In search of sustainable finance

Sustainable finance reforms are well-progressed in many nations, particularly the European Union.

As well as helping to manage the financial risks posed by climate change, biodiversity loss and other sustainability challenges, these reforms seek to align private-sector capital and resources to effectively address these critical problems.

This means shifting business and investment away from activities that worsen climate change and biodiversity loss, in line with the goals set out in the Paris Agreement on Climate Change, the Kunming-Montreal Global Biodiversity Framework, and other key sustainability instruments.

The first draft of Australia’s Sustainable Finance Strategy includes important reforms such as mandatory climate risk reporting for businesses, and a new sustainable finance taxonomy to support investors to allocate capital to business activities that help achieve sustainability goals.

Yet there are some missed opportunities, too.

Our recent research (prepared for the Australian Conservation Foundation and Jubilee Australia) explored opportunities to reform Australian corporate law to support more sustainable business practices.

To see real progress towards a more sustainable financial system, we argue for more targeted disclosure rules, new sustainability duties for company directors, and mandatory human rights and environmental due diligence obligations for large companies.

These are three reforms that should be carefully considered as Australia’s Sustainable Finance Strategy develops.

We could see real impact if companies are explicitly required by law to disclose not only the financial risks posed to company interests by sustainability issues, but also the risks and impacts of company activities on social and environmental issues such as climate change, biodiversity, and human rights.

This is called a double materiality approach. The European sustainability disclosure standards require this, but the proposed Australian reforms do not.

Double materiality recognises that not all social and environmental issues will pose financial risks to companies, especially in the short term. But many business practices contribute to social and environmental harms that pose systemic risks across society and that undermine important global human rights norms and environmental goals.

Taking biodiversity as an example, the loss of pollinator insects might pose financial risks to some companies in the agriculture sector and would therefore need to be disclosed.

However, other biodiversity impacts, such as ecosystem decline and species extinction, wouldn’t necessarily register as a financial risk for many types of businesses, despite the fact many business activities contribute to these problems, and they pose serious long-term social and environmental challenges.

There’s potentially a very significant mismatch between the pace and scale of emissions reductions required to meet climate change temperature goals established by the international Paris Agreement, and the pace and scale of risk management approaches that an individual company engaged in emissions-intensive activities (for example,, fossil fuel production) may adopt to manage the financial risks posed by climate change to its business.

Best practice approaches to climate risk management, such as Climate Action 100+’s Net Zero Benchmark, therefore emphasise the importance of aligning company-scale risk management with Paris Agreement goals.

European sustainable finance reforms under the EU Corporate Sustainability Reporting Directive (CSRD) and the proposed EU Directive on Corporate Sustainability Due Diligence take a similar approach. Large European companies are likely to be required to develop and implement transition plans to ensure their business model is compatible with limiting global warming to 1.5°C in line with the Paris Agreement.

They’re also increasingly required to demonstrate how their business is, or will become, compatible with biodiversity targets set out in the Global Biodiversity Framework and the EU biodiversity strategy.

Under the proposed Australian Sustainable Finance Strategy, companies will only be required to disclose a climate transition strategy, where they have one, and to report on self-determined transition targets.

There’s no clear regulatory direction for companies to align their climate risk management with Paris Agreement goals.

Mandating the preparation and disclosure of net zero transition plans for large companies and requiring these to align with the 1.5°C temperature goal is a more direct and effective way to ensure that this strategy helps shift capital away from climate-damaging activities.

Existing legal and regulatory frameworks enable or require company directors to integrate sustainability considerations, including climate change, into corporate decision-making where these issues pose material financial risks to company interests.

But the legal duties that govern company directors provide considerable discretion over the factors that directors can consider and how they respond to sustainability issues. Even though directors are not legally confined to maximising profits or shareholder returns in the short term, this has become a dominant social norm in Australia and around the world.

This means it’s reasonably open for directors to decide to continue high-emitting, climate-damaging activities, such as fossil fuel development, if the associated financial risks for the business can be appropriately managed, including through diversifying business activities over time.

The fact that public-facing, heavily-scrutinised Australian companies are proceeding with expansionary fossil fuel projects in conflict with the goals of the Paris Agreement illustrates that the permission to integrate sustainability considerations into decision-making is insufficient to incentivise improved corporate climate performance at the extent and pace necessary.

Reforming the legal duties that govern company directors – by clarifying that social and environmental considerations should be central to directors’ decision-making, and by including a general sustainability duty requiring directors to take reasonable steps to prevent and mitigate social and environmental harms – would provide a firmer legal foundation for Australia’s Sustainable Finance Strategy.

Introduced around the world to increase corporate accountability for social and environmental harms, these laws are now in place in Germany, France, Norway and the Netherlands. The EU is also finalising its Directive on Corporate Sustainability Due Diligence.

These laws require large companies to assess actual and potential adverse impacts on human rights and the environment caused, or contributed to, by the company’s activities and business relationships.

Companies are required to take reasonable steps to prevent harms occurring, and address them.  The strongest laws provide sanctions for non-compliance and remedy for victims of harms.

While Australia already has modern slavery legislation, this has been ineffective due to a lack of enforcement mechanisms, very little focus on remediating risks and impacts, and insufficient regulatory oversight and support.

Further, this legislation focuses narrowly on a particular subset of serious human rights violations. Other human rights abuses in the supply chain and environmental harms remain unaddressed.

Australia’s Sustainable Finance Strategy would be strengthened by including mandatory due diligence laws. An explicit focus on preventing, mitigating and remedying social and environmental harms in corporate value chains would help us move capital and resources away from activities that worsen climate change, biodiversity loss, and lead to human rights abuses.

This article was written by Anita Foerster, an Associate Professor of Business Law and Taxation at Monash University; Ingrid Landau, a Senior Lecturer in Business Law and Taxation at Monash Business School; Vivien Chen, a Senior Lecturer in Business Law and Taxation at Monash Business School; and Mayleah House, a Research assistant at  Monash Business School. It was published by Lens.