considered to ensure liability is proportionate to inherent uncertainty within some required climate disclosures.
There is already a high level of expectation on Australian businesses to disclose their approaches to decarbonising and managing climate-related risks, from regulators and investors alike. Further, given recent attention of Australian regulators on greenwashing claims, with ASIC announcing its first formal greenwashing enforcement action in October, we expect that a number of submissions will be made on these points. Read more about recent developments in this space in our article: 'And so it begins … ASIC takes its first enforcement action for ‘greenwashing’'.
In our view, it will be prudent in the lead up to the reforms for entities who are not already disclosing their approaches to managing climate-related risks, including their corporation transition plans, as part of their annual reporting requirements to consider strategies for doing so.
Structures for ensuring that reporting is fit for purpose
Given international developments in climate and sustainability risk disclosure standards, Australia’s financial disclosure framework needs to be capable of implementing and supporting climate risk disclosure, in a way that ensures high integrity of the system and enables Australia to remain attractive for investment. The Consultation Paper recognises the need for Australia’s financial reporting framework to be able to respond flexibly to issues as and when they emerge, by reducing structural barriers and resultant operational inefficiencies. It proposes three possible structures for the implementation of climate risk disclosure standards and ensuring the ongoing efficiency of the financial reporting system:
(a) AASB responsible for climate-related financial disclosure standards
The first proposed structure is to confirm the AASB as the entity responsible for developing and monitoring the standards for climate and sustainability-related risk disclosure, under Financial Reporting Council (FRC) oversight. AUASB would be tasked with developing and maintaining relevant assurance requirements.
The reason for nominating the AASB comes down to the AASB’s existing experience in taking preparatory steps towards introducing climate and sustainability-related risk disclosure standards, while capitalising on the AASB’s general standard-setting experience and credibility. Additionally, the AASB has strong relationships with international standard-setting bodies.
(b) Separate sustainability standards board
Alternatively, a separate sustainability standards board could be established, which would have the power to develop and monitor standards for climate and sustainability-related risk disclosure, again under FRC oversight.
This approach would clearly delineate the functions and powers of the various standard-setting boards and would also reflect the creation of the International Sustainability Standards Board. Consequently, this structure would be easily understood by national and international entities. However, this could also lead to further fragmentation of Australia’s financial reporting framework and thereby lead to inefficiencies. In order to minimise such issues, the operational requirements of the proposed board would be merged with those of the AASB and AUASB to the greatest extent possible.
(c) Combine powers of various entities into one
Finally, Commonwealth legislation could be amended to combine the functions and powers of the FRC, AASB and AUASB into one entity that is responsible for oversight of the entire financial reporting system. This body would have the power to make climate and sustainability-related risk disclosure standards, with a government-appointed governing board as well as independent resourcing and the power to create technical expert sub-committees.
This would provide independence and flexibility to respond to future developments, thereby allowing the Australian financial reporting system to adapt over time, while also removing operational inefficiencies in the current system. However, this approach may lead to uncertainty for some stakeholders and could also impact timely implementation of disclosure standards.
In our view, establishing a separate sustainability standards board under FRC oversight, may enable a more effective and timelier implementation of climate disclosure standards, however, this will of course depend on the mandate of the board.
Submissions on the Climate-related Financial Disclosure Consultation Paper are open until 17 February 2023 and will be used to inform a specific design proposal for further consultation in 2023. At that time, views will be sought on more detailed proposals for the new reporting requirements, their implementation and sequencing.
This consultation follows a year of proposed regulatory and legislative overhaul due to the change in Federal Government. This month alone saw legislation introduced into Parliament that will form part of changes to the Safeguard Mechanism under the National Greenhouse & Energy Reporting Act 2007 (Cth), and an announcement of planned major reforms to the Environment Protection and Biodiversity Conservation Act 1999 (Cth). In addition, the outcomes of the Independent Review of Australian Carbon Credit Units led by Professor Ian Chubb are expected by the end of the year. Read more about the review in our article: Movements in Australia’s climate and energy policy