TCFD recommendations more than building block for SEC climate disclosure rules?

Instead of New Year’s resolutions, public companies would be wise to write new goals for their climate-related performance or tweak existing ones. They should seek out metrics and internal data that support those goals and begin planning how to make improvements over the next year, the next five years, and the next decade.

In the United States, the Securities and Exchange Commission (SEC) has made it clear it intends to issue rulemaking on mandatory climate-related disclosures for public companies in early 2022. SEC Chair Gary Gensler has hinted the rules will likely be pegged to an international framework, specifically mentioning the Task Force on Climate-Related Financial Disclosures (TCFD).

The TCFD first issued its recommendations in 2017 and has updated them occasionally since, most recently this year. More than 2,600 organizations and companies around the globe have officially endorsed the TCFD.

The current climate disclosure landscape

The European Union, United Kingdom, France, Switzerland, New Zealand, and Stock Exchange of Hong Kong have passed laws and rules mandating large companies make climate-related disclosures, some of them using the TCFD’s recommendations as a framework. Other countries, like Australia and the United States, are likely to follow in 2022.

Beyond the TCFD, some of the prominent environmental, social, and governance (ESG) organizations that offer guidance or frameworks for companies seeking to make climate-related disclosure are:

• The Sustainability Accounting Standards Board (SASB), which has developed sustainable accounting practices that apply to 77 industries worldwide;
• The United Nations-supported Principles of Responsible Investment (PRI) that offer a “menu of possible actions for incorporating ESG issues into investment practice”;
• The One Planet Sovereign Wealth Funds (One Planet SWF), which was created following the 2015 Paris Agreement to “accelerate efforts to integrate financial risks and opportunities related to climate change in the management of large, long-term asset pools”;
• The Global Reporting Initiative (GRI), which has created the world’s “most widely used standards for sustainability reporting”; and
• The Climate Action 100+, “an investor-led initiative to ensure the world’s largest greenhouse gas emitters take necessary action on climate change.”

But since Gensler has name-dropped the TCFD as a potential framework for the SEC to mirror, let’s keep our focus there.

The TCFD’s recommendations are driven by two distinct risks posed by climate change. The first is physical risks to economies and individual organizations caused by storms, droughts, wildfires, or other changing weather patterns over time. Physical risks are also represented by sea level change, which can endanger coastal real estate and any businesses connected to it.

The second risk is transitory risk, or the risks associated with an abrupt adjustment to a low-carbon economy. Such risks include rapid losses in the value of assets because of changing policy or consumer preferences.

The TCFD recommends private companies disclose climate-related risks in four separate areas: governance, strategy, risk management, and metrics and targets.

An organization would disclose its governance of climate-related risks and opportunities by describing how its board and management oversee and assess them.

Disclosure of strategy would involve describing “the actual and potential impacts of climate-related risks and opportunities on the organization’s businesses, strategy, and financial planning where such information is material.” Such disclosures would include short-term and long-term effects on the organization; the impact of those risks; and attempt to measure the resilience of that strategy, taking into consideration different climate change scenarios.

Risk management disclosures would describe how an organization identifies, assesses, and manages climate-related risks.

Finally, organizations would disclose the metrics and targets “used to assess and manage relevant climate-related risks and opportunities where such information is material.”

In addition, the SEC and other regulators have indicated they might expect organizations, as part of their climate-related disclosures, to describe Scope 1 and Scope 2 greenhouse gas emissions. Scope 1 covers emissions from a company’s operation and Scope 2 from its use of electricity and similar resources. Disclosure of Scope 3 emissions—that is, emissions generated by third parties in a company’s supply chain—could also be required.

These disclosures would vary dramatically among industries. Manufacturers and the energy sector will grapple with how to describe their progress in reducing their carbon footprint, greenhouse gas emissions, and energy water usage. Financial institutions would have significantly fewer problems measuring their carbon footprint and are instead encouraged to disclose the climate-related risks posed by lending (banks), underwriting (insurance companies), asset management (asset managers), and investing (asset owners).

Where to begin?

Most organizations are already under pressure to disclose some of their ESG-related risks, of which climate is solidly in the “E” category. But how those risks are assessed and managed are part of the “G.”

In any case, your organization might have already taken steps to measure climate-related risks internally but hasn’t yet disclosed them to stakeholders. Or perhaps some goals have already been established to combat climate change and measure its risks to your organization, but those goals need to be assessed, measured, and monitored.

It helps to benchmark where your organization is compared to others in your industry—most notably, direct competitors. Benchmarking can help you explain the “why,” as in why your firm is disclosing climate-related risks, so you can move on to the “how.”

Law firm Crowell & Moring polled 225 in-house counsel and professionals involved in compliance, ESG, and sustainability matters in July and August. The resulting study, released in December and entitled “ESG Survey: Environmental Performance and the Stakes for Your Business,” found:

• 78 percent of respondents said their organization has identified environmental performance goals beyond required regulatory compliance.
• 82 percent felt their board of directors is adequately focused on the environment.
• 44 percent reported measuring their company’s carbon footprint.
• 33 percent measured supply chain sustainability.
• 45 percent said the new U.S. administration has already driven changes in strategic business decisions.

“Pressure to improve ESG performance could soon reach a fever pitch. Businesses are increasingly expected to measure, improve, and disclose their ESG performance to investors, to consumers, and to regulators. Their efforts are reaching into every area of their operations, as are the risks and opportunities that follow,” said Thomas Lorenzen, co-chair of Crowell & Moring’s Environment & Natural Resources group and a former assistant chief of the Environmental Defense Section at the Department of Justice.

What’s motivating firms to act, beyond what’s required by existing environmental laws? The survey found half of all respondents said their environmental initiatives were geared toward improving brand image and reputation among customers. One in three reported their firms were motivated to stay competitive in the market, or by increasing pressure from investors and shareholders. One in five answered to manage risk and regulatory compliance; because of increasing pressure from federal regulators; or because of increasing pressure from activists and nongovernmental organizations. Survey respondents were allowed to choose more than one answer.