Executive summary

Climate change is considered to be a financially material risk for listed companies that account for two-thirds of global market capitalisation. That is why climate change and associated risks are the number one priority for institutional investors when engaging with companies globally. However, corporate governance frameworks have not yet fully responded to the major challenges that climate change has engendered in relation to the corporate sector.

This report presents the main trends, issues and implications of climate change for corporate governance. In particular, it focusses on relevant developments for policy makers evaluating their legal and regulatory frameworks for corporate disclosure, the responsibilities of company boards and shareholder rights.

Corporate disclosure. While financial standards already require disclosure on how climate change may impact a company’s business, a number of concerns have been identified with respect to the structure, comparability and reliability of such disclosure. For instance, as a rule, many financial standards do not require a structured disclosure on strategy, risk management and non-financial information (e.g. greenhouse gas emissions) that may be relevant for investors to assess a company’s business and risks.

To date, a number of reporting standards have been developed for companies to disclose sustainability information but these standards vary with respect to their target audiences, the issues they cover and the threshold they recommend for information to be disclosed. This plenitude of existing standards also raises questions related to the comparability of sustainability information disclosed by companies. A lack of comparability harms investors’ capacity to adequately evaluate companies when deciding how to allocate their capital and engage with these companies.

A growing number of jurisdictions have established regulations or initiated public consultations on proposals to mandate companies to disclose sustainability information according to a specific reporting standard. Many of these regulatory initiatives across OECD, G20 and FSB members have focused on climate-related disclosure requirements or guidance, frequently with reference to the FSB’s Task Force on Climate-related Financial Disclosures (TCFD) recommendations to facilitate the comparison of sustainability disclosure between companies. Additional work is underway to align different standards under a single sustainability disclosure standard that would build upon the TCFD and other frameworks.

The use of multiple sustainability reporting standards is not the only barrier to greater consistency and comparability of corporate sustainability disclosure. When the sustainability information disclosed is not assured by a third party based on robust methodologies, this can undermine confidence in the information. Globally only around half of large listed companies that disclose sustainability information provide some level of assurance by a third party. And a majority of these assurance engagements provide only “limited” assurance reports.

Importantly with respect to any reporting standard, a key issue is the definition of which information is material and, therefore, should be disclosed. Information is “financially material” if it could reasonably be expected to influence an investor’s analysis of a company’s future cash flows. The concept of “double materiality”, in turn, incorporates what is financially material, but also includes within its scope information relevant to the understanding of a company’s impact on the environment and on society. This concept is new, and is not the standard in most jurisdictions.

While in theory clearly distinct, the frontiers between financial and double materiality may be rather fluid in practice. For instance, in what constitutes one aspect of “dynamic materiality”, a risk that does not seem to be financially material at a moment in time may quickly become financially relevant, if for instance the social context changes. To some extent, therefore, the time horizon used in the analysis of materiality may also be key: the longer the time horizon, the larger the potential for overlap between financial and double materiality.

The responsibility of the boards. While business reality is complex, corporate law generally presents a simplified definition of directors’ duties, including the duties of care and loyalty, in order to make them functional. These frameworks underlie an ongoing debate on how directors’ decisions may reflect the interests of shareholders and stakeholders and how these interests may be balanced. Jurisdictions vary in relation to who is effectively the recipient of directors’ duty of loyalty between the following two extremes:

• At one end of the spectrum, company law may fully adhere to the “shareholder primacy” view, obliging directors to consider only shareholders’ financial interests while complying with the applicable law and ethical standards. This still requires attention to stakeholders’ interests, but only to the extent that those interests may be relevant for the creation of long-term shareholder value.

• At the other end of the spectrum, directors need to balance shareholders’ financial interests with the best interests of stakeholders, and, in addition, to fulfil a number of public interests.

Both models above have their advantages and drawbacks. Independent of these considerations, some companies are already actively integrating sustainability considerations into their strategies and executive compensation plans. Globally, 30% of listed companies with performance-linked executive remuneration use sustainability-linked performance measures in their plans.

Shareholder rights and engagement. With investors allocating a growing share of their portfolios to sustainability and ESG-related funds, shareholders have expressed a high priority in their engagement strategies to focus on climate-related concerns. In doing so, shareholders commonly use three main fora to compel companies to incorporate climate change considerations into their business decision-making processes: direct dialogue with directors and key executives, shareholder meetings and courts.

In shareholder meetings, shareholders may typically propose a resolution requiring a change in corporate policy, change the composition of the board or even alter a company’s articles of association. By mid-February 2021, shareholders had filed 66 resolutions specifically related to climate change for the year’s US proxy season (in addition to 13 proposals about climate-related lobbying). Twenty-five of those climate-related proposals asked for the adoption of greenhouse gas emission reduction targets in line with the Paris Agreement.

While shareholder proposals often demand relatively short-term action from management such as developing a strategy, they may also propose amendments to a company’s articles of association that have longer-term consequences. Meaningfully diverting a company from a profit-making goal would, nevertheless, create a number of challenges. That is why some jurisdictions offer a legal structure that enables for-profit corporations to adopt objectives other than simply maximising long-term profits. This is the case of the public benefit corporations (PBC) in Delaware (currently, there are 207 private and seven listed PBCs) and sociétés à mission in France (203 private and three listed).

In some cases, shareholders and stakeholders may decide a lawsuit is the best or only solution to a disagreement with a company’s management. Corporations are defendants in at least 18 climate-related court cases filed globally between May 2020 and May 2021. Climate-related corporate litigation has been traditionally focused on major carbon emitters, but an increasing number of claims cover the current fulfilment of fiduciary duties and due diligence obligations by companies and their directors in industries other than oil and gas, and cement.