The risks of climate change are no longer “mere” ethical and reputational issues. In 2017, Australia’s prudential regulator, APRA publicly warned financial institutions to ‘rise to the challenge’ and address climate change risks because of real financial implications it will have on asset values and bottom lines. Being a keystone to the Australian economy, institutional investors (particularly superannuation funds) may soon face significant exposure to the financial and transitional impacts of global climate change.
More recently, a growing body of Australian and international case law has put additional pressure on governments and corporate companies to play their part in addressing climate change risk. In the recent Federal Court decision of Sharma v Minister for the Environment, it was found that the Minister for Environment owed a novel duty of care to Australian children who may suffer potential ‘catastrophic harm’ from climate change. Internationally, a Dutch court held that Royal Dutch Shell (as a private company) owed an unwritten duty of care to Dutch residents to curb carbon emissions by 45 per cent by 2030. As community expectations towards Environmental and Social Governance (ESG) and climate change continues to evolve, attention will soon turn to how superannuation trustees will mitigate these risks to protect their members’ best interests.
Trustees’ duties and the changing regulatory landscape
It is widely acknowledged that climate change risk will likely have material impacts to superannuation funds including reputational, market, and investment risk. However, what remains ambiguous is whether superannuation trustees have a duty to consider these risks as part of their broader trustee and fiduciary duties. To date no specific trustee duties relating to climate risk are codified in ‘hard law’ but it appears the trajectory of policy and regulator guidance indicates that it may not be far off.
Earlier this year, pre-eminent counsel Noel Hutley SC and James Mack released a revised opinion on the interplay between climate change risks and superannuation trustee duties. Notably, the opinion highlights the need for superannuation trustees to understand and take thorough steps to manage climate change risks as they would any other financial risk. Hutley and Mack consider these actions essential in order to satisfy the trustee’s covenants in the Superannuation Industry (Supervision) Act 1993 and APRA Prudential Standard SPS530 on investment governance. Namely, a consideration of climate change risks should play into how superannuation trustees exercise their powers in the best (financial) interests of members. In practical terms, this will likely require a close examination of investment selection, management, and diversification to better manage the climate risks attached to investment options as well as asset classes or sectors.
Changing investment attitudes
The increased focus on ESG as an active factor for investment managers is not new, considering the long-standing focus previously adopted by sovereign funds internationally. For example, Norway’s Sovereign Fund barred investments considered to be contrary to Norway’s international law obligations as early as 2001, three years into the fund’s existence. One of Singapore’s national investment corporations, Temasek Holdings, reports annually on its portfolio’s estimated emissions impact. However, due to the nature of their investment mandate, that is, maximising returns to beneficiaries, sovereign funds may be reluctant to pursue early-adopter, activist positions. In the case of the world’s largest pension fund, Japan’s Government Pension Investment Fund with assets under management of about $1.63 trillion, they were recognised as an early-adopter but has more recently been accused of backtracking on their ESG positions due to a shift in risk appetite.
Similar concerns amongst investors have also contributed to an emergence of so-called ‘shareholder activism’. For example, the world’s largest asset manager, BlackRock, announced early in 2020 that it would remove companies which generate more than 25 per cent of revenue from thermal coal from its discretionary active investment portfolios. The following year, a commitment to net zero carbon emissions by 2050 was made citing the need to promote durable, long-term profitability for its clients. These public declarations, moratoriums, and commitments in favour of addressing climate change will likely increase – whether through a reduction in capital investment in ‘dirty’ assets, intensified proliferation of carbon-neutral and negative investments, or even carbon tariffs.
This push for stronger action on climate change has been felt across all classes of shareholders and public fora. For example, shareholder proposals in June that sought greater disclosure on how a company’s lobbying aligns with the Paris Agreement received majority votes in ExxonMobil, United Airlines, and Delta. Similarly, there is growing international sentiment to establish hard law instruments such as the mandatory Law on the Corporate Duty of Vigilance in France which imposes a ‘duty of care standard’ as opposed to a ‘due diligence standard’; and the European taxonomy for sustainable activities which requires a circumspect view of sustainability through life-cycle considerations and the economic lifetime of assets. Closer to home, Commissioner Armour recently noted that ASIC would be reviewing and assessing “greenwashing” to ensure that representations of environment or social responsibility were accurate and would not mislead or deceive investors, members, and the public.
In addition to changes in investment management attitudes, institutional investors like superannuation funds will also need to address the public sentiment on these ‘dirty’ investments. This factor could result in greater uncertainty in the prevailing investment environment as investors face public pressure to divest these assets while other players might instead seek to short the market. There is also the maverick ‘Gamestop phenomenon’ contributing to the unpredictability of the investment performance, risk, and viability of these assets.
Is climate change no longer a mere residual risk for trustees?
In NSW, rising waters this year on the Nepean River floodplains have realised the warnings raised by former Head of Insurance at APRA, Geoff Summerhayes, at a speech late last year that there was the possibility of general insurance being unaffordable or unavailable in parts of Australia. This means that certain assets may only be either insured at high expenses or might be entirely uninsurable, leaving investors exposed to extreme risk levels. Therefore, superannuation funds may need to consider whether investments in assets that are exposed to these insurance risks are truly in the best interests of members.
It is settled law that superannuation trustees must act in their members’ best interests. Recent amendments to superannuation law as part of the Treasury Laws Amendment (Your Future, Your Super) Act 2021 (Cth) have clarified this duty to ensure the determinative factor is members “best financial interests”. Though there has been plenty of discussion on whether this clarification is required, super trustees should be starting (if they haven’t already) to contemplate the distinct risk posed by climate change on whether they are acting in members’ best interests. As a starting point, trustees should examine the following factors when considering investing in assets with high climate-risk:
- whether climate change (directly or indirectly) impacts the viability of holding on to existing ‘dirty’ assets
- the costs of real and potential regulatory burdens because of ‘dirty’ investment divestment
- managing a due diligence process or similar to verify that companies have feasible ESG transition plans in place and to identify any speculative ‘greenwashing’
- member appetite or desire for divestment from assets with high levels of sensitivity to climate risk
- weighing the short and long-term risks and benefits of an increasingly volatile market in climate change-sensitive sectors such as energy, resources, and agriculture
- reputational impacts with investing in either ‘green’ or ‘dirty’ assets and its impacts on membership and long-term fund growth or scale
- potential short and long-term disclosure burdens in an environment where regulatory frameworks are still being consulted on and finalised
- the risks and benefits of becoming an early-adopter or a late-adopter including reputational impacts and whether the adopted strategy may be incompatible with the approach of regulators, the market, or other investors
While institutional investors like superannuation trustees could decide to take ESG action, they will still need to ensure that they act consistently with the sole purpose test, though mounting evidence suggests that financial outcomes for members may be impacted by the ESG actions of trustees now. Whilst the prudential guidance on climate risk from APRA has yet to be finalised (which includes the specific role of boards in APRA-regulated institutions), it is clear that climate risk is a key emerging issue that superannuation trustees need to consider to properly discharge their duties to members.