In the most recent Australian Institute of Company Directors’ (AICD) Director Sentiment Index, climate change was identified as the number one long-term issue that company directors want the Federal Government to address.
Climate change presents significant risks and opportunities, not least of all due to the political landscape surrounding responses to it. It is not surprising that it is rated as such a high priority issue for company directors, or that corporate governance practices and the disclosures of companies are coming under increased regulatory scrutiny.
To assist in navigating the emerging and complex area, this Alert provides a brief summary of key developments in relation to climate change risk, and forecasts what may lie ahead.
Understanding and managing climate change risk
Climate change risks may be grouped into two key categories:
- Physical risks – The risks associated with damage caused by acute weather events as well as the longer term changes to climate (eg increased droughts or floods); and
- Transitional risks – Legal, technological, market and reputational risks arising from new laws and policies aiming to transitioning the economy to a low carbon one.
These risks interplay with director and company obligations in two key ways. First, directors owe duties of care, skill and diligence in understanding the risks facing their company, and responding appropriately. Second, companies (and directors) owe duties to properly disclose risks to enable informed investment decisions.
In short, companies and their directors are expected to consider and understand climate change risks, and ensure they are disclosed and (where appropriate) mitigated. In February 2017, Geoff Sumerhayes of APRA said:
For example, an infrastructure or utility entity seeking to construct a new facility should ensure any designs adequately accommodate expected future weather conditions (including as influenced by climate change) such as the likely occurrence of extreme heat days or “once in X year” flooding events.
In relation to transitional risks, and with the result of the federal election now clear, companies should not expect significant new legal risks to emerge at the Commonwealth level.
The centrepiece of the federal government’s climate policy, the $2 billion Climate Solutions Fund, will build on the existing Emissions Reduction Fund mechanism by purchasing emissions reductions. The federal government is also expected to progress developing Snowy Hydro 2.0, which will be a significant new source of reliable, low-emissions generation which may affect wholesale prices in the National Electricity Market. However, the proposed emissions requirement of the National Energy Guarantee appears unlikely to be revisited. This means that individual states and territories may play an increased role in renewable energy and emissions reduction requirements (eg by way of higher legislated and/or policy targets) in the future.
Both physical and transitional risks can have financial implications, and disclosures about these risks may be very pertinent to investors. Further, existing disclosure requirements already specifically encompass these risks. For example, ASX Guidance Note 9 requires that listed companies include in their annual Corporate Governance Statement disclosure of:
While there is an increasing understanding about the obligations and liabilities associated with climate change risks, there remains a lack of detailed guidance for companies and directors in how to appropriately respond.
High level guidance may be found in specific regulatory materials, such as:
- ASIC Regulatory Guide 228 (in relation to prospectuses); and
- ASIC Regulatory Guide 247 (in relation to directors’ reports).
However, these materials do not assist with more general questions of, for example, what type of modelling companies should engage in for future climate scenarios. In September 2018, ASIC released Report 593 “Climate risk disclosure by Australia’s listed companies” based on ASIC’s review of climate risk disclosures by a sample of ASX entities. The report found that the majority of ASX 100 companies reviewed had considered climate risk to some extent, however there were fragmented or varied disclosure practices and more general risk disclosures were not useful for investors assessing the exposure to climate risk.
A key development in relation to disclosure obligations was the 29 June 2017 Final Report from the G20 Financial Stability Board’s (FSB) Task Force on Climate-Related Financial Disclosures (TCFD). This report includes detailed recommendations on climate-related financial disclosures for companies to adopt in their own disclosing practices (TCFD Recommendations). As reported in the TCFD’s September 2018 status report, over 510 organisations have since signed up as “supporters” of the TCFD Recommendations.
Notably, ASIC has endorsed the TCFD Recommendations. In the June 2018 keynote address referred to above, Commissioner Price said that ASIC would:
Another useful reference for companies and directors seeking to address climate change risk is the Commonwealth Climate and Law Initiative (CCLI). This is a research and education project, established in collaboration with the University of Oxford, which considers director’s liability and climate risk in four Commonwealth countries: Australia, Canada, South Africa and the UK. The CCLI has published detailed research papers on liability in Australia, as well as a “corporate governance primer” on climate risk reporting which should accompany any reading of the TCFD recommendations.
These resources are all voluntary frameworks, but given their positive treatment by Australian regulators, they should be seriously considered by companies and directors seeking to ensure compliance with this emerging area of risk.
Regulating the management of climate change risks
The interplay between climate change risks and directors’ duties is also well known. In a memorandum of opinion dated 7 October 2016, barristers Noel Hutley SC and Sebastian Hartford-Davis, provided a useful summary of directors’ obligations and potential liability (Hutley Opinion). The Hutley Opinion was updated on 26 March 2019 with a Supplementary Memorandum of Opinion.
A key conclusion of the Hutley Opinion is that Australian courts will most likely consider that climate change risks are foreseeable, and that directors who fail to consider those risks may be liable for breaching their duties of care and diligence. More concerning, the supplementary memorandum noted that the multitude of recent developments in this area “elevate the standard of care that will be expected of a reasonable director”.
At the same time, key regulators have increasingly strengthened their statements in relation to climate change risks. In a keynote address delivered in June 2018, ASIC Commissioner John Price observed that ASIC’s priorities for climate risk, at a high level, are:
- the prudent and appropriate management of issues such as climate change (be it climate risk or opportunity), led by directors and senior management; and
- ensuring that the laws in relation to disclosure are complied with in a way that is useful and relevant to the market.
ASIC continues to be active in this space, and has joined a climate risk working group established by the Council of Financial Regulators. Other members of this group include APRA, the Reserve Bank of Australia and Treasury. Businesses should expect that ASIC will continue its focus on climate change risks in 2019, for example ASIC is expected to again focus on impairment testing and asset values in its review of 30 June 2019 financial reports.
Climate Change Litigation
Regulators are not the only ones seeking to ensure that companies and their directors consider and respond to climate risks. Climate change litigation is a growing global trend. According to Columbia Law School’s Sabin Center for Climate Change Law, Australia is the number two country in the world for climate change litigation actions (behind the US).
One wave of climate change litigation focuses on corporate decision making and disclosures, and the role of directors in those contexts.
Many early cases have failed – especially those seeking to sheet home responsibility for climate change itself against public authorities. However, there have already been some successful decisions abroad. For example, in the US, corporate regulators have undertaken investigations concerning the adequacy of the disclosure by major corporates of their exposure to transition risks, and in two of those investigations have concluded that the disclosures had been inadequate. The New York Attorney-General (NYAG) has also commenced proceedings against Exxon Mobil on the basis that its disclosures to investors did not adequately state the expected impact of transition risks. This followed three years of investigation commenced by the NYAG in November 2015.
Closer to home, Australian companies have already been subject to a number of proceedings in relation to their disclosures regarding climate change. There is also the perceived class action risk as litigation funders eye this emerging area of litigation.
In 2017, two shareholders commenced actions against the Commonwealth Bank in relation to the allegedly inadequate disclosures in its 2016 annual report. This action was ultimately abandoned, after the 2017 annual report was released and stated that climate change is “a significant long-term driver of both financial (credit, market, insurance) and non-financial (operational, compliance, reputation) risks”.
In 2018, a pension fund member commenced Federal Court proceedings against the Retail Employees Superannuation Trust (REST). This was on the basis that REST had failed to provide sufficient information about climate change risks and REST’s plans for mitigating those risks, in contravention of its obligations under the Corporations Act 2001 and Superannuation Industry (Supervision) Act 1993 as well as the equitable duties it owed as trustee. That case, Mark McVeigh v Retail Employees Superannuation Pty Ltd ACN 001 987 739 is ongoing, with the parties currently preparing evidence, including expert evidence.
A separate wave of climate change litigation presents a different risk and that is the litigation directed at challenging, on climate change-related grounds, government approvals associated with development of a project, typically relating to fossil fuel projects or projects with high carbon emissions.
A successful challenge can have serious consequences for a company’s investment strategy (just as a regulatory decision to refuse development approval can, even if made in the absence of any third party litigation). To date, the majority of such challenges in Australia have been unsuccessful and, even where successful, often conclude with the matter being remitted to the decision maker only to be remade with the same effect as the original decision but in a way which takes into account the court findings on process.
That said, these are issues which present a degree of risk to companies involved in carbon-intensive enterprises and others as well, such as those companies upstream or downstream of such companies in the supply chain.
The need to understand and manage – and possibly even disclose – these risks, whether direct or indirect, is growing.
Next Steps and Recommendations
Despite continuing calls for greater policy certainty for industry on climate change there have been significant developments in climate change regulation as far as obligations on companies and directors are concerned. With the federal election now behind us, there is an increasing understanding and awareness of both climate change risks and the interplay of those risks with company disclosure requirements and directors’ duties. There is also a growing body of work providing guidance on those obligations, including the TCFD Recommendations.
Although the outcome of the federal election indicates that significant new legal transitional risks may not emerge at a Commonwealth level, we expect that individual states and territories may play an increased role in renewable energy and emissions reduction requirements.
Companies and their directors must monitor these developments and ensure that their governance and disclosure practices meet the increasingly well understood obligations.
Strategic Insights by Jeff Lynn, Partner; James Clarke, Partner; John Briggs, Partner; and Tim Rankin, Lawyer – from global law firm Ashurst