Targeting net zero: climate change is putting governance to the test

It is recommended that organisations explore duties widely, because climate-related legal obligations can arise under legislation and common law principles which have no obvious connection to climate change (eg consumer laws).

Soft law frameworks (rules, principles and guidelines setting out standards of corporate behaviour, which often act as a precursor to hard law) may also be relevant to this assessment. A recent complaint lodged with the Australian OECD National Contact Point by Friends of the Earth against a major Australian bank alleging that it has contravened the OECD Guiding Principles for Multinational Organisations in connection with fossil fuel lending practices, provides an example of how these frameworks might apply in relation to climate change.

Once the spectrum of common law, statutory and 'soft law' duties have been mapped out, boards can work with the management team to develop:

• a compliance framework to ensure that relevant duties in relation to climate change are being fulfilled; and
• a strategy to evidence compliance with these duties.

Relevant risks might include, for example, chronic physical effects (eg reduced surface or groundwater availability), acute physical risks (eg bushfires and increased storm severity), asset stranding, technological change, customer sentiments, regulatory risk, litigation risk, reputational risk, transition risk, financial risk, and shareholder activism.

There may be relevant primary risks, such as direct physical effects of climate change on assets, as well as secondary risks, such as the impacts on export markets. Further discussion on relevant categories of risk, and the scenario analysis approach to assessing risks, is contained in Chapter B of the TCFD Final Report.

We suggest that materiality of risk is also important, as materiality will inform the resources required to respond to the risk.

A related line of inquiry is the predicted impact of physical phenomena on insurance costs (and insurability) as insurers obtain a clearer understanding of the likely physical impacts of climate change.

The net zero transition will present opportunities as well as risks. Relevant opportunities will vary from sector to sector but might include, for example:

• market recognition for leadership in climate change mitigation/adaptation;
• income from carrying out carbon abatement projects and selling carbon credits;
• increased energy efficiency and reducing cost of resources;
• stimulating innovation through developing less carbon-intensive products and services;
• more resilient supply chains not reliant on price-volatile fossil fuels;
• leveraging the increasing private and public investment in renewable energy and other low-emissions projects;
• tapping into increased demand for eco-friendly products and infrastructure; and
• access to climate-oriented finance (green bonds).

Embedding climate-related risks and opportunities into core business and financial decision-making is not a 'one size fits all' matter, but might include, for example:

• incorporating climate-related risks and opportunities into due diligence frameworks for new investments;
• ensuring that climate-related risks and opportunities are assessed through a financial (in addition to ESG) lens;
• conducting scenario analysis in relation to existing assets, portfolios and strategies, and documenting how corporate decisions respond to scenario analysis; and
• making organisational changes to ensure that core financial and strategy decision-makers are informed about, and  give regard to, material climate-related financial risks and opportunities.

Benchmarking performance against industry peers can be a helpful exercise to sense-check company policies and strategies. Being out of step with competitors may increase the risk of becoming a target of public interest litigation.

Organisations increasingly undertake climate-related disclosures in accordance with the TCFD Final Report. These reports, as well as individual climate change statements, policies and strategies, can be helpful sources of information on industry trends. There are also a number of websites which publish lists of companies and their performance, including, for example:

• companies that have signed up to the Science-based Targets Initiative can be viewed here;
• CDP (an environmental not-for-profit) consolidates sustainability data from, and rates the performance of over 8,000 companies based on climate change action and disclosures; and
• As You Sow publishes the Carbon Clean 200 list, which similarly identifies companies excelling on climate action.

The endorsement of the TCFD recommendations by ASX, APRA and ASIC strongly signals that Australian corporate regulators consider it best practice to adopt the TCFD Final Report in relation to climate risk disclosures. In February 2020, the Governance Institute of Australia published a practical guide to reporting on climate-related risks and opportunities.

However, this is a high level blueprint for disclosure and there are likely to be, in each industry, more granular, and more tailored, data sets, analytical techniques, disclosure tools and stress testing frameworks available to support climate risk and opportunity analysis.

We recommend that boards ask subject-matter experts within their business what best practice looks like, and what resources are available to support this practice.

Key stakeholders, such as shareholders, financiers, consumers, business partners, employees, insurers and the community, are demanding more of businesses in relation to climate change. Recent trends demonstrate the importance of stakeholder alignment:

• Climate-related shareholder activism is on the rise. Recently, some of the world's largest investors, including AXA, PIMCO and Australian Super have exerted pressure on major companies to take steps to address climate risk. This trend looks set to continue in 2020, with Climate Action 100+, a global investor movement with $50B funds in management predicting a surge in shareholder activism in 2020. Divestment is also a significant issue, with major oil companies now flagging divestment as a material risk in their securities disclosures. In late 2019, the climate divestment movement reached the milestone of $16 trillion in funds moved out of fossil fuel industries.
• As consumers increasingly look to use their buying power to drive climate action, companies are launching new products to appeal to climate conscious consumers.
• Australian insurers are increasingly vocal about the impact of climate change disasters on insurance premiums in the future, and have called on organisations and government to focus on climate resilience planning.

Employees are also looking to speak out on climate risk. Notably, from late 2019, Amazon's employees have been petitioning and striking, demanding Amazon achieve zero emissions by 2030 and limit trading with significant emitters.

Climate change issues have typically been addressed within sustainability, HSE and/or ESG teams. Today, it is an issue requiring attention from a multidisciplinary team of experts within the business, including senior commercial, financial, strategy and legal professionals. For example, the Harvard Business Review recently stated the most important person in a company to address climate change is the CFO, noting that 'today, smart organisations are shifting their sustainability responsibilities toward the finance function'. 

Taking stock on the mix of capabilities available within the organisation, and whether these ought to be augmented with external consultants or legal advisers, or through recruitment, may be an important step to take.

A related line of inquiry is whether a change in the allocation of capex or opex is justified having regard to the materiality of climate-related risks and opportunities. A number of companies and fund managers have recently made major announcements about step changes in their investment priorities to meet emissions targets.

Boards are expected to remain informed on up-to-date techniques for translating a complex series of inputs into financial risks and non-financial risks and opportunities, and to ensure that they are regularly revisiting what constitutes 'best practice'.

It may be advisable to build into governance frameworks a requirement that climate-related governance and disclosure practices come under review regularly (eg annually), to ensure they do not become out of step with the market.