Climate change risks, costs, and opportunities are now firmly part of the corporate governance landscape. In this FYI we explain why, and what the board’s risk management agenda should include to address this.
Our earlier FYI discussed the legislative changes underway in response to climate change risks, the most recent being the Climate Change Response (Zero Carbon) Amendment Bill.[1] This bill will go hand in hand with amendments being made to the Emissions Trading Scheme (ETS) so as to drive economic decisions to respond to climate change.
Climate change as a requirement of good corporate governance
Climate change is becoming embedded into the corporate governance landscape, even without impending legislative changes.
Governance codes of conduct are requiring it:
- Environmental risk awareness and management now features in all of New Zealand’s major corporate governance handbooks (NZX, FMA and NZ Institute of Directors “Four Pillars of Governance”).
- There is specific NZX guidance for listed issuers considering disclosure of ESG (Environmental, Social and Governance) matters as part of adhering to the NZX Corporate Governance Code.[2]
- Chartered Accountants Australia & New Zealand recommends that climate risks are considered in relation to disclosure of material risks in financial reports.[3]
- The G20’s Financial Stability Board Task Force on Climate-related Financial Disclosures has released recommendations for climate-related financial disclosures to assist entities to standardise their approach.[4]
Customers and other stakeholders are requiring it. Increasing awareness of climate change issues is requiring businesses to take into account that consumers and other stakeholders increasingly make economic choices informed by corporate actions (or inactions) relating to climate change risk, mitigation and adaptation.
The investment community is requiring it. Investors and investment managers are actively looking at climate change risks and corporate governance relating to climate change. For example, earlier this year the NZ Superfund publicised its climate change investment strategy after concluding that climate change risks are under-priced by markets. This strategy is designed to specifically address climate change risks in investment decisions.
There is an increasing expectation, globally, for boards of directors to consider not just the immediate economic interests of shareholders (so-called “shareholder primacy”) but also to consider employees, customers and other stakeholders – and thus consider not just short term economic value, but longer term sustainable value.
In New Zealand, that hasn’t yet translated into clear direction on exactly how climate change risks feature in a director’s duties. Direction will have to wait until legislative amendment is made or a case on the issue goes through the courts – which could take years (also summing up the wider problem).
However, what we know for sure is that a director of a company is there to consider, and manage, risks that are relevant to the company. It is this requirement that lies at the heart of a director’s duty to the company and to shareholders. Consideration of climate change risks will certainly become a relevant factor for all companies either directly or indirectly in the foreseeable future.
How boards should address climate change risks
The first step is to identify relevant environmental risks:
- Physical – environmental risks associated with changing sea levels, global warming and more extreme weather events. Businesses in agriculture, operating on low-lying coastlines, involved in or reliant on tourism, and insurance companies, are obviously more susceptible to the physical consequences of climate change.
- Transition – ability to comply with legal/regulatory changes driven by climate change.
- Liability – potential legal action (eg failure to disclose material climate change risks in securities offerings, breaches of environmental regulations).
- Market – supply and demand changes due to climate change (eg rising costs of transport fuels, market changes driven by customer and investor preferences).
The next step is to manage those risks:
- Set targets and incentives – set targets with a view to managing the success of the company over a relevant timeframe and ensuring that executives are incentivised to consider that timeframe, not just immediate profits which can potentially be at the expense of longer term adaptation and mitigation.[5]
- Set strategies – develop strategies for long-term resilience (eg identifying different pathways or new collaborations, or plans for investment in technological change, and in people knowledgeable about climate change and sustainability).
- Reporting – develop a reporting framework and measure the impact of the company’s activities so as to inform what is working and what is not, and to hold the company to account.
- Communicate – communicate the company’s strategy and plans to stakeholders and exchange information with others.
Companies that address these issues now will position themselves for the future, and be ready to act (and potentially lead) when the day comes for mandatory action.
[1] The Zero Carbon Bill seeks to implement a framework for complying with New Zealand’s international obligations under the 2016 Paris Agreement – committing New Zealand to net-zero for long-lived greenhouse gas emissions by 2050
[2] http://nzx-prod-s7fsd7f98s.s3-website-ap-southeast-2.amazonaws.com/attachments/NZXR/311692/271467.pdf
[3] https://www.charteredaccountantsanz.com/member-services/technical/business-issues/climate-change-risk
[4] https://www.fsb-tcfd.org/wp-content/uploads/2019/06/2019-TCFD-Status-Report-FINAL-053119.pdf
[5] A good resource for boards is: http://www3.weforum.org/docs/WEF_Creating_effective_climate_governance_on_corporate_boards.pdf
