Embed Size (px)
Citation preview
Let’s talk: sustainabilitySpecial edition on stranded assets
March 2015 Issue 4
“Stranded assets”: from fact to fiction
Disruptive innovation
Grid parity
Between a bank and a hard place
The future of global climate policy — multilateralism or realpolitik?
Regulators put the spotlight on sustainability disclosure: are you ready to comply?
Identifying material sustainability risks: realising the benefits within your organisation
An effective sustainability strategy needs to look at all of the components that can affect your business. In Let’s talk sustainability, we help you demystify the highly complex world of sustainability, and assist you in taking concrete actions to identify competitive advantages, increase operational efficiency and mitigate risk. EY has identified nine key elements that frame the discussion:
Join the conversation.
Continue the dialogueFor more insights or to browse our archive of webcasts and videos, visit ey.com/au/sustainability.
Reporting
Social impact
Supply chain
Tax implications Climate
change
Beyond compliance
Emissions
Energy agenda
Innovation
Sustainability
ey.com/au/sustainability 1
“Stranded assets”: from fact to fiction
Foreword
History behind the ‘stranded assets’ debate
The concept of environmentally stranded assets originated in NGO campaigns against the major fossil fuel companies that sought to demonstrate that there are more proven reserves on the balance sheets of the world’s fossil fuel majors than could possibly be monetised if the world was to avoid catastrophic climate change. Given that most of the world’s governments share a stated intention to avoid catastrophic climate change, the hypothesis was that a large number of coal, oil and gas assets must eventually be stranded through political intervention. These campaigns called for greater disclosures from the fossil fuel industry to attempt to force it to either acknowledge the existence of effectively stranded assets, or the non-existence of an effective climate change strategy. While these campaigns captured a few headlines they did not initially inspire much concern within the financial mainstream.
Climate change | Emissions | Energy agenda
For the global sustainability community, the most effective catalyst of change has long been seen as the informed self-interest of the mainstream financial community: if banks and investors could be convinced of the proximity of environmental risk or societal impacts, then it has been assumed that capital diverted from ‘unsustainable’ practices would render all other interventions unnecessary. In practice though, the sustainability community has found the financial sector a hard nut to crack. Although recent years have seen a substantial increase in the integration of environmental, social and governance (ESG) data forming part of investment analysis, the continued emphasis on short-term results and incentives has pushed longer-term environmental risks, such as climate change, outside of the boundary of risks contemplated by mainstream analysts. That is, until recently.
2014 saw a remarkable increase in the analysis of environmental and associated geo-political risks in the wider financial community, the primary focus of which was on the suddenly credible prospect of ‘stranded assets’ in the fossil fuel sector.
Adam CarrelSydney [email protected]
In this special edition of Let’s talk: sustainability we seek to distinguish ‘fact from fiction’ regarding stranded assets. It is not intended to draw a conclusive line under the debate, which we expect to become more rigorous over the coming years. In part, as discussion relies to a great degree on the accuracy of forecasted political intervention, and changes in global energy demand and economic conditions. Instead, it examines four variables driving concerns that do have the capacity for significant disruption, were one or more to converge unexpectedly in the short-term. These being:
• The price competitiveness and uptake of renewable electricity generation — We consider whether the progress of renewable forms of generation will continue in spite of any potential stagnation of global climate policy, and what impact this may have.
• Disruptive technologies — We take a look at some x-factor technologies, including industrial-scale energy storage and carbon capture and storage, to get a sense of how proximate these potential game-changers might actually be.
• Debt and project finance — We discuss the challenges facing debt funding in light of significant tightening of international and national carbon policies.
• Global and domestic climate policy — We consider what, if any, political consensus towards substantive multilateral climate intervention might be expected of the Paris Climate Summit in December this year; or whether the unilateral interventions of China and the US could affect more material change.
We have seen a raft of mainstream investors publically contemplate the longevity of fossil fuel related assets, with obvious and far-reaching implications for major coal exporting nations such as Australia.
What is most striking about some analysis is that any political intervention to limit, say coal-related emissions (in particular by the world’s largest coal consumer, China) is being portrayed as only one frontier in a battle that might well be lost to new forms of energy generation with or without political assistance. Furthermore, the diversity of issues and perspectives regarding the rate of change in the global energy sector has permitted a degree of data ‘cherry picking’ on both sides of the debate which can make it difficult to objectively evaluate exposure at the company level.
Let’s talk sustainability2
Challenges and opportunities in the energy supply chain
Progress, technology, disruptive innovation. Disruption has become a byword for progress in the modern economy. Yet throughout history, innovators have developed and adapted new technologies — sometimes supporting new activities, sometimes displacing old ways of doing things, sometimes both. The potential for disruption exists across all industry sectors, though information technology is often front-of-mind for most.
Across the energy value chain disruptive innovation offers new opportunities to deliver our energy needs with lower overall CO2 emissions; from accessing previously untapped reserves via fracking, to dramatic improvements in the emissions-intensity of coal-fired power stations through the uptake of ultra-supercritical coal, to improving the energy efficiency in appliances. However, disruption can also fundamentally challenge the business model on which the industry currently relies. Indeed, the “stranded assets” thesis requires disruption. That is, if radical decarbonisation will be needed in the way we generate electricity (alongside innovation in other sectors). Under such a scenario, the use of fossil fuels could be disrupted through innovations including:
• Electricity storage
• Carbon capture and storage
Electricity storage
Electricity storage can operate at large scale, and in different physical forms. For example, pumped hydro systems have used electricity at times of oversupply to pump water uphill, to then generate electricity at a later time as the water flows back downhill. But with electricity storage costs falling rapidly, distributed electricity storage is increasingly being considered as an approach to1:
• Delaying transmission capacity upgrades
• Increasing the use of variable output renewables such as solar photovoltaic (PV) and wind power by better matching supply and demand patterns (see article: Grid parity)
To limit global warming to within 2˚C in 2050 (a broadly recognised target that avoids the most extreme impacts from climate change), the International Energy Agency (IEA) forecasts2 that global wind power capacity would increase 15-fold, and solar PV around 60-fold, from current levels. Electricity storage will likely be a fundamental enabler of this massive re-alignment of global electricity generating capacity.
For fossil-fuel based electricity generators, such a future could be seen as a major challenge. For countries increasing their electrification rates, renewable alternatives such as domestic-scale solar PV plus electricity storage could offer a viable alternative to the traditional grid-expansion-plus-centralised-generation electricity delivery model.
1 Vassallo, T, 2014. Energy storage: from development to deployment. Australian Institute of Energy, v32, no.4
2 IEA, 2014. Energy Technology Perspectives 2014. www.iea.org/etp2014
At the same time, achieving a 2˚C climate scenario could see a 40% fall in demand for gas, 70% fall in demand for coal, and over 95% fall in demand for oil in global electricity generation by 20503. However, this must be put in context: with overall global energy demand increasing (in particular from developing nations) the total quantity of fossil fuels needed will equate to a predicted increase in their extraction, despite making up a smaller percentage of the energy equation overall.
Innovation in electricity storage, then, could underpin significant disruption in the current electricity supply chain over the mid- to longer-term. The key to unlocking these disruptive changes in supply may be the cost and capability of battery technology, of which there is plenty of hope.
Carbon capture and storage (CCS)
CCS has been described as “the critical enabling technology that would reduce CO2 emissions4”. Ubiquitous CCS use should be an attractive option for industry, government and society, as it would simultaneously address pressing climate concerns, increase infrastructure investment, and support the long-run value of coal assets.
3 Fossil fuels are used far more widely than for electricity generation: for example, oil is used extensively in transport, gas in fertilisers, and coal in steel production. Despite these other uses, over 80% of the reduction in coal demand forecast by the IEA in 2050 arises from falling coal demand in the electricity sector. Changes based on IEA 2014.
4 MIT, 2007. The future of coal: options for a carbon-constrained world. web.mit.edu/coal/The_Future_of_Coal_Summary_Report.pdf
Stranded assets: from fact to fiction (continued)
Disruptive innovation Graham [email protected]
Climate change | Emissions | Energy agenda
ey.com/au/sustainability 3
Despite this potential, implementation of CCS to date has been limited: currently, CCS plants around the world remove around 0.1% of the world’s annual CO2 emissions5 . For CCS to deliver an 80% reduction in forecast CO2 from coal in the electricity sector by 20506, five current-generation CCS projects would need to be completed each week between now and 2050.
CCS also adds cost to electricity generation and other industrial processes. When combined with enhanced oil recovery (EOR), oil field production benefits can offset the additional capital and operational costs7. Emissions trading schemes offer a source of revenue; however, the political and price uncertainty associated with ETSs to date have not been sufficient to drive private sector investment in commercial scale CCS. In addition, CCS faces significant liability challenges, principally arising from the long-term nature of storage required.
Addressing these challenges, alongside the development of a robust climate finance model that creates long-term incentives for investment, will be necessary for CCS to become a major disruptive force in energy and climate policy.
5 Global CCS Institute, 2015. Large Scale CCS Projects. www.globalccsinstitute.com/projects/large-scale-ccs-projects
6 Assumes an 80% reduction in emissions from coal-based electricity generation in 2050, based on IEA forecast of coal consumption in electricity generation in 2050 under a 6o warming scenario
7 To-date, around 90% of operational and in-development CCS capacity (by annual CO2 capture volume) is associated with EOR (Global CCS Institute, 2015)
Disruption, innovation, and stranded assets
Disruptive innovation is not necessarily a universal threat to fossil fuel companies: disruptive innovation can contribute to both sides of the stranded assets debate, and could occur at a scale that underpins large-scale change.
The fossil fuel sector is intimately linked to each of these technologies, and therefore to the effects of the disruption to come, yet it may have a limited ability to influence innovation in these sectors. The development and adoption of electricity storage have their own commercial drivers, and consumer uptake could occur at a rate that challenges the traditional energy supply chain. Widespread CCS deployment is strongly linked to robust and stable climate policies being adopted by government. Recognising these challenges will best place the sector for what lies ahead.
Figure 1: Levelised cost of electricity ($/MWh) by generation type10
10 Bloomberg New Energy Finance, H2 2014. Levelized Cost of Electricity Update
Let’s talk sustainability4
Stranded assets: from fact to fiction (continued)
Grid parity Jamie [email protected]
Graham [email protected]
What is it, and how does it impact stranded assets?Long seen as a holy grail for renewables, “grid parity” may be upon us. But what is it, and how does it relate to the stranded assets debate?
Grid parity refers to the threshold at which an emerging electricity generation technology is able to compete favourably on price against grid-electricity, in particular from coal and gas-fired generators, without incentives or subsidies. The significance of grid parity is that, once reached, electricity users could have the option, and possibly an incentive, to move away from centralised electricity networks and generators.
Such a move would have significant implications for existing assets: decreased demand from traditional electricity sources would not only undermine the large-scale generation market, but could also impact on the ability of transmission and distribution operators to recover costs. Under current tariff arrangements, retail prices are dominated by energy costs, yet the underlying price structure is dominated by fixed costs. Were energy sales to fall, fixed capital costs would be spread over lower energy demand, raising prices. The electricity industry has referred to this as the “death spiral” with higher unit costs for electricity driving further reductions in energy demand, which in turn increase unit costs for energy further.
Achieving grid parityFor the death spiral to occur, the cost of self-generation will need to reach grid (or “socket”) parity, including the cost of generating electricity, plus transmission, distribution, profit, and other costs. This threshold has already been reached by solar systems in most parts of Continental Europe, South West US, and Australia.
It is also predicted to do so in Japan by 2016 and in the UK and Brazil by the early 2020s8. Other forecasts are even more bullish9.
However, as the retail price of electricity includes transmission and distribution, some commentators consider that a more comparable challenge for renewables (including wind and solar) would be to achieve “wholesale parity” where energy is able to be supplied at (significantly lower) wholesale market prices. This would be no mean feat, as Australian wholesale electricity prices are currently at record lows of around $40/MWh.
There is logic to this “wholesale parity” view, for while technologies such as rooftop solar PV displace energy demand on the grid (unless they also depress peak power demand), the fixed transmission and distribution costs remain, and thus need to be recovered from a reduced demand for grid electricity. This “free rider” effect is real, but it is not new: any electricity consumer whose energy demand is low compared to their peak power demand receives such a benefit (at the expense of other consumers).
8 Citi Research, 25 September 20149 Deutsche Bank predicts that 80% of countries will
be at grid parity by the end of 2017 (DB 2015 solar outlook).
A level playing fieldBoth falling distributed generation costs and increasing grid prices contribute to reaching grid parity, and over recent years both have been occurring. Solar PV capacity costs have fallen around 80% over the last five years, largely due to massive investment in production capacity in China. In sunny regions, photo-voltaic generation costs are beginning to drop below $100/MWh. At the same time, retail electricity prices in Australia have increased significantly, and now sit at around $250/MWh. This price/cost differential makes a compelling case for household investment in solar PV.
And it is not just rooftop solar PV. Wind power has also experienced significant cost reductions, and on a standard levelised cost of generation analysis the cost of generating electricity in some regions is lower from new-build onshore wind than it is from new-build coal (refer Figure 1).
Climate change | Emissions | Energy agenda
ey.com/au/sustainability 5
Yet these comparisons may still obscure the true cost of electricity, due to direct and indirect subsidies in electricity generation. In Australia, the subsidy provided by the Renewable Energy Target has been a focus of attention; however, traditional electricity generators also enjoy subsidy support. Some are quite transparent — tax and depreciation benefits, for example — and they have been widely documented11.
11 OECD, 2014.
Parity in energy services
Electricity networks do not just deliver energy, they also deliver energy services such as reliability and reserve capacity, as well as ‘smoothing’ demand patterns over a large number of sites and matching supply with demand. Renewables alone tend not to achieve this: solar PV generates electricity when the sun shines, and wind power when the wind blows. This variability can also result in over-supply, with network operators in Queensland and New South Wales recently implementing grid connection rules which prevent household systems from exporting excess electricity back to the grid, but it can also result in under-supply.
The grid has a role to play in managing this variability, at the right price. But it faces disruption from electricity storage systems, a technology that itself is seeing rapid cost reductions. At network level, new electricity storage systems may provide an alternative to traditional reserve capacity. But stand-alone storage systems could also deliver energy services parity, as they allow for electricity supply to be matched to demand (see Disruptive Innovation).
Grid parity and stranded assetsWidely adopted, small-scale storage systems could further erode the demand for grid-based energy (and possibly also undermine demand for the grid).
Research by global investment bank UBS suggests that the average Australian household could find it cost-competitive to go off-grid as soon as 2018. But achieving grid parity does not necessarily spell the end of the grid, and there may also be different impacts for network operators and traditional generators.
For network operators, grid parity may drive a transition from energy delivery to energy services, acting as a ubiquitous battery that provides energy whenever demand outstrips renewable output. For generators, grid parity offers greater challenges. Renewables directly substitute for energy delivered by generators, reducing demand. At the same time, wide-scale adoption of storage could deliver peaking and reserve services usually provided by conventional generators. Being not only cost competitive, but also operating at virtually no marginal cost, these technologies could guarantee access to competitive markets by outbidding traditional generators.
And while the stranded assets debate has tended to focus on the implications of robust climate policy for traditional fossil fuel energy sector investments, it is the cost-competitiveness implicit in achieving grid parity that could present the greatest challenge to incumbents. For many consumers, grid parity itself may not be a sufficient driver, as the time and effort involved in achieving energy self-sufficiency may not be seen as viable. But grid parity is not an end-point for alternatives to the grid: costs continue to fall, potentially taking renewables (and storage) beyond parity. A cheaper source of electricity could be very attractive to consumers, leaving assets stranded and an entire industry facing significant challenges.
“The point at which solar-plus-battery systems reach grid parity — already here in some areas and imminent in many others for millions of U.S. customers — is well within the 30-year planned economic life of central power plants and transmission infrastructure. Such parity and the customer defections it could trigger would strand those costly utility assets”.
“The Economics of Grid Defection”, Rocky Mountain Institute, February 2014
“As energy management options such as smart appliances, energy management software, in-home generation and battery storage become more available and affordable, we expect to see a significant change in the way customers use energy and our network… (which) will have wide-ranging implications for the way the distribution network is planned, built and operated”. Energex, Annual Report 2013-2014
Let’s talk sustainability6
Stranded assets and the challenges facing debt fundingThe last two years have seen a new front in environmental activism emerge both in Australia and internationally, focussing on the potential investment risk associated with the fossil fuel (in particular, coal) value chain. In Australia, this divestment argument focusses on NSW and Queensland, with the large coal deposits of the Galilee basin, and related coal export infrastructure becoming the new face of environmental activism in Australia.
While the focus of the divestment campaign was initially on equity owners (Superfunds, University Endowments), the scope of the campaign has now broadened to include debt and project finance. Over the last six months, the campaign has targeted a number of global banks (e.g. Deutsch Bank in Germany) and the big four banks in Australia. The campaign request is clear: given the significant contribution of coal combustion to global GHG emissions12, and the significant local impacts associated with the coal and infrastructure projects (e.g. on the Great Barrier Reef, air quality), banks are being urged not only to shun new fossil fuel investments, but also to publically disclose their current exposure and risk to fossil fuel assets that have the potential to be
“stranded” in the future due to a significant tightening of international and national carbon policies.
When disclosure is not enough
The extension of the fossil fuel divest campaign to include banks and project finance creates a number of challenges and dilemmas for the Australian banks in particular, and which could ultimately result in less project finance being available to support these large investments. In most instances, banks 12 Coal accounts for 41% of global anthropogenic
CO2 emissions. EY analsyis, based on IEA (www.iea.gov) and European Commission (edgar.jrc.ec.europa.eu)
have historically relied mainly on regulatory approvals, the application of appropriate standards (e.g. Equator Principles), and their own ESG risk and credit due diligence processes to assess participation in these projects. However, this new operating environment is more complex and nuanced, requiring institutional bankers to consider a much broader suite of issues as part of their decision-making processes.
Long horizons, deep challenges
And these challenges will not be trivial, as many go to the heart of the business model. Banks are largely sector agnostic, lending across most sectors as part of a diversified portfolio of economic activities. At the same time, most Australian banks have public positions that recognise and accept climate science, and the necessity to move towards a low carbon economy (i.e. maintaining global warming below a 2˚C increase on historic levels).
These two issues are not mutually exclusive, as achieving a 2˚C scenario would still see coal use within the electricity sector and wider economy in 205013. And despite a lower overall predicted share of the global energy market, actual coal demand is predicted by most to increase out over the next 40 years. This makes for interesting analysis, where certain forms of coal will likely outperform others, due to their thermal calorific values, ash and sulphur content. In a carbon-constrained world then, not all coal is created equal.
Climate policy, or financial security
Limiting exposure to the fossil fuel sector, and particularly the coal value chain, as a mechanism for policy delivery would sit uncomfortably for many, not least the banking sector itself. That’s easy to understand, given the significant uncertainty in future development of
13 IEA, 2014. Energy Technology Perspectives
energy infrastructure, and what increased role coal could play in a lower-carbon future should supercritical and ultra supercritical coal-fired power generation become more prevalent, or should carbon capture and storage become cost-competitive and more commonplace.
These are, of course, not new considerations for banks: any exposure to assets should be accompanied by an appreciation of risk, and priced accordingly. But in the context of the prevailing policy uncertainty and complex operating environment faced by banks (and other investors), a clear decision-making framework for mitigating risks, identifying new lending opportunities and for enhancing decision-making processes in respect of assessing energy sector investments is essential. Indeed, the framework for decision-making could well be influenced by the tenure of investment, with longer-term risks being significantly discounted on short-term loans, say.
Regardless, a framework will likely include the development of long-term views on the evolution of the energy sector under different climate policy environments, together with an appreciation of the likely path forward; communication and consultation with key stakeholders of the underlying rationale for the banks’ position; establishing targets consistent with this long-term view; and integrating these portfolio requirements into project due diligence procedures.
And of course, revisiting the logic and assumptions regularly. For as recent history has shown, stakeholder concerns and climate policy can shift rapidly. Whether or not these changes result in stranded assets, only time will tell; but understanding the interaction between climate policy, stakeholder concerns and investment opportunity is most likely to ensure that risk in the energy sector, and many other sectors, continues to be priced appropriately.
Graham [email protected]
Mark [email protected]
Stranded assets: from fact to fiction (continued)
Between a bank and a hard place
Climate change | Emissions | Energy agenda
ey.com/au/sustainability 7
Adam [email protected]
Stranded assets: from fact to fiction (continued)
The future of global climate policy — multilateralism or realpolitik?
Less than 25 years since the end of the Cold War, the era of multilateralism that it ushered in is facing challenges on many fronts, not least of which is climate change. As the 20th UNFCCC Conference of the Parties (in Lima) comes and goes with little tangible progress, the prospects for a global climate agreement being forged in Paris in late 2015 are hardly clear. Of course, a global climate agreement was always going to test the limits of multilateralism’s potential. But with the European Union and WTO facing their own challenges to multilateralism, the prospect of an enforceable successor to the Kyoto Protocol being agreed in the near-term could seem remote.
Increasingly the arena of international negotiation is circling back to regionalism and bilateralism, with the idea of a global liberal consensus seemingly on ice until the global financial crisis is a distant memory. On the face of it, this might appear to spell doom for meaningful climate change mitigation; however, this is not necessarily the case.
All politics is local
The biggest sticking point of the Kyoto saga was America’s refusal to pursue substantive emissions reductions if the world’s second largest economy, China, did not act comparatively. Although China appears in no hurry to commit to a global climate treaty, its domestic response has become much more active, and much more so than the USA. While China is still the largest GHG emitter in gross terms, it is also the world’s largest investor in renewable energy, and has announced plans to roll out a national emissions trading scheme (ETS) that builds on the regional pilots that are
already functioning. The China ETS, once implemented, will be over twice the size of the European Union ETS. In addition, the government has placed new restrictions on stationary power generators and the quality of imported coal as a means of addressing China’s major air quality issues.
To some extent, these recent climate policy developments in China remove a barrier to action in other countries, in particular for the USA, and at the G20 meeting in December 2014 the USA repackaged its domestic efforts as part of a bilateral agreement with China. This agreement set longer term greenhouse gas emissions targets of a 26-28% reduction by 2025 from 2005 levels for the USA, and a peak in absolute emissions in China by 2030 with at least 20% of power generation coming from non-fossil fuel sources. It is likely that there is also an element of ‘containment’ in China and the USA’s newfound interest in climate partnership, an attempt to ensure that approaches to climate mitigation remain within each other’s manageable range. But these developments also build on an increasing history of climate policy development, whether these be domestic schemes such as in the USA (RGGI, WCI), Japan, Europe, NZ or elsewhere: developments that have proceeded without multilateral consensus.
Politically stranded
For the stranded assets debate, climate bilateralism ahead of any multilateral agreement may present an easier path forward for government (even while a globally binding climate agreement remains a minor), and might present the final straw for already marginal assets. And much now hinges on the 2016 US
Presidential election. While potential Republican candidates may be as eager to unwind the USA’s emissions reduction programs as they have been in Australia, a Democrat victor (in particular, Hilary Clinton) is likely to view the USA’s current efforts as a line from which there can be no retreat. And an accord between the world’s two remaining superpowers has a certain gravitational pull which smaller States are likely to be drawn towards, including Australia.
Meanwhile, unlikely sources of support for climate science, and refocussing investment, are emerging. Already a central figure in the lives of over 1.4 billion people, Pope Francis is increasingly popular in secular circles: his comments in support of climate change mitigation have the potential to re-wire the attitudes of a portion of the US electorate historically unmotivated by climate policy. Meanwhile, the Rockefeller Brothers Fund and other investors publicly stated their intention to divest $50b from fossil fuel investments, in a move that is likely to add fuel to the stranded assets debate.
It is likely that the USA and Obama’s new found interest in brokering global climate agreements plays to that oldest of Realpolitik precepts: appearing weak when you are strong and strong when you are weak. Either way, that climate change mitigation has remained elevated on the global political agenda despite the wane of the multilateral ideal confirms that, as an x-factor in the consideration of long-term investment decisions, climate policy it is most certainly here to stay.
Climate change | Emissions | Energy agenda
Let’s talk sustainability8
Recent additions to reporting requirements for Australian companies have put a new focus on sustainability risk disclosure. In line with international regulatory trends and supporting the push from stakeholders, both the Australian Securities Exchange (ASX) and the Australian Investment and Securities Commission (ASIC) are calling on companies to report their sustainability risks.
Australia’s changing regulatory environmentIn March 2014, the ASX Corporate Governance Council released version three of its Corporate Governance Principles and Recommendations. The Principles and Recommendations set out the corporate governance requirements applicable to all ASX listed entities. Entities are expected to prepare a statement responding to the Principles and Recommendations or explain why not in accordance with the if not, why not approach.
One of the key changes, as detailed in Principle 7, is an increased focus on risk management and a requirement to disclose non-financial and sustainability related material risks.
Changes to the ASX reporting requirements support the ASIC’s Regulatory Guide 247, released in March 2013. It provides guidance to directors preparing an operating and financial review (OFR) or directors’ report, as required by the Corporations Act 2001, and highlights that effective disclosure should include environmental and sustainability risk disclosure.
The ASX recommendations take effect for an entity’s full financial year commencing on or after 1 July 2014, while the ASIC regulatory guide applied to OFRs from the 30 June 2013 reporting period.
International trends in reporting requirementsThe ASX and the ASIC reporting requirements are reflective of an international trend encouraging companies to not only disclose their sustainability risks but also explain how they are managing those risks.
Governments in both developed and developing nations are requiring sustainability disclosure through a variety of mechanisms including regulation and the report or if not why not approach. Research released in 2013 by Global Reporting Initiative14 reviewed sustainability reporting requirements from 45 countries and found 180 policies specific to sustainability disclosure of which 72 percent were mandatory.
14 https://www.globalreporting.org/resourcelibrary/Carrots-and-Sticks.pdf
In September 2014 the European Union joined jurisdictions including Australia, South Africa, India, Hong Kong and Brazil and published its requirements for non-financial disclosure with a focus on policies, risks and outcomes regarding environmental matters, social and employee-related aspects, respect for human rights, anti-corruption and bribery issues, and diversity on boards of directors.
Regulatory requirements are supported by the increasing profile of international sustainability reporting frameworks including the Global Reporting Initiative, Global Compact and International Integrated Reporting Initiative, all of which are referenced in the ASX Principles and Recommendations.
What are the sustainability disclosure requirements?While the focus of the ASX and the ASIC reporting requirements vary slightly they are both focus on disclosure of sustainability risk.
The key audience for the ASIC disclosure is investors with the focus on the potential of those risks to impact an entity’s financial performance. The ASX recommendations makes specific mention of the large range of stakeholders impacted by an organisation’s business activities including security holders, employees, customers, suppliers, creditors, consumers, government and the community.
Regulators put the spotlight on sustainability disclosure
Are you ready to comply?
Reporting
Kathryn FranklinMelbourne [email protected]
ey.com/au/sustainability 9
ASX Principle 7: Recognise and manage risk
Principle 7 acknowledges the importance of a sound risk management process. It requires companies to have a committee, or committees, to oversee risk (Recommendation 7.1), supported by a regular review of the entity’s risk management framework (Recommendation 7.2), and an audit function (Recommendation 7.3) to improve risk management process.
A significant risk disclosure requirement is detailed in Recommendation 7.4 which requires an entity to disclose whether it has any material exposure to economic, environment and social sustainability risks and, if it does, how it manages or intends to manage those risks.
The ASX defines a material exposure in this context as a real possibility that the sustainability risk in question could substantively impact the listed entity’s ability to create or preserve value for security holder over the short, medium or long term. Definitions for economic, environment and social sustainability risks15 focus on long term impacts.
15 Economic sustainability: the ability of a listed entity to continue operating at a particular level of economic production over the long term.
Environmental sustainability: the ability of a listed entity to continue operating in a manner that does not compromise the health of the ecosystems I which it operates over the long term.
Social sustainability: the ability of a listed entity to continue operating in a manner that meets accepted social norms and needs over the long term.
While security holders are specifically referenced, the commentary supporting 7.4 acknowledges sustainability risks have the potential to impact a much broader set of stakeholders including employees, customers, suppliers, creditors, consumers, government and the local communities in which it operates.
ASIC Regulatory Guide 247
ASIC’s Regulatory Guide 247 provides guidance around the content of an entity’s OFR or directors’ report which forms part of a listed entity’s annual report and contains information investors would reasonably require to make an informed assessment of the entity’s operations, financial position, business strategies and future prospects.
Section 247.63 recommends that the OFR should include a discussion of environmental and other sustainability risks where those risks could affect the entity’s achievement of its financial performance or outcomes disclosed taking into account the nature and business of the entity and its business strategy.
Where do companies report their disclosure?The OFR or directors report forms part of an entity’s annual report as required by the Corporations Act 2001. Therefore any sustainability risks with the potential to impact the entity’s financial performance would be included in the OFR.
Under listing rule 4.10.3 ASX listed entities need to include in their annual report either a corporate governance statement or make reference to where the statement may be found on its website.
Recommendation 7.4 goes on to provide further advice that this particular recommendation may also be met by a cross reference to an entity’s sustainability report. Although such a report is not a requirement of this recommendation.
Are you ready to report?In order to comply with both the ASX and the ASIC recommended requirements, entities need to ask some key questions:
• Do we have a risk management framework to meet the ASX requirements?
• Have I identified my key economic, environmental and social sustainability risks?
• Was the approach to identifying these risks robust and transparent?
• Do I understand my stakeholders’ perspective on my entity’s sustainability risks?
• Does my board understand sustainability and sustainability risks, and will they be comfortable signing off on the disclosures.
• How and where are we going to disclosure our sustainability risks?
Let’s talk sustainability10
Identifying material sustainability risks
Realising the benefits within your organisation
Reporting | Beyond compliance
Kathryn FranklinMelbourne [email protected]
There is no disputing that external stakeholders have driven the sustainability disclosure agenda, as they demand more than compliance based financial information to provide them with a broader understanding of overall company performance.
Investors want assurance that companies understand and are mitigating a wide range of risks. Up-stream organisations require that suppliers disclose a range of non-financial issues including environmental, and health and safety performance. Customers are showing their interest in brands with strong sustainability platforms. And NGOs continue to focus on the environmental and social impacts of companies particularly around supply chain, human rights and the environment.
Sustainability disclosure provides companies with the opportunity to respond to these external stakeholders. Regulation, usually considered a lag indicator, is reflecting these demands with international and local bodies, including the ASX and ASIC, now requiring companies to report their key sustainability risks (See article: Regulators put spotlight on sustainable disclosures: are you ready to comply?). Key to this sustainability disclosure is ability to identify those material sustainability risks, as well as corresponding opportunities.
While organisations use a variety of standards and frameworks to determine risk — be they financial, community, employee or reputational risks — the key differentiator between traditional and sustainability risk assessments is the consideration of external stakeholder and long term perspectives that is applied to the later.
There is no doubt that traditional risk assessments provide a sound process for risk management, however there is a significant opportunity for organisations to complement this with the outcomes of a comprehensive assessment of material sustainability risks.
The Global Reporting Initiative (GRI) G4 and AA1000 Principles Standard both provide guidance on how to define material sustainability issues. While they involve gathering input from internal stakeholders within the business, they are explicit in the need to include contributions from a range of external stakeholders including investors, suppliers and customers. The AA1000 also incorporates a review of the broader external environment looking at issues being reported in the media (both traditional and non-traditional), and by peers, industry bodies and NGOs. It is this external review that adds a different dimension to the risk assessment and which provides an opportunity to identify emerging risks and potential red flags, as well as opportunities.
This external perspective is extremely valuable, also providing a significant opportunity to drive internal performance and mitigate non-financial risk.
However there are many recent examples of companies who failed to consider issues from a longer term and external perspective. In the environmental space we saw companies that had not taken into consideration the impact of palm oil production when it had been on the NGO agenda for some time. These companies then scrambled to address the cost implications, when considered analysis of material risks from an external perspective would have identified the issue early on. The importance of understanding social risk in the supply chain was firmly put in the spotlight following the tragedy in the clothing manufacturing industry in Bangladesh.
External stakeholders are telling companies these issues are important to them but many companies discount or underestimate the potential impact that these issues and external stakeholders can have on their business when they fail to respond.
ey.com/au/sustainability 11
Key steps: • Clearly document and communicate the process for identifying material issues. Input from external sources is vital but also involve senior managers to gather their perspectives but also to engage them in the process and the outcomes. A robust process will give the board and the executive team confidence in the outcomes and will satisfy them that the issues identified are truly those that matter to stakeholders.
• Externally report on how you are managing those material issues. Set targets. Report on targets. Give details on how you are managing the issue.
• Use the information to work with internal stakeholder to develop a response to managing key sustainability issues. Set targets and improvement opportunities. Provide frequent performance reporting against targets to ensure feedback is timely and opportunities for improvement, (be they behavioural or process), can be identified and implemented. Engage with the broader workforce.
While a solid review of material sustainability issues forms the basis of sound sustainability disclosure, it also presents opportunities for internal audiences, from the board to site based working groups, to use the information to not only mitigate risk but to help drive performance. Management of these issues does not have to fit into an annual reporting cycle. They can be monitored and assessed as often as required. Improvement opportunities can be implemented as soon as they are identified. Employees can be engaged in the process and provide immediate input.
While an assessment of your material sustainability issues provides a platform for transparent disclosure to stakeholders, it also provides the link to developing an internal sustainability strategy, driving associated sustainability initiatives, raising management awareness of sustainability risks and opportunities, and integrating the sustainability and corporate strategy.
In the next edition of Let’s talk: sustainability we will look at how to use the information from sustainability reports to support internal reporting and drive improvement throughout your organisation.
ey.com/au/sustainability 12
EY | Assurance | Tax | Transactions | Advisory
About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.
EY refers to the global organisation, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organisation, please visit ey.com.
About EY’s Climate Change and Sustainability Services Climate change and sustainability continue to rise on the agendas of governments and organisations around the world with rapidly evolving drivers and expectations. Your business faces regulatory requirements and the need to meet stakeholder expectations as well as respond to the opportunities presented for revenue generation and cost reduction. This means a fundamental and complex transformation for many organisations and the embedding of climate change and sustainability into core business activities to achieve short term objectives and create long-term shareholder value. The industry and countries in which you operate as well as your extended business relationships introduce additional complexity, challenges, responsibilities and opportunities. Our global, multidisciplinary team combines our core experience in assurance, tax, transactions and advisory with climate change and sustainability skills and deep industry knowledge. You’ll receive a tailored service supported by global methodologies to address issues relating to your specific needs. Wherever you are in the world, EY can provide the right professionals to support you in achieving your potential. It’s how we make a difference.
Ernst & Young ABC Pty Limited (ABN: 12 003 794 296); Australian Financial Services Licence No: 238167
© 2015 Ernst & Young, Australia. All Rights Reserved. APAC no. AU00002172
M1527432This communication provides general information which is current at the time of production. The information contained in this communication does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Ernst & Young disclaims all responsibility and liability (including, without limitation, for any direct or indirect or consequential costs, loss or damage or loss of profits) arising from anything done or omitted to be done by any party in reliance, whether wholly or partially, on any of the information. Any party that relies on the information does so at its own risk. Liability limited by a scheme approved under Professional Standards Legislation.
ey.com
Let’s continue the conversation. Find out how we can help you tackle your sustainability challenges at ey.com/au/sustainability.
Sustainability on the goAccess our thought leadership anywhere with EY Insights, our new mobile app. Visit eyinsights.com.
Mathew NelsonAsia Pacific Managing PartnerClimate Change and Sustainability Services +61 3 9288 8121 [email protected]
Terence Jeyaretnam PartnerClimate Change and Sustainability Services +61 3 9288 [email protected]
Matthew Bell PartnerClimate Change and Sustainability Services +61 2 9248 [email protected]
Michele VillaPartnerClimate Change and Sustainability Services+61 8 9429 [email protected]
Susan KoremanDirector Climate Change and Sustainability Services+61 7 3011 [email protected]
