Establishing strong governance
A ‘high risk jurisdiction’: climate change and directors’ duties
Australian law requires certain standards of conduct of company directors, including that directors act in the best interests of the company and exercise care and diligence in performing their role.
To date, no Australian court has considered whether a director’s duties require a director to take into account climate change-related risk that may be relevant to the company’s business. However, following the conclusion of the Paris Agreement in 2016, the Australian think tank, the Centre for Policy Development, commissioned legal opinions from barrister Noel Hutley SC to assess the extent to which Australian corporate law requires company directors to respond to climate change risks. Hutley’s opinions, the most recent of which was published in 2019, conclude that:
- climate change risks are capable of being foreseeable risks to the interests of a company;
- climate change risks may be relevant to a director’s duty of care and diligence under s180(1) of the Corporations Act 2001 (Cth) to the extent that they interact with the interests of the company; and
- company directors can and, in some cases, should be considering the impact of climate change risks on their business, or else risk breaching their obligation to exercise care and diligence.
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The opinions are confined in their scope to a director’s duty of care and diligence and did not consider other statutory or fiduciary duties of a director. Kenneth Hayne QC has subsequently remarked in a November 2019 speech that the duty of a director to act in the best interests of a company includes taking into account climate change risks relevant to that entity.
‘Climate change risks’ refers to physical risks associated with rising temperatures, such as property destruction, and to transitional risks associated with adjusting towards a lower-carbon economy, such as regulatory changes or shifts in investor behaviour that may impact a company’s business. One type of transitional risk identified in the opinions is ‘stranded asset risk’ – the risk that companies will be unable to develop certain fossil fuel reserves if emissions targets are to be met. Climate change risk also extends to litigation risk, exposure to which Hutley SC considers will rise exponentially over time. ASIC has endorsed the Hutley opinions. In a 2018 speech, ASIC Commissioner John Price considered that the opinions were ‘relatively unremarkable’ and said that, in ASIC’s opinion, the view expressed ‘appears legally sound and is reflective of our understanding of the position under the prevailing case law in Australia so far as directors’ duties are concerned’. Commissioners Sean Hughes and Cathie Armour further emphasised ASIC’s agreement with the Hutley opinions, and stressed the importance for company directors of considering the impact of climate change on the company’s business, and ensuring that strong effective corporate governance practices are sustained in the company.
Australia’s directors nominated climate change and energy as the top issues they want the Federal Government to address in both the short and long term.
Breach by a director of their duty of care and diligence (arising, eg from a failure to give appropriate consideration to climate change risks) can give rise to personal liability. A director may also be found to have breached their duty if they do not appropriately disclose the risks posed by climate change to the business.
In addition, ASIC has recently used a ‘stepping stone’ approach to litigate against directors personally. This requires an action against a company for contravention of legislation (such as the Corporations Act), which then allows ASIC to launch a derivative civil liability claim against a director for breaching their duty of care in exposing the company to risk of prosecution.
One way to mitigate against the risk of exposure is to ensure that robust governance frameworks are put in place, supported by effective implementation, execution and accountability. Directors should be able to demonstrate that they have considered climate change-related risk in their decision making, and that they have done so in a way that is more than ‘cursory acknowledgment and disclosure’. This means ensuring that directors have access to all necessary information, in an appropriate format and level of detail. ASIC Commissioner John Price has spoken of a need for directors to adopt a ‘probative and proactive’ approach in gathering the information reasonably required to inform their decision making with respect to climate-related risk. Whether directors have considered such information adequately may affect their ability to rely on the defence that they exercised their business judgment under corporate law if their decision making is ever impugned.
While ensuring they are properly informed is the primary duty of the director, in some circumstances, further action may be required where a climate risk is identified. The magnitude of the risk and the probability of it occurring must be balanced against the difficulty, expense and inconvenience of taking action to alleviate it.
Asking the right questions
- Has the board, from a technical, financial and commercial perspective, been educated on the specific risks that climate change poses to your organisation, and their level of materiality?
- Is the board composition appropriate, considering the nature and materiality of climate-related risk to the organisation?
- Has the board established a system of regular review on climate-related risk, noting it is a dynamic area?
- Is a robust system in place to document the briefing and deliberations of the board in relation to climate-related risk?
- Is there a system in place to ensure material climate-related risks are reported up to the board on an equal footing with non-climate related financial risks?
- Is the board aware of the importance of accessing and considering such information as part of its decision making processes?
- Have appropriate resources been made available, and governance frameworks established, to ensure that accurate, complete and timely information is provided to the board in relation to climate risk?
Disclosure of climate-related financial risk: major change is underway
There has been a global proliferation of voluntary reporting standards that companies might adopt with respect to disclosure of climate change-related financial risk.
Notably, in 2016, the G20 Financial Stability Board established the Task Force on Climate-Related Financial Disclosures (TCFD), which released a set of recommendations for the voluntary disclosure of climate change-related financial risks in 2017, around which there has been widespread business convergence.
What sets the TCFD recommendations apart is their sophistication – they require companies to disclose qualitative data, including scenario analysis, which identify risks based on differing climate change-driven scenarios. Despite being developed as a voluntary framework, the TCFD recommendations are rapidly becoming mainstream by virtue of their endorsement by major investors, regulators and many major companies worldwide.
For example, signatories to the United Nations Principles for Responsible Investment (UNPRI) are required, from 2020, to adopt and report under the TCFD recommendations. At the time of writing, UNPRI members include more than 160 organisations headquartered in Australia, including many of the country’s major banks, investment managers and asset owners.
The relevance of climate-related risks to today’s financial decisions and the need for greater transparency have only become clearer and more urgent over the past two years. Nearly 800 public- and private-sector organizations have announced their support for the [Task Force on Climate-Related Financial Disclosures] and its work, including global financial firms responsible for assets in excess of $118 trillion.
Letter from Michael Bloomberg to Randal Quarles, Chair of the Financial Stability Board (31 May 2019)
The New Zealand Government and a joint taskforce of UK regulators are also exploring the possibility of changing the law in those jurisdictions to mandate TCFD reporting. There is currently no proposal to change the law in this way in Australia, but federal regulators have released guidance endorsing the TCFD framework (and climate-related risk disclosure more broadly):
ASIC: In 2019, ASIC published updates to two Regulatory Guides, RG228 and RG247, to provide guidance on climate-risk disclosure. Significantly, RG247 highlights climate change as a systemic risk that might impact the company’s future financial prospects, and that may need to be disclosed in an operating and financial review (OFR). The updates followed the publication by ASIC in 2018 of ASIC Report 593 on Climate Risk Disclosure by Australia’s Listed Companies. This confirmed that a listed entity must disclose any material business risks — including, where relevant, climate-related risks — affecting future prospects in its OFR in accordance with s229A(1)(c) of the Corporations Act.
Further, in December 2018, the Australian Accounting Standards Board (AASB) and the Auditing and Assurance Standards Board (AUASB) released guidance on ‘Climate-related and other emerging risks disclosures’. The AASB/AUSAB Practice Statement provides a decision tree to assist entities with the process of disclosing climate risks within their financial statements.
Companies that fail to report on climate-related risks in the manner required may contravene Australian corporations law or listing rules.
Companies should also consider the risks associated with inaccurate corporate disclosures constituting misleading and deceptive conduct under the Australian Consumer Law (Australian Consumer Law issues are discussed further on Page 25). This risk of legal non-compliance is, in turn, a key driver of corporate behavioural changes in relation to climate change. Companies realise that, to report effectively in response to corporate reporting obligations, they need to conduct extensive internal due diligence to better understand their operations and potential impacts on the world around them. They also recognise that non-compliant reporting is considered ‘low-hanging fruit’ for activist NGOs seeking to draw attention to corporate behaviour in relation to climate change. The sophistication of the required reporting will likely increase in line with the uptake of the TCFD recommendations. Market participants, including investors, lenders and consumers are increasingly expecting that companies will adopt voluntary disclosure frameworks such as the TCFD recommendations, and ASIC has recommended that companies with material exposure to climate change consider voluntarily reporting under the TCFD framework. A failure to disclose risks in a way that allows stakeholders to assess their potential impact on a business may affect a company’s ability to attract investment (see further below the section on ‘Just Transition’ commencing on Page 44).
Asking the right questions
- Considering statutory duties, regulatory guidance and voluntary commitments through (eg) UNPRI, should your organisation adopt TCFD reporting?
- Are adequate systems in place to provide assurance on the accuracy and completeness of climate-related disclosures?
- Has your organisation considered who may rely on climate-related disclosures, and satisfied itself that those people will not be misled in substance by those disclosures? How do your organisation’s climate-related disclosure practices compare to its industry peers?
- Do your organisation’s climate-related reporting practices put it at a competitive disadvantage? Will this remain the case?
- If your organisation does not currently report, should it have a roadmap which sets out how it intends to progress towards reporting in the future? Is there an identified trigger point?
- Does your organisation have systems in place to regularly confirm its disclosure practices meet market and regulatory standards as this area continues to evolve?