Corporate Governance in 2022 – Climate Change Risks
Market Insight 24 March 2022 24 March 2022
Directors have far-reaching legal duties and responsibilities and must consider issues such as climate change to even international global geopolitics with diligence and due care. In 2022 the focus has, to some extent, shifted away from the business impacts of COVID-19 and on to the resumption of regular business and the trends in governance that have now gained momentum.
In our “Corporate Governance in 2022” article series, Clyde & Co’s Australian teams detail some of the key issues and trends in the local market as industry prepares to resume regular business operation in a post-COVID-19 landscape. The first article looks at current trends and regulatory updates with respect to climate change risks including their predicted impact on governance in 2022.
The next two articles will explore recent trends regarding the oversight of compliance risk by boards of financial services organisations and the issues and trends regarding sanctions, modern slavery and anti-money laundering in governance.
Emerging ESG Issues
- Climate change financial risk
- Increased risk of litigation
- Future proofing business
1. Climate change financial risk
As highlighted in our 16 February 2022 article ‘Insurers and the changing tide - APRA's final prudential practice guide for CPG 229 and climate change’, APRA released its final prudential practice guide CPG 229 Climate Change Financial Risks in November 2021 (CPG 229). CPG 229 provides that an institution should manage and mitigate the financial risks borne by climate change through governance, risk management, scenario testing and disclosures.
CPG 229 provides that financial climate change risk includes physical risk, transition risk and liability risk. Briefly:
- Physical risk includes financial risk arising to the lowering of asset values, increased frequency of insurance claims, or the disruption of the supply chain arising from changing climate conditions or extreme weather events that cause direct damage to property or assets.
- Transition risk relates to the policy changes, technological innovation and social adaption which causes disruption from the adjustment to a low-emission economy. Here, financial risk lies in the impact on pricing and demand, stranded assets, and defaults on loans.
- Liability risk arises from stakeholder litigation and regulatory enforcement. This is the direct consequence of not responding to the impacts of climate change, leaving businesses open to litigation.
On 1 February 2022, APRA also released its supervision priorities for 2022 in which it lists climate-related financial risks as a cross-industry resilience priority. Here, APRA notes that it will look to develop additional tools to evaluate climate-related financial risks and increasing its scrutiny of entities’ progress in addressing the impact of climate risk. Part of APRA’s short term activities include the completion of the Climate Vulnerability Assessment, which seeks to explore the potential financial exposure and macroeconomic risks to large ADIs, the financial system and economy from both physical and transition risks of climate change.
APRA has also identified the conduct of the climate risk self-assessment survey in the first half of 2022 as a short-term objective. On 2 March 2022, APRA briefed all APRA-regulated entities regarding the climate risk self-assessment survey. The results of this survey will assist APRA and industry understanding of approaches taken to identify, assess and manage climate related financial risks. Survey participation is voluntary for medium-to-large APRA regulated entities. Participation would pose considerable benefit for institutions seeking to understand where their practices regarding climate related financial risks sit in relation to other peer participants and subsequent regulator insights.
2. Increased risk of litigation
Institutions and their boards will need to consider the increased likelihood of litigation being initiated against them from stakeholders and regulators as climate change expectations and policy crystalises into the common law, regulation or statute. Institutions that fail to take measures to mitigate and manage the climate change risk at a company or board level may be met with stakeholder action.
These considerations were echoed in Noel Hutley SC and Sebastian Hartford Davis’ third updated opinion in their series of legal opinions on climate change and directors’ duties.
The litigation risk that accompanies climate change has been pronounced in examples of recent case law. For example, on 26 August 2021 two shareholders in Abrahams v Commonwealth Bank of Australia NSD864/2021 brought an action against the Commonwealth Bank of Australia in the Federal Court, seeking access to the bank’s alleged involvement in seven oil and gas projects which potentially infringe its Environmental and Social Framework (E&S Framework) and Environmental and Social Policy (E&S Policy). The E&S Framework and E&S Policy requires the bank to carry out an assessment against its projects in respect of their environmental, social, and economic impacts and whether they are in line with the objectives of the Paris Agreement.
Looking to the future, boards and senior management of institutions should take stock of their obligations and consider the litigious repercussions of breaching same. As foreshadowed in our 15 November 2021 article and 14 December 2021 article, Australian companies and their boards may be held to account for their public commitments made in respect of climate change targets, namely net zero commitments. In a speech on 3 March 2022, ASIC Chair, Joe Longo warned the super fund industry that it will be conducting a review to establish whether the practice and promotion of managed investment and superannuation funds that offer ‘ESG’ or ‘green’ products are actually aligned. The ACCC chair, Rod Sims echoed this sentiment in a 3 March 2022 speech, where he stated that the ACCC will also be looking at claims made in the manufacturing and energy sectors with respect to false promotion of environmental or green credentials used to capitalise on consumer preferences. This includes business’ claims regarding the carbon neutrality of their production processes. Modern day governance requires a higher standard of care in respect of climate change and demands that institutions carefully consider their messaging and public statements. In doing so, an institution should verify whether the information contained within their messaging or statement is accurate and substantiated by their practices and documents.
3. Future proofing business
An institution that does not plan and action strategies to future proof their business will not be equipped to mitigate and manage the increasing risk posed by climate change.
On 14 December 2021, ASIC published a media release encouraging Australian listed companies to use recommendations set out by the Task Force on Climate-related Financial Disclosures (TCFD) as the primary framework for voluntary climate-change disclosures. In doing so, ASIC states that listed companies following the TCFD reporting method will be well-placed for transitions to any future standard.
In ASIC report 593, ‘Climate risk disclosure by Australia’s listed companies’, the regulator makes the following four recommendations to directors and senior management of listed companies and their advisors:
- consider climate risk at a board level including director knowledge regarding the risk profile of climate change and an ability to continually reassess existing and emerging risks;
- develop and maintain strong and effective corporate governance to facilitate the identification of and managing of material risks;
- comply with the law including the disclosure of material business risks affecting future prospects in an OF; and
- disclosing useful information to investors especially in circumstances where the listed company is.
Such recommendations are vital to a business’ longevity in the face of the changing climate landscape. Themes of risk management and proactive disclosure were also echoed in CPG 229. Where current regulator advice with respect to climate change accounts for the uncertainty of climate change risk, it deals with and mitigates this risk by demanding a cautious and proactive response from institutions. Boards and senior management should follow the latest regulatory advice but also be proactive in obtaining and informing themselves on the latest information available regarding climate change and its potential business impacts. The alternative would be an institution left vulnerable and unprepared for future challenges, which may eventuate in legal or regulatory consequences.
4. What should business be doing in 2022?
- For APRA regulated institutions, the physical, transition and liability risk posed by climate change should be met with a swift governance response in managing and mitigating its financial risk. At a bare minimum, this includes risk management, scenario testing and disclosures as provided by CPG 229. Beyond regulator advice, institutions should be forming their strategy around the latest information available and periodically updating their climate change strategy to mitigate financial risk.
- For other institutions, a fundamental understanding of climate change liability and the causes from which this liability stems are vital to avoid litigation or regulatory action. Directors ought to be dynamic in addressing climate change risk and reflect these issues at a board level and in carrying out fiduciary duties under the Corporations Act.
- Businesses should strategise for the near and long term impacts of climate change from a commercial, regulatory and legal perspective and adopt regulator-recommended practices such as TCFD disclosures. This will involve ensuring that its practices do not fall foul of ‘greenwashing’ or over-promising on net-zero commitments, as this can lead to costly litigation and the consequences of same. On 25 August 2021, the Australian Centre for Corporate Responsibility (ACCR) sued Santos in Australasian Centre for Corporate Responsibility v. Santos 2021 regarding Santos’ claims that it provides clean energy natural gas and that it has a net zero emissions plan in action for 2040. Although the case is still ongoing, it serves as a stark reminder to institutions to be mindful of their practices and messaging.
As the groundswell of climate change picks up pace, business in 2022 should keep up to date with updates with respect to regulatory and legal obligations. To read more thought leadership articles on the climate change topic please visit our Resilience Hub. If you would like to know more about how we can help you in identifying and navigating climate change related risks that your organisation may face, please contact partners Dean Carrigan and Jacinta Studdert or visit our Climate Change Risk webpage.