Directors should not go to prison for failing to report climate risks

Directors should not face jail time for failing to comply with proposed new climate-reporting standards. 

On the disciplinary spectrum, imprisonment is as severe as it gets. This seems an unduly harsh penalty to hold over individuals, particularly for an entirely new and complex set of regulatory obligations. 

In a world first, last year the government announced climate-related financial disclosures (CRFD) would be mandatory for publicly-listed companies, large insurers, banks and investment managers. The resulting Financial Sector (Climate-related Disclosures and Other Matters) Amendment Bill is currently before a parliamentary select committee.

Under the new rules, around 200 domestic-based entities will have to report on their exposure to climate risk based on standards devised by the External Reporting Board (XRB). CRFDs are likely to become mandatory for reporting periods ending in 2023. Imprisonment of directors is just one of a number of proposed penalties for non-compliance.

The Institute of Directors (IoD) fully supports the bill’s aims, which should help smooth the transition to a more sustainable, low-emissions economy by ensuring reporting entities actively consider the effects of climate change on and from their operations.

We all need to take action to tackle the often-devastating effects of climate change that, left unchecked, will have consequences for our social, economic and environmental ecosystems. The IoD has identified it as one of our top five issues for directors each year since 2018. The government’s proposed new climate-reporting regime is an essential tool to help us identify and manage some of these risks.

Complex to interpret and implement

However, the regime is complex and a substantial development on top of existing reporting frameworks. It will take time for organisations to understand what is required, develop the reporting and regulatory structures and, crucially, build professional capability and competence. This is particularly true for smaller listed entities.

Some organisations are further ahead than others. In the IoD’s 2020 director sentiment survey, 42% of directors of publicly-listed companies (who responded) said their organisation had included disclosures on climate-related risks and/or the impact of climate change on their organisation in their latest annual report. However, this covers a range of reporting from general commentary to narrative to a few early adopters reporting under the TCFD framework. Most will be starting from scratch.  

The bill allows organisations to apply for exemption from reporting where they can reasonably determine that climate change does not materially affect them. However, they need to provide independent assurance about reliance on the exemption from a qualified practitioner. 

Meanwhile, there are no clear guidelines for what might constitute materiality. The risk is that seeking an exemption is even more onerous than the reporting itself.  

To be effective there needs to be a longer transition period for the regime’s implementation, with assurance requirements phased in over time after reporting has become more entrenched. This isn’t unprecedented; it usually takes years to institute such standards due to their technical nature and the need to embed knowledge and capability within organisations. In fact, the XRB usually allows three-four years for entities to get their systems and processes up to speed for new reporting obligations.   

Good things take time

It took decades to lift the quality of non-financial performance reporting in our public sector, for example. Legislation was introduced during the late 1980s, then refined in the early 2000s. Yet, in 2008 the Auditor general reported to parliament on the ‘poor quality of non-financial reporting’. Good things take time. Patience and guidance help, too. 

The proposed penalties for non-compliance are severe and disproportionate to the offence, while enforcing them from the outset would be particularly unhelpful. We should be encouraging entities and their directors to consider their climate-related issues and risks, rather than punishing them for making incorrect assessments, especially in the early days. Furthermore, the information required in CRFDs is more future-focused, uncertain and speculative than that provided in standard financial reports.

For the reporting regime to be both meaningful and successful, it needs to go beyond compliance to encompass education and an ethos of continuous improvement that is critical to driving strategic thinking and organisational change.