The time is now - climate risk a mandatory issue for all boards

The false narrative develops yet again

On 31 October 2019, the NZ Government released a Discussion Paper outlining mandatory principles-based disclosure of climate risks for all companies.   

Importantly, disclosure will use the framework outlined in the June 2017 final report of the G20 Financial Stability Board’s Taskforce on Climate-Related Financial Disclosures (TCFD Framework).  

The TCFD Framework divides climate risks into:

• physical risks (the threat to a company’s assets and profits from increased extreme weather events); and
• transition risks (those arising from the move to a lower-carbon economy, such as the cost of complying with mandatory carbon pricing and reputational and litigation risks when a company fails to take action on climate change).

In Australia, with the intense public and media scrutiny of climate change continuing unabated following weeks of Extinction Rebellion protests and recent NSW and QLD bushfires, the NZ Discussion Paper has generated a lot of industry buzz.  Some have suggested that Australia should ‘also’ adopt mandatory climate risk disclosure, with the discussion evolving once again into calls by some commentators for directors to place climate change concerns ‘above’ shareholder returns.

The emotive nature of the climate change debate is prone to blanket assumptions and law reform calls which proceed on a misunderstanding of what the law already requires.

This post corrects that narrative and reinforces the point that directors of all companies in Australia already have an obligation to consider, disclose and effectively manage the unique climate risks impacting on their businesses.  Failure to do so will expose the company and individual directors to significant civil and criminal liability and compensation orders.

Disclosure of climate risks is already mandatory in Australia 

In August 2019, ASIC released its revised Regulatory Guides 228 and 247, requiring climate change risks to be disclosed by all companies in a fundraising prospectus, and specifically by listed entities in their annual operating and financial reviews.  This followed new policy guidance from  ASX and APRA earlier this year emphasising the need for listed and APRA-regulated entities respectively to ensure the same level of disclosure in annual financial reporting.

Both regulators and the ASX recommend entities use the TCFD Framework as the specific standard for considering and disclosing material climate risks. 

But it is a mistake to assume that companies which are unlisted, and are not regulated by APRA, can sit back and do nothing. 

Under sections 292 and 298 of the Corporations Act, all public companies, large proprietary companies and certain other entities are required to prepare and lodge annual financial reports and annual directors’ reports.  The latter must detail, among other things, circumstances that may significantly affect the company’s operations and state of affairs in future years (section 299).  There is also an obligation for directors to certify that annual financial statements give a true and fair view of the financial position and performance of the company (section 297).  In light of the very real financial and operational impacts physical and transitional climate risks may have on companies across various sectors (see below), these Corporations Act obligations may already serve as the basis for mandatory disclosure of any material climate risks by most Australian companies.

Don’t stop at disclosure! 

But the story doesn’t end there.  While important, disclosure is only one piece of the ‘climate risk puzzle’.  There is a strong incentive for directors of all companies to not just consider and disclose material climate risks, but to proactively manage and mitigate those risks.  Mitigating action may consist of anything from investment in renewables, carbon offset initiatives and green bonds, to establishing new supply chain networks (reducing exposure to heavy emitters) and diversifying into ‘cleaner’ product offerings.  The connection with a company’s existing ESG commitments and actions is clear. 

The risk for directors is that, if they fail to take these steps, they will breach their duties under sections 180 and 181 of the Corporations Act to act with reasonable care, skill and diligence and in the best interests of the company.

Indeed, the physical and transitional impacts of climate change are very real for many companies.  The impacts are not just theoretical – they can have measurable financial impacts.  Climate risks are no less material simply because the physical impact of a changing climate may take time to materialise and the Federal Government’s policy agenda for placing a price on carbon and mandating renewables investments remains uncertain.  On the contrary, the regulatory uncertainty enhances transition-related climate risks because entities’ future investment options, product lines and demand and supply chains are compromised

Of course, not all companies will be impacted by climate change in the same way.  Companies in the energy and resources sector understandably may face the greatest threat to their operations, returns and sustainability arising from both physical and transitional climate impacts.  

But other companies also face a significant risk, from heavy emitters that currently depend on fossil fuels in the manufacturing sector, to operators in food and agriculture impacted by drought and bushfires, and banks and insurers with exposure to borrowers and insured parties in climate-impacted industries and regions.  Even companies in more ‘remote’ industries such as transport, tourism and real estate face flow-on physical and transition climate threats that will force them to reshape how they do business in a lower-carbon economy and a world facing more severe and hazardous weather events. 

But regardless of the unique climate risks impacting on a particular company, the point is that there is now an obligation for all directors to at the very least consider what those risks are.  If they are material, directors must then disclose and take mitigating action to address the risks.

Taking action on climate change and acting in the interests of shareholders are not mutually exclusive

By acting in this way, directors are not in any sense preferring climate change concerns over the maximisation of shareholder returns.  Rather, proactively responding to material climate risks is an important means for ensuring that very end.  

If directors do nothing, treating climate change as an issue for ‘tomorrow’s board’, the company could well be exposed as it finds it can no longer rely on the same supply chains, products and investments to drive ongoing profitability.  It will also lose the chance to obtain a competitive edge in the market from developing new products to accord with changing consumer demands in a lower-carbon economy.  Not to mention the reputational impact as climate-conscious employees, investors, financiers and customers take their business elsewhere.  

Further, if directors do not take action on climate change, they will not only expose the company to civil and criminal penalties, but will also leave themselves open to personal enforcement proceedings from ASIC and shareholders for breach of their duties.  

This risk has increased due to the continued growth in shareholder class actions in the last 12 months.  Climate-related litigation is widely predicted to be the next ‘boom area’ in shareholder class actions.  While climate litigation remains very much in a ‘test’ phase, the scrutiny on climate action will not be going away and will itself motivate future proceedings as claimants seek to create enough ‘smoke’ and publicity to secure a hefty sum of ‘go away money’.    

The takeaway 

As the climate risk space continues to rapidly evolve across multiple industries and sectors, directors and executives must remain proactive – embedding climate risks within their organisational policies and procedures and actively considering what impact a changing climate and the transition to a lower-carbon economy has on their businesses.  If material, the relevant climate risks not only need to be disclosed to shareholders and the broader market but also positively managed through specific mitigation measures.

As the regulators have been careful to emphasise, the time for awareness is over as we now enter a new phase of positive action.