Climate Change – The Undeniable Emerging Risk For Directors and Insurers

Introduction

It’s now widely accepted that climate change presents a potential financial risk to companies and boards which, in turn, presents a risk to insurers, particularly in the directors and officers (D&O) liability insurance space.

In recent years we’ve seen a global shift in community expectations and pressure when it comes to environmental, social and corporate governance (ESG) data and commitments from companies to address climate change. In Australia, environmental sustainability and proactive action on climate-related risks is rapidly becoming a prerequisite to business deals and investments, with companies being assessed for their ESG commitments and ability to manage climate-related risks.

This societal shift has led to various stakeholders, including investors in Australian publicly listed companies and government regulators, taking greater interest in ensuring that companies follow through on their climate-related commitments, rather than simply ‘talking the talk’. This sentiment is also reflected in the increase in climate-related litigation we are seeing in Australia and worldwide.

In this article, we examine recent developments in this space, including recent litigation, legal developments, regulatory guidance and, in turn, what this means for D&O insurers considering the growing risk that is climate change. On one view, the recent developments show that this risk is no longer ’emerging’ but is now a ‘real’ risk, and needs to be given due attention.

Climate-related litigation

Climate-related litigation is not a new phenomenon. Globally, there have been 1,828 climate-related cases filed since 1986 (although most have been filed since 2007), with 115 filed in Australia.¹

However, in 2021, we have already seen two landmark decisions handed down, each making waves in the world of climate-related litigation:

• On 26 May 2021, a Dutch court ordered Royal Dutch Shell to reduce its emissions by 45% by 2030² (compared with its emissions in 2019) in accordance with the Paris Agreement emissions targets. This is despite Royal Dutch Shell not being a party to the Paris Agreement; and
• On 27 May 2021, the Federal Court of Australia found that the Commonwealth Minister for the Environment owed a duty to take reasonable care to avoid causing personal injury to children when deciding to approve (or not approve) a coal mine expansion in New South Wales. The Court also found in this case that the Minister had not breached this duty of care.³

In the last 12 months, we also saw an individual beneficiary of the Retail Employees Superannuation Trust (REST) superannuation fund commence climate-related proceedings in the Federal Court of Australia.⁴ The plaintiff argued that, amongst other things, REST failed to act in his best interests as a beneficiary by not properly considering the risks that climate change poses to the fund’s investments. The case did not ultimately proceed to trial and was settled.  However, as part of the settlement, REST released a statement acknowledging that climate change is a material, direct and current threat to the superannuation fund and set out actions that it would begin to implement including a long-term objective of “net zero” emissions by 2050.⁵

Directors’ duties and climate-related risks

Relevant to this trend towards climate-related litigation both in Australia and overseas, in April 2021, we saw a further supplementary legal opinion released by Mr Noel Hutley SC and Mr Sebastian Hartford-Davis of counsel, discussing the issue of climate change and directors’ duties. This expanded on the authors’ earlier 2016 and 2019 opinions, which have been widely regarded as the leading legal opinions on directors’ duties and climate-related risks.

As noted in our publication in 2017, Mr Hutley SC and Mr Hartford-Davis in their 2016 opinion indicated that, like with any potential risk of harm to the interests of the company, directors owe a duty of care and diligence to the company pursuant to s180(1) of the Corporations Act 2001 (Cth) when considering climate-related risks. In turn, the same key questions must be asked when it comes to determining whether directors have appropriately discharged their s180(1) duty in managing climate-related risks that have the ability to impact their company:⁶

1. What would a ‘reasonable‘ person do if they were a director of the company in the company’s circumstances in response to these risks?
2. Were these risks ‘foreseeable‘ at the time?⁷

In particular, Mr Hutley SC and Mr Hartford-Davis concluded at the time that directors can and, in certain circumstances, should be considering climate change risks, and that directors who fail to do so could be found liable for breaching their duty of care and diligence in the future. This view was further solidified in 2019 after Mr Hutley SC and Mr Hartford-Davis considered the shift in the way that Australian regulators, firms and the public perceived climate risk which, in their view, elevated the standard of care that would be expected of a reasonable director.⁸

Misleading or deceptive conduct and “greenwashing“

Significantly, in April this year, Mr Hutley SC and Mr Hartford-Davis took their opinion further by outlining how directors run the risk of engaging in misleading or deceptive conduct or making misleading representations relating to climate change deemed to be mere “greenwashing“.

“Greenwashing” is a term used where companies make various disclosures, statements or commitments which address climate change when in reality, those statements are unfounded, making them misleading or deceptive.  In other words, it is where companies ‘talk the talk’ to manage the optics of the business rather than actually committing to managing climate-related risks. This has become particularly prevalent in relation to “net zero” emissions commitments by companies, whereby they aim to reduce their carbon emissions to zero by certain aspirational dates in the future.

In their 2021 Opinion, Mr Hutley SC and Mr Hartford Davis note that the increase in “net zero” commitments by companies amplifies the risk of “greenwashing”.⁹ Legislation, including the Corporations Act  and the Australian Consumer Law, requires “reasonable grounds” for representations about a “future matter“, otherwise the representation might be “taken to be misleading“.¹⁰ According to Mr Hutley SC and Mr Hartford-Davis, statements by boards that companies are committed to net zero emissions are likely to be representations as to future matters and therefore require reasonable grounds under the legislation.¹¹

To protect boards and companies from falling foul of this legislation when making net zero commitments, as honourable as they may be, counsel recommend that the following steps be taken:

1. A company should identify its “reasonable grounds” in support of the representations contained within net zero commitments at the time of making such commitments.¹²
2. A company’s net zero strategy should be integrated with its operational strategy, be documented, and detail the drivers of the company’s ability to decarbonise and the assumptions underpinning the strategy.¹³
3. A company should be specific and identify which emissions the net zero strategy encompasses and for what timeframe (for example, if the strategy relates to emissions released from manufacturing processes, then this detail should be specified).¹⁴
4. Any amendment to a company’s net zero strategy should be disclosed in a timely manner (for example, if it is not fulfilled, that it was affected by supervening events or becomes untenable).¹⁵

Australian regulators increasingly interested in climate-related risks

As noted above, Australian regulators are becoming increasingly interested in company directors actively turning their minds to, and managing, climate-related financial risks.

In April 2021, the Australian Prudential Regulation Authority (APRA) released its Prudential Practice Guide – Draft CPG 229 Climate Change Financial Risks (CPG 229) in response to industry requests for greater clarity around the regulator’s expectations and examples of best practice when it comes to managing climate-related risks. APRA has invited feedback until 31 July 2021, and expect the final version of CPG 229 to be released in late 2021.

While the draft CPG 229 does not present any new enforceable requirements, it aims to assist companies in complying with pre-existing prudential standards when it comes to climate change considerations.¹⁷ APRA recognises that climate-related financial risks to companies have the potential to be profound. The draft CPG 229 outlines prudent practices in relation to financial risk management as it relates to climate change,¹⁸ including through:

1. Governance: Boards need to understand and regularly assess the financial risks arising from climate change that affect their company both now and in the future.¹⁹
2. Risk management: Boards can manage climate-related risks by:²⁰

• setting up relevant policies and procedures;
• identifying material risks and assessing the potential impact on its business;
• monitoring risks;
• managing identified risks; and
• risk reporting through procedures to provide relevant information to the board and senior management on its material climate risk exposures.

3. Scenario analysis: Companies can use scenario analysis and stress-testing to assess climate-related risks in order to identify and understand their short and long-term risks. This involves identifying and simulating scenarios which are both plausible and relevant to the company’s operations.²¹
4. Disclosure: Disclosure of climate risk information allows interested stakeholders to assess a company’s resilience to climate-related risks. APRA suggests that a lack of certainty about the potential future impact of climate-related risks should not be a reason to avoid disclosure of potential exposure to these risks. APRA refers to the framework established by the Task Force on Climate-Related Financial Disclosures as a basis for producing information that is useful for a company’s stakeholders.²²

Other regulators such as the Australian Securities and Investments Commission (ASIC) and government bodies such as the Reserve Bank of Australia (RBA) also expect that climate change will pose significant financial and economic risks.²³ ASIC has said that the key priorities when it comes to climate change include having strong and effective corporate governance and disclosure of climate risks.²⁴ ASIC also referred to consideration of climate-related risks in regulatory guides about effective disclosure in prospectuses and in an operating and financial review.²⁵ Similarly, the RBA noted the effect of climate change on the economy, monetary policy and financial stability, and the need to adapt to this changing landscape.²⁶

Concluding comments for D&O insurers

When it comes to climate-related risks, recent case law, APRA’s draft CPG 229, and the latest legal opinion by pre-eminent counsel further reinforce the ever-growing need for directors and officers to understand their responsibilities in relation to assessing and managing climate risks, and what they say to the public about a company’s climate change policies.

It follows that D&O insurers must similarly remain informed of developments in the climate change space, as these developments have the potential to impact their portfolios.

It now goes without saying that climate-related financial risks should be considered by insurers from all angles of their business, including from the following perspectives:

1. Underwriting: whether insurers are managing their portfolios by considering the potential for climate-related risks to impact their insureds, given the legal opinions around directors’ duties and misleading or deceptive conduct.
2. Claims and coverage considerations: whether D&O policies will respond to any climate-related litigated claims and if potential coverage issues will arise.
3. Business perspective: whether insurers themselves should examine their own policies, procedures and commitments to managing climate-related risks to ensure that they are robust, measurable and in accordance with prudential standards.

We are continuing to monitor developments in the climate change space, which will no doubt continue to grow.

For further information about this topic, please contact the authors of this article.

To view the financial lines update from March, please click here.

To view the financial lines update from April, please click here.

To view the financial lines update from May, please click here.

¹ https://climatecasechart.com/climate-change-litigation/
² https://uitspraken.rechtspraak.nl/inziendocument?id=ECLI:NL:RBDHA:2021:5339
³ https://www.judgments.fedcourt.gov.au/judgments/Judgments/fca/single/2021/2021fca0560#_Ref72921795, [490 – 491].
⁴ McVeigh v Retail Employees Superannuation Pty Ltd, Federal Court of Australia file number NSD 1333 of 2018.
⁵ Rest reaches settlement with Mark McVeigh, 2 November 2020.
⁶ Noel Hutley SC and Sebastian Hartford-Davies, The Centre for Policy Development and the Future of Business Council, Climate Change and Directors’ Duties, Memorandum of Opinion, (7 October 2016) (2016 Opinion), page 4.
⁷ 2016 Opinion, page 6.
⁸ Noel Hutley SC and Sebastian Hartford-Davies, The Centre for Policy Development and the Future of Business Council, Climate Change and Directors’ Duties, Supplementary Memorandum of Opinion, (26 March 2019) (2019 Opinion), page 2.
⁹ Noel Hutley SC and Sebastian Hartford-Davies, The Centre for Policy Development and the Future of Business Council, Climate Change and Directors’ Duties, Further Supplementary Memorandum of Opinion, (23 April 2021) (2021 Opinion), page 10.
¹⁰ Corporations Act 2001 (Cth), section 769C; ASIC Act 2001 (Cth), section 12BB; Australian Consumer Law, section 4; 2021 Opinion, page 12.
¹¹ 2021 Opinion, page 14.
¹² 2021 Opinion, page 15.
¹³ 2021 Opinion, page 16.
¹⁴ 2021 Opinion, page 17-18.
¹⁵ 2021 Opinion, page 18.
¹⁶ See APRA Prudential Practice Guide, Draft CPG 229 Climate Change Financial Risks, April 2021.
¹⁷ Prudential Standard CPS 220 Risk Management (May 2019); Prudential Standard SPS 220 Risk Management (December 2019); Prudential Standard CPS 510 Governance (April 2019); Prudential Standard SPS 510 Governance (October 2016).
¹⁸ CPG 229, page 5.
¹⁹ CPG 229, page 10.
²⁰ CPG 229, page 12.
²¹ CPG 229, page 15.
²² CPG 229, page 18.
²³ See 2019 Opinion, pages 2-3.
²⁴ Keynote address by John Price, Commissioner of ASIC, Centre for Policy Development: Financing a Sustainable Economy, Sydney, Australia, 18 June 2018.
²⁵ Ibid.  See ASIC Regulatory Guide 228 on Prospectuses: Effective disclosure for retail investors (August 2019) and ASIC Regulatory Guide 247 on Effective disclosure in an operating and financial review (August 2019).
²⁶ Speech by Guy Debelle, Deputy Governor of the RBA, Reserve Bank of Australia: Climate Change and the Economy, Sydney, Australia, 12 March 2019.
²⁷ Guest Post: Climate Change Litigation Threats to Directors and Officers, Francis Kean, Executive Director FINEX Willis Towers Watson, D&O Diary, 21 January 2020.