Risky business: how companies are getting smart about climate change

The divestment movement is gaining momentum – and is just one of the emerging risks from climate change that businesses face. The Paris climate agreement not only signalled social change but also sent the market a strong signal to move away from carbon-intensive investment.

The divestment movement may be seen by some businesses invested in fossil fuels as a risk. But it is not the only force shaping how companies address climate change. So, what are some of the other factors in rethinking climate risk?

Evolving social norms

The Paris Agreement recently gained more steam with ratification by the United States and China. This signalled the intent of these leading global economies to commit to helping to limit global warming to 2℃. Achieving this will require a transition to a low-carbon or decarbonised economy. China, for example, has been aware of how important this is since 2008.

Since the launch of the Low Carbon Economy Index by PricewaterhouseCoopers in 2009, companies have been better equipped to understand and measure private sector climate risk. This has flow-on effects to just about all human behaviours, and has had a particularly significant impact on private equity investments.

In particular, pension funds and the insurance sector are among the leading sectors in considering future climate risk within and across their portfolios. This is facilitating evolving social norms around climate change. These changes have long been recognised as critical for climate change mitigation and adaptation.

The role of law

Liability risk remains at the forefront in current trends. The acceptance of legal responsibility demonstrated by global leaders' ratification of the Paris Agreement is all the more interesting when we consider recent developments in climate litigation.

Some argue that, in future, there will be parallels between tobacco and asbestos tort litigation and climate litigation, given that the consequences of a changing climate have been well known for decades, and widely cited by scholars and practitioners alike. It is therefore difficult for a legal entity to claim ignorance of climate risks.

Internationally, a decision in 2015 held Dutch public officials legally accountable in reducing emissions. In the United States, instances of litigation have increasingly focused on companies' disclosure of known future climate risk. Pressure has also been building on Exxon Mobil as evidence emerges that the company may have lied to shareholders about this known risk.

In Australia, some recent interesting developments in coastal planning law are contributing to a more coherent body of climate law.

Fiduciary duties are an important aspect of rethinking climate risk. In law, they can require companies to disclose future risk. A failure to disclose on “the business strategies, and prospects for future financial years” under the Corporations Act may be considered a breach of the law and subject to ASIC enquiry.

While some regulatory guides exist for how to achieve general compliance, recent submissions to the Senate inquiry into carbon risk disclosure have argued that specific regulatory guidance for future climate risk is needed. Arguably, disclosing future risks includes future climate risks to assets and company investments.

The courts are moving where regulation and policy may be slower to act. In April 2016, the New South Wales Supreme Court relaxed the hurdles for shareholders to bring action against a company in a case where an insurer, HIH, led the market to believe it was trading more profitably and had greater net assets than was the case. This artificially inflated the HIH share price, resulting in shareholders suffering a loss because they bought overpriced shares. This case is important for shareholder class actions because it is the first time the court has accepted the principle of indirect market based causation.

In a similar way, a failure to disclose known future climate risk in required disclosure documents could potentially amount to misleading and deceptive conduct. This is particularly the case where companies may fail to disclose their asset exposure to climate change impacts.

Technological risk

The World Economic Forum’s Global Risks Report 2016 noted that the number-one risk to the global economy was a failure to mitigate and adapt to climate change.

Some argue that technological responses, including carbon capture and storage, continue to require research and development input. Others suggest that investing in renewable energy, particularly for developing countries, will lead to more sustainable global outcomes including, importantly, social equity.

While mitigation technologies continue to compete for long-term success, investors need to be increasingly aware of where and how they prioritise their mitigation efforts.

Where to now for Australian companies?

The 2016 carbon risk disclosure inquiry was due to publish its report in June 2016 but lapsed due to the federal election. This Senate inquiry ought to recommence as a matter of priority.

Additional legal mechanisms that will have flow-on effects for evolving social norms and for rethinking climate risk could include legislative change to require the inclusion of reporting asset exposure risks, under the National Greenhouse and Energy Reporting Act.

Climate risk, the transition to a low-carbon economy, evolving social norms and the continued growth of climate law evidence a need to ensure coherence across economic, social and governance frameworks.