Nature-related risks can have an enormous impact on a broad range of companies both in terms of their day-to-day operational activities and the subsequent profit margins achieved. Therefore, understanding these risks and the ways in which they should be addressed is relevant to the role and function of a company's board alongside a director's fiduciary duty to act with reasonable care, skill and diligence under the Companies Act 2006 (the Act). We consider nature-related risks and their impact on a directors' decision making in further detail.
Taskforce on Nature-related Financial Disclosures (TNFD)
In June 2021, the Taskforce on Nature-related Financial Disclosures (TNFD) was established to encourage and facilitate a shift in the mindset of company directors towards nature-related risks in financial decision making. TNFD was a crucial step towards developing a standardised framework for companies to report and act on such risks.
In September 2023, TNFD published a series of recommendations (TNFD Recommendations) aimed at improving strategic decision-making and risk management, transparency, and sustainable business practices. The points captured shine a spotlight on directors' responses to nature-related risks as part of a director's decision-making. The TNFD Recommendations can be accessed here Taskforce on Nature-related Financial Disclosures (TNFD) Recommendations – TNFD.
Understanding nature-related risks
Nature-related risks can be classified as:
- Physical: risks resulting from the degradation of nature (e.g. changes to the ecosystem) and consequential loss of ecosystem services that economic activity depends upon. Physical risks arise as a result of changes in the biotic and abiotic conditions that support healthy, functioning ecosystems, with such risks usually being location specific. For example, a food wholesaler may suffer as a result of decline of ecosystem services from which it sources its products.
- Systemic: risks arising from the breakdown of the entire system, rather than a failure of individual parts. One loss triggers a subsequent chain of other losses and stops systems from recovering their equilibrium after such a shock. Not only does this capture risks to a financial system, it covers risk from a breakdown of natural systems. For example, a food retailer may be heavily dependent on the supply of meat from livestock reared by its selected farmers, however due to a catastrophic event, the livestock could be culled, resulting in a shortage of meat for the retailer to supply to its customers.
- Transition: risks to an organisation that stem from a misalignment of economic actors with actions aimed at protecting, restoring and/or reducing negative impacts on nature. This can be prompted by changes to policy and regulation, technology and consumer preferences. For example, changes to law prohibiting import of products that is produced on illegally occupied or used land.
How nature-related risks impact on Director's Duties
Nature-related risks are widespread and can impact at least three aspects of a director's role:
- the duty to promote the success of the company for the benefit of the members as a whole (s.172 of the Act), which states that a director should have regard to "the impact of the company's operations on the community and the environment";
- the duty to act with reasonable care, skill and diligence (s.174 of the Act). For example any failure by a director to properly understand and take action to mitigate nature-related risks may not only hinder the sustainability of a company, but mean the company is not properly safeguarded for the future; and
- the obligations on directors to disclose information about the company in its narrative reports (to the extent it is required to produce these).
A director does not only need to consider the company's profitability, but directors will also need to give consideration to the indirect impact of the company's activities, such as its relations with its customers/clients, suppliers, and employees. Consideration of nature-related risks is necessary for proper business management even where there is no direct or material financial effects in the short or long term.
It is not sufficient for a director to merely show awareness of the relevant risks posed to the company. A director should also show that consideration has been given to the nature-related risks and that a reasonable conclusion has been reached as to what, if any, actions should be taken in light of the risks.
Consequences of failing to consider and/or to mitigate nature-related risks
Directors can be exposed to claims in the event of a breach of any of their duties under the Act. Any failure by a director to:
- identify and consider any nature-related risks, regardless of how trivial or non-trivial the risks might appear; and
- take any preventative action to mitigate such risks,
may expose the director(s) to claims that they have acted in breach of their fiduciary duties under the Act. A further consideration is that, alongside any director breaches, the company may also suffer reputational harm, as well as being exposed to civil claims for damages by any person who has suffered harm because of the company's impact on nature.
Considerations for Directors to mitigate nature-related risks
Prudent directors will:
- update existing risk management frameworks to identify and consider the nature-related risks facing their company;
- make an assessment on whether or not the risks are relevant and non-trivial and seek expert advice as appropriate before deciding in good faith whether or not a course of action is required to mitigate any of the risks identified; and
- keep a record of all such considerations, referrals and decisions in writing (e.g. in properly recorded board minutes) or in the company's narrative reports.
For further support on managing emerging nature-related risks, please get in touch.
