Directors are being urged to prioritise governing climate risk, which requires a rethink of an organisation's strategy, risk and future-proofing plans.
When Microsoft outlined a strategy to halve its carbon emissions by 2030 in January — including through its supply and value chain — and to go carbon “negative”, the company’s share price soared and it reported increased interest from people wanting to work for it and do business with it. “The scientific consensus is clear,” said Microsoft president Brad Smith. “The world confronts an urgent carbon problem. If we don’t curb emissions, and temperatures continue to climb, science tells us that the results will be catastrophic. Given the scope of the climate crisis, Microsoft no longer believes it’s enough to be carbon neutral.”
Scientists and insurers have long warned of the environmental, societal and financial risks associated with climate change. QCs have opined on the fiduciary responsibility for directors and investors are mobilising their capital and exiting fossil fuels, warning of a climate “emergency”.
In February, economists from investment bank JP Morgan, which has a high level of exposure to the resources sector, warned of the potential catastrophic impact in coming decades. In the same month, Reserve Bank of Australia governor Philip Lowe told a Melbourne forum, “The economic implications are profound. The world is getting hotter and the climate is more variable. We’re seeing already in Australia, perhaps more than anywhere else in the world, the effects of that. Climate change is affecting the nature of production in Australia, the nature of investment, ultimately the nature of our exports,” said Lowe. “When asset values change, the value of balance sheets change and that has financial implications for institutions and asset managers.”
Much of the focus of climate debate has been on costs of mitigation, which will be significant. However, there is an increasing focus on the investment needed.
The Business Council of Australia’s recent 2020 Energy and Climate Change Project scoping paper says ultimately emissions reduction is delivered by large scale investment. It notes that the European Union has identified $440b of new investment is needed each year until 2050 to deliver net-zero emissions. Applying this metric to Australia, the level of investment would be at least $22b a year, a total of $660b to 2050.
Economists Professor Tom Kompas, Marcia Keegan and Ellen Witte in Australia’s Clean Economy Future: Costs and Benefits, a 2019 issues paper by Melbourne University’s Sustainable Society Institute, quantified potential damages from climate change to Australia at current global emissions patterns as $584.5b in 2030, increasing to $762b in 2050 and ramping up dramatically thereafter to more than $5 trillion in cumulative damages between now and 2100. “Overall, the costs of emissions reduction are far less than the damages of inaction,” the report said.
"Climate action is going to require new investment in a range of energy sources, including renewables and natural gas, and in technologies to abate emissions. It’s going to require innovation and effort from companies that have decades of experience in solving big, complex engineering challenges and are not shy of taking on large projects. For example, Woodside.
More businesses have elevated climate risk from an environment, social and governance (ESG) lens to a major strategic and risk issue requiring strong board oversight. Mark Joiner, chair of QBE Insurance Australia and NZ, says the speed of shift on the issue will catch many directors by surprise so it’s vital to rapidly upskill on the issues to help guide their organisations through. “You think you’re fine and then, a bit like the banking Royal Commission and the Catholic Church, opinions shift and you look like a donkey for not acting faster, earlier.”
Climate change risk is an important issue that boards need to proactively manage, says Louise McCoach, special counsel at Gilbert & Tobin law firm. “The world is rapidly transitioning to a low carbon economy,” she says. “This is forcing companies to respond to these developments or risk being left behind. It is also forcing directors to adopt a more proactive approach to considering and disclosing foreseeable climate-related risks to the companies they oversee.”
From a director liability perspective, Joiner says the signals must be heeded. “There are little test cases going on. They are not big numbers, but they are trying to establish precedence. A farmer in the Andes is suing a German utility (RWE) for about €20,000 and a 24-year-old [Australian ecologist] is suing his pension fund for not taking his long-term retirement income needs into consideration.”
But if directors only view the issue from a strict liability problem, they miss the vital picture. “When it comes to the issues, things can get complicated,” says Joiner. “Essentially there are three things. Number one, the science says the temperature is rising too far too fast and if anything that’s accelerating — this gets into exponential impacts. Two, we are experiencing a massive loss of biodiversity — and a loss of biodiversity makes the system less able to adapt. Three, this is a shared problem. Eventually it will get everyone.”
"The nature of politics of climate change in Australia has not generated any sense of urgency to shift and therefore what’s driven shift has been shareholders and investors who are requiring the companies they invest in to drive change.
While concerned policymakers and directors rue 15 years of false starts and lost opportunities, and student and activist protests become a regular occurrence, investors are mobilising. “The need to move to net zero [removing as much carbon as is created] emissions by 2050 to achieve the Paris Agreement goals is now widely acknowledged,” says Emma Herd, CEO of the Investor Group on Climate Change (IGCC), which represents funds that oversee $2 trillion in assets. “Australia needs prudent management of climate risks to reduce the financial, economic and community costs of climate change. This includes physical risks such as worsening drought and fires, and the economic risk of a disorderly shift to net zero emissions.”
At a director roundtable in November 2019, the discussion highlighted that risks continue to rise for company directors, investors and regulators. It also found strong support for accelerated action on climate change and a national mission to address climate risk and opportunity across Australia’s economy and financial system.
The Governance Institute of Australia’s recent Climate Change Risk Disclosure report noted that as investors assess how well companies are positioned in the face of climate change, they are increasingly paying attention to the climate governance systems of those companies as a performance predictor.
Ross Garnaut AC, author of the 2008 Climate Change Review has long argued that transitioning the economy can provide Australia with huge low-carbon opportunities. It could lead to a clean electricity system with more capacity, a transformed economy, and new and expanded industries in minerals smelting. “The fog of Australian politics on climate change has obscured a fateful reality: Australia has the potential to be an economic superpower of the future post-carbon world,” Garnaut writes in his book, Superpower: Australia’s Low-Carbon Opportunity.
In his 2020 letter to listed company CEOs and chairs, BlackRock executive chair Larry Fink wrote that the challenge cannot be solved without a coordinated, international response from governments, aligned with the goals of the Paris Agreement. Under any scenario, the energy transition will still take decades. “We need to be mindful of the economic, scientific, social and political realities of the energy transition,” he wrote.
Australian Conservation Foundation president Mara Bun says the issue is relevant to every organisation. “There are two threshold questions — one relates to climate mitigation: how does this company contribute to greenhouse emissions across its value chain? A second set relates to climate adaptation: how does our enterprise respond when a shock related to severe weather hits the ground? A first consideration is awareness of the materiality of the organisation’s exposure and potential risk, then it requires consideration of what actions are required and what is an appropriate board policy, assurance framework. We also need to be mindful the decisions we make have generational impact.”
The AICD is currently preparing a practical guide for members on how to oversee their organisations’ climate change risks and opportunities.
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