As investors become aware of the threat posed by climate change to their portfolios, companies are under increasing pressure to disclose climate impacts on their businesses.
However, few are doing so in a clear and consistent way. Investors are looking for climate-related data that is materially relevant to companies’ financial returns, yet in 2017 nearly three-quarters of companies worldwide failed to acknowledge climate change as a financial risk.
In order to close this gap and to help investors understand the resilience of their investments, the G20’s Financial Stability Board formulated The Task Force on Climate-related Financial Disclosures (TCFD). In June 2017, the taskforce launched its final recommendations report, calling for a structured approach for companies to report on both the risks and the opportunities of climate change. The objective? Better, more consistent and reliable disclosures with material climate-related information forming part of companies’ mainstream financial filings.
Since the launch of the TCFD, the recommendations have been supported by more than 500 public and private organisations, including financial services companies responsible for nearly $100 trillion in assets. Ratings and rankings agencies such as CDP and Dow Jones have aligned their environmental questionnaires with the TCFD recommended areas of disclosure and other investor focused organisations such as Moody’s Investor Services and BlackRock are also calling on companies to disclose in line with the recommendations.
Investors are looking for climate-related data that is materially relevant to companies’ financial returns.
Despite widespread support, climate-related disclosures in most countries are still only voluntary. However, there are signs that they could soon become mandatory as G20 member states start to put in place the regulatory frameworks to support their implementation.
France leads the way, having implemented the recommendations into its legal framework through France’s Article 173 and establishing a financial sector network to allow central banks to exchange knowledge and experiences around climate risk management disclosure.
Other regulatory authorities, namely the EU and Japan, are following suit, by publishing action plans for implementation, such as the EU’s Sustainable Finance Action Plan and Japan’s Ministry of Economy, Trade and Industry guidance document on how to disclose material ESG risks.
The United Kingdom and The United States are lagging behind but heading in the right direction, having taken actions to drive political and private sector engagement for the adoption of the recommendations.
Despite widespread support, climate-related disclosures in most countries are still only voluntary.
Commonwealth countries like Australia, Canada and South Africa have been slower to adopt the recommendations, citing legal liability barriers to TCFD compliance, where companies may suffer losses if forward looking statements do not materialise. However, experts at the Commonwealth Climate and Law were quick to respond by saying that these concerns misunderstand the nature of the TCDF recommendations and warning directors that they are likely to face even greater liability if they fail to assess and disclose climate financial risks.
And right they were. Australia saw the world’s first litigation case regarding climate risks this year when the Commonwealth Bank was sued by shareholders over poor climate disclosure practices. Though the case was eventually dropped, it certainly served as an incentive for banks to better prepare their climate disclosures. Australian companies have now been warned that ‘there’s nowhere to hide’ as investors, regulators and litigation lawyers are all demanding more detailed information about climate change impacts.
But despite increasing pressure and apparent progress towards reporting against the TCFD recommendations, how are companies actually reporting on their climate risks? According to the TCFD 2018 Status Report, companies and asset owners are still a long way from aligning their disclosures with the recommendations and major gaps in disclosure have been identified.
UK banks have been said to be unprepared for the impacts that climate change. A climate risk survey published by the Bank of England’s Prudential Regulation Authority (PRA), which covered 90 per cent of the UK banking sector representing more than £11 trillion in assets, found just 10 per cent of banks are equipped to properly manage climate risks. Even the French early adopters are struggling to report in line with the recommendations. Of 50 financial institutions, only a quarter included substantial analysis on their exposure to the physical impacts of climate change in their 2017 reports, with the remaining emphasizing the lack of tools and models as a major impediment for doing so.
Companies and asset owners are still a long way from aligning their disclosures with the recommendations.
In light of these findings, it worth analysing why companies are struggling to align their disclosures with the recommendations and noting what the key challenges are. According to a report published by CDP and the Climate Disclosure Standard Board (CDSB), companies face three main challenges:
- Lack of leadership support in climate change management: Although most companies report oversight of climate change at board level, only ten percent incentivise the board to prioritise climate risks, and only 6 percent of boards see climate change as a top priority issue affecting their businesses. This present an obstacle to a top-down strategic approach to managing climate risks and to fully factoring them into the business financial performance.
- Lack of internal collaboration: Companies are struggling to raise attention of climate risk beyond sustainability departments, which is preventing a holistic understanding of climate change impacts. Effectively reporting against TCFD recommendation must be a joint effort across different departments and teams, including finance, risk, investor relations, legal and sustainability to allow for group-wide informed business decisions.
- Limited experience and technical knowledge of climate scenario tools: One of the most cited challenges is the lack of know-how to translate potentially uncertain climate scenarios data into meaningful financial analysis. Companies are advised to leverage publicly available scenarios and stress test their particular portfolio and circumstances, to only focus scenarios on a few key variables associated with long-term material impact on the business, and to explore not one but a broad range of futures and testing those against a company’s strategy.
Despite challenges, positive lessons can be learnt from the first year of TCFD reporting. Take AXA France, for instance, a company that received the ‘’International Award on Investor Climate-Related Disclosures’’ for excelling at reporting the physical impacts of climate change. The oil and gas sector, including companies such as BP, Royal Dutch Shell and Equinor, are pioneers in the disclosure if scenario analysis. And even some banks, whose portfolios often have exposure to high-intensity industries, have convened to develop a methodology designed specifically for banks to carry out forward looking, climate risk and opportunity assessments through state-of-the-art global climate change scenarios.
Companies are struggling to raise attention of climate risk beyond sustainability departments.
Towards Full Disclosure
Just over a year since the TCFD recommendations were launched, it is not surprising that full climate disclosure is still not common practice. But the growing and present danger posed by climate change means that shifts in strategic approaches to manage risks are increasingly needed.
The gradual adoption of the recommendation from regulators, investors and companies indicates that the implementation will take place over time. However, work remains to be done to report fully in line with recommendations as companies still face challenges in their approach to disclosure of financial climate impacts.
Although there is still a long way to go, interim steps such as CDP’s integration are already helping companies to better report on their climate-related financial information and paving the way to full disclosures. It is only a question of time until climate until climate risk disclosure becomes the standard rule and both companies and investors and the whole financial market become a more unified resilient system against climate change.