As noted in the proxyseason blog from thecorporatecounsel.net, asset manager State Street Global Advisors has recently published an updated Climate Change Risk Oversight Framework For Directors. Climate change is identified as a continuing priority for SSGA’s asset stewardship and company engagement program. In the commentary introducing the framework, SSGA advises that boards should look at climate change “as they would any other significant risk to the business and ensure that a company’s assets and its long-term business strategy are resilient to the impacts of climate change.” A similar view was expressed by the NACD in Board Oversight of ESG, which advises that “climate-related risks must be integrated into the company’s ongoing risk assessment and quantification processes and the board’s oversight of risk management.”
As stated in SSGA’s commentary, the Paris Climate Accord has introduced a new sense of urgency into the transition to lower carbon emissions, including energy efficiency and use of renewable sources, and that transition presents both challenges and opportunities. The challenges include “possible changes to strategy to meet specified goals; allocating capital in technology and/or infrastructure; and managing reputation based on corporate practices that demonstrate a company’s climate consciousness. The opportunities are presented through proactively identifying new business lines; mitigating future regulatory risk; and leveraging sustainability practices as a differentiator to enhance brand/firm reputation.” These challenges and opportunities extend well beyond the traditional “high-emitting sectors of energy, utilities and transportation,” to a wide variety of industry sectors.
The SSGA framework was designed to help directors evaluate climate-related risks within various industry sectors in three primary categories: physical risks, regulatory risks and economic risks. “Physical risks” involve tangible adverse effects—such as infrastructure damage, supply chain disruption, raw materials scarcity or harm to human health—that could result from a rise in sea levels, droughts, floods, extreme temperatures and increased frequency of extreme weather events. ”Regulatory risks” involve possible changes in the regulatory environment that could affect business operations or the cost of doing business. “Economic risks” are a bit more nuanced, addressing the risk of “changing consumer habits and a growth in climate consciousness as individuals recognize their role in aiding climate change, and reputational risk stemming from a company’s sustainability practices relative to stakeholder expectations. It also includes investment allocation decisions in companies and sectors that are better suited for a low carbon economy.”
The Framework then identifies the three categories of risk by industry sector. For example, in the consumer discretionary/staples sector, SSGA identifies the physical risks as the availability and quality of raw materials that may be impaired by changing climate conditions and potential supply chain disruption, and the regulatory risk as possible changes to fuel/energy taxes and regulations that could increase costs. The economic risk lies in the potential increase in cost of raw materials, decrease in quality of finished products resulting from adverse impact on the quality of raw materials; the impact on demand from possible changes to consumer behavior and reputational risk to the company as its products and sustainability practices are evaluated by environmentally conscious consumers.
In the materials/industrials sector, SSGA identifies the physical risk as potential “obsolescence or innovation required to existing products to withstand changing climate conditions and extreme weather events.” The regulatory risks arise out of the potential for the industry to be viewed as a future targeted “INDC sector” in light of the sector’s high emissions, as well as possible risks to the supply chain resulting from conservation efforts. (“INDC” refers to Intended Nationally Determined Contributions pledged by countries under the climate agreement.) Economic risk results from potential changes in consumer preferences for materials that enhance energy efficiency and facilitate environmental certifications such as LEED.
While no regulatory risk was identified for the health care sector, SSGA identifies the physical risk as the impact of climate on health, such as through asthma, vector-borne diseases or nutrition (e.g., starvation resulting from drought), but also identifies the same risks as potential growth opportunities.
In the information technology/ telecommunication Services sector, the physical risk was identified as possible disruption in services resulting from the impact of climate on infrastructure and, similarly, the regulatory risk as “regulation on reporting of company’s climate preparedness given sector’s critical infrastructure status.” The economic risks to this sector were identified as possible changes in consumer preferences for energy-efficient products and reputational risk related to the company’s sustainability practices.
With regard to the financials sector, the physical risk was identified as investment exposure to “properties, infrastructure and businesses vulnerable to impact risks of climate change.” Similarly, the regulatory risk was also exposure to other industry sectors vulnerable to changing regulations, and the economic risk arose out of credit risk and potentially larger insurance payouts for climate-related events. The framework also addresses the Energy/Utilities sector.
SSGA advises directors to analyze their companies’ exposure, understand the adequacy of risk mitigation and periodically assess the potential impact of climate risk on long-term strategy using scenario analyses. Directors are also advised to review capital investments in risk mitigation or other competitively advantageous technologies and to stay current with respect to potential regulation and policy changes. Directors should also be knowledgeable about and prepared to discuss the company’s climate change strategy with investors. If the company is in a high-risk sector, the board should consider whether additional climate-related board expertise is required and ways to access climate expertise to educate directors on evolving risks. Finally, SSGA advises that directors should review and evaluate shareholder proposals, including considering “the spirit of proposals in the context of the business risk.”