Climate Change: An Emerging Risk for Corporate Directors and Officers
Climate change is fast emerging as one of the most significant risks facing the economy, and Asia is considered to be one of the most vulnerable regions in terms of its physical impacts.
In recent years, climate change has become a headline issue for both governments and the private sector due in part to emerging rules and regulations. However, most companies in Asia have only just begun to address the potential impact of climate change at the board level. The increasing call for clarity in climate risk disclosure has spurred risk managers, board members, and chief financial officers to examine this evolving management risk exposure.
The Time to Act is Now
Regulators, large institutional investors, and sovereign pension and wealth funds are increasingly focusing on the performance of companies in the face of climate change risks. This includes the preparedness of companies and their boards to effectively deal with operational, regulatory, and reputational risks resulting from climate-related exposures. We expect to see the development of claims against companies and their directors arising out of the disclosure (or lack thereof) of climate-change related risks.
Knowledge and awareness of risks and opportunities associated with climate change are critical for boards and senior executives. Directors and officers can expect increased scrutiny in the years ahead from shareholders, regulators, and young prospective employees regarding their companies’ responses to address the emerging risks and opportunities of climate change. The absence or lack of board awareness and accountability on climate change and sustainability may result not only in breach of regulations but also reputational damage and lower company valuations relative to those of more engaged industry peers.
Risk managers must therefore understand and communicate climate-change risk issues to their boards. This includes focusing on issues that concern boards and presenting information in a manner that is both meaningful and beneficial to the directors’ decision-making process. Boards, in turn, need to provide guidance to the risk committee, as part of enterprise-wide risk management, so that risks and opportunities resulting from climate change can be incorporated into the strategic planning process. Prudent, long-term planning is important to mitigate the adverse impacts and take advantage of the opportunities presented by climate change risks.
Social and environmental considerations fall within the purview of fiduciary responsibility of board members. This is because they have fiduciary duties to act in the best interests of their company with reasonable care and due diligence, in following their mandate to maximize returns, concurrently.
Directors’ and officers’ liability exposure continues to grow in the climate risk space. Of particular note are the following trends:
Increasing call for clarity in climate risk disclosure. Shareholders and regulators alike are increasingly seeking greater transparency on corporate policies related to the environment. Directors and officers may be required to respond to allegations of failure to disclose the company’s climate-change related risks, or to ensure compliance with climate related laws and regulations. Recent legislative developments in Asian countries such as India and Thailand now enable investors to commence securities-related class action litigation. A derivative suit might occur where failure to prepare or respond to climate risk results in considerable financial loss to the company. Even a shareholder class action might arise if the failure to disclose climate risk exposure or events was to cause material negative impact to the company’s share price.
Increased regulatory action. Regulators are becoming more vigilant, and enforcement is becoming more broad broad. Increased regulatory activity often leads to increased liability. Some regulations now require disclosure of a corporation’s climate change-related risks. It is possible that within the next few years, guidelines—if not mandatory rules concerning climate risk disclosure—will be established in many countries. Furthermore, as companies expand their business operations to new and foreign jurisdictions, directors need to be aware of the various legal and regulatory developments overseas. This goes beyond traditional financial regulators, and includes other climate change-related regulatory and quasi-regulatory bodies. Severe penalties can be imposed on directors who fail in their duties to consider and disclose the potential risks of climate change, including fines and/or disqualification from holding directorships.
Negative impact on company valuation and reputation. Liability from direct or inadvertent climate-related risks can be significant, if not catastrophic, as demonstrated in the case of asbestos, oil spills and ground leaching. A company can go bankrupt cleaning up a site or defending lawsuits arising from environmental torts. There is also a danger that adverse publicity generated through unexpected social-media coverage might harm product sales as customers turn to substitutes. Therefore, crisis management preparedness is increasingly valuable. Companies that are unwilling or unable to integrate climate change considerations into operational and investment decisions may be viewed negatively by customers and shareholders.
The Safety Net
As with other parts of the world, many countries in Asia such as Japan, Hong Kong, Thailand and Singapore are moving toward a more litigious culture, with the objective of making companies and individuals more accountable. There is a growing trend toward seeking punitive and personal legal action against senior executives for failure to follow regulations and standards.
The globalization of risks and exposures and increased awareness of consumer rights in Asia is resulting in investigations, criminal prosecutions, or civil litigations over alleged wrongdoing. These action have put company and individual assets at risk. In such cases, senior executives might look to the Directors’ and Officers’ (D&O) liability insurance policy to help with defense costs, settlement, or judgments.
D&O liability insurance or management liability insurance, provides indemnity to the directors and officers of a company for their personal liability to pay damages to a third party, resulting from an actual or alleged wrongdoing. This includes a breach of their duties in the course of managing the affairs of the company. Noteworthy in the climate change context is the pollution exclusion typically contained in a D&O policy, which is designed to prevent the D&O policy from covering physical and environmental perils, as physical perils are afforded cover under other insurance policies available in the market. However, most D&O insurers allow the insured to “buy back” some cover within the pollution exclusion for non-indemnifiable claims, which are claims for which the company cannot reimburse an executive for liability or defense costs. D&O insurance in Asia has become an integral part of sound risk management for many companies as it provides financial protection for executives against the consequences of actual or alleged wrongdoing.
Climate change is a key global risk. It follows that the law may be increasingly used as a means of forcing the corporate sector to respond to its challenges. As the legal landscapes across Asia evolve, further litigation will likely emerge in Asia from the issues and laws associated with climate change.
Risks for companies and their management are growing and liability claims arising from climate change-related risks can be extremely complex and costly. Action on climate change is gathering pace and boards are more aware of the need to act on the unprecedented challenges posed by it. Directors and officers need to recognize their responsibilities: They need to accept that good management of environmental governance is imperative for the protection and enhancement of shareholder value of the company.