Climate change is one of the greatest challenges we currently face. As the situation escalates, nations and corporations are increasingly being held accountable for their actions (or lack thereof) to mitigate the fallout. Indeed, between 2017 and 2020, the volume of climate-related litigation cases filed globally sharply increased, with more than 1,800 court cases filed against entities across 40 countries as of May 2017.
Executive SummaryWith the effects of climate change becoming more palpable, a rise in climate litigation cases could have significant financial and reputational repercussions for corporates. Thomas Englerth, associate director at S&P Global Ratings, explores how the potential risks associated with this emerging issue can be identified and managed.
Climate litigation will continue to pose a risk to businesses and countries that are not deemed to be acting well—or quickly—enough.
A report by the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) also found 2021 to be “an exceptional year” for climate-related litigation and noted that supervisory authorities may not have, so far, fully recognized the impacts of such cases.
While, to date, none of the cases have had a material impact on an issuers’ creditworthiness, investors likely will be concerned with the rising number of cases—and how it could affect the value-at-risk in their portfolios. In order to reduce the likelihood of legal challenges, there are several key areas in which corporates can attempt to at least partially mitigate their exposure.
Attribution Science Advancing
A recurring issue that unites many climate litigation cases is the element of causation. In a courtroom scenario, this refers to plaintiffs’ ability to prove a defendant committed harmful environmental actions that directly contributed to climate change, which in turn caused the damage they suffered or will likely suffer.
To help substantiate these claims, climate change attribution science—which aims to link shares of emissions and the associated harmful climate effects to responsible parties with research and modeling—is playing an increasingly important role. Legal scholarship, such as a note in the Columbia Journal of Environmental Law in 2020, suggests that the current state of climate change attribution science is likely sufficient for establishing causal connections for some types of legal adjudications. However, attributing past or future impacts from climate change to specific defendants, particularly in a courtroom setting, remains a complex task.
According to research by Nature, more attention and funding in key areas may address the current evidentiary shortfall. These include attributing climate change impacts to individual emitters, the foreseeability of climate change impacts resulting from future emissions, and research disentangling the social and physical drivers of climate risk.
The 2015 Huaraz Case provides a pertinent example of how advancements in this area could help to substantiate climate change-related litigation claims. Saul Luciano Lliuya, a Peruvian farmer, filed a suit against one of Germany’s largest electricity generation companies, RWE, alleging that greenhouse gas (GHG) emissions from the company had contributed to climate change and, as a result, had caused a glacial melt into a nearby lake that threatened local farmland.
Although the case was initially dismissed after the trial court ruled there was no “linear causal chain,” the case was granted appeal in 2017, providing a second opportunity to argue causation. Given the case is currently on hold due to the pandemic, no formal decision has yet been made, but its outcome will be of particular interest for many given that it involves climate-related damages suffered in a jurisdiction entirely remote from the defendant company’s operations.
Why Net Zero Targets May Not Be Enough
As companies’ decarbonization strategies are increasingly scrutinized by their stakeholders, many are choosing to implement net-zero targets. Although an important first step, the effectiveness of some of these targets has been brought into question—particularly as many corporates fail to cover the full spectrum of Scope 1, 2 and 3 emissions, set interim targets, or account for the entirety of their organization’s operations. (Scope 1 emissions are direct emissions from owned or controlled sources. Scope 2 emissions are indirect emissions from the generation of purchased energy. Scope 3 emissions are all indirect emissions, not included in Scope 2, that occur in the value chain of the reporting company, including both upstream and downstream emissions.) As a result, questions from investors and other key stakeholders regarding the credibility of such claims are progressively arising—and sometimes paving the way for legal challenges.
Any perceived lack of adequate disclosure and coverage leaves companies—and indeed countries—vulnerable to legal challenges. This was found to be the case with Royal Dutch Shell in 2019. Several Dutch NGOs and over 17,000 Dutch individuals filed a case against the oil and gas giant, calling for the courts to recognize Shell’s failure to commit to further reductions in its GHG emissions as an unlawful act under tort law.
Although Shell protested it already had net zero by 2050 commitments in place, the trial court held that Shell owed a duty of care to reduce its carbon dioxide emissions, and eventually ruled that the company be compelled to reduce these by a net 45 percent relative to 2019 levels by the end of 2030. While Shell is seeking to appeal this ruling, the outcome is significant, as it shows that the courts are willing to sanction more aggressive emissions reductions, which could inspire similar legal action worldwide.
Better Disclosure and Transparency Needed
Another area in which corporates are becoming increasingly exposed to litigation risk is disclosure. Corporate reporting has become a key priority for many organizations—with 90 percent of S&P 500 companies publishing a sustainability report in 2020. In Europe, a growing number of companies are using an integrated reporting framework to disclose sustainability-related information alongside traditional financial disclosures. Meanwhile, in the U.S., the Securities and Exchange Commission recently announced plans for new rules on mandatory climate change disclosure, signaling that the number of sustainability-related disclosures may increase over time.
But there are growing calls for improved transparency into businesses’ climate-related risks and opportunities from investors, regulators and customers, with stakeholders requesting higher-quality, more detailed disclosures that underline any substantial financial exposures in the face of climate change.
As we look toward the future, the number of more extreme and acute weather events is expected to rise as the world continues to search for a quick and effective path to decarbonization. The actions of nations and corporations will be closely monitored, meaning climate litigation will continue to pose a risk to businesses and countries that are not deemed to be acting well—or quickly—enough. As such, it is plausible that we will see an increase in climate litigation, and it could be one of the many mechanisms by which transition and physical risks crystalize for issuers.
*This article was originally published by Insurance Journal, our sister publication.