This update forms part of our #COUNTDOWNTOCOP26 series of articles on the risks and opportunities organisations may face in the transition to a low carbon economy. M&A partner Gillian White and professional support lawyer Rosie Graham look at prospective new requirements for climate change disclosures, at the growing trend for companies to embed their ESG ambitions in their constitution, and at a new legal drafting project generating a bank of climate-aligned clauses.
Climate change disclosures
Companies and boards are increasingly under pressure to assess their climate change risk and report on it. There are several different drivers:
- Regulators are likely to impose more onerous climate change reporting and other requirements.
- Investors increasingly require companies to report on climate-related financial risk and their proposals for addressing it.
- The expectations of a varied group of stakeholders, which may include employees and workers, customers, consumers and climate activist groups.
- Physical risks from climate change, including damage to assets and operations, and the potential associated impact on the company's business, its supply chains and the availability of insurance.
- The requirements of potential buyers or partners in M&A or joint venture activity.
As COP26 draws nearer, and following the publication of the IPCC report "Code Red for Humanity", we expect that calls for climate-related corporate accountability will only increase in volume and urgency.
More positively, we are seeing a whole panoply of new developments being driven by the climate change imperative, most obviously the need for cleaner energy. These may present business and market opportunities for companies. To spot and exploit these opportunities, companies need to be outward-looking, agile and open to change.
Although it can be convincingly argued that climate emergency is the single biggest issue facing humanity, climate change is just one of several environmental factors within the concept of ESG – the range of environmental, social and governance factors against which the behaviour of companies can be measured. Over time, all companies will need to demonstrate that they carefully consider the risks and opportunities they face in confronting climate-related and wider ESG issues. Climate change in particular, and ESG in general, needs to be on every board's agenda.
Specific requirements around reporting will vary from sector to sector, and many companies will have been reporting on, for example, their energy use and greenhouse gas emissions for several years. However, there has to date not been a uniform approach to reporting more general climate disclosures. This looks set to change, as the voluntary standards for reporting established by the Taskforce on Climate-Related Financial Disclosure (TCFD) are increasingly being adopted. The TCFD has developed four recommendations on climate-related financial disclosures that are applicable to organisations across sectors and jurisdictions. The recommendations are structured around four thematic areas: Governance; Strategy; Risk Management; Metrics and Targets. These four core areas are supported by 11 recommended disclosures and accompanying guidance.
In the UK, reporting in line with the TCFD recommendations on a comply or explain basis is currently mandatory only for commercial companies with a premium listing on the London Stock Exchange. However, the UK government intends to extend the requirements to quoted companies and large private companies and LLPs. It intends to make the necessary regulations by the end of 2021. The requirements will come into force on 6 April 2022, and apply to accounting periods starting on or after that date.
Companies and LLPs which are within the scope of the new requirements will be required to disclose climate-related financial information in line with the four core TCFD recommendations:
- Details of the governance arrangements that they have in place to identify and manage risks and opportunities arising from climate change.
- Details of who has operational responsibility for climate change, including the experience of that executive or committee.
- If the company has an audit committee, whether climate change is a matter considered by it.
- A brief description of the company's business model and strategy.
- A description of how the business model and strategy may change in response to the effects of climate change and the trends and factors that affect this.
- A description of the principal risks and principal opportunities, including material financial risks and opportunities, relating to transition risk, physical risk and regulatory risk arising from climate change which may affect the business and a description of how the company manages those areas of risk and opportunity including:
- A description of its business relationships, products and services which are likely to cause adverse impacts in those areas of risk
- A description of how it manages the principal risks
- A description of the risk management policies pursued by the company in relation to climate change, any due diligence processes implemented by the company in pursuance of those policies and a description of the outcome of those policies.
Metrics and targets
- A description of the key performance indicators relevant to the entity's exposure to climate change risk and opportunity, and the targets set by the business for those key performance indicators.
The B Corporation Movement
Stakeholder expectations are one of the most powerful drivers for increasing ESG accountability. There are currently record levels of interest in attaining certified B Corporation status. A company which achieves this is sending a powerful signal to consumers, workers and investors alike that it is legally required to consider the impact of its decisions on its workers, customers, suppliers, community, and the environment. To achieve B Corp certified status, UK companies must go through a three-stage process (outlined on the B Corporation UK website at https://bcorporation.uk ). This includes embedding a positive benefit obligation in the company's constitution, stating that the company's objects include its business and operations having a "material positive impact" on society and the environment.
The B Corporation movement is spearheading a move to extend this concept so that all UK companies would have a legal responsibility to balance purpose with profit. The change it wants to see involves a key section of the UK Companies Act 2006 which sets out the duties that directors owe their companies. S. 172 of the Act provides that directors must act in the way they consider most likely to promote the success of the company for the benefit of its members as a whole. "Success" for a commercial company is generally interpreted as meaning a long-term increase in value. Directors are legally obliged to consider wider stakeholder interests, but the interests of shareholders take precedence over stakeholder interests if there is any conflict between them. The Policy Council of B Lab (UK) wants this section to be recast so that the directors' duty will be to "advance the purpose of the company", replacing the duty to promote its success. The purpose of a company would be not only to benefit its members as a whole, but to do so whilst operating in a manner which:
- Benefits wider society and the environment (commensurate with the size of the company and the nature of its operations); and
- Reduces the harm the company creates or costs it imposes on wider society or the environment, with the goal of eliminating any such harm or costs.
This would establish a mandatory "triple bottom line" for all companies, requiring them to operate their businesses for the benefit of wider society and the environment as well as shareholders.
Even without a change in the law, and without undertaking the B Corp certification process, company owners can still change the company's constitution to make it clear that directors who exercise their powers with an eye to benefiting wider society and the environment, as well as to increasing the company's value, will not be in breach of duty.
The Chancery Lane Project
The Chancery Lane Project is a ground-breaking initiative to develop new legal drafting to help fight climate change. A collaborative effort by lawyers around the world, it produces climate-aligned clauses which are free to download and use. At present, the website (https://chancerylaneproject.org ) includes 70 model clauses which can be incorporated into commercial agreements, 46 standard climate-related definitions which can be used in drafting climate-aligned provisions, and 10 model laws intended to inspire law and policy-makers considering climate issues. A suite of new clauses will be launched to mark COP26. Howard Kennedy is among the many law firms giving their expertise and time to the project on a pro bono basis.