A misleading climate-related disclosure claim serves as a reminder that climate change is a financial risk issue. It must be robustly considered and disclosed in the same way as any other material financial risk.
The claim has been filed against the Commonwealth and, notably, a number of its officers, on behalf of a retail purchaser of Commonwealth sovereign bonds.
The claim alleges that the investor information statements issued for exchange-traded Australian government bonds are misleading or deceptive. This is contrary to section 12DA(1) of the Australian Investments and Securities Commission Act 2001 (Cth) (ASIC Act). The claim suggests that the statements are promoted in breach of the Commonwealth's duty of utmost candour and honesty, as they do not adequately disclose the economic and fiscal risks associated with climate change, and associated credit risks to the issue. The claim further alleges that, as officials of the Commonwealth entity issuing the allegedly misleading disclosure documents, the Secretary to the Department of Treasury and the CEO of the Australian Office of Financial Management failed to discharge their statutory obligation to exercise due care and diligence under section 25(1) of the Public Governance, Performance and Accountability Act 2013 (PGPA Act).
About the claim
The claim, O'Donnell v Commonwealth & Ors (22 July 2020, VID482/2020) (Federal Court Claim), essentially alleges that the investor information statements and memoranda are misleading or deceptive. It is alleged that this is due to their failure to provide information to investors in relation to the susceptibility of the Australian sovereign's fiscal position and investment performance of the bonds to physical and economic transition risks associated with climate change. It states, in part: 'Climate Change Risk can have a material impact on the fiscal position of the Sovereign and the investment performance of Sovereign bonds by, amongst other things, the impact on a Sovereign’s (a) gross domestic product; (b) fiscal policy; (c) foreign exchange rates; (d) inflation; (e) taxation revenue; (f) terms of trade; (g) international relations; (h) bond yield'.
It alleges that the Commonwealth, as promoter of the information statements, has engaged in misleading or deceptive conduct, and breached its duty of utmost candour and honesty to investors in exchange-traded government bonds, due to a failure to disclose information about material climate-related risks that can influence the investment decision. It further alleges that, in approving the disclosure documents, the Secretary to the Department of Treasury and the CEO of the Australian Office of Financial Management, failed to discharge their statutory obligation to exercise due care and diligence under section 25(1) of the PGPA Act.
The applicant is seeking a declaration of breach, and an injunction prohibiting the Commonwealth from further promoting exchange-traded government bonds that do not contain information about material climate-related financial risks.
Unprecedented, but not novel
The Federal Court Claim is the first of its kind, globally. However, it is interesting to note that similar arguments have been raised in a climate context previously – by an oil and gas major in a Texas court as part of a defence against a series of claims filed by Californian municipalities seeking damages for the costs of adaptation to climate-related impacts to their municipal infrastructure. The argument in that case essentially ran that, if the plaintiffs' claims about their financial exposures caused by their vulnerability to sea level rise were correct, that this should have been disclosed as a material financial risk in their municipal bond prospectuses (which had not occurred). The petition, relating to pre-trial discovery, was ultimately unsuccessful on jurisdictional grounds. However, it illustrates that the claim filed in our own Federal Court should not be considered as novel.
So, is this just an issue for green-labelled bonds, or across all fundraising?
It is important to emphasise that the Federal Court Claim does not allege 'greenwashing' in the disclosure documents – ie a representation of the green credentials of the issuer or intended use of proceeds that lacks substance in reality. Rather, it goes to the heart of an issue with which many market participants are yet to fully grapple: that climate change presents foreseeable, and often material, financial risks (and opportunities) that must be considered and disclosed in the same way as any other financial risk relevant to a financial product issuance. This is reflected in updates which were made to ASIC Regulatory Guidance 228 in August 2019 (RG228), which flagged climate-related risks in the nature of those described by the Recommendations of the G20 Financial Stability Board's Taskforce on Climate-related Financial Disclosures as being key risks in disclosure documents prepared in accordance with the requirements of the Corporations Act. Whilst the ASIC update applies only to prospectuses issued to retail investors, we consider it would be imprudent to rely on the sophistication of wholesale investors as justification for any failure to robustly consider and disclose relevant climate-related financial risks (for example, an information memorandum).
Of course, that is not to suggest that issuers and their advisors should not consider whether a particular debt issue is a good candidate for 'green'-labelled issue, or any other form of sustainability-linked debt capital (including rapidly growing instruments such as sustainability linked loans). The growth of such 'sustainable financial instruments' continues to accelerate, driven by both investor demand, issuer liquidity and book-building considerations and, increasingly, evidence of preferential pricing versus 'vanilla' bonds (particularly in secondary markets).
Implications for financial product and service issuers
With the threat of legal challenge to product disclosures moving from credible to actual, both sovereign and corporate issuers should review the robustness of their approach to climate-related financial risk evaluation, verification and disclosure. A proactive approach to climate change risk management should not necessarily be seen as an additional cost, but one that is essential to maximise efficiency and minimise unforeseen risks (and now, the very real threat of litigation). Moreover, identification of relative resilience to climate-related risks may even provide issuers with opportunities to maximise pricing in the market.
A few initial issues to consider for issuers and their advisors include:
- Fundraising structure - do we (and our key advisors) understand the range of climate-related financial risks that may be material to the issue, its size and structure, intended use of proceeds, credit rating, issue timing, covenants, pricing and subscription demand? What are the risk metrics and variables that will need to be considered?
- Information gathering and verification – how do we, and our advisors, remain across dynamic climate-related financial risk issues, regulatory expectations and investor preferences, and integrate appropriate due diligence procedures into our information gathering and verification frameworks?
- Disclosure documents – what disclosures should be made in our disclosure documents – both narrative and quantitative? What is the materiality threshold we should apply? What disclosure of forward-looking stress-testing and scenario analysis against the plausible range of climate futures should be included?
- Roadshows, investor presentations and market questions – what are the key climate change-related questions that we may expect from potential subscribers?
MinterEllison has led the market, both in Australia and globally, in advising on climate-related financial risk exposures through a corporate and securities law lens. We would be pleased to work with your product, risk management and legal teams to review your structuring, due diligence and disclosure verification processes.
Please do not hesitate to contact our Climate Risk Governance team if you would like to discuss these issues.