Climate Risk in the Boardroom

05 Aug 2021

Climate Risk in the Boardroom

Climate science has been saying for a long time “we need to act, and we need to act quickly.” Ask yourself “what does this all mean to our business?”

Despite my personal efforts around carbon offsetting, using clean energy and only travelling when truly required (much easier in our current COVID state), I have a genuine concern that I’m not doing enough to address the risks posed by climate change. I often ask myself ‘what more can I do? What should I be mindful of? How can I make a difference?’

As someone who spends a lot of time with Board Directors, and with an academic interest of my own in climate change, I am often asked similar questions by people from the boardroom. The problem is I don’t really have any strong answers. So, I went looking for some.

I recently spent time with three experts in their field, who were particularly generous in giving me their time. They were;

  • Brad Archer, CEO of the Australian Government’s Climate Change Authority and former head of the International Climate Change and Energy Innovation Division in the Department of the Environment and Energy.
  • Jillian Edwards, Founder of Beyond Business as Usual, a consultancy advising on advanced climate and disaster risk management. Formerly Director in the Australian Government developing the National Disaster Risk Reduction Framework - a foundation for action to reduce the impacts of climate and disaster risks in Australia.
  • Neil Plummer, Independent research specialist on Climatology, Director at Out of the Box Executive and former General Manager from the Bureau of Meteorology.

My plan? Keep things simple and stick to the FAQs…..

Climate change is here and not something to put off worrying about. Climate change presents a physical risk being validated through increasingly frequent extreme events, e.g. heatwaves, long dry periods and wildfires - all of which we have seen in Australia in the last 18 months. The likelihoods of more droughts, intense rainfall events, and further sea-level rise are increasing too. Records are being broken every year and these ‘once-in-a-hundred-year’ events are occurring much more frequently than their name suggests.

The effects of these have been widespread and significant, and cover every element of our lives – housing, energy, transport, infrastructure, jobs, resources, food, water, tourism, hospitality, education, health...the list goes on. Climate change is very real for a lot of people.

How governments, investors, consumers, communities, courts etc. respond to this physical risk also presents transition risk.

What are the drivers causing boards to be more climate engaged?

One can speculate that boards have historically not set aside too much time to consider the ‘once-in-a-hundred-year’ event. Possibly because they’ve been more focused on performance and other matters, possibly because their tenures are typically much shorter than a hundred years.

Climate science has been saying for a long time “we need to act, and we need to act quickly”. The World Economic Forum consistently puts climate related risk at the top of the list. Moving through 2015, we saw many countries signing up to the Paris Agreement on climate change. Then in 2016 we read the original Hutley Opinion which found that directors who do not properly manage climate risk could be held liable for breaching their legal duty of due care and diligence.

In 2019 the Hutley Opinion was supplemented by emphasising five material developments that have elevated the need for directors to consider climate risks and opportunities, and reinforced the urgency of improved board-level governance of this issue. The report concludes that;

“these matters elevate the standard of care that will be expected of a reasonable director. Company directors who consider climate change risks actively, disclose them properly and respond appropriately will reduce exposure to liability. But as time passes, the benchmark is rising.“

Fortunately, governments are shifting their views and policies, with (varying) commitments to emissions reductions (a topic of a whole separate conversation) and both corporate and financial regulators making new recommendations. It’s clear the financial disclosures work now being rolled out is an effective ‘big stick’ in inducing action. With APRA requiring organisations to identify how they are addressing climate risks (and subsequent decision making), many people (notably in the financial services sector) are applying their mind and asking ‘what do we need to do as a board?’ This is good news, particularly as it all helps protect the economic prosperity of Australia.

We are also seeing increased pressure from investors who are no longer willing to ignore the elephant in the room – climate change poses real risk. But COVID-19, as a Black Swan event, has broadened the conversation further, and opened many more people's eyes to other global-scale risks. So, off a low base, investor and consumer sentiment is changing and becoming increasingly important with respect to the organisation’s social license to operate.

We are also seeing profound transformation in the energy market away from a centralised system of large fossil fuel generation towards an array of smaller scale, widely dispersed wind and solar generators, grid scale batteries and demand response. The ‘energy transition’, especially through disruptive technologies, is of the scale of the industrial revolution but happening much faster. People want to be part of this transformation, drive R&D and harness innovation.

To summarise, increasing numbers of people feel that if climate risk is not being discussed in the boardroom, then that board isn’t doing its job properly. There is greater recognition that Boards and companies have responsibilities to all their stakeholders and not just shareholders. Reputational risks are on the rise and this has increased the importance of ESG to organisations. This should cause Boards to be more climate engaged but on the whole it isn’t. In short, boards should be paying more attention.

What are some useful first steps for a board seeking to better understand and engage on climate matters?

You should start by assessing where you, the board and the organisation is at with regard to its maturity on dealing with climate-related risks and opportunities. Are you just beginning on this journey?

If you or your organisation are at the beginning, it starts with self-education. Familiarise yourself with / understand climate risk. Look at the TCFD which lays out the core elements of physical and transition risk (including investor and consumer risk, and how the regulatory environment is evolving). APRA (and ACSI) are continually updating their guidance on how boards can better manage climate risks and opportunities, as part of their governance frameworks. Climate risk is just another risk.

Companies also need to be comfortable in themselves determining what their investors and customers want / need. Ensure the organisation understands the expectations of all of its key stakeholders, including customers, partners, suppliers, regulators, and staff. Risks in supply chains are also important.

Ask yourself “what does this all mean to our business?” Try to understand the systemic damage climate risks present to your organisation. Work out what is materially relevant for the board with regard to the climate, energy and circular economy transition (responsible use of materials / reducing consumption / re-use and recycling). Work out what is value-destroying for the organisation, and where you can create value.

For businesses with a heavy exposure to climate risk, make the conversation mainstream rather than just appointing an Environment and Sustainability Officer (ESO). The risk is that everyone else considers climate to be the ESO’s problem to solve for the business, and not necessarily theirs too.

Seek out the increasing number of tools and methodologies to help identify and assess risks and opportunities, develop responses through scenario analysis, and integrate with governance and strategy.  Consider engaging management consultants and boutique advisory services to get advice on these matters.

How should the org / board structure itself? How can the board build its capabilities, skills and structures to better respond?

Ask yourself “what are the skills necessary for the board to oversee the management of risks and opportunities?” Look internally to determine if you already have those skills, where are the gaps and how are these best filled?

You may need to educate the board and build capability. Bring expertise on to the board. Upskill and recruit well. Don’t be constrained by the current rules - ask outsiders for help. Collaborate. Network with other organisations to build your understanding, capabilities and share ideas. Develop ‘inclusive governance’.

The board should also ensure it has the right structures in place, e.g. use existing committees like audit & risk or create a new, dedicated sustainability committee (with representation from all business units). Environmental and sustainability issues are gaining importance and climate change is a big part of that. Hence the conversations around sustainable development goals (SDGs), corporate social responsibility and your social license to operate.

Ensure that the board maintains access to the information and advice it needs. Incorporate climate-related risks in your risk register. Do you have a standing item in your monthly Board meeting / AGM? Ensure effective connection to, and communication with, management.

Take a systems approach – look at emerging risk, points of disruption and where you can intervene. Think beyond ‘business as usual’.

What should boards report on? What and how should boards measure and report?

As mentioned above, the Taskforce for Climate-Related Financial Disclosures (TCFD) gives very useful guidance on this matter and is widely considered the frontrunner. Yes, its voluntary but there is increasing appetite to incorporate TCFD reporting. TCFD is the emerging standard.

Boards should ensure that material climate-related risks, opportunities and strategic decisions are consistently and transparently disclosed to all stakeholders – particularly to investors and, where required, regulators.

Disclosures should be made in financial filings, such as annual reports and accounts, and be subject to the same disclosure governance as financial reporting.

However, some companies are concerned that detailed disclosures could reveal commercially sensitive information or make the company vulnerable to future legal action. But despite this concern, accurate and decision-useful climate-related disclosures should help mitigate risks of failing to disclose relevant information to stakeholders.

How can a board integrate risks and opportunities into its governance and strategy

Firstly, it is recommended that boards explore integration rather than having a stand-alone climate or environment strategy because the climate-related risks will generally have a significant impact on products and services, customers, company finances and reputation.

Ensure that climate-related risks and opportunities are appropriately included and weighted in developing strategic responses. Ensure strategy development includes scenario analysis and pathways approaches that are designed to account for, and respond to, climate-related risks and opportunities.

Take on an opportunistic mindset. While there are real and major risks with climate change, there are big opportunities too, especially in the energy and circular economy transition, e.g. new markets, innovative products and services, new jobs, lower cost energy, lower cost manufacturing and community support.

Final comments

What is increasingly clear is that if we are to meet the goals of the Paris Agreement, we need to start a major shift in energy use and land use, and major changes are coming to Australia. For our economy and Australian companies to thrive we need to recognise risks and identify and respond to opportunities.

This is ultimately about active and adaptive learning. Take your personal learning and expand it, use it as a catalyst for change. The challenge is we don’t know for sure what best practice is yet, despite lots of work being done by governments and regulators to support a consistent reporting framework. Understand the guidelines being issued. Be aware of where we’re heading and don’t be paralyzed by the uncertainty.

As time passes, the benchmark is rising. Be curious. Be involved. Don’t get left behind.

 

Useful links

https://cpd.org.au/2019/03/directors-duties-2019/ Updated Hutley opinion on directors’ duties and climate risk

https://www.tcfdhub.org/  TCFD - Task Force on Climate-related Financial Disclosures - described as the best place to start in terms of assessing what sort of information to disclose. In the UK, entities with material climate risks should consider reporting under the TCFD.

https://www.apra.gov.au/news-and-publications/apra-releases-guidance-on-managing-financial-risks-of-climate-change APRA releases guidance on managing the financial risks of climate change

https://acsi.org.au/policies/climate-change/ Australian Council of Superannuation Investors. Exists to provide a strong, collective voice on environmental, social and governance (ESG) issues on behalf of its members.

https://www.sustainablefinance.org.au/ ASFI - Australian Sustainable Finance Initiative - a program to reshape the financial system to deal with climate change.

https://www.cmsi.org.au/  Climate Measurement Standards Initiative - works with climate scientists from the CSIRO, the Bureau of Meteorology and major research universities to help build the nation's first comprehensive set of common climate change risk disclosure standards.

https://www.thelawyer.com/esg-how-well-equipped-are-you-to-help-your-clients-succeed/ Environmental, social and governance (ESG) issues have rocketed to the top of boardroom agendas. But are law firms taking the right action to help boards and GCs succeed in their sustainable business transitions?