Essential ESG: Episode 30 – Navigating Australia’s Mandatory Climate Reporting Regime

Sophie: Welcome to another episode of Essential ESG, coming to you today from Brisbane, on the lands of the Turrbal and Jagera People. My name is Sophie Parr, and I’m a responsible business and ESG consultant at Corrs Chambers Westgarth, and it’s my pleasure to welcome back to the podcast Anna White, one of our Environment, Planning and ESG Partners, and Kate Gill-Herdman, a Partner in our Responsible Business and ESG team. Thank you both so much for joining us today.

Kate: Thank you.

Anna: Great to be here.

Sophie: Today, we will be discussing mandatory climate reporting under the Corporations Act. With some Group 1 entities having completed their first reporting cycle, we wanted to take stock and dive into lessons learnt, the practical hurdles that emerged, and what’s on the horizon as Groups 2 and 3 prepare to report. So, Kate, I might start with you to really set the scene for our listeners who might not be as familiar with this space. Could you give us a brief overview of the regime, and in particular, really what it requires, how long it’s been in place, and how it extends the existing financial reporting framework.

Kate: Thanks, Sophie. I can do that. So, Australia’s mandatory sustainability reporting regime came into effect a couple of years ago but it’s just earlier this year that the first reports have been prepared and filed under the regime, so it’s very new. So, the regime was introduced through amendments to the Corporations Act to expand financial reporting to sustainability reporting, so there’s a legislative requirement now to prepare a sustainability report which includes the climate statement. So that’s why it’s often referred to interchangeably as mandatory sustainability reporting, or mandatory climate reporting. That’s because at this stage of the reporting regime, the only mandatory part is the climate statement. So that needs to be prepared in accordance with an underlying sustainability accounting standard called AASB S2. That underlying standard is drawn from the international standard so really the key point is that the Australian government has implemented a climate-related financial disclosure regime that is broadly aligned to what’s happening internationally. So, the climate statement needs to disclose information across topics of governance, strategy, risk management, and greenhouse gas emissions metrics and targets, including scope 1, scope 2, and scope 3. Scope 3 are not required until the second reporting period. The directors are required to give a declaration, which we’ll come back to. That declaration is that the entity has taken reasonable steps to comply with the regime. And then there is also assurance requirements. So, just like the auditing of financial statements, there is an assurance process for sustainability reports, that starts with quite limited assurance over a small number of topics, and then expands over the course of several years.

Sophie: Just to go back a step as well, Kate, would you be able to briefly step out what a Group 1 or a Group 2 or a Group 3 entity is?

Kate: It’s probably easiest to explain it by reference to Group 3 reporting entities because that is the threshold for the reporting requirements to kick in. What the government has done though, is phase those reporting requirements so that they’re introduced as requirements for very large entities in the first year, and then there’ll be market lessons from the first year of reporting. Group 2 will commence reporting next year. And then Group 3. But the baseline threshold for Group 3 reporting entities is if you meet two of the three criteria; so, consolidated revenue of $50 million, consolidated gross assets of $25 million, and group employees of 100 or more. I should say as well though that the government has proposed an increase to those thresholds; there’s no bill that has introduced it, but they flagged it in the recent budget announcements. So, if that is introduced, then those thresholds increase to $100 million revenue, $50 million gross assets, and the employee number remains at 100 employees.

Sophie: Great, thanks Kate. And that also really brings me to one of the themes we flagged on one of our past Insights which was the challenge of operationalising some of these obligations that you’ve just stepped out. So, now that some of Group 1 has had their first reporting cycle, Anna, I’d love to hear some of your reflections on some of the biggest practical challenges that you’ve seen.

Anna: Yeah, as Kate described, there’s obviously a number of layers of requirements that need to be reported on in these new sustainability reports and I think to reflect on that operationalisation challenge, we almost need to step back and look at what is the objective of the reporting regime. So here, the objective of AASB S2 is for climate-related disclosures to require an entity to disclose information about its climate-related risks and opportunities that is useful - it’s got to be useful to primary users of general-purpose financial reports - in making decisions relating to the provision of resources to the entity. So, if we think about that objective, what are the lessons that are learnt because it’s not the role of a single person within any organisation to prepare the sustainability report. It’s really clear, working with a number of reporting entities on how they’ve approached this challenge in the first year, that you do need a very diverse, multidisciplinary team from within an organisation to compile all of the inputs that are needed to prepare the report. So we’ve tended to see the multidisciplinary team including people from the sustainability group, finance and accounts, procurement teams, legal and risk all coming together within an organisation to identify what needs to be compiled, assessed, and goes in to figuring out precisely what language is going to be used in the sustainability report. As part of this transitioning phase in the first year of reporting and beyond, there really is a lift among a number of organisations in developing that climate literacy to prepare for the reporting, and different entities have different levels of existing climate literacy. But definitely, there - across the board - tends to be an uplift beyond just the knowledge and the sustainability team to broader groups within a reporting entity. That’s developing an understanding of concepts like setting boundaries around your emissions, looking at what a transition plan actually means, and undertaking scenario analysis. And some of these concepts require training to unpack them so that everyone knows what they involve. From the legal side, it’s been very interesting and a real privilege working with a number of clients who’ve been trying to navigate the requirements and the importance of tackling some threshold legal issues up-front in the process, because if you don’t, they end up lurking in the background which can present problems for down the track. But with those multidisciplinary teams, it’s really important that there’s a common understanding about some of the fundamental elements that go into the reporting that’s required. For example, understanding the corporate structure and unpacking what goes in and doesn’t need to go into the sustainability report, and sometimes when we’re talking about multinational organisations, particularly when there’s multiple Australian subsidiaries, looking at whether or not it’s reporting on a consolidated group or not, that requires a bit of close consideration. Another legal issue that can sometimes lurk in the background is actually stopping to properly define who your primary users are. Coming back to that objective I mentioned before, the purpose of these disclosures is ultimately to provide decision-useful information to primary users. So, if there is disagreement internally, or with your assurance provider around who those primary users are, that can result in quite different approaches being taken to assessing what information is material, and what needs to be included in a disclosure.

Sophie: Yeah, thank you, Anna. And I might stay with you, actually, because you’ve just brought up something about a specific challenge we have been advising on which is Australian subsidiaries of global corporate groups, and in particular, where climate commitments and targets are set at the parent-level and are not neatly attributable to the Australian reporting entity. So, what are some of the key issues that arise in that context, and how have you found businesses navigating the tension between the group level sustainability strategies, and entity-level legal obligations.

Anna: It’s a good question, and the answer is - there is no one size fits all solution to the question because you very much have to look at the specific wording of the Standard, S2, what is required to be reported, and usually, that relates to the specific entity, but sometimes, the reporting entity’s position on a particular issue may actually be informed by decisions being made up the chain by a parent overseas. So, if we just take targets as one example, the starting position is that S2 only requires a reporting entity to report the targets that have been set by the entity itself - so that’s the reporting entity - and any targets that it’s required to meet at law or under regulation. There’s no requirement in S2 for reporting entity to explain why a reporting entity has not set its own targets if there might be one at the parent-level. S2 does not expressly contemplate, nor provide any guidance on the scenario where a target might be set at the parent-level, so the role of the parent-level’s target needs to be unpacked to determine what might need to be disclosed for the reporting entity here in Australia. This is particularly the case if that parent-level target is really well publicised and expressed as being a global target that one might look at on a website somewhere and form a view or an impression that that seems to apply to all of the global operations, including Australian subsidiaries. Where the international parent company requires the Australian subsidiary to adopt and take actions to achieve that parent-target, then it’s difficult in some respects to say that this target is not one that the subsidiary accepts, that it has, in a sense, set for itself and therefore it should be reported. But on the other hand, if the parent does not require the global target to be adopted by a subsidiary, and the parent’s target plays no role in decisions around governance and risk management, then there would be a basis not to disclose this. So this requires quite careful consideration because often the governance and the risk management decisions are informed by the parent’s target. So, as I say, there’s not a single answer to it. It does need to be unpacked but it is one that people should have on their radar, particularly when they’re part of a broader international group.

Sophie: Interesting. Thank you so much for diving into that because I think that will be an area that some of our listeners are also navigating at the moment. Switching now as well to the directors’ role, another key topic in mandatory climate reporting, Kate, what are you observing about how directors are managing the new requirements, and what should boards be really thinking about when navigating this space?

Kate: Thanks, Soph. That’s a really important question and so before maybe getting to answering your question, I might just set the scene by explaining what the liability regime is for climate reporting. So, I said earlier that it’s helpful to think about it being the same liability regime that applies to financial reporting however, there is a three-year transitional relief period and we’re in that relief period at the moment. The first thing to understand is the criminal offence and civil liability provisions. Civil liability and criminal offence provisions are similar to financial reporting. So, for example, civil liability for a director that fails to take all reasonable steps to comply, or secure compliance, financial and sustainability record keeping and reporting. It’s a criminal offence for the entity to fail to keep sustainability records. And coming back to that subsidiary international parent scenario where there’s records kept outside of Australia, there are particular requirements there. So, there’s some quite strict requirements. In terms of the transitional relief, so there’s a three-year safe harbour from private litigant action for disclosures relating to the more tricky areas; they are scope 3 emissions, transition plans, and scenario analysis. There’s also a one-year safe harbour for forward-looking statements about climate. This is a report that is all geared towards short, medium, long-term time horizons for decarbonisation, so there are going to be many highly qualitative and future-oriented statements, so that’s a key area to be aware of.

What should directors be thinking about? They need to give a declaration that the entity has taken reasonable steps to comply with the requirements of the regime, so that means they need to, in discharging their duties, reach a reasonable level of satisfaction that the entity has, in fact, taken reasonable steps. So, there’s lots of ‘reasonableness’ here. At a minimum, that requires directors to have a level of climate literacy. They need to understand what key terms are used in the Standard. So, emissions, transition plans, scenario analysis, what do all those things mean, and how is the entity undertaking those? And they need to be satisfied that the process that the reporting entity has been through in order to compile the information, identify and select the relevant methodologies that enable them to report information, are sufficiently robust. And lastly, I think directors should also be thinking about what type of verification will be done on the report, and that will really depend on if you’re a highly regulated entity, a public-facing entity, you may want to undertake a high level of verification, but there’ll be lower risk entities, too. So, it’s really about calibrating that verification process to the type of entity that you are. So, what we’re seeing directors do in preparation is ensure climate literacy. They might receive a board briefing from technical experts to assist them with understanding key climate terms. They might receive briefings from lawyers explaining to them core aspects of the regime, the liability frameworks, and the types of questions that they need to be asking to reach that level of satisfaction that the entity has undertaken reasonable steps to comply.

Anna: And I’ll just add to what Kate said there, when we’re thinking about that verification process, one of the things that needs to be borne in mind is maintenance of appropriate sustainability records. It’s a requirement under this new regime that the sustainability records that support the disclosures are kept and maintained. And so making sure that the processes are in place with that verification that the records do exist and do substantiate whatever the disclosure is that has been decided upon are maintained within the organisation.

Kate: So even though there is a three-year transitional relief period from private litigant action, there’s no relief from ASIC enforcement proceedings. That’s probably a long way of saying: draw only limited comfort from the three-year transitional relief from private litigant action. ASIC has already provided guidance to the market on the first cohort of Group 1 reporting entities, so anyone who’s still to report should familiarise themselves with that guidance. It has said it will take a soft approach; it understands that this is a huge capability uplift. It will support reporters to understand the requirements of the regime and potentially take enforcement action only against egregious breaches in the early phases. So, not filing a report, not maintaining sustainability records, for example.

Sophie: So, while entities are navigating these initial rounds of reporting, greenwashing risk should also be front of mind, particularly given, as you said before, Kate, ASIC’s focus in this area. So, what does good practice look like here?

Kate: I’ll talk about two areas, and Anna will have some observations as well. The first is the sustainability report itself and ensuring that any forward-looking statements have a reasonable basis for being made.  So that’s within the report itself. But the safe harbour provisions only apply to statements made in the mandatory climate report. They don’t apply to identical statements made in marketing collateral or other types of external publications like voluntary sustainability reports. So, it is critical that reporting entities ensure that their statements in the report are accurate, but also statements made outside the report are accurate, and doing that cross-check to make sure that there’s nothing lost in translation in moving between those reports.

Anna: And just to jump in there, Kate, it’s really interesting ASIC has just in the last couple of days released some initial observations from that first cohort of reports that have been submitted, and one of their observations is noting that it’s very interesting that for some reporting entities who had, in fact, disclosed in previous years in their financial reports – so this is before this regime existed – they had identified that certain assets or operations had the potential to be impacted by extreme weather events. They’re observing that it’s now interesting in this year’s first sustainability reporting that some of those entities are not now reporting that that disclosed information from previous years somehow doesn’t mean that there are any risks that have been identified as affecting their prospects over the short, medium, or long-term in the sustainability report. The point being: ASIC is aware that there could be a disconnect between what an entity is reporting in one document, being its financial statements, versus its sustainability report. So, reporting entities do absolutely need to be thinking about what they’re saying, and the consistency of that information across different reporting contexts.

Kate: Absolutely. And ensuring that if there is inconsistency between previous reports and future reports or different types of reports, that the reasoning process, decision-making process, for those differences is clearly documented and maintained. So, if ASIC, using their new investigation powers, issues a notice to ‘please explain’, then you’re able to furnish ASIC with information that puts to rest any concerns.

Sophie: Australia’s climate reporting regime obviously sits within a broader international movement towards this mandatory climate and sustainability reporting, so I’d like to ask you both where you see this heading over the next few years, including the potential expansion to broader sustainability topics beyond climate, and maybe as well, what our listeners should be thinking about, both in terms of the medium and long-term strategic positioning.

Anna: It’s interesting Australia might not have been leading the pack at the start of this global discussion around sustainability reporting, but in the end, we ended up being a jurisdiction that is amongst one of the first reporting jurisdictions. So, particularly for multinational organisations, Australia really is a bit of a testing ground around the approach to be taken, working through issues with assurances providers, and looking at the guidance coming from the regulator around what is appropriate to be disclosed, and what might not need to be disclosed. Reflecting on all of that, a key takeaway from my perspective is that reporting entities should not underestimate the time involved in travelling this journey for the first year of reporting, and the second when the scope 3 emissions come in. Making sure that you are on the same page as your assurance providers is key, and tackling some of those issues up-front, particularly the legal threshold issues that need to be addressed to make sure that everyone’s very clear on what inputs are required and how it’s all going to come together in that final report. Looking ahead, I do think it’s interesting to think about the whole objective sitting behind this framework is ultimately decarbonisation for our economy. Maybe in the first couple of years we’re not going to see significant developments in the achievement of decarbonisation initiatives, but as time goes on, it will be fascinating to see – has the transparency that is borne out of this mandatory reporting regime actually shifted the dial on companies self-identifying what their own transition plan and targets are, and year-on-year reporting against that, and perhaps holding themselves to account against an emerging market standard to achieve improvements. Or, is it just a disclosure regime that sits there. Time will tell. It’s obviously a new and complex regime, and one that Australia actually, at the end of the day, is leading the pack on.

Kate: Anna summarised her thinking very neatly and I agree with everything she said. I might leave the audience with a few practical things to think about, particularly for Group 2 reporting entities. So, the first thing is: Check how you’re tracking against your revenue/asset employee projections. If you think you might tip in to Group 2, then start preparing. There’s no exemption and you shouldn’t expect relief necessarily from ASIC if you do well and tip yourselves into a Group 2 scenario. There’s a couple of things around, particularly for legal teams, in assessing legal readiness to operationalise this new regime. So, the first is around accountability – who within the organisation has accountability for mandatory climate reporting? So, we’ve seen, because this is a financial reporting regime, teams were in charge of voluntary reporting. There has been a real shift into the CFO’s office, and as Anna was talking about before, the multidisciplinary approach, but who is ultimately accountable? Reporting governance. So, is the reporting governance framework clear and well understood for all of those teams that need to come together? What management or board subcommittees are involved? What’s their remit? And is there a decision-making trail about key decisions, particularly around those threshold legal issues that Anna took you through, that goes up to the board, that can demonstrate the entity’s taken reasonable steps to comply with the Act. And finally, the last, but critical piece, board readiness. You know, is the board climate literate? Do they know what question to ask? How will you, as general counsel, brief the board to ensure that they know what they need to do in order to give this declaration?

Sophie: Thank you, Kate, and Anna, for sharing your insights with us today. It’s just been fantastic and a thoroughly interesting conversation. We’ve covered a lot of ground in the last half an hour from lessons learnt from Group 1’s first reporting cycle, to the challenges facing subsidiaries in global groups, directors’ liabilities, greenwashing risks, and really what people should be thinking about, especially if you’re in Groups 2 and 3 coming up. Thank you both so much for joining us today, and thank you all for tuning in to Essential ESG and we’ll see you next time.