Japanese company directors must consider climate risk or face potential liability

Directors of Japanese companies could be held liable for failure to report on and address climate-related risk, a report by the Commonwealth Climate Law Initiative (CCLI) shows.

In their research paper Directors’ Duties Regarding Climate Change in Japan, Japanese and international legal academics outline the legal obligations that directors have to effectively navigate the financial implications of the climate crisis under Japanese law.

A key finding of the report is that directors should put in place systems to assess and analyse the physical risks and transition impacts associated with climate change.

At the very least, a board committee must be responsible for matters related to climate governance and directors must be able to engage with the company’s management on climate risk.

To guide their decisions, directors should also seek external expertise if the company lacks climate-governance experience at the board and executive level.

Failing to establish such a climate risk management system means that directors could be in breach of Japan’s Companies Act – and be held personally liable, the report cautioned.

It stated: “Failure by corporate directors to recognise their obligation to address climate-related risks and opportunities could result in personal liability for failure to act with due care and in the best interests of the company.”

There is growing understanding among Japanese regulators and top corporate and financial sector firms of the seriousness of climate-related risks. But it is evident from the report that directors also have a legal obligation to effectively respond to them in order to perform their responsibilities in line with the law. - Raphael Soffer, ClientEarth lawyer.

Directors may also be unable to defend against the imposition of liability through the business judgement rule if they neglect to, “undertake reasonable research and analysis of the relevant facts, fail to get expert advice on climate-related risk management, and fail to exercise due care in respect of climate risks,” the paper concluded.

ClientEarth lawyer Raphael Soffer said: “The CCLI’s report makes it clear that company directors in Japan need to give serious consideration to climate-related risk in order to properly discharge their duty of care.

“This includes embedding sustainability into business decisions from the top down, establishing effective governance, risk management and business strategies to address the risks and capture the opportunities of the net zero transition.”

The legal research paper comes as Japanese regulators continue to emphasise both the materiality of financial risks for companies as well as the risks to financial stability presented by climate change. Such instances include:

• In its Strategy on Climate Change published in July, the Bank of Japan announced plans to examine and monitor financial institutions’ response to climate risk, as well as their engagement with corporate customers to address their environmental impact.

• Meanwhile, the Financial Services Agency has made sustainable finance a priority policy focus this year, after being given a mandate from the government to push banks and companies to accelerate decarbonisation.

• In June 2021, the Tokyo Stock Exchange also reinforced the set of principles regarding sustainability in the revised version of Japan’s Corporate Governance Code. The code includes new rules for all listed companies to “take appropriate measures to address sustainability issues…such as climate change” and emphasises that social and environmental matters are “important management issues that can lead to earning opportunities as well as risk mitigation”.

This is a clear indication that companies are expected to consider the risks and opportunities of climate change, and that the board should be in charge of addressing them.

The CCLI report highlights that once adopted by a company, the principles of the code should be treated as important internal rules and provide a framework for the director’s duty of care.

In October 2020, Prime Minister Suga pledged to cut Japan’s greenhouse gas emissions to net zero in the next 30 years, and there has been strong political emphasis on the private sector’s role in realising such ambitions.

The position of the Japanese corporate sector appears paradoxical. On the one hand, Japanese companies appear as being among the most progressive in the world on climate risk, with over 300 having committed to report on climate risk using the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).

On the other hand, too few Japanese companies are taking actual steps to decarbonise their operations.

They face increasing pressure from foreign and domestic sustainability-minded asset owners and managers to elevate reporting to concrete action to reduce emissions.

Soffer added: “There is growing understanding among Japanese regulators and top corporate and financial sector firms of the seriousness of climate-related risks. But it is evident from the report that directors also have a legal obligation to effectively respond to them in order to perform their responsibilities in line with the law.

“Strengthening risk assessment and management practices related to climate change – backed by science-based research and expert advice – will help protect against duty of care breaches as regulatory attention on corporate climate action intensifies.”