Climate risk disclosure – a globally coordinated approach by regulators?

With the world’s leading climate change scientists warning that the world has only 12 years to limit a climate change “catastrophe”, in the UN Intergovernmental Panel on Climate Change, published on 8 October, the focus on climate change has never been higher and regulatory scrutiny of how businesses assess and disclose their climate change risk exposures is set to increase dramatically.

On 20 September 2018, the Australian Securities and Investments Commission (ASIC) released a report, Climate risk disclosure by Australia’s listed companies, which contains ASIC’s key observations and findings in relation to a surveillance project examining climate risk disclosure by listed companies in Australia.

The Task Force on Climate-related Financial Disclosures (TCFD) was established by the G20 Financial Stability Board in December 2015 to develop voluntary, consistent climate-related financial risk disclosure for use by companies, globally. In conducting the project, TCFD identified two main categories of climate-related risks:

• Transition risks – transitioning to a lower-carbon economy may entail extensive policy, legal, technology and market changes to address mitigation, and adaption requirements related to climate change.
• Physical risks – physical risks resulting from climate change can be acute or chronic. Acute physical risks refer to those that are event-driven, including increased severity of extreme weather events, such as cyclones or floods. Chronic physical risks refer to longer-term shifts in climate patterns (for example, sustained higher temperatures) that may cause sea-level rises and chronic heatwaves.

ASIC finds that:

• There are fragmented climate risk disclosure practices. General, as opposed to specific, risk disclosure is not useful for assessing climate risk exposures.
• The majority of the 100 Australian listed companies in ASIC’s sample had, to some extent, considered climate risks to their business. However, the percentage of annual reports of all listed companies that contained climate change-related content had fallen from 22% in 2011 to 14% in 2017.
• A number of listed companies in ASIC’s sample intend to adopt the recommendations (either in full or in part) of the TCFD.

The key recommendations by ASIC include:

• Consider climate risk: directors and senior managers of listed companies need to understand and continually reassess existing and emerging risks that may be applicable to the company’s business, including climate risk. This should extend to both short-term and long-term risks.
• Develop and maintain strong and effective corporate governance. Transparency is one of the fundamental tenets of strong corporate governance. When climate risk is material, consideration should be given to disclosing the company’s governance and risk management practices around climate risk.
• Comply with the law such as section 299A(1)(c) of the Corporations Act 2001, which requires disclosure of material business risks affecting future prospects in operating and financial reviews (OFR). ASIC considers that the law requires an OFR to include a discussion of climate risk when it could affect financial performance or previously disclosed outcomes.
• Disclose useful information to investors. Specific disclosure is more useful than general disclosure. ASIC recommends, where appropriate, listed companies assess and disclose climate risk with reference to the categories formulated by the TCFD: physical and transition risk.

Meanwhile, on 15 October 2018, the UK Prudential Regulation Authority (PRA) issued a draft supervisory statement on banks’ and insurers’ approaches to managing the financial risks from climate change. The PRA proposes that firms in those sectors:

• Dully embed the consideration of financial risks arising from climate change into their governance framework. Boards and senior-level executive management should allocate responsibility for identifying and managing financial risks from climate change.
• Address the financial risks from climate change through their existing risk management frameworks.
• Where appropriate, use long-term scenario analysis to assess the impact of the financial risks from climate change on their current business strategy.
• Develop and maintain an appropriate disclosure process for climate-related financial risks. The PRA expects firms to consider whether additional disclosures are necessary to enhance the transparency of their approach to the disclosure of financial risks arising from climate change.

Both ASIC and the PRA have emphasised the need for climate change risks to be continuously monitored and assessed at board/senior management level and disclosed where necessary.

The UK’s Financial Conduct Authority also published a discussion paper on climate change and green finance on 15 October 2018, setting out a proposed approach, including disclosure in capital markets. As ASIC commissioner John Price recently stated, climate change is now a foreseeable risk that directors and officers of listed entities need to understand and continually assess. In June 2018, Mr Price referred to a memorandum of opinion by Noel Hutley QC and Sebastian Hartford-Davis, which observed that it is “conceivable that directors who fail to consider climate change risks now could be found liable for breaching their duty of care and diligence in the future”.

This is an evolving area, in respect of which regulators are taking a globally coordinated approach. We will continue to monitor developments.

 

Contributed by Dean Carrigan, partner, and Naoko Aoo, associate, Clyde & Co, Sydney