Some 1400 directors and senior business leaders gathered in Sydney and virtually, for the inaugural Climate Governance Forum on 1 August, the first major Climate Governance Initiative Australia event hosted by the AICD. They heard that the effects of climate change are already being felt in an Australia warming above the global average, and that transition to a low-carbon economy presents a $420b investment opportunity. We outline the major themes, governance, risk and strategy considerations.
NET ZERO PATHWAYS
The climate discussion inside Australian boardrooms has shifted rapidly from the reality of climate change, to considering how best to respond to, plan and execute for climate change, and should also start to focus on opportunities this represents, the AICD Climate Governance Forum heard. In his keynote opening address, National Australia Bank chair Philip Chronican GAICD said climate change was one of — if not the most — significant long-term challenges and opportunities we face and it would take a concerted effort to address. Over the past two years, climate change has moved from being a subject raised occasionally by investors, customers and colleagues, to one that regularly features in conversations.
“It is important we focus the discussion on a more positive framework and the opportunities created through the necessary change,” he said. “While we have a good understanding of the significant challenges of getting to net zero, we can do better highlighting the opportunities that come with a transition to a low-carbon economy.”
Chronican described the commercial opportunity to finance the climate transition as “massive”, because the low-carbon solutions that must be developed and deployed for this transformation require investment. Disruptive innovation involves some risk-taking and only a small percentage of inventive concepts reach commercial viability, so the backing of business, industry and government is critical. He said coming federal government legislation was getting us closer to clarity on the path for business to be able to invest effectively and with certainty.
“To get to net zero, every business in every industry will have to evolve. Every household will need to make changes,” he said.
New industrial revolution
NAB and Deloitte Access Economics released research on the scale of economic opportunities in the transition to a net zero economy in All Systems Go: Transforming Australia’s economy to grow. It calculates Australian governments and industries will invest around $20 trillion to 2050 — regardless of whether we become net zero. But in becoming net zero, that $20 trillion investment will be allocated differently, out of emission-intensive activity and into new low-emission activity. An estimated $420b in new capital investment will be required to achieve Australia’s emissions target across four core economic systems and supporting industries.
Chronican’s theme was taken up in the panel session by Pradeep Philip, lead partner for Deloitte Access Economics. Taking no action on climate would result in a $3.4 trillion hit to Australia’s GDP over the next 50 years, while dealing with climate change in a coordinated and effective manner would boost the economy by $890b. “The industrial revolution went on for a century, but now businesses have to recapitalise the economy to zero carbon in less than 30 years,” Philip said.
“The reason this matters for non-executive directors is that this places a very strategic dilemma: how to pivot, when what you currently have is generating good returns, towards the new, where the costs are upfront and the dividends are back end,” he said.
New legislation enshrining Australia’s 2030 emissions reduction target of 43 per cent means directors should accept they are going to start to see the structural economic changes implied by transition to a low-carbon economy, Zoe Whitton, managing director of investment and advisory firm Pollination, told the forum. “This is happening now and it is real,” she said. “That means you should expect changes in the economy that sits around the entity that you are responsible for. This predicts that we are moving to a world... where we’re trying to produce goods and services in a way that allows us to reduce our footprint.”
The conversation inside boardrooms has shifted from directors trying to understand why they have to respond to climate change to trying to understand what they have to do and when, said Katherine Woodthorpe AO FAICD, chair of Natural Hazards Research Australia and AICD NSW Division President. They are considering how to modify risk control systems and capital allocation decision-making. “We’re probably starting to get into the ‘how much it’s going to cost’ period.”
Boards are making more use of climate scenarios, and to do so they need to have a very clear roadmap outlining what the steps are, when they need to be taken and the cost. For boards to engage effectively with management on their company’s transition, they need to have the same level of understanding of the roadmap as they would of any other strategic plan management had presented, said Woodthorpe.
Guy Debelle, CFO of Fortescue Future Industries and a former deputy governor of the Reserve Bank of Australia, said there is more focus from stakeholders on not only the targets companies are setting, but also the steps they are taking to meet those targets and their decarbonisation plans. Boards should also be considering the benefits. Fortescue is working to decarbonise hard-to-abate sectors and is responsible for the proposed decarbonisation of one of the biggest resources companies in the world by 2030 — parent company Fortescue Metals Group. It is currently working on reducing the use of fossil fuels in mining trucks, and the project’s rate of return stacks up “pretty well” given the current price of diesel, said Debelle.
However, he noted that decarbonisation can involve changing processes and the way people go about their jobs. “It’s not necessarily just swapping out one truck for another, for example,” he said. Construction company Lendlease has had a focus on sustainability for at least a decade, which is now bringing financial benefits, said chair Michael Ullmer AO FAICD. He outlined how the company had won a $3b contract to redevelop telco Singtel’s global headquarters in Singapore.
“One of the key things they called out was our approach to sustainability, how important that was and how aligned it was to the way they were thinking,” said Ullmer. “It was a key determinant in their decision to select us over a very capable and reliable competitor.”
Ullmer said it cost more to construct an office building using approaches consistent with a net zero carbon target. However, tenants and their staff prefer sustainable buildings, so these properties let out more quickly and at a premium. This makes it a more attractive proposition for investors, leading to a lower capitalisation rate and higher valuation.
Net Zero Investment Targets
$20tr will be invested in Australian economy to 2050 (net present value)
To achieve net zero emissions:
$70b must be reallocated from emissions-intensive activity into low-emissions activity.
$420b in new capital investment needed to achieve Australian emissions target across 4 core economic systems:
61% share of emissions
23% economic contribution (GVA)
- $25b reallocated from emissions-intensive to low-emissions assets by 2030
- $100b increase in low-emissions capital assets by 2050
14% emissions 17% economy (GVA)
- $3.5b reallocated away from emissions- intensive to low-emissions assets by 2030
- $30b increase in low-emissions capital assets
Raw material manufacturing
16% emissions 31% economy (GVA)
- 42% manufacturing energy use is from natural gas
- $1.5b reallocated away from emissions- intensive to low-emissions assets
- $50b increase in low-emissions capital assets
Food and land use
16% emissions 13% economy (GVA)
- $0.1b reallocated away from emissions- intensive to low-emissions assets
- $20b increase in low-emissions capital assets
GVA = gross value added
% do not add up to 100, due to overlap of system elements
Source: Deloitte Access Economics All Systems Go
Directors should start preparing for global climate disclosure standards because they will affect all organisations, listed and unlisted, large and small, said Karen Chester, deputy chair of the Australian Securities and Investments Commission (ASIC).
In a move that has broad backing of Australian regulators, the International Sustainability Standards Board (ISSB) is preparing to harmonise international sustainability standards and — via the Australian Accounting Standards Board (AASB) — implement them in the Australian market.
“We are at an incredible turning point at the moment with what we see emerging internationally with the ISSP,” Chester told the forum. “This is inevitable — it’s going to happen.”
Global capital investors want transparency on climate. They don’t just want to know that a company earned $100 in revenue. “They actually do want to know how sustainable your enterprise value is into the future,” said Chester. “That’s what those standards are about.”
The AICD is backing the efforts by the ISSB and the AASB for a consistent, comparable and high-quality set of disclosures by organisations. In submissions to both bodies, the AICD has strongly supported the principle of harmonised international sustainability standards and urged a consistent approach across jurisdictions. “We have consistently heard from members that there is a need to consolidate competing existing non-financial reporting frameworks, and to address growing investor demand for high- quality, comparable disclosure,” AICD managing director and CEO Angus Armour FAICD wrote in the submissions. “Such reporting will also allow companies to better benchmark their own sustainability practices and see where there may be room for improvement.”
In its submission to the ISSB, the AICD said the consolidation of existing ESG reporting frameworks is needed to meet the evolving needs and expectations of investors. However, it added that further work needs to be done to clarify and refine the standards so they are capable of reasonable, independent assurance. The AICD also called for a carefully designed, phased-in approach that recognises the considerable uplift in practice and capability required in markets such as Australia.
The proposal for new sustainability reporting standards has broad support. The Council of Financial Regulators (CFR) — comprising the RBA, ASIC, Treasury and the Australian Prudential Regulation Authority (APRA) – is also supportive of the efforts. The standards will provide investors and other capital market participants with information about entities’ sustainability-related risks and help them make informed decisions, the group said in its submission to the ISSB.
In the meantime, there are today’s standards to meet and the risk of greenwashing. Chester pointed to an information sheet on climate reporting obligations ASIC has published, noting the organisation has some surveillance activity underway around climate disclosures. “We feel now’s the time for us to make sure that people are meeting their current regulatory obligations,” she said. “There will be different ways we’ll deal with that — some people might get a phone call. Where we see egregious examples of greenwashing, where we think there’s harm from that, then we probably will be taking enforcement action.”
Sustainability reporting is changing, with 103 of the ASX 200 companies now voluntarily reporting under the Task Force on Climate-Related Financial Disclosures guidelines, the forum heard. While most large publicly-listed companies have been producing sustainability reports for several years, there is more of a focus on climate, and a shift from aspirations and case studies to a lot more hard data, said Penny Bingham-Hall FAICD, a non- executive director at Fortescue Metals Group. Disclosing the future cost of transitioning from fossil fuels will be important, but difficult for hard- to-abate industries, where the cost will be large.
Notwithstanding, there are a large number of unknowns and companies should be as transparent as they can with their underlying climate assumptions. Even though directors can’t know the cost, other stakeholders could be imagining much worse numbers, so releasing some information will provide an anchoring effect for expectations, said Bingham-Hall.
PwC partner Matthew Lunn MAICD noted a lot of climate reporting isn’t currently from auditable data. When the new standards are adopted, organisations will need to rely on robust and supportable data. Chester added that the more transparent companies are with their climate disclosures, the less likely they are to fall foul of their legal obligations. “Transparency is not just for the glass-half-full story,” she said.
For directors, Geoff Summerhayes GAICD, chair of Beyond Zero Emissions and a non-executive director of Zurich, rated the TCFD framework as “a great and very simple lens. What is your strategy? What is your governance, what is your risk management, what are your metrics and targets? All of us in all the companies we’re working in should have that sort of framework — strategy governance, risk management and targets. And that should be sustainable in terms of this massive transformation, of massive economic opportunity.”
Accountability in action
Boards are facing strong, sometimes conflicting expectations on climate from a wide range of stakeholders and there’s nowhere for directors to hide. Summerhayes, who is chair of Beyond Zero Emissions and a non-executive director of Zurich, said that there is an unusually broad stakeholder community when it comes to climate change. “The climate space is complex and full of very passionate people — and rightfully so,” he told the Delivering for Stakeholders panel session.
The stakeholder community includes shareholders, employees, who can often be passionate about climate change, and suppliers, supply chains and customers. There are also capital markets players who want to see companies’ climate change credentials. Then there are activist groups, litigation class action lawyers, and regulators.
“There is increasing transparency, climate rating agencies and other organisations, so there isn’t anywhere to hide on climate,” said Summerhayes. “There’s a growing expectation of boards, particularly for large organisations.”
Companies are increasingly asked not just about their Scope 1 and Scope 2 emissions — those from their own activities and electricity they use — but also their Scope 3 emissions, which include emissions from their supply chain and from their customers when they use their products. Expectations are particularly growing for financial organisations, with stakeholders wanting these companies to assist with the transition to net zero.
“There’s an expectation around us at Zurich that we’re working with our customers,” said Summerhayes. “Not just putting up our premiums, but actually working [to] help them mitigate and transition as an organisation.”
Commenting on how boards can win community acceptance for major transition initiatives, he said it is a leadership opportunity. The community expects organisations and corporates to lead on issues that affect their customers, employees and the communities in which they operate. Prof David Karoly MAICD, a CSIRO atmospheric scientist, outlined why there is so much at stake for Australia in the climate debate. He said unless organisations take into account the risks described under the Task Force on Climate-related Financial Disclosures (TCFD) they will “potentially be subject to any and all of shareholder and stakeholder responses”. He says Australia has already suffered a faster-than-expected rise in heat-related mortality for people and wildlife. There is also the compound impact of increases in bushfires, floods, droughts, heatwaves, storms, and sea level rise.
“We’ve experienced all of those in Australia in the past 10 years,” he said. “In some sense, for other countries, Australia is the canary in the coal mine.”
In a discussion around building “climate competency” in board skills, AMP Capital Funds Management chair Ming Long AM GAICD said that in considering directors to join a board she’s involved with, she wants to see they genuinely care about climate change, because they will have the curiosity to learn more. “You also understand that if you're just getting your education from the management team, they have a vested interest, and they have a shorter time frame in terms of how they look at things,” she said.
While being a director carries collective responsibility, Long urged directors to take on accelerating climate change as a personal responsibility.
“You have that great opportunity with the power to actually speak publicly and advocate for the change we actually need, not just through government people might be attached to, but also as leaders within the community,” she said. “You’re talking about that with all the circles of influence you have — and you will have a lot just by virtue of the fact that you are directors.”
In a later session on scenario planning, Diane Smith-Gander AO FAICD, a director of AGL, raised the issue of how directors could balance decisions that will provide good returns today versus the interests of other stakeholders. For her, the two are not irreconcilable.
“We should always recognise that as directors, we are there for the interests of the company, and the shareholders who want their returns are one of the stakeholders that need to be taken into account,” she said. “A company can only provide returns to its shareholders if it actually exists. And if we regard some of these [climate] risks as dangerous, that does give us a very different way of trying to think about that risk-return dynamic.”
Sarah Barker MAICD, head of climate risk governance at law firm MinterEllison, said directors can’t presume or assume how climate change will affect their businesses.
“We have to form a conscious understanding of the physical, economic transition and liability risks associated with climate change that impact on our business over the short, medium and long term. And then strategically, how do we continue to thrive and maximise wealth in that context?”
Before setting targets
Australian Council of Superannuation Investors (ACSI) data reveals two thirds of ASX 200 companies have set at least one emissions-reduction target, while the number who have adopted net zero commitments has almost doubled in a year to 95 — accounting for 70 per cent ($1.59 trillion) of the ASX 200 market capitalisation.
Asked what homework companies and their boards need to do before making a public net zero commitment, Chester recommended two tasks — one policy and one practical — including ASIC’s 2019 Regulatory Guide 247: Effective disclosure in an operating and financial review.
“On the regulatory policy front, boards need to consider their legal obligations around forward-looking statements,” she said. “ASIC has policy about forward-looking statements in an operating and financial review, which applies to listed companies.” The general position is that representations about future matters need to be supported by reasonable grounds. Otherwise, such disclosures will be taken to be misleading under the Corporations Act 2001 (Cth). They cannot be purely aspirational statements. “This is the long-standing position so there are no surprises here,” said Chester.
She noted directors should disclose what the target relates to and when that target is expected to be achieved, as well as clear, detailed, time-based action plans on how the target will be achieved. In doing this, directors should consider:
- Whether the statements are properly framed, for example, being based on the information available at the time
- Whether the statements have a reasonable basis, which involves good governance at board level for signing off on the statements
- Whether there is ongoing compliance with continuous disclosure obligations when events or results overtake forward-looking statements in the OFR (operating and financial review).
“On the practical side, what is reasonable largely turns on the facts — the company’s particular situation and the specific representation made,” said Chester. “A good starting point, in assessing whether a reasonable basis exists, is to consider matters such as: the parameters and framing of the representation; its technical feasibility and use of offsets; the cost and budget; any milestones and tracking progress; disclosure under the TCFD, including underlying assumptions; and governance around keeping the market updated under continuous disclosure.”
Chester’s final director homework reading, especially for listed companies, was the TCFD’s Guidance on Metrics, Targets and Transition Plans.
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