Climate change disclosures have become an increasing focus for investors. Apart from the legal risk disclosure obligation, directors need to consider whether the extent of activist pressure will be expressed in director elections and remuneration report votes.
We have seen instances of this already where alternative candidates are nominated for board election. It may not be too far down the track before some investors use the absence of disclosure, or action, in the same way they have for companies with no women on the board, i.e. vote against any current director standing for re-election.
Here is a brief discussion of some of the obligations directors should be aware of.
ASX disclosure recommendations, “if not, why not”
An ASX listed entity must “disclose whether it has any material exposure to economic, environmental and social sustainability risks and, if it does, how it manages or intends to manage those risks”. (ASX Corporate Governance Principles and Recommendations, recommendation 7.4).
If the listed company considers this recommendation is not appropriate for it, it must explain why not – under the “if not, why not” principle. Investors can then factor that information into their investment decisions.
Whether a company correctly regards climate risk as immaterial, is seemingly a grey area. Many listed companies that do not disclose, often do not supply a “why not”. Presumably, they have assessed the risks as not being a material exposure.
It may be that some companies are not considering the indirect risks, for example severe weather effects on the supply chain, or changes in policy or technology, that can be material.
Legal opinion on directors’ duties
The grey areas are slowly becoming clearer, with more influential opinion on the implications of non-disclosure becoming apparent.
The APRA’s executive board member, Geoff Summerhayes, gave a speech earlier this year, stating APRA’s viewpoint that climate risk is a material and current risk. In it, he refers to a publication by the Centre for Policy Development, ‘Climate Change and Directors’ Duties’, an influential legal opinion on company directors’ legal obligations to consider the impacts of climate change. It states that:
“directors who fail to recognise and disclose impacts may be liable for breaching their duty of care and diligence under section 180 of the Corporations Act in the future.”
Mr Summerhayes went on to say that “It is likely to be a matter of time before litigation against a director who has failed to perceive, disclose or take steps in relation to foreseeable climate risk that can be demonstrated to have caused risk (physical or reputational) to a company.”
Many of Australia’s listed companies are failing to disclose how they are managing potentially large financial climate-related risks. According to a report by the Australian Council of Superannuation Investors (ACSI), one third of ASX 200 companies did not make any climate related disclosures in 2016. ACSI’s ‘Corporate Sustainability Report’ assesses the level of sustainability disclosure by ASX 200 companies (see here)
ACSI, which represents not-for-profit superannuation funds that collectively manage $1.5trillion in assets, produces this report annually. Climate-related risk was included in the report for the first time in 2016, as it is fast becoming widely understood that climate related risks and opportunities have a material impact on investment outcomes. ACSI assessed whether ASX 200 companies were reporting on:
- their greenhouse gas emissions,
- whether they had a carbon emissions target, and
- whether they had a climate policy statement.
Each company is given an individual rating. ACSI’s CEO, Louise Davidson, was disappointed with the findings. “It was disappointing to see that such a high number of companies did not make any climate-related disclosure,” Ms Davidson said. “I find it almost impossible to believe that all 70 of them have no significant exposures.”
The sector with the highest level of disclosure was the Energy and Utilities sector. This is not surprising given the NGER scheme (National Greenhouse Gas and Energy Reporting Act 2007) requires large greenhouse gas emitters and energy consuming companies to report their energy and emissions information.
Banks also scored relatively well, following the move away from financing high carbon-intensive industries.
The worst performing sectors were consumer services – telecoms, retail, and food, beverage and staples sectors, often with no climate-related reporting at all.
Companies that do not report on sustainability risks for four or more consecutive years are classed by ACSI as ‘laggards’, and their names are disclosed.
As this is the first year that ACSI has included climate-related disclosures in its survey, it does not currently release names of the worst performing companies, although they have indicated they may “name and shame” in future. ACSI writes to all ASX200 companies to advise them of their individual rating, encouraging them to adopt the Task Force on Climate-related Financial Disclosures’ (TCFD) best practice framework.
Task Force on Climate-related Financial Disclosures
Currently, climate-related disclosures for Australian listed companies are voluntary. But, there is mounting pressure from global investors for companies to disclose how they are managing these risks.
The Task Force for Climate-related Disclosures (TCFD) has developed recommendations for voluntary, consistent climate related disclosures. The TCFD, chaired by Michael Bloomberg, is a collaboration between users and preparers of financial reports. It comprises international representatives spanning various organisations, including banks, insurance companies, asset managers, pension funds, large non-financial companies, accounting and consulting firms and credit rating agencies.
These recommendations will help companies understand what financial markets want from disclosure in order to measure and respond to climate change risks. They are intended to encourage firms to align their disclosures with investors’ needs.
Climate-related risks include physical risks e.g. severe weather risks and their implications (supply chain disruptions or damage to assets) and transitional risks e.g. financial risks due to changes in markets, technology or policy. Transitional risks are often harder to quantify.
Companies that do not disclose their ESG risks could have their risks estimated for use by investors.
Sustainalytics is one of the two main providers of ESG, corporate governance research and ratings to investors. Where a company provides limited ESG information, Sustainalytics uses its estimation model to assign an estimate of the company’s ESG risks. Companies may be better served to have their risks quantified based on their actual data rather than an estimate, given that risk quantification finds its way into trading algorithms.
Suggested action: a checklist
While companies may not perceive climate risk to be relevant to their business, it is evident from a regulatory and legal perspective that this view is questionable. Given the growing expectations of investors, and the rise of shareholder activism, disclosure of climate-related financial risks will likely increase.
Suggested actions for boards may include:
- Review current disclosures for compliance with ASX CGC Recommendation 7.4
- Review the company’s most recent assessment of its direct and indirect risks stemming from climate change. If there has not been such an assessment in the last three years, now would be a good time to undertake it. This may require an independent assessment.
- Review the rating of your company by the two primary ESG rating suppliers.
- Engage with your investors to ascertain the extent to which your company’s riskiness feeds into their investment decisions.
- Review objectives to minimise climate-related exposures.
- Engage with management to assess priorities and how climate-related risk is reflected in performance management systems.