In brief 13 min read
In a first-of-its-kind action worldwide, representative proceedings were issued in the Victorian Registry of the Federal Court against the Australian Government and named officers for allegedly failing to disclose to investors the climate change risks attached to sovereign bonds.
This brings together growing trends in Australia for:
- enforcement of allegations of inadequate financial and governance disclosures of climate change risk through litigation; and
- class actions concerning ASX disclosures relating to governance issues and their financial impacts.
We assess the significance of these proceedings and outline the key questions your organisation and its Board should be asking to best navigate both the risks and opportunities related to climate change.
- Australia is becoming front and centre as a forum for activist climate change litigation against corporates, financial institutions and government.
- This case is a stepping stone towards more commercially focussed climate change disclosure class actions against corporations.
- Actions for failure to disclose climate change risks are one tool that activists are using to drive behavioural change by companies and government, as much as to direct development of the law.
- Despite climate change financial disclosures being fairly well established, this proceeding is innovative because it:
- is the first action worldwide to relate to climate change risk in the sovereign bond market;
- targets individual public office holders in relation to duties that are closely analogous to directors' duties, and, in this regard, might serve as a caution for members of publicly listed boards;
- includes a claim of 'misleading and deceptive conduct'. While this particular claim is made pursuant to s12DA(1) of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act), the provision is largely analogous to the 'misleading or deceptive conduct' provision contained in the Australian Consumer Law. This could signify future litigation risk in a consumer protection sense and a need to consider climate-related risk through both the corporate and consumer law lens. It is also largely analogous to the 'misleading and deceptive conduct' provision of the Corporations Act 2001 (Cth), which is typically deployed in shareholder class actions.
- Notwithstanding the barriers to success for a plaintiff in an action of this kind, the case serves as a reminder that companies should have in place policies and procedures to satisfy their disclosure obligations on climate change risk, given the likelihood that such systems (and related disclosures) will be subjected to increasing scrutiny.
- This proceeding is likely to signify the emergence of a growing trend. In February 2020, former High Court Chief Justice Robert French stated that Australian governments, big business and regulators face a 'growing tide' of climate change-related legal challenges.
On 22 July 2020, Kathleen O'Donnell, a 23-year-old student, filed the claim in the Victorian Federal Court on her own behalf and as the representative of retail investors and holders of Australian Government Bonds (AGBs). The respondents are the Australian Federal Government and two of its officers – the Secretary to the Department of Treasury and the CEO of the Australian Office of Financial Management (AOFM).
The claim alleges that investors in AGBs face material climate change-related risks which should have been disclosed in Term Sheets and the Information Memoranda issued by the Government in relation to the AGBs (together, the Information Documents). These risks include:
- Physical impacts: such as higher minimum temperatures and increases in droughts and bushfires;
- Transition impacts: such as increased exposure to stranded assets and legal actions, and changing markets and policies; and
- Sovereign response and resilience to climate change, etc: in particular, risks related to how the Government responds to climate change, including by refence to emissions reductions (including under the Paris Agreement) and emissions per capita under Government energy policy, for example.
The plaintiff asserts that Australia is materially exposed and susceptible to these risks, and that they are factors which are material to an investor’s decision to purchase or trade in AGBs. It is alleged that, in failing to disclose the climate change (and related) risks, the Government has breached its disclosure obligations and engaged in misleading or deceptive conduct, as follows:
- Failure to disclose: breach by the Government of its duty of disclosure and s12DA(1) of the ASIC Act.
- Misleading or deceptive conduct: breach by the Government of s12DA(1) of the ASIC Act by engaging in conduct that is 'misleading or deceptive or likely to mislead or deceive' by disclosing in the Information Documents 'some risks' – but failing to disclose material information about the climate change-related risks.
- Breach of public duties: by failing to disclose the climate change risks, breach by the CEO of the AOFM and the Treasury Secretary of their duties to exercise their powers, perform their functions and discharge their duties 'with reasonable care and diligence' under s25(1) of the Public Governance, Performance and Accountability Act 2013 (Cth). This duty is closely mirrored by the duties imposed on directors under the Corporations Act.
The claim seeks declarations of breaches to this effect, as well as an injunction to prevent further promotion of bonds until the Government complies with its duties of disclosure. No damages are sought.
There are increasingly overt expectations for companies to make fulsome disclosures concerning their approach to climate change, including governance, risk management, strategy and metrics:
- There has been widespread business convergence around disclosure under the recommendations of the Task Force on Climate-Related Financial Disclosures (known as the TCFD Recommendations). The TCFD Recommendations require companies to disclose qualitative data, including scenario analysis, which identify risks based on differing climate change-driven scenarios.
- Regulators are setting more explicit expectations concerning climate change disclosures. For example:
- In April 2019, the AASB and AuASB republished a guidance document in relation to how climate-related risks should be considered in the context of financial statements, including their potential impact on the amounts recognised and associated disclosures.1
- In August 2019, ASIC updated Regulatory Guidance 228 and Regulatory Guidance 247 to outline ASIC's expectations that climate issues will be considered as a systemic risk that could impact an entity's financial prospects for future years and will be addressed as part of strategic reviews and reporting on strategy.2
- In February 2020, APRA announced it is preparing a new prudential practice guide aimed at encouraging regulated entities to better prepare for climate risks.
- The fourth edition of the ASX Corporate Governance Principles and Recommendations applies to annual reports for the first full financial year after 1 January 2020. They encourage ASX listed companies to disclose (or explain why they do not disclose) whether they have material exposure to social or environmental risks, and how they intend to manage the exposure. The Corporate Governance Principles endorse the TCFD Recommendations as a framework for considering climate change risk for the purposes of making these disclosures.
- While not specific to Australia, there is growing interest within the investment community in whether companies are adequately assessing and reporting climate change risks. Investors are increasingly requesting climate change-related disclosure, benchmarking performance and pressing for improvement on this front.
- The Investor Group on Climate Change (IGCC), for example, a collaboration of more than 70 institutional investors from Australia and New Zealand with total funds under management of over $2 trillion, is encouraging investors to implement a climate change policy and to report against the TCFD.
- In his 2020 letter to CEOs, BlackRock Chairman Larry Fink announced BlackRock’s intention to require the companies it invests in to disclose sustainability information and climate-related risks, and noted that BlackRock will be 'increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them'.
There have also been recent recommendations by the Climate Change Authority which propose to extend mandatory TCFD reporting to all companies in Australia (public or private), and to create supplementary guidelines to improve the quality of disclosures. However, we do not expect that these recommendations will be adopted in the short term.
No Australian court has yet considered whether directors' duties require a director to take into account climate change-related risk that may be relevant to the company’s business. However, legal opinions commissioned by the Australian think tank, the Centre for Policy Development, and authored by barrister Noel Hutley SC, have concluded that climate change risks may be relevant to a director’s duty of care and diligence to the extent that they interact with the interests of the company. In such cases, company directors should be considering the impact of climate change risks on their business, or else risk breaching their obligation to exercise care and diligence. Hutley's opinions have generally been endorsed by the Australian financial regulators.
A stepping stone towards the kind of climate change class action we have identified as a threat on the horizon
The proceedings have been commenced by Ms O'Donnell on her own behalf, and as representing other holders of, and investors in, AGBs who have the same interest in the proceeding.3
The prevalence of disclosure class actions and their impacts upon companies are well known. For example, the Australian Law Reform Commission's 2018 Report: Integrity, Fairness and Efficiency—An Inquiry into Class Action Proceedings and Third-Party Litigation Funders4, devotes a chapter to the commercial dynamics behind, and impacts of, shareholder class actions. The current Parliamentary Joint Committee on Corporations and Financial Services Inquiry into Litigation Funding and the Regulation of the Class Action Industry is also exploring these issues.5
The possibility of class actions relating to non-disclosure of business risks of climate change has been a threat on the horizon for some time.6
There is a reasonably clear template for shareholder class actions concerning the disclosure of governance issues and their financial implications. Consistent themes in the architecture for claims of this kind are:
- first, a financial disclosures lens – a claim that the governance or risk management issues gave rise to a risk of future financial consequences in the form of possible fines, reputational damage or lost business and should therefore have been disclosed; and
- second, there is a governance and risk management disclosure lens. This usually has two aspects to it:
- There is a general allegation that governance and risk management processes were ineffective, and this was itself material information that ought to have been disclosed; and
- There is an allegation that what was said about governance and risk management systems, eg in Corporate Governance Statements, created an implied representation that the systems would be 'effective', which must have been misleading (because, it is said, they were not).
This template is easily adapted for climate-related disclosures:
- there is a financial disclosure lens to climate change disclosures concerning the future financial risks of climate change (see eg the Australian Accounting Standards Board guidance and TCFD Recommendations referred to above);
- there is also a climate change governance and risk management disclosure lens (see eg the Corporate Governance Principles and ASIC regulatory guidance referred to above).
It is also worth noting the broader momentum towards litigation of climate-related issues:
- we have seen significant class action activity from people affected by issues that may have some climate change overlay: fires, floods and other environmental catastrophes where there is a reasonably proximate corporation to sue, such as a power company or dam operator.
- we have also seen activists use litigious and semi-litigious processes, including two complaints against banks concerning disclosure issues and one against a superannuation fund.
The proceedings appear to be primarily an advocacy piece (borne out by the fact that the plaintiff is not seeking damages). In this regard, they bear some relation to the complaint issued in May last year by the UK non-profit Client-Earth to the UN Human Rights Committee against the Australian Federal Government in relation to its response to climate change.
There will be some significant hurdles for the claimant to overcome to succeed in the claim. These include that the plaintiff will need to establish there was a 'reasonable expectation' in all the circumstances that the climate change-related risks would have been disclosed to potential investors and holders of AGBs. She will also be required to put forward a clear allegation as to what the particular information was that ought to have been disclosed.
Given that climate change-related risks by their nature are complex, and are more likely to crystallise over the longer term, the plaintiff is likely to face challenges in establishing that a reasonable expectation of a particular disclosure existed, and that such an omission was material as to future financial consequences. It may be difficult to navigate which facts are material enough to warrant disclosure, and to what extent future possibilities are sufficiently certain to warrant disclosure. Prospects of success might be higher in a corporate disclosure context, given that climate change-related exposure might be more foreseeable in the operational context.
Importantly, however, this claim does not make any claim for compensation. Accordingly, it does not need to grapple with the challenges of extrapolating a quantification of climate-related loss and damage to a business into the loss and damage suffered by its shareholders that is attributable to a non-disclosure.
On the duties aspect of the claim, and the read-across risk for companies, it is well established that companies are required to consider and manage material risks to the business. Listed entities are expected to have in place a sound risk management framework, and to review the effectiveness of that framework periodically. Risks presented by climate change to financial services and products are merely another category of risk that should be considered, managed and, where appropriate, disclosed.
That said, this proceeding (and others like it) should not be dismissed as insignificant.
- Firstly, they demonstrate increasing creativity in the approach of environmental activist litigants, and an interest in pursuing government bodies and corporates directly. In light of the increasing focus on risks presented by climate change, governance and systems are likely to come under scrutiny, particularly in the event a climate change-related risk crystallises.
- Secondly, they workshop principles and approaches (and may create precedents) that can be leveraged by more commercially-focussed climate change class action claims.
The move by regulators (discussed above) to broaden the basket of what climate related risks and issues a company ought reasonably to be aware of, and which should be disclosed, is creating more detailed disclosure that can be analysed by plaintiff firms with the benefit of hindsight.
- Does your organisation have systems in place to regularly confirm its disclosure practices meet market and regulatory standards as this area continues to evolve?
- Does the Board regularly consider climate change matters and risks, including when discharging their duty to act in the best interests of the company, and are there appropriate processes to ensure a timely flow of material climate change-related information from management to the Board?
- Considering statutory duties, regulatory guidance and voluntary commitments through (for example) UNPRI, should your organisation adopt TCFD reporting?
- Are adequate systems in place to provide assurance on the accuracy and completeness of climate-related disclosures?
- Does your organisation engage in periodic testing of those systems?
- Has your organisation considered who may rely on climate-related disclosures (or absence of climate-related disclosures), and satisfied itself that those people will not be misled in substance by your organisation's current reporting?
- If your organisation does not currently report, should it have a roadmap which sets out how it intends to progress towards reporting in the future? Is there an identified trigger point?
Please reach out to one of our experts below if you would like to discuss any climate change matters relevant to your organisation or industry, or to help in answering some of the questions above.
Climate-related and other emerging risks disclosures: assessing financial statement materiality using AASB/IASB Practice Statement 2 April 2019.
RG 228 'Prospectuses: Effective disclosure for retail investors'; and RG 247 'Effective disclosure in an operating and financial review'
While the proceeding was a representative proceeding, it is not clear whether the matter is intended to be run pursuant to the conventional class action procedures provided in Part IVA of the Federal Court of Australia Act 1976 (Cth).