May 28, 2020
Business Risk

The extent to which law will dictate the impact of climate change is yet to be seen. As regulation increases businesses need to be aware of their new obligations. Additionally,  the wider economic implications of consumer perspective, shareholder leverage and affected supply chains means that climate change has the potential to completely change the face and operations of a company. Below is a broad outline of some of the risks and regulations in the UK.

Financial stability risks

The former Governor of the Bank of England, Mark Carney, identified three key areas of risk to financial stability from climate change:

  • Physical risk: risks from the direct impacts of climate change, including impacts on insurance liabilities and the value of financial assets that arise from climate- and weather-related events, such as floods and storms that damage property or disrupt trade.
  • Liability risk: the impacts that could arise in the future if parties who have suffered loss or damage from the effects of climate change seek compensation from those they hold responsible. These types of claims are likely to impact most severely on carbon extractors and emitters, and their insurers.
  • Transition risk: the financial risks that could result from the process of adjustment towards a lower-carbon economy. Sudden or disorderly changes in policy, technology and physical risks could prompt a reassessment of the value of a large range of assets as costs and opportunities become apparent.

Increased recognition

Recognition of the severity of the risks from climate change has grown exponentially over recent years. For the first time, the World Economic Forum’s Global Risk Report 2020 identified climate change risk and biodiversity loss as among the most important global risks. Price Waterhouse Cooper’s 23rd Annual Global CEO Survey, ‘Navigating the rising tide of uncertainty, found that two thirds of CEOs identified climate change as a risk to their business, while many also recognised the opportunities.

Climate change impact on organisations

Climate change can impact companies and other types of business in several ways, including:

  • Physical impacts: Companies’ operations may be affected by extreme weather events (such as droughts, flooding, storms or fires), particularly those with operations or supply chains in vulnerable areas of the UK or other countries. This can also lead to increased insurance premiums or difficulty in obtaining insurance, for example for businesses located in high risk flood areas.
  • Litigation risk: Climate change litigation is increasingly being used in some jurisdictions (notably, the US) to influence government action and corporate and investment decisions relating to climate change, and to seek compensation for losses already sustained and future adaptation costs.
  • Climate change legislation: may limit the ability of companies to operate, or affect their growth strategies.
  • Project and development risk: It will be harder for some types of project, developments and activities to obtain the necessary permits and consents. For example, the successful climate change judicial review challenge to the Airports National Policy Statement (NPS) for Heathrow expansion impacts on many businesses involved in the project.
  • Resource risk: It may be harder or more expensive for companies to secure resources, such as energy and water.
  • Market risk: Businesses may be at a competitive disadvantage if they fail to recognise market trends driven by climate change. Consumers’ understanding of green products and services is increasing and their demands becoming more sophisticated.
  • Technology risk: Low-carbon technologies will disrupt the economy and reduce demand for some types of product.
  • Supply chains and public sector procurement: Companies are putting increasing pressure on their suppliers to reduce their carbon footprints, in order to be able to show the extent of their own commitment to reducing carbon emissions. Companies will wish to ensure that their chain is resilient to climate change risks. Public sector organisations are also subject to increasing green procurement obligations. This could put companies at a disadvantage when bidding for contracts.
  • Reputational risk: Companies are increasingly expected to report on their climate change risks, set carbon reduction targets and mitigate their climate change impacts. Failure to engage visibly with decarbonisation may impact on a company’s reputation and brand.
  • The race to net zero: An increasing number of companies (including global corporations) have set net zero targets over recent years, putting pressure on their peers to do the same. For information on organisations that have made net zero commitments, see UN: Business Ambition for 1.5°C – Our Only Future (businesses that have committed to set science-based targets aligned with limiting global temperature rise to 1.5°C) and UN: Net-Zero Asset Owner Alliance (institutional investors who have committed to transition their investment portfolios to net zero by 2050).
  • Investor pressure: Insurers, lenders, shareholders and other investors are putting increasing pressure on companies to provide information about climate change so that they can assess the financial impacts on their investments.
  • Activist risk: Companies that are involved in greenhouse gas (GHG) intensive industries (like power plants and airports) are at risk of organised protests, which might result in financial loss. Increasingly companies are also seeing action by shareholder activists. For example, Climate Action 100+ is an investor initiative that calls on the world’s largest corporate greenhouse gas (GHG) emitters to take necessary action on climate change, and Follow This is a group of shareholders in oil and gas companies that organises support for oil and gas companies to commit to the goal of the Paris Climate Agreement to limit global warming to well below 2 degrees C.
  • Business opportunities: Climate change may provide new business opportunities (for example, in the clean tech and renewable energy sectors). Government financial incentives may also provide opportunities in new sectors (for example, feed-in tariffs to support renewables).
  • Employee pressure: Employees are increasingly calling on employers to recognise the importance of climate change and commit to reducing emissions. Addressing these concerns and engaging with employees is important for recruitment and retention, and can also have reputational impacts (for example, media coverage of how employers are dealing with the global climate strikes in September 2019).
  • Stranded assets: Achieving climate change targets, in particular limiting climate change to less than two degrees, will require a large proportion of existing fossil fuel reserves to remain unused. The value of these assets might not be fully reflected in the value of companies that own the assets or that extract or distribute fossil fuels, or energy intensive industries. Pricing in this risk could result in a sudden drop in value. Assets could become stranded by legislation (for example, the phase out of coal-fired power stations in the UK), an increased demand for renewable energy, or legal action.
  • Competition law: Competition issues may arise where businesses are seeking to engage with peers, suppliers or customers on climate change, or where businesses exclude certain suppliers based on their climate change performance or other sustainability criteria.

Climate change legislation: framework and government targets

Although the public debate about climate change continues, the scientific consensus is clear that man-made climate change is real.

In response, the international community has developed an evolving framework of climate change legislation, through the United Nations Framework Convention on Climate Change (UNFCCC), the Kyoto Protocol and the Paris Agreement.

The EU and UK have adopted ambitious targets and legislation to reduce GHG emissions, improve energy efficiency and increase renewable energy. In particular, the EU adopted a framework for climate change and energy policy with targets for 2030 and the UK adopted the Climate Change Act 2008, and, in 2019, set itself a statutory net zero carbon target for 2050.

Climate change legislation in England and Wales: summary of key areas

Some climate change legislation impacts only on certain, primarily high-energy businesses. However, increasingly, climate change legislation has a far wider application. The key areas are:

  • Climate Change Act 2008.The Climate Change Act 2008 provides the overall framework for the UK’s climate change policy and legislation. It imposes a legally-binding duty on the government to reduce the UK’s GHG emissions by 100% by 2050, through a series of “carbon budgets”, thus giving businesses (including investors) a strong signal of the government’s overall trajectory.
  • Carbon reporting.Medium-sized and large quoted companies have been required to report on their GHG emissions in their annual company reports for some years. The streamlined energy and carbon reporting(SECR) regime imposes new and additional reporting requirements on GHG emissions, energy consumption and energy efficiency action by quoted companies, large unquoted companies and large limited liability partnerships (LLPs) in respect of financial years beginning on or after 1 April 2019. SECR extends carbon reporting requirements to many companies that were not required to report before.
  • EU Emissions Trading System (EU ETS).The EU ETS is a mandatory emissions trading scheme for installations in certain energy-intensive industries across the EU, including manufacturing facilities, oil refineries and power stations. The government allocates allowances to installations within the EU ETS, allowing them to emit a certain amount of carbon dioxide each year. Since 2012, a significant level of allowances has been auctioned instead of allocated for free. At the end of each year, the amount of carbon dioxide emitted by an installation must be less than or equal to the amount of allowances that it holds. Companies can trade allowances with each other to achieve compliance. The UK government is considering various carbon pricing options to replace the UK’s participation in the EU ETS at the end of the transition period.
  • Carbon emissions tax.Following the UK’s departure from the EU on 31 January 2020, the government is considering introducing a carbon emissions tax as part of the UK’s future carbon pricing policy after the end of the transition period, depending on the terms of the future relationship between the UK and EU. A carbon emissions tax is a possible option in the event that the government cannot agree its preferred option of a UK ETS linked to the EU ETS. (The alternative is a stand-alone UK ETS).
  • Climate change levy (CCL).The CCL is a carbon tax that adds around 15% to the energy bills of businesses and public sector organisations. It is levied on non-domestic consumers of certain energy supplies (for example electricity, gas, solid fuel and liquefied gas). The rate of CCL was increased from April 2019 to reflect the abolition of the CRC Energy Efficiency scheme. Energy-intensive business users can enter into voluntary climate change agreements (CCAs) to receive a discount from the main CCL rate. CCAs commit energy-intensive installations and facilities to targets for improving their energy efficiency or reducing carbon emissions, in return for receiving the reduced CCL rate.
  • Energy Savings Opportunity Scheme (ESOS). ESOS requires larger companies and non-public sector organisations in the UK to carry out mandatory energy saving assessments. It requires participants to calculate their total energy consumption, carry out energy audits and identify where energy savings can be made.
  • Energy efficiency.The government is also seeking to improve the energy efficiency of buildings and products and appliances, including requirements for eco-design and energy labelling, and voluntary initiatives by manufacturers and retailers.

Climate change in contracts

In February 2020, The Chancery Lane Project (TCLP) published the first edition of its Climate Contract Playbook and Green Papers of Model Laws, based on pro bono drafting by more than 120 legal professionals at its November 2019 climate change hackathon. The Project aimed to bring legal professionals together to collaborate and rewrite contracts and laws in order to support communities and businesses in fighting climate change and achieving net zero carbon emissions.

New standards

An increasing number of companies (including global corporations) have set net zero targets over recent years, putting pressure on their peers to do the same. The World Economic Forum (WEF) called for all companies attending the 2020 Davos meeting to set a target of net zero carbon emissions by 2050. The WEF also provided guidance on setting a net zero target and recommended that companies also set an interim 2030 goal and disclose the climate risks facing their business.

Regardless of the size of the business or organisation concerned, some form of planning or awareness of the impact of climate change is crucial to help regulation run smoothly and in preparation for the consequences of an increasingly volatile situation.

If you have any questions on the above please contact us.