ECONOMY

How Climate Risk Is Heating Up Corporate Boardrooms

Climate change has absorbed significant 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 material financial risk for companies has become incontrovertible. Since companies face greater scrutiny and responsibility in the context of climate risk, the nature of their governance gains prominence, and the duties and liabilities of directors on corporate boards become pivotal.

Directors’ Duties That Call For Greener Boardrooms

In India, section 166(2) of the Companies Act, 2013, provides that a “director of a company shall act in good faith … in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment”. The jurisprudence surrounding this provision suggests that directors ought to consider the long-term interests of the company, which compels directors to identify and assess the risks emanating from climate change and implement strategies to address them. Conduct that involves sacrificing the long-term interests of the company in favour of short-term profitability would militate against the statute.

Furthermore, the fact that “the protection of the environment” commands its own space in section 166(2) is indicative of the fact that directors are obligated to garner their attention towards the topic regardless of any associated financial implications. The protection of the environment stands on an equal footing as catering to the interests of the shareholders or other stakeholders. Hence, directors are not entitled to side-step issues of climate change in favour of other stakeholders such as shareholders.

Corporate directors also bear a duty of competence.

Given that climate change is not only a key risk for Indian companies but is one that is gaining greater prominence over time, directors’ duties to account for climate risk can undoubtedly be determined against the aforesaid legal framework in India.

Hence, companies in general, and those that are vulnerable to the effects of climate change in particular, would need to establish clear systems and processes to identify and address climate risk.

This includes appropriately disclosing climate risks on the lines of well-known reporting frameworks and ensuring that they are represented in the financial statements and more generally formulating strategies to ensure that the company will resiliently and sustainably operate in a net-zero carbon global economy.

All this is evident from the scope of directors’ competence duties, although the details of the degree and nature of risk may vary from company to company. Due to the predominance of climate change as a leading risk that companies face, ignorance or inaction on the part of the directors to assess and deal with the risk would cause them to breach their duties under company law.

Dealing With Climate Risks And Impact

Even if directors acknowledge climate risk, it is possible that they may nevertheless come up with strategies or processes that are inadequate to deal with the risk.

First, where directors have been made aware of material information pertaining to climate risk that their company is facing, their duty to act with care and diligence will require them to make further investigations.

Where they see a proverbial ‘red flag’, they shoulder a duty to make further enquiry as any reasonable person in their circumstance would have done. By way of illustration in the climate context, a ‘red flag’ could be a significant shareholder vote on a climate-related issue, inaccuracies in a report produced before the board on climate risk, or the imposition of a new climate-related regulation on the company that its operations currency do not comply with.

Second, where directors do not have sufficient expertise to assess and deal with climate risk, the discharge of their competence duties would involve seeking professional advice by engaging experts.

Third, where directors delegate responsibility to members of management to monitor climate risk and draw up and implement strategies to address them, the directors bear the duty to oversee and supervise the delegates.

Sunlight Is The Best Disinfectant

Companies and their directors also carry duties under corporate and securities law to make disclosures of matters pertaining to climate risk.

The nature and extent of disclosure required usually turns on the question of ‘materiality’ of the risk.

Disclosure norms 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 within India.

For instance, the board’s annual report should carry details of material changes affecting the financial position of the company 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 materialised during the period.

More specifically, the annual report must include steps taken by the company towards the conservation of energy, which would also incentivise boards to treat it as an opportunity in the transition towards clean energy.

Material Disclosures And BRSR

SEBI’s listing rules require immediate disclosure of events that are, in the opinion of the board, material in nature. These would include climate events that result in disruptions to the company’s operations or its supply chain.

More importantly, the concept of business responsibility and sustainability reporting has become a mainstay in Indian securities regulation. This requires companies to report on how their businesses are being carried out “in a manner that is sustainable and safe”, and what efforts they are expending “to protect and restore the environment”.

These developments have brought about a considerable increase in awareness regarding sustainability issues as well as the incidence of sustainability reporting by companies in recent years. The existing disclosure practices indicate that, within the gamut of sustainability reporting, there is a greater focus on environmental issues.

Disclosure obligations on corporate boards are key because they compel directors to turn their attention towards climate change as a material financial risk and as a matter of business responsibility and sustainability. The expectation is that this would naturally enable boards to acknowledge and address climate risk while acting overall in the long-term interest of the company. For instance, the 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 out of climate change, such as natural calamities and extreme weather patterns, that may adversely affect the company’s business. As a corollary, the board would be required to devise strategies to deal with such events. In that sense, disclosure and transparency requirements have a significant impact in altering corporate behaviour in the context of climate change.

In the era of increasing private litigation globally for climate change, especially against companies, the question of directors’ liability for climate risk has acquired tremendous salience.

Directors of Indian companies are not spared from this trend, given India’s vulnerability to climate risk. Hence, climate risk has become paramount in the corporate governance discourse and in corporate boardrooms.

Add to the mix the slant of Indian corporate law towards stakeholder interests that seeks to motivate boards to act in the interests of non-shareholder constituencies as an end in itself. Such a combination of market forces and legislative mandates will require corporate boards to both address climate risks and also seize opportunities arising from climate change, such as the drive towards green energy.

Umakanth Varottil is an Associate Professor of Law at the National University of Singapore. He specialises in company law, corporate governance and mergers and acquisitions.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.

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