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Climate risk governance

An actionable imperative for boards

RFP
Mata Atlantica - Atlantic Forest in Brazil Boards have an important role to play as companies take steps to address the physical and economic transition risks driven by climate change. Public and private companies alike face increased calls for information and progress on climate issues from a broad swath of stakeholders including not only investors, but also customers, employees and communities. Understanding the macroeconomic issues related to the financial exposure organizations face from climate change is imperative. As board oversight responsibility expands to governance over climate-related risks and opportunities, it is critical for directors to ensure they are well-positioned to address these new challenges.

On March 21, 2022, the SEC proposed disclosure requirements for public companies. Among other requirements, the proposed rule calls for companies to disclose more information related to climate change governance, strategy and risk management. Given the prominence of the board’s role in these disclosure topics, it is necessary to consider the board’s oversight role as it relates to the risks and opportunities posed by climate change.

The role of the board In recent years, enterprise risk has become more complex and interdependent. A critical emerging enterprise risk for many companies is climate change. Boards should understand and fully address their fiduciary responsibilities as it relates to the oversight of climate-related risks. Accordingly, each director must have a common understanding of their individual, committee, and overall board responsibility related to climate risk oversight.

Appropriate board governance may require additional training for directors or recruitment of members with the requisite knowledge and skillsets to provide robust oversight of management as the company identifies and responds to climate-related risks and opportunities. Boards have assigned governance responsibilities in different ways: some boards have formed specific environmental, social and governance (ESG) committees, others have assigned the responsibilities to existing committees, while others have left the responsibilities with the full board.

As boards navigate their approach to climate-risk governance, questions to consider may include:

  • How does the board oversee overall enterprise risk management?
  • How does the board oversee risks and opportunities related to climate change; in particular, how does the board ensure all members have an awareness and understanding of climate risk?
  • How does the board integrate climate change risks and opportunities into overall enterprise risk management?
  • Are there particular risks or opportunities related to climate change that require focused attention from the board?
  • Do external stakeholder expectations, such as investor mandates or shifting customer preferences, warrant focused attention from the board?

Oversight of management’s response to climate risks and opportunities While the board is responsible for the governance of climate-related risks and opportunities, management is tasked with the design, implementation, and execution of the organization’s response. To assess the adequacy of management’s approach, directors may ask questions such as:

  • How is climate risk integrated into the organization’s enterprise risk management program?
  • What climate-related requests have emerged from investors and other stakeholders?
  • What are the risks and opportunities along the organization’s value chain? For example, are key suppliers at risk? Are there opportunities to increase market share related to investing in renewable technology? Are key customers looking for more sustainable options?
  • How does the workforce view the company’s commitment to environmental sustainability?

As stakeholder sentiment and expectations are rapidly advancing, it’s important to revisit these topics with management on a periodic basis — and communicate that intention to management.

The board may also need to consider the effectiveness of the company’s actions and its performance against climate-related goals. In instances where the company has not made as much progress as expected, the board should understand the cause. In cases where there may be a lack of organizational commitment or buy-in, the board may consider what support it can provide to management to facilitate progress. For example, to drive organizational commitment, some companies now include sustainability targets in executive management’s compensation plans. If the board is not yet ready to implement sustainability into management’s compensation, it may still articulate to management its expectations regarding periodic updates against the company’s plans and the specific data points it would like to see.

Guiding external disclosures Companies have become more attuned to the relevance of climate change, evidenced by increased voluntary disclosures on climate risk and the related opportunities. Climate change disclosure has expanded rapidly in recent years; in their 2020 sustainability disclosures, 397 companies within the Russell 1000 Index indicated that they responded to the CDP (formerly Carbon Disclosure Project) and, of the 92% of companies in the Russell 1000 Index that produce a sustainability report, 38% referenced the Task Force for Climate-related Financial Disclosure (TCFD). Directors and management of private companies face increased focus on sustainability and climate risk from private equity firms, lenders and customers. While SEC disclosure rules may not apply to private companies, the expectation to develop, execute and report on the company’s climate strategy and related progress remains.

Since early 2021, the SEC has signaled an increased focus on climate change disclosures, reminding registrants of their existing disclosure obligations under the SEC’s current principles-based disclosure requirements and also highlighting areas of comment in SEC filing reviews. These initiatives, paired with the newly released proposed rule, are in response to investor outcry for consistent, comparable climate disclosure. The SEC rule will bring both increased scrutiny to climate change risk disclosures and clarity to investors and other stakeholders seeking to understand and compare risk exposure across companies.

Regardless of whether the disclosure is voluntary or required, boards should provide appropriate oversight of external disclosures and be cognizant of potential legal risks related to sharing materially incomplete or misleading information. To promote fair and balanced disclosure, boards should encourage the use of accepted disclosure frameworks and standards. In the case of voluntary disclosure, boards may ask management how various disclosure options were evaluated. In all situations, the board should understand how management ensured that disclosures fairly portray the company’s environmental footprint, strategy and progress, and how management provided appropriate review of external disclosures.

Boards may also encourage management to look at climate-related data and disclosure as a tool. Proactive companies stand to derive significant benefit from collecting, analyzing, and acting on climate-related information. For example, understanding the main sources of the company’s carbon footprint and finding ways to reduce its overall environmental impact may drive value for customers, employees, and local communities. Boards may ask management to consider how climate-related data could influence the company’s decision-making or how the metrics and targets identified by management help the company manage climate risk.

Increased investor scrutiny With investors focused on sustainability, and climate risk in particular, directors may face increased scrutiny in this and future proxy seasons. Directors may be held accountable if their organizations fail to address climate change appropriately. Large asset managers, such as BlackRock, State Street and Vanguard, have recently shared their 2022 voting policies, which include increased expectations around climate change disclosure.

 
BlackRock
We ask every company to help its investors understand how it may be impacted by climate-related risk and opportunities, and how these factors are considered within strategy in a manner consistent with the company’s business model and sector. Specifically, we ask companies to articulate how their business model is aligned to a scenario in which global warming is limited to well below 2°C, moving toward global net zero emissions by 2050.
Vanguard
Boards need to get smart on climate risk. This means having directors with relevant expertise, participating in ongoing climate education, and maintaining perspectives that are independent of management. We expect active, independent monitoring of climate issues and integration of climate risks into strategic and financial planning.
State Street
Starting in 2023, we will be prepared to hold directors accountable if these companies fail to show adequate progress on meeting our disclosure expectations. Through our engagements, we will aim to better understand climate transition plans and strategies, and gain insight on each company’s unique set of climate-related risks and strategic opportunities presented by the transition. Where relevant, our expectations will be used to inform our assessment of issuer climate transition plan disclosure and related shareholder proposals.

Similar announcements have been made by proxy advisory firms such as ISS and Glass Lewis, who have shared voting policies that include director accountability for ESG governance failures.

Closing thought Board-level focus on climate risk preparedness will help clarify the risks and opportunities associated with climate change. While pivoting from business as usual to a climate-risk preparedness mindset may be seen as cumbersome, it is necessary. Delaying appropriate action now may put the company at a competitive disadvantage later and could even erode shareholder and stakeholder value. Prudent boards will communicate climate change as a risk or opportunity multiplier; companies that capitalize on climate-risk opportunities may drive increased customer and employee engagement and benefit from future resilience and competitive advantage.

Contacts:

James BurtonJim Burton
Partner, ESG & Sustainability Services
T +1 303 813 3945


Marjorie Whittaker Marjorie Whittaker
Managing Director, ESG & Sustainability Services
T +1 202 521 1535


Mark LemonMark Lemon
Senior manager, ESG & Sustainability Services
T +1 703 637 2949