Pressure is building on carbon-intensive companies to disclose their climate-related risks to investors.
A total of 130 investors with more than $13tn in combined assets under management (AUM) recently recommended just that, when they urged G20 leaders to push national financial regulators to “require disclosure of material climate risks”.
This came amid ever-increasing regulatory scrutiny of climate risk disclosures. The Financial Stability Board has established a task force on climate-related financial disclosures, and the New York Attorney General (NYAG) and others are investigating Exxon Mobil for allegedly providing misleading information to investors regarding climate change.
Last year, the NYAG also agreed a settlement with Peabody Energy Corporation, which is now required to improve its climate change disclosures.
ClientEarth has increased the intensity of this spotlight on climate risk disclosure. In August, we alerted the Financial Reporting Council (FRC) to reporting breaches by two oil and gas companies, SOCO International Plc and Cairn Energy PLC.
These complaints are the first submitted to a UK regulator in respect of specific failures to report climate-related risks. They give the FRC the opportunity to demonstrate that it is taking the issue seriously.
Climate-related risk is manifest in various ways for different economic sectors (and indeed for different companies in the same economic sector). As with any other type of risk facing a company, it may not be possible to determine with precision the exact consequences of climate risk for a company.
However, while climate-related risk may affect companies in different economic sectors in a variety of ways, as a financial risk to the business, it must be disclosed so that investors can adequately factor these considerations in to the investment case.
Our complaints demonstrate that companies in the oil and gas exploration sector are acutely vulnerable to climate risk, which includes:
- transition risks (i.e. the business and financial risks arising from the transition of the world economy to a lower carbon intensity over the coming years); and
- physical risks (i.e. the risk of the physical impacts of climate change—extreme weather, sea level rise, water scarcity etc—damaging the economic value in the business).
These climate-related risks could expose oil and gas companies to increased operating and capital costs, the potential for stranded assets (e.g. exploration licences, oil and gas reserves or infrastructure required to develop those reserves), reputational damage and/or reduced market valuation.
By failing to report on climate-related risks, we consider that the annual reports of both SOCO and Cairn fail to provide:
- a fair review of the company’s business and a proper account of the main trends and factors likely to affect the future development, performance and position of the company’s business; and/or
- a proper description of the principal risks and uncertainties facing the company.
These reporting failures prevent shareholders from assessing how the directors have performed their duty to promote the success of the company.
Cairn’s annual report makes only two brief statements about climate change. It is impossible to discern from these statements how important Cairn’s directors consider climate-related risks to be, or what the impact of these risks will be on the company’s operations and strategy.
Following our complaint, Cairn publicly stated: “We continually identify corporate responsibility priorities and our 2015 annual report featured climate change in the comprehensive materiality matrix.”
This misconstrues the nature of the risk. As a material financial risk to the business, climate risk should be disclosed in the core business information and risk sections of Cairn’s annual report.
SOCO’s annual report makes no reference to any risks associated with climate change. SOCO responded that its board had decided that, in keeping with its sector peers, it would not include climate change as “a separate risk among the principal risks to the company’s strategy in 2015”.
We say this is an unsatisfactory response that does not conform to the current legal requirements. The information that must be disclosed is judged in terms of materiality to the business or shareholders. In any case, other companies in the sector do disclose information on climate risk (although we make no comment about the adequacy of that information).
Directors—and non-executive directors in particular—should take note.
Directors must exercise reasonable care, skill and diligence in their role and this requires them to proactively identify and monitor risks to their own business.
The UK Corporate Governance Code states that boards should have the appropriate balance of skills, experience, independence and knowledge of the company to meet this duty (Principle B.1). For non-executive directors—who should “constructively challenge” and satisfy themselves that systems of risk management are robust and defensible (Principle A.4)—risk identification is central to their role.
The FRC will now investigate in accordance with its Operating Procedures. It can publicly communicate the outcome and the action required of the company following this investigation. Ultimately it can apply for a court order forcing the company to prepare a revised report (and the costs of this can be recoverable from the directors personally).
For investors to properly exercise their fiduciary duties, proper enforcement of statutory reporting requirements is crucial. With the evidence we have presented, it is difficult to see how any effective regulator could fail to act.
David Cooke is a lawyer with ClientEarth.