By Mark Bland, Partner

On Monday 2 November, superannuation fund trustee Rest settled the Federal Court proceedings brought against it by ecologist and member Mark McVeigh. It is a case that has attracted global attention and, despite not creating a legal precedent, sets a standard against with other superannuation funds will be measured. This article summaries the background and the settlement terms of this case. It also contains analysis on the legal implications and risks for superannuation trustees and directors presented by this development and their response to it.

Background

This case started with Mark McVeigh making an enquiry of the trustee of his superannuation fund about how it managed the financial risks associated with climate change. After a year of communication with Rest, McVeigh was not satisfied with Rest’s response and so in July 2018 filed his claim in the Federal Court.

McVeigh’s claim was initially about disclosure, claiming that Rest had breached s 1017C of the Corporations Act 2001 by failing to provide him with adequate information for him to make an informed judgement about the management and financial condition of the fund. Later that year, McVeigh amended his claim to include the conduct of the trustee.

McVeigh’s claim points to both “physical impacts” of climate change (such as higher temperatures) and “transition impacts” (such as change of government policies on climate change and changes in technology and community perceptions).

The conduct aspect of the claim was directed at whether Rest had complied with covenants under s 52 of the Superannuation Industry (Supervision) Act 1993 to act in the best interests of members, exercise adequate care, skill and diligence and exercise due diligence in setting an investment strategy. It also brought into consideration the conduct of investment managers and asset consultants by claiming Rest failed to require its investment managers to provide information on investment performance and capability in order for Rest to adequately manage climate change risk and provide the required information to McVeigh.

Rest pleaded in its defence that climate change risk was just one of many material factors to be considered by Australian investors and denied that climate change was likely to, have a material or major impact on the financial condition of the fund. Rest also argued that McVeigh had not identified any particular investment of Rest put at risk by climate change.

McVeigh was indemnified by Friends of the Earth and was advised by David Barnden of Equity Generation Lawyers, who is also running actions against the Federal Environment Minister for breaching her common law duty of care for young people in relation to climate change and the Australian Government for failing to disclose risks that climate change could have on government bonds.

Settlement

The settlement was reached at the end of the first day of a 3 day trial. Media releases were issued by both Rest and by Equity Generation Lawyers.

In Rest’s media release, it makes general acknowledgments about the risks that climate change pose to its investments and also commits to specific initiatives.

Rest acknowledges that climate change is a material, direct and current financial risk to the fund across numerous risk categories. Accordingly, Rest considers it important develop the systems to ensure these risks are identified, considered and mitigated and managed having regard to the goals of the Paris Agreement and international efforts to limit climate change.

Rest states that it will take steps to ensure that investment managers consider, measure and manage climate change risks and other ESG risks and report back to Rest on their efforts. Rest will also take steps to improve the compliance of investment managers with these requests.

The 9 specific initiatives that Rest commits to are:

1. Set an objective to achieve a net zero carbon footprint for the fund by 2050.
2. Measure, monitor and report outcomes on its progress in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).
3. Encourage its investee companies to disclose in line with the TCFD recommendations.
4. Publicly disclose the fund’s portfolio holdings.
5. Enhance its consideration of climate change risks when setting its investment strategy, including by conducting scenario analyses.
6. Actively consider all climate change related shareholder resolutions and otherwise engage with investee companies and industry associations to promote business plans and government policies to be effective and reflect the climate goals of the Paris Agreement.
7. Conduct due diligence and monitoring of investment managers and their approach to climate risk.
8. Develop its climate change policy and internal risk framework to reflect the above.
9. Seek to require that its investment managers and advisers comply with the above.

Implications

Lost opportunity for certainty?

This case promised the first judicial consideration of the disclosure and conduct of obligations of superannuation trustees as they relate to managing climate change risk.  A judgement would have provided certainty for trustees who are operating in a highly uncertain environment.  The requirement for action on climate change risk by ASIC and APRA is at variance with the views expressed by members of Government. Also, the strongest voices for addressing climate change risk at each of ASIC and APRA will have departed by the end this year.

While settlement is, in one sense, a lost opportunity for certainty, it has the direct impact of setting the $60bn in Rest on a course where climate change risks are actively managed. It also sets a standard against which other funds can expect to be measured by their members.

The claim was also based on conduct prior to July 2018, so any judgement may have been highly fact specific and related to expectations at that time, which have shifted considerably.

While the commitments made by Rest do not appear to be directly enforceable, the mechanism of a press release amounts to a representation that, if Rest were to depart from privately, would result in misleading or deceptive conduct.

Directors

Directors of trustees of other superannuation funds will likely be considering how their fund compares with the standard set in this settlement. While McVeigh could have included directors in the proceedings, it is likely they were excluded for strategic reasons. The next case may very well include directors, as one of the director covenants under the SIS Act is to “exercise a reasonable degree of care and diligence for the purpose of ensuring” the trustee complies with the trustee covenants.

Rest’s acknowledgement that climate change is not just a financial risk, but one that impacts reputation, governance, strategy and third party risk, aligns with the top down approach recommended by the TCFD. This squarely places climate change risk as a matter to be dealt with at board level.  The courts have found that a director’s duty can extend to protecting the company’s reputation, regardless of any financial loss. However reputational damage in superannuation can easily lead to large numbers of members and departing the fund, as occurred in the retail sector during the Royal Commission.

Super Funds

Funds that are lagging in the management of ESG related risks will be carefully considering what steps they will need to take to avoid being the next target of such an action and to ensure they don’t see members exit the fund in favour of funds that are actively managing climate change risk.

Funds should be careful, however, in rushing to make commitments in response to member pressure. Not only could the failure to keep to promises cause significant reputational damage, it would also likely amount to misleading or deceptive conduct.

While Rest is not appearing at the House Standing Economics Committee hearings late this week on 6 November (there is another on 20 November), climate change and voting was a subject raised in the September hearing and is sure to be raised again. Funds appearing should be prepared to respond to questions about how they compare with the Rest initiatives.

Fund Managers

One of the important implications of the Rest initiatives is that Rest will seek to hold their investment managers more accountable on how they manage climate change risk, including by providing more detailed reporting on steps taken by themselves and in the operation of assets.

Fund managers can expect their superannuation trustee clients to renegotiate their agreements to ensure they have vastly increased accountability and reporting measures.

9 Rest initiatives

As for the 9 specific initiatives, the first a target of a net zero carbon footprint by 2050, Rest will be joining other industry funds HESTA, Cbus, Local Government Super, Unisuper and Aware (equities only) which have made this commitment already. Due to its investments in renewables, Future Super is already there.

The second and third initiatives reference the Task Force on Climate-related Financial Disclosures. The TCFD was created by the Financial Stability Board, a group of international financial institution including the Reserve Bank of Australia. The TCFD recommendations are designed to create a comparable reporting regime on four thematic areas, governance, strategy, risk management, and metrics and targets.

The TCFD initiatives will have a ripple effect on investment managers. Super funds will likely need more and better information from investment managers to enable them to comply and will need a lift in conduct so that their reporting to members reflect an appropriate level of management of climate change risks. The TCFD recommendations include disclosing “scope 3” greenhouse gas emissions which has been the subject of controversy of late, including a shareholder resolution at Rio Tinto’s AGM earlier this year.

The fourth initiative, to disclose the fund’s portfolio holdings will require Rest to publish the assets it holds, so member can know what assets are held by the Fund. This obligation was first contemplated initially legislated in December 2013 and has been deferred by ASIC on multiple occasions since then. It is now scheduled to commence on 31 December 2020 but ASIC has indicated it may be deferred again.

The fifth initiative is to enhance its consideration of climate change risks and conduct scenario testing, which is arguably currently required under APRA’s SPS 530 Investment Governance which presently requires funds to have a sound investment governance framework including an effective due diligence process for the section of investments and conducting scenario analysis of the impact of significant risks. It also addressed investment reporting measures and risk management. Scenario testing is also one of the recommendations of the TCFD, and so is implicitly required to meet the TCFD disclosure requirements.

Actively considering all climate change related shareholder resolutions (sixth initiative) is done by many industry funds through the Australian Council of Superannuation Investors (ACSI), as well as broader engagement with companies, industry associations and government to reflect the climate goals of the Paris Agreement.

Climate change risks and the TCFD reporting recommendations will not be new to directors of publicly listed companies as ASIC has made clear in regulatory guidance that companies face court action if they fail to disclose how they manage climate change risks, and strongly encouraged companies to adopt the TCFD recommendations. The ASX also published guidance on reporting on climate change risks earlier this year.

The seventh and ninth initiatives relate to investment managers.  Due diligence and monitoring of investment managers relating to climate change risk is likely to be included in APRA’s proposed updated SPS 530 Investment Governance. However APRA has made clear that trustees should not wait for this update to address climate change risks and encourages adopting voluntary disclosure frameworks such as the TCFD recommendations.

The ninth initiative will have the ripple effect discussed above, as trustees ‘seek to require’ that its investment managers also comply with these initiatives.

The eight initiative importantly requires the implementation of these initiatives into Rest’s internal risk framework.

Legal risks

While the terms of the settlement do not set a legal precedent, Rest cannot have agreed to these terms without being confident that it could do so and comply with its legal obligations.

The fact that Rest considered that it could make this commitment is an important point because trustees are being forced to navigate a course between Scylla and Charybdis (or the devil and the deep blue sea) in addressing climate change risks. On the one hand, trustees are told by their Minister it is “not your job” to “reframe the climate debate”, implying that expenditure on lobbying on climate change may breach the best interests and sole purpose tests; on the other hand, trustees are told by APRA that climate change risks are “material, foreseeable and actionable now”.  With government policy being a significant contribution to the “Transition Impacts” of climate change, it appears that it is very much a trustee’s job to seek to influence government policy.

The Rest initiatives will cost money. With the Your Future, Your Super, trustees will have to more carefully consider their expenditure on ESG considerations against their best interests obligations. This should be founded on a framework built on robust legal considerations.

Trustees’ current agreements with investment managers and asset consultants are unlikely to have the clauses necessary to ensure they are accountable for managing and reporting on climate change risk. While managers and consultants are stepping up their efforts in this regard, trustees should ensure it is a contractual obligation that can be enforced.

Trustees will need to ensure that legal risks relating to disclosure are managed appropriately, ensuring that the mandatory statement in relation to conduct doesn’t lag behind marketing.  The PDS should be checked for the accuracy of the statement about the extent to which “labour standards or environmental, social or ethical considerations are taken into account”.

ESG factors may also be considered in determining a target market determination for the forthcoming design and distribution obligations.

Broader implications

The case also has gained attention internationally, as an emerging tactic of climate activism against the increasingly significant pools of capital in pension funds.  McVeigh’s lawyer, David Barnden of Equity Generation Lawyers is also running the proceeding against the Australian Government for the alleged failure to disclosure the impact of climate change risks on government bonds and the proceeding against the Environment Minister for the alleged breach of a common law duty of care for young people in relation to climate change. As universal owners of the economy, trustees need to engage with the broad implications of climate change related legal action.

Conclusion

Trustees that are actively engaging in managing climate change risk can take some comfort from Rest’s commitments but there remains considerable risk where the views of the Government and Regulators diverge on such an important subject. Trustees inevitably have to form their own view on how to manage their various legal obligations, as do directors in the context of their personal duties and personal liability.