Financial risk: climate change, a significant financial risk

In early 2021, Engine No. 1, a six-month hedge fund that managed around $ 250 million in assets had a slight 0.02% shard from ExxonMobil, the $ 250 billion oil and gas giant. of dollars. Engine No. 1 launched an activist shareholder challenge to divert ExxonMobil away from fossil fuels and succeeded in getting three of its candidates elected to the ExxonMobil board of directors. The hedge fund stressed in its letter to shareholders that there was an urgent need for “new leadership in a rapidly decarbonizing world”, stick to oil and gas, and not explore alternatives clean energy, was an “existential risk” and that it was time for shareholders to “weigh”.

In 2019, in what is known as the Urgenda case, an injunction was sought to force the Dutch government to cut emissions and the Dutch government ultimately conceded to cut the capacity of its remaining coal plants by 75% and put implementing a € 3 billion package of measures to reduce Dutch emissions by 2020.

This year, India was one of 120 countries gathered at the United Nations Climate Change Conference (COP26) to fight inaction on the global climate crisis. India is the world’s fourth largest emitter of carbon dioxide after China, the United States and the EU. India has pledged to get 50% of its energy from renewable resources by 2030, and by the same year to cut total projected carbon emissions by one billion tonnes and ultimately reach zero by 2070 (net zero, or becoming carbon neutral, means not adding to any amount of greenhouse gases in the atmosphere).

A growing urgency is being demonstrated by various stakeholders in the US, UK, Australia and Commonwealth countries, forcing business leaders in certain industries and governments to recognize their responsibilities by providing them with protection , both financial and otherwise, against the impacts of climate change. cash.

As we shift to responsible manufacturing, production and value creation, countries around the world have witnessed increased shareholder activism forcing business leaders to behave more responsibly, the courts urging regulators to demand better disclosures and governments urging market players to change their way of doing things. Business. However, no measure has been as effective as litigation. This has proven to be a successful form of redress for stakeholders affected by climate change to demand immediate redress from governments and businesses. Examples abound in the US, UK, France, Italy, Australia, and Poland. There are several agencies that publish their watch on the success of climate change litigation.

Going forward, litigation strategies will influence the actions of various stakeholders in other industries, primarily manufacturing sectors and carbon majors. We have seen across the world, human rights arguments used as backing in a growing number of cases (such as climate change affected citizens seeking asylum), nuisance and fraud actions, deceptive greenwashing marketing campaigns and disclosure related lawsuits. In India we may see class actions that may soon be implemented by stakeholders in this context, shareholder disputes that may focus on climate issues, proxy advisory firms encouraging shareholders and investors to speak out and large foreign investors who might force such conversations or insist on a transitional framework.

Litigation and disputes with stakeholders involve financial risks and economic costs for the company. This would include legal fees, fines, damages, increased insurance premiums and, of course, market assessments. The conscious investor seeking to invest in “clean” companies could undertake event studies to assess the potential impact of climate disputes on the stock prices of these companies.

Stakeholders will seek to ensure that these returns are not minimized due to the company’s reluctance to recognize and abandon its traditional ways of doing business. For a company seeking to become a national or global major, it will need to learn how to communicate to its shareholders, investors and regulators on how it will engage with them in its corporate climate plans. FLCT Global, a non-profit organization, has made available a phrasebook on climate transition that provides tools in this regard for businesses.

In India, the management responsibilities and governance required in this regard have been set out in the general sections of the Companies Act 2013, which deal with the duty of trust, due diligence, competence, disclosure and loyalty. Although several companies have formed ESG committees, it will be crucial to see what is discussed with regard to the climate, to what extent the company is prepared against regulatory recommendations in this regard and if the transition will have a financial impact. negative due to lack of preparation. Globally, investors are increasingly using sustainability reports and climate responses as a measure to assess management’s effectiveness in addressing emerging risks. If global investors expect that these matters are not discussed in a meaningful way on these boards, it could result in lower valuations and an assessment of the Company’s financial outlook for its future. Risk management committees must fully appreciate the impact and communicate intensively to the board of directors and the CEO a planning horizon to mitigate risks.

The cost of inaction by manufacturers and other “issuers” will far outweigh the cost of early action. The board’s sensitivity in this regard will differentiate companies that are future-proof from those that are not. As Indian businesses begin to globalize and continue to attract record foreign investment, it makes sense to stay tuned to changes in global case law.

Aarthi Sivanandh (partner), J. Sagar Associates (JSA)

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