The United Kingdom has paved the way for companies to report on the future financial impact of climate risks, but the process is far from easy and rates of noncompliance—at least initially—could be high.
From this year, some 1,300 businesses and financial institutions will have to report on a “comply or explain” basis against the financial disclosures recommended by the Task Force on Climate-Related Financial Disclosures (TCFD), an organization that seeks to provide a standardized framework for companies to report on how climate change impacts the bottom line.
The 11 recommended disclosures are meant to show how climate risks impact a company’s governance, strategy, risk management, and metrics and targets. In theory, the TCFD’s framework will show how boardroom decision-making is influenced by physical climate risks like floods and wildfires while also examining how companies quantify the financial impact of transitional risks as the business adapts to the global move toward a low-carbon economy.
Legal experts believe the U.K.’s mandates might inspire other countries to follow its lead. Many experts think organizations not yet covered by the requirements should start to understand what they need to do for when the disclosure rules (eventually) apply to them.
“Disclosure needs to be accurate and transparent regarding approach, methodology, and any limitations. If it is not, a company risks facing a claim for failure to disclose or for disclosure of misleading, inaccurate, or incomplete information.”
Kate Gee, Counsel, Signature Litigation
The Financial Reporting Council, the U.K.’s corporate governance regulator, warned in October that climate-related risk disclosures would be at the heart of its monitoring in 2022.
“Having to think about a nonfinancial risk in a financial manner is going to be a novel change for many companies,” said David Savage, partner and head of financial crime investigations at law firm Stewarts.
Experience suggests companies have not found it easy to disclose in line with the TCFD’s recommendations. A report released in September by financial think tank Carbon Tracker found limited consideration and reference of climate change in the 2020 financial statements of more than 70 percent of the 107 global companies it reviewed.
Because climate risk is so embedded in company processes, it has proved challenging to discuss separately in risk management and governance disclosures. Disclosing scenario analysis assumptions is difficult because companies might include confidential business information. Providing details about the metrics and targets used to assess and manage relevant climate-related risks and opportunities has also been problematic because of a lack of standardized metrics for some industries.
Brian Scott-Quinn, emeritus professor at Henley Business School, said the concerns around metrics “is undoubtedly a difficult issue to resolve.” For example, on carbon dioxide, metrics can measure different features of emissions such as absolute emissions, emissions per U.S. dollar of asset investment, or emissions per U.S. dollar of revenue. In each case, much depends on what category these metrics need to be reported under (Scope 1 or 2) or if the impact of the supply chain also needs to be included.
Scott-Quinn added while there is now guidance to help companies prepare, the accounting standards set to be used will not even be issued in draft form until later this year.
Another problem is that while some companies have been voluntarily reporting on climate-related financial risks for some time, they might not have been doing so in line with the TCFD’s recommendations. As a result, incidents of noncompliance could be high.
Franki Hackett, head of audit and ethics at data solutions firm Engine B, said collecting and understanding climate risk data presents the greatest challenges for companies. This is because the information is diverse; is not uniformly formatted; is spread across multiple systems; and is often not even collected.
Even once companies collect the data, they then need to perform an informed risk assessment, which means they need the expertise to understand the information before they present it in a meaningful way to management and external stakeholders. This process is another substantial barrier for many organizations, Hackett said.
To get around these challenges, Hackett said companies should “follow the leaders” and not try to hide “uncomfortable truths.”
“My advice would be to look to those who have previously reported voluntarily for examples of best practice,” she said. “Management needs to ensure it understands both its responsibility and what the data is communicating regarding its climate risks.”
One of the key concerns for businesses and directors will be the prospect of any legal liability regarding forward-looking public statements that prove ultimately to be false or, for entirely innocent reasons, do not come to fruition.
Failure to report—or reporting poorly—can be met with fines under the U.K. Companies Act 2006 as well as other legislation, including the Streamlined Energy and Carbon Reporting (SECR) requirements implemented in 2019. Legal experts warn investors and clients alike might seek to rely on false, misleading, or inaccurate statements in support of legal claims for resulting loss.
“Disclosure needs to be accurate and transparent regarding approach, methodology, and any limitations,” said Kate Gee, counsel at law firm Signature Litigation. “If it is not, a company risks facing a claim for failure to disclose or for disclosure of misleading, inaccurate, or incomplete information.”