Mandatory climate-related financial disclosure – exposure draft legislation released for comment

Treasury has released an exposure draft of its climate-related financial disclosure (CRFD) legislation for public comment. This is the next step towards introducing mandatory and standardised CRFD for medium and large listed and unlisted entities that will begin (for very large entities) in FY25 – that is, in the annual report for the financial year that begins between 1 July 2024 and 30 June 2025.

We think that between 6,000 and 8,000 companies, disclosing entities, registered managed investment schemes (MISs) and registrable superannuation entities (RSEs) are potentially within the scope of the new CRFD regime (not just the 1,800 mentioned by Treasury in its Policy Impact Analysis). Treasury estimates the initial transition costs of complying with the new disclosure requirements for each affected entity will exceed $1 million and annual compliance costs will exceed $500,000.

Our short Q&A contains an overview of what is proposed.

The exposure draft legislation is open for public comment until 9 February 2024. The Australian Accounting Standards Board (AASB) draft sustainability standards (against which affected entities will have to report) are also out for public comment, closing 1 March 2024.

Even for entities already reporting against the voluntary Taskforce for Climate-related Financial Disclosure (TCFD) guidelines, the new mandatory CRFD will require a significant investment in sustainability reporting capability and some hard thinking by directors required to sign-off on the disclosures.

What is required?

CRFD requires both record-keeping and reporting. It will add a new part to the entity’s annual report (alongside the financial report and the directors’ report) called the ‘sustainability report’ which includes climate statements, notes to the climate statements, and (potentially) other disclosures about environmental sustainability required by the Minister.

Who is affected?

CRFD will apply to companies, disclosing entities, registered MISs, and RSEs that lodge annual reports with ASIC, and that are either subject to the National Greenhouse and Energy Reporting Act 2007 (Cth) (NGER), or above a specified size. The size is either or both of:

• two out of three (on a consolidated basis) of: (1) revenue of $50 million or more; (2) gross assets of $25 million or more; (3) 100 or more employees ; or
• $5 billion or more in consolidated assets (this test is intended to capture large RSEs and registered MISs).

CRFD applies to entities above this size, regardless of sector and whether or not the entity is listed.

The exposure draft legislation provides for a phased implementation schedule, with very large entities reporting from FY25, large entities and investment funds from FY27, and medium entities from FY28.

What are the outstanding issues?

We think the exposure draft legislation raises four significant policy issues. These go to the directors’ declarations, the ‘modified liability’ arrangements that are intended to apply for FY25, FY26 and FY27, the application of CRFD to Group 3 entities, and the content of the required disclosures.

1. Directors’ declarations

Directors are being asked, from their first reporting year, to declare that in their opinion the sustainability report complies with the sustainability standards (draft s 296C) and that the climate statements and notes disclose the required matters (draft s 296D). This is similar to the declaration directors pass about the financial report (but not the directors’ report). A statement of opinion carries with it a representation that the opinion is reasonably held.

However, the auditing profession has told the Government that it will be unable to form a view on these matters until it has built additional assurance capacity and capability – therefore an audit opinion on these same questions will not be available until FY31. This is well after the (limited) modified liability arrangements for FY25, FY26 and FY27 expire.

We think it is manifestly unworkable to ask directors to make these declarations when reliable assurance is not available to them and the audit profession has made it clear that existing assurance capability is not up to the task. The Government should align the commencement dates for the directors’ declaration and the audit report. That is, the directors’ declaration should not be required until the first financial year in which the audit report is available.

To meet community expectations, the audit profession may need to work quickly to bring the FY31 commencement date forward.

2. Modified liability arrangements

The modified liability arrangements are much narrower than the Government had foreshadowed in its earlier consultation.

They only apply for statements in sustainability reports prepared for FY25, FY26 and FY27. Therefore, they only allow one year’s leeway for Group 2 entities and expire before Group 3 entities even begin reporting.

They only cover statements relating to scope 3 emissions or scenario analyses, leaving private plaintiffs the ability to bring civil proceedings (including class actions) for any other statements (including any other forward-looking statements) in a sustainability report.

They do not protect against criminal prosecutions, including for ‘no fault’ strict liability offences and criminal prosecutions instigated by private litigants.

They do not prevent ASIC bringing civil penalty proceedings, and asking for pecuniary penalties, for contraventions of provisions with a fault element including negligence.

For ‘no fault’ contraventions (for example, misleading conduct) they restrict ASIC’s civil remedies to declarations and injunctions, but this is not a concession – these are already the main civil remedies available to ASIC for misleading conduct.

We think the Government would achieve better quality climate disclosure in the medium to long term if it gave the system (and the assurance arrangements) more time to mature before exposing entities, their officers and auditors to the full range of disclosure liability. Modified liability arrangements should apply at least until the Government has completed its mandatory post-implementation review of the legislation (required as soon as practicable after 1 July 2028).

Those modified liability arrangements should be that only ASIC or the Commonwealth Director of Public Prosecutions can commence proceedings based on statements in the sustainability report that go to future matters, that they can only do so where there is evidence of fault, and that the only civil remedies available to ASIC should be a declaration or injunction (not pecuniary penalties).

3. Group 3 entities

Group 3 entities are smaller business (listed and unlisted) that file annual reports with ASIC, are not NGER reporters, and that meet two of the three tests of: (1) consolidated revenue of $50 million or more; (2) consolidated gross assets of $25 million or more; (3) 100 or more employees.

Following earlier consultation, the Government introduced into the exposure draft legislation a provision for Group 3 entities that consider (based on the materiality test in the sustainability standards) that they have no material climate-related risks or opportunities. The provision is that they can include a statement to that effect as the ‘climate statements’ component of their sustainability report.

But they still must produce a sustainability report, and meet the sustainability record-keeping requirements. The statement (as to the absence of material climate risks and opportunities) is covered by the directors’ declaration and therefore must be made on reasonable grounds.

We think the provision, intended to reduce the compliance burden on medium enterprises, may not go far enough. It also exposes boards making the materiality assessment to challenge.

It might be better to exclude Group 3 entities for now, and revisit the position after the post-implementation review. Another option might be to restrict Group 3 to medium entities that operate only in (defined) sectors that are likely to see a material climate impact in the short to medium term.

4. Content of disclosure

The exposure draft legislation uses financial reporting as the conceptual template for sustainability reporting. But the two types of disclosure are different, as TCFD reporting has shown. Sustainability reporting is often more qualitative and forward-looking than financial reporting, and involves statements about the future that are made in conditions of significant uncertainty. It is often closer in character to the disclosures in the directors’ report than in the financial report.

The sustainability standards are yet to be finalised, but the draft standards already go beyond what is in IFRS S2 Climate-related Disclosure and the TCFD framework. Also, the legislation allows the Minister to add disclosure requirements related to ‘environmental sustainability’ outside the AASB standards-making framework.

We think good quality, reliable and internationally comparable disclosure across entities whose activities can have a significant climate impact should be the goal. There is a risk that, by ignoring the inherently qualitative, future-looking and uncertain nature of some elements of good climate disclosure, the Government risks entities producing prolix, defensive disclosure that is costly to produce and poorly aligned to international disclosure, where both the content requirements and liability settings are more nuanced.

Next steps

Public consultation on the legislation closes on 9 February 2024.

Assuming (as we do) that the legislation will pass quickly and without significant modification, Group 1 entities need to be ready, from the beginning of FY25, to keep the sustainability records that will enable them to produce the report, and to think about how they will achieve a reasonable assurance (in the absence of audit for seven years) to allow them to publish the report with confidence.

For Group 2 and 3, it is important to engage now, as once the legislation is passed it will be difficult to change. There may be the chance to revisit the requirements as part of the mandatory post-implementation review in the second half of FY28, but by then significant costs will already have been incurred preparing for compliance.

Our Board Advisory & Governance team and expert ESG lawyers are available to take you through the exposure draft legislation and assist in the consultation process.