Climate-related disasters—from floods to droughts to wildfires—are financially pummeling the world’s largest companies, even as many executives concede they aren’t fully prepared for the consequential adverse financial impact. It’s no wonder the heated debate over climate-risk disclosures has reached a global boiling point.
One clear indication of this trend is the growing number of local governments around the world that are seeking to mandate the currently voluntary recommendations of the Financial Stability Board’s widely adopted Task Force on Climate-Related Financial Disclosures (TCFD). Leading the way is New Zealand, which is on course to become the first country in the world to require the financial sector—banks, credit unions, asset managers, and insurers—to report on climate risks in line with the TCFD’s recommendations.
Climate risk disclosure is “fundamental to investors’ ability to assess and price risk. It’s also fundamental for the shift that needs to occur toward an orderly transition to a green, sustainable economy. Disclosure alone won’t accomplish the second piece—the shift. That’s not in our wheelhouse, but disclosure is the first fundamental building block for getting there.”
SEC Commissioner Allison Herren Lee
Under New Zealand’s proposed comply-or-explain regime, announced by Climate Change Minister James Shaw on Sept. 15, large financial institutions would have to annually disclose their governance arrangements, risk management, and strategies for mitigating any climate-change impact or explain why they have not done so. If approved by Parliament, the reporting regime would capture roughly 200 financial institutions, who could be required to make disclosures by 2023.
Other countries working toward some form of climate-risk disclosure initiatives include the European Union, the United Kingdom, Canada, Japan, and Australia. The U.K. government, for example, under its ambitious “Green Finance Strategy,” said it expects “all listed companies and large asset owners to be disclosing in line with the TCFD recommendations by 2022.” The move was welcomed by financial regulators in the United Kingdom—the Financial Conduct Authority, Financial Reporting Council, The Pensions Regulator, and Prudential Regulation Authority—who, in a joint statement, urged companies to consider the likely consequence of climate change on their business decisions.
U.S. regulatory actions
Trailing far behind is the United States, whose government’s head-in-the-sand mindset has forced U.S. regulators to take a much more piecemeal approach to climate-risk disclosure. For example, the New York State Department of Financial Services (NYDFS) on Sept. 22 issued a circular letter addressed to all New York domestic and foreign insurance companies outlining its expectations and to begin a dialogue on how to manage financial risks posed by climate change.
“Unfortunately, no financial regulator in the United States has really been able to officially take up the topic and embrace it and do something about it,” said NYDFS Superintendent Linda Lacewell, speaking on a Sept. 29 Compliance Week Webcast. “We really had to look across the pond to our peer financial regulators in Europe.”
According to the NYDFS, all New York insurers must begin integrating “the consideration of the financial risks from climate change into their governance frameworks, risk management processes, and business strategies.” Additionally, “insurers should start developing their approach to climate-related financial disclosure,” looking to the TCFD for guidance, the NYDFS said.
Questions pertaining to an insurer’s approach and activities related to the financial risks from climate change will be integrated into NYDFS’s examination process starting in 2021. “With the federal government’s decision to withdraw the U.S. from the 2015 Paris Agreement and other actions that undermine its intent, it is more important than ever for states to take the lead in ensuring the financial stability of the institutions they regulate in the face of climate change,” Lacewell said in the circular letter.
On a state regulatory level, this development is significant, as the NYDFS supervises and regulates the activities of approximately 1,500 banking and other financial institutions with assets totaling more than $2.6 trillion, and nearly 1,800 insurance companies with assets of more than $4.7 trillion.
Equally significant in its breadth and scope is a groundbreaking policy report that was published in September by a commissioner of the Commodity Futures Trading Commission (CFTC), laying out the systemic risks climate change poses to the U.S. financial system. “With this report in hand, policymakers, regulators, and stakeholders can begin the process of taking thoughtful and intentional steps toward building a climate-resilient financial system that prepares our country for the decades to come,” CFTC Commissioner Rostin Behnam said in announcing the report.
Companies can also expect climate change issues to be increasingly captured by the requirements of the International Accounting Standards Board (IASB), “both in terms of recognition and measurement and disclosure,” IASB Chairman Hans Hoogervorst said in a Sept. 28 keynote at the IFRS Foundation Virtual Conference.
For example, if an oil company cannot recover the cost of some of its exploration assets due to climate change, “IAS 36 will then require it to impair those assets,” Hoogervorst said. In another example, a bank whose loan portfolio is heavily exposed to carbon-intensive industries runs increasing credit risks when more stringent emissions-reducing regulations take effect. “When that results in an increase in expected credit losses, IFRS 9 would require the bank to reflect that in its provisioning,” he said.
“The potential interplay of IFRS requirements with sustainability issues is quite far reaching,” Hoogervorst continued. “The more urgent sustainability issues become, and the more stringent public policy towards a zero-emission future becomes, the more financial statements will be affected by these developments.”
The decision to exclude climate risk disclosure requirements from recent amendments to Regulation S-K also was a key point of contention among Securities and Exchange Commission (SEC) commissioners, resulting in a split 3-2 vote to relax the risk factor disclosures companies must make in their financial statements. “We are long past the point at which it can be credibly asserted that climate risk is not material,” SEC Commissioner Allison Herren Lee wrote in her dissenting opinion.
Commissioner Lee stressed the importance of the SEC’s role in climate risk disclosure further while speaking on Compliance Week’s Webcast with Lacewell. Disclosure is “fundamental to investors’ ability to assess and price risk,” she said. “It’s also fundamental for the shift that needs to occur toward an orderly transition to a green, sustainable economy. Disclosure alone won’t accomplish the second piece—the shift. That’s not in our wheelhouse, but disclosure is the first fundamental building block for getting there.”
Investor demands are also intensifying, both at a private- and public-sector level. On Sept. 16, several major investor groups from around the world, representing over $103 trillion in assets, in an open letter called on companies and auditors to ensure their financial reports and accounts reflect the IASB’s opinion paper addressing the pressing need to reflect climate-related risks in financial reports.
“Markets require information to operate effectively—what gets measured gets managed,” said former Bank of England Governor Mark Carney, who spearheaded the TCFD. “Investors need to understand how extreme weather events and climate policies to achieve net-zero affect business models and what could be the associated financial impact. This requires an improvement in the quantity, quality, and comparability of reporting, which, as the IASB has made clear, should be included in the core financial reports issued by companies.”
The proxy season has also brought with it more investor pressure. Recently, fund manager BlackRock published its first ever report on its investment stewardship activities, in which it disclosed it has identified 244 companies in 2020 that it said are making “insufficient progress integrating climate risk into their business models or disclosures.” Of these companies, it took voting action against 53 companies and put the remaining 191 companies “on watch.” Those that do not make significant progress risk voting action against management in 2021, BlackRock said.
In another example, Storebrand Asset Management—Norway’s largest private money manager—in August said it will no longer invest in companies that earn more than 5 percent of revenue from coal or oil-sands based activities. Nor will it invest in companies that are involved in “severe and/or systematic unsustainable production of palm oil, soy, cattle and timber” or that “deliberately and systematically work against the goals and targets” of the Paris Agreement. Storebrand said its overall goal is for its investment portfolios to have “net-zero GHG emissions by 2050, at the latest.”
All of this is to say that as climate-related financial disclosures increasingly become mandatory all around the world, compliance officers have an increasingly important oversight role to play here as well, ensuring not only that such disclosures are made, but that they are accurate, truthful, and complete. Regulators and investors will be expecting nothing less.