A Change in the Weather New Climate Change Challenges Increase the Potential for Litigation and Regulation

Printer version  PDF

by Gary S. Guzy

As climate change continues its residency on the front pages of newspapers in the U.S. and around the world, companies are becoming increasingly familiar with the business risks and issues it presents. Yet of late, two emerging trends are heightening the climate change challenge in the United States. First, the climate debate is shifting rapidly from the world of public discourse into the realm of the courts, presenting important legal issues. Second, corporate behavior is facing increased scrutiny as sophisticated investor groups seek to develop corollaries to financial accounting and disclosure for climate risks.

Climate change is now before the highest court in the United States. The Supreme Court agreed to consider and hear oral arguments in Commonwealth of Massachusetts v. United States Environmental Protection Agency (EPA). This case involves a challenge by several states and environmental advocacy groups, spurred by Massachusetts, to the EPA's decision not to regulate greenhouse gases as pollutants under the federal Clean Air Act. The case, argued in late November 2006, is a marker of the importance of global warming in the national political debate.

The case arises out of a petition by environmental groups to the EPA to regulate greenhouse gases emitted from automobiles. Its results, however, are likely to apply broadly across all areas of potential emissions. The EPA, in denying the petition from these groups, reasoned that the U.S. Congress could not have intended so sweeping an outcome without explicitly addressing greenhouse gases. The petitioners, on the other hand, argued that the relevant federal environmental law — the Clean Air Act — includes climatic effects within its overall set of concerns and that greenhouse gases are chemicals emitted into the atmosphere just like any other air pollutants. In making this argument, the petitioners were joined by four former EPA administrators — equally divided between those who served in Republican and Democratic administrations.

Regardless of the outcome of this case, it represents a heightening of the national climate change debate in the United States. Should the Supreme Court find that the Clean Air Act permits climate change regulation by the EPA, this will likely increase significantly the pressure on the Executive Branch to take action. Should the Supreme Court find otherwise, the spotlight will shift to Congress, where there is already extensive activity regarding how best to design a regulatory system. Such a ruling would impose considerable pressure on Congress to plug this hole in the law.

Legal scholars worldwide are conducting research, authoring articles, and convening conferences to explore the legal basis for action on climate change. The increasing willingness of climate advocates to test these theories and turn to the courts has also been seen in the use of novel public nuisance theories in cases. The California attorney general, for example, has brought an action against six leading automobile manufacturers claiming that emissions from the vehicles they manufacture have affected the climate, are causing damage across California, and will cause damage in the future. Interestingly, in other litigation — involving, for instance, claims challenging the adequacy of environmental review for Export Import Bank financing of coal fired power plants — plaintiffs have succeeded in meeting the tough federal court tests for “standing,” which requires that they demonstrate real harm, that the defendants' actions caused the harm, and that it can be redressed by court action. Standing is likely to continue to be a significant source of contention in the courts.

Because greenhouse gases tend to stay in the atmosphere for a very long time, the California case brings with it reminders of the retrospective liability scheme imposed by the federal Superfund law for hazardous waste disposal. Perhaps implicit in the California public nuisance litigation is the question of whether greenhouse gas emissions somehow have the potential to become the next asbestos or tobacco litigation free-for-all. Regardless of the outcome of these cases, there's no doubt that they raise the ante on global warming concerns.

The other notable qualitative element with the potential to alter the climate change debate is the increasing institutional investor focus and sophistication around climate risk issues. Institutional investors have focused on climate risk issues for several years, primarily through the Carbon Disclosure Project, a coalition of investors with $31 trillion in assets under management. These investors, who some estimate to represent nearly 40 percent of global capital markets, have asked the largest global corporations for information on their greenhouse gas footprints and management approaches.

In October 2006, a broad-based group of institutions and investors — known as the Climate Risk Disclosure Initiative — put forth a new “Global Framework” to be employed by corporations for disclosing climate risk. In releasing the framework, the authors noted that fewer than a dozen of the Fortune 100 companies had prepared comprehensive climate risk assessments that might meet this new standard.

The Global Framework for Climate Risk Disclosure calls for a rigorous and significantly enhanced analysis and disclosure compared to prior efforts such as the Carbon Disclosure Project. The Framework calls for companies to assess and disclose their greenhouse gas emissions footprint, the strategic implications of climate change for their operations and future activities, the physical risks faced by their facilities, operations, and personnel, and the effects of regulatory trends on current and future activities.

The strategic assessment of climate risk is one of the more interesting and ambitious parts of the new Framework. The signatories call for an examination of how climate change is being addressed from a corporate governance perspective, including the role of a company's board of directors, and disclosure of links between greenhouse gas performance and executive compensation. The assessment should include an analysis of emissions reduction, offset, and trading strategies, as well as any new business oppor-tunities created by projections of future carbon regulation.

As happened with the Carbon Disclosure Project, it is not unreasonable to project that institutional investors may target for further action those companies that do not fully meet the new standards of this Framework. Nearly 30 companies a year have received shareholder proxy resolutions calling for basic greenhouse gas emissions disclosure, so there is every reason to expect this trend to continue.

One of the goals of the Global Framework is to make greenhouse gas assessment and disclosure more rigorous and more uniform. The model for this is financial reporting and Generally Accepted Accounting Principles. The Framework seems to represent the first step by a variety of capital market participants to develop this uniform, voluntary standards-based approach.

Companies thus face the prospect of a new litigation environment around global warming concerns, as well as rising expectations regarding the rigor of their internal assessments and disclosure of a wide range of climate risk implications. What may also be in the offing is the potential convergence of these two trends. Increasingly, shareholder derivative actions are centering on the adequacy and fairness of management disclosure — particularly as it relates to future trends that could have a profound effect on investment performance. That being the case, it's not difficult to imagine a scenario where shareholder derivative litigation focuses squarely on the quality of a company's climate risk disclosure.

This new playing field in itself presents an important tactical and strategic choice: Does it make more sense to await the onset of these potential demands, or to be as actively engaged as possible to have credible answers if and when they hit? With no ready solution to climate change on the horizon — either domestically in the United States or internationally in the global discussions for what should follow the Kyoto Protocol — climate change is an issue that is unlikely to go away any time soon. Companies would do well to prepare as much as possible.

Seeing these trends, Marsh and its sister MMC companies have been refining the diagnostic tools available for climate risk assessment and strategic decision making around climate issues, so that companies can enhance their preparedness — and the quality of their decisions — across the board. We also are heightening the quality of materials available to companies for understanding these issues by partnering with Yale University's School of Forestry and Environment and Ceres — two leading institutions in the climate change arena from the academic and non-governmental organization sectors — to develop risk training tools for corporate directors. As climate risk challenges continue to grow, bringing to bear the most sophisticated and broadest-based thinking on these issues will continue to be critical.

Gary S. Guzy is the national practice leader for Emerging Environmental Risk at Marsh. He spearheads Marsh's Climate Risk Initiative and is based in Washington, D.C. Gary came to Marsh after his appointment by President Clinton to serve as the General Counsel of the U.S. Environmental Protection Agency (EPA).