ASIC will undertake surveillance of climate change-related disclosure practices for listed entities, and will be expecting to see climate change disclosures in both OFRs and prospectuses.
Adding to previous guidance from the Australian Prudential Regulation Authority and the Australian Securities Exchange, the Australian Securities and Investment Commission (ASIC) has now weighed in with its new guidance for directors on disclosure of climate change risks as such risks may "pose a systemic risk that could have a material impact on the future financial position, performance or prospects of entities".
ASIC is encouraging entities to include climate change risk as part of a listed entity's operating and financial review, consider climate change risks in prospectuses, and factor climate change into impairment calculations.
Why did ASIC issue this guidance?
The new guidance was implemented through amendments to Regulatory Guide 247, Effective disclosure in an operating and financial review (RG 247), and Regulatory Guide 228 Prospectuses: Effective disclosure for retail investors (RG 228). Changes were also made to Information Sheet 203 Impairment of non-financial assets: Material for Directors (INFO 203). Why this focus on climate change risk?
In June 2017, the industry-led Task Force on Climate-Related Financial Disclosures (TCFD) released its Final Report: Recommendations of the Task Force on Climate-Related Financial Disclosure. The Report provided a framework for climate-related financial disclosures. The Report highlighted two types of climate-related risks:
- transition risks: risks in relation to the transition to a lower-carbon economy; and
- physical risks: risks related to the physical impacts of climate change.
Also in 2017, the Senate Economics References Committee held an inquiry into carbon risk disclosure. Its report, Carbon risk: a burning issue, recommended that ASIC and the ASX provide more explicit guidance on carbon risk disclosure.
In September 2018, ASIC released a review into climate risk disclosure, in which it reported that it had found fragmented disclosure practices. In particular, the Report noted that disclosure often did not create a full picture of a company's climate risk exposure, and that disclosures were often too general to be useful.
The Report recommended:
- directors and officers of listed companies should adopt a probative and proactive approach to climate change;
- companies should develop and maintain strong and effective corporate governance to identify, assess and manage material risks;
- companies should disclose material business risks affecting future prospects in an operating and financial review (OFR) – which may include climate change; and
- listed companies with material exposure to climate change should be encouraged to consider reporting voluntarily under the TCFD framework.
The guidance documents are ASIC's implementation of those recommendations.
What does the guidance recommend?
Under the Corporations Act 2001 sections 299A(1)(a)-(c), as part of their annual director's report, listed entities must prepare an operating and financial review (OFR). The OFR must contain information that would reasonably allow for an informed assessment of the entity's operations, financial position, business strategies and prospects for the future. In effect, covering material business risks affecting future prospects.
According to RG 247, an OFR should include a discussion of environmental, social and governance risks where those risks could affect the entity's achievement of its financial performance or outcomes. More specifically, RG 247 now recognizes climate change as "a systemic risk that could have a material impact on the future financial position, performance or prospects of entities."
RG 247 recommends that directors consider whether to discuss climate change risks as they may affect prospects for future financial years. In addition, directors are encouraged to voluntarily disclose additional information under the TCFD framework or in a sustainability report where the information is not already required for the OFR. However, RG 247 notes that disclosures made under this voluntary framework should not be inconsistent with disclosures made in the OFR.
RG247 recognizes that there may be an exemption from disclosing information that presents a likelihood of 'unreasonable prejudice' to the entity. But it recommends that the basis for relying on the exemption be evaluated and established by the directors before any required information is omitted.
Change to RG 228
RG 228 discusses a wide range of issues that need to be detailed in a prospectus, in order to provide relevant information to investors. Obviously, this includes key information about the business model - in other words - how the entity will make money and generate income or capital growth.
In detailing the business model, the guideline recommends that the prospectus include information about external threats, such as "the impacts of climate change on the business". The guidance document goes on to state that in reviewing risks to the business model, an example of a risk to the issuer that "may need to be included in the prospectus" is a discussion of climate change, including the policy, legal, technology and market changes that transition to a lower carbon economy may entail (transition risks), and the financial implications of physical risks.
Change to INFO 203
Finally, INFO 203 provides a table of matters to ensure that the common issues arising with impairment calculations are addressed. One of the listed matters is "key assumptions", with the accompanying query being whether the impact of risks associated with climate change have been considered.
What does this mean for directors?
Although all three documents are, of course, only guidance, as noted in RG 228, ASIC's guidance documents explain how ASIC interprets the law, and how ASIC will exercise specific powers under legislation (such as the Corporations Act).
Directors of listed entities, and those looking to issue a prospectus, should consider:
- '"material risk" now appears to include the risks posed by climate change;
- accordingly, ASIC will undertake surveillance of climate change-related disclosure practices for listed entities, and will be expecting to see climate change disclosures in both OFRs and prospectuses; and
- voluntary climate change reporting under the TCFD framework will be encouraged.
Arguably, climate change risk is becoming a factor in directors demonstrating that they have exercised due care and diligence.