Australia: Climate Change Up-Date: Full Disclosure: CDP4 Raises Host of Legal Traps for the Unwary

At the start of this month, ASX 100 and NZX 50 companies will receive an information request from the Carbon Disclosure Project (CDP), a coalition of institutional investors that, together, represent in excess of US $31 trillion in funds under management. The request will seek data on the possible impacts on company value of climate change related regulation, new technology, changes in customer behaviour and altered weather patterns.

This will be the first time many Australian and New Zealand companies have been asked by investors to provide information of this kind. Although the CDP was created in 2002 (and its financial backing has since grown sixfold), its focus until now has been on the FT 500 (the world’s top 500 companies by market capitalisation). Consequently, the global rise of investor interest in climate risk has largely gone unnoticed within corporate Australia/New Zealand. As a result, many companies may be a little uncertain about why the information is being sought, whether they should respond, and what the implications of doing so might be.

In order to understand the significance of the CDP’s information request (known as ‘CDP4’), it is necessary to look back on what drove its creation in the first place. The key fact is that the global economy has a lot at stake in the climate change debate. Predicted changes in weather patterns, and emerging efforts to regulate greenhouse gas emissions are likely to be highly disruptive if not properly planned for (see ‘Climate change and business’). Institutional investors, with their preference for long term stability, want to ensure they can identify the likely winners and losers early, so that they can adjust their portfolios. The CDP is intended to help investors do this by gathering and analysing data that is not routinely provided through traditional reporting structures.

When seen in this light, it is clear the CDP is fundamentally about long term share value, and this distinguishes it from other initiatives that have sought to engage with companies on climate change. Readers may recall the letter that plaintiff firm, Maurice Blackburn Cashman sent on behalf of Climate Action Network Australia to the ASX 150 in 2003. The CANA letter raised the spectre of litigation, and suggested that directors are legally required to factor climate risks into their decision making. CANA's action was driven by a concern for the environment, and for this reason probably made little impact on the key decision makers in many companies. What the CDP illustrates is that climate change is now a mainstream business issue, regardless of your position on the environment.

Approaching the CDP from a business perspective may not come naturally for many companies, particularly those that look on environmental issues as more a question of compliance than strategy. For such companies, the initial question is likely to be, why should we respond at all? The best answer to this question is probably another question – how lucky do you feel? For while it is unlikely that we will see climate risk/CDP responses driving broad scale share price movements in the short term, institutional investors would not be participating in CDP if they did not intend to use the data collected.

Already we are seeing speculation on carbon value for low emission businesses boosting prices in individual stocks. In 2005, there were two major Australasian transactions in which carbon value was reportedly a key component of the final prices paid – Infrastructure Funds Management’s purchase of Pacific Hydro, and AGL’s purchase of Southern Hydro from NZ’s Meridian Energy. This trend is set to continue globally in 2006 – the UK's Sunday Times recently reported that the sale of nuclear-reactor maker Westinghouse (a subsidiary of British Nuclear Fuels) is likely to fetch double initial expectations as a result of the positive outlook for the nuclear sector in light of climate change concerns.

With all this focus on the possible upside of low emission technology, it can only be a matter of time until attention turns to the downside, and capital starts flowing away from climate risks. When this process starts, companies that have failed to engage with their investors on climate risk are likely to be seen as ‘riskier’ than those who have communicated effectively how the issue is likely to effect them, and what the strategic approach will be. For this reason, companies should not dismiss CDP4 lightly.

Those companies that do respond to the information request will need to ensure they give their response the same level of attention as any other market disclosure. In coming to terms with the strategic implications climate change has for the business, it would be easy to overlook some of the fundamental legal issues (see ‘CDP4 – 4 key legal issues’), which could more damaging than not responding at all.

Climate change is widely regarded as the greatest environmental challenge facing the world today. The problem arises because fossil fuel combustion has released significant amounts of greenhouse gases (GHGs), primarily carbon dioxide. This has altered the composition of the atmosphere, and now more heat from the Sun is retained by the Earth than previously.

Current predictions have global average temperatures rising by 1.4-5.8°C by 2100. This will produce sea level rises and an increase in the frequency and intensity of extreme weather events. The greater the increase in average temperature, the more disruptive the changes are likely to be, and a consensus seems to be emerging that the global objective should be to keep the temperature increase below 2°C. Even this apparently modest increase is likely to have significant impacts on existing infrastructure, supply chains and business operations.

To constrain the temperature rises to 2°C will require a reduction in global GHG emissions by approximately 60% on 1990 levels by 2050. This is a challenging task, given the growing global demand for energy and current reliance on fossil fuels for energy production. It will require a major restructuring of the energy sector, threatening profits for energy companies that cannot adapt.

Pressure will also be applied to energy consuming business to change their practices also. If a global GHG emission reduction target of 60% by 2050 is to be achieved, companies will need to make big changes to how they use energy. In this environment, companies that can find ways to reduce energy consumption per unit output are likely to pull ahead of those that cannot. A growing appreciation of these likely competitive impacts of GHG emission regulation is driving major investors to gather data and analysis on how individual companies might fare.

Companies responding to the CDP 4 information request must remember it is fundamentally about long term share value, despite its environmental overtones. Given this, there are a number of legal issues that will need to be considered. The top four are:

The Corporations Act and ASX Listing Rules require listed public companies to disclose price-sensitive information to the market before releasing it to analysts or other persons. Given the purpose of the CDP, it is arguable that responses to the CDP information request fall into this category. Failure to comply with these requirements can lead to a suspension of trading in the company’s securities or even the delisting of the company. In addition, a breach of the Corporations Act can result in criminal prosecution and/or the imposition of civil penalties on any person involved in the contravention (eg, directors and/or company officers).

Companies investigating climate risk for the first time should also be aware of the potential for information to emerge that requires changes to financial forecasts or expectations that have already been communicated to the market.

CLERP 9 introduced more stringent reporting requirements for public companies, including an obligation that companies disclose sufficient information to enable investors to make an informed assessment of the company’s business strategies and prospects for future years. What is now known about climate risk (through the work of the CDP and others) suggests that many companies may already be obliged to disclose information of the kind sought by CDP4 under these provisions.

The business judgement rule protects directors and officers who make informed decisions about activities that involve risk of loss. The key to this rule is the requirement that decisions be ‘informed’ to the extent that the decision-maker reasonably believes to be appropriate. Without a detailed understanding of the climate change debate, the range of possible regulatory responses and current predictions of likely changes to climate systems, it may be difficult for directors and officers to demonstrate that the rule’s requirements have been met. Consequently, many may risk exposure to personal liability for breach of duty when making decisions about company initiatives that involve material climate risks. And, perhaps more disturbingly for shareholders, may not even be able to tell when this is the case.

The increasing prevalence of sustainability reporting, often as an adjunct to statutorily required financial reports, creates another issue for directors and officers to manage when responding to CDP4: consistency and transparency of data. It is vital that each of these documents is completely consistent, not only in what they say, but in terms of their implications. Analysts examining CDP4 responses will look to extract meaningful financial risk information, and cross check responses against other available data. Any discrepancies may well undermine market confidence, and raise questions about the company’s governance and compliance frameworks.

This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.