With reporting season looming large, Australian directors have begun to broaden their focus beyond immediate COVID-19 concerns to assurance and reporting.
One key area of focus – in which regulatory and investor expectations have continued to progress in FY20 – is climate change risk governance, assessment and disclosure.
“Our analysis of FY19 annual reports indicates that only 21 (7%) of ASX300 companies had 'meaningful' climate change risk disclosures, compared with 137 (45.5%) of reports containing little or none.”
These relativities do not bode well for many listed companies in light of ASIC's recent announcement that it will prioritise surveillance of the climate change risk disclosures in FY20 annual reports.
So how do boards assure themselves that they are in the former category, and not the latter?
To assist, we have set out below our top 5 climate change-related governance issues for directors, and the company secretaries and general counsel on which they rely, to consider this reporting season.
An increasing proportion of mainstream institutional investors (including the world's largest investor, BlackRock, and members of the US$40trillion Climate Action 100+) now expect investee companies to apply the governance, strategy, risk metrics and disclosure framework set out in the 2017 Recommendations of the Bloomberg Taskforce on Climate-related Financial Disclosures (TCFD). One of the key TCFD Recommendations relates to stress-testing and scenario planning of business strategies against a plausible range of climate futures. Investor demands are now underwritten by regulatory imperative, with ASIC updating its Regulatory Guidance on Operating & Financial Reviews, RG247, to include information on the impact of climate change on financial performance, position and prospects.
COVID-19 has done little to dampen the corporate trend towards embracing commitments to transition to net zero emissions by (or before) 2050 in accordance with Paris Agreement or 'science-based' targets. Many of these net zero pledges – across sectors as diverse as manufacturing, pharmaceuticals, information technology, apparel, retail, mining, and oil and gas – now include 'scope 3' emissions from downstream consumption. Mainstream investors and large proxy advisors (such as ISS and Glass Lewis) are increasingly voting in favour of activist shareholder resolutions that seek corporate disclosure of net zero emissions strategies – often against the recommendation of management.
As the urgency to transition the global economy to a low-carbon trajectory accelerates, investors are increasingly dissatisfied with bare pledges of 'support for Paris Agreement goals' that are not backed by credible corporate strategies. In FY20, investors are looking for a road-map of short- and medium-term targets against which to assess a corporation's net zero transition commitment, and evidence of credible progress on that journey. In addition to the well-publicised votes at a number of Australian and European oil and gas producers, this was evident in several bank proxy battles in the recent northern hemisphere reporting season. These included JP Morgan, where a pledge to commit US$200 billion to sustainable lending was insufficient to secure withdrawal of a resolution calling for publication of a Paris-aligned portfolio decarbonisation pathway, which received 48.6% shareholder support. Similarly, at Barclays, a resolution calling for a plan to phase out lending to 'non-Paris aligned' fossil fuels and utility companies received 24% support, despite a 'counter proposal' in which Barclays pledged its ambition to become a net zero bank by 2050 (which itself secured 99.9% shareholder support).
The reasonableness, and consistent application, of material climate change-related assumptions is squarely relevant to financial reporting and audit in FY20. In April 2019, the Australian Accounting Standards Board and Auditing and Assurance Standards Board issued joint guidance stating that climate change-related assumptions have the potential to be a material accounting estimation variable, impacting on asset useful lives, fair valuation, impairments and provisions for bad and doubtful debts. Although the guidance is 'voluntary', the standard setters made clear that they 'expect' it will be applied by report preparers and auditors. ASIC followed with its own guidance in August 2019, updating INFO 203: Impairment of non-financial assets: Materials for directors to highlight climate change and other risks that may be relevant in determining key assumptions that underly impairment calculations. The potential impacts are far from theoretical, with a number of large corporations – including Repsol and BP – recently announcing multi-billion dollar asset write-downs necessitated by a 're-basing' of their climate-related valuation assumptions.
Finally, activist shareholders often seize on executive remuneration as a core driver of (or barrier to) a company's strategic alignment with climate change goals.
To guard against proxy challenge on point, companies should benchmark their governance of climate change strategy and risk management against the Recommendations of the TCFD (including board-level oversight of, and senior executive accountability on, climate-related strategy), and ensure that a portion of the discretionary remuneration of relevant senior officers is linked to progress against the business' climate targets.