Climate-related financial disclosures: a new frontier for general counsel

Once an issue confined to environmental impacts, climate change is now understood as a systemic risk to the global economy. Decarbonisation is both an environmental and economic imperative, with implications extending far beyond high-emitting sectors and into every facet of commercial activity.

In response, Australia, like many jurisdictions, has introduced a mandatory climate-related financial disclosure regime. This represents a new frontier for general counsel and in-house legal teams, who will have a critical role to play in supporting directors and company officers to discharge their duties and obligations and, ultimately, protect the company from legal risk.

Australia’s climate-related financial disclosure regime (CRFD regime), will commence on 1 January 2025 by extending the existing financial reporting requirements of the Corporations Act 2001 (Cth) to require the preparation of a sustainability report. The CRFD regime is designed to provide investors with the information they need to understand the financial impact of climate change on the companies in which they invest.

Organisations already voluntarily reporting under the Taskforce on Climate Related Financial Disclosures will be able to leverage established processes to respond to the increased granularity and specificity of the CRFD regime’s disclosure requirements. The CRFD regime also places a considerable burden on directors and company officers as ‘gatekeepers’, who have a material obligations burden in relation to the financial management and reporting undertaken by the organisations they lead.

Key disclosure requirements

Under the CRFD regime, reporting entities^[1] are required to prepare an annual sustainability report that includes the climate statement for the year, notes to the climate statement and the directors’ declaration. The climate statement is required to disclose all of the following:

• any material financial risks and/or material financial opportunities relating to climate), to be determined in accordance with the relevant sustainability standards;^[2]
  
  
• any metrics and targets of the entity relating to climate, including scope 1, 2 and 3 greenhouse gas (GHG) emissions, and those required to be disclosed by the sustainability standards;

• any information about the entity’s governance, strategy and management of risks, opportunities, metrics and targets required to be disclosed by sustainability standards; and

• any notes required by the sustainability standards (or by legislative instrument) in relation to the preparation of, and anything included in, the climate statements (together, the climate statement disclosures).

The CRFD regime requires reporting entities to assess and disclose climate resilience against a projected increase in global temperatures of 1.5 degrees Celsius by 2050 and a scenario that ‘well exceeds’ 2 degrees Celsius by 2050. Scenario analysis is the primary tool by which entities assess their resilience to climate change and identify climate-related risks and opportunities.

There are inherent uncertainties about possible future events and the financial impacts across these timeframes. Accordingly, identifying the financial materiality of climate-related risks and opportunities to the entity’s prospects requires the formulation of assumptions and exercise of judgment about what risks and opportunities are (or may become) financially material over extended timeframes based on different scenarios.

Directors’ declarations as to compliance with the CRFD regime

Presently, in the context of financial reporting, the law requires directors to:

• question the information provided to them;
  
  
• have a reasonable level of financial literacy and basic accounting knowledge;
  
  
• ensure the executive team has systems, protocols and controls in place to ensure sound corporate governance; and
  
  
• individually adopt the annual financial statements and not completely delegate their review and consideration of the financial statements.

For the first three years of the CRFD regime an entity’s climate statement must include a declaration that, in the directors’ opinion, the entity has taken reasonable steps to ensure the climate statement and notes of the sustainability report are in accordance with the Corporations Act (reasonable steps declaration).

The close relationship between directors’ existing obligations to exercise care and diligence in their consideration and approval of the financial statements and the new reasonable steps obligations in relation to climate statement disclosures set out in the CRFD regime means directors should have regard to the content of their existing obligations when considering how to discharge their new responsibilities.

Three years after the commencement of the CRFD regime, directors will need to make a declaration as to whether, in the directors’ opinion, the substantive provisions of the sustainability report are in accordance with the Corporations Act, including compliance with sustainability standards and climate statement disclosures (directors’ declaration of compliance). The same liability provisions apply to both forms of declaration, including liability for false or misleading statements and misleading or deceptive conduct, including representations as to future matters not made on reasonable grounds.

Declarations in the absence of reasonable assurance

The requirement for external assurance (audit) will be gradually phased in from the commencement of the CRFD regime through to 2030. The Australian Assurance Standards Board has proposed further consultation on the requirement for limited assurance of certain disclosures for the first three reporting years. Audit assurance is not proposed until the fourth reporting year, except for scope 1 and 2 emissions which will be proposed from the second reporting year. Should these proposals be adopted, for a period of time directors and corporate officers will be required to make declarations outside the audit assurance process as to the most complex aspects of climate disclosures, including scenario analysis and assessment of an entity’s climate resilience, transition plans and scope 3 emissions.

In the absence of an audit to test the assumptions made by directors and management in the preparation of their reports, general users of financial reports will be reliant on the adequacy of a reporting entity’s systems, processes, controls and resources to discharge the entity’s disclosure obligations and understand the financial impact of climate risks and opportunities on the entity’s prospects. They may also place greater reliance on declarations given by directors as to the entity’s compliance with the disclosure requirements and underlying climate standards.

This heightened focus on the directors’ declaration exposes directors and corporate officers to greater reputational and legal risks.

Elevated risks despite transitional relief

Climate statement disclosures will ultimately be subject to the same liability provisions that apply to reporting entities and their directors for the preparation of annual reports. However, the CRFD regime will provide some limited transitional relief from liability, including a three-year period of immunity from private litigants for higher risk statements made in the sustainability report such as disclosures about scope 3 GHG emissions, scenario analysis or transition plans.

However, this relief is limited in both scope and duration. There is no immunity from Australian Securities and Investments Commission (ASIC) enforcement action. Immunity for forward-looking statements expires after one year unless those statements are about scope 3 GHG emissions, scenario analysis or an entity’s transition plan made in the sustainability report. All immunity expires after three years.

Importantly, the limited relief provisions are confined to the sustainability report and do not apply to:

• the directors’ obligations to ensure that the reasonable steps declaration is not misleading;
  
  
• accounting for the financial impact of climate risks and opportunities in the financial statements e.g. adjustments to asset values or contingent liabilities in relation to environmental remediation obligations;
  
  
• the requirement in s295 of the Corporations Act for directors to give a declaration as to the financial position of the entity; or
  
  
• the requirement in s295A of the Corporations Act for a listed entity’s chief executive officer and chief financial officer to give a declaration about the listed entity’s financial statements.

‘Reasonable steps’ in the face of uncertainty

In the absence of a statutory definition of ‘reasonable steps’ and case law considering reasonable steps in the context of climate disclosures, reporting entities will need to be guided by the courts’ treatment of reasonable steps more generally. What might constitute ‘reasonable steps’ is largely an objective test which is highly fact-dependent and will differ depending on the entity, complexity of the entity’s business and the internal reporting procedures within the business.

In Centro, ‘reasonable steps’ was defined as a standard determined by reference to the particular circumstances that oblige the directors to take a sufficient interest in the material available to them (or that they might appropriately demand from executives or agents). This case also highlighted the close relationship between a director’s more general duties to the corporation and the specific statutory requirements associated with the adoption of financial statements.

Directors and the executive team that supports them need to carefully consider the level of climate literacy needed to discharge their obligations having regard to:

• the complexity of the entity’s business model and corporate structure;
  
  
• its operating environment; and
  
  
• the nature of the information directors require to enable them to provide those declarations.

To enable them to test the assumptions and judgments underpinning the entity’s disclosures, directors and executive teams also need to understand the sources of physical and transition risks of climate change and how those risks are likely to affect the entity. They need to use that knowledge to be satisfied that the entity’s policies, processes and procedures for assessing the financial materiality of climate risks and opportunities and making the climate statement disclosures are robust and defensible. Reasonable steps may also include underlying data collection, retention and management processes and the engagement of external expertise to supplement internal capabilities.

The role of general counsel

General counsel have long been considered an officer of the company with a duty to protect it from legal risk. In the context of climate disclosures, this includes:

• promoting corporate compliance with the CRFD regime’s requirements (both substantive and administrative);
  
  
• promoting compliance with prohibitions on misleading conduct and ensuring the board of directors is properly informed of matters that create or increase a risk that would put them in breach of their legal obligations; and
  
  
• protecting against litigation risk.

Accordingly, in-house legal teams have an important role to play in ensuring management and the board understand the entity’s disclosure obligations and whether the entity’s compliance framework is sufficient to meet those obligations so as to enable corporate officeholders to discharge their duties and responsibilities.

In-house legal teams will also play a crucial role in helping to ensure corporate officeholders understand the legal risks (including legal risks arising from harm to the entity’s reputation) arising from compliant climate disclosures that reveal potential inadequacies in the governance, strategy or management of climate risks and opportunities.

***

With the Federal Government and ASIC expanding their focus to nature-related financial risks, in-house legal teams should plan for the CRFD regime’s natural extension to nature-related financial risks. As ASIC Chair Joe Longo told audience members earlier this year, entities should “ensure that any systems and processes they adopt for the purpose of climate-related financial disclosures be sufficiently agile to incorporate additional sustainability topics in future years.”

^{[1]  Reporting entities include (i) companies, registered schemes, registered superannuation entities and disclosing entities that meet two of the three criteria – equal to or greater than 100 employees and/or value of consolidated gross assets of that entity and the entities it controls is greater than AUD $25 million and/or consolidated revenue for the financial year of the entity and the entity it controls is greater than AUD $50 million; (ii) entities who report under the National Greenhouse and Energy Reporting Act 2007 (Cth); and (iii) entities where the value of its assets (and the entities it controls) is equal to or greater than A$5 billion.}

^{[2]  Information is material if omitting, misstating or obscuring that information could reasonably be expected to influence the decisions that primary users of general purpose financial reports make on the basis of financial statements and any climate-related financial disclosures. For example, in Australian Securities and Investments Commission v Healey [2011] FCA 717 (Centro), Centro’s 2007 accounts, approved by the directors, failed to reveal that the shopping centre giant had about A$2 billion in current liabilities. Another A$1.75 billion in guarantees was not disclosed.}