Mandatory climate-related financial disclosures are on the horizon
Climate change presents an unprecedented source of risk and volatility for businesses. Shareholders, customers, employees, partners, the public and authorities are increasingly demanding businesses report on the environmental health of the company and its impact. It’s the ‘E’ in the company’s ESG (environmental, social and governance) strategy.
Governments around the globe are beginning to mandate climate-related financial disclosures and Australia is heading down that path too. The introduction of mandatory reporting has implications for insurance – from an insurers’ perspective and on risks for policyholders.
Focus on climate change
Businesses are under pressure to act on climate change from multiple fronts – regulatory requirements; climate impacts and increased insurance losses; investor, bank and insurer pressure; and stakeholder interests and directors’ duties.
Australian business leaders are responding by increasing their investments in sustainability, according to a report from Deloitte. Climate change was cited as one of the top three issues facing Australian executives, with 68% of leaders reporting they had increased their investment in sustainability. For more than three-quarters (78%) of survey respondents, Australia’s evolving regulatory environment was the key motivation for their climate action in 2022. Deloitte noted that there was a shift from voluntary action to mandated change.
Complying with regulator change was one of the top three challenges related to ESG cited by 43% of the leaders surveyed by KPMG.
As businesses are increasingly expected to become more environmentally sustainable, the Australian Government is looking to introduce mandatory climate risk reporting. It comes at a time when climate litigation is also increasing.
Climate litigation on the rise
According to Clyde & Co, climate litigation cases are rising in Australia. In its APAC insurance predictions report, the insurance law firm noted that Australia has one of the highest numbers of climate litigation cases globally – and the numbers are predicted to skyrocket in 2023 with greenwashing and over-inflated ESG commitment litigations to grow. In particular, the company predicts 2023 will see a rise in arguments over duty of care obligations, and challenges to corporate governance by shareholders for failure to consider and address climate risk. They foresee less focus on monetary compensation but rather increased litigation towards regulation or accountability of corporations.
The Government is also monitoring compliance and the Australian Securities and Investments Commission (ASIC), Australasian Centre for Corporate Responsibility (ACCR) and the Australian Competition and Consumer Commission (ACCC) have recently undertaken climate litigations in respect to greenwashing (the process of conveying a false impression or misleading information about how a company’s products or services are environmentally sound).
Combating greenwashing was cited by the Financial Services Council as one benefit of the introduction of a mandatory climate disclosure regime.
Mandatory climate risk disclosures
The changing climate is a core strategic concern globally. The rising concentration of CO2 in the atmosphere is leading to increased surface temperatures. According to the United Nations, in addition to hotter temperatures, the impacts of climate change include more severe and frequent storms, increased drought, rising sea levels, and loss of species on and in the ocean. To combat the effects of climate change, global emissions need to fall by 43% by 2030, according to the International Panel on Climate Change. To help meet this target, a range of stakeholders including regulators, investors, financiers, insurers, boards, consumers and communities are expecting businesses to take action on their contribution to emissions.
Clearly, agreed measures to track progress and trace the environmental health of a company and its impact are needed. To provide these, the Taskforce for Climate-Related Financial Disclosures (TCFD) was established and is supported by over 110 regulators and government entities globally. In 2017, the TCFD released recommendations to assist organisations to disclose climate-related financial risk and opportunity to investors and other stakeholders through existing reporting processes. A number of countries are making TCFD compliance mandatory, and businesses are having to report on how they monitor and manage climate risks.
The TCFD’s regulatory framework is now being used to develop requirements in the EU, Singapore, Canada, Japan, South Africa, New Zealand, the US and the UK. Australia is set to follow their lead. In December 2022, Treasury released a consultation paper seeking views on the design and implementation of a climate-related financial risks disclosure regime. Treasury aims to align climate risk disclosure requirements with international standards. “The Government has committed to ensuring large businesses provide Australians and investors with greater transparency and accountability when it comes to their climate-related plans, financial risks, and opportunities,” the consultation paper said.
It is widely expected that mandatory climate change financial risk reporting will be introduced in Australia in FY24.
Impact on insurance – for insurers
The introduction of mandatory reporting will see local and Australian-based insurance companies reporting on their climate risks. To help insurers achieve net-zero emissions for their operations by 2030 and across their activities by 2050, the Insurance Council of Australia (ICA) released the Towards a Net Zero and Resilient Future roadmap.
According to global professional services company EY, the insurance industry has a unique role to play as they are the risk transfer safety-net that every other part of the finance sector, and every other part of the economy, relies upon to deal with the financial implications of many sustainability issues.
While insurers will be required to report on their own climate change financial risks, there is also the opportunity for the industry to use the data from Australian businesses to inform products and pricing.
“Mandatory disclosure is a good thing for the insurance industry because if you’re insuring, let’s say, an Australian agricultural company that has cattle in floodplains, you might want to know what they’ve done to assess climate risk and how they’re mitigating or how they’re managing that risk,” said Terence Jeyaretnam, EY’s APAC leader and partner for climate change and sustainability services. Jeyaretnam added, as an insurer, it’s useful if a company does this work because it helps you better understand the risks and work out management plans to mitigate or prevent them. “So that the risk is minimised and therefore the premiums and risk of insurance payouts is reduced,” he said.
Impact on insurance – for policyholders
With the growing scrutiny on a business’ ESG commitments, and imminent mandatory reporting requirements, there is an increasingly high risk for directors and officers (D&O) if there is failure to meet disclosure obligations. D&Os may risk fines or other penalties if their company breaches its obligations. Rising shareholder activism linked to climate causes is of concern to insurers, which are keenly focussed on emerging liabilities related to ESG risks. As a consequence, businesses may find it harder to secure cover or may see premiums increase.
Contracts, such as construction projects, are also increasingly likely to include climate change obligations, according to Clyde & Co. This has a flow-on effect for insurance as there may be liability for negligence regarding duty of care to address climate change risks.
In addition, businesses may find that they are underinsured in respect to climate change risks if they underestimate the full extent of potential losses. According to the Association of Insurance and Risk Managers in Industry and Commerce (Airmic), the long-term impact of climate change is not receiving the prioritisation it deserves as risk managers concern themselves with managing short-term risk, such as flooding and tropical cyclones.
Businesses should talk with their EBM Account Manager about their climate-risk exposures and an insurance program that includes liability covers (D&O, contracts) along with perils and business interruption protections.
