A Legal Mandate for Australian Executives to Address Climate Change
Abstract
A recent landmark legal opinion has highlighted the level of responsibility that Australian company directors have to address climate change risks. This, coupled with the unique exposure of Australia to climate change, the growing awareness of climate change impacts by the public, and increasing expectations by shareholders for climate change related transparency and accountability, mean that Australian directors need to address climate change risks urgently.
Keywords: environment, sustainability, leadership, CSR
1. Climate Change and the Australian Context
A tide of change is taking over the boardrooms of Australia, bringing with it a new level of awareness of the impacts of business on climate change, and the impacts of climate change on business.
48% of Australian CEOs now consider climate change to be a risk to their organisation’s growth (compared to 33% globally). Similarly, 40% of Asia Pacific’s CEO’s are “extremely concerned” about climate change and environmental damage to their organisation’s growth (versus 31% globally).[7]
Indeed, it makes sense that Australian executives are even more concerned than those overseas, about the impacts of climate change: Australia is particularly susceptible to the effects of climate change.[4]
2. The Law on Climate Change Risks
How is this concern about climate change reflected in the law? A landmark paper by Hutley and Hartford-Davis[2] has recently addressed this question, creating waves not only in the legal sector, but also throughout Australian boardrooms.
According to Hutley and Hartford-Davis, directors must actively consider and disclose climate change risks. In their view “company directors who fail to consider climate change risks now could be found liable for breaching their duty of care and diligence in the future.”[2] As time passes, the benchmark for this duty of care is rising.
They’re not the only ones who are raising awareness of the legal obligations of company directors to address climate change risks. According to the Australian Securities and Investments Commission (ASIC), “Climate change is a foreseeable risk facing many listed companies in the Australian market in a range of different industries. Consequently, directors and officers of listed companies need to understand and continually reassess existing and emerging risks (including climate risk) that may affect the company’s business. This extends to both short-term and long-term risks.”[6]
Indeed, the message is starting to get out to directors; 17% of listed companies already identify climate risk in their reporting.[6]
3. Your Responsibility as a Company Director
A director’s ‘duty of care’ means that a director must carry out their duties with “the degree of care and diligence that a reasonable person would exercise” if they were a director in the corporation’s circumstances.[8] In other words, factors such as the size and nature of a company’s business, as well as the director’s individual skills and responsibilities, are taken into account.
This duty of care extends beyond the company itself, and can include the physical environment within which the company operates.
According to Hutley and Hartford-Davis, it follows that directors should consider climate change risks such as physical risks (e.g. power outages caused by extreme weather events) and transition risks (e.g. loss of water, regulation changes, reputational damage as a result of changing societal attitudes).
In Australia, Australian Stock Exchange (ASX) listed companies are subject to additional requirements. The ASX states that a “listed entity should disclose whether it has any material exposure to economic, environmental and social sustainability risks and, if it does, how it manages or intends to manage those risks.”[9] It defines environmental sustainability as “the ability … to continue operating in a manner that does not compromise the health of the ecosystems in which it operates over the long term.”
Similarly, the Australian Accounting Standards Board (“AASB”) and the Auditing and Assurance Standards Board (“AUASB”) have advised that companies should consider how climate change affects their financial assessments. As a result of investor concern for climate related risks “entities can no longer treat climate-related risks as merely a matter of corporate social responsibility, but should also consider them in the context of their financial statements.”[10] This includes provisions for fines/penalties, changes in the useful life and valuation of assets, and expected credit losses for loans. These potential impacts should be assessed in the context of climate change.
4. What is Climate Risk?
Australian directors must address ‘foreseeable’ risks. That is, risks that are not farfetched or fanciful. This is different from ‘probable’. A risk can be unlikely, yet foreseeable.[2] Indeed, much corporate planning (e.g. disaster planning and business continuity planning) already deals with improbable events, so this expectation lies well within normal business practices.
Given that the vast majority of climate scientists agree that climate change is real and is the result of human activity, one’s personal belief as to the cause and effect of climate change, or even its existence, would appear to be irrelevant in this context. Given the current level of discourse on this topic, one could hardly argue that the risks arising from climate change are unforeseeable or fanciful. In fact, one need not believe in man-made climate change at all, in order to be compelled to act. The mere fact that extreme weather events are on an upward trend is enough to oblige directors to act to reduce the impact of foreseeable risk to the interests of a company.
Take coal projects in the Australian Galilee Basin as an example. To meet the world’s obligations to the Paris Agreement to keep global temperature increases within 2°C, it is expected that only 20% of the Earth’s known fossil fuel reserves can be burnt before 2050. It is therefore foreseeable that much of the coal in the Galilee Basin will potentially become ‘stranded assets’ that will need to be left in the ground. This will be driven by government regulation, a fall in global demand, as well as “increasing social pressure for action on climate change”.[5]
A company director, who did not consider this risk in seeking, or approving new investments in coalmines in the Galilee Basin, would therefore be expected to be aware of these risks. A reasonable person in their position certainly should be aware of climate change and the Paris Agreement. In fact, it is a director’s obligation to consider the impact of climate change risks and obtain the knowledge required to guide their company effectively. A court would certainly not see these risks as being farfetched or fanciful[2] and therefore, a director that failed to address these risks would be failing in their duty of care.
5. The Fallout
As a result of these trends and regulations, directors now have an obligation to plan and deal with the increase in frequency and severity of extreme weather events: an outcome of climate change. These include events such as severe storms, flooding and sea level rises. In Australia (a hot and dry country), it also includes changing rainfall patterns, drought and heat waves.
Some specific results of climate change that were identified by the Garnaut Review[4] include:
- cessation of the large majority of agricultural production in the Murray Darling Basin
- catastrophic destruction of the Great Barrier Reef and subsequent impacts on tourism
- increased water costs
- increased health related deaths and vector-borne diseases
- major dislocation from Asian coastal megacities
It is difficult to imagine any Australian company being immune from these far reaching climate change impacts.
“It is likely to be only a matter of time before we see litigation against a director who has failed to perceive, disclose or take steps in relation to a foreseeable climate-related risk that can be demonstrated to have caused harm to a company (including, perhaps, reputational harm).” In fact, the exposure of directors to “climate change litigation is increasing, probably exponentially, with time.”[2]
Given the rapid growth of shareholder concerns on the impact of climate change, and the fact that legal proceedings may be commenced 6 years after an alleged contravention, it would be wise for directors to immediately consider whether they are adequately addressing their obligations.
Already we are seeing the consequences of ignoring the impact of climate change. In mid-2017, proceedings were commenced against the Commonwealth Bank in relation to its climate risk disclosure. We are also seeing “a number of prominent climate-related shareholder resolutions being moved at company meetings, including the QBE Insurance Group, Origin Energy and Whitehaven Coal, with the aim of setting or improving climate-related risk targets and disclosures and scrutinizing membership of industry or lobbying associations.[2] It would behove any Australian company to address growing shareholder concern for the environment quickly and proactively.
6. What You Need to Do
As a director or company officer, there are two types of risks that you need to consider.
1. Physical Risks
What physical impact will climate change have on your company? Will these be acute, or chronic?
Acute physical risks include events that will increase in severity, such as cyclones, hail storms and floods. Chronic physical risks are longer-term events such as sea level rises or chronic heat waves.
2. Transition Risks
What impact will a transition to a lower carbon economy have on your company? These impacts include policy, legal, technology and market changes.
In those sectors where climate risks are most evident (banking, insurance, asset management, energy, transport, materials, agriculture, food and forest), regulators and investors now expect “rigorous financial analysis, targeted governance, comprehensive disclosures and, ultimately, sophisticated corporate responses at the individual firm and system level. The effect of regulatory and investor intervention is that large scale firms will be expected to invest seriously in capabilities to monitor, manage and respond to climate change risks.”[2]
As a director, you should identify and address foreseeable risks. The foundation for this is an understanding of climate change, its impacts, and community and shareholder expectations and perceptions around corporate social responsibility. Climate science and community expectations are evolving rapidly. Is your company evolving and responding rapidly enough with respect to climate change?
About the Author
Dr Gerald Khoury is the Managing Director of GK Strategic. He has worked with some of Australia’s foremost leaders in the areas of strategy and innovation.
GK Strategic can show you how to develop and effectively communicate a strategy for reducing your environmental impact, leading to improved profits, sustainability and employee engagement.
References
[1] Dines, P 2010 Northbay biz magazine 26 Vol 35, Number 2
[2] Hutley N and Hartford-Davis S 2016 Supplementary Memorandum of Opinion, 26 March 2019, The Centre for Policy Development, Climate Change and Directors’ Duties
[3] ASX Guidance Note 9, “Disclosure of Corporate Governance Practices” (July 2014), p.5
[4] Garnaut, R 2008 The Garnaut Climate Change Review: Final Report, p. xix
[5] Woodside Petroleum 2015 Sustainable Development Report 2015, p.20
[6] ASIC 2018 Climate risk disclosure by Australia’s listed companies (REP 593,20 September 2018), p 3, <https://asic.gov.au/regulatory-resources/find-a-document/reports/rep-593-climate-risk-disclosure-by-australia-s-listed-companies/> accessed on 4 June 2019
[7] KPMG 2018 Global CEO Outlook The Australian Perspective Australian Accounting Standard’s Board 2017 AASB’s Second Practice Statement: Making Materiality Judgements. <http://www.aasb.gov.au/admin/file/content102/c3/AASBPS2_12-17.pdf> accessed on 4 June 2019
[8] Australian Government 2019, Corporations Act 2001, <https://www.legislation.gov.au/Details/C2019C00185> accessed on 5 June 2019
[9] Australian Stock Exchange 2014, ASX / ASX Corporate Governance Council Developments, <https://www.asx.com.au/documents/asx.../third-edition-roadshow-presentation.pdf> accessed on 5 June 2019
[10] Australian Government 2019, Climate-related and other emerging risks disclosures: assessing financial statement materiality using AASB/IASB Practice Statement 2 <https://www.auasb.gov.au/admin/file/content102/c3/AASB_AUASB_Joint_Bulletin_May2019.pdf> accessed on 5 June 2019