The Lower Huia Reservoir in the Waitakere Ranges. Photo / Brett Phibbs
Directors must include climate risk management in their toolkit for board duties and actions — if they don't, they face possible litigation, says a report authored by Daniel Kalderimis and Nicola Swan of legal firm Chapman Tripp.
The Chapman Tripp report, commissioned by the Aotearoa Circle and titled Managing climate risk in New Zealand in 2020, points out that legal opinions in Britain, Australia, New Zealand and Canada all say the same thing: directors' duties of due care and diligence require them to think through climate-related financial risk when making decisions.
And because climate change presents a foreseeable risk of financial harm to many businesses, directors need to factor it into their risk management and strategy.
"Complex litigation where lots of people have suffered major harm can lead to unexpected results — especially where society wants someone to blame," says the report. "In these types of cases, corporate defendants may well face liabilities they did not expect.
"Expectations of directors' knowledge of climate change science, likely local impacts and possible damage will continue to rise. What is 'reasonably foreseeable' is different now than it was even five years ago."
The report predicts that New Zealand judges will face huge pressure in future to 'do something' to address the increasing losses and injustices from harms caused by climate change. "Defendants will find it difficult to justify not having done more to prevent the serious damage that will result from climate change."
The report quoted Chief Justice Helen Winkelmann and Justices Susan Glazebrook and Ellen France at last year's Asia Pacific Judicial Colloquium. They said: "Companies that do not (adequately) respond to climate change face legal risk, ranging from the possibility of being sued for breaching human rights or, as climate change becomes a financial issue rather than an ethical one, for breaching directors' duties and corporate disclosure and financial risk management laws."
The justices were also quoted as saying: "Corporations also face significant challenges arising out of climate change such as disrupted supply chains, physical damage to assets, and changed market demand. Such challenges could be sudden and catastrophic or gradual onset."
Chapman Tripp partner Daniel Kalderimis and senior associate Nicola Swan, told the Herald that the message of managing climate risk was getting through to boards of directors — more so with public listed companies than the medium-sized businesses, which are less exposed.
NZX-listed companies involved in agriculture, horticulture and aquaculture, for instance, are already starting to see the physical impacts of climate change.
The issue, the authors said, is that fewer boards are really clear about the steps they should be taking to mitigate the climate risk. Hence, they have issued a toolkit for directors in their report.
Kalderimis said "we want boards to embrace the uncertainty and to focus on being agile and responsive to dealing with managing climate risk." Swan said "this requires a focus on resilience, creating a budget and finding space and time for staff to deal with the unexpected. Climate risk will hit businesses in different ways at different times."
They said businesses need to very carefully watch where consumer sentiment has moved to and where their social licence to operate now sits. "Taking reasonable care is to ask customers and shareholders whether you are doing enough to manage climate risk."
In the report, the authors challenged the directors to think mid- to long- term strategy and resilience.
"Action in response to climate risk is no longer optional; it is expected," they say. "Climate change impacts are already locked in, with quickly increasing public awareness of likely future damage. The pace at which boards will need to confront this challenge is ramping up.
"An organisation that takes 'business as usual' steps to govern, manage and respond to climate risk is almost guaranteed to be seen from the viewpoint of a court in 2030 to have under-estimated the risks and what is required. This is not a function of bad faith. Rather, businesses have not had to respond to such a large scale, complex change in the world before now.
"Commitments to achieve emission reductions and/or offset emissions and use of new low emissions technologies provide hard examples of consumer expectations hitting the bottom line."
The authors expect the global Taskforce on Climate-related Financial Disclosures (TCFD) reporting is likely to become mandatory in New Zealand for listed issuers, banks, general insurers, asset owners and asset managers. Companies already using TCFD reporting include Meridian Energy, Mercury, Contact Energy, Orion NZ, Air New Zealand, Westpac, ANZ, Rabobank, AIG, Z Energy, Downer Group, and Sanford.
Climate Change Minister James Shaw signalled in May this year that reporting could also extend to large emitting private companies and public entities. Businesses with a March balance date would first need to report for the year ending March 31, 2023, and September 30, 2023 for those with a September balance date.
The TCFD, which made its recommendations in 2017, encourages organisations to disclose to investors, lenders, insurers and other stake-holders, their governance arrangements for managing climate-related risks and opportunities.
TCFD also encourages disclosure of the actual and potential impacts of the risks and opportunities on the organisation's business strategy and financial planning — as well as disclosing the metrics and targets used to assess and manage them.
The report suggests that directors should first:
● Start the TCFD conversation.
● Identify the top three or four risks to their businesses and accept that they won't spot every risk.
● Ensure reporting is consistent by checking material climate-related financial risks are being disclosed alongside other material risks.
● Make sure there is expertise in place, such as a board sub-committee and responsibility within the senior leadership team.
● Don't assume immunity from climate risk impact — are major consumers or suppliers likely to be affected by climate changes?
● Consider actions the company could take now to reduce exposure to physical, legal and commercial risks on the horizon from climate change.
● See guidance from the World Economic Forum, the TCFD Research Hub, and from Niwa (National Institute of Water and Atmospheric Research) on New Zealand-specific climate scenarios to identify specific risks.
Over the next five years, directors should:
● Move the conversation from predicting the company's future to being resilient, irrespective of exactly how the future turns out — this likely favours values-based approaches to strategy.
● Track the views of consumers to see if they increasingly support or criticise business actions on climate change — this data will determine the litigation risk more quickly than traditional risk advice.
● Recognise the increasingly measurable impact of climate-related risk on company and asset valuations.
● Expect adverse impacts to worsen while remaining open to spotting opportunities.
Covid-19 learnings
The Chapman Tripp report says the Covid-19 crisis provided timely lessons for the climate risk management. "Black swans — low probability but high magnitude events that appear obvious in retrospect — do happen. And climate change is more grey than black because we all know it is happening. What we don't know is exactly how its impact will be felt.
"Covid cases grew exponentially from a certain point. The scientific community has warned for many years that climate change affects may similarly face dramatic acceleration. Big risks will hit simultaneously. Customers, employees, suppliers, funders and regulators are hit."
The report says Covid has illustrated that risks can manifest indirectly, as well as directly. Many businesses have been impacted not only by the physical threat of Covid but by the regulatory response. Other businesses have been impacted not by their own situation but by their suppliers, customers or consumers.
"Covid represents an important opportunity to redesign our economy to deal with climate change. New Zealand is both closer to the world — video conferencing is now the norm — but much further from it.
Our working bubble within our tightly-closed border will be New Zealand's distinguishing feature of 2020.
"There may be lessons here for climate change. Market access and trading conditions that we take for granted are already changing due to the rapidly changing physical conditions, geopolitics or consumer sentiment."
In managing climate risk, the report concludes that the courts' expectations of reasonable care will likely increase over time. Building resilience will become an aspect of taking reasonable care. "Covid is accelerating our understanding of what resilience means for business but it will translate to climate change."
In advice to businesses, the report suggests that climate risk management may be different to managing others risks such as cyber. They should focus on the best scientific information available and have it turned into implications for the organisation in terms that everyone can understand. Make this a long-term investment in capability, no matter how hard or how uncomfortable.
Specific sectors will be blamed more than others — for example, litigation overseas and in New Zealand has focused on large corporates, financial services providers, utilities and energy companies.
"Don't just add climate change to the risk register and move on — empower your business to take decisions on the biggest climate-related concerns for the business," said Swan.
Kalderimis said "in 10 years' time directors can't say they didn't know the climate risk would be so bad.
"The information is out there, and they will ultimately be judged on their actions, by present and future generations."
Identifying climate risk
• Climate change can have both physical and financial impacts on businesses' assets and value. Here are some examples:
• A business may over-invest in infrastructure on the coast and be affected by coastal erosion or flooding. Or it may have a reliance on fossil fuels and coal-fired burners when it knows energy consumption change is coming.
• Insurance companies may not insure buildings or houses that are prone to coastal erosion — or ask for a premium. The buildings will get a lot cheaper, but people may want to congregate in different places.
• While some areas are hit by flooding, others are struck by drought. This will impact power generators.
• A network of power lines is built to withstand a level of wind speed and a one-in-50-year event, but the event starts happening every five years and the network becomes expensive to maintain or new pylons are put in, at extra cost, to handle the higher wind speed.
• Frost patterns are changing in the North Island and kiwifruit may need to be grown in other places.
• Changing frost patterns and increasing high temperatures may affect the harvest and reputation of celebrated wine areas such as Central Otago for pinot noir, Marlborough for sauvignon blanc, and Hawke's Bay for chardonnay. Wine producing regions may change.
• The warmer sea temperature affects a successful mussel farm with access to export markets, and its harvest decreases by 20 per cent. The profit is down and the value of the business is reduced.
EBOS begins ESG programme
EBOS Group, the largest healthcare and animal care company in New Zealand and Australia, told shareholders at the recent annual meeting that "we have significant responsibilities as a leading corporate citizen to manage our business in a manner that reflects the expectations of our communities."
During the year EBOS — the eighth biggest New Zealand company listed on the New Zealand Stock Exchange — began implementing its formal Environmental, Social and Governance (ESG) programme to set out its standards for responsible corporate practice.
Under its ESG framework, the EBOS board sets out three key areas of focus: Environment and its performance as a steward of nature; social by managing its relationships with stakeholders and the community; and how the company is governed.
The framework will be guided by an ESG Steering Committee, which will work to identify and assess current performance across these areas and set out recommended targets that are measurable and achievable, EBOS said.
OPINION: Tensions are likely to become more evident next year.