On 12 August 2019, the Australian Securities & Investments Commission (ASIC) released updates to two important Regulatory Guides (RGs) to formally include climate change as a risk that issuers should consider disclosing in a prospectus for retail clients (RG228) or in a company's operating and financial review (RG247).
This is the latest in a series of comments, announcements and actions from ASIC which demonstrate that the regulator views climate change as an important financial risk that must be assessed and disclosed, where relevant, under Australian law.1
Baker McKenzie is pleased to provide clients with the following summary of what these changes are, and what they are likely to mean in practice. As with all financial risks and disclosures, the particular type and severity of risk will vary for each company, and compliant disclosures must speak to those specific circumstances.
1. Climate change risks in the context of prospectuses
Under the Corporations Act 2001 (Cth), offers of securities to retail investors require a disclosure statement (subject to a limited number of specified exceptions). Typically, issuers will satisfy the applicable disclosure requirements through the publication of a prospectus.
Together, the Corporations Act and RG228 set out what must be disclosed in a prospectus, and how it should be disclosed. The general disclosure principles in RG228 stipulate that a prospectus must:
- include the information required by the general disclosure test under section 710 of the Corporations Act, namely, it "must contain all the information that investors and their professional advisers would reasonably require to make an informed assessment of the relevant matter";
- be "clear, concise and effective" in both wording and presentation;
- make specific disclosures, including disclosures about interests and benefits of persons involved in the offer; and
- ensure it is not misleading or deceptive.
ASIC's recent updates make it clear that climate change may be a relevant consideration to the approach taken in complying with each of these disclosure obligations. Specifically, RG228 contains a list of examples of risks "that may need to be included" in a prospectus- with climate change having now been added to that list with ASIC noting:
Transitioning to a lower-carbon economy may entail extensive policy, legal, technology and market changes to address mitigation and adaption (sic) requirements related to climate change. Depending on the nature, speed and focus of these changes, transition risks may pose varying levels of financial and reputational risk to companies (transitional risks of climate change). Physical risks resulting from climate change can be event drive (acute) or longer terms shifts (chronic) in climate patterns.
Physical risks may have financial implications for companies, such as direct damage to assets and indirect impacts from supply chain disruption.
Accordingly, climate change is now also specifically listed as one of the "external threats" that may need to be considered as part of the "explanation of industry".
Crucially, a prospectus for retail clients must do more than state a risk in general or technical terms. It must describe the risk, and the potential consequences of that risk to a company's financial performance, with sufficient detail and clarity that a retail investor could reasonably understand the disclosure.
For this reason, Baker McKenzie recommends that companies undertake a disclosure analysis process that is based on the standards developed by the Taskforce on Climate-related Financial Disclosure (TCFD). For more on the TCFD standards, please see our client alert entitled, "Climate Change Risks and Opportunities".2
2. Climate change as part of the operating financial review (OFR)
The Corporations Act requires all companies to publish an annual financial report and a directors' report.
Further, a listed entity’s directors’ report must contain information that shareholders would reasonably require to make an informed assessment of the entity’s:
- financial position; and
- business strategies and prospects for future financial years.
This information is contained in the OFR, making it a crucial part of corporate disclosures. The importance of OFRs in the Australian context is even greater, as Australia's regulatory regime often permits companies to raise capital from certain investors without issuing a prospectus, and this ability to raise capital is in part due to information contained in regular financial reporting (including the OFR) which is accessible by the investors.
Importantly, RG247 sets out the guidelines relating to OFRs. It contains a section that provides guidance on how to approach disclosure and discussion of "prospects for future financial years."
As a result of ASIC's recent updates, there is now a standalone reference to climate change within this section of the guidance, which provides:
Climate change is a systemic risk that could have a material impact on the future financial position, performance or prospects of entities. Examples of other risks that could have a material impact for particular entities may include digital disruption, new technologies, geopolitical risks and cyber security. Directors may also consider whether it would be worthwhile to disclose additional information that would be relevant under integrated reporting, sustainability reporting or the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), where that information is not already required for the OFR.
3. Key takeaways
ASX listed companies should consider adopting the TCFD framework for understanding and disclosing their climate change-related exposure
In the two years since it was published, the TCFD framework has been adopted by 825 leading international organisation that have become official "TCFD Supporters",3 while countless more have adopted some or all of its reporting recommendations. Significantly, the TCFD framework is increasingly endorsed by regulators in Australia and internationally, with the effect that it is becoming the benchmark standard used by those bodies that must determine whether a company has met its disclosure obligations.4
This is especially true in Australia. In its press release announcing its updated guidelines, ASIC commented that:
ASIC welcomes the continuing emergence of the TCFD framework as the preferred market standard, both here in Australia and internationally, for voluntary climate change related disclosures. ASIC considers this to be a positive development and we again strongly encourage listed companies with material exposure to climate change to consider reporting voluntarily under the TCFD framework.
Accordingly, it is critical for companies to understand that undertaking a robust TCFD process will almost certainly require specialist assistance. This is because TCFD calls for a detailed stocktake and analysis of how a company's finances - including, for example, its physical assets such as specific buildings, its supply chains, the particular goods and services that it offers, and the vulnerability of its workforce - to at least three different scenarios for varying degrees of climate heating. Depending on the nature of the business and its assets, this could involve a team that includes specialist engineers and emissions assessors. Similarly, legal advice may be required to ensure that the disclosures in respect of those risks meet the standards that are now imposed by regulators as well as the market more broadly.
However, within the TCFD framework, there is an acknowledgment that it will take companies several reporting cycles to fully implement the modelling and disclosure regime, with an acceptance that the first TCFD process may well be comparatively superficial. This will usually be acceptable, so long as a company is forthright about explaining what analysis it has undertaken, why, and how the resulting disclosures may be limited and what it intends to do to improve data for future reporting cycles.
For these reasons, going forward the managing climate risks may entail a range of changes to investment decisions protocols, governance processes and internal policy documents. Examples of such changes include amendments to board charters, as well as the possibility of introducing environmental social and governance (ESG) targets into employee compensation packages, as some major companies have already done.5
A reminder that the requirement to disclose climate change-related risks is not limited to these circumstances
While these additions have been made to two specific guidelines relating to retail prospectuses and OFRs, it is essential for companies to understand that climate change risk is now viewed by Australian (and many international regulators) as a financial risk like any other, and must be assessed, disclosed and managed as is the case for any other material risk.
These updates by ASIC are a particularly timely reminder of the growing importance of climate disclosure, given that in making their announcement last week, ASIC also gave the following forewarning:
In the coming year, ASIC will conduct surveillances of climate change related disclosure practices by selected listed companies. ASIC will also continue to participate in the Council of Financial Regulators’ working group on climate risk and participate in discussions with industry and other stakeholders on these issues.
1 Eg https://asic.gov.au/about-asic/news-centre/speeches/climate-change/.
4 Eg www.rba.gov.au/speeches/2019/sp-dg-2019-03-12.html; www.apra.gov.au/media-centre/media-releases/apra-step-scrutiny-climate-risks-after-releasing-survey-results.
5 Eg https://www.bhp.com/investor-centre/sustainability-report-2018