Integrating Climate Risk into Corporate Governance

Since the introduction of the Taskforce on Climate-related Financial Disclosures (TCFD), there has been increased scrutiny of corporate climate governance and broader associated risks. Investors have increased their focus on climate risk, as governance mechanisms are likely to be impacted by transition and physical risk challenges[i].

Sustainalytics’ ESG data shows that companies are facing increased risk from controversies relating to environmental and social issues such as community relations problems and resource overuse. The root cause is mismanagement and lack of governance around physical and transition risk provoking non-climate related controversies in the form of Social and Governance risks.

One such corporate governance controversy was driven by Blackrock voting against the re-election of the chairman for Volvo AB due to inaction on the company’s carbon footprint reduction.

As climate change becomes an ever-increasing priority for the investor community, we explore how good climate governance, is also good corporate governance.

The Importance of Corporate Climate Governance

Companies that identify and address emerging climate-related risks and opportunities are in a better position to mitigate risks and compete in an ever-changing market. Therefore, it is increasingly necessary that corporate boards and executives champion for sustainability and climate management.

In addition to Blackrock voting against the re-election of a chairman due to climate inaction, they also vote against resolutions at 53 companies because of shortcomings related to climate leadership[ii]. Furthermore, they warned another 191 companies that they risk voting action in 2021 if they do not make substantial progress in improving climate disclosures.

The GHG Risk Management Indicator, which assesses, in part, climate governance risk within Sustainalytics’ ESG Risk Rating, demonstrates that companies highlighted within Blackrock’s July 2020 report, score below average, demonstrating heightened risk in this area.

The figure below demonstrates the performance against the average performance of this indicator by peer group.

Figure 1: Blackrock Flagged Company Performance against Peer Group Average for GHG Risk Management[iii]

There are exceptions where companies highlighted by BlackRock do perform well against this indicator, however, they are involved in controversies driven by climate risk mismanagement, demonstrating that existing risk management measures are not as effective as company disclosure would lead us to believe. For example, a major investment firm recently divested their shares from two of the companies highlighted in Blackrock’s report (Chevron and Exxon) due to their involvement in anti-climate lobbying against private action[iv]. This resulted in a public policy related controversy for Chevron increasing their overall risk exposure.  As we advance, we could see increased risks due to these types of controversies where they conflict with good climate governance.

Elements of Climate-Competent Board Governance

As stated, the investor community increasingly reviews elements of climate governance; for instance, Storebrand has implemented a new climate policy targeting companies that block green policies. In another example, Suncorp has disclosed a commitment to end the financing of oil and gas by 2025, in addition to implementing a ban that supports new coal projects. Additionally, Suncorp committed to lend and invest in companies where there is a clear and consistent approach to a net-zero emissions economy by 2050[v]. As this trend continues, companies with inadequate governance and limited disclosures around climate-related risks may face increasing legal and divestment risks. Of the companies highlighted by BlackRock, nearly half of the companies have no board oversight when it comes to climate governance.

Board-level oversight ensures a company’s long-term resilience concerning potential shifts in the business landscape that may result from climate change. A climate-competent board will

• Integrate subject matter expertise or perspectives related to climate risks and opportunity.
• Ensure that climate risks are integrated into the company’s investment planning and strategic decision-making processes.
• Incentivize performance by including climate-related targets and metrics in executive compensation schemes.
• Ensure that material climate-related risks are consistently and transparently disclosed to all stakeholders.
• Maintain regular dialogues with peers, policymakers, investors and other stakeholders to stay informed about the latest climate-relevant risks and regulatory requirements.

Figure 2: Board Level Responsibility for BlackRock highlighted Companies within the Sustainalytics Universe

What can we expect going forward?

As carbon emissions continue to rise and the physical risks emerge, climate incidents are also likely to increase, driving climate-related events in other ESG areas. As much as we have seen an increase in events pertaining to COVID-19[vi], the same can be expected as it relates to climate change and climate governance. Continued climate inaction has resulted in the increasing number of low-level events based on scrutinization of targets, greenwashing claims, lawsuits, transition management and human rights issues.

Climate litigation is an area where companies may encounter future controversies and governance risks,[vii] as legislation tightens, and physical impacts of climate change are realized. There has been an increase in climate litigation lawsuits throughout 2020, compared to 2019[viii] and it is only expected to rise going forward, adding another dimension of risk to the climate challenges that companies face. Companies that establish comprehensive climate governance practices with board-level oversight can mitigate risks arising from such issues and establish a competitive advantage.

Contact Clients Services to learn more about Corporate Governance as a foundational element of Sustainalytics’ ESG Risk Ratings.

Sources:

[i] WEF, How to Set Up Effective Climate Governance on Corporate Boards Guiding principles and questions
http://www3.weforum.org/docs/WEF_Creating_effective_climate_governance_on_corporate_boards.pdf

[ii] Blackrock, BlackRock Investment Stewardship
https://www.blackrock.com/corporate/literature/publication/our-commitment-to-sustainability-full-report.pdf

[iii] Sustainalytics

[iv] The Guardian, “Major investment firm dumps Exxon, Chevron and Rio Tinto Stock” https://www.theguardian.com/environment/2020/aug/24/major-investment-firm-dumps-exxon-chevron-and-rio-tinto-stock?utm_campaign=Carbon%20Brief%20Daily%20Briefing&utm_medium=email&utm_source=Revue%20newsletter

[v] The Guardian,  “Insurance giant Suncorp to end coverage and finance for oil and gas industry”
https://www.theguardian.com/environment/2020/aug/21/insurance-giant-suncorp-to-end-coverage-and-finance-for-oil-and-gas-industry

[vi] Sustainalytics, ESG Spotlight |The COVID-19 Incidents Curve: Corporate Events and Impacts
https://connect.sustainalytics.com/the-covid-19-incidents-curve-corporate-events-and-impacts?_ga=2.124888330.1045674800.1600438344-3e19279d-2ff6-e911-a813-000d3abaacd3

[vii] Bloomberg, Climate Change Warriors’ Latest Weapon of Choice Is Litigation
https://www.bloomberg.com/graphics/2018-climate-change-lawsuits/

[viii] Norton Rose Fulbright, Climate change litigation update
https://www.nortonrosefulbright.com/en/knowledge/publications/7d58ae66/climate-change-litigation-update

^ix PRI, TCFD-based reporting to become mandatory for PRI signatories in 2020
https://www.unpri.org/tcfd-based-reporting-to-become-mandatory-for-pri-signatories-in-2020/4116.article