Carbon intensive companies should expect to face greater scrutiny over governance and climate change risks as a result of recent changes to corporate reporting. In the latest step in a campaign by environmental law charity ClientEarth, energy companies Cairn Energy Plc (Cairn) and SOCO International Plc (SOCO) have been referred to the Financial Reporting Council (FRC) for alleged breaches of reporting obligations under Section 414C of the Companies Act 2006. The claim made is that both companies failed to make adequate disclosures in their Strategic Reports 2015 about the risks posed to their businesses by climate change.
The complaints made by ClientEarth allege that both Strategic Reports failed to provide “a fair review of the company’s business” and so did not contain a proper account of “the main trends and factors likely to affect the future development, performance and position of the company’s business”; and/or a proper “description of the principal risks and uncertainties facing the company”. ClientEarth claim that the reports should have addressed ‘transition risks’, which are business and financial risks associated with the adjustment of the world economy from high carbon intensity to much lower carbon intensity over the coming years, and ‘physical impacts’ of climate change damaging economic value in the businesses.
Following changes made to the Companies Act 2006 in 2013, a company is required to provide a Strategic Report as part of their Annual Report. Non-mandatory Guidance on the Strategic Report published by the FRC in June 2014 advises that a high quality strategic report should provide shareholders with ‘a holistic and meaningful picture of an entity’s business model, strategy, development, performance, position and future prospects’. The extent to which companies should provide information relating to non-financial matters, including the environment, depends on the size of the company. The information is in addition to mandatory disclosures of greenhouse gas emissions (GHG) by companies listed in the UK.
The information on which ClientEarth has based the complaints has been taken from both the Strategic Reports and each company’s voluntary ‘Climate Change 2015 Responses to CDP’ (formerly the Carbon Disclosure Project) on climate change risks. Based on this, ClientEarth asserts that any reasonable director standing in the shoes of each company’s directors would have reached the conclusion that climate risks constitute a material trend or factor likely to affect the business in its standard investment cycle. The SOCO Strategic Report for the y/e 31 December 2015 made no reference at all to climate change or associated risks. The Cairn Strategic Report identified climate change as a corporate responsibility issue, stated that the company would assess the implications more fully in 2016 and recorded its expectation that emissions management and controls will become increasingly important to any future production. However, it did not then address the potential for climate change risks in the risk management section of its Strategic Report.
ClientEarth has urged the FRC in both cases to open an enquiry and to appoint a review group to investigate each complaint to determine whether either company is in breach of its obligations to properly disclose risks. If a breach is identified, the FRC could issue a Committee Reference or a Press Notice or apply to the Court for a declaration that either Strategic Report does not comply with the requirements of the Companies Act 2006. If the court made such a declaration it would mean that every director who knew that the Strategic Report did not comply, or was reckless as to whether it complied, and who failed to take reasonable steps to secure compliance with the requirements or to prevent the report from being approved would have committed an offence. A person guilty of an offence under section 414D is liable on conviction on indictment to an unlimited fine and on summary conviction (in the Magistrates’ Court) to a fine not exceeding the statutory maximum of £5,000.
The consequences of a finding by the FRC that a Strategic Report does not comply with the requirements of section 414C go beyond the penalties set out in the Companies Act 2006. Investor reaction and the potential for impact on brand and reputation are among other consequences. However, it is early days both for strategic reports and for the development of climate change governance practice – for example, the FRC guidance itself does not advise on the approach that companies should take to reporting climate change risks, and the oil and gas sector is not alone in the potential for impacts. Both companies reject the complaint that has been made against them.
In the meantime, the complaints flag the importance to all operators in the oil and gas sector of ensuring awareness of increasing standards of regulation across the world on corporate governance, greenhouse gas emissions and climate change risks. The complaints made by ClientEarth to the FRC’s Conduct Committee summarise legal and other reporting provisions in the UK and elsewhere. They refer to Tullow Oil Plc and to Royal Dutch Shell as examples of companies whose strategic reports have gone beyond those of Cairn and SOCO, though without endorsing them as best practice.
The complaints also show the importance of ensuring that information in the public domain is consistent. Increasing ease of access to company information in combination with a growing global focus on climate change risk and mitigation makes it far easier for third parties, competitors, investors and other stakeholders to access information about a company. Attention should also be paid to the recent changes in the UK Corporate Governance Code, which apply to accounting periods beginning on or after 17 June 2016. In April 2016 an investor coalition represented by global investment firm Sarasin & Partners and ClientEarth wrote to the FRC to set out their belief that the new requirements should require boards of directors of carbon intensive companies to address climate-related risks in their assessments of the prospects of their businesses.
Sarah Holmes is a legal director specialising in environmental and planning law at Bond Dickinson.
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