Do you understand your duty of care and diligence when it comes to climate-related risks?

Do you understand your duty of care and diligence when it comes to climate-related risks?

Key take aways There is growing accountability on company directors to exercise duty of care and diligence on climate-related risks. This is fuelled by regulatory developments, investor demands, increasing shareholder resolutions, legal action and the release of public recommendations made by the Financial Stability Board s Task Force on Climate-Related Financial Disclosures (TCFD). Directors need to be better informed on how the company is managing its climate-related risks including climate-related financial risks. Directors who understand climate-related risks and its implications, will be better positioned to effectively evaluate the company s risk profile, respond to growing demands from investors, and help protect both the company and themselves against potential legal action.

Why are climate-related risks important considerations for Directors? In 2016, Noel Hutley SC and Sebastian Hartford-Davis issued an important legal opinion that Australian company directors who fail to consider climate change risks now could be found liable for breaching their duty of care and diligence (under section 180 of the Corporations Act). This statement sends a strong message to Directors consider the implications of climate change or risk personal legal action. Furthermore, there are a number of other influencing factors that contribute to the growing accountability on company directors to exercise a duty of care and diligence on climate-related risks. This includes litigation, regulatory developments, investor demands, increasing shareholder resolutions, and the release of public recommendations made by the Financial Stability Board s Task Force on Climate-Related Financial Disclosures. Litigation At the time of writing a company in Australia is under legal action on the premise that they failed to adequately disclose the risks posed to their business by climate change in their annual report. It represents the first action of its type in the world and follows a recommendation made by the TCFD for firms to disclose climate information as part of their financial statements, as well as warnings from APRA that climate change poses a material risk to the entire financial system. In the US, similar action is being taken by coastal councils against major resource companies due to the physical impacts they may face due to climate change. Investor demands Investors, and the asset managers who represent them, win or lose by the decisions they make in respect of the companies they invest in. They are therefore already considering how companies including Directors manage the physical and transition risks (and opportunities) arising from climate change. Most recently, Blackrock (the world s largest investor) issued a statement (post release of the TCFD) stating that they expect the whole board to have a good understanding of how climate risks may affect the business and management s approach to adapting and mitigating risks. They have also indicated that they may make assessments through direct engagement with independent board members, if necessary. Increasing shareholder resolutions According to the Centre for Education and Research in Environmental Strategies (Ceres), US companies will face a record 200 resolutions on climate matters in 2017, compared to 174 such resolutions during 2016. 1 Both in the US and Australia, resolutions require disclosures to be aligned with recommendations on climate risks disclosures issued by the TCFD. ExxonMobil faced shareholder resolutions in 2016 and 2017 requesting the company to report on the portfolio risks under a two degree aligned scenario a key recommendation of the TCFD. This gained 38.1% in 2016 and 62.3% in 2017. The resolution was passed at the 2017 AGM in opposition to the Board s recommendation. Investors are seeking information that provides the confidence that company directors are considering long-term issues posed by climate risks. Companies that get this right will be rewarded for their leadership and reliance. Dr. Matthew Bell, EY Oceania Climate Change and Sustainability Leader 1 Thomson Reuters News, More company climate votes ahead, as Trump may loosen energy rules, (Cited 25 November 2016) Available from: http://uk.reuters.com/article/us-usa-climatechange-shareholders/more-company-climate-votes-ahead-as-trump-may-loosen-energy-rules-idukkbn13k18f?type=company. Do you understand your duty of care and diligence when it comes to climate-related risks? 3

What can you do to exercise your duty of care? In light of these developments, it has become difficult for a company director to not consider the risks that could materially impact the business in relation to climate change even if their personal beliefs or political affiliations challenge the basis of climate change itself. So how does a company director exercise their duty of care and diligence on climaterelated risks? Unfortunately, guidance is scant and unspecific. Directors will mostly need to form their own assessment and make their own decisions regarding the materiality of the climate change risk to their business, what action should be taken and what appropriate disclosures are to be made to external stakeholders. To be in a position to make informed decisions, Directors should assess the adequacy of their companies governance, risk analysis and disclosure of climate-related risks and expect management to be able to answer the following key questions, as outlined in the table below. Key questions Directors should be able to answer Governance What are your governance and risk management processes for assessing the implications (including financial implications) of climate change risks? How do these align with your processes for other material risks? What is your knowledge over the climate risks and impacts faced by your organisation? What is your internal audit process? Risk analysis Disclosure In what ways will climate change risk impact the organisation? Do you conduct scenario analysis? Does this include considering a 2 C scenario aligned scenario and what timeframe does it covers? Under a business-as-usual and 2 C scenario, what is the magnitude of financial impacts? Are these financial impacts material and if so how are they disclosed? If not, are governance and risk management processes disclosed to show these risks have been assessed? Where do you report your climate risk disclosures? If assessed as a material risk, are the financial impacts incorporated in the appropriate places? Are your disclosures aligned to the TCFD Recommendations? If not, why not? Has your external auditor considered and reviewed your climate disclosures? If these questions cannot be answered confidently, red flags should be raised and immediate action be taken within your business to address concerns. 4 Do you understand your duty of care and diligence when it comes to climate-related risks?

EY can help EY can assist businesses seeking to build a strategy to respond to climate-related financial risk. Our Climate Change and Sustainability Services professionals work alongside our risk, governance and financial reporting teams, and can provide you with company-specific climate risk analysis, modelling and implementation advice that broadly meets the TCFD disclosure recommendations. We have already done so with several large Australian companies. Our climate change scenario risk analysis services are tailored to meet the requirements of the TCFD Recommendations, which requires organisations to model the transition and physical impacts of at least one 2 C scenario. The results of these risk assessments are designed to meet the requirements of the organisation and can be qualitative or quantitative in nature. Do you understand your duty of care and diligence when it comes to climate-related risks? 5

Let s continue the conversation. For more insights or to browse our archive of webcasts and videos, visit ey.com/au/sustainability. EY Asia-Pacific Mathew Nelson mathew.nelson@au.ey.com Melbourne Rebecca Dabbs rebecca.dabbs@au.ey.com Terence Jeyaretnam terence.jeyaretnam@au.ey.com Christopher Thorn christopher.thorn@au.ey.com Brisbane Elizabeth Rose elizabeth.rose@au.ey.com New Zealand Tracey Ryan tracey.ryan@nz.ey.com Sustainability on the go Access our thought leadership anywhere with EY Insights, our new mobile app. Visit eyinsights.com. EY Oceania Matthew Bell matthew.bell@au.ey.com Sydney Andi Csontos andi.csontos@au.ey.com Adam Carrel adam.carrel@au.ey.com Perth Lynsay Hughes lynsay.hughes@au.ey.com EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organisation, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organisation, please visit ey.com. About EY s Climate Change and Sustainability Services Governments and organizations around the world are increasingly focusing on the environmental, social and economic impacts of climate change and the drive for sustainability. Your business may face new regulatory requirements and rising stakeholder concerns. There may be opportunities for cost reduction and revenue generation. Embedding a sustainable approach into core business activities could be a complex transformation to create long-term shareholder value. The industry and countries in which you operate as well as your extended business relationships introduce specific challenges, responsibilities and opportunities. Our global, multidisciplinary team combines our experience in assurance, tax, transactions and advisory services with climate change and sustainability knowledge and experience in your industry. You ll receive tailored service supported by global methodologies to address issues relating to your specific needs. Wherever you are in the world, EY can provide the right professionals to support you in reaching your sustainability goals. 2017 Ernst & Young, Australia All Rights Reserved. APAC no. AUNZ00000772 PH1730887 ED None This communication provides general information which is current at the time of production. The information contained in this communication does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Ernst & Young disclaims all responsibility and liability (including, without limitation, for any direct or indirect or consequential costs, loss or damage or loss of profits) arising from anything done or omitted to be done by any party in reliance, whether wholly or partially, on any of the information. Any party that relies on the information does so at its own risk. Liability limited by a scheme approved under Professional Standards Legislation. Ernst & Young ABC Pty Limited (ABN: 12 003 794 296); Australian Financial Services Licence No: 238167 6 Do you understand your duty of care and diligence when it comes to climate-related risks? ey.com