Climate Change Governance

Over the past five years, corporate leaders have consistently rated climate change and extreme weather as the top macroeconomic risks over the next 10 years in terms of both impact and likelihood, in the World Economic Forum’s annual Global Risks Report (January 2019).

The top five global risks include extreme weather events, natural disasters and the failure of climate change mitigation and adaptation.

International governance principles and guidelines

The World Economic Forum in January 2019 released a tool, How to Set Up Effective Climate Governance on Corporate Boards – Guiding principles and questions, to help boards steer through climate risks and opportunities. These principles are designed to increase directors’ climate awareness, embed climate considerations into board structures and processes and improve navigation of the risks and opportunities that climate change poses to business. For each principle, guidance and guiding questions are included in the tool. The tool is designed to be widely applicable across most organisations, sectors and jurisdictions, recognising that there is no one-size-fits all approach to good climate governance.

The principles and guidelines build on existing corporate governance frameworks, such as the International Corporate Governance Network’s Global Governance Principles, as well as other climate risk and resilience guidelines, such as the recommendations of the Financial Stability Board Task Force on Climate-Related Financial Disclosures (TCFD).

Link to the existing recommendations of the TCFD

The TCFD recommendations emphasise governance as a foundational building block of effective climate risk and opportunity management. Without effective climate governance structures in place, a company will struggle to make climate-informed strategic decisions, manage climate-related risks, identify climate-related opportunities and establish and track climate-related metrics and targets.

While the recommendations of the TCFD remain voluntary, regulators, listing authorities and public companies have pointed to them as a useful framework for disclosure. The latest edition of the ASX Corporate Governance Council’s Principles and Recommendations (Principles and Recommendations), issued 27 February 2019, makes reference to this framework.

Investor demand

Investors are also looking at company efforts in this area, recognising that climate change will have inevitable impacts on investment returns. In December 2018, the Institutional Investors Group on Climate Change – a group of 415 investors from around the world (including Australia) 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.

Challenges for directors

The difficulties that executive and non-executive directors have in struggling to address the related risks and opportunities of climate change are outlined in the publication and include:

• Competing priorities – climate change is one of a number of emerging and strategic risks that boards should be addressing
• Complexity of climate change – the risks are diverse and uncertain and not yet visible in some markets
• Short-term time horizon and focus – companies are under constant pressure to deliver short-term results.

These guiding principles and questions will assist boards in addressing some of these difficulties.

The principles

Principle 1 – Climate accountability on boards

The board is ultimately accountable to shareholders for the long-term stewardship of the company. Accordingly, the board should be accountable for the company’s long term resilience with respect to potential shifts in the business landscape that may result from climate change. Failure to do so may constitute a breach of directors’ duties.

Principle 2 – Command of the (climate) subject

The board should ensure that its composition is sufficiently diverse in knowledge, skills, experience and background to effectively debate and take decisions informed by an awareness and understanding of climate-related threats and opportunities.

Principle 3 – Board structure

As the stewards for long-term performance and resilience, the board should determine the most effective way to integrate climate considerations into its structure and committees.

Principle 4 – Material risk and opportunity assessment

The board should ensure that management assesses the short, medium and long-term materiality of climate-related risks and opportunities for the company on an ongoing basis. The board should further ensure that the organisation’s actions and responses to climate are proportionate to the materiality of climate to the company.

Principle 5 – Strategic and organisational integration

The board should ensure that climate systemically informs strategic investment planning and decision making processes and is embedded into the management of risk and opportunities across the organisation.

Principle 6 – Incentivisation

The board should ensure that executive incentives are aligned to promote the long-term prosperity of the company. The board may want to consider including climate-related targets and indicators in their executive incentive schemes, where appropriate.

Principle 7 – Reporting and disclosures

The board should ensure that material climate-related risks, opportunities and strategic decisions are consistently and transparently disclosed to all stakeholders – particularly to investors and, where required, regulators. Such disclosures should be made in financial filings, such as annual reports and accounts and be subject to the same disclosure governance as financial reporting.

Principle 8 – Exchange

The board should maintain regular exchanges and dialogues with peers, policy-makers, investors and other stakeholders to encourage the sharing of methodologies and to stay informed about the latest climate-relevant risks, regulatory requirements, etc.

Australian requirements

Listed companies are required to include in their directors’ report an operating and financial review which includes information on the business strategies and prospects for future financial years. ASIC has indicated that material risks should be disclosed as part of this information, one of those risks being climate change risk.

Both ASIC and APRA have increased their regulatory focus in this area, speaking on this topic and referencing the recommendations of the TCFD. ASIC also reviewed the climate risk disclosures of listed companies and found that more can be done to improve consistency in disclosure practices across listed companies. As mentioned above, the latest version of the ASX Principles and Recommendations has also referenced these recommendations.

Directors have become more aware of their legal obligation to consider climate-related risks through the legal opinion of Noel Hutley SC, which considered the extent to which the law permits or requires Australian company directors to respond to climate-change risks.

For more information on the Australian context for consideration of climate-change risk, refer to the latest article by our Governance Leadership Centre Climate change a growing focus for boards.