1. Briefly tell us about the NCCARF project you lead – what is the rationale behind it?
The Australian business community has long been aware of the risks and opportunities associated with greenhouse gas mitigation and climate change policies. Some businesses have taken initial steps to adapt to the expected effects of climate change however most enterprises are only vaguely aware of the breadth of adaptation that may be required. Associated with strategic adaptation are the principles of financial / operational risk management and governance, as well as financial impact disclosure to investors and regulators. We develop a consolidated framework in which boards and executive managers can develop a robust approach to climate change adaptation governance, climate change risk assessment and financial disclosure. The project outlines a matrix of disclosures required for investors to enable them to evaluate corporate exposure to climate change risk.
2. What process did you use to engage with the private sector and why?
The project comprised a set of workshops with members of the Australian business community, industry representatives, regulatory authorities and academics with expertise in business risk and disclosure effects. Each workshop focused on a separate theme that built upon the work of previous workshops. A set of follow-up discussions was held with some of the key members who contributed to the project including the Australian Stock Exchange (ASX), Investor Group on Climate Change (IGCC), Australian Accounting Standards Board (AASB) and the Australian Institute of Company Directors. This discussion permitted each body to comment on the final report, advise on the mechanics of the costing, reporting and disclosure approaches of climate change adaptation and lend their expertise the formulation of an appropriate framework.
The scope of the research was constrained to firm behaviour and the requirements for investor disclosure and governance of adaptation activities. The project therefore focused on financial analyses undertaken by firms with regard to investing in climate change adaptation activities and projects. While the economic costs and benefits are important to organisational adaptation activities, they represent a secondary level of analysis that may need to be done on either an independent or cumulative scale by governments or other bodies to measure the wider effects.
3. What findings are emerging?
As the degree of sophistication in climate change adaptation activities, modelling and cost estimation increases along with the anticipated growth in interest of both company boards and managers, it is expected that accounting standards, ASX listing rules and disclosures required under the Corporations Act would need to explicitly reflect these corporate actions. The asset allocation of banks, mutual funds, superannuation funds and other investments is likely to also adapt as companies quantify their exposure to climate change. The makeup of assets in investment portfolios may therefore markedly shift and thus indirectly adjust to the climate change adaptation activities of companies in the broader market.
For companies to successfully prosecute their response to climate change through adaptation, they require a framework for valuing, executing and managing risks associated with adaptation actions. The framework we describe in this study advocates that climate change risks and adaptation measures should be managed under an integrated framework that:
- articulates climate change adaptation policy;
- demonstrates commitment;
- allocates resources;
- assigns responsibility; and
- advocates continuous improvement.
The framework is constructed to cater for company boards and executives, investors, regulators and other stakeholders such as community bodies, consumers and suppliers. The broad framework identifies four distinct activities where businesses will increasingly need to apply effort to successfully manage its adaptation activities:
- Risk Assessment;
- Adaptation; and
The major issues of reporting on adaptation activities identified in the study include:
- Initial accounting for adaptive (idle) capacity;
- Impairment and provisioning of adaptive capacity assets and insurance;
- Financing adaptive activities;
- Defining additional financing costs for adaptive capacity; and
- Revaluation of assets with adaptive capacity through time.
4. What do you see as current or potential barriers to adaptation in the private sector?
Climate change activities will naturally impact important aspects of company reporting. Based on the potential financial impacts associated with climate change, there are several existing financial accounting standards that adequately address disclosure of climate change risk and adaptation activities. However there are a number of elements that are of concern. Adaptation activities such as building adaptive capacity into assets and operations may incur detrimental accounting treatment if such investment occurs in the absence of tax relief under certain accounting standards and principles. While building adaptive capacity can be an alternative to insurance, insurance can be expensed but adaptive capacity in excess of an asset’s ‘fair’ or book value cannot. This puts firms who adopt adaptive capacity activities (that is, firms who self-insure) at a disadvantage relative to those who simply obtain insurance coverage from a third party.
A particular danger to publicly traded companies is not the fact that they face greater disclosure obligations, but when they undertake greater disclosure commitments, either voluntarily or compulsorily, may be exposed to allegations that they engaged in ‘selective disclosure’ or ‘omission’ of unfavourable information. It may be inevitable that unintended disclosures transform into civil complaints. Prescriptive reporting requirements under the direction of the ATO, AASB or ASIC (and other relevant industry bodies) may alleviate the risk of relatively loose disclosure principles impacting on the actions of company Boards and executives.
5. Do you see any opportunities for the private sector emerging from climate change?
Companies taking action to adapt to climate change must identify current and potential impacts on business, reduce vulnerability to them and take advantage of any potential opportunities they present. Companies will increasingly and inevitably address adaptation as aspects integral to their business strategy and risk management. Actions taken to minimise and respond to the effects of climate change should ultimately be reflected in financial statements, but there are other implications for continuous disclosure rules, reporting transparency for improving investor relations, auditing of financial statements around adaptive capacity and board and executive governance of the adaptation and risk management process.
Three key factors influence firm decision-making for climate change adaptation. First, uncertainty over the future and firm learning will have a material effect on the extent of that uncertainty. Second, it should be possible for firms to delay implementation of adaptation options or at least implement them in stages. Third, adaptation options being considered will be at least partially irreversible, which means that they constitute sunk costs which are not fully recoverable, or be subject to adjustment costs if they are to be adapted for other uses. Examples of irreversible options include defensive infrastructure projects (no one will want to buy a levee that is never needed) whereas the decision to change the mix of crops planted may be quite reversible (assuming the change occurs at negligible cost).
Firms will increasingly need to take account of the value of deciding based on new information received in the future, and then weigh this against the loss of benefits from not acting today. This requires an appreciation for contingent valuation techniques such as real options analysis and other quasi-option approaches.
6. Any suggested reading or further comments?
Future research needs to address the following issues:
- Development and coherent integration of loss models for improved risk measurement and management;
- Capital market valuation of adaptation options;
- Development of public-private partnerships to better address the financing of adaptation options;
- Development of generalised models for SMEs to employ for their own risk assessments; and
- Development of a national climate change database that can be used by business in making adaptation decisions, and that will capture user information and inform researchers of the current gaps in climate data.