Guerdon Associates released a 2020 remuneration checklist late last year with climate change risk as one of the suggested key focus areas for boards (see HERE). We mentioned that activist resolutions on climate change are being supported by a growing proportion of institutional investors.

For the first time, the Investor Group on Climate Change (IGCC), a collaboration of Australian and New Zealand institutional investors and advisors with two trillion dollars in assets under management, released a publication last month describing requirements for company climate-related reporting.

What was interesting were investor perspectives on board and executive expertise, materiality of risk and supporting evidence, remuneration and climate change, and the extent that climate change reporting factored into investment decisions.

Summary

The investor survey provided several insights.

Survey respondents required greater detail in company reports on how climate-related risk information is translated into action. Important details included discussions on how climate risk informs strategy and planning, evidence that the board understands climate-related risks, assessment of impact of actions taken to manage risk and capture opportunities, and evidence of performance.

Investors also emphasised the importance of disclosing supporting evidence relating to companies’ climate-related statements. This included proof of relevant expertise among responsible executives and board members, discussion of inputs and assumptions in scenario analysis, disclosure of assumptions of current business model and base case, and granular reporting of the three scopes of  emissions.

Survey participants noted relationships between individual elements disclosed should form a coherent whole. Investors are paying close attention to relationships, particularly between climate-related performance and remuneration, risk and opportunity analysis, and how decision making is affected by targets.

Survey respondents expect ongoing improvements in company disclosures that will demonstrate skills and expertise in climate change at both board and executive levels and will disclose links between climate-related performance and executive remuneration. It is also clear that they expect considerable improvement in their own expertise to evaluate climate-related risk and company response.

Participants

The survey was undertaken in two steps; twenty-five IGCC investor members participated in the survey and fifty investors joined a workshop thereafter to test the survey findings and implications.

The majority of survey participants were asset/fund managers and institutional investors, and had responsible investment or ESG-related considerations in their investment function.

How investors make use of climate-related reporting

The majority of survey participants use climate-related reporting as part of ESG integration (inclusion of ESG issues in investment analysis and investment decisions) and engagement with companies. Less than half the respondents used climate-related reporting as part of the portfolio construction, valuation and screening process, though some respondents noted that uses of climate-related reporting are expected to evolve.

Most respondents directly engage with companies on climate-related risk rather than through proxy organisations. Potential topics for engagement included linking remuneration metrics to climate risk management responsibilities for relevant executives, more challenging scenario analysis and greater detail of headline risk mitigation actions. Though investors have different strategies and hypotheses, the common focus was for companies to understand their risk exposure, ability to benchmark risk exposure against comparable peers and to drive higher decarbonisation ambitions.

Investors are also using findings of external frameworks, such as metrics by providers of ESG indices, to test against company disclosures. Investors are also developing relationships with research and advisory organisations to build internal capacity for assessment.

Governance

The Taskforce on Climate-related Financial Disclosure (TCFD) developed recommendations for voluntary climate-related financial disclosures that assists investors when making investment decisions. Governance is one of the four pillars that relates specifically to executive remuneration (the other pillars being Strategy, Risk Management, and Metrics and Targets).

Respondents ranked board and executive expertise and responsibility the highest priority (with three-quarters of respondents ranking this as “very important”). Acceptance of climate science was ranked second. Linking executive remuneration to climate targets was equal third. Investors noted that this area is a growing concern and will become a more material requirement in the near future. Operation of relevant committees was also equal third important followed by trade association memberships.

A governance case study was evaluated where the majority of survey participants rated the disclosure as “average current practice”. Gaps identified included lack of detail surrounding how the company ensures it has appropriate climate-related expertise, relevant expertise of sustainability committee members, how each business unit contributes to the climate risk strategy, reporting and responsibility structures, and whether and how remuneration is linked to climate-related risk.

Moving forward

Investors expect future company disclosures to better demonstrate skills and expertise in climate change at board and executive levels. Investors also expect companies to report links between climate-related performance and executive remuneration.

Other expectations include disclosures relating to strategic and organisational response to climate-related risks and opportunities, extension of reporting metrics to include scope 3 emissions, report on transition and physical risk, and auditing and assurance of results.

As institutional investors’ expectations of climate-related governance continue to rise rapidly, boards are encouraged to identify reliable and valid measures that can be applied, test materiality in terms of risk, identify the data that can be collected efficiently and applied, and to what extent and how to reflect this in the remuneration framework.

The full report can be found HERE.

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