How climate risk is heating up corporate boards
Climate change has garnered considerable attention in recent times and is one that even the immediacy of Covid-19 has failed to eclipse. The fact that climate change is a significant financial risk for companies has become inescapable. As companies face increased scrutiny and accountability in the context of climate risk, the nature of their governance grows in importance and the duties and responsibilities of directors on boards of directors become essential.
The duties of directors who demand greener boardrooms
In India, Section 166 (2) of the Companies Act 2013 provides that a “director of a company acts in good faith… in the best interests of the company, its employees, shareholders, community and for the protection of the environment. “Case law surrounding this provision suggests that directors should consider the long-term interests of the company, which requires directors to identify and assess the risks emanating from climate change. and to implement strategies to deal with them.A behavior which consists in sacrificing the long-term interests of the company for the profit of short-term profitability would be against the law.
Moreover, the fact that “environmental protection” has its own place in section 166 (2) is indicative of the fact that directors are required to bring the matter to their attention regardless of the associated financial implications. Protecting the environment is just like meeting the interests of shareholders or other stakeholders. Therefore, directors do not have the right to dismiss climate change issues for the benefit of other stakeholders such as shareholders.
Company directors also have a duty of competence.
As climate change is not only a key risk for Indian businesses, but grows in importance over time, directors’ obligations to report on climate risk can undoubtedly be determined in relation to the aforementioned Indian legal framework.
Therefore, businesses in general, and those vulnerable to the effects of climate change in particular, should establish clear systems and processes to identify and manage climate risks.
This includes appropriately disclosing climate risks in accordance with well-known reporting frameworks and ensuring that they are represented in the financial statements and more generally formulating strategies to ensure that the business will operate in a resilient and sustainable manner. in a global zero carbon economy.
All of this is clear from the scope of the competency duties of directors, although the details of the degree and nature of the risk may vary from company to company. Due to the predominance of climate change as a major risk that companies face, the ignorance or inaction of directors to assess and manage risk would cause them to default on their obligations under company law.
Manage climate risks and impacts
Even if directors recognize climate risk, they may still come up with inappropriate strategies or processes to deal with the risk.
First, when directors have been made aware of material information relating to the climate risk facing their business, their duty to act prudently and diligently will require them to conduct further investigations.
When they see a proverbial “red flag”, they have a duty to investigate further as any reasonable person in their position would have. As an illustration in the climate context, a ‘red flag’ could be an important shareholder vote on a climate-related issue, inaccuracies in a report produced to the board on climate risk, or taxation. new climate-related regulations on the company that its operating currency does not respect.
Second, where directors do not have sufficient expertise to assess and manage climate risk, the performance of their competent functions would involve seeking professional advice by engaging experts.
Third, when directors delegate to members of management the responsibility of monitoring climate risks and developing and implementing strategies to deal with them, directors have a duty to supervise and supervise the delegates.
Sunlight is the best disinfectant
Companies and their directors are also required under company and securities law to disclose information relating to climate risk.
The nature and extent of the disclosure required generally depends on the question of the “materiality” of the risk.
Disclosure standards that deal with the financial risks of climate change as well as those that relate to environmental, social and governance factors have proliferated both internationally and in India.
For example, the board’s annual report should contain details of significant changes in the financial condition of the business that may have occurred during the period to which the financial statements relate. This would include the financial impact of climate change, such as any physical risk, transition risk or litigation risk that may have materialized during the period.
More specifically, the annual report should include the actions taken by the company towards energy conservation, which would also encourage boards of directors to see it as an opportunity in the transition to clean energy.
Material disclosures and BRSR
SEBI’s listing rules require the immediate disclosure of events which, in the opinion of the Board of Directors, are of a material nature. These would include weather events that cause disruption to the company’s operations or its supply chain.
Most importantly, the concept of corporate responsibility and sustainability reporting has become a mainstay of Indian securities regulation. This forces companies to be accountable for how their activities are conducted “in a safe and sustainable manner” and for their efforts “to protect and restore the environment”.
These developments have resulted in a tremendous increase in awareness regarding sustainability issues as well as the impact of sustainability reporting by companies in recent years. Existing disclosure practices indicate that, across the spectrum of sustainability reporting, more emphasis is placed on environmental issues.
Disclosure obligations of boards of directors are essential because they force directors to focus on climate change as a significant financial risk and as an issue of business responsibility and sustainability. This is expected to naturally allow boards to recognize and manage climate risk while acting globally in the long-term best interests of the company. For example, management’s discussion and analysis of the financial condition and results of operations as reflected in the financial statements would require the board to take note of unusual and infrequent events arising from climate change, such as as natural disasters and extreme weather conditions, which can adversely affect the business of the company. As a corollary, the board would be required to develop strategies to deal with such events. In this sense, disclosure and transparency requirements have a significant impact on changing business behavior in the context of climate change.
In an era of increasing global private litigation over climate change, particularly against businesses, the issue of directors’ liability for climate risk has gained considerable importance.
Indian business leaders are not immune to this trend, given India’s vulnerability to climate risk. As a result, climate risk has become prominent in corporate governance discourse and on corporate boards.
Add to the mix the orientation of Indian corporate law towards stakeholder interests which seeks to motivate boards of directors to act in the interest of non-shareholder stakeholders as an end in itself. Such a combination of market forces and legislative mandates will force boards to both manage climate risks and seize opportunities arising from climate change, such as the trend towards green energy.
Umakanth Varottil is Associate Professor of Law at the National University of Singapore. He specializes in corporate law, corporate governance and mergers and acquisitions.
The views expressed here are those of the author and do not necessarily represent those of BloombergQuint or its editorial team.