It is increasingly becoming evident that climate risk is a material financial risk, meaning it can affect companies’ bottom line. A recent report by Textile Exchange stated that the fashion industry will not stay within the 1.5-degree pathway without significant changes to the way it operates, extending to textile fibre selection, innovation, re-thinking growth and climate leadership.¹

In this piece, we look at directors’ responsibilities in respect of climate change within the context of existing legal requirements regarding fiduciary duties and disclosure obligations of fashion company directors.

All companies are governed by a board of directors who are elected by the company’s shareholders and make decisions as a ‘fiduciary’ on behalf of the company. ‘Fiduciary duties’ are the rules determining the obligations of those who manage capital or assets on behalf of others. The main duties of directors under corporate law are the ‘duty of loyalty’, which requires acting in the ‘best interests’ of the company, and the ‘duty of care and diligence’, which is judged by a ‘reasonable person’ test: whether in the circumstances, a reasonable person in the directors’ position would have acted in the same way.

The board’s role is to oversee strategy, identify and manage risk, and ensure corporate performance, which has historically been viewed through the lens of maximising profits. Corporate governance is the system of rules and procedures for decision-making that determine how companies are directed and controlled. It can be thought of as a toolkit for effective management that helps those in charge meet the company’s objectives and maintain legal compliance and oversight of stakeholder interests. Good governance ensures that the right infrastructure exists to allow for improvement in the quality of decision-making by those who manage the business. 

To date, risk has been viewed primarily in financial terms, reiterated under securities law, where annual financial statements require the disclosure of risks that are ‘material’ to the company, that a reasonable investor would deem important. This is because one of the predominant functions of financial markets is to price risk adequately. This is so that decisions around capital allocation are made using timely and accurate information to ensure assets are priced and valued correctly. In 2017,  the Task Force on Climate-related Financial Disclosures (TCFD), which was created by the Financial Stability Board (FSB),² issued recommendations to help companies assess and disclose foreseeable material financial risks relating to climate change within their existing reporting processes. It also outlined that climate change is one of the most significant and complex risks facing organisations.³ Further, this years World Economic Forum’s (WEF) Global Risks Report shares that respondents to the Global Risks Perception Survey 2021 – 2022 (GRPS) rank  ‘climate action failure’ and ‘extreme weather’ among the top five critical risks across the short-term (0-2 years), medium term (2-5 years) and long term (5-10 years).⁴

A growing sense of urgency among companies, investors and governments has manifested as the link between climate risk and financial risk becomes clearer.  The scientific consensus leading to the Paris Agreement and subsequent physical risks, such as the rising rates of natural disasters and supply chain disruptions, have made the effects of climate change unavoidable. Additionally, there are transition risks as countries move towards low carbon economies, policies and consumer sentiment changes, stakeholder expectations shift and technological innovation increases. Consequently, this presents climate change as a foreseeable, and in many cases material, financial and sectorial risk,⁵ which increases reputational risks and the risk of liability for company directors. The increasing pressure of climate disclosures required by regulators also contributes to the growing evidence-base and overarching context that the ‘reasonable person’ test would likely be assessed against. In simple terms, it can be argued that based on the evidence, discourse and tangibility of climate change, it is unlikely that a  ‘reasonable person’ could ignore the risk of climate change.

Furthermore, there is an inextricable relationship between climate and business, meaning the decisions made by business leaders can have a positive or negative effect on climate change (for example, using renewable energy instead of burning fossil fuels) and in turn, climate change will result in risks and opportunities for businesses. Therefore, such risks and opportunities – ‘climate risk’ governance – should fall within the broader scope of existing directors’ duties under good governance;⁶ because just like with any other risk, climate has the ability to drive both financial risk and competitive opportunity. 

Despite this growing awareness that climate risk is a business risk, the Climate Governance Initiative (CGI) has found that there is uncertainty among board members on how to factor climate risks into their decision-making and how such risks relate to their legal fiduciary obligations. One ‘misapprehension’⁷ is that following Paris aligned objectives could result in ‘leaving profitable business on the table’⁸ and place them in breach of their duties.⁹ On the other hand, as these risks materialise more tangibly, leaving climate risks out of overall risk management strategies could be a breach from a long-term value standpoint. An example is a threatened case by the NGO ClientEarth¹⁰ (a shareholder of Shell) against its board for breaching its duty to act in the best interests of the company by failing to develop and implement a climate strategy aligned with the Paris Agreement. The argument is that by failing to properly prepare the company for net zero, the directors breached their duty as it increases Shell’s risk of stranded assets, causing them to make write-downs (a devaluation) of its fossil fuel assets due to both physical and transition risks. Developments on the case are still unfolding.

A closer look at fashion

The fashion industry has extreme sensitivities to climate risk across the entire supply chain. This is because the industry has a heavy reliance on raw materials, which are often sourced from areas that are already vulnerable to climate impacts and because of the long, opaque and complex web of supply chain relationships.

Looking at the beginning of the supply chain, there are risks to the availability of high-quality raw materials as well as threats to other inputs involved (such as water), which have a direct correlation to climate change. For example, cotton is the second most widely used material after polyester.¹²  While cotton has some resiliency to different climates, risk increases as the regions cotton is grown in, is  susceptible to other climate risks like water scarcity and droughts, which can affect overall cotton yields.¹³ This was seen in the 2014 Australian droughts, which reduced the country’s cotton production estimates by approximately 35%; in California, where water shortages affected production predictions by 26%, and in Texas, where a 2013 drought-affected cotton yields by 18%. ¹⁴

At present, the flooding in Pakistan has damaged up to 45% of the country’s cotton crop¹⁵ and resulted in an up to 30% price increase.¹⁶ Compounding this is an overall shortage of cotton because other producers have also faced extreme weather:¹⁷ a heat wave in China, droughts in the United States, heavy rains and pests in India, and extreme heat and drought affecting Brazil.¹⁸

In addition, as the global economy moves towards decarbonisation, for the fashion industry to meet climate targets and stay ahead of policy changes, companies across the supply chain will need to reduce their reliance on fossil-fuel energy and the resource-intensive production of goods, as well as keep up with reporting and disclosure requirements.

The fashion industry is well aware of the impacts of climate change. In 2018, fashion stakeholders created the Fashion Industry Charter for Climate Action, an industry-wide mission statement with the vision to achieve Net Zero emissions by 2050.¹⁹ It was renewed in 2021 and has 109 signatories and 43 supporting organisations.²⁰ In addition, there are a number of other voluntary stakeholder initiatives to align the industry with broader climate change policy such as the the G7 Fashion Pact²¹ and the Race to Zero²² – all attempting to coax the industry towards keeping global warming at or below 1.5 degrees. As of October 2022, over 270 textiles, apparel, footwear and luxury goods companies have committed to science-based targets that are aligned with the Paris Agreement (although it is important to note that this too is a voluntary, non-binding commitment).²³

Given the evidence, it can be argued that the fashion industry is aware of the financial risk that climate change poses and therefore boards of directors have a responsibility to manage climate change in the same way as any other strategic risk to ensure they do not breach their legal fiduciary duties.

Stay tuned for the full report, authored by Sonia for the Commonwealth Climate Law Initiative that builds the evidence base for climate risk as a material financial risk in the fashion industry and provides practical guidance for boards of directors.