ACSI July report 2022: What do these findings show for Board reporting of climate risk and emissions reduction?

As companies increasingly report their climate change strategy and emissions target, there is a growing need for investors to evaluate the strategy and ability of companies to meet their targets. In July 2022, the Australian Council of Superannuation Investors (ACSI) released its “Promises, pathways & performance – Climate change disclosure in the ASX200” report.

This article outlines the key takeaways from the Report and builds on our previous examination of the increasing pressure on ASX listed companies from investors and regulators to improve their reporting on climate change issues and risks, and the steps taken to address those issues and manage these risks (here and here).

The ACSI analysed public reporting by ASX200 companies up to 31 March 2022, finding management and disclosure of climate-related risks and opportunities has continued to significantly improve. However, the Report found challenges remain for companies to strengthen the standard of reporting so investors can adequately assess how strategies are aligning with the Paris Agreement goals. The Report made key findings which should be considered, which include:

Net zero emissions commitments and emissions reduction targets

Net zero commitments have become normal for Australian companies with $1.59 trillion or 70% of the ASX200's collective market capitalisation adopting net zero commitments. This equates to 95 companies, being double the number recorded from March 2021.

More detailed targets are now being set to support long-term ambitions. Medium targets are dominating company-set targets, with 96 companies having a target focused between 2026-2039, tripling since 2019.

Two-thirds of the ASX200 have set at least one emissions reduction target. Companies without emissions reduction targets are now outliers and are under increasing pressure to establish sector relevant targets.

Climate change is increasingly being integrated into management decisions and corporate disclosure. This is mainly done through using a shadow carbon price and integration into executive compensation.

Taskforce on Climate-related Financial Disclosure (TCFD)

Most companies are now adopting and disclosing against the TCFD. The Report found 103 companies are either fully or partially aligning their disclosure to the framework, increasing from 11 recorded in 2017.

This includes most companies in higher risk sectors are using the TCFD, including 83% of energy and utilities, 60% of industrials and 75% of materials.

Transition risk and physical risk

Companies are increasingly disclosing climate scenario analysis, with the majority of companies using models testing against less than 2°C of warming. However, investors are still often faced with inconsistent, incomplete, incomparable and unverifiable information with scenario analysis.

In terms of physical risk, this has increased slightly by ASX200 companies. This includes providing a basic identification of physical risk. However, ACSI found most physical risk analysis do not quantify potential financial impacts and business risks.

Our comments on the applicable Australian legal bases, potential liability and legal risks

Under the existing law an ASX listed company’s obligation to disclose in relation to emissions commitments and emissions reduction arises under section 299A of the Corporations Act 2001 (Cth): the entity’s directors report in the operating and financial review must contain information that members would reasonably require to make an informed assessment of the business strategies and prospects for future years. The Australian Securities and Investments Commission (ASIC) has determined that climate change is a systemic risk that may materially affect the future financial position of an entity which may well require disclosure in the operating and financial review.

The ASX Corporate Governance Council Recommendation 7.4 suggests companies should report on “material exposure to environmental or social risks”, and this expressly includes any risks associated with climate change. Material exposure has been defined as “a real possibility that the risk in question could materially impact the listed entity’s ability to create or preserve value for security holders over the short, medium or longer term.”

Furthermore, additional to disclosures in annual reports and the like, the Australian Accounting Standards Board (AASB) and Auditing and Assurance Standards Board (AUASB) released joint guidance asserting that while climate related risks may be noted in company annual reports, these have not been reflected in financial statements, where they often should be.

In reporting on emissions commitments and emissions reduction targets, a listed entity and its board must recognise that statements in relation to the same are by their very nature forward looking. For this reason, the entity and its board must ensure that they have reasonable grounds for making the representation. This is an objective standard and arises because under section 769C of the Act, a representation with respect to future matters is taken to be misleading if the person who made it does not have reasonable grounds for doing so.

A person who makes a statement which is misleading is likely to have infringed section 1041H of the Act by having engaged in conduct that is misleading or deceptive or is likely to mislead or deceive. This may result in liability to compensate those who suffer loss as a result of that conduct.

There is an increasing focus on climate change-based litigation, such as cases where a member of an Australian investment fund brought a case against REST which settled in November 2020, which forced REST to recognise that climate change risks were financial risks requiring appropriate disclosure. Furthermore, there is ACCR v Santos in which the applicant is seeking to establish that Santos lacked reasonable grounds for the statements about its net zero roadmap in its 2020 Annual Report.

What investors are looking for

There is a growing expectation from investors and regulators towards companies and their ability to transition and adopt their business model to compete more effectively in an evolving market. Thus, the Report recognises that, from the investor’s perspective, it is imperative that companies disclose a comprehensive transition plan to assist investors in understanding the steps required for companies to meet their net zero commitments. In assessing a comprehensive transition plan, investors are looking for three key aspects:

The company's plan is credible

Investors want the plan to address the company's sector-appropriate material emissions and be informed by Paris-aligned scenario analysis. As such, an effective company plan will disclose a roadmap and long-term strategy for its resilience or transformation, including key levers and sector-specific indicators that the company can use to demonstrate progress and investors are able to use to assess it.

The company's plan is ambitious

A company's plan should include short-, medium- and long-term decarbonisation targets which are Paris-aligned and consider the broader societal impacts of the reorganisation to a low-carbon economy. The disclosure should also demonstrate and explain how the targets are Paris-aligned and how the broader impacts have been considered.

The company's plan is backed by real action

It is imperative for investors to see and assess how the company is prioritising decarbonisation and integrating climate change into decision making, through internal carbon prices and abatement curves. Investors need to be able to account for the action undertaken each year by the company and compare it against leading target companies set ahead of time.

Our comments: This focus confirms our observations that concern in relation to climate change has transitioned from specific public interest groups to the broader institutional and retail investment community.

Scope 3 emissions

The Report notes that a rising area of importance and focus for companies is reducing Scope 3 emissions. Scope 3 emissions refers to a company's indirect emissions, occurring in its value chain resulting from activities related to the company. Companies cannot ignore Scope 3 emissions as investors seek disclosure as to how they are managing the risks and developing opportunities. Without an adequate management of Scope 3 emissions, demand destruction for products and services could occur if other lower carbon alternatives emerge.

While setting Scope 3 targets and milestones is a complicated process that may rely on actions outside a company's operational control, the Report notes that many ASX200 companies have begun developing strategies and targets to reduce Scope 3 emissions. It is no longer becoming a 'too hard to measure' basket with 93 companies in the Report providing Scope 3 emissions data.

Our comments: As companies look to manage and reduce their Scope 3 emissions it is inevitable that they will look to see what the participants in their supply chain, and those to whom they supply products and services, are doing to reduce emissions. If not satisfied in relation to that, and in order to reduce their own Scope 3 emissions, companies may elect to move their custom to other parties who they perceive are better addressing their emission issues.

Climate target and remuneration

The increased short- and medium-term targets set by companies have been seen to be linked with short-term incentives (STI) and long-term incentives (LTI). This means it is important for investors to understand how management teams are being incentivised to drive change. The Report found 38 companies within the Materials, Energy and Utilities, Industrials, Health Care, Real Estate, Financials and Consumer Discretionary sectors had integrated sector-relevant metrics into their executive remuneration. The majority of which was integrated into STIs, with some instances of integration into LTIs or standalone equity grants. Climate targets and remuneration is a growing area, which ACSI expects more companies will seek to integrate decarbonisation and transformational targets into incentive structures.

Our comments: The focus of this integration into STIs is not surprising given that STIs typically include matters of subjective judgment and the difficulties that have been encountered in attempting to incorporate the same into LTIs.