Mandatory climate and sustainability reporting developments

Increasing frequency and severity of regulatory action against “greenwashing” is prompting Australian companies to focus on embedding climate strategy and better incentivising performance in line with climate targets, say King & Wood Mallesons’ Emma Newnham and Jeremy Brown.

Federal Treasury is working on a mandatory climate reporting regime. The likely result will be the required disclosure of how boards monitor progress towards climate targets, including how climate performance metrics are factored into remuneration policies. To help entities navigate the transition to more highly scrutinised mandatory reporting, King & Wood Mallesons (KWM) has tracked and analysed best practice voluntary climate reporting by the ASX 50 over the past three years.

Evolving best practice: key findings

The number of ASX 50 entities linking executive remuneration to climate or sustainability-related targets has doubled in recent years (80 per cent in 2022, up from 46 per cent in 2021 and 40 per cent in 2020).

There are now 90 per cent of ASX 50 entities with supplier codes of conduct (or similar documents) with requirements or expectations concerning climate or sustainability.

For practical purposes, climate governance structures of ASX 50 entities are now mostly set, with ultimate responsibilities for climate risk residing with boards and/or audit and risk board committees.

Just over one third of ASX 50 entities have established dedicated sustainability committees.

Almost a third of ASX 50 entities have appointed a dedicated climate or sustainability executive, while half have set nature targets.

Greenwashing and the need to embed climate strategy “Greenwashing” is the term used to describe misleading and deceptive conduct in relation to statements about sustainability, for example, making statements about a company’s sustainability performance that don’t accurately reflect practices.

To avoid greenwashing, it is critical that those responsible for setting and reporting on climate strategy talk to all those responsible for implementing that strategy.

To put this in context, those responsible for strategy can’t say they’re going to stop servicing fossil fuel customers, only to have their frontline employees continue doing exactly that.

Applying incentive mindset

As part of mandatory climate reporting, entities will be required to report scope 3 emissions (the emissions of their customers, suppliers and others in their value chain) not because they control them, but because they can influence them.

In recent years, financial services entities have grappled over how best to do this. That is, whether to reduce exposure to fossil fuel customers or to work with them if they have a viable strategy to get to net zero in an acceptable timeframe.

In May this year, the United Nations special rapporteur on modern slavery, Professor Tomoya Obokata, commented on the same broader question at a Melbourne University seminar — explaining that cutting off suppliers in developing nations who perform poorly regarding modern slavery can be the worst thing for the supplier, their employees and their local community.

Applying that thinking to the sustainability challenge, companies should be thinking about — and many already are — what other levers they can pull to motivate performance. In particular, whether and how they can reward customers, suppliers and others in their value chain for becoming greener.

A classic example of this is CommBank’s green loan (up to $20,000), which rewards customers with a low rate if they put the money towards solar panels, solar hot water systems, battery packs and other clean energy products. Insurance discounts for green homes is another.

While money is always a good motivator, there may be alternative ways to incentivise greener performance in a positive way, such as awards and other promotions.

Nature — climate’s twin sister

The Taskforce on Nature-related Financial Disclosures (TNFD) will publish its final recommendations in September this year. It has adapted the notions of “scopes” (scope 1, scope 2 and scope 3 emissions) to the nature context as “direct”, “upstream”, “downstream” and “financed”, so they will require the same thinking around how best to motivate performance in areas companies can’t control.

The TNFD has also adopted draft disclosure recommendations aligned with those of the Taskforce on Climate-related Financial Disclosures (TCFD), meaning many of the learnings around greenwashing and the due diligence and verification needed for climate reporting can be adopted in the nature context.

Forward-looking statements about nature targets, as with climate targets, will need to be supported by reasonable grounds.

Companies will need to consider whether disruptions in progress towards nature targets, like climate targets, might give rise to continuous disclosure obligations. In the same way that the standards directors will be held to on climate are increasing, so will the standards directors are held to on nature, as understanding of companies’ impacts on nature, and nature-related risks on companies, increases.

As climate’s twin sister, regulators aren’t likely to allow the same amount of time they have for education on nature issues.

Rather, we would expect to see regulators focus on nature targets and nature-related greenwashing in the same way they are focused on climate targets and climate-related greenwashing. It is clear they have moved from education to enforcement there.

But nature is not the last item under consideration. Following closely behind it are other evolving areas of sustainability reporting, such as inequality.

Other evolving areas

After biodiversity, human capital and human rights are next on the International Sustainability Standards Board’s agenda, according to its work plan, which is currently subject to consultation.

The Taskforce on Inequality-related Financial Disclosures and the organisations preparing a Taskforce on Social-related Financial Disclosures have recently merged, consolidating efforts into a single initiative.

As reporting expands to include these topics, companies will need to grapple with their social impact in ways they may not have previously considered. Interesting questions will be raised about the role of AI, including its impact on jobs in developing nations.

Conclusion

There are important lessons companies can take from best practice climate governance and voluntary reporting as they move to mandatory climate reporting and reporting on other sustainability topics like nature and inequality. Companies that can leverage those learnings and stay abreast of best practice as it continues to develop will be best placed in the transition to broader mandatory sustainability reporting.

Climate reporting developments

The International Sustainability Standards Board (ISSB) has issued its new sustainability standards and the Commonwealth Treasury has released a follow-up consultation to introduce mandatory climate-related disclosures in Australia.

A three-tiered approach is proposed, depending on organisational size.

Proposed timings are:

• Cohort 1 (2024–25 reporting periods): Reporting entities (those required to report under Part 2M of the Corporations Act 2001 being disclosing entities, public companies, registered schemes and large private companies) which are National Greenhouse and Energy Reporting Scheme (NGERS) “controlling corporations” that meet the NGER publication threshold; and reporting entities that fulfil two of the following three thresholds: (1) over 500 employees (2) $1b-plus in consolidated gross assets (3) $500m-plus consolidated annual revenue.
• Cohort 2 (2026–27 reporting periods): Reporting entities that fulfil two of the following three thresholds: (1) over 250 employees (2) $500m-plus in consolidated gross assets (3) $200m-plus consolidated annual revenue.
• Cohort 3 (2027–28 reporting periods): Reporting entities which are NGERS controlling corporations; and reporting entities that fulfil two of the following three thresholds: (1) over 100 employees (2) $25m-plus in consolidated gross assets (3) $50m-plus consolidated annual revenue.

For all cohorts, as drafted, the current proposal does not capture charities registered with the Australian Charities and Not-for-Profits Commission (ACNC).

The government suggests climate disclosures be set out in the annual report. For listed entities, this will be in the operating and financial review (OFR) within the directors’ report. Listed entities are given the option of reporting “metrics and targets” standards in a separate report, provided it is referenced in the directors’ report. Disclosures the government initially wants to include are governance, identification and management of climate risks and opportunities, transition plans, qualitative scenario analysis, and scope 1 and 2 emissions.

Entities will only be required to disclose material scope 3 emissions from their second reporting year onwards.

Assurance requirements will be phased in, starting with limited assurance over scope 1 and 2 disclosures and reasonable assurance over governance disclosures for cohort 1 entities in the reporting period commencing 1 July 2024.

Civil penalty provisions will be introduced into the Corporations Act 2001, so failure to disclose or inadequate disclosure will attract a civil penalty. Enforcement for misleading or deceptive conduct or “similar claims” in respect of scope 3 emission disclosures or select forward-looking disclosures (scenario analysis and transition planning) will be limited to regulator-only actions for a fixed period of three years.

Where do ISSB standards fit in?

The government is proposing that the content of disclosures is based on the ISSB climate standard IFRS S2, as adopted or modified by the Australian Accounting Standards Board. IFRS S2 was finalised on 26 June 2023, following an extensive consultation process.

Key requirements of IFRS S2 include:

• Disclosure under the Taskforce for Climate-related Financial Disclosure (TCFD) topics of governance, strategy, risk management and metrics and targets.
• Disclosure of the current impact of climate change risks and opportunities on the business, and the current actions taken to manage these, including disclosure of scope 1, 2 and 3 emissions, financed emissions, the amount and percentage of assets and business activities vulnerable to climate risks and aligned to climate opportunities, capital deployment towards climate risk and opportunities, internal carbon prices and remuneration linked to climate.
• Disclosure of anticipated future impacts of climate change risks and opportunities on the business, and planned actions to manage these, including disclosure of the anticipated changes to the business model/resource allocation; anticipated change to the business’ financial position and performance in the short, medium and long term; scenario analysis; and disclosure of transition plans and climate targets.

The AICD will make a detailed submission on the consultation, informed by comprehensive consultation with AICD members and stakeholders.

As host of the Climate Governance Initiative (CGI) Australia, the AICD is also preparing a Climate Reporting Guide for directors, which we anticipate releasing this month.

This article highlights our findings and looks at how companies can apply these learnings to motivate performance in other sustainability areas such as nature, and evolving areas such as inequality.

This article first appeared under the headline 'Evolution of Sustainability’ in the August 2023 issue of Company Director magazine.