Managing climate risk for directors

ASIC Commissioner Cathie Armour says disclosing and managing climate-related risk is a key director responsibility.

ASIC has previously highlighted climate-related risk as a systemic risk in our market that has the potential to significantly impact companies, investors and consumers. Our focus is on ensuring listed companies have appropriate governance structures in place to manage this issue, and providing the market with reliable and useful information on their exposure to material climate-related risks and opportunities.

Just before the pandemic struck, ASIC looked at a selection of listed companies to assess how they were managing and disclosing this issue. We focused on reporting by companies under the framework established by the Financial Stability Board’s Taskforce for Climate-related Financial Disclosures (TCFD). We previously recommended the TCFD framework to listed companies, including via our guidance on Prospectuses and Operating and Financial Reviews in annual reports. The ASX’s Corporate Governance Principles and Recommendations include a similar recommendation. We are in the process of following up with many of the companies we considered as part of these reviews. Our aim is to pass on targeted guidance as they commence their next reporting cycle.

Separate to our review processes, ASIC has also written to several companies that had come to our attention as potential “laggards” in this area to remind them of their statutory obligations.

Surveillance

ASIC surveillance began in the first half of 2019–20 and commenced with examinations of several large listed companies spanning a range of industries including energy, financials, industrials, property and consumer discretionary. Overall, we observed that voluntary adoption of TCFD reporting by some larger listed companies has materially improved standards of climate-related governance and disclosure in the market. Among larger listed companies, ASIC has clearly observed a significant and meaningful increase in the level of engagement, and disclosure, on climate-related matters since last examining this area in 2017–18.

We found evidence of board oversight of climate risk across all surveillance targets and noted that TCFD reporting has generally led to material improvements in the standards of disclosure.

Challenges

Notwithstanding these steps forward, there is still a way to go and some companies are much further along than others. Unsurprisingly, we saw that solid governance of this risk generally leads to better disclosure. Some of the challenges for preparers and users of climate-related disclosure continue to be:

• Scenario analysis — where listed companies choose to undertake and disclose it. Particularly, the diversity of scenarios being disclosed against, and how individual scenarios are applied differently by companies operating in similar industries, locations and circumstances.
• Physical risks of climate change — the assessment, management, mitigation and disclosure of the physical risks of climate change. The intersection of scientific outputs with financial-sector input remains an underdeveloped area, including the lack of common language and taxonomies.

There are various developments in these areas that could see greater alignment and progress, such the work by the industry-led Climate Measurement Standards Initiative and the Australian Prudential Regulation Authority’s upcoming climate change vulnerability assessments for the major banks. The TCFD has just released it latest status update and ASIC’s observations around improvements and challenges in Australia are echoed in its global review.

ASIC intends to adopt a consultative approach as we continue to monitor the adoption of TCFD reporting and the development of climate-risk disclosure practices over the coming period. However, as is always the case, we may consider enforcement action should there be serious disclosure failures. This includes whether the failures relate to the impact of climate change, or to other matters such as operations or the prospects of the business.

While ASIC acknowledges that climate-risk disclosure practices are still evolving (not only in Australia, but internationally) we encourage directors and advisers of listed companies to consider our four high-level recommendations relating to climate-risk management and disclosure.

Climate change risk guidance for directors

1. Consider climate risk Directors and officers of listed companies need to understand and continually reassess existing and emerging risks that may be applicable to the company’s business, including climate risk. This should extend to both short- and long-term risks. Boards should ask if they have considered climate risk in their decision-making process.
2. Develop and maintain strong and effective corporate governance Strong governance facilitates better information flows within a company and facilitates active and informed engagement and oversight by the board in identifying and managing risk. Boards should consider if they are comfortable with the level of oversight they maintain over climate risks and opportunities and the governance structures in place to assess, manage and disclose these risks and opportunities.
3. Comply with the law Directors of listed companies should carefully consider the requirements relating to operating and financial review (OFR) disclosures in annual reports under s299(1)(a)(c) of the Corporations Act 2001. ASIC considers that the law requires an OFR to include a discussion of climate risk when it is a material risk that could affect the company’s achievement of its financial performance. Depending on the circumstances, disclosure of climate risk may also be required by the law in other contexts, such as a prospectus or continuous disclosure announcement. Boards should ask if material climate-related disclosures have been made and updated where necessary and appropriate.
4. Disclose useful information to investors The voluntary disclosure recommendations issued by the TCFD are specifically designed to help companies produce information useful for investors. ASIC recommends listed companies with material exposure to climate risk consider reporting under the TCFD framework.