Climate change risks – understanding what they are and your company’s potential liability

As climate change risks continue to grow, company boards are likely to come under increased scrutiny over their handling and recognition of these risks.

Regulators, such as the RBA, APRA and ASIC, have all publicly acknowledged the serious economic challenges posed by climate change and the accompanying implications for directors, companies and investors.

This acknowledgement is likely to give rise to increased potential liability for directors and companies under existing legal frameworks, such as the public disclosure requirements contained in the Corporations Act 2001 (Cth) (Corporations Act) and the ASX Listing Rules.

Understanding climate change risks

Climate change poses different types of risks that affect the financial security of a company. These risks, according to Sydney SC Noel Hutley and barrister Sebastian Harford Davis, can be grouped as ‘physical’ risks and ‘transitional’ risks, and are increasingly “well publicised and significant.”

Physical risks are the increased extreme weather events such as flooding and drought, as well as longer term temperature increases, whereas transitional risks are the legal, market and reputational risks arising from new policies and the implementation of technologies for climate change mitigation and adaptation.

We expect to see these physical and transitional risks interact more frequently with existing director and company obligations as directors’ duties to exercise due care, skill and diligence extend to addressing climate change risks and a company’s statutory financial reporting obligations require consideration and disclosure of climate-related financial risks. Sectors which have significant climate-related exposures will have greater need to fully interrogate, address and report on their climate change risks to avoid liability.

Financial disclosure expectations

Regulators have identified these climate change risks and pointed to existing regulatory materials for companies to gain high-level guidance on these requirements. Despite this high-level guidance, there is currently no clear mandatory framework or requirements in Australia for companies to adequately assess the extent of their potential climate change liability.

ASIC’s Commissioner, John Price, has called for disclosures that are “relevant and useful to the market”. A key development in disclosure obligations is the “Climate-related Financial Disclosures” (TCFD), a new global reporting benchmark, which has been endorsed in Australia by both APRA and the RBA. The TCFD recommendations assist companies to make climate-related financial disclosures that are useful for investors, lenders and insurance underwriters in understanding material climate change risks.

Litigation risks

Regulators are only one part of the increased spotlight on company and director liability for climate change risks. The rise of climate change litigation is already underway in Australia. Such litigation to date has focussed on blocking and challenging government approvals of environmentally controversial projects on climate change grounds. Regardless of a court’s ultimate decision, litigation of this kind can present uncertainty and risk for a company’s investment strategy (particularly in relation to affected projects), as well as having broader implications for other companies in the supply chain.

Whether ultimately successful or not in the courts, public and highly publicised climate litigation can cause significant financial cost and reputational damage for companies.

Looking ahead – what can you do?

The responses of regulators, markets and the public to climate change risks highlight an increasing change in the way that Australian regulators and the public perceive climate risks. Directors and companies alike need to be aware of the growing scrutiny of how climate change risks affect their company’s financial performance. Whilst regulators have acknowledged the financial risks to businesses due to climate change, there is a lack of clear guidance on how businesses need to adequately assess and disclose these risks within existing legal frameworks. As a result, directors should be cognisant of their directors’ duties in addressing climate change risks and company boards should also ensure that corporate reporting accounts for these risks in their financial performance and prospects.

By Ingrid Mohr and Jordy Finch