Climate-risk disclosure takes investors by storm

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Adapted from State of Green Business 2019, published by GreenBiz in partnership with Trucost, part of S&P Global.

For more than 20 years, large companies have been ramping up the depth and breadth of their disclosure on GHG emissions. At the same time, the amount of forward-looking financial information on climate risks and the opportunities being provided to investors has been patchy at best.

But in the short time since July 2017, following the release of the TCFD guidelines, more than 500 large businesses, investors and industry groups have signed on to provide this type of forward-looking financial disclosure. Companies in the financial services industry are leading the way in their support of the TCFD recommendations, including BlackRock, State Street and S&P Global, along with the Association of Chartered Certified Accountants.

It’s not limited to the financial services industry. Other sectors are signing on, including Statoil and Shell in the energy sector, consumer product companies such as H&M and Nestlé, materials companies such as BASF and DowDuPont, as well as industrial companies such as Saint-Gobain and Ingersoll Rand.

The moment for improved financial disclosure on climate has arrived.

This investor- and business-led initiative grew out of a growing belief that a changing climate and energy transition will have profound implications for both individual companies and the global economy. For example, some experts have estimated that the cost of climate-related impacts could reduce the U.S. Gross Domestic Product by 1 to 4 percent. Companies’ and investors’ disclosures of the financial implications of climate change can benefit all parties. In the words of the TCFD:

Better access to data will enhance how climate-related risks are assessed, priced and managed. Companies can more effectively measure and evaluate their own risks and those of their suppliers and competitors. Investors will make better-informed decisions on where and how they want to allocate their capital. Lenders, insurers and underwriters will be better able to evaluate their risks and exposures over the short, medium and long-term.

The TCFD guidelines provide a framework for companies to evaluate climate risks and opportunities on four dimensions: company governance; strategy; risk management; and metrics and targets. What is new to many corporates is the explicit expectation to translate climate issues into financial implications on their income statements, cash flow statements and balance sheets.

Companies are expected to address climate-related physical risks such as water scarcity or extreme weather events, as well as transitional risks such as changes in policy, technology, market or reputational issues that could create both risks and opportunities for the organization.

As companies begin to address the TCFD guidelines and make disclosures in line with the recommendations, common challenges and questions are emerging.

One concern is how to incorporate climate change into existing operational decision-making processes and standard business functions. For example, how should climate be included in reports to the board and in company financial reports? Product innovation pipelines need to consider how urgently companies should invest in creating different products and services that capture climate-related opportunities or reduce risks from policies that will cut demand for energy intensive products. Many companies have risk-management processes that address business continuity in the event of a severe storm, but the wider range of longer-term climate risks is not generally part of the analysis.

For example, Rio Tinto’s sustainability report describes how it has put in place an internal carbon price to assess the possible cost and impact on product prices, and how the company has conducted a physical risk assessment of its assets to understand the business implications of climate-related risks such as water stress and rising sea levels. General Motors reports how it includes energy reduction targets in its business plans.

There’s also growing awareness that the climate conversation isn’t just about energy. Consider water. Are company assets sufficiently resilient to rising seas, droughts or flooding? Is enough fresh water available for operations and supply chains? For example, Danone, among other food and agriculture companies whose operations are heavily dependent on water, includes reporting on water scarcity risks as well as the steps it takes to assess these physical risks in developing new manufacturing sites. How will companies attract top talent to work in regions that are becoming more drought-prone?

Adaptation to a changing climate is another emerging issue, as more companies realize that today’s business models and commercial strategies may not be the same in a low-carbon economy. For example, Swedish steelmaker SSAB describes its strategic decision stemming from its analysis of climate-related risks to become a fossil fuel-free steelmaker by 2045.

Still another issue is standardizing scenario analyses under the TCFD guideline — that is, the likely impacts to a company and its operation under various climate scenarios. The guidelines do not prescribe specific scenarios, and companies have been using a wide range of approaches, assumptions and frameworks — 1.5 degrees Celsius of warming, 2 degrees Celsius, etc. Without a more standardized approach to scenario analysis, it’s unclear if investors will be able to consistently apply the results.

Practical tools, data and analytics to help companies conduct climate-related analysis are rapidly surfacing. The U.N. Environment Program Finance Initiative, together with 16 leading banks as part of a TCFD pilot project, released two reports in 2018 providing best practices on transition risk, "Extending Our Horizons" and "Navigating a New Climate." Climate and energy scenario analyses are available through organizations such as S&P Global Platts and the International Energy Association. Frameworks for translating climate exposure into exposure into financial risk and opportunity have emerged, as well as new Committee of Sponsoring Organizations of the Treadway Commission (COSO) guidelines for incorporating ESG risks into company enterprise risk management processes.

The TCFD guidelines notwithstanding, key questions remain. For example, what is decision-useful climate information, and how will it get mainstreamed into the capital markets?

Investors, particularly large institutional investors such as asset managers and pension funds, are just beginning to understand how to incorporate corporate climate disclosure data into their investment strategies, processes and financial valuations.

What’s clear is that different types of investors use corporate climate data in different ways depending on their investment strategies and asset classes. As these practices mature, investors are likely to sharpen their focus on specific aspects of corporate climate disclosure, such as how the company’s board is engaging on climate or the need for more robust GHG emissions-reduction targets. While leading investment analysts, banks and organizations are pioneering ways to financially value the implications of climate, these techniques are not yet standard practice. Investors will need to build organizational capacity on these methodologies.

Mainstreaming climate data into capital markets in decision-useful form will require standardization. For now, corporate disclosure on climate impacts is mostly voluntary. But the demand for mandatory climate disclosure is intensifying. In 2019, the European Commission is expected to address the TCFD guidelines as part of existing non-financial corporate reporting requirements.

Key players to watch

Climate Disclosure Standards Board — offers resources including the TCFD Knowledge Hub to help organizations understand and implement guidelines of the Task Force on Climate-related Financial Disclosures.

Committee of Sponsoring Organizations of the Treadway Commission (COSO) — the leading risk management organization has published a framework for integrating ESG considerations (such as climate) in corporate risk management processes.

European Commission — it intends to revise the guidelines of its non-financial reporting directive in 2019 as part of the EU Action Plan for Financing Sustainable Growth, to include guidance on data disclosure in line with the TCFD recommendations.

U.N. Environment Program Finance Initiative (UNEP FI) — convenes pilot projects working with the financial services industry to address TCFD reporting.

World Business Council on Sustainable Development (WBCSD) — is creating sector-specific TCFD workgroups and has published guidance on effective disclosure practices for the oil and gas industry.

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