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Farrer & Co | When things get heated: managing climate change risk and reputation for businesses

With strikes taking place across the world today, the impact of climate change is increasingly hard to ignore. According to the 2019 Global Risk Report by the World Economic Forum (WEF), environmental threats are now the dominant global risk in terms of likelihood, and the second most dominant in terms of impact (behind weapons of mass destruction). The effects of climate change are well-known and would be difficult to overstate, and the pressure on governments and businesses to take responsibility is only going to increase.

For businesses, the failure to take action is not only a risk to environmental safety; climate change comes with unique reputational and financial threats. These will not only affect those involved in fossil fuel production or deforestation: any business with a public profile should now expect to be held accountable for its impact on the environment. In this article, we look at climate-related risks, and what businesses can do to ensure that they are not on the wrong side of the climate crisis.

Reduce your contribution (and your risk of liability)

The WEF notes that as the effects of climate change increase, “it will become increasingly difficult to treat those risks as externalities that can be ignored or shipped out.” As a result, businesses should expect to face greater repercussions for the environmental damage they cause. For those who are not actively reducing their contribution to climate change, the financial risks are increasing quickly. The UK recently passed the Climate Change Act 2008 (2050 Target Amendment) Order 2019, which will make major demands of business and industry in order to reach a zero emissions target by 2050. There is also a growing body of research on the contribution of individual companies to carbon emissions and the associated costs, such as this Cambridge study designed to help investors, “manage their exposure to climate change risk”. As these findings increase, so will the risk of liability. The US has already seen a wave of litigation from cities and states seeking damages from fossil fuel companies, and other countries are likely to follow suit. While many businesses are already affected by carbon pricing and carbon taxes, pressure to increase corporate liability for contributions to climate change is on the rise.

Demonstrate a commitment to sustainability

In addition to lawsuits, companies are also under increased pressure from investors and consumers to demonstrate an active commitment to reducing their environmental impact. Fossil fuel divestment is increasing, while initiatives like Climate Action 100+, an investor group with assets of over $30trn, are putting pressure on companies to demonstrate the action they are taking to reduce emissions, increase accountability and provide enhanced disclosure. Even for companies with a less overt link to climate change, institutional investors increasingly employ ethical investment policies aimed at minimising contribution to environmental damage. From a company’s carbon footprint and plastic consumption to the ethics of its supply chain and waste disposal mechanisms, it is now commonplace for investors to require evidence of efforts to increase sustainability and reduce environmental harm, while consumers are prepared to boycott companies that are seen to be failing to try and tackle the crisis. Climate change is also a matter of massive public interest, so organisations should be prepared for media scrutiny of their sustainability initiatives.

Communicate accountability and transparency, avoid greenwashing

With scrutiny over sustainability increasing, so is the need for companies to provide an honest account of their impact on the environment. This should include proactive disclosure on current environmental impact; measures taken to reduce this impact; and policies to increase sustainability. Section 172 of the Companies Act requires directors to have regard to, “the impact of the company's operations on the community and the environment”, and companies that do not provide honest and adequate disclosure of their impact on the environment face reputational, financial and regulatory backlash. When Volkswagen was found to have lied in emissions tests, it suffered its first quarterly loss in 15 years (as well as criminal charges and hefty fines). Meanwhile BP was accused of ‘greenwashing’ after introducing a ‘low-carbon strategy’ by cutting its operational emissions, while failing to take action on its biggest contribution to climate change – the burning of the oil and gas products it sells. A company that is upfront about its environmental impact as well as disclosing the measures put in place to tackle this can demonstrate its commitment to sustainability and improve its relationships with stakeholders, as well as minimising the chance of adverse press attention.

Governance and risk management

In addition to scrutiny over their impact on the environment, businesses also need to demonstrate active management of climate-related risk. From the contractual implications of extreme weather events to the impact of tightening environmental regulation, it is important for senior management to be aware of and plan for the increased risk posed by climate change. This should include the implementation of a climate-related risk strategy and crisis plan, and may require increasing climate competence at board level.

It is also important that climate-related financial and risk information is communicated to key stakeholders. The Financial Stability Board’s Task Force on Climate-related Financial Disclosures has developed voluntary risk disclosures for use by companies in four key areas: governance; strategy; risk management; and metrics and targets. Following these recommendations can help companies to ensure they are not falling short of the industry standards and avoid legal, reputational and financial damage, such as that currently faced by Exxon Mobil, currently being sued by the State of New York for allegedly misleading investors about its management of climate change risks.

Brexit means…disruption?

Sadly, no article about risk can avoid a discussion of Brexit. Currently, environmental regulation in the UK is heavily influenced by EU legislation and compliance with environmental standards is overseen by the European Commission and the Court of Justice. Brexit provides the government with an opportunity to follow its own path, and a draft Environment Bill was put forward in December 2018. The draft Bill has been criticised by Parliamentary Select Committees for downgrading environmental standards as well as for failing to account for the loss of EU governance mechanisms. These criticisms are currently being reviewed and revisions to the Bill are expected. In terms of what this means for business, it is important to bear in mind the disruption that Brexit may cause to current environmental regulation and to factor the impact of this uncertainty into risk assessments.

The cost factor

Tackling the climate crisis will be costly for business, but the costs of complacency are probably higher. With the financial and reputational risks associated with climate change on the rise, companies that fail to account for climate-related risk are not only a threat to the environment, they are also a threat to themselves. By demonstrating a genuine commitment to sustainability, accountability and transparency, as well as implementing adequate governance, risk and communications strategies, businesses can help to ensure a sustainable future for themselves and for others.

If you require further information about anything covered in this briefing, please contact Alicia Mendonca-Richards, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, September 2019

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