Corporate Boards Can No Longer Ignore Climate Risk
Climate risk management is critical to long-term value creation. According to a study by Carol Hansell, a renowned Canadian lawyer, directors of Canadian companies have an obligation to address climate change risk. Hansell notes that “the obligation of directors to consider the implications of climate change risk is grounded in the duties each director owes to the corporation he or she serves.” Hansell’s legal opinion, provided to the Canada Climate Law Initiative, is the first in-depth legal analysis of directors’ responsibilities in a corporate governance context by a senior Canadian lawyer. This legal opinion has brought to the fore the “G” in the “ESG” (Environmental, Social, Governance) equation — the often underappreciated, but central pillar that upholds environmental and social performance of an organization.
Climate science demands swift action towards decarbonization
The climate crisis is disrupting business as usual practices. IPCC, the foremost scientific body on climate science, underscores that global greenhouse gas (GHG) emission levels need to fall by 45% from 2010 levels by 2030, and reach net-zero by 2050. The World Economic Forum (WEF)’s 2020 Annual Risk Report, found for the first time in its history that the top five most likely risks over the next 10 years are all environmental-related. While there has been a notable ramp up in climate action commitments from the private sector since the Paris Agreement in 2015, global progress towards emissions reduction has not occurred. The UN 2019 Emissions Gap Report shows a widening gap between current global emissions and the emission levels needed to achieve the Paris Agreement’s objectives. Moreover, the Government of Canada has pledged to achieve net-zero emissions by 2050, although the most recent National Inventory Report showcases that Canada’s emissions are increasing. The overall message is that much greater action is urgently needed, and business as usual is no longer an option.
Increasing investor demand for climate risk management & sustainable value creation
Moreover, attention from investors on this issue has accelerated dramatically. They are increasingly demanding that companies analyze exposure to material climate-related risks, and that boards incorporate these considerations in decision-making processes. In fact, ESG funds have proven to be more resilient and ESG investment has continued to increase during the pandemic. The integration of ESG issues across business strategy is increasingly perceived as a fiduciary responsibility as investor demand for improved sustainability performance, and granular and comprable data continues to rise.
Corporate directors oversee long-term business strategy and risk management. They will need to prepare and adapt strategies for the net-zero transition. Accountability for climate risk management at the board level, as suggested by the Hansell legal opinion, can help ensure that companies take a holistic and credible approach to climate action for e.g. aligning lobbying efforts with decarbonization efforts. This also means that boards need to have information on how climate risks and opportunities impact business strategy in order to make informed decisions; and management needs direction from the board to effectively manage these climate-related risks and opportunities.
Using frameworks to assess and manage climate-related risks and opportunities
The Task-Force for Climate-Related Financial Disclosures (TCFD) recommendations are not merely a disclosure framework but a management tool that is designed to help organizations identify and report on the financial risks of climate change in four key areas: governance, strategy, risk management, and metrics & targets. The TCFD recommendations break down climate risks into transition risks (policy, legal, technological or market shifts required to transition to a low-carbon economy) and physical risks (physical impacts of climate change such as increased frequency of extreme weather events). A key aspect of TCFD is scenario analysis — an exercise that allows an organization to understand how and which climate-related risks and opportunities may impact its business, strategy and financial performance overtime. Corporate directors can use this information in their decision-making processes, although consistency in climate reporting is needed to make these “decision-useful.”
There is a strong indication that TCFD-aligned reporting, and more importantly, adoption of TCFD recommendations, is poised to grow. Earlier this year, BlackRock, the world’s largest asset manager, announced that it is demanding its portfolio companies to produce TCFD-aligned reports. Recently, it also took steps to hold corporate boards accountable for failure to effectively manage climate risks. Most recently, the UK government has proposed making TCFD-aligned reporting mandatory for pension schemes. Closer to home, the Canadian government stipulated that large companies applying for financial support during the pandemic through the LEEFF program will be required to report on climate risk in alignment with TCFD. The Bank of Canada is also demanding greater adoption of climate disclosures as a means to reduce financial risk.
Strong governance is a key aspect of accelerating credible corporate climate action
In all of this, we also need to consider the issue of board diversity — who is and isn’t around the table making these decisions. All in all, convergence of increased investor demand for climate risk analysis and disclosure, the increased need for credible corporate action towards net-zero ambitions, and the bleak realities of the climate crisis, make it irrefutable as Hansell notes, that “directors have a clear responsibility to be informed about the risks that climate change poses for the business of the corporation they serve and to be satisfied that those risks are being appropriately managed.”
Corporate boards can no longer ignore climate risk — it is in fact essential to integrate these risks into business strategies in order to ensure long-term value creation.
Further Reading:
- 6 ways company boards should prepare for climate risk — World Economic Forum
- Net Zero Investment Framework provides blueprint for investors to achieve net zero emissions by 2050 — IIGC
- How to set up effective climate governance on corporate boards — World Economic Forum
- Climate change briefing: questions directors should ask — CPA Canada
- Blueprint for responsible policy engagement of climate — Harvard Business Review
- Climate Change Board Toolkit — Chapter Zero
- What does climate risk really mean — GreenBiz
- Climate Lobbying — Influence Map
- Mark Carney joins Brookfield to lead firm’s expansion into ESG funds — Bloomberg
- How to tell if companies are truly fighting climate change — Bloomberg
