Disclosure to oversight: navigating mandatory climate reporting

Not only are boards grappling with extensive new regulatory disclosure obligations under the Australian Sustainability Reporting Standards AASB S2 (AASB S2), but boards are also faced with increasing scrutiny by ASIC, investors and interest groups concerning alleged misleading or deceptive conduct in preparing climate disclosures.

Directors across all industry sectors must move quickly from passive awareness to disciplined ownership of climate-related financial risks and opportunities to ensure regulatory compliance and minimisation of reputation risk. Below are some of the key risks facing Group 1 entities finalising their first sustainability reports in 2026 which are also applicable to Group 2 and 3 entities that are starting to prepare their disclosures.

Directors must "own" reporting process

Until financial year ending 31 December 2027, directors must declare that, in their opinion, the reporting entity has taken reasonable steps to ensure the sustainability report is in accordance with the Corporation Act and AASB S2. For the following years, directors must declare that the sustainability report is in accordance with the Corporations Act and AASB S2. This transitional arrangement recognises that auditors as well as companies need some time to skill up and address some of the more challenging disclosures such as scope 3 reporting.

Directors risk not discharging their duties with reasonable care and diligence if they fail to endorse appropriate reporting structures and processes sufficiently early and with the required robustness. This does not require a complete overhaul of existing governance and risk management requirements but may require some changes to deal with the new disclosure requirements.

For example, directors should:

• consider a gap assessment and clarify governance roles across legal, finance, sustainability and, in some instances, procurement and marketing teams particularly for those entities not already voluntarily disclosing against international financial sustainability reporting standards;

• establish and document clear controls, policies and procedures for sustainability reporting;

• consider whether they have to, or can elect to, prepare a sustainability report for all Australian liable group companies; and

• apply a critical lens to proposed disclosures.

Such oversight is critical, particularly for Year 1 reporting, to ensure boards are aligned with key decisions and directors' duties are discharged.

For global groups, this governance uplift can be challenging when seeking to align with group climate-reporting frameworks but ultimately Australian directors must ensure that compliance with Australian legal requirements are met.

Materiality thresholds

At the heart of sustainability reporting in Australia is a single materiality threshold to assess whether a climate risk or opportunity can impact an entity's financial performance. Directors are required to challenge and truly understand what decisions have been made about materiality and, importantly, the rationale for time horizons for the climate resilience/risk assessments that have been used.

What is material is not an internal reference point. The lens is of the "primary user" ie. the existing and potential investors, lenders and other creditors. Directors should not focus on single risk analysis but consider whether a risk is material in combination with other risks.

Materiality is not static. Time horizons are particularly important when assessing stranded asset risks, cost of capital and climate adaptation issues that will start materialising in a 10 year horizon. Decisions in relation to whether to adopt the same materiality thresholds for other financial reporting or, alternate thresholds, due to the nature of the climate risk or opportunity, the industry sector or the expectations of the primary user (eg. about returns) will also need to be made. Early engagement with an entities audit team is important around these issues to ensure alignment.

Scenario testing / proportionality / value chain assessments

In order to test the climate resilience of the business, entities need to consider climate-related financial impacts and opportunities under short, medium and long term horizons (which they set) under at least two warming scenarios (one being 1.5^oC to align with the Paris Agreement and the other a high warming scenario of greater than 2.5^oC). These different warming scenarios are intended to stress test transitional risks (i.e. legal or policy changes) as well as physical risks to the business. Two key risk issues that Group 1 companies are grappling with are whether to:

• make quantitative or qualitative disclosures about material current or anticipated future risks; and

• the extent to which they need to disaggregate their data sets to avoid misleading statement or omissions.

Directors will need to get comfortable with how their disclosures have been prepared having regard to these risks.

A number of the AASB S2 disclosures are subject to a requirement to "use all reasonable and supportable information that is available to the entity at the reporting date without undue cost or effort" (also referred to as the "Proportionality Principle"). Directors should ensure that disclosures in these key areas should be supported by evidence which includes both entity-specific factors (i.e. climate scenario analysis) and broader environmental conditions and can span past events, current conditions and future forecasts.

The AASB S2 standard also requires disclosing entities to make judgements and assumptions in defining their scope 1, scope 2 and scope 3 emissions disclosures. Value chain assessments for some sectors will be complex and require significant investment and contract amendment/management to obtain necessary data to align with AASB S2 and reflect the Greenhouse Gas Protocol Corporate Value Chain (Scope 3) Standard. Directors should be across developments in this area particularly any new industry sector guidance designed to promote consistency in reporting approaches across the sector.

Regulatory enforcement risk

ASIC has foreshadowed that it will take a "proportionate and pragmatic" approach to administration and enforcement. Significantly, ASIC has new direction powers to compulsorily require an entity to provide documents and information to support statements made in sustainability reports where it considers a statement to be incorrect, incomplete or misleading. ASIC may also direct an entity to correct or amend the statement in accordance with its directions. Directors should ensure that appropriate verification packs and supporting documents are prepared during the preparation of sustainability reports to support statements made and minimise the risk of regulatory enforcement.

It is expected that ASIC will be actively engaging with entities about its first sustainability reports and ASIC has announced it will undertake its first review in 2026. This is expected to involve a desktop review, engagement with entities, potential remedial action and, ultimately, the publication of its findings. For entities not required to report until financial year 2027, this will mean a growing body of reference material for decision making but also an increased level of regulatory expectation that should be closely monitored.

Greenwashing and other risks

Entities will generally be required to disclose their sustainability reports to shareholder or otherwise make the reports available on their websites. Such publication will likely mean the reports will be the subject of scrutiny by investors and interest groups particularly in the early years of reporting.

The modified liability regime applicable to sustainability reports is limited to specified "protected statements" (for example, statements about scope 3 emissions, scenario analysis and transition plans) and only ASIC can bring a civil action against an entity concerning specific "protected statements" until 31 December 2027. Entities may face challenge from investors and interest groups after this time over "protected statements" or at any time from publication about other statements.

Importantly, the modified liability regime does not extend to the use of "protected statements" outside of an entities' sustainability report or the auditor's report meaning that investor communications or media releases of such matters may leave the entity exposed to potential allegations of misleading or deceptive conduct. Again, directors should take care that robust verification for statements is requested and maintained to confirm statements are accurate and complete.

Beyond reporting

Once entities have identified material climate-related financial risks or opportunities, the challenge for boards is to ensure that the outcomes of the sustainability report are integrated across their enterprise risk management, operations and business strategy. Meaningful engagement in the outcomes of the sustainability report is necessary to ensure that (for example) any future statements as to net zero aspirations are genuine and not liable to potential misleading claims. Directors should ensure they not only identify climate-related risks and opportunities but take active steps to address and capitalize on such matter to ensure they are not exposed to potential allegations of failures to meet their duties.

_Disclaimer

_{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.}