Changing corporate behaviour – the crucial role for auditors and accountants in the climate change fight - DAC Beachcroft

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Changing corporate behaviour – the crucial role for auditors and accountants in the climate change fight

Published 6 July 2023

ESG, and particularly climate change, is becoming an increasingly essential plank of corporate business planning and reporting. Strategic reports demand a review of principal risks and uncertainties facing companies. Some larger corporates have mandatory climate-related financial disclosure obligations. The Financial Reporting Council (FRC) issued the FRC ESG Statement of Intent (January 2023) concerning the development of guidance and best practice in relation to ESG data, ensuring disclosures remain relevant and auditors pay particular attention to climate-related risks in their assessments. ICAEW has been very active too. In short, the climate risks to which a company is exposed (and the disclosures it makes) are key aspects on which auditors and accountants must advise.

For some years, the corporate, regulatory and professional responses to climate change have been matched by the growth of climate litigation in the UK and internationally. There are now well over 2000 climate-related cases issued around the world brought against governments and corporates.  This litigation is being prosecuted by activists and the investor and asset management communities to achieve changes in boardroom behaviours, insulate businesses from climate risk and accelerate the transition to net zero. These claimants are sophisticated, motivated, and well resourced. Litigation against corporates, particularly associated with their climate disclosures, has the very real potential to shine a spotlight on the role played by the company's auditors.

The way in which litigation of this type can impact UK businesses has recently been tested in the case of ClientEarth v Shell Plc and others, which concerns ClientEarth's efforts to bring a derivative action against the board of directors of Shell Plc. The case has attracted significant attention from all businesses engaged in sustainability reporting and those committed to the transition to net zero.  ClientEarth submits that Shell's directors had breached Section 172 Companies Act (imposing a duty to act to promote the success of the company), and section 174 (requiring the exercise of care, skill and diligence in the running of a company).

ClientEarth's case has various complex elements, including those based on criticisms of Shell's disclosed approach to managing climate risks. In short, however, in May of this year Mr Justice Trower dismissed the application, holding that ClientEarth could not demonstrate that the directors were managing Shell’s risks in an unreasonable manner. Moreover, ClientEarth’s evidence offered no engagement on how the directors’ alleged wrongful actions constituted an approach that no reasonable director could have adopted, given that directors are required to take into account a range of competing considerations, the proper balancing of which is a classic management decision with which the court is ill-equipped to interfere.

The initial decision in the Shell case is instructive.  It endorses the UK courts' inherent unwillingness to interfere with the invariably difficult roles that boards of directors must fulfil, particularly when confronted with the highly complex challenges of climate risks and carbon transition.  This preliminary decision will be subject to review at an oral hearing on 12 July 2023, and that hearing will undoubtedly provide further insight but certain lessons can be drawn from the judicial consideration so far, each of which has relevance to the role auditors play.

The importance of appropriate corporate governance and skills

It is the first line of defence to show that the climate and transition risks confronting businesses have been adequately considered at board level. The courts should be very slow to interfere, respecting the autonomy of directors in their decision-making. Auditors and accountants have an important role working alongside boards in assessing adequacy and robustness of corporate governance systems.

The adequacy of climate-related risk disclosures

Shell was able to point to comprehensive and detailed reporting both as to its transition strategy but also the metrics around its annual reporting. Climate risk-related reporting is developing rapidly but still an evolving discipline.

The role of auditors 

Mr Justice Trower expressly referenced the role of Shell's auditors in supporting his conclusion that the Board had adequately taken into account the range of competing considerations associated with climate risks and the implications for its business, including the risk of stranded assets.

While Shell may have won this particular skirmish, there is little doubt that ClientEarth will continue its efforts to use climate litigation (in all of its forms) to effect corporate change.  And there will be companies (across sectors) who have not invested in their climate-related governance and disclosures to the level of Shell and they will certainly be in the firing line.  The challenge of climate-related risk is that it is non-linear and the standards expected of corporates and their auditors and advisers will become more exacting over time, as the body of overall reporting enables better benchmarking. Some business will fail as a direct consequence of physical, liability and transition exposures. Accountants and auditors will not wish to be caught in the fallout.

Moreover, the FRC and the ICAEW have made it very clear that they will be monitoring climate-related disclosures and the adequacy of those disclosures.  Auditing standards and guidance are developing rapidly.  Even if the liability risks for auditors and accountants are for now manageable, perhaps the most imminent risk is of regulatory investigation and censure, particularly as regulators respond to our warming world.


Simon Konsta is a disputes partner at international law firm DAC Beachcroft.

 

This article was first published in Accountancy Age.

 

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Simon Konsta

Simon Konsta

London - Walbrook

+44 20 7894 6123

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