Superannuation trustees and company directors had been keenly anticipating the outcome of the claim by Mark McVeigh against the trustee of REST Super. The case was regarded as the first opportunity globally for the courts to make a call on strategy and risk management oversight regarding climate change-related financial risks. However, on 2 November, the case was dismissed. But what does this mean for superannuation fund trustees and the financial services sector more broadly?
Climate change has evolved from an 'ethical', 'non-financial' issue to one that presents materials financial risks (and opportunities) for the financial services sector, across mainstream investment horizons. For universal and long-term investors such as superannuation funds, it is clear that climate-related risks are (to quote APRA Executive Board Member Geoff Summerhayes) material, foreseeable and actionable now.
No judgement – but a standard was still set
There was no judgment in the McVeigh v REST case, and therefore no legal precedent to guide trustee conduct on climate change. However, the terms on which the parties agreed to settle illustrates how sharply this area of institutional investment governance has evolved in the two years since the claim was filed.
The claim and consent orders
In July 2018, an Australian pension fund member, Mark McVeigh, sued the corporate trustee of his pension fund, Retail Employees Superannuation or REST, for its failure to provide him with information he requested on their plan for managing climate change risks to the fund's investments. The fund then responded to the member's requests and purported to provide all relevant information and on the basis of this response, the member amended his claim to allege breach of duties. The amended claim alleged that the fund had failed to properly considering the risks to its investments associated with climate change. It said that such failure was a breach of the duties of the fund's corporate trustee to act with due care, skill and diligence, and to act in the 23 year old member's best interests, under section 52 of the Superannuation Industry (Supervision) Act. The claim alleged that to fulfil the trustee’s legal duties, it was necessary to have regard to the recommendations on climate risk governance, strategy, risk metrics and targets, and disclosure set out by the Taskforce on Climate-related Financial Disclosures (TCFD). In January 2019, there was an interim judgment on costs in which the judge noted that the case involves the 'public interest' and described the basic structure of McVeigh’s claim as ‘relatively straightforward’ and ‘not hopeless’.
The parties reached a settlement at the eleventh hour, just prior to the scheduled start of the hearing on 2 November. Justice Perram made orders, by consent, to dismiss the proceeding, and for each party to bear its own costs.
The corollary – in the absence of a court judgment, does this mean trustees can ignore climate change?
The claim settled prior to trial. However, the absence of judicial precedent does not mean that funds can presume that they have no obligation to consider climate-related risks. Since the filing of the McVeigh claim in 2018, domestic and international market trends and 'soft law' continue to raise the bar on the standard of care to which institutional investment trustees will be held on climate-related risks. Such 'soft law' developments include, for example:
- explicit statements of expectation by relevant prudential and securities regulators (including APRA, ASIC, the Reserve Bank of Australia, the ASX and AASB/AuASB) and professional institutions of which AMP Capital or the directors themselves are members (such as the UN Principles of Responsible Investment, the Investor Group on Climate Change, the Climate Action 100+ investor coalition, and the Australian Institute of Company Directors); and
- ASIC's August 2019 release of updated Regulatory Guidance on market disclosures for both retail prospectuses (RG228) and annual report operating and financial reviews (OFRs) (RG247) to refer to the climate-related financial risks in the nature of those subject of the Recommendations of the G20 Financial Stability Board's Taskforce on Climate-related Financial Disclosures (TCFD).
These 'soft law' trends have increased the requisite standard of care.
The terms on which Mr McVeigh and REST agreed to settle the case reflect this steep trajectory of evolution in expectations on climate-related investment governance.
Terms of settlement – a new standard of care on climate change
In announcing the settlement, REST acknowledged that climate change is a material, direct and current financial risk to the superannuation industry across many risk categories, and accordingly an important concern for members. It stressed the importance of identifying, quantifying and managing climate-related financial risks at both asset and portfolio level, and integrating these issues into consideration of both investment strategy and asset allocation mix.
In terms of specific initiatives, REST will take further steps to ensure its investment managers actively consider, measure, manage and report back on the financial risks posed by climate change. The announcement also notes REST's commitment to a target of net zero carbon footprint for the fund by 2050, and to report on portfolio holdings, risk management processes and decarbonisation progress in line with the Recommendations of the TCFD.
Four duties - the standard of care for trustees and directors in a contemporary climate change context
Notwithstanding that no judicial precedent was set, the matters that REST have agreed to in the settlement will be seen by many as setting a bar on climate-related risk governance that all institutional investment trustees will be expected to meet.
It is clear that climate change is an economic risk that presents financial, physical and transition risks to the Australian economy. It is a material and direct financial risk to superannuation fund portfolios, and actionable now. It traverses not only reputational risks, but investment, market, strategic, governance and third-party risks. Accordingly, we believe that the elements required to satisfy the standard of care on this issue can be summarised as follows:
1. Governance, investment strategy and risk management
Superannuation fund trustees not only can consider climate change related issues, but indeed must do so in pursuit of their purpose to maximise retirement benefits to members, in the same way as they would any other financial risk issue. In the ordinary course, such consideration is likely to include:
- identification and, where possible, quantification of climate-related risks (and opportunities) to both individual assets and the fund’s portfolio as a whole;
- consideration of the impact of climate change across the fund’s investment strategy and asset allocation positions, including by undertaking stress-testing and scenario analysis across the plausible range of climate futures; and
- ensuring that the relevant risks are otherwise appropriately mitigated and managed, having regard to the goals of the Paris Agreement (under which the 196 signatory countries have committed to introducing policies consistent with limiting global warming to well below 2C above pre-industrial averages). Following a report by the United Nations IPCC in December 2018, it is widely regarded that in order to reach that target, the entire global economy must be operating on a net zero emissions basis prior to 2050 – such that funds should consider whether it should introduce portfolio emissions reduction targets consistent with a Paris-aligned trajectory.
2. Asset manager appointment, mandates and performance monitoring
Asset owners should actively integrate climate-related investment expectations into asset manager mandates, and into the performance monitoring of its managers.
Asset owners should disclose climate-related risks to members of those risks, and the systems, policies and procedures maintained by the trustee to address those risks, in line with the Recommendations of the TCFD.
4. Active stewardship
Asset owners should proactively engage with both managers and investee companies to promote the uptake of Paris Agreement-aligned strategies.
Importantly, the duty of care is an obligation of robust process, rather than one that dictates any substantive outcomes or course of investment strategy. Accordingly, it would not be a correct restatement of the duty to say that it requires superannuation trustees to determine, for example, that they must divest from all emissions-intensive assets, or commit to portfolio decarbonisation along any particular trajectory, or that environmental sustainability must be universally prioritised. Trustee conduct must remain directed towards a pursuit of the best interests of fund members. And, in pursuing those interests, the risks and opportunities associated with climate change must be balanced against other relevant considerations, such as liquidity and cash flow requirements, adequate diversification, taxation consequences and cost.
However, what is clear is that the nature of the issues that should be robustly considered by a superannuation trustee, and the extent of that consideration, in order to discharge the standard of care required continues to evolve.
Further information about these, and other domestic and international capital market developments, are outlined in our recent publication Are Australian companies facing a watershed on climate change?
Conclusion and next steps
The trajectory of climate-related financial risk – and the proportionate governance response of superannuation fund trustees – only continues to accelerate. However, with already limited bandwidth consumed with the immediate social and commercial implications of COVID-19, many financial services sector boards are finding the step-change in climate risk governance and disclosure expectations a significant challenge. Those who have remained abreast of this dynamic area are struggling to understand the additional assurance measures that may be required.