Climate-related litigation risk management

What you need to know

• Climate-related litigation is an emerging risk, with litigation continuing to increase within Australia and internationally.
• The Network for Greening the Financial System (NGFS) recently published two reports highlighting recent trends and developments in climate-related litigation and micro-prudential supervision considerations for climate-related risks.
• The NGFS defines climate-related litigation as "cases before judicial and quasi-judicial bodies that involve material issues of climate change science, policy, or law" and climate-related litigation risk (CLR) as "any financial risks that impact an institution either directly or indirectly, arising from climate-related litigation".
• Awareness, understanding, response to, and supervision of CLR is at an early stage of development.
• Greenwashing is a particular type of climate-related litigation, which continues to be a focus of regulators both in Australia and internationally.

What you need to do

Businesses should prepare for and implement a risk-based approach, identifying their highest climate-related compliance risks, and prioritising the development of controls, policies, and procedures to mitigate the risks of climate-related litigation.

Risk landscape

Climate-related litigation is increasing globally and growing rapidly, not only in terms of the volume of cases initiated, but also the legal arguments used, and the diversity of parties. The significance of this risk is expected to continue to increase in coming years, not only with respect to climate change related matters, but also broader environmental and nature-related considerations including biodiversity and human rights. For example, Amazon indigenous communities and international NGOs have sued supermarket giant Casino over alleged deforestation and human rights violations under French law.

CLR is a complex risk that warrants special consideration by businesses, and a heightened awareness and nuanced understanding of the key risk drivers and implications of an inappropriate response:

• CLR is a "transverse risk" that potentially intersects and impacts several risk categories across businesses, including strategic, financial, and reputational risk;
• On this basis, CLR is best considered as a sub-category of "physical" (ie physical effects of climate change) and "transition" (ie transition to a low carbon economy) risks, rather than as a standalone risk category. This sub-category is also referred to as "liability risk";
• CLR is distinct from "general litigation risk" in that the latter is typically captured within operational or compliance risk management frameworks.

Although the overwhelming majority of CLR takes the form of climate-aligned litigation, there is also an emerging trend in the growth of the "anti-ESG movement", the rise of non-climate-aligned litigation, and concerns that, for example, climate collaboration amongst the financial sector could be treated as an anti-trust violation.

Potential consequences

The financial and reputational implications of climate-related litigation can be substantial, and unpredictable. Climate-related litigation cases have the potential to impact many different business types, including financial institutions. Notably, climate-related litigation does not have to be successful for costs to materialise; a credible threat of litigation or even unsuccessful litigation can have serious reputational and financial consequences for businesses, and impact future business practices, while "green-hushing" (choosing not to actively promote environmental achievements or credentials due to a concern about "greenwashing" allegations or other potential legal challenges) risks depriving customers of information about more attractive options and choices.

Climate-related litigation can lead to direct or indirect consequences for businesses, although data and methodology challenges can make it difficult to quantify litigation losses or assign the probability of occurrence:

• Direct exposure could include businesses appearing as defendants in climate-related litigation or in regulatory investigations or enforcement proceedings, while direct costs could include damages, fines, legal and administrative fees, or insurance premium costs.
• Indirect exposure could include exposure to defendants, broader assets classes, sectors, or geographies, while indirect costs could include insurance pay-outs covering legal fees or settlements, credit losses, deterioration of creditworthiness, reputational costs, or changes to the valuations of loans and investments.

"Greenwashing", the term used to describe situations where disclosures, statements or commitments are made to give the impression that the company or certain procedures, policies or products are environmentally friendly or sustainable when this impression may be misleading or untrue, is a specific type of climate-related litigation risk. Greenwashing is an emerging focus for enforcement action across many jurisdictions, and the potential penalties for greenwashing have increased substantially in recent years. Regulators have identified that they are targeting conduct such as (i) net zero statements and targets; (ii) use of terms such as "carbon neutral", "clean" or "green" (or images, colours and "trust marks" that give that impression), and (iii) the scope and application of investment fund exclusions and screens.

Allegations may also be made against directors that they should be found personally liable for greenwashing or for failing to discharge their duties with care and diligence.

Important business considerations

Overall, CLR is an emerging risk and awareness, understanding, response to, and regulatory supervision of this risk is at an early stage of development. However, it is certain that businesses should be considering CLR as a distinct risk category, separate from general litigation risk. This is supported by supervisory bodies' (eg the Australian Competition and Consumer Commission and Australian Securities and Investments Commission) close monitoring of CLR with the expectation that the businesses they supervise will understand, assess, and act on CLR by taking a risk-based approach.

Applying a risk-based approach should support regulated businesses to meet or exceed the expectations of supervisory entities who, depending on the context, may respond to businesses' management of CLR with a range of low to high intensity supervisory options, drawing from a "toolbox" that could include: exercises raising thematic awareness of CLR, risk mitigation and transfer considerations, establishing governance and risk management expectations to be assessed in prudential reviews, climate-related litigation disclosures, and testing resilience through scenario analysis and regulatory capital considerations.

How to take a risk-based approach

Businesses should immediately start taking a more proactive, risk-based approach in order to anticipate and reduce CLR to as low as reasonably practicable.

This risk-based approach should include:

• Identification of climate-related risks and business activities where these risks could materialise;
• Assessing the likelihood and severity of CLR, and the current level of vulnerability and exposure of the business to CLR;
• Prioritising possible response options to CLR on the basis of the risk identification and assessment;
• Managing the response to these risks, including through the enhancement of existing CLR controls, policies and procedures, and the design and execution of further CLR controls, policies and procedures; and
• Conducting ongoing monitoring and evaluation activities to support continuous improvement of the CLR risk management framework, to ensure that solutions remain robust, fit-for-purpose, and future-proof in responding to the ever-changing landscape of climate-related litigation risk.

Conclusion

The NGFS reports expose climate-related litigation as an emerging risk, with evidence of litigation continuing to increase globally. The focus on this issue continues from various stakeholders, including supervisory bodies. There should be continued focus on this as a significant risk to business activities, and to proactively seek assistance in developing processes, systems and frameworks to manage this emerging risk as a priority.