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Understanding and Addressing Climate Risk: A Quick Guide for Company Directors

May 2019

Legal pressure continues to mount on Australian company directors to consider, assess and disclose the potential impact of climate change on their business. But what is ‘climate risk’, why is it an issue for company directors, and how might it be disclosed?

Globally, litigation relating to corporate climate risk disclosure is on the rise.  In the United States, Peabody Coal has recently been pursued in the US Courts for not disclosing its modelling for the impact of climate change on its business.  Closer to home, proceedings were commenced in 2017 against the Commonwealth Bank (though later withdrawn) in relation to its climate risk disclosure.

In Australia, shareholders have filed climate risk focused resolutions with several listed companies. These companies include: Shell, BHP and Rio Tinto in the resources sector; and CBA and ANZ in the financial sector. Resolutions requiring better climate change risk disclosure have been successfully passed by Shell, BP and Rio Tinto, raising the disclosure bar for these corporations.

Corporate regulators ASIC and APRA have recently highlighted the need for directors to ‘understand and continually reassess existing and emerging risks (including climate risk) that may affect the company’s business’, including short term and long-term risks.1

There are increasing moves from financial regulators towards mandatory reporting of climate-change related risks. In 2020, Taskforce for Climate-related Financial Disclosure (TCFD) based reporting will become mandatory for the almost 2500 global signatories to the Principles for Responsible Investment (PRI) signatories. APRA and the Reserve Bank of Australia have endorsed the TCFD framework, and ASIC has also indicated its support expressing that statutory reporting obligations require climate change risks to be disclosed in a way that is ‘useful and relevant to the market’.2

What are climate risks?

Risks to companies as a result of climate change can be understood as:

  • Physical - for example, direct damage to assets or property, decreased asset values, supply chain disruption and an increased chance of insurance claims.
  • Transitional - such as policy changes, technological innovation and social adaptation to climate change. From this there can be a disruption from the adjustment to a low carbon economy with impacts on pricing and demand, stranded assets and the potential of defaults on loans.
  • Liability – including stakeholder litigation as well as regulatory enforcement from directors not considering or responding to impacts of climate change. This can result in business disruption from litigation as well as penalties from litigation.3

Climate Risk and Directors’ Duties

The Hutley Opinion on Climate Change and Directors’ Duties warns that Australian directors and boards should actively engage with climate change risks in order to meet their statutory requirements of a duty of care and diligence under s 180 of the Corporations Act 2001 (Cth).4 Directors who do turn their attention to the impact of climate change risks on their business will need to form their own assessment as to what action needs to be taken. This is likely to include obtaining and relying upon information and advice provided by employees or experts. Directors who are proactive in this regard may have the protection of a statutory defence ‘the business judgment rule’ under s 180(2) of the Corporations Act.

Under Australian Corporations Law, listed reporting companies are required to prepare and lodge a ‘financial report and directors’ report’ every financial year (s 292(2)). If the company’s operations are subject to any significant environmental regulation, the directors’ report is required to give details of the company’s performance in relation to that regulation (s 299(1)(f)). Directors may have a duty to assess the ability of their company to deal with increasing incidences of extreme or varied weather events, particularly those companies whose operations depend significantly on energy transmission or whose business is otherwise exposed to extreme weather events, such as insurance companies. Failure to take these events into account may lead to exposure to shareholders and others who suffer loss as a result. Conversely, those companies that address climate change issues early and in a meaningful way are well-placed to obtain a competitive advantage over competitors through an early transition to an increasingly climate-conscious regulatory environment, as well as reputational and investment benefits.

What should company directors do?

ASIC has recently released a report into climate change risk disclosure by Australian listed companies in 2018.5 ASIC recommends that directors and officers of listed companies:

  • Adopt a proactive approach to emerging risk, including climate risk;
  • Develop and maintain strong corporate governance;
  • Ensure legal compliance, including s 299A(1)(c) of the Corporations Act 2001 (Cth) that requires the disclosure of material business risk affecting prospects in an Operating and Financial Review, which may include climate change.

The current and future impacts of climate change pose significant financial risk to many corporations. APRA’s 2019 Information Paper 3 identified a range of risk management initiatives that companies can use to address and manage climate-related financial risk. These include:

  • Incorporating climate-related financial risks in risk registers;
  • Incorporating climate risk considerations into existing policy documents, and investment and underwriting procedures;
  • Undertaking improved due diligence on customers for lending, underwriting and investing; and
  • Producing regular board and management reports on climate-related risks.

APRA notes that many of its regulated entities have disclosed climate change related financial risks to their external stakeholders in multiple reports, including: the annual financial report, sustainability reports, investor presentations as well as global reporting requirement and through reporting on their website.

Directors should take steps to inform themselves about climate related risks to their business.

Directors should consider when and how these risks might materialise, and whether there is anything that can be done to alter the risk. In more complex situations which require specialist knowledge, a director should seek out expert advice as described in s 189 of the Corporations Act.

Accurate and timely disclosure of the risks of climate change allows regulators as well as investors to assess whether entities are financially viable, well-governed, compliant with regulators and resilient to the financial impacts of climate change. This is important not only for regulatory compliance, but also helps to ‘future proof’ companies as they adapt to a changing environment.

Material in this article is available for information purposes only and is a high level summary of the subject matter. It is not, and is not intended to be, legal advice. You should first obtain professional legal advice prior to taking any action on the basis of any information contained in this article. This article is copyright. For permission to reproduce this article please email Hazelbrook Legal: enquiry@hazelbrooklegal.com

References

  1. Disclosing climate risk Read
  2. Climate Change Read
  3. Climate Change: Awareness to Action Read
  4. Climate Change and Diretors' Duties Read
  5. Climate risk disclosure by Australia's listed companies Read
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