RELATED KNOWLEDGE
Disclosure of climate-related risks has become the new norm as investors expect full transparency to ensure that companies are managing climate risks appropriately.
Throughout the 2020 AGM season we saw a significant increase in investor pressure and concerns about climate change. Companies needed to be vigilant of and thinking about their responses. However, this pressure has shifted to an expectation on the part of shareholders that companies and their boards are dealing with and reporting on climate risks in a proactive and meaningful way. Shareholders are not accepting much less, and those outliers that aren't responding risk shareholder action, such as board spill resolutions, which is discussed in some detail below using the ExxonMobil case study.
As we approach the start of the 2021 AGM season it is worthwhile examining how companies are responding to this shift.
Background: shareholder pressure on climate-related risks
During the 2020 AGM season shareholders in Australia and around the world became increasingly vocal about their desire for companies to engage with and report on climate-related risks. Whilst shareholders are unable to directly influence the management of a company at an AGM, they can indirectly express their opinions through proxy voting.
This occurred frequently during the 2020 AGM season and the proxy results showed a clear message: shareholders want companies to disclose climate-related risks and the company's management of those risks. For example, the proxy results showed that over 10 climate-related resolutions received support from over 20% of proxy voters, six received over 30% proxy support; and one received more than 50% support from proxies lodged.
What we have seen as we progress into the 2021 AGM season is that boards are responding to this pressure.
What's happening now in the 2021 AGM season
Now as we continue into the 2021 AGM season, it would seem that the desires of shareholders have come to fruition as it has been commonplace for companies to report on climate change.
The investor pressure has shifted to an expectation that companies are meaningfully tackling climate risks and ESG matters more broadly, and disclosing the same. Morrow Sodali conducted a global survey of over 40 institutional investors in which 85% of respondents indicated that climate change was the most important topic for engagement with the board. And 86% found that the most effective way of influencing the board was through collaboration with shareholders. We saw this at the ExxonMobil 2021 AGM.
ExxonMobil case study: shareholders may call for significant change
ExxonMobil is the largest international energy provider and chemical manufacturer that is publicly listed on the New York Stock Exchange. At its 2021 AGM, Engine No.1, a small hedge fund with only a 0.02% interest in ExxonMobil, nominated four directors to the ExxonMobil Board. It did so with the intention to "Reenergize Exxon" by turning it away from fossil fuels and to decarbonise in a world that is increasingly focussed on net-zero emissions. Three of Engine No.1's nominated directors were elected.
Engine No.1 was able to achieve this through gathering the support of major institutional investors, Blackrock, Vanguard and State Street, who are calling for companies to be transparent in relation to climate change and to shift their goals to align with the goals of the Paris Agreement. This demonstrates that shareholders are rallying together to ensure companies are addressing climate change issues and this issue is now significant enough to result in substantial change such as board spills.
Companies are reviewing their trade associations
Another lesson we have learnt from the ExxonMobil case study and through the BHP 2020 AGM is that trade associations are also feeling the pressure from investors as listed entities are forced to consider whether their participation in trade associations aligns with their climate goals. Companies appear to be taking action in this respect, for example, in August this year Origin Energy released an in-depth review of its industry associations to ensure their goals are aligned with Origin's climate goals.
What are companies and their boards doing?
We have seen investors become more proactive in understanding the conduct of companies and companies and their boards have taken steps to increase transparency through the implementation of various initiatives to manage and report on climate change.
Companies are engaging with both shareholders and stakeholders to properly understand their expectations and to respond accordingly. For example, companies such as Origin Energy, Santos, AGL and Rio Tinto have agreed to put a non-binding vote on a climate report to their shareholders at their AGM. In particular Origin Energy has been proactive in its approach in engaging with shareholders and in a media release in August 2021 stated that:
“The non-binding, advisory vote will complement the continuing conversations we are having with our shareholders and stakeholders about the risks and opportunities climate change presents for the business."
It is clear that boards are seriously responding to and engaging with shareholders and stakeholders expectations and companies such as Origin Energy are certainly leading the way. Increasingly detailed reporting on climate risks and management strategies are another initiative that we have seen, for instance, Wesfarmers issued a highly detailed report on its climate approach in its annual report to shareholders in respect of its financial year ending 30 June 2020. The Commonwealth Bank's latest annual report announced the development of a "glide paths" strategy which involves an assessment of whether specific sectors are on a sustainable emissions trajectory consistent with the goals of the Paris Agreement in order to inform funding decisions. Glide paths have so far been developed for thermal coal mining, upstream oil and gas, and power generation, with the intention to develop similar assessments for other sectors. CBA intends to make these "glide path" assessments public. It is conduct like this that sets the bar for other companies, as those that do not have proactive initiatives in place are susceptible to shareholder action as outlined above.
Further, boards and management are being reconstituted to ensure that their skills and expertise properly equip the company to respond to shareholder and stakeholder expectations in relation to climate change and broader ESG-related matters. Ken Mackenzie, the chair of BHP, highlighted this in a recent interview with the Australian Institute of Company Directors. He also emphasized the constantly evolving challenges that boards and management face in tackling the multitude of ESG-related matters and the expectations that they are conducting the business in a socially conscious manner. The need for Board's to have the relevant skills to understand these risks in order to inform strategy is also an expectation of investors, as was made clear in the investor survey report Full Disclosure published in August 2020 by the Investor Group on Climate Change. It is therefore important that boards and management are resilient, adaptable and across shareholder concerns.
How are companies reporting?
Transparency has been a key issue for boards and management in relation to climate change. As mentioned above, we have seen increased disclosure in annual reports and other initiatives to increase disclosure. However, there does not seem to be a single standard or approach to climate reporting.
The Morrow Sodali survey of institutional investors gave us some insight into what shareholders are expecting. Significantly, 75% of survey participants indicated that the framework developed by Taskforce on Climate-related Financial Disclosure is the most popular ESG reporting framework (TCFD framework). ASIC has recommended that companies report in accordance with the TCFD framework and many companies are doing so. However, there are other frameworks that companies may choose to report in accordance with. Whatever way a company chooses to report, the key message remains: companies need to be reporting honestly and in considerable detail.
Significantly, the US Securities Exchange Commission (SEC) has now joined the debate on climate change reporting and is proposing the development of a climate disclosure framework. On 28 July 2021, the chair of SEC, Gary Gensler, announced that SEC was in the process of developing a framework in response to the rise in investor pressure to make disclosures with respect to climate change and is intended to increase transparency to investors and accountability of companies.
It is anticipated that the framework will require both qualitative and quantitative disclosure elements. Whilst many companies already report on their Scope 1 and 2 emissions, emissions created by the business and its activities, in order to give the full picture to shareholders, SEC is considering the extension of disclosure requirements to include Scope 3 emissions, which are emissions created in the supply chain rather than by the company's assets and facilities.
These frameworks are being developed in response to this shift in investor expectations that companies are reporting on climate change. Whilst the TCFD framework appears to be the most popular, companies and their boards need to make sure that this framework, or any other framework, are sufficient to adequately report on the climate risks specific to the company and management's response to those risks.
Increased risk of litigation
A rise in litigation risk also accompanies this shift in shareholder expectations. Around the world we have seen an increase in cases brought against companies in relation to climate change. And, it is not just investors bringing action, it is ordinary citizens who are expecting more from local councils, governments and companies.
We all know of Sharma v Minister for the Environment [2021] FCA 560, the case where eight children brought a case in the Federal Court of Australia against the Commonwealth Minister for Environment, where the court found that the Minister owed a duty of care to children when deciding whether to grant an approval under the Environment Protection and Biodiversity Conservation Act 1999 to consider the threat of harm caused by the carbon emissions from the project, in this case a new coal mining project. While the Minister has appealed against that decision, cases like this are also being brought against companies.
For example, in the Netherlands, Friends of the Earth, the largest international activist group, and over 17,000 co-plaintiffs brought a case against Shell for its impact on the climate. The court ruled that Shell had to decrease its carbon emissions by 45% by 2030. Locally, in the matter of McVeigh v Retail Employees Superannuation Trust (REST) [2019] FCA 14, Mark McVeigh, a member of the Australian investment fund, brought a case against REST which settled in November 2020 and which forced REST to recognise that climate change risks were financial risks and that it would comply with the TCFD reporting framework, despite its argument that it had no obligation to do so.
This demonstrates that Boards are simply expected to be actively reducing climate risks and accordingly, reporting on them. A failure to do so could result in litigation and at the very least, shareholder and investor action as we saw in the ExxonMobil case study. The history of the tort of negligence demonstrates a willingness on the part of courts to develop new categories of duty in response to new risks and new societal expectations. Climate risk is an area in which expectations are changing rapidly.
Greenwashing concerns
While it is important that companies are satisfying the expectations of investors, boards should be warned against "greenwashing" conduct that may very well leave companies susceptible to misleading or deceptive conduct breaches under the Australian Consumer Law. If a company makes a statement about its response to climate risk, it must be sure that it can make good on that statement.
In any event, shareholders will not tolerate greenwashing conduct. Companies need to ensure that they are reviewing their entire business model to ensure that all elements of the business align with their stated goals. For example, as mentioned above, one of the reasons that Engine No.1 was able to win three seats on the board was due to the misalignment between ExxonMobil's asserted climate approach and its trade associations. We saw this also in the BHP case study, where 22.4% of shareholders at the 2020 AGM called on BHP to suspend memberships with trade associations if the goals of the association did not align with the Paris Agreement.
What is expected of Boards?
Boards are simply expected to be actively reducing climate risks and accordingly, reporting on them. A failure to do so could result in litigation and at the very least, shareholder and investor action as we saw in the ExxonMobil case study. The recent release by the Intergovernmental Panel on Climate Change of its Sixth Assessment Report: Climate Change 2021 is likely to increase pressure on boards to do more, more quickly, just as it will increase pressure on policy makers to do the same.
Boards need to ensure that they do fully understand the risks that climate change poses on the company and also need policies and plans to manage these risks. Those Boards which are best positioned to do that have considered whether the board has the appropriate skill set and where necessary taken active steps to review board composition. Boards should also review their whole business model to ensure that all aspects of the business are aligned with their climate goals.
It is vital that boards are actively reporting on climate-related risks and management of these risks if companies want to maintain the support of their investors. Boards need to be actively assessing and reviewing whether their approach to management and disclosure of climate risks is sufficient and need to be asking "what more can we do?" as investors want to see a proactive response to climate change.
The authors would like to acknowledge the considerable support of Alana Dunn.