Reporting on climate risks on the bottom line

While companies have made steady progress reporting on how their operations impact the environment and what steps they are taking to reduce their carbon footprints, only a select few industries have looked at how climate change may impact them.

Those at the forefront of such dangers—namely, extractive and utility industries—have started providing numbers based on scenario analyses in response to investor demand. However, relatively little movement has been made so far by companies in general to examine and disclose the financial risks that climate change may have on their own underlying business, and regulators and investors are keen to address the omission.

As a result, 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 guidelines on how companies can report on the potential impact that climate-related risks might have on their bottom lines. Last December, the Task Force published a consultation paper outlining its recommendations.

The FSB asked the Task Force to develop a set of voluntary, consistent, comparable, and clear disclosure recommendations for use by companies in providing information to investors, lenders, and insurance underwriters about the financial risks companies face from climate change. The TCFD framework that it produced includes disclosures about the way firms consider the impact of climate change as part of their governance, risk management, and strategy, and it sets out metrics and scenarios that firms should consider disclosing.

Speaking about the draft recommendations, FSB Chair Mark Carney said: “The disclosure recommendations will give financial markets the information they need to manage risks, and seize opportunities, stemming from climate change. As a private sector solution to a market issue, the Task Force has focused on the practical, material disclosures investors want and which all capital-raising companies can compile.”

The consultation period ended on 12 February. A final draft of the recommendations is expected by June and will be presented to the G20 summit in July.

Generally, the TCFD framework has had a positive reception from regulators and investors. Companies have also provided strong support. “The recommendations presented by the TCFD create a common platform for assessing and reporting climate-related risks and opportunities across all parts of the private sector,” said Dr. Neil Hawkins, Dow Chemical’s chief sustainability officer and corporate vice president of Environment, Health and Safety in a statement of support.

“This is a report the world can't afford to ignore,” said Mark Wilson, CEO at insurer Aviva. “Comprehensive and consistent corporate disclosure of climate risks is a crucial and timely recommendation. What gets measured, gets managed and what gets disclosed and published gets managed even better.” Wilson added that “we should give the disclosure real bite by making these recommendations mandatory, not voluntary. Only then will climate risk become integral to corporate governance and how we all do business.”

“The disclosure recommendations will give financial markets the information they need to manage risks, and seize opportunities, stemming from climate change.”

Mark Carney, Chair, FSB

However, despite strong support for the FSB’s lead, some have also flagged shortcomings and concerns. At the end of February the U.K.’s corporate governance regulator, the Financial Reporting Council (FRC), published its response to the consultation.

At the crux of the FRC’s concerns is the “prescriptive” nature of any disclosure, particularly as “it is not clear to us that climate change is a principal risk for all companies” or that “the disclosures described in the recommendations may not be relevant for all companies.”

It believes that a list of suggested disclosures may encourage companies to adopt a checklist mentality. “There is a risk that blind compliance may lead to irrelevant or immaterial disclosures that obscure important information investors need about the principal risks a company faces,” says the FRC in a statement.

“Collaboration between companies, investors and climate experts to develop methodologies is more likely to succeed than a standard-setter attempting to establish restrictive practice standards or rules,” it adds.

Instead, the FRC believes that a more principles-based approach—with less emphasis on detailed lists of suggested disclosures—is likely to be more effective.

This approach, it says, world work in conjunction with the seven fundamental principles for effective disclosure as set out in Appendix 6 of the consultation. These state that disclosures should: present relevant information; be specific and complete; be clear, balanced, and understandable; be consistent over time; be comparable among organisations within a sector, industry, or portfolio; be reliable, verifiable, and objective; and be provided on a timely basis.

As they currently stand, the FRC says that the size, complexity and detail of the recommendations may impair their usefulness. Instead, it favours a “gradual implementation process” with “incremental improvements” and “more sophisticated” methodologies developing over time through consultation and feedback from companies and investors to develop best practice. “This will be crucial for achieving the widespread adoption envisaged,” says the FRC.

The FRC is also unsure whether all companies are capable of conducting scenario analysis, and it questions whether it is appropriate to make such analysis public given most companies’ lack of experience and expertise. It therefore calls for “incremental” improvements, particularly as such reporting is voluntary.

Anthony Appleton, the FRC’s director of accounting and reporting policy, says that “we support the Task Force’s project, but we think that its proposals are too prescriptive at present. We feel this may lead to companies backing away from reporting on climate-related financial risks to their business rather than embracing what the FSB is trying to do to improve long-term financial reporting.”

How can my company prepare for the TCFD recommendations?

Lois Guthrie, founding director of the Climate Disclosure Standards Board (CDSB), provides some handy hints for compliance officers to ensure that their organisations embrace and follow best practice when preparing to make climate-related financial disclosures.
1. Bring together the sustainability, governance, compliance colleagues to agree on roles.
2. Get climate change integrated into the governance process with board buy-in, and get the audit and risk committees on board.
3. Adapt existing ERM/risk management processes to take account of climate risk: quantify, stress test and use scenarios.
4.  Use the same quality assurance and compliance approaches for climate-related financial information as for finance, management and governance disclosures.
5. Look at existing tools you already use to help you collect and report climate-related financial information, such as the CDP Questionnaire and the Climate Disclosure Standards Board (CDSB) Framework.
6. Look specifically at the financial impact of climate risk, and how it relates to revenues, expenditures, assets, liabilities and capital.
7. Get feedback from engaged investors about what information they need to know about climate-related financial risks.
8. Assess your business against various scenarios.
9. Prepare the information you report as if it was going to be assured, even if you decide not to do so right now.
10. Look at the existing structure of your annual report and think about how you can incorporate the recommendations into your discussion of risks, management discussion and analysis (MD&A), and governance sections, for example.
Source: Climate Disclosure Standards Board

Others have also highlighted some concerns with the Task Force’s consultation (while also being generally supportive). Lois Guthrie, founding director of the Climate Disclosure Standards Board (CDSB), a non-profit organisation that promotes the integration of climate change-related information into mainstream financial reporting, says that one of the main problems is that “it is still unclear as to how these recommendations are going to be integrated into mainstream reporting.”

She points out that “with mandatory reporting requirements, companies know what information they need to disclose and how that data is supposed to be verified against recognised standards. With voluntary reporting, there can be a greater difference in the level of disclosure that companies make and how that information is presented.”

Guthrie also says that the Task Force has not defined what is meant by a “material climate risk”, or specified how long into the future companies are supposed to carry out scenario analysis for. “Each company will have to decide what it thinks is a ‘material’ risk and how far into the future it is conducting its scenario analysis, which means that like-for-like comparisons between companies is going to be very difficult, even if the companies belong to the same industry sector.”

Whatever the TFCD’s final recommendations may look like, compliance professionals will be interested to learn that experts believe that companies need to start taking the issue of reporting on climate-related financial disclosures seriously, and plan accordingly. Robert Wilson, director of forensic accounting at Exiger, a governance, risk and compliance consultancy, says that companies should be thinking about how climate risks might impact their long-term operations over the long-term, and the FSB’s recommendations on voluntary reporting are a welcome step in the right direction.

“Companies need to assess the likelihood of climate-related risks affecting their operations directly, as well as indirectly through the supply chain, and what the potential consequences could be,” says Wilson. “This is an essential part of good risk management, and investors and other stakeholders will need to see more evidence that boards are considering these issues as part of the long-term performance of the business,” he adds.

Dr. Alison Stowell from the Pentland Centre for Sustainability in Business at the U.K.’s Lancaster University, says that “the list of governments and stock exchanges around the world requiring or encouraging corporate sustainability disclosure continues to grow—at last count there were 180 laws and regulatory standards in 45 countries calling for some aspect of corporate sustainability reporting. So, the challenge becomes how to create reporting that is consistent and can be compared across different sectors/markets. One must remember that institutional investors are looking toward the stock exchange as a mechanism to encourage and create sustainable capital markets.”

There is little doubt that companies need to start taking account of how climate risks may impact their businesses and potential financial performance, says Brad Duncan, head of legal at environmental advisors the Carbon Trust. “It is no longer enough to just write platitudes stating that your business recognises the challenge of climate change,” he says.

“The critical audience for climate-related financial disclosures is institutional investors, so reporting needs to be in their language,” says Duncan. “And what they want to see is verifiable data based on commonly used metrics, alongside a clear narrative of risks and opportunities, which then allows analysts to assess and compare a company’s performance and prospects,” he adds.

To properly understand this, Duncan says that companies need to consider their “value-at-stake” as a result of climate change. This involves working through plausible scenarios that take into account factors such as the impact of possible regulations and carbon pricing across key geographies, or technology breakthroughs and shifts in consumer behaviour. It is also important to demonstrate an understanding of likely operational disruptions that could occur from the physical impacts of climate change, such as more frequent incidents of drought and flooding, he says.

In order to make this assessment meaningful, companies should disclose the assumptions underlying their scenarios (which Duncan believes will become increasingly standardised over time). This might include assessment reports from established international bodies and treaties, such as the Intergovernmental Panel on Climate Change, energy transition scenarios from the International Energy Agency, or the Nationally Determined Contributions of individual countries under the Paris Agreement.

The importance of using external advisers and gaining third-party assurance for climate-related disclosures should also not be underestimated, says Duncan. “Investors rightly rely heavily on independent opinions. We are already seeing the importance attached to proper verification in the rapidly growing green bond market,” he says.

Equally as importantly, says Duncan, is that companies should also use this process as an opportunity to ensure that their boards and management are properly informed about the potential impact of climate change on the business. “Making disclosures should not be seen as an end in itself, but a fundamental part of setting an effective strategy for long-term success,” he says.