What is climate-aligned contracting – and how can organisations use it as a key lever in the transition to net zero? It's an important tool for the infrastructure and construction industries in particular. We explore what it means and how to start using it.

Key takeouts

  • Climate-aligned contracting is a practical tool to allocate the accelerating and dynamic risks (and opportunities) associated with climate change.
  • Key drivers for addressing climate in your contracts include the elevated expectations for organisations to set and meet ambitious emission reductions targets and the increased demand for 'green' investments by ESG-aware investors.
  • Globally, organisations are embedding climate solutions into commercial arrangements and using contractual drafting to deliver net zero targets today.

So, you've set a net zero target (or your client has!)… now what? How can your organisation take demonstrable steps to deliver to these net zero commitments?

Your contracts may be the key.

Embedding climate objectives into procurement and counterparty arrangements has transitioned from a ‘sleeper issue’ to a key lever in the transition to a net zero economy. Governments and organisations have for some time focussed on setting net zero targets and establishing policy frameworks to deliver to these commitments. Now, however, they are turning to contracting as a practical tool to implement their commitments.

There is increasing financial value at risk due to the impacts of climate change. Emissions reduction in particular is an entire value chain proposition – and in the construction industry, a significant portion of those emissions are scope 3 emissions and outside business fence lines. Contracting is one of the few mechanisms within a party’s sphere of influence to manage their scope 3 emissions and protect their organisation from the risks of climate change, in a forward-looking way.

Climate change is a dynamic issue that principals and contractors have the opportunity to mitigate and manage the impact of through their contractual arrangements. In this article, we unpack what 'climate-aligned contracting' is for the infrastructure and construction industries, the drivers for addressing climate risks (and opportunities) in contracts and highlight some climate clauses to start using in your contracts today.

What is climate-aligned contracting?

Addressing climate change risks and opportunities in contractual frameworks goes beyond including obligations to meet 'green' or sustainable design/as-built standards or construction practices (such as the Infrastructure Sustainability Council Rating Scheme or Green Star).

Climate-aligned contracting involves drafting contractual provisions (or levers) to allocate and to deal with both the specific climate related risks – namely physical risks and economic transition risks – and the opportunities associated with climate change in the global transition to net zero.

Physical risks are both the acute risks associated with an increase in the frequency and intensity of extreme weather events. This includes coastal and inland floods, bushfires, extreme winds and heatwaves, and gradual onset impacts such as sea level rise, increasing average temperatures and rainfall variation. They need to be factored into how infrastructure projects are delivered in the short-term and maintained over decades.

Economic transition risks are the responses of governments, capital markets and consumers as the real economy transitions toward net zero emissions.

Economic transition risks include policy and regulatory responses (such as emissions reduction laws, heightened planning and building codes and prudential regulation), technological developments (in areas such as renewable energy and electric vehicles) and shifts in stakeholder preferences (including of debt and equity investors, insurers, users of infrastructure and the community).

Climate-aligned contracting is rapidly becoming (if not already) an essential requirement for both long term infrastructure projects and short to medium term 'standard' construction contracts. Physical risks, in particular, continue to accelerate and increase exponentially with longer project timelines and asset lifespan. The earlier that these issues can be planned for - during the planning, design and procurement stages - the greater the opportunity to address and manage climate change risk during the project lifecycle. In adopting this early stage intervention approach and including climate-aligned contracting in contractual arrangements now, contracting parties will not be left playing 'catch up' to develop and implement solutions as climate risks materialise.

Climate-aligned contracting is also a mechanism for capturing the opportunities posed by climate change today. Principals and contractors alike can use their counterparty arrangements to deliver to net zero commitments, and to capitalise on the parties' climate credentials (e.g. by aligning the terms of green financing with low carbon or net zero project delivery metrics).

Find out more about climate-aligned contracting here: Five tips for 'climate-conscious' contractual drafting and negotiation.

Drivers for including climate drafting in infrastructure and construction contracts

Why are infrastructure and construction players turning to contracts to deliver net zero in project delivery? The drivers of change can be summarised over three key themes. The defining and common characteristic of these shifts is the speed in which the changes are occurring.

1. Acceleration of emissions reduction with heightened focus on 2030 targets

The release of the updated consensus science on the state of the climate, IPCC's Sixth Assessment Report (AR6) in August 2021 has further clarified the understanding of the impacts of human-induced climate change.

AR6 has illuminated the need for immediate and rapid emissions reduction in order to meet the Paris Agreement goals. Specifically, this means a global reduction of carbon emissions by at least 45% by 2030 compared to 2010 levels.

Setting a 2050 net zero target is now a 'ticket to play' – with the focus shifting to interim emissions reduction targets to 2030. In 2022, that focus is now on the 'how' of getting to net zero – with contracts as a key lever in the implementation of organisational emissions reduction plans.

2. Early mover governments are looking to infrastructure to pursue their climate and emissions reduction policies

Governments with ambitious climate policies (such as the EU and UK) are moving beyond target setting to implementation of their transition plans. Infrastructure and public procurement is a focus area for these governments, as there is large scope for emission reductions given the significant contribution of transport and buildings to global emissions. We can look to these first mover jurisdictions to understand what is in the pipeline for Australian projects.

For example, a number of UK and EU climate specific public procurement and infrastructure policies were released in 2021 and early 2022. These frameworks raise the bar on climate mitigation and resilience in the delivery of infrastructure assets/public procurement; shaping best practice and contracting methods for climate-proof infrastructure. For example, the UK Government requires bidding suppliers on projects over £5million to have a Carbon Reduction Plan setting out the supplier’s commitment to achieving net zero by 2050 in the UK. They also need to set out the environmental management measures that they have in place, which will be in effect and utilised during the performance of the contract. See also, for example, the European Commission Technical Guidance on the climate proofing of infrastructure in the period 2021-2027 (2021/C 373/01) and EU Taxonomy for sustainable activities – Regulation 2020/852.

3. Debt and equity investors are seeking 'green' investments to meet increasingly ambitious ESG mandates

Over 90% of global GDP (and 83% of all greenhouse gases) is now subject to a national net zero target. There are over $10.6 USD trillion in assets under management globally covered by a net zero commitment under the UN-convened Net Zero Asset Owners Alliance. All five big banks in Australia have joined up the UN-convened Net Zero Banking Alliance, committing to align their lending and investment portfolios with a Paris Agreement-aligned pathway to net zero by 2050.

ESG-aware investors are now seeking investments for their 'green' capital – including 'green' or 'net zero aligned' infrastructure projects. This is driving the uptake of green-labelled financial products to incentivise project proponents to meet and beat 'green' project metrics, such as carbon reduction targets for project delivery (e.g. through design, material procurement and construction methodology). This trend is informing future contracting methods, particularly as principals seek to ensure that there are sufficient contractual enforcement mechanisms in place to ensure the 'green' objectives are met on completion and throughout the asset's useful life.

Climate clauses for infrastructure and construction

Organisations around the world are embedding climate solutions into their commercial arrangements today. MinterEllison is a proud contributor to The Chancery Lane Project (TCLP), a global legal initiative which produces precedent clauses to assist organisations in delivering net zero through contracts.

There is no 'one size fits all' for climate-aligned contracting, as every site, project and organisation has varied exposures to climate risks and opportunities. This means that careful consideration is required when incorporating climate-aligned clauses into commercial documents. Organisations need to consider the size and sophistication of counterparties and the counterparties' relative net zero ambitions, as well as the unique risk profile of the asset and site to both physical risks and economic transition risks. Like all precedent clauses, it is critical that these are appropriately adapted to suit the relevant commercial objectives and arrangements.

There are a number of TCLP clauses which can be used to deliver net zero in infrastructure assets today (each named by TCLP with child's name):

A self-assessment questionnaire for contractors, subcontractors and suppliers which can be used by principals and contractors during procurement as an evaluation criteria for assessing a respondent's approach to climate risk and emissions reduction.

The questionnaire sets out questions in relation to climate risk management and the respondent's overall approach to emissions reduction, with guidance on what is considered high to low ambition across a range of criteria. The respondent is then required to self-assess against its existing climate and sustainability practices. If used during the RFP phase, Robyn's Questionnaire can be used as part of the tender evaluation criteria. The responses can also be revisited and updated periodically throughout the engagement and used to assess performance during the delivery phase against the climate risk criteria and progress toward achieving net zero targets.

A clause which provides a specific mechanism for contractors to propose sustainable net zero aligned modifications to the project works. Luna's Clause can be used to encourage contractors to propose and implement sustainable construction solutions during the delivery phase. Similar to traditional modification regimes in typical construction contracts, this clause is a contractual mechanism that is specifically directed to net zero aligned modifications. Contractors are encouraged to propose sustainability focused modifications, which, despite being likely to come at increase cost in the short term, have benefits for the principal (through reduced energy and operating costs and increased green financing opportunities), the project and the environment.

A clause which sets a 'carbon' budget for the materials procured for a construction project.

Tristan's Clause can be used alongside the financial budget for the project to incentivise contractors to reduce the embodied carbon emissions across the project lifecycle. By including metrics for emissions reductions, the contractor is encouraged to make decisions which reduce embodied carbon, which may not otherwise be made under traditional value for money assessments that do not take into account embodied carbon.

A clause which makes infrastructure or project finance conditional upon the principal or borrower developing and implementing a whole-of-life decarbonisation plan (which covers both the construction and operational phases).

Rose's Clause can be built into finance documents to incentivise mitigatory behaviour regarding climate change and decarbonisation during the life of the project. It also provides contractual levers for lenders to activate in response to continued breach (e.g. failure to meet net zero standards).

A clause that passes through the principal's net zero targets and obligations through to its supply chain arrangements. The clause entitles the principal to offset the counterparty's carbon emissions where the net zero obligations are not achieved, or even terminate the contract.

Owen's Clause can be used to enable principals to align net zero targets with their supply chain and contractors which contribute to the principal's own carbon emissions (e.g. such as the materials procured for a construction project which would be considered scope 3 emissions). Requiring ongoing emissions reporting against these targets also allows the principal to control or otherwise manage the achievement of their own net zero commitments.

TCLP has published a practical Net Zero Toolkit containing climate-aligned contract clauses and tools to assist organisations to deliver to their net zero commitments through contracts.