The onset of the pandemic has seen businesses spend a lot of effort adapting to changes brought on by the COVID-19 crisis but while health risks remain a priority, organisations have also turned their focus back to systemic challenges and that includes climate change.
Discussions around climate-related risks are again at the front and centre of boardroom discussions and with the UN Climate Change Conference (COP26) taking place at the end of this month, it is timely to revisit the duties of company board directors in steering organisations onto a sustainable path. With climate change increasingly evolving into a financial risk for companies, it is undeniable that addressing it as a foreseeable threat is not just an ethical issue for boards but a fiduciary duty.
Legal and moral responsibility
Compared to counterparts in Europe and the US, board of directors in Asia are generally less sensitised to the urgency of the climate crisis which has implications on corporate culture and strategy. But sustainability targets and disclosures are critical for transparency and accountability, and are increasingly demanded by investors, regulators and other stakeholders.
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Interestingly, one of the more common concerns voiced by directors in pursuing climate transition is being held responsible for leaving profitable business on the table. However, such fears are rather unfounded. In fact, directors should ask themselves which presents the greater risk – that they may draw censure for taking actions that compromise the company’s near-term profitability or face personal liability if they fall short of addressing climate risks (including the physical, transition, and liability risks) and ensuring long-term sustainability of the company. Legal opinion increasingly points to the latter.
We are seeing several examples of how environmental risk, if not managed properly, can lead to liability exposures for companies – the high-profile ruling of the Dutch courts against Shell in June this year being a case in point. Reasons for such litigation includes failure to mitigate the effects of climate change, lack of focus on climate transition strategies and inadequate disclosures on material financial risks.
Whether they are single catastrophe events or longer-term changes in weather patterns, corporations have a fair understanding of how climate change could have a financial impact in terms of damage to assets or disruptions to supply chain. However, not many have fully grasped the risks and implications that entail the transition to a lower-carbon economy.
The potential financial impacts that arise when transitioning to a more sustainable future could range from implications on revenues, new capital expenditures to asset and investment valuations due to regulations or shifts in investor preferences.
While making a change seems daunting, what is certain is that the cost of inaction will be significantly higher than the cost of transitioning to a greener future. This is especially so when investors and regulators are constantly raising the bar on net-zero targets.
Boards should not view climate action as all about costs, but rather a growth and investment opportunity. Green operations tend to be leaner and companies that make smart green investments can increase profits in the long run.
Strategic investments in low-carbon projects such as renewables have also netted companies superior returns, with renewables outperforming fossil-fuel based investments by more than three-fold in the last decade, according to analysis by the International Energy Agency and Imperial College Business School.
Three important considerations
As the world deals with the climate emergency, here are three things that company board directors ought to consider.
Directors must be climate-literate
To carry out their responsibilities effectively, it is increasingly apparent that directors must be climate-literate, if not climate experts. Investors today demand that companies provide robust disclosures on the impact of climate change and would increasingly vote against directors who do not steer their company towards decarbonisation.
The Singapore Exchange (SGX) recently issued a consultation paper proposing new enhancements to its Sustainability Reporting regime, which includes directors of listed companies undergoing a one-time training on sustainability. In fact, there is a legal view that Singapore directors are required to consider climate change risks as part of their duties to act in the best interests of the company, and failure to do so can result in legal action for their companies and themselves personally, according to SGX.
Notably, empirical proof among Singapore-listed companies suggests that sustainability reporting is positively related to a firm’s market value. There is also growing evidence globally of a positive correlation between financial performance and sustainability performance.
Robust risk management planning
The standard of due care and diligence that is reasonably expected of a director has increased in various jurisdictions both in Asia and globally. Hence, directors need to ask themselves how robust are the assumptions that go into their organisation’s strategic and risk management planning, and whether these are considered risks and opportunities associated with climate change.
It is worth noting that the law obliges directors to ensure robust processes are in place even if it is not responsible for dictating outcomes.
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A good reference point for organisations to start with is to align with the recommendations from well-regarded international reporting frameworks, such as the Task Force on Climate-related Financial Disclosures (TCFD).
Having the right incentives in place
We are believers that what gets measured gets done and what gets rewarded certainly gets measured. Thus, one big lever to drive climate transition priorities is to align it with executive compensation. Organisations should focus on having the relevant systems that can measure and track emissions, set clear and stretched reduction targets and then align executive compensation plans with these goals.
One may ask how much time directors should spend thinking about climate issues? Well, start with the time they would have spent on the pandemic and multiply that by five or ten! The gravity of the climate crisis means that directors have a legal and fiduciary responsibility to set the right conditions for their organisations to be climate resilient, and the time to act is now.
The writers represent Willis Towers Watson, a leading global advisory, broking, and solutions company. Shai Ganu is Managing Director and Global Leader, Executive Compensation, and James Wong is Director, Strategic Risk Consulting.