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Managing ESG Risk - the importance of accurate and transparent disclosures

A significant risk associated with embarking on your corporate environmental, social and governance (ESG) journey is over promising and under delivering. Stakeholders are increasingly, and publicly, calling corporations to account for statements made in relation to carbon reduction limits or sustainability performance. Whilst the focus may be tilted heavily to the emissions part of the ‘E’ at the expense of the ‘S’ in this equation, and some activities a little too critical of companies undergoing transition; the activism does highlight the risk ESG creates for board. The importance of exercising due care and good judgement in reviewing and signing off a corporate strategy, and subsequent communications on commitments and achievements, is evident. This article examines some of the governance risks when considering your ESG strategy. 

Recent legal activity 

In August 2021, the Australasian Centre for Corporate Responsibility filed a Federal Court action challenging the veracity of net zero emissions targets set by Santos. The proceedings, a world first of this type, relied on several complex legal issues, but the takeaway for boards is the risk of greenwashing claims about corporate statements on greenhouse gas emissions or sustainability targets. Reliance upon these corporate statements has significant financial implications for investors (both private and institutional) and boards must be prepared for investor activism to increase. 

On 4 November 2021, the Federal Court ordered the Commonwealth Bank to provide access to internal bank documents relating to seven oil and gas projects.1The purpose of access was stated to enable investor scrutiny of the bank’s compliance with its net zero climate change policy. This is a far-reaching decision as it opens a new path of governance oversight, allowing investors to look under the hood and test corporate statements. 

Governance implications 

Boards should plan for an increased risk of activism, either at AGMs or in the courts. Australia is something of a tinderbox for climate change litigation with a class action lodged against the Commonwealth for not disclosing the risks of climate change to sovereign bond investors.2The recent decision in Sharma3 further highlights the willingness of private citizens to explore novel arguments and means of challenging government approvals of projects with large carbon footprints. 

This raises another risk for boards - deciding how and at what pace to decarbonize. As the Santos application demonstrates, once the decision has been made to move to net zero, it will be scrutinised for accuracy and veracity.   

Looking at overseas developments, a range of sectors have faced customer and even employee scrutiny. From airlines (Ryanair), to banks (Deutsche Bank) and fashion companies (Allbirds), the complaints and subsequent legal filings have arisen from distrust of sustainability claims made by corporations. 

Managing risk

Whilst the outcome of these cases is yet to be determined, the risks have materialised. ESG is no longer a single blanket risk for boards. It can manifest in a range of ways including reduced access to finance, stakeholder requests for information, shareholder motions at AGMs, complaints and litigation. 

The very clear message to boards is to take the ESG journey seriously. The board’s ESG strategy requires deliberate planning to:

  • understand activities and impacts; 
  • resolve the methodology for setting metrics and measurement; 
  • determine baseline data; 
  • resolve target priorities over a three to five year horizon; and 
  • inculcate the strategy and actions into the whole of the organisation.  

This is the preparatory work before statements are considered and targets set. 

Further, ESG risk is not a risk limited to the oil and gas sector or the airline industry. As Allbirds, the manufacturer of woolen sneakers has discovered, the sustainability claims about its wool producers (and thus suppliers) has been challenged in a New York Court. This case highlights the interconnectedness of environmental stewardship and social impact. 

What next?

ESG may have been on the horizon for a few years, but it can no longer be ignored by boards. There are aspects of technical knowledge in understanding the assessment and measurement of corporate environmental and social impacts. It is reasonable for board members to come to the table without this knowledge, however it is also reasonable to expect directors to seek out information and reach an agreed level of understanding on ESG across the board.  

Effective Governance provides tailored governance training and support to board wherever they find themselves on their ESG journey. Contact our team for more information. 

1Abrahams v Commonwealth Bank of Australia [2021] FCA 

2O’Donnell v Commonwealth of Aust (2021) FCW 1223
3Sharma v Minister for the Environment [2022] FCAFC 35 (15 March 2022)

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