As investor and public awareness grows around the need to reduce our reliance on carbon emitting activities, and legislators and regulators sharpen their response to climate change, the heat is building in the boardroom.
This is the second instalment in our Building resilience to climate change series. The first, Managing risk in a more hazardous world, looked at the implications for insurance.
Chapman Tripp first wrote about climate change as a developing risk for directors in May 2017. That piece was prompted by the reaction in corporate Australia to a legal analysis published by two leading Australian barristers, which concluded:
"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)."
They have since updated their advice in a supplementary memorandum of opinion, released on 26 March this year, to capture events in the intervening three years – the effect of which, they think, will be to further elevate “the standard of care that will be expected of a reasonable director”.
The developments they trace in the areas of regulation, disclosure and investor pressure are directly relevant in the New Zealand context.
New Zealand's position
The director’s duty of care
A key director’s obligation under the Companies Act 1993 is the duty to exercise the care, diligence and skill that a reasonable director would exercise in the same circumstances. The risks that a reasonable director would take into account depend on the foreseeability of, and likely harm that could be caused by the relevant risk.
The risks arising from climate change take three main forms:
- physical risks to the business arising from rising sea levels and adverse weather events and their second round effects, for example higher insurance premiums and financing costs
- regulatory risks arising from imposts such as a higher carbon price, and
- reputational risks arising from higher public and investor expectations that businesses reduce their carbon footprint, and the imposition of environmental, economic and social sustainability (ESG) reporting.
At the weekend, the Government announced that it will adopt two disclosure-based recommendations from the Productivity Commission’s Low Emissions Economy inquiry:
- it will endorse the Task Force on Climate-related Financial Disclosures guidance that material financial risks and opportunities associated with climate change should be disclosed, and
- it has instructed officials to work closely with stakeholders over the next few months to identify how best to implement mandatory (on a comply or explain basis) principles-based, climate-related financial disclosure as a means to help investors, lenders and insurers to make more informed decisions on how to ensure that the New Zealand economy (and their own investments) remain resilient to the impacts of climate change.
These announcements were delivered into an already busy reform programme.
The passage of the Climate Change Response (Zero Carbon) Amendment Bill (the Bill) and the pending changes to the Emissions Trading Scheme (ETS) will significantly raise the regulatory risks for business – both directly and indirectly.
The ETS will be substantially strengthened through changes that will increase the carbon price, introduce auctioning of emissions units, include additional sectors of the economy and phase down free allocation to emissions intensive, trade-exposed industries.
Features of particular relevance to directors are the requirements that:
- five yearly carbon budgets be prepared to plot a path to the net zero emissions target, including the preparation and publication by the Minister of emissions reduction plans featuring sector specific policies and strategies, and
- the Climate Change Commission produce a National Climate Change Risk Assessment every six years to which the Government must respond with a National Adaptation Plan.
These provisions will substantially improve the quality of information available to businesses to develop appropriate climate change adaptation and mitigation programmes. Directors also have the advantage of the Productivity Commission’s prescription for the transition to a low carbon economy, and of a growing body of advice from an increasing range of sources.
With better information comes greater accountability.
Reputational risks/ESG disclosure
The New Zealand Exchange (NZX) introduced Recommendation 4.3 into its Governance Code in 2017, requiring issuers on a ‘comply or explain’ basis to provide non-financial disclosure at least annually on their material exposure to ESG risks.
It subsequently strengthened this by:1
- issuing a guidance note on ESG reporting in December that year, and
- adding a requirement, effective this year, to Recommendation 4.3 that the reporting should “include forward looking assessments and align with key strategies and metrics monitored by the board” – in other words, the NZX is looking for progress measurements around ESG.
Early adopters are raising the bar further by moving beyond these minimum requirements. Meridian Energy last month became the first NZX-listed company to release a climate change risk report.
The New Zealand Climate Leaders Coalition – which now has 109 members, accounting for over half of New Zealand’s gross emissions – has committed to measure and publicly report its emissions, set public emission reduction targets in line with the Paris Agreement, and work with its suppliers to reduce the supplier’s emissions.
A number of entities have also signed up to the Principles for Responsible Investment, which will require climate-related reporting from 2020.
ESG reporting is effective only if investors consider a company’s ESG performance when making their investment decisions. A recent survey suggests this is very much the case in New Zealand.
It shows that responsible investment accounts for 72% of total assets under management here (compared to only 44% in Australia), and many New Zealand boutique and mainstream funds now offer specific responsible investment products and approaches (including environmental).
The Guardians of the New Zealand Superannuation Fund, NZX’s single largest investor, is also taking a conscious leadership role in promoting ESG values, both internally as an organisation and in its interactions with the market2. So much so that it was recently identified as a world leading practitioner of responsible investing in a global survey of almost 200 sovereign wealth and government pension funds.
On the global stage, investors managing nearly US$34tn in assets (around half of the world’s invested capital) have written to the Group of Twenty (G20) urging member countries to commit to meeting the emission reductions set out in the Paris Agreement.
In Australasia, the Australasian Investor Group on Climate Change (a group of institutional investors with funds over AU$2tn under management), is highlighting the likely impacts of climate change and the need to include these in investment analysis.
Climate change litigation
No successful climate change-based cases have been taken against directors anywhere so far (and none have even been attempted here), but the risk will grow when it becomes possible to prove a direct causal connection between weather induced damage and climate change.
While the increased incidence of severe weather events is clearly linked to increased carbon dioxide in the atmosphere, the direct link between a specific event and climate change is currently more difficult to demonstrate.
Cases taken against private corporates in other countries
Pacific Coast Federation of Fishermen’s Associations v Chevron Corp & Ors
Filed in November 2018 against 30 fossil fuel companies seeking damages for major losses suffered by crabbers in California and Oregon due to algal blooms attributed to global warming. Status: Trial date yet to be set.
Conservation Law Foundation Inc v Shell Oil Products US
A citizen’s suit alleging that Shell failed to incorporate climate risks when investing in a bulk storage and fuel terminal in Rhode Island. Status: Yet to be heard.
The People of the State of New York v Exxon Mobil (and some of its executives and directors)
Alleges that Exxon misled investors by understating the risk to the company’s assets posed by climate change. On 13 March 2019, an application to have the case dismissed was rejected by the Federal Court.
McVeigh v Australian Retail Employees Superannuation Trust
Filed in July 2018 by a beneficiary of the trust alleging that the trust had violated the Australian Corporations Act 2001 by providing inadequate disclosure of climate change risks. Status: Yet to be heard.
Guy Abrahams v Commonwealth Bank of Australia
Filed in August 2017 alleging failure to disclose climate change risks. The action was dropped after the bank included this disclosure in its 2017 annual report.
Lliuya v RWE AG
Filed by a Peruvian farmer in Germany against German utility company RWE AG for its role as a major greenhouse gas emitter in causing glacial melt which threatens his home in the Peruvian Andes. Status: Ongoing.
Where to from here
The physical risks will intensify as the climate change effects intensify, accepting that a level of deterioration is already locked in.
As this happens, the need to engage in adaptation and mitigation strategies will become even more compelling and urgent and the sanctions attached to inaction or insufficient action will become even sharper.
Directors should now be actively engaged in developing a long-term climate change response which is appropriate to the emissions profile of the business and might include the following elements:
- measures to mitigate the foreseeable effects of climate change on the business and, where mitigation is not possible, to implement adaptation strategies which will ensure the survival of the business
- investing in capabilities to monitor, manage and respond to climate change risks – physical, regulatory and reputational
- ensuring processes are in place to keep abreast with any developments and/or progress relating to the company’s climate change policy, rather than taking a set and forget approach (e.g. having response to climate change as a regular board agenda item), and
- reporting to stakeholders on both financial and non-financial climate change associated risks.
Chapman Tripp has been commissioned by The Aotearoa Circle to prepare a detailed opinion, intended ultimately for public release, on this topic. We look forward to further engagement in due course.
1 Responsible Investment Benchmark report 2019 New Zealand
2 The Guardians of the New Zealand Super Fund released How we invest White Paper – Climate Change in March 2019