Why now?
The natural systems upon which our societies depend are collapsing.
Wildlife populations have declined by almost 70% since 1970, with worldwide extinction rates up to hundreds of times higher than over the past 10 million years. We have transgressed six of the nine planetary boundaries that define the safe operating space for humanity.
The current state of nature means that countries like the UK no longer have a sustainable natural system that can meet growing demand for clean water, air purification, climate regulation, and food production.
We now also understand that the state of global ecosystem collapse poses material risks to companies and their directors. Preliminary analysis indicates that 52% of UK GDP and 72% of the stock of UK lending is dependent on ecosystem services. Similarly, 74% of sectors covered by the UK FTSE All-Share Index are estimated to be highly dependent on natural capital, which is rapidly declining.
What does the Opinion say?
The Opinion provides a detailed and comprehensive analysis, which finds that nature-related risks are relevant to directors’ duties under sections 172 and 174 of the Companies Act 2006. This means that a director who properly identifies and manages their company’s nature-related risks will generally be promoting the success of their company and acting with skill, care, and diligence in their role as director.
However, if the director is unable to demonstrate proper consideration of nature risks faced by the company, they could potentially be exposed to increased shareholder scrutiny and legal consequences. The Opinion makes clear that a director who fails to identify and mitigate the nature-related risks faced by the company can be exposed to liability both under sections 172 and 174.
The Opinion makes a number of other key observations, including that:
- A company’s nature-related risks can cause harm to its financial health in both the short and long term. Where these risks are ignored or overlooked for the sake of short-term saving, the company can be adversely affected by, amongst other things, supply chain disruptions or failures, reputational damage, higher operating costs, direct consequences of its own damage to the ecosystems from which it sources its products, and potentially civil proceedings.
- Identification and assessment of nature-related risks are relevant to the promotion of the success of the company. Consideration of relevant nature-related risks is necessary for proper business management. Complete inactivity by a director is now increasingly likely to constitute a breach of duty.
- A director who ‘greenwashes’ the company is likely to expose the company to: (i) latent financial risks arising from unaddressed nature-related impacts and dependencies, (ii) the risk of shareholder and investor claims (including for deceit) and (iii) reputational risk.
- The recent judgment of Trower J in ClientEarth v Shell should not be read as a general bar to derivative claims in relation to nature-related risks being brought in the future. As illustrated by Lord Carnwath’s extrajudicial criticism of that decision, another Judge could come to a different view to that reached by Trower J.
- As regards a company’s disclosure obligations, the regime is highly complex but for some of the largest companies, they will likely have to give disclosure of matters which are financially material to the company and also in some particular cases, their impact on nature.
- A director can face serious consequences for breach of duty including potentially claims for damages or compensation. Even in cases where it is difficult to quantify the loss the company has suffered, a director can face adverse consequences for the breach, such as termination of employment, or a challenge to any remuneration or exit package. Such claims could potentially be brought against directors by shareholders on behalf of the company in a derivative action.
What are nature-related risks and what are some practical examples?
The Taskforce on Nature-related Financial Disclosures (TNFD) defines nature-related risks as “potential threats (effects of uncertainty) posed to an organisation that arise from its and wider society’s dependencies and impacts on nature”. It is important to clarify that climate change is one of the five drivers of biodiversity loss. Additionally, nature-related risks are broader than, and encompass, climate-related risks.
The Shivji KC & Stubbs KC Opinion identifies a number of practical examples where nature-related risks can have material financial consequences for companies and their supply chains.
This includes physical risks, such as a decline or collapse of ecosystems that underpin a company’s operating model. One such example is that companies in the UK food production sector are highly dependent on soil health, which is essential for producing crops and livestock but is being degraded by unsustainable practices. The UK Government Department for Environment, Food & Rural Affairs estimates that “soil degradation, erosion, and compaction result in losses of about £1.2 billion each year and reduce the capacity of UK soils to produce food.” Further, the UK’s House of Commons Environment, Food and Rural Affairs Committee has recently pointed to the Environment Agency’s findings that “soil degradation is putting 4 million hectares of soil at risk of compaction as well as over 2 million hectares of soil at risk of erosion (which could take hundreds, or thousands of years to form again)”. This dependency on soil health could therefore result in reduced access to, or higher costs for, key commodities required as inputs for food producers, manufacturers, retailers and financiers in the supply chain.
Companies can also face transition risks, including shifting consumer preferences and new legal requirements seeking to reduce nature loss. The Opinion highlights restrictions under Schedule 17 of the Environment Act 2021, which will prohibit businesses operating in the UK that use key forest-risk commodities produced on illegally occupied or used land. Another example is the EU Deforestation Regulation, which places due diligence requirements on UK companies selling specified products into the EU to ensure that they are deforestation-free.
The type of nature-related risks faced by a company will depend on the company’s specific business activities, operating locations, and supply chains. Additionally, nature-related risks can be systemic and affect the whole financial system by way of supply chain disruption, price volatility, collateral and asset depreciation, increases in defaults, and greater insured losses.
How should directors respond?
The Shivji KC & Stubbs KC Opinion concludes that directors subject to the law of England and Wales would be prudent to take the following steps in light of their duties under sections 172 and 174 of the Companies Act 2006:
- Identify and actively consider the extent to which the company faces nature-related risks. In some scenarios, independent expert advice will help in understanding the character, scope and seriousness of those risks.
- Assess and evaluate those risks and the potential they have to cause harm to their company. The TNFD framework may be of assistance in this regard.
- Manage and mitigate nature-related risks where this is considered appropriate.
- Disclose those risks in line with legislative and regulatory requirements. It is also open to directors to give broader voluntary disclosure, such as under the TNFD or a double materiality approach, if that is deemed to be suitable in discharging their duties (e.g., to meet emerging market standards or investor expectations).
- Document a director’s decisions and the reasons behind them.
Download a copy of the Opinion at the top of this page to find out more about nature-related risks and the duties of company directors in the UK.
The opinion was commissioned by Pollination and CCLI, and written by Sharif Shivji KC, Rebecca Stubbs KC, Karl Anderson, Hossein Sharafi and James Burton. Pollination Law was the instructing law firm.
For more information, please contact:
Thea Philip, Associate Director
Related to this Capitals Coalition, with support from Pollination have also published a business decision-making template for boards or decision-making committees to ensure information on all capitals (natural, social, human and produced) are included in decision-making processes. Download the template here
