Climate change a growing focus for boards

Pressure on boards to take action to manage climate risk.

Climate change has at times been viewed with scepticism in Australia and directors’ attitudes have been somewhat ambivalent. Yet this is changing as Australian businesses are increasingly compelled to respond to the growing focus on sustainable development and climate action.

Internationally, climate change is perceived as a key global risk. Each year the World Economic Forum identifies the most pressing risks facing the world in its Global Risks Report, and this year the top three risks were related to the environment and climate change: (i) extreme weather events; (ii) failure of climate-change mitigation and adaption; and (iii) natural disasters.

Some organisations have attempted to measure the quantum of climate risk. The Economist Intelligence Unit, for example, estimated the value of global assets at risk from climate change to be between $24 trillion and $43 trillion from now until 2100.

Business is on alert. A recent publication by Ceres and The B Team, Getting Climate Smart: A Primer for Corporate Directors in a Changing Environment, points to a range of market risks that arise for businesses from climate change – including physical, value chain, regulatory, technological and reputational risks.

Last year, for the first time, Australian directors nominated climate change as the number one issue they want the federal government to address in the long term. This was the finding of the AICD’s Director Sentiment Index: Second Half 2018, based on a biannual survey of over 1,200 public and private company directors.

That climate change is now at the forefront of Australian directors’ minds is not surprising given the pressures that boards are facing to take action. We are observing 4 forces that are contributing to the increasing focus on climate risk governance: (a) pressure from investors; (b) increasing compliance and disclosure frameworks; (c) a developing understanding of the legal risks for directors; and (d) the greater focus of Australian regulators.

1. Pressure from Investors

Climate change has come to be recognised by the investment community as a legitimate risk to the sustainability of investment portfolios. Climate-change risks include both physical risks (including severe weather events and rising sea levels) and transition risks (that is, indirect financial risks arising from transition to a lower carbon economy, including changes in policy, technology or investor preferences). Many superannuation funds, such as Future Super and Australian Ethical, now provide investment options that screen out or substantially limit fossil fuels.

ASIC’s 2018 report on the annual general meeting season for S&P/ASX 200 listed entities (issued in January 2019) showed a significant increase in the level of support for requisitions in the area of climate change. ASIC observed that ‘shareholders sought to understand the steps boards were taking to identify, address and mitigate climate-related risks to the company’s business, as well as advocating for boards to take action…’

In December 2018, the Institutional Investors Group on Climate Change – a group of 415 investors from around the world who collectively manage US$32 trillion in assets – reiterated their call on governments to accelerate steps to combat climate change and implement the actions to achieve the goals of the Paris Agreement.

Recently, the world’s largest asset manager, BlackRock, named ‘environmental risks and opportunities’ as one of its investment stewardship engagement priorities. In his 2019 Letter to CEOs, BlackRock CEO, Larry Fink, also noted the growing materiality of environmental, social and governance issues to corporate valuations as investor preferences change. This follows BlackRock’s decision in mid-2017 to publish company-specific information on climate change reporting.

This growing investor concern around climate risk is changing corporate practices. For example, last year and following pressure from major shareholders, Exxon Mobil said it would “enhance” climate-related disclosures going forward. In May 2017, ExxonMobil management was defeated as nearly two-thirds of shareholders voted to instruct the company to report on the impact of global measures designed to keep climate change to 2 degrees Celsius. However, the timing of when Exxon Mobil will “enhance” its disclosures is unclear, with investors in December 2018 calling on the company to set and disclose emission reduction targets. Exxon Mobile also faces multiple law suits tied to its climate-related business practices.

2. Regulation, compliance and disclosures

Since 1997, the number of climate change regulations globally has grown twenty-fold to 1,200. It is expected that this trend will continue as the number of groups proposing frameworks for climate change disclosures is growing.

Of note is the disclosure framework issued in June 2017 by the Financial Stability Board. This framework, known as the Task Force on Climate-related Financial

Disclosures (TCFD), provides for voluntary consistent disclosure recommendations that companies can adopt to provide information to investors and other stakeholders about climate-related risks.

Some organisations, such as ANZ, have begun to implement climate-reporting frameworks, set metrics and targets, and report against them. ACSI research suggests that 22 ASX200 companies have now adopted or have committed to adopt the TCFD. In an interview with the Governance Leadership Centre, Ed John, Executive Manager, Governance Engagement and Policy at ACSI, said that he expects that within 5 years the TCFD will be the norm for climate-related disclosure and reporting.

Another notable recent development is the guide released by the World Economic Forum in January 2019, titled How to Set Up Effective Climate Governance on Corporate Boards Guiding Principles and Questions. The guide outlines eight principles and related guidance to help boards steer a climate transition strategy. These principles and guidance build on existing corporate governance frameworks, such as the International Corporate Governance Network’s (ICGN) Global Governance Principles, as well as other climate risk and resilience guidelines, such as the recommendations of the TCFD.

3. Legal consequences for directors

Directors have also become more aware of their legal obligations to consider climate-related risks. The legal opinion of Noel Hutley SC (commissioned by the Future Business Council and Centre for Policy Development in 2016) considered the extent to which the law permits or requires Australian company directors to respond to climate-change risks.

The Hutley Opinion found that courts would likely view climate change risks as “foreseeable business risks” and, as such, relevant to a director’s duty of care and diligence to the extent that those risks intersect with the interests of the company. Directors could face liability for breaching their duties if they cannot show they have adequately considered and responded to the risks of climate change on their business.

The Centre for Policy Development issued a further discussion paper in January 2019 suggesting that public authority directors are also likely to have duties of care and diligence to consider climate risk in their activities, at least as stringent as the duties of private corporation directions.

4. Focus for Australian regulators

Australian regulators have also increased their focus on climate-change risks. In February 2017, APRA publicly warned companies about climate change and urged them to view it as a risk-management issue. In its first major speech on climate change, APRA executive board member Geoff Summerhayes highlighted that some climate-change risks are distinctly financial in nature and cannot be considered only through an ethical or environmental lens.

ASIC’s John Price followed suit in 2018 with a key note address stating that the Hutley Opinion appears legally sound, and reflects the position under the prevailing case law in Australia so far as directors duties are concerned.

In September 2018, ASIC reviewed the climate risk disclosures of listed companies and found that more can be done to improve consistency in disclosure practices across listed companies. In particular, it found there was very limited climate risk disclosure outside the top 200 companies. ASIC encouraged listed companies and their directors and advisors to:

• adopt a probative and proactive approach to emerging risks, including climate risk;
• develop and maintain strong and effective corporate governance which helps in identifying, assessing and managing risk;
• consider how best to comply with the law where it requires disclosure of material risks; and
• disclose meaningful and useful climate risk related information to investors, noting that the voluntary framework developed by the TCFD could assist with this.

In light of such recent developments, climate risks are increasingly being considered by boards as part of their governance, risk management and corporate strategies.

Recently, Dr Katherine Woodthorpe, Chair of start-up Fishburners, said that “company directors were not just being influenced by regular warnings, but also a push from investors to act.” She also noted that “[M]ost people understand that it [climate change] is a real and an increasingly urgent issue”.

Climate change is a difficult topic and the risks are difficult to forecast. In 2019 we will likely see boards becoming more sophisticated in how they grapple with this important issue.