Investors put directors on notice on climate change risk

Blackrock Investment Institute has released a new report titled Adapting portfolios to climate change - Implications and strategies for all investors, which states that investors can no longer ignore climate change, regardless of whether they question the science. This accords with analysis in Australia that directors’ duties must see climate change risk factored into decision-making, whether or not the director believes in the science, given that the market indicates it sees it as a risk to the value of the investment; ongoing policy and regulation decisions related to climate change; as well as the widespread reporting on the subject which means a director should be informed.

Given the size of Blackrock and its investments globally, the report is likely to have significant impact. The report is a call to arms for the investment sector, stating clearly that Blackrock’s overall conclusion is that ‘We believe all investors should incorporate climate change awareness into their investment processes’. It details how investors can mitigate climate risks and exploit opportunities, and notes that climate-aware investing is possible without compromising on traditional goals of maximizing investment returns.

The detail includes explanation of how more frequent and severe weather events over the long term; advances in energy storage, electric vehicles or energy efficiency undermining existing business models; tightening emissions and energy efficiency standards; changing subsidies and taxes; and changing consumer preferences and pressure groups advocating divestment of fossil fuel assets all present market risks and opportunities. And it clarifies that, while the long-term risks compound for an asset owner, 'even short-term investors can be affected by regulatory and policy developments, the effect of rapid technological change or an extreme weather event'.

The report calls on analysts to factor environmental, social and governance (ESG) factors into their examination of companies and integrate climate factors into the investment process to identify and manage the risks and opportunities. This is supported in a separate report issued by AMP Capital, which in its 2016 Mid-year Corporate Governance Report confirms that AMP Capital has for many years been complementing its fundamental investment analysis with a comparison of the ESG attributes of individual companies and considering how these factors impact relative value and the long-term sustainability of company earnings. AMP Capital research focuses on a broad range of factors such as demographic trends, climate change, technological advances, risk management, supply-chain management, employee engagement, leadership, company culture, board diversity and occupational health and safety performance.

The report notes that the drivers of company value ‘can generally be split into two categories: sustainability drivers that relate to the entire industry (such as the relevant demographic, regulatory and technological change) and intangible drivers that focus on each company’s response’.

Both investor reports call on companies to engage with investors on climate change risks. In an article published in Governance Directions in February 2015, Sarah Barker of Minter Ellison argued that boards must actively engage with how the issue of climate change impacts on their operations, risk and strategy. She noted, moreover, that a passive approach to climate change governance may be inadequate to satisfy directors' duties of due care and diligence.

Noting that companies that do not proactively adapt will face increasing competitive disadvantage, bringing with it the prospect of value impairment and, in some cases, insolvency, the article argued that ‘climate change can no longer be treated as an environmental “externality”, but as a material determinant of corporate wealth’.

Taken in conjunction with the higher standards of directors now expected by both the courts and the general community of proactive engagement and consideration of the best interests of the company, Sarah Barker notes that ‘passivity, reactivity or inactivity on climate change governance is increasingly likely to contravene a director’s duty of care and diligence under s 180(1) of the Corporations Act'.

She notes that ‘Specifically, this includes governance strategies that emanate from climate change denial, a failure to consider its impacts due to ignorance or unreflective assumption, paralysis caused by the inherent uncertainty of its magnitude and timing, or a default to a base set by regulators or industry peers. In addition, even considered decisions to prevail with ‘business as usual’ are increasingly unlikely to satisfy the duty (or the 'business judgment rule' defence) — particularly if they are the product of a conventional methodology that fails to recognise the unprecedented challenges presented by an erratically changing climate. Accordingly, directors who do not proactively respond to the commercial risks and opportunities of climate change, now, may be held to account under the Corporations Act if corporate value becomes impaired into the future’.

With major investors now calling for climate change to be factored into companies’ strategic planning and how climate risks and opportunities affect the company’s long-term value and sustainability, directors not considering these risks could well be putting themselves in danger of breaching their duties. 

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