Climate change: how can financial regulators punish firms that don’t respond effectively?
The financial world is bracing itself for climate shock. Last week the IPCC issued a report saying the pace of CO2 cuts need to accelerate – the world is doing too little, not too much. This comes on the heels of a report released by the Bank of England’s Prudential Regulatory Authority (PRA) that 70% of banks recognise climate change poses financial risks and that regulators expect companies to respond now. Making clear the expectation for firms to act, Bank of England Governor Mark Carney said: “Financial policymakers will not drive the transition to a low-carbon economy, but will expect our regulated firms to anticipate and manage the risks associated with that transition”.
Firms can’t wait to be told by regulators how to transition to a low carbon future. They need to respond now.
As a lawyer who’s worked both defending corporates from very punitive regulatory actions and then, on the other side for several years, when I was in enforcement for the UK’s financial regulator – I have seen how corporate behaviours are influenced not so much by the technical detail of policy as the way regulators enforce that policy.
Hypothetically, how could the FCA flex its regulatory muscle? What if it turns to a UK-listed oil company and says “that oil in the ground that you value at $500 billion might only be worth $100 billion as you can’t expect to sell it after 2040. You have to tell people.” Or people start suing oil majors over emissions and the FCA says to firms “this is like cigarettes. We want you to warn investors the payout could be $1 trillion.” Will oil majors that don’t issue these warnings face massive fines for inadequate disclosure?
But how can the hydrocarbon industry and investors respond to hypotheticals in this new environment with climate-related policy still in its infancy? One thing you learn working at a regulator is that even if policy isn’t fully developed, when the chips are down and the public demands action, the regulator can find ways to punish the companies that in public perception didn’t do the right thing. Even if policy details are changing, the direction of travel is clear. Carbon reduction requirements will bite increasingly hard on the oil sector. Regulators are going to face huge pressure to enforce environmental policies as the public feels ever more tangibly the cost of global warming.
It seems at times that with global warming European legislators are caught at the same point of inaction and policy uncertainty as they were with financial regulation before the pain that was inflicted by the 2008-2009 financial crisis. When the financial crisis hit, regulators not only introduced new policies but tried– and succeeded – in flexing existing policy to inflict pain on corporations. For example, financial regulators issued monumental LIBOR fines even though the setting of LIBOR wasn’t even a regulated activity. Banks were fined not because they failed to tick boxes – there weren’t any boxes to tick – but because they failed to understand and manage risk appropriately.
A catastrophic climate event in Europe or further deterioration in global warming may lead regulators to the same place regulators found themselves after the financial crisis – they will find a way to punish companies that contributed to global warming. They are likely to be more accommodating to companies that showed effort to minimise emission while fining companies that in public perception didn’t do enough to stop the fire.
What would happen if the cumulation of climate events leads financial regulators to attack listed oil majors for failure to disclose climate risk?
In the UK, the FCA’s starting point when determining how to punish a company is topline revenue for any product benefiting from a regulatory breach. Penalties can go up to 20% of revenue before even looking at aggravating factors. 20% for each and every year a company benefitted from breaking rules. $200 million for every $1 billion of topline revenue.
Given that in the US regulators are already looking to attack oil majors for allegations of inadequate climate disclosure, is this where European regulators will look to draw the battle lines when pressure heats up to fine corporates?
The number of climate change lawsuits is gaining pace. To date governments have been the defendants in most – but not all – of these cases. In the US, we see Exxon Mobil under investigation whether it misled investors about the risks posed by climate change. In a German case filed against the German utility RWE, a Peruvian farmer filed suit for damages to offset the costs of protecting his town from melting glaciers. The plaintiff went so far as to ask the court to specify RWE’s precise contribution to global warming! He didn’t win – among other things, the German court felt it would require too much work to quantify RWE’s contribution in such a manner. But it indicates the direction of travel with climate litigation cases and it’s possible a better funded litigant will have a better chance of success.
The take home message that dominates is just how far back regulators are willing to go to appease public outrage and inflict pain.
Want to keep up with developments in the regulatory space or find out more about your particular regulatory requirements? Email ruth@zeilbergerstone.com.