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11 Mar 2021

Attention directors: investors call for climate change management and disclosure

By Brendan Bateman, rory moriarty, greg williams and rod halstead

Concerns about climate change are no longer just a fad. Investors are becoming increasingly active in expressing their expectations of what businesses should be doing to manage their climate change risks and in disclosing the same. In this Briefing Note, we explain the pressures on directors and managers to engage meaningfully with climate change and report on the risks, and management's response to those risks.

Climate change is real and investors are alert to this

Climate change has been of consistent and considerable concern for the past two decades, but this concern has moved beyond environmental activist groups to investors as their goals swing from short-term gains to long-term security. The growing pressure investors are exerting on ASX-listed companies to increase disclosure of their identified climate-related risks and their management of them, and the quality of those disclosures, can no longer be ignored by companies. Investors are demanding that companies seriously engage with climate change, no longer as a matter of corporate social responsibility, but as risks to be integrated into companies' main business policies, practices and financial statements.

Risks can be either physical, such as rising sea levels, severe weather events, increase temperatures, or transitional risks, such as changes in laws, policies and market and consumer attitudes. The last two years have only focused attention more keenly on climate change risks, with Australia's devastating bushfires followed by severe flooding and storms in 2019-2020, straight into a global pandemic.

Before this, it might have been acceptable for companies to prioritise other matters, but these drastic weather events and pandemic are changing their risk profile. It has never been more apparent that climate risk is investment risk. Investors, both retail and institutional, are managing for the long-term, and they expect companies to respond accordingly.

Directors' failure to anticipate and account for climate-related risks may very well result in their companies being seen as a potentially risky investment. Companies who take the opportunity to appropriately address these issues are likely to be well supported by investors, because active engagement with the transition to a low carbon economy gives companies the opportunity to reframe and grow their business, and to put themselves a step in front of their competitors. Both risks and opportunities can and should be reflected in risk management planning and the company's financial statements.

The mounting pressure for greater transparency on climate-related risk identification and management appears to be two-fold deriving firstly from investors, and secondly from regulators.

Failure to anticipate and account for climate-related risks may make companies a potentially risky investment.

Investor pressure through AGMs

Investors have shown their growing support for climate-related risk disclosures through proxy voting results from company annual general meeting (AGMs) resolutions. The rules regulating shareholder and security holder voting at company AGMs provide limited scope to influence the management of the company. Nevertheless, investors have found a way to express their opinions on climate change issues. Even if directors, technically speaking, do not have to give them any regard in practice they should be doing so and indeed there is evidence that this is happening.

What shareholders can't do

Under sections 249N and 252L of the Corporations Act 2001 (Cth), shareholders and security holders can propose resolutions to move at an AGM. However, unless otherwise specified in the company Constitution (which is likely not the case for all ASX listed entities), shareholders are not permitted to vote at an AGM on matters that relate to the Board of Directors' power to manage the company. This principle applies to preclude advisory resolutions and has been relied on by many boards to deny consideration of shareholder proposals.

What shareholders can do

What shareholders can do is propose a special resolution to amend the constitution, which, generally speaking, would permit shareholders to express an opinion or make a request about the way in which a power vested in the directors has or should be exercised. The members will then propose resolutions, contingent on the passing of the special resolution, regarding a specific matter, for example, the reporting of climate change management. This has occurred regularly over the past three years. Unsurprisingly, the special resolution is never passed, but for information purposes the proxy vote results on the proposed contingent resolutions are released on the company's Australian Securities Exchange (ASX) AGM results announcement. While public interest groups have proposed all of the resolutions, investor support for the climate change proposals is growing materially. In 2019-20:

  • over 10 resolutions received over 20% proxy support;
  • six resolutions received over 30% proxy support; and
  • one resolution received more than 50% support from proxies lodged.

This is in comparison to 2017-18, where only two resolutions received over 20% proxy support.

A high-profile Board's response

At BHP's AGM held in October 2020, a resolution proposed to amend the Constitution only drew proxy support of 9.6%. A subsequent resolution, however, was proposed recommending the company suspend membership of industry associations with a record of advocacy inconsistent with the Paris Agreement's goals. This received proxy support of 22.4% notwithstanding that the resolution was not valid as the amendment to the Constitution was not passed. Consequently, BHP issued a statement in its 2020 AGM results that it would engage with investors to better understand the reasons underlying the support for the resolution.

This investor support should not be ignored

The high level of investor support expressed through proxy votes, although not valid, cannot be ignored. Boards should seriously engage with shareholder proposals regarding climate change, particularly where proxy support is high.

Institutional investors are clearly more actively submitting climate-related resolutions at AGMs. TCI Fund Management, a well recognised UK fund manager, has expressed its intention, in no vague terms, to continue to submit shareholder resolutions requesting that companies make disclosures in accordance with the TCFD Recommendations and that shareholders be entitled to a non-binding advisory vote in respect of such matters. A similar sentiment was expressed by the Institutional Shareholder Services (ISS) in its Proxy Voting Guidelines: Benchmark Policy Recommendations 2020 which recommend that the Board should consider proposals on a case-by-case basis, examining whether implementation of a proposal is likely to enhance or protect shareholder value regardless of the power to deny consideration of such proposals.

Regulatory pressure on boards and management

Echoing pressure from investors, regulators are pushing ASX listed entities to report on climate change matters. Although this is not mandatory, it would be wise for Boards to consider the sizeable totality of regulatory pressure when considering the question of climate change.

The Australian framework

The ASX Corporate Governance Council Recommendation 7.4 recommends that the companies should report on "material exposure to environmental or social risks", and this expressly includes any risks associated with climate change. Material exposure has been defined as "a real possibility that the risk in question could materially impact the listed entity’s ability to create or preserve value for security holders over the short, medium or longer term." Further, the Australian Securities and Investment Commission (ASIC) determined that climate change is a systemic risk that may materially affect the future financial position of an entity. Therefore, under sections 299(1)(a)(c) and in the case of a listed company, section 299A of the Corporations Act, a listed entity's obligation to disclose material business risks affecting future prospects in an operating and financial review may very well include climate change.

As we have seen a rise in severe weather events, shifting policies and regulations relating to climate change and general changes to the environment, undoubtedly many, if not all, companies would be impacted by climate change risks, almost certainly in the long term but even so in the short term. ASIC has made this patently clear when the ASIC Commissioner, Cathie Armour, revealed that ASIC had written to numerous companies that were deemed "potential 'laggards' in this area" to remind them of their statutory obligations, and warned that it is prepared to take tougher action if necessary. The Australian Prudential Regulation Authority (APRA) has too expressed its focus on climate risks, stating that it would embed the assessment of climate change risks into its ongoing supervisory activities and toughen its approach.

Despite the clear sentiment from ASX, ASIC and APRA, disclosure on climate-related risks is not mandatory, nevertheless an entity does run the risk that disclosure obligations will not be fulfilled, particularly given the guidance has expressly outlined that they could be material.

TCFD Reporting Principles

The Taskforce for Climate Related Financial Disclosure (TCFD) was created in December 2015 and consists of 31 members from the G20. In July 2017 the TCFD released its final recommendations providing a framework, which identifies four core areas common to all entities: governance, strategy, risk management and metrics and targets, in respect of which appropriate disclosures relating to climate change should be made in each (TCFD Recommendations).

It has been widely suggested that entities should make disclosures in accordance with the TCFD Recommendations framework in order to ensure, firstly, compliance with disclosure obligations and secondly, an appropriate response to investor pressures. It makes entities consider how climate change could affect their business' strategy, operations and finances in the short-, medium- and long-term. This allows companies, investors and stakeholders to make informed evaluations of expectations for the entity and the market.

The framework has been highly endorsed by both investors and regulators, as it would create a more informed market to permit greater investments and a more robust financial market. It should, however, be noted that the G20 is comprised of a large portion of European members and is therefore heavily influenced by European standards. Despite the framework being mandated in the UK and New Zealand, compliance in Australia is voluntary at this stage with the only statutory obligations being those under section 299(1)(a)(c) of the Corporations Act.

The Governance Institute discussed the EY Climate Risk Disclosure Barometer Australia 2019 report, which assessed whether entities had covered the TCFD recommendations, and the quality of those disclosures. It found that of approximately two-thirds of companies that had started to disclose climate change-related risks the quality and depth of the disclosures was poor.

The Australian Accounting Standards Boards

Additional to disclosures in annual reports and the like, the Australian Accounting Standards Board (AASB) and Auditing and Assurance Standards Board (AUASB) released joint guidance asserting that while climate related risks may be noted in company annual reports, these have not been reflected in financial statements, where they often should be. It was contended that when making materiality judgments (as required by Australian Accounting Standards) qualitative external factors should be considered, such as whether the entity operates in a sector particularly susceptible to the impacts of climate change. These factors pose serious threats to companies and their operations, and this risk should be appropriately accounted for.

The US is now moving

Regulatory support is not isolated to Australia. On 24 February 2021, the US Securities and Exchange Commission (SEC) Division of Corporation Finance was directed by the Acting Chair of SEC, Allison Herren Lee, to strengthen disclosures of climate change matters by public companies, including through updating SEC's 2010 guidance on climate change disclosures. Ms Lee highlighted investors' accelerating pressure for climate-related risk disclosure whilst recognising the responsibility of SEC and public companies to ensure that investors are fully informed to make investment decisions. SEC has now announced the establishment of a new Climate and ESG Taskforce focused on proactively enforcing ESG-related misconduct and whistleblower complaints.

The European Union's EU Regulation on Sustainability-Related Disclosures

The European Union's Regulation on Sustainability-Related Disclosures, which came into effect on 10 March, is part of its regulatory package which will require AIFMs, UCITS management companies, portfolio managers and investment advisers to disclose the sustainability risks and sustainability factors of their investments; the Regulation could also apply to some offshore bodies which market their funds in the EU or UK.

The lack of an adequate standard for reporting climate change risks will not necessarily insulate companies and directors from the legal consequences of inadequate disclosure.

Litigation risks

The mounting pressure on directors to manage and report on climate change creates growing exposure to litigation, in particular class actions, arising from failures to disclose relevant risks, greenwashing, and breach of directors' duties. The uncertainty around standards of disclosure, risk management and societal expectations makes the true extent of litigation risks unclear.

Noel Hutley SC and Sebastian-Hartford Davis in their 2016 memorandum expressed the view that directors can and in some cases should consider the impact of climate change risk on their company in the discharge of their duty of care and diligence under section 180 of the Corporations Act and, consequently, the adequacy of disclosure of such risks within the company's reporting frameworks. In 2019, they updated their advice in a supplementary memorandum which raised the concern of increased litigation risks, suggesting that directors that actively engage with climate change and report accordingly significantly reduce their exposure to liability, and warning that the benchmark for satisfying these duties is rising in correlation with the accelerating pressures. In 2019, the NSW Land and Environment Court rejected a development consent for an open-cut coalmine on various grounds including that the project would "result in the emission of greenhouse gases, which will contribute to climate change", thus suggesting that the Court is willing to recognise that climate change is a foreseeable risk that must be managed by directors.

To date, a number of cases have been brought before the Court by investors relating to a failure to adequately disclose and account for climate change risks: one currently before the court, and another settled outside the court. Nevertheless, the message is that directors and companies need to truly assess climate risks in all sectors of their businesses and reflect those risks in financial reports and disclosure and fundraising documents and prospectuses. Directors should be cautioned from greenwashing conduct that may very well leave companies susceptible to misleading or deceptive conduct breaches under the Australian Consumer Law.

Making meaningful climate change risk disclosure to investors

In the midst of COVID-19, climate change has remained front of mind, with an increase in natural disasters, increasing temperatures, unpredictable weather conditions accompanied by shifts in regulatory systems. Such unprecedented and unpredictable events, that show no signs of subsiding, have forced investors to look to long-term, stable investments, and seek certainty that the companies they invest in have identified these risks and are managing them, and thus greater disclosure from Boards.

Despite some entities beginning to respond to these demands through disclosure of climate-related risks, the quality of disclosure has been reported to be poor, as entities fail to seriously engage with the risks at hand. While disclosure is necessary, so too is taking action to assess the risks and create methods to manage them appropriately. It has been suggested that the TCFD Recommendation framework is inadequate for guiding companies on how to provide quality disclosures, which may explain the lack in quality of disclosures noted above by EY and the Governance Institute.

This issue may be averted as there has been some movement and discussion of the introduction of uniform disclosure standards relating to climate change into the International Financial Reporting Standards, but it remains unknown when this will eventuate. Companies and directors must be cautious because the lack of an adequate standard for such reporting will not necessarily insulate them from the legal consequences of inadequate disclosure.

It is unsurprising therefore that in many companies more is going on behind the scenes that is not readily observed. It has recently come to light that a group of CEOs from ASX listed companies has been meeting regularly to discuss methods and strategies to manage climate change issues. There have also been companies that have reported quite exceptionally on climate change risks, including Wesfarmers. Wesfarmers provided, in its Annual Report 2020 and Half-Yearly Report 2021, an in-depth analysis of its climate change strategy in accordance with TCFD Recommendations. Most notably, Wesfarmers reflected its emissions risks in financial statements in its half-yearly report, with CEO Rob Scott stating that this reinforces the fact that decarbonisation is now a key business metric.

Another possible explanation of the inadequacy of climate related reporting is that companies are not meaningfully engaging with and addressing climate change risks. This failure is to the detriment of companies' growth as climate change provides companies with the significant opportunity to reframe their business models through actively and innovatively engaging with the real threat of climate change and the shifting sentiment of investors. In doing so, and no doubt many are doing so, Boards need to equip themselves with the appropriate skills, capabilities and qualifications to effectively enhance internal capabilities of the business to proactively engage with climate change. Companies that do engage with these issues and make appropriate disclosures are likely to be rewarded with strong investor support.

The authors would like to acknowledge the considerable support of Alana Dunn.

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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.