Carbon risk is a new buzzword in business.

It refers to the financial risks of:

New laws and policies designed to reduce greenhouse gas emissions and mitigate climate change (e.g. carbon taxes, emissions trading schemes); and

Changes in market conditions due to the transition to renewable and low carbon energy sources and technologies.

Companies whose business model relies on the exploitation of fossil fuels – such as mining companies, conventional energy generators and retailers and their financial backers – face major financial risks in the future.

For example, restrictions on the full exploitation of coal reserves may result in these assets being 'stranded'. Similarly, the rise of renewable and distributed energy technologies may reduce the lifespan, and consequently the value, of conventional power generation assets.

Publicly-listed Australian companies have a legal obligation to report exposure to material business risks. But our review of Australian companies that rank in the top 20 greenhouse gas emitters found that current reporting practice is highly varied. Most companies do not report on carbon risk in a comprehensive and accessible fashion within mainstream financial reports.

Major American fossil fuel companies are being investigated for failing to fully disclose these risks.

In 2010, the US corporate regulator – Securities and Exchange Commission (SEC) – clarified that companies should be reporting on all material business risks posed by climate change, including the potential business impacts of complying with changing climate regulations, the indirect effects of those requirements, and business trends that include declining demand for carbon-intensive products.

But an investigation of Peabody Energy Corporation – the largest private sector coal company in the world – found that the company's SEC filings from 2011-14 misled shareholders by understating the severe potential business impacts of carbon risk and claiming an inability to predict the financial impacts of future climate policy laws or regulations.

Similar investigations have been launched against Exxon Mobil, claiming the company has repeatedly and deliberately concealed from investors the financial risks associated with climate change.

These developments are a wake-up call for Australian companies. Inadequate reporting of carbon risk may be found to be misleading disclosure, leading to serious penalties and damage to reputation.

Carbon risk disclosure can encourage clean energy practices

Poor and misleading disclosure may be a looming legal issue in Australia, but there is also growing evidence that requiring carbon risk disclosure can have the positive effect of driving companies to lower emissions, adopt energy efficiency measures, switch to renewable energy, divest of fossil fuels and invest in clean energy.

Since the international Paris Climate Agreement in late 2015, the international business community has supported initiatives to improve disclosure and commit to emissions reduction targets and other clean energy goals.

For example, a special taskforce of the Financial Stability Board is currently preparing recommendations for consistent climate risk disclosure to provide useful information for lenders, insurers, investors and other stakeholders. Many leading businesses and large-scale investors have also signed up to a range of ambitious clean energy initiatives, including the Carbon Asset Risk Initiative, Carbon Action Initiative and the We Mean Business Coalition.

Some jurisdictions have introduced targeted laws to support this private sector transition. In late 2015, new French legislation enshrined targets for emissions reduction and renewable energy targets. It also strengthened mandatory disclosure requirements for listed companies and institutional investors, who must now disclose carbon risk, set their own targets to assess their contribution to meeting international and French energy transition targets, and report on actions taken to achieve these targets.

Law reform is needed in Australia

A Senate Inquiry into carbon risk disclosure began in March, but lapsed due to the 2016 Federal Election. Submissions identified a range of reform options to improve carbon risk disclosure.

We highlight two potential reforms that should be prioritised by the Turnbull Government to ensure that Australian companies are as well prepared as their American and European counterparts to successfully navigate the clean energy transition:

As a minimum measure, Australia's corporate regulator ASIC should follow the US example and issue a Regulatory Guideline to explain how companies should disclose climate risks to comply with existing corporate law.

Reporting requirements under the National Greenhouse and Energy Reporting Act 2007 (Cth) should also be expanded and linked to corporate law reporting so that a greater range of companies report not just on their greenhouse emissions, but also other aspects of carbon risk (such as asset exposure) and how this relates to future business prospects.

At a time when regulatory responses to climate change in Australia remain so contested, these disclosure measures are an indirect, relatively low-level intervention with considerable potential to tap into market drivers to spur the clean energy transition and avert dangerous climate change.

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