The Situation: After conducting a period of market surveillance, Australian Securities & Investments Commission ("ASIC") Commissioner Cathie Armour recently released a statement reiterating ASIC's expectation that disclosing and managing climate change risk is a key responsibility of directors.
The Result: ASIC identified that since its last review in 2017-2018 there has been a significant increase in the level of engagement and standards of disclosure on climate-related matters by Australian listed companies, and there is now broad-based board oversight of climate change risk in each of the companies included in the review.
Looking Ahead: Commissioner Armour's statement is consistent with an accelerating international trend of regulators raising the standards in relation to climate-related disclosures. While ASIC is adopting a consultative approach to improving disclosure practices, serious disclosure failures could lead to enforcement action. Accordingly, boards should continue to make climate change and related disclosures a corporate governance priority.
Overview of ASIC's Expectations for Climate Change Disclosures
The genesis of the Commissioner's statement was market surveillance by ASIC of the climate-related disclosures of a group of large listed companies. ASIC commenced this review prior to the COVID-19 pandemic.
In reporting the outcome of the review, Commissioner Armour's statement emphasises that:
- Existing and emerging risk assessments should consider short and long term climate risk;
- Good governance is key: Boards should consider whether they have appropriate levels of oversight of climate risks and opportunities, and whether effective governance structures are in place to assess, manage and disclose these matters; and
- Directors should be aware of specific legal obligations which exist in relation to disclosing climate-related risk, including specifically in the context of operating and financial review disclosures, as well as prospectus requirements and continuous disclosure statements.
Commissioner Armour also commented on disclosures by Australian listed companies under the Taskforce for Climate-related Financial Disclosures ("TCFD") recommendations. In 2017, the TCFD published 11 categories of recommended disclosures which fall within four thematic areas: governance, strategy, risk management and metrics.
Reporting under this framework is intended to be granular. By way of example:
- Governance: Disclosures may include details of the frequency with which its board and management committees consider climate-related risks.
- Strategy: Disclosures may include descriptions of how a company's investment and portfolio managers are incentivised to manage ESG risks, and how such risks are documented and reviewed. Strategy may also include scenario analysis, including detailing the methodology and assumptions underlying such analysis.
- Risk: Disclosures may describe how the three-lines of defence model—i.e., layered risk management processes comprised of first-line risk management, compliance oversight and independent assurance—is applied specifically to climate-related risks within a company.
- Metrics: May include a calculation of greenhouse gas emissions and ratings against business indicators which assess exposure to ESG risk, using recognised methodologies.
ASIC has previously recommended that Australian listed companies voluntarily make disclosures in line with the TCFD framework, including via its guidance on Prospectuses and Operating and Financial Reviews in annual reports. The ASX's Corporate Governance Principles and Recommendations include a similar recommendation.
ASIC's Market Surveillance: General Levels of Improvement, but Challenges Remain
Given that the last review was in 2017-18, it is not surprising that in its latest review ASIC has observed notable increases in the level of engagement, and disclosure, on climate-related matters.
ASIC's assessment is that while the TCFD framework has improved the quality of disclosures, there is still a way to go. The key challenges include:
- Scenario analysis: Under the TCFD framework it is recommended that companies disclose a resilience strategy, taking into account different climate-related scenarios, including scenarios in which emissions are capped with the aim of achieving a rise in average global temperatures of two degrees or lower than pre-industrial levels. ASIC has identified that meaningful disclosures of this nature remain challenging because of the variety of scenarios being used as baseline cases, and different assumptions about similar scenarios being made across similar sectors.
- Physical risks: Assessment of the physical risks of climate change, along with mitigating actions remains unclear. As a consequence, disclosures in relation to how companies assess, value and mitigate these risks remain underdeveloped.
Focus on Increasing the Quality of Climate Change Risk Disclosure
Commissioner Armour's comments suggest no change to ASIC's position that disclosures under the TCFD framework will remain voluntary. However, expectations around the quality of disclosures continue to increase. This is a clear trend internationally. Most notably, in November 2020, the UK Government released a road map for mandatory climate-related disclosures under the TCFD framework, with some requirements flagged for introduction in 2023 and others in 2025.
The UK Government has also signalled that this will likely involve the legislating of more specific detailed disclosure requirements to promote consistent, comparable and enforceable disclosures across sectors.
ASIC's Practical Guidance for Directors
In its statement, ASIC encourages directors to approach climate change risk with the following in mind:
- Consider climate risk and opportunities: Understand and reassess existing and emerging risks, including climate risk from both short and long-term perspectives.
- Develop and maintain strong and effective corporate governance: Better information flows and maintaining a level of board oversight over climate risks and opportunities is important.
- Comply with the law: The Corporations Act imposes requirements on directors of listed companies in relation to operational and financial review disclosures. Commissioner Armour's statement confirms that ASIC considers that these requirements extend to climate risk.
- Disclose useful information to investors: Listed companies with material exposure to climate risk should consider reporting under the TCFD framework.
From a governance and disclosure perspective, we suggest that directors should also:
- Understand both the risks and opportunities that may emerge for the company from climate change, taking account of a variety of scenarios;
- Consider how these risks and opportunities are being assessed and disclosed, including any applicable metrics and assumptions;
- Consider whether the company is taking a sufficiently rigorous and consistent approach in determining the impact of climate change risk on a company's strategy and operations; and
- Remain mindful of litigation risks associated with all disclosures so that a company does not find itself unwittingly exposed despite its best intentions.
Directors are entitled to consider the current consensus science on climate change (rather than reinvent the wheel on the science) and should consider the shifting dynamics of stakeholder opinion and likely market and regulatory responses to climate change. This is part of directors' general duty of skill and diligence to be aware of the market and regulatory environment in which the company carries on business.
Three Key Takeaways
- ASIC's recently completed review of how large listed companies are managing and disclosing climate-related risk found that this is receiving more board oversight, and that reporting under the TCFD framework has led to improved standards of disclosure, with room for improvement.
- As climate-risk disclosure practices evolve globally, ASIC is taking a consultative approach to improving disclosure, but has said that serious disclosure failures may warrant enforcement action.
- Directors of Australian listed companies should maintain a focus on understanding the specific risks and opportunities for their company, including the potential impact on the company's strategy, in articulating their risk disclosures.