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12 Nov 2020

No Rest for superannuation trustees on climate change risk

By Greg Williams, Brendan Bateman, Vanessa Pallone, Kate Madgwick and Josh Krechman

Expectations about superannuation trustees' essential obligations when it comes to assessing climate change risk, and the actions expected of those investing someone else's money, are changing rapidly.

On the eve of a much anticipated hearing in the Federal Court, Retail Employees Superannuation Trust Pty Ltd (Rest) announced on 2 November it had resolved litigation brought by fund member Mark McVeigh alleging that it had breached its obligations as trustee of his superannuation fund. That settlement confirms a quickening in the market as firms accept and acknowledge climate change risk as a key financial risk and move towards greater transparency and disclosure of that risk.

What was the Rest / McVeigh settlement about?

Rest is the trustee of one of Australia's largest superannuation funds, the Retail Employees Superannuation Trust (Rest Trust). Mark McVeigh is a young Rest Trust member who will not ordinarily be able to access his funds before 2055. In 2018, Mr McVeigh filed proceedings in the Federal Court of Australia originally seeking access to information pursuant to s 1017C of the Corporations Act but later amended his claim to include alleged breaches of section 52 of the Superannuation Industry (Supervision) Act (SIS Act).

Mr McVeigh alleged that Rest at all times knew or ought to have known that the Rest Trust's “Climate Change Business Risks”, a range of risks arising out of the physical and transition impacts of climate change, may or were likely to have a material impact on the financial condition or investment performance of the Rest Trust and on the Rest Trust's sub plans.

Mr McVeigh said that he had sought information as to the Rest Trust's Climate Change Business Risks but that the information provided in response to that request was not sufficient to permit him to make an informed judgment about the management, financial condition or investment performance of the Rest Trust.

Mr McVeigh also alleged that Rest breached its obligation to exercise and act with "care, skill and diligence" and perform the trustee's duties and exercise the trustee's powers in the best interests of the beneficiaries (sections 52(b) and (c) of the SIS Act) by failing to:

  • require its Investment Managers (IMs) to provide information to the Rest Trust, its Board and the Board's Investment Committee in the nature of that sought by Mr McVeigh; and
  • ensure that its risk and disclosure processes were consistent with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations.

McVeigh sought declarations as to Rest’s obligations under the Corporations Act and SIS Act in relation to climate change risks as well as injunctions requiring it to act in accordance with those obligations.

Mr McVeigh's claim was due to be heard by the Federal Court in early November.  However, on 2 November 2020, the parties reached a settlement in which McVeigh discontinued his claim and each party agreed to pay its own costs. On the same day Rest issued a media release in which it acknowledged that "Climate change is a material, direct and current financial risk to the superannuation fund across many risk categories, including investment, market, reputational, strategic, governance and third-party risks."

Rest indicated that it would continue to develop its systems, policies and processes to ensure that the financial risks of climate change are:

  • identified and quantified at an asset and portfolio level;
  • considered in fund investment strategy and asset allocation decisions;
  • appropriately mitigated and managed having regard to the goals of the Paris Agreement among other things.

Rest said it would take further action to ensure that its IMs took active steps to consider, measure and manage climate related financial risks and ESG risks, with compliance reporting and assessment of the performance of the IMs.

Rest noted its other initiatives to:

  • implement a long-term objective to achieve a net zero carbon footprint for the Rest Trust by 2050. The Rest Trust has now joined the approximate 20% of Australian super funds which are committed to net-zero emissions;
  • measure, monitor and report on the outcomes of its climate related progress and actions in line with the recommendations of the TCFD;
  • encourage its investee companies to disclose in line with the TCFD recommendations;
  • publicly disclose the Rest Trust's portfolio holdings;
  • enhance its consideration of climate change risks when setting its investment strategy and asset allocation positions including by way of scenario analysis;
  • actively consider all climate change related shareholder resolutions of investee companies and otherwise continue to engage with investee companies and industry associations to promote business plans and government policies to be effective and reflect the climate goals of the Paris Agreement;
  • conduct due diligence and monitoring of IMs and their approach to climate risk;
  • continue to develop its management processes and implementing changes to its climate change policy and internal risk framework, which apply to all of the Rest Trust's investments, to reflect the above; and
  • seek to require that its IMs and advisers comply with the above.

What have Australian regulators been saying about climate change risk?

The Australian regulatory landscape's view on climate change risks has noticeably shifted in recent years with the RBA, APRA and ASIC all recognising that climate change is a first-order financial risk.

In February 2020, APRA indicated in its letter to superannuation trustees that:

  • APRA continued to encourage the adoption of the TCFD recommendations by regulated entities;
  • APRA would be conducting deeper supervisory assessments of each entity that participated in APRA's 2018 climate change survey;
  • APRA will be developing and consulting on a climate change financial risk prudential practice guide;
  • APRA will conduct climate change financial risk vulnerability assessments of regulated entities starting with the largest ADIs in 2021; and
  • APRA will consult on changes to SPS 530 and Prudential Practice Guide SPG 530 for ESG considerations.

What this means for superannuation trustees

Investor expectation

Rest has acknowledged and accepted, as have other superannuation trustees, that climate change is relevant to a member’s investment decisions and that greater transparency and disclosure is required as to the risks and opportunities of climate change.  This has the immediate impact on superannuation trustees having to consider how their disclosure to members describe such risks and whether current disclosure is sufficient in this regard.

Member outcomes

Climate-related risks may also be relevant to various elements of SPS 515 (which requires superannuation trustees to assess the outcomes provided to members and identify opportunities for improving those outcomes) including:

  • as regards “strategic objectives” – the RSE’s risk appetite, investment and insurance strategies and its assessment of operational risk (and the financial resources necessary to cover those risks);
  • as to the business plan – an RSE may need to consider “new” science and new or increased climate related risks in an ongoing way and may need to consider how those matters and others affect the assumptions that underlie financial projections;
  • as for the outcomes assessment – an RSE may need to consider which scenarios and pathways to include in its assessments, as well as the selection of benchmarks and whether and how climate risks and opportunities might better protect or improve the outcomes for members.

Impending risks

There is clearly a risk of litigation and regulatory scrutiny for firms that fail to consider, manage and disclose the potential financial risks arising out of climate change.

The inevitable transition towards a decarbonised economy

Markets and governments appear to be moving rapidly towards decarbonisation with Japan, Germany, the UK, South Korea, China (by 2060), the EU and NZ (amongst others) pledging to net-zero emissions by 2050 in the last 18 months. Meanwhile, President-elect Biden has pledged to re-join the Paris Agreement and invest in low-carbon technologies which will reduce the US' carbon footprint.  

Closer to home, the New South Wales Government announced on 9 November a plan to encourage a $32 billion investment in private infrastructure for renewable energy in regional areas to fully change the State's electricity infrastructure. The plan aims to increase renewable energy's share of NSWs power supply from approximately 16% to at least 60% by 2030.

ANZ recently declared that it will be applying a "net zero emission" test as part of its lending criteria / conditions with a commitment to:

  • no longer provide lending to any new business customers with material thermal coal exposures of more than 10% (the previous threshold was 50%);
  • stop lending directly to any new coal-fired power plants or thermal coal mines by 2030 (after 2030 ANZ will only directly finance gas and renewable power generation);
  • "wind down" existing direct lending to coal-fired plants and thermal coal by 2030; and
  • help existing customers with more than 50 per cent exposure to thermal coal exposure to seek specific, time bound and public diversification strategies by 2025.

It also follows shortly after institutional investors with over $850 billion in Australian assets (including Lendlease, Cbus, and AustralianSuper) formed a new ten-year, private sector-led initiative called the "Climate League" with the purpose of moving Australia towards further reductions in annual emissions of at least 230 million tonnes by 2030. Each Climate League member has committed to at least a single action each year that will reduce make a demonstrable contribution to reducing Australian emissions.

Rest has made it clear that it has expectations regarding the companies that it invests in to disclose their exposure to both physical and transitional risks arising out of climate change. This will place increasing pressure on Australian businesses and asset owners to assess, manage and report their exposure to climate change risks, with a commensurate increase in the need for robust data and quality of reporting.  This is not virtue signalling but a clear demonstration of the management of investment risk.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.