William attended the UNFCCC forum. He is a Juris Doctor student at RMIT University in Melbourne. William works and volunteers at a non-government organisation that aims to ensure finance and investment is used to help solve major environmental problems like climate change.
Meeting the climate goals set out in the Paris Agreement will require a reallocation of capital, away from emissions-intensive activities, and towards clean, efficient alternatives. In order to optimise this reallocation, investors must understand which companies are best placed to take advantage of the opportunities posed by climate change, and which are most exposed to climate change risks.
The G20 Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) has recommended that organisations disclose information regarding the risks and opportunities they face as a result of climate change, along with their plans to manage those risks and opportunities. The recommendations were adopted by the G20 at its July 2017 summit in Hamburg, giving a clear indication as to the direction of future domestic policy in Australia.
Given climate change poses material business risks to some organisations, it is clear that some level of disclosure is already required under the Australian corporate regulatory regime. However, climate risk disclosure to this point has been far from uniform or comprehensive. Further guidance, supervision and enforcement is required to ensure climate risk disclosure is sufficient to give an accurate representation of a company’s prospects. This would enable markets to make informed investment decisions, thus driving the push towards a cleaner, more sustainable economy.
This paper identifies the immediate and longer term regulatory measures that should be implemented to ensure mandatory uniform climate risk disclosure amongst Australian companies.
● As an immediate measure, recommendation 7.4 of the Australian Stock Exchange (ASX) Corporate Governance Principles and Recommendations should be amended to specifically recommend listed entities disclose any exposure to climate change risks and plans to manage those risks.
● Also in the short term, the Australian Securities and Investment Commission (ASIC) should create and publish a Regulatory Guide explaining companies’ disclosure requirements as they exist within the current regulatory system.
● Relevant sections of the Corporations Act 2001 (Cth), Australian Accounting Standards, and ASX Listing Rules should be amended to explicitly require Australian companies uniformly measure and disclose the risks and opportunities they face as a result of climate change.
The Need for Disclosure
In December 2015, 196 nations agreed to limit ‘the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels.’ The Paris Agreement has since been ratified by 168 countries and entered into force on 4 November 2016. Global action to curb greenhouse gas emissions in an effort to restrict global warming is underway, as the goals of the Paris Agreement filter through to influence domestic policies. The global transition to a cleaner economy has begun.
This transition poses risks and offers opportunities to corporations and their investors (TCFD, 2017). The Economist Intelligence Unit in 2015 found that ‘the wider community of investors of all sizes is facing the prospect of significant losses from the effects of climate change.’ The risk climate change poses to global financial markets was estimated at between US$4.2 trillion and US$43 trillion out to 2100 (The Economist Intelligence Unit, 2015). Clearly, in order to make appropriate and astute decisions and avoid this massive potential risk, investors must be well informed of the climate risks faced by companies they currently, or may wish to, invest in.
It has been argued that the short-term investment horizons of institutional investors are insufficient to ensure climate risks, which are essentially longer-term in nature, are adequately priced by the market (Harmes, 2011). However, this critique is no longer true in a post-Paris economy. As noted by Australia’s own financial regulator APRA, the risks posed by climate change are ‘distinctly financial in nature,’ and ‘many of these risks are foreseeable, material and actionable now’ (Summerhayes, 2017). No longer can investors ignore the risks climate change poses to the companies they own.
Defining Climate Risk
The G20 Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) has identified two major categories of climate risk: ‘Transition Risks’ and ‘Physical Risks’ (TCFD, 2015).
Transition Risks include: policy and legal risks, such as the potential cost of carbon-pricing mechanisms; technology risks, such as renewable energy replacing fossil fuel generation; market risks, as supply and demand shift due to climate change considerations; and reputation risks, where consumer opinions of an organisation are affected by that organisation’s perceived action on climate change (TCFD, 2017).
Physical risks are those directly related to changing weather and climate patterns. These can be acute, such as the increasing severity of extreme weather events, or chronic, such as sea level rise or sustained high temperatures (TCFD, 2017).
Australian organisations are clearly susceptible to these climate risks. In order to limit their own risk, and make appropriate decisions, investors must be informed of the extent to which companies are exposed to climate risk, and how those companies plan to manage the risks.
Level of Disclosure Required
The TCFD Recommendations provide a robust climate risk reporting framework, demonstrating the level of disclosure that is required for investors to guide a timely and measured transition to a clean economy. Organisations should disclose details of the governance, strategies, risk management processes, and targets and metrics employed when assessing and managing their exposure to climate-related risks and opportunities (TCFD, 2017).
For example, a company should disclose the resilience of its ‘strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario’ (TCFD, 2017). Another specific example of appropriate disclosure would be measurements of a company’s direct and indirect greenhouse gas emissions, along with an explanation of the associated risks, such as the potential impact of carbon-pricing policies.
Specific risks and opportunities will be more or less relevant depending on the organisation concerned, however each organisation should be required to at least investigate and report on their exposure. Where exposure is identified, management techniques should be disclosed. These disclosures should be made regularly through mainstream financial reporting frameworks.
Current Regulatory Regime and its Limitations
Australia’s existing corporate regulatory system already requires some level of climate risk consideration of companies and their directors (Hutley and Hartford-Davies, 2016). However, under the current regime, Australian companies undertake climate risk disclosure in a limited, haphazard manner, if at all (Foerster et al., 2017). KPMG have found that less than half of Australia’s top 100 organisations by revenue recognise climate change as a financial risk (2017). This makes it impossible for investors to adequately measure and compare the risks and allocate capital accordingly.
The most relevant elements of the Australian regulatory regime include sections of the Corporations Act 2001 (Cth), Australian Securities and Investment Commission (ASIC) Regulatory Guidance documents, ASX Listing Rules and Principles and Recommended Practices for Good Governance, and Australian Accounting Standards Board (AASB) Standards. The requirements of each of these elements, as well as the interactions between them, could form the basis of a strong climate risk disclosure regime. However, this would require far more prescriptive provisions and guidance to ensure the comprehensive and uniform disclosure that is required for investors to make fully informed decisions.
The Corporations Act requires directors of listed companies to report information that shareholders ‘would reasonably require to make an informed assessment of: the operations of the [company]; and the financial position of the [company]; and the business strategies, and prospects for future financial years, of the [company]’ (section 299A). ASIC regulatory guidance on this requirement states: ‘An [operating and financial review] should include a discussion of environmental and other sustainability risks where those risks could affect the entity’s achievement of its financial performance or outcomes disclosed’ (ASIC Regulatory Guidance 247.63). It therefore seems the financial risks posed by climate change should be disclosed by companies, but the current level of disclosure by Australian companies is insufficient (Foerster et al., 2017).
The ASX Listing Rules, along with the Corporations Act, operate to impose ‘continuous disclosure’ obligations on listed companies, requiring them to inform the market of any information that a reasonable person would expect to have a material effect on the price or value of the company’s securities. For example, this could mean a coal port operator would have to inform the market if emissions-restrictive policies were instituted in countries that had been relied upon as trading partners. The ASX Rules also impose specific disclosure requirements on mining, oil and gas companies, including the economic assumptions underpinning their resource development expectations (Chapter 5). While climate change’s potential impact on resource demand seems entirely relevant to these assumptions, there is no specific requirement that the assessment or management of these kinds of risks be reported.
Principle 7 - and particularly recommendation 7.4 - of the ASX Principles and Recommendations for Corporate Governance (2014) are relevant to climate risk disclosure for ASX-listed entities. In accordance with Principle 7, listed entities should establish and regularly review a risk management framework, and disclose compliance or reasons for non-compliance with this recommendation. Specifically, recommendation 7.4 calls for listed entities to disclose any material exposure to economic, environmental and social sustainability risks, and how they manage these risks. Clearly climate-related risks should be captured by these principles and recommendations, but they are not explicitly referenced.
The AASB Standards are given effect by section 296 of the Corporations Act, and provide regulatory guidance around financial reporting for public and private organisations. Two standards are particularly relevant to climate risk: Standard 13 (Fair Value Measurement); and Standard 136 (Impairment of Assets). In order for organisations to adequately report on the fair value of their assets and liabilities, and whether or not certain assets are impaired, they should factor in the potential costs of climate change. For example, the owners of an oil field may need to reduce the value of that asset as a result of a fall in expected demand caused by emissions reduction policies. However, the current standards do not prescribe climate change considerations be taken into account when assessing fair value or impairment of assets.
The disclosures required under the current regulatory regime appear to require disclosure of the financial risks posed by climate change. However, as noted by Foerster et al. (2017), even disclosures by large, heavily climate risk-exposed, ASX-listed companies are highly variable, and generally lack detailed analysis and evaluation of current and potential climate risk factors. It is clear that the current regime must be supplemented to ensure a uniform adequate level of climate risk disclosure.
Room for Improvement
The current Australian corporate regulatory regime provides the bones of a robust climate risk disclosure system, but lacks the specificity and detail needed to ensure an appropriate level of disclosure in the post-Paris economy. Australian companies’ implementation of the current requirements demonstrates a major gap between local climate risk disclosure practice and the recommendations of the TCFD. Measures should be implemented as soon as possible to provide companies with guidance to bring their level of climate risk disclosure into line with the TCFD framework.
1. Amend ASX Recommendation 7.4
The first measure, to be implemented immediately, would be to amend recommendation 7.4 of the ASX Principles and Recommendations for Corporate Governance. The recommendation should explicitly call on listed entities to report their exposure to climate change-related risks. This simple amendment would ensure the potential impacts of climate change are built into risk management reporting practices amongst ASX-listed companies. Any failure to reports on climate risk would have to be justified by those companies, in accordance with the listing rules. While this step is far from a complete response to the current lack of climate risk disclosure in Australia, it is a simple measure that could be implemented in the short term to make significant headway and prepare organisations for the more comprehensive policy reforms to follow.
2. New ASIC Regulatory Guidance Document
Also in the near term, a new ASIC Regulatory Guidance document should be created and disseminated to all ASIC-regulated organisations, stating categorically that climate change poses material financial risks to many Australian organisations. The Regulatory Guidance document should reference the disclosure requirements under the current regulatory regime, and describe the level of climate risk disclosure needed to meet those requirements. The document should present the disclosure framework recommended by the TCFD as an appropriate disclosure model. This would help foster comprehensive, uniform, and comparable disclosure amongst Australian companies.
3. Comprehensive Regulatory Reform
The final, most comprehensive step of policy reform in this area should be to amend the Corporations Act, ASX Listing Rules, and AASB Standards to specifically require TCFD-compliant climate risk disclosure of all Australian companies. If companies do not believe they are exposed to any climate change risks or opportunities, they should be required to disclose their basis for such a belief. Importantly, this type of regulatory reform would bring climate risk disclosure within the full enforcement powers of corporate and financial system regulators ASIC and APRA. Failure to meet climate disclosure obligations or providing misleading information about climate risk would be treated in the same manner as other serious breaches of corporate law, providing a significant deterrent and thereby promoting comprehensive and accurate climate risk reporting.
With a simple amendment to the ASX recommendations, and a new guidance document produced by ASIC, it is possible for climate risk disclosure in Australia to be significantly improved in a very short time frame. Following these intermediate steps, comprehensive regulatory reform is the ultimate measure required to ensure an appropriate level of climate risk disclosure amongst Australian organisations. This disclosure is necessary to enable markets to make informed investment decisions, which can guide the transition towards an economy that aligns with the aims of the Paris Agreement.
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