Could Disclosing Climate-related Financial Information Become the New Normal?

Laura Leka | October 17, 2017

Climate change disclosures in corporate reports are common, including disclosure of greenhouse gas (GHG) emissions and other metrics measuring the impact of an organization on the environment. But what is often missing is the link to the financial implications of climate change, both current and in the future. GHG disclosures in themselves are not adequate enough for investors to fully understand a company’s exposure to climate-related risks and opportunities as well as its strategies for managing them.

A recent global survey found that 56% of investors surveyed considered disclosures on climate-related risk “highly inadequate.” More than 475 institutional investors participated in the survey, Surveying Corporate Issuer and Investor Attitudes to Sustainable Finance, commissioned by HSBC, one of the world’s largest banking and financial services organizations, and conducted by market research firm East & Partners.

Back in 2015, the Organisation for Economic Co-Operation and Development (OECD) and the Climate Disclosure Standards Board (CDSB) published a joint study, Climate Change Disclosure in G20 Countries: Stocktaking of Corporate Reporting Schemes, comparing climate change reporting schemes across G20. The report found that while 15 G20 countries have mandatory schemes, only 9 encourage broader reporting of information beyond GHG, e.g., on risks and strategy.

Climate change is on global political agendas. In December 2015, almost 200 governments agreed to limit the increase in global temperatures this century to below 2ºC relative to pre-industrial levels, with efforts to try and limit this even further to 1.5ºC (known as the Paris agreement). In order to meet this commitment, companies, and particularly those in carbon intensive industries such as energy and transportation, will need to adapt their business models and strategies to move towards a lower-carbon economy. And indeed there are examples of companies that have been doing so for some time.

December 2015 also saw the announcement that the Financial Stability Board (FSB) was establishing the Task Force on Climate-related Financial Disclosures (TCFD). This industry-led task force is chaired by Michael Bloomberg, Founder of Bloomberg LP and former mayor of New York, and comprises representatives from various organizations around the world, including providers of financial capital, insurers, large non-financial companies, accounting firms, and other experts.

The idea of such a task force was introduced in a speech by Mark Carney, FSB Chairman and Governor of the Bank of England. Mark described climate change as the “tragedy of the horizon” and set out the growing and urgent demand for decision-useful, climate-related information.

The TCFD was tasked with developing “voluntary, consistent climate-related financial disclosures that would be useful to investors, lenders, and insurance underwriters in understanding material risks.”

After 18 months, consideration of existing climate-related disclosure regimes, and extensive consultation with stakeholders around the globe, in June 2017 the TCFD released their final report, Recommendations of the Task Force on Climate-related Financial Disclosures. It provides recommendations for disclosures focused around four areas: governance, strategy, risk management, and metrics and targets. It’s important to note that the recommended disclosures around strategy and metrics and targets are subject to the principle of materiality, whereas governance and risk management disclosures are not and could be included in all cases to provide contextual information.

The recommendations are intentionally ambitious, but are also designed to be pragmatic so that any organization, regardless of their maturity of reporting, can make a start in implementing them. The report recommends that, where possible within local regulatory reporting requirements, relevant, material disclosures should be included in mainstream financial filings.

Transparency of the actual and potential impacts of climate change on an organization’s business and strategy is encouraged, along with information on how an organization identifies, assesses, and manages climate-related risks, including how this is integrated into overall risk management processes.

Climate-related risks are categorized into 2 types:

  • Transition risks: risks associated with the transition to a lower-carbon economy, e.g. investment in new technologies, regulatory, and legal risks.
  • Physical risks: risk of extreme weather events or longer term shifts in climate patterns associated with climate change.

The report also identifies different areas of opportunity, including resource efficiency, cost savings, new products and services, and access to new markets.

Regardless of one’s stance on global warming, climate change is having, and will continue to have, significant financial implications for businesses across sectors, industries, and jurisdictions, as well as for governments. But given its often long-term nature and the many uncertainties and unknowns associated with it, understanding and accurately quantifying the financial effects of both climate-related risks and opportunities is a huge challenge.

The report recognizes this. A key aspect of the recommendations is encouraging the use of scenario analysis to better illustrate the potential implications under different conditions, including a 2ºC or lower scenario aligned with the objectives of the Paris agreement. A further technical supplement, The Use of Scenario Analysis in Disclosure of Climate-related Risks and Opportunities, was published alongside the main report to provide further guidance.

In compiling the recommendations, the task force considered existing disclosure requirements and the various climate-related reporting regimes. Implementing the TCFD recommendations is expected to help companies to meet their existing mandatory reporting requirements. Likewise, those already using other frameworks, such as the CDSB’s Climate Change Reporting Framework and the International Integrated Reporting Framework, will be in a good place to start by using, and adapting where necessary, existing processes and content to meet the disclosure recommendations of the TCFD. The use of integrated reporting to support transparency of climate change disclosure was considered in the previous article, “Integrated Reporting and Climate Change: A Perfect Marriage.”

Fully implementing the recommendations of the TCFD will take time and disclosures will evolve and mature as companies experiment. The TCFD report itself sets out a five-year implementation path.

The question now is will a voluntary framework be enough to change the practices of companies? Or does it need regulatory enforcement?

Overall, there has been broad acceptance from the business community and the TCFD recommendations already have the support of over 100 leading companies, across sectors from banking, insurance, investment, energy, asset managers, pension funds, and others.

In addition, 10 companies, including Aviva plc, Marks and Spencer, and Philips Lighting, have gone a step further to commit to implementing the TCFD recommendations within the next 3 years.

There are also examples of regulators taking an interest in the financial risks of climate change. Australia’s financial regulator, the Australian Prudential Regulation Authority (APRA), is one such example. A speech given by executive board member, Geoff Summerhayes, very much aligns with the work of the TCFD. In it he talks about scenario analysis as the new normal and concludes that “climate risks will become an important and explicit part” of the APRA’s thinking.

Advocacy of the TCFD recommendations will be essential to achieve their widespread adoption and the TCFD will remain in place until at least September 2018, in order to monitor progress.

 

Further guidance from the FSB

Implementing the recommendations of the Task Force on Climate-related Financial Disclosures – includes general guidance for all sectors, supplemental guidance for the financial sector, and supplemental guidance for non-financial groups (focusing on those most likely to be impacted by climate change): energy, transportation, materials and buildings, and agriculture, food, and forest products.

 

Laura Leka

Technical Manager, Global Accountancy Profession Support, IFAC

Laura Leka is a Technical Manager in IFAC's Global Accountancy Profession Support team, which promotes and supports the role of Professional Accountants in Business. She was previously an Audit Manager for Grant Thornton, specializing in public sector assurance in the UK. She also spent a year on secondment to the International Integrated Reporting Council (IIRC), where she was responsible for managing their public sector and business network programs. Laura is a qualified member of the Chartered Institute of Public Finance and Accountancy (CIPFA), and started her career with the Audit Commission. See more by Laura Leka

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