How to… govern for climate change

It’s the risk that disrupts business as usual. AICD’s new essential director’s guide developed in collaboration with MinterEllison provides practical guidance to help boards build capability and develop strategies for transition. We outline the important issues, steps and resources.

In August, the AICD announced it would host the Australian Chapter of the Climate Governance Initiative, to support members in meeting the challenges, risks and opportunities of governing climate change risk. It will provide members with access to a global network of experts in risk, resilience and resources to help non-executive directors and their organisations’ governance response to climate change.

The Climate Governance Initiative (CGI) is a rapidly growing global network of more than 20 bodies that promote the World Economic Forum (WEF) Climate Governance Principles for boards and effective climate governance within their jurisdictions. The principles support directors to gain awareness, embed climate considerations into board decision-making and understand and act upon the risks and opportunities climate change poses to their organisations. CGI chapters have already been established in many comparable countries, including the UK, US, Canada and France.

In parallel, AICD has released a new plain- language guide for directors on climate risk governance. The guide comes in three parts and considers the issue in the context of the non- executive director’s role and duties. It includes an introduction to key climate change concepts and risks, questions for directors on how to get climate change onto the board agenda, establish good governance structures, consider strategy and risk, and report and disclose.

It also provides guidance on when your duties as a director might interact with climate change risk and opportunity — and the legal and strategic issues you and your organisation may need to consider.

Why climate change is an issue for organisations and boards

Climate change has rapidly evolved from one seen as an ethical and environmental issue to one that presents material financial risks and opportunities for organisations — across short, medium and long terms. This evolution has been driven by developments in climate science and a stark shift in institutional investor, debt finance, regulator, market and community expectations. Today, many employees also see an organisation’s environmental impact as an important factor impacting their choice of employer. The regulatory environment in Australia has also changed significantly in the past five years. Australian regulators acknowledge the foreseeability of climate-related financial risks and are largely aligned on the economic/financial significance of climate-related risk. The Australian Securities and Investments Commission (ASIC) has also signalled it has an enforcement focus on “greenwashing” — misleading disclosure risk associated with climate change.

Risks

Climate change creates two primary financial risks: the physical impacts of a changing climate; and risks in the transition to a net zero emissions economy. A failure to manage these risks can, in turn, give rise to significant risks to a company’s reputation, social licence to operate and, ultimately, exposure to litigation risks.

Physical risks — to the natural and built environment. These include acute risks associated with an increase in the frequency and intensity of extreme weather events, such as coastal and inland floods, extreme winds and precipitation, soil contraction, heatwaves and drought, and gradual onset impacts such as rising sea levels, increasing average temperatures and rainfall variation. These, in turn, have significant consequences for ecosystem loss, human health, the integrity of the built environment and supply chains. Consequences for organisations may include damage to assets and project delays; uninsurability of projects and assets; and supply chain disruptions.

Economic transition risks — as governments, capital markets and the real economy shift in pursuit of low-emissions targets. Transition risks include policy and regulatory responses (such as emissions reduction laws, trade laws and tariffs, prudential regulation and heightened planning and building codes), technological developments (in areas such as renewable energy and electric vehicles) and shifts in stakeholder preferences (including of investors, insurers, tenants and the community).

These global emissions reduction commitments are increasingly being applied across adjacent areas of regulation — including tariffs and trade, and capital regulatory requirements.

Litigation transition risks — arise from a failure to manage or disclose the physical or economic transition risks. including in areas such as directors’ duties, misleading disclosure in corporate documents and contracts, contractual disputes and nuisance/negligence, where third parties suffer damage due to a failure of an asset owner to adapt their assets to foreseeable climate-related risks.

Questions for directors

At its core, climate change disrupts “business as usual”. This can present both risks and opportunities. Consider issues such as:

Governance

• How are issues associated with climate change integrated into our board governance (strategic and oversight) responsibilities? Is this issue receiving adequate time and focus within the board/committee agenda?
• Should this be a matter for the full board, included within the remit of a subcommittee — for example, audit and risk — or for your organisation, does it warrant a specific sustainability subcommittee?
• What is our organisational policy on climate change? Do we need a specific policy document?
• How do we as a board, and senior management (including legal, governance, finance and risk teams) ensure we are staying up to date in this dynamic area?
• Are our remuneration structures aligned with our strategic approach to climate change, or do they create perverse incentives — for example, that may favour investment in assets at risk of being stranded in the transition to a low-carbon economy?

Strategy planning/risk oversight

Reporting

More information in the AICD Climate Governance Guide

Where are we now?

Climate change is an evolving and complex issue with the potential to significantly impact on organisational risk, opportunity and strategy. As with any dynamic issue, consideration may require your organisation to embark upon a course of reflection and change. In beginning your climate governance journey, it is important to take a constructive approach that is sensitive to the varying levels of understanding around the board table.

All board members should have some understanding of key climate change concepts (see Part 1 of the guide). The extent of understanding will depend on how directors assess the importance of climate change to your organisation, the materiality of the risk and the size of the opportunity.

Depending on the size and nature of your organisation, it may be appropriate to arrange specific briefings for the board and executive on current climate-related issues and relevant impacts. Among questions to consider are:

• What should be done to introduce climate change on the board agenda? What reports or other inputs do we require from management? Do we need external advice or assistance?
• Can we have an effective and constructive conversation about climate change and its dynamics around the board table?
• Do we need to consider how we work together to build consensus? What will be the effect on board dynamics? Should we bring an external party in to assist us with this process?

Duties and expectations of a director

Where climate change is a material and foreseeable risk to an organisation, directors will have obligations to seek to address it as part of their risk oversight role. This does not mean that climate change necessarily needs to be prioritised by directors over any other foreseeable risk. But it does mean that directors should inform themselves of the impact of climate change risks and/or opportunities to their organisation. If they determine such risks and/or opportunities are material, directors must appropriately consider these in their governance of strategy and risk oversight — in the same manner as they would any other foreseeable risk or opportunity. In particular, climate change may be relevant to a director’s duty to act in the best interests of the company and their duty of care and diligence.

Whether the foreseeable risks associated with climate change have a material impact on a corporation’s strategy, financial position or prospects, the magnitude of that impact and the appropriate organisational response are matters that can only be determined in the unique context in which an organisation operates.

Board readiness check

Directors can assess their readiness through a board readiness check, which enables boards to self-assess their current state, understand the implications and identify an intended target state and the need for change. Developed by Chapter Zero in the UK with the support of the Berkeley Partnership and Hughes Hall Centre for Climate Engagement, it helps guide boards to assess their understanding across five areas and has a four-stage maturity model of climate change action.

AICD’s launch of the Climate Governance Initiative (CGI) on 26 August opened a deep discussion among more than 3000 members on how directors can best guide their boards during the period of transition. Speakers included CGI Governing Board chair Karina Litvack and AICD managing director and CEO Angus Armour FAICD. David McElrea, AICD senior policy adviser, advocacy chaired a director discussion with Lendlease chair Michael Ullmer AO FAICD, PWR Holdings chair Teresa Handicott FAICD, and MinterEllison partner Sarah Barker MAICD.

What they said

Karina Litvack, chair CGI Governing Board, non-executive director Eni

“This issue has now been recognised as the single greatest risk to the global economy, the single greatest risk to global systemic financial stability.”

“There’s no debate anymore that climate change must be on the agenda of boards of directors, be they very large listed companies, private companies, small and medium companies, non-profits, government institutions. This is an all-of-everybody mission.”

“It’s incumbent on us as board directors to understand how all these pieces fit together and these principles for effective governance help map that out.”

Sarah Barker MAICD, partner/head climate risk governance MinterEllison

“Often when we talk to directors, they say, ‘Climate change isn’t a material issue for us, so we don’t need to think about it’. It’s really quite important here from a legal point of view to understand that the obligation on a director is not to consider material issues. The obligation is to consider foreseeable risk issues and to interrogate those issues, because how do you know if an issue is going to be material in its impact on your business, on your organisation, unless you’ve actually thought about it?”

Teresa Handicott FAICD, chair PWR Holdings, non-executive director Downer EDI

“Understanding and managing risks, identifying and pursuing opportunities, is at the heart of what companies do. And it’s at the heart of our obligations as directors. You’ll find if you approach this topic through the lens of your existing governance practices around the assessment and management of risk, and your existing governance practices for strategy, short, medium and long term, it really does help to demystify the task.”

Michael Ullmer AO FAICD, chair Lendlease, non-executive director Woolworths

“I draw a parallel, first of all, with safety. So you’ll get people who say, ‘Well, I can’t afford to have a safe work environment because of everything you have to do’. And yet, when you get a tragedy or serious accident, or heaven forbid a fatality, the consequences of that in terms of shutting down a site, of counselling team members, of working with families... and everything that comes from that, is far more than the cost of doing it properly. I would, first up, think about safety and climate change in a similar light.”

Access the video and full transcript of the CGI launch here.