Planning a successful TCFD project? Begin with the end in mind
Part One of a three-part series.
As the recommendations of the Financial Stability Board’s (FSB’s) Task Force on Climate-related Financial Disclosures (TCFD) continue to gain support, managers of leading global corporations are starting to plan for enhanced climate disclosure. Climate-related financial disclosures, especially those explicitly considering alternative climate scenarios, are entirely new. And like anything new, there is confusion about ends and means — objectives and process. Best practices are not yet well defined, and there are many potential pitfalls.
Avoid wasted time and resources by following this brief guide on how to design and implement a successful TCFD project.
Understand the FSB’s objectives
In April 2015, after having identified climate change as a systemic risk to global financial stability, G20 Finance Ministers and central bank governors asked the FSB to review how the financial sector could take account of and better manage climate-related risks. This led to the formation of the TCFD, which was tasked with developing a framework of financial disclosures that "would enable stakeholders to understand better the concentrations of carbon-related assets in the financial sector and the financial system’s exposures to climate-related risks."
Using these climate-related financial disclosures, the FSB envisioned that:
[F]inancial institutions and other relevant stakeholders could then assess the credibility of firms’ transition plans and their ability to execute them and analyze the potential changes in value of their assets and liabilities that could result from a transition to a lower carbon economy or to other climate-related events (physical or legal risks). This would allow stakeholders not only to manage and price these risks accordingly but also, if they wish, to take lending or investment decisions based on their view of transition scenarios.
Stated differently, the FSB believes that the systemic financial risk posed by climate change can be better managed (avoided, mitigated, transferred or accepted) by encouraging firms to future-proof their organizational strategy against climate-related financial risks and provide financial disclosures sufficient to allow financial markets to independently assess their progress and capabilities.
Clarify project objectives
At the outset, clarify the objectives of the proposed TCFD project. For example, is the purpose to:
- improve the firm’s environmental, social and governance (ESG) public image consistent with similar prior public relations efforts (improve the firm’s CDP ranking)?
- get a head start on future mandatory disclosure requirements?
- check the box as a TCFD adopter?
- meet the letter and spirit of the TCFD recommendations?
- improve the firm’s resilience to climate change?
The objectives will determine the project’s stakeholders, leadership, risks, barriers, resources, budget and schedule. Don’t begin detailed planning until objectives are well understood and agreed.
Get buy-in from key stakeholders
Get buy-in early on in the project planning process. An otherwise well-designed TCFD project will not succeed without cross-functional senior management buy-in.
Begin by identifying the key internal stakeholders — those who must support the project in order for it to succeed — and gaining their support for the project. Depending on the project’s objectives, key internal stakeholders may include the CEO, CFO, chief sustainability officer (CSO), general counsel, director of strategic planning and analysis, director of investor relations, and managers responsible for climate-related risk (sustainability, corporate social responsibility and ESG experts).
After getting buy-in from key internal stakeholders, assign project leadership and ownership of the climate disclosure function to one or more senior managers with sufficient authority to ensure effective implementation and continuing operation consistent with the firm’s objectives. For example, if the firm intends to integrate audited scenario-based financial disclosures into its mainstream financial filings, assign leadership to the CFO and not the CSO.
Identify and resolve potential barriers
Key stakeholders may be skeptical about the feasibility and benefits of increased climate disclosure. Following are potential barriers to buy-in from key internal stakeholders and suggestions to resolve them:
- Barrier: Concern that TCFD disclosures will mislead investors and distort markets. Response: Reconcile this with the growing support for TCFD. Since the recommendations were issued in June 2017, the number of firms in support of TCFD has grown to over 500, with market capitalizations of over $7.9 trillion, including financial firms responsible for assets of $100 trillion.
- Barrier: Perception that climate-related financial risks are not material. Response: Deciding the materiality of climate change before conducting strategic analysis is putting the cart before the horse.
- Barrier: Skepticism about the feasibility/utility of long-term (30-plus years) forecasting. Response: If the firm currently performs long-term economic forecasting of supply, demand and prices for its products, what is the rationale for excluding consideration of climate change?
- Barrier: Concern that limitations in data availability and quality will prevent reliable strategic analysis and planning. Response: Strategic analysis always has certain data limitations. Such limitations should be clearly explained when communicating the degree of uncertainty to internal or external audiences, consistent with existing guidance in securities regulations and accounting standards.
- Barrier: Scenario-based disclosures will expose the firm to potential litigation when future outcomes underperform forecasts. Response: Scenario analysis is not used to predict what will happen but to help plan for what could plausibly occur, and scenario-based disclosures are not forecasts. Mandatory disclosure regimes provide protections for "forward-looking" statements made in good faith with a reasonable basis (see 17 CFR 240.3b-6 — Liability for certain statements by issuers). Firms can mitigate litigation risk to an acceptable level by clearly and accurately communicating the types and levels of uncertainty inherent in climate-related strategic planning and analysis.
- Barrier: Uncertainty about first-mover advantages vs. safety of running with the pack. Response: Climate strategy must precede and inform climate disclosure. Is running with the pack an acceptable approach to strategic planning?
- Barrier: Concern about disclosure of confidential business information (CBI). Response: Don’t disclose CBI. TCFD disclosures are voluntary, and mandatory disclosure regimes provide protections for CBI (see 19 CFR 201.6 — Confidential business information).
Preparing a matrix that lists the names, functions, objectives and barriers of key internal stakeholders is a good way to facilitate discussion and gain buy-in.
Develop an implementation path
Developing a realistic phased implementation path over time can set appropriate expectations and avoid costly missteps. Depending on the project’s objectives, a phased approach may be necessary or appropriate. Strategic planning and analysis managers are accustomed to forecasting long-term supply, demand and prices, and to using scenario analysis to optimize strategy against uncertainty. However, few firms have fully incorporated climate-related risks into their strategic planning processes, and none are accustomed to disclosing the data inputs, assumptions, methodologies and distributional results of their analysis.
The time required to integrate climate change into the firm’s internal management processes may alone span more than a single reporting cycle. Full implementation of the TCFD’s recommendations, including scenario analysis, with the quality required for mainstream financial filings may take several more reporting cycles.