Readers of this blog well know that one of the current hot topics in the world of D&O is ESG – and not just in the United States, but in Europe, and elsewhere as well. In the following guest post, Persia Navidi, Partner in Insurance, Cyber and Climate Risk at Hicksons Lawyers, provides an overview of the state of play with regard to ESG in Australia, and also discusses the related insurance issues. I would like to thank Persia for allowing me to publish her article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is Persia’s article.
It has been an eventful year thus far in the world of ESG, and in particular climate risks in Australia. Regulators continue to target greenwashing and we’ve a seen a rise in climate-related litigation, including enforcement actions commenced by regulators. We’ve also seen the Australian Government turn its focus to the disclosure of climate-related financial risks and announce the development of sector-based decarbonisation plans to support its plans to reach net zero by 2050.
Globally, the International Sustainability Standards Board (ISSB) introduced the long-awaited global standards for climate and sustainability-related disclosures and we’ve continued to see landmark litigation against companies and their directors overseas. In this article, we delve into what these latest developments, in particular the introduction of the ISSB standards, mean for Australian companies, directors and their D&O insurers.
Recent developments in Australia on the topic of climate risks and, more broadly, ESG, have been significant.
In 2022, the Australian government introduced laws regarding Australia’s targets to reduce greenhouse gas emissions by 43% by 2030 (compared with 2005 levels), and also to achieve net zero by 2050.
In March 2023, the Senate referred the issue of greenwashing for inquiry, with a report due by 5 December 2023.
Regulators such as the Australian Securities Investment Commission (ASIC) have made it abundantly clear that they are targeting corporate greenwashing.
ASIC – civil penalty proceedings commenced against Mercer Super
ASIC announced that its 2023 enforcement priorities would centre around action against greenwashing and the regulator has followed through on that promise, instituting its first civil penalty proceeding relating to greenwashing against superannuation fund, Mercer Super in February 2023. The proceedings allege that Mercer made false or misleading representations that funds invested in its ‘sustainable plus’ options were not invested in companies involved in, or deriving profit from, the production or sale of alcohol, gambling, or extraction or sale of carbon intensive fossil fuels. ASIC alleges Mercer failed to ensure all asset classes were excluded from investing in such companies.
ASIC – civil penalty proceedings against Vanguard Investments Australia
In July 2023, ASIC initiated a second civil penalty proceeding, this time against Vanguard Investments Australia, alleging misleading conduct in relation to claims about certain ESG exclusionary screens applied to investments in a Vanguard fund. Specifically, it is alleged that it made false and misleading statements and engaged in conduct liable to mislead the public in representing that all securities in the Vanguard Ethically Conscious Global Aggregate Bond Index (Index) were screened against certain ESG criteria. Vanguard claimed the Index excluded issuers with significant business activities in a range of industries including those involving fossil fuels, but ASIC alleges that ESG research was not completed for a significant portion of issuers of bonds in the Index and therefore the fund, meaning that these bonds exposed investor funds to investments which involved fossil fuels and activities linked to oil and gas exploration.
ACCC – draft guidelines released
The Australian Competition and Consumer Commission (ACCC) has similarly cracked down on greenwashing. In March 2023, the ACCC released results of its ‘internet sweep’ into greenwashing, which found that 57% of the businesses reviewed were making potentially misleading environmental claims. Following these findings, the ACCC has published a “draft guidance for business” to improve the integrity of environmental/sustainability claims made by businesses and protect consumers from greenwashing. The draft guidance identifies 8 principles which the ACCC encourages businesses to apply when making environmental claims which, if followed, will result in businesses being less likely to mislead consumers and contravene the Australian Consumer Law, according to the ACCC.
With increased regulator, investor and consumer scrutiny and highly publicised greenwashing interventions, there has also been the growth of another phenomenon known as ‘greenhushing’. This is where companies minimise their environmental commitments (or the publicity of their environmental commitments) in the hope that this will lower the risk of being targeted by regulators, investors and climate activists.
This practice is unlikely to solve the greenwashing issue for most corporations, particularly given that they remain subject to continuous disclosure and other obligations under the Corporations Act 2001 (Cth) (Corporations Act) and ASX Listing Rules. As stated by the ASIC chair, “… greenhushing is… just another form of greenwashing, and risks misleading by omission. Silence … and failing to engage isn’t the answer”.
Australian Centre for Corporate Responsibility v Santos
In Australia, in addition to the two proceedings commenced by ASIC mentioned above, the proceedings commenced by the ACCR against Santos in 2021 alleging, amongst other things, that Santos’ net zero roadmap was misleading or deceptive, continues to move through the court. This was the first court case in the world to challenge the veracity of a company’s net zero emissions plan. The outcome of this case is one to watch closely, particularly as any judgment will provide invaluable insights into how Australian courts are likely to adjudicate greenwashing litigation.
ClientEarth v Shell’s Board of Directors
Overseas, we saw a derivative action commenced in February 2023 by ClientEarth against Shell’s board of directors in the UK. It is alleged that the directors breached their legal obligations under the UK Companies Act. It is the first case of its kind, seeking to hold the directors personally liable for alleged failure to manage the risks that could impact the future success of the company. The English High Court dismissed the case, however ClientEarth was granted an oral hearing at the High Court to have it reconsider their dismissal. In July 2023, the Judge maintained his decision. ClientEarth will now seek leave to appeal against the High Court’s decision.
Disclosure of climate-related financial risks – what’s next?
In 2021, the ISSB was established to develop a comprehensive global baseline of sustainability disclosures.
On 26 June 2023, the ISSB issued two disclosure standards – IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information (IFRS S1) and IFRS S2 Climate-related Disclosures (IFRS S2).
In brief, these standards aim to require companies to disclose information about its sustainability-related and climate-related risks and opportunities that is useful for investors, shareholders, and others who rely on their financial reports in making investment decisions.
What do IFRS S1 and IFRS S2 mean for Australian businesses?
The release of IFRS S1 and IFRS S2 is set to have a significant impact on Australian companies. ASIC has been vocal in supporting the ISSB’s development of global standards. As put by ASIC chair, Joe Longo “the nation is in the centre of a once-in-a-generation shift in financial reporting and disclosure standards” and incoming changes “won’t look kindly on those who aren’t prepared.”
While IFRS S1 and S2 are not yet mandatory in Australia, they provide a guide for Australian businesses on best practice for disclosure of climate-related financial risks until such time that the government introduces a reporting framework into law.
Consultation Paper – Climate-related financial disclosure
Recent consultations from the Australian Treasury suggest that mandatory reporting of climate related financial risks will be introduced in Australia on 1 July 2024.
In December 2022, the Australian Treasury issued its first consultation paper on Climate-Related financial disclosure, where it considered the possibility of a mandatory climate change disclosure regime.
Fast forward to June 2023, and directly following release of IFRS S1 and IFRS S2, the Treasury released a second consultation paper (second consultation paper), seeking views on the implementation of standardised disclosure of climate-related financial risks and opportunities in Australia. The Treasury has been transparent about its intention to align “Australian standards…as far as practicable with the final standards developed by the ISSB.”
It specifies that mandatory reporting requirements will commence from 1 July 2024 for Australia’s largest listed and unlisted companies and financial institutions, with other businesses phased in by 2027/2028, and all impacted organisations to be reporting climate disclosures by 2030-31.
The second consultation paper offers 12 proposals, some of which include:
- There will be a requirement to:
- disclose information about governance processes, controls and procedures used to monitor and manage climate-related financial risks and opportunities.
- use qualitative scenario analysis to inform their disclosures, moving to quantitative scenario analysis.
- disclose information about any climate-related targets (if they have them) and progress towards these targets.
- disclose information about material climate-related risks and opportunities to their business, as well as how the entity identifies, assesses and manages risk and opportunities.
- disclose material scope 3 emissions for all reporting entities from their second reporting year onwards.
- From commencement, transition plans would need to be disclosed, including information about offsets, target setting and mitigation strategies.
- From commencement, scope 1 and 2 emissions for the reporting period would be required to be disclosed.
- Climate-related financial disclosure requirements would be drafted as civil penalty provisions in the Corporations Act. The application of misleading and deceptive conduct provisions to scope 3 emissions and forward-looking statements would be limited to regulator-only actions for a fixed period of three years (i.e. private litigants will not be able to commence civil proceedings during that period).
Liability and Litigation
Proposed civil penalty regime
From a liability and litigation standpoint, the second consultation paper acknowledges that climate disclosures fall within the ambit of directors’ duties, misleading representation provisions and reporting requirements. However, to ensure that companies are not overly cautious with disclosures that do not meet the need and expectations of the market or investors, it is proposed that new climate reporting requirements will be drafted as civil penalty provisions in the Corporations Act.
In the proposed new laws, directors would be afforded protections in civil proceedings under the Corporations Act in circumstances where they have acted honestly. As outlined above, it is also proposed that reporting on scope 3 emissions will have a three-year exemption period whereby directors will be protected from misleading or deceptive conduct/false or misleading representation claims brought by private litigants (ASIC would still be allowed to take action where appropriate).
The introduction of a civil penalty regime will no doubt lead to more insurance claims in time, something for D&O insurers to be cognisant of when assessing their portfolios for 2024 and beyond.
What about the ‘S’ in ESG?
When talking about ESG, there is often a heavy focus on the ‘E’ element, with less said about the ‘S’ and ‘G’ aspects. In Australia, litigation that falls under the ‘S’ category is nothing new. There is a long history of litigation arising from an organisation’s social policies, including gender-based or other discrimination.
We are, however, in the midst of a generational shift in community, societal, worker, and wider expectations on matters such as diversity and inclusion and workplace culture. As society shifts, and new laws are introduced, the nature of the ‘S’ risks also evolve.
In Australia, we’ve recently seen the introduction of a positive duty on employers to prevent unlawful conduct from occurring in the workplace or in connection to work, including taking reasonable steps to prevent sex discrimination, sexual harassment and victimisation.
Millions of Australians – individuals and organisations – have also been victims in large-scale cyber-attacks in 2022 and 2023. The question is, are cyber and AI risks classified as ESG risks that fall under the ‘S’ umbrella? To the extent that a cyber incident has the potential to impact workers at an organisation through the leaking of personal information, data and privacy, it is arguable that cyber risks could fall under an organisation’s responsibilities under the ‘S’ umbrella of ESG.
Similar to ‘greenwashing’, there is also a growing risk of various other iterations of ‘washing’, including ‘social washing’, which is where organisations present themselves as taking a certain stance publicly on a social issue when in actual fact these statements do not match the organisation’s actions. As more organisations adopt broader social policies, the likelihood of increased regulator action and litigation is also increased.
In the US, there has been significant litigation under the ‘S’ banner, including enforcement action brought by the Securities Exchange Commission (SEC) against the case against Activision Blizzard. The video gaming company agreed to pay $35m to settle an SEC enforcement action for matters including an alleged lack of internal controls and procedures to ensure that workplace misconduct would be assessed and disclosed in a timely manner. This came after allegations of gender-based discrimination and harassment at Activision.
Although we are yet to see consistent ‘S’-based litigation or enforcement action to a comparable large scale in Australia, it is nonetheless a risk that Australian companies should be mindful of – particularly given Australia’s fertile class action environment. ASIC has recently raised concerns with the responsible entity of a managed fund for using vague terms such as ‘social diversity’ when describing its investment approach. Company directors and their insurers should therefore proactively consider, and be mindful not to overlook the ‘S’ risks when assessing ESG, as it is likely something regulators will be looking to target into the future.
What do these developments mean for company directors and their insurers?
The developments of 2023 to date have been significant, as ESG continues to move at a rapid pace in Australia. The following points should be front of mind for company directors and their insurers:
- Insurers of companies likely to be impacted by mandatory disclosure of climate-related financial risks should be mindful of developments as to mandatory reporting in Australia as any new laws have the potential to impact many insureds (starting with larger organisations) from 2024 onwards.
- Insurers should pre-empt what’s to come and manage the risk by reviewing their portfolios and identifying which organisations are likely to be impacted by mandatory disclosure. This includes assessing which insureds are likely to have an increased risk of liability with the proposed introduction of a new civil penalty regime.
- Companies and their directors should have a plan for managing reporting of climate risks, (if they are not already reporting on these risks), and for the transition to mandatory reporting frameworks likely to be introduced in 2024.
- Climate risk management plans should be readily communicated with insurers to assist not only in assessing their potential exposure or risk of potential liability once mandatory disclosure laws are introduced, but also to demonstrate that they are proactively managing the risks.
- Many organisations make forward-looking statements about their net zero commitments and targets they hope to achieve by a date in the future (that date is often ‘2030′). We are therefore likely to see greenwashing litigation resulting from such statements manifesting in or around 2030.
- Insurers should be mindful of trends and developments that fall under the ‘S’ umbrella of ESG. As generational ideologies and community expectations evolve, the potential for litigation arising from an organisation’s social policies is also likely to increase.
Persia Navidi is a Partner in Insurance, Climate & Cyber Risk at Hicksons Lawyers.
With over 12 years’ experience in insurance, Persia specialises in insurance law and litigation, speciﬁcally claims arising from directors’ and officers’ liability insurance. Persia works with both Australian and global insurers and acts in complex claims and disputes.
Persia’s expertise extends into emerging risks, including climate and cyber risks and their impact on insurers and insureds. As boardroom accountability for both climate and cyber risks continues to evolve, Persia works with clients to effectively respond to, manage and mitigate the risks as a trusted legal adviser.
Persia regularly speaks at industry events on legal issues and developments relevant to insurance, climate/ESG and cyber. Persia was named as a ‘Rising Star’ in the Insurance Business Australia Rising Star Award 2022 and was elected as a committee member for the Australian Professional Indemnity Group in 2023.
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