The push for large companies to report how they assess and mitigate climate change-related risks to their businesses has taken another step forward as the European Bank for Reconstruction and Development (EBRD) has published guidance to help corporates disclose the long-term impacts of climate change in their financial results.
The financial services sector has long had concerns that companies and assets are being mispriced because climate risk is not being factored into financial reporting. This has prompted greater demand for more meaningful and transparent climate-related financial information.
In response, the Financial Stability Board (FSB), the international body set up in the wake of the financial crisis to ensure better regulatory oversight of financial markets and financial risks, set up a Task Force on Climate-related Financial Disclosures (TCFD) in December 2015 to draft a voluntary framework on how companies can report on the potential impact that climate-related risks might have on their bottom lines.
Around two thirds of G20 member states have engaged with the framework since its launch in June last year, but there has been criticism that the voluntary guidelines do not provide much concrete detail on the metrics for reporting climate risks and opportunities in financial disclosures.
“A corporation’s vulnerability to climate impacts goes well beyond the physical exposure of its facilities.It includes supply chains, distribution networks, customers and markets. Furthermore, a company’s resilience to physical climate impacts depends on its risk management and business plans, as well as its governance.”
Consequently, the EBRD—set up originally to fund development projects in the former eastern bloc—has tried to fill that void. The report, called Advancing TCFD guidance on physical climate risks and opportunities and written in collaboration with the Global Centre of Excellence on Climate Adaptation (GCECA), a non-governmental organisation, presents 18 recommendations on disclosing physical climate risks and opportunities in financial reporting (see sidebar at right).
These recommendations are based on analysis conducted by industry-led working groups, which included representatives from heavy-hitters such as Shell and Siemens, as well as major financial firms including Allianz, Barclays, Lloyds BNP Paribas, and Citi. The Bank of England and the OECD were also involved.
The report says that companies should perform forward-looking risk assessments and disclose material exposure to climate hazards such as flood risk, water stress, extreme heat, storms, and sea level rise over a five-to-20-year timeframe. Risks beyond 20 years should also be assessed using scenarios to account for uncertainty in climate policy and impacts of climate change. Firms should also investigate the benefits of investing in resilience.
But as well as reporting on climate change risks, the report also wants companies to explore and leverage opportunities in managing existing physical climate risks (as well as responding to emerging risks) to provide new products and services.
In terms of specific recommendations, the report says that companies should provide more detailed information on the location of their critical operations, suppliers, and key markets, since this would allow investors and creditors to conduct analysis on exposure to risk in their portfolio.
List of 18 recommendations
The EBRD guidance distinguishes between “first-order” and “second-order” impacts. First-order impacts are direct hazards from climate change—both acute and chronic— that affect specific regions or locations, often within a specific timeframe, and which can be measured in physical terms, such as degrees Celsius, millimetres of rain, and sea temperature.
Second-order impacts, meanwhile, involve those that affect humans and the economy more widely. These may include changes in the availability of natural resources, for example, or agricultural productivity, the geographic distribution of species, disruption to transport, changes to global trade routes, migration, and macroeconomic indicators such as GDP, employment, and interest rates. Unlike direct climate hazards, second-order impacts are difficult to predict and even harder to mitigate through traditional approaches to risk management.
The 18 recommendations are as follows.
Assess exposure to all first-order physical climate impacts.
Assess physical climate risks over the duration of an asset’s lifetime or over the lifetime of a financial instrument.
Disclose locations that are critical to value chains.
Provide detailed information on the financial impacts of recent extreme weather events.
Disclose the impacts of weather variability on value chains.
Perform forward-looking assessments of physical climate risks.
Describe risk management processes for physical climate change impacts.
Identify opportunities based on managing physical climate risks and related market shifts.
Assess physical climate opportunities over timeframes relevant to business planning.
Disclose physical climate opportunities for business at the segment level; for critical facilities, disclose climate resilience benefits at the facility level.
Disclose benefits from climate resilience investments using the same metrics as for the disclosure of physical climate risks.
Include physical climate opportunities for business in qualitative disclosures.
Consider current and desired greenhouse gas concentration pathways and related warming projections as a basis for scenario analysis of physical climate risks and opportunities.
Integrate scenario analysis of physical climate risks and opportunities into existing planning processes to ensure strategic, flexible, and resilient businesses and investments.
Avoid standardised scenario analysis in order to have a more comprehensive range of outcomes.
Consider data from a wide variety of sources and scales when developing scenario analysis of physical climate risks.
Take account of scientific uncertainty inherent in climate data and in scenario analysis of physical climate risks and opportunities.
Disclose qualitative information that is relevant to the company and its investors.
Source: Advancing TCFD guidance on physical climate risks and opportunities
Companies should also provide in their financial filings detailed information on the historical impacts of extreme weather events, including metrics on the number of days of business interruptions and associated costs, costs of repairs or upgrades, fixed-asset impairment, and supply chain disruptions and lost revenues.
The EBRD report also says that companies need to provide more details on the risk management processes they have in place for identifying, assessing, and managing the physical climate risks. This could include information relating to insurance coverage, planned facility moves or retrofits, the company’s corporate climate resilience strategy, and its engagement with local authorities to build climate resilience locally. ?
“A corporation’s vulnerability to climate impacts goes well beyond the physical exposure of its facilities,” says the report. “It includes supply chains, distribution networks, customers, and markets. Furthermore, a company’s resilience to physical climate impacts depends on its risk management and business plans, as well as its governance.”
The demand for greater information regarding the financial impact of climate change-related risks has gathered pace recently. This month Legal and General Investment Management, one of the biggest investment funds in Europe, said it would take action against companies that are not addressing the risks of climate change by excluding them from its Future World index fund.
Meanwhile, earlier in June the U.K. Parliament’s Environmental Audit Committee called for clarification about how climate risks are factored into financial decision-making in pension funds—particularly if pension fund managers are financially incentivised to opt for short-term returns—and has asked the U.K.’s financial services regulator, the Financial Conduct Authority, to provide guidance.
It also said that the Department for Work and Pensions should propose a change in the law to require pension fund fiduciaries to actively seek the views of their beneficiaries when producing their statement of investment principles or investment strategy statements.