Why 2020 is the crunch year for climate risk reporting
Companies are clearly feeling the heat as investors ramp up pressure to address and disclose climate and energy transition risks. But organizations of all stripes will have to get much better at forecasting how these factors will affect business outcomes because those who can't answer investors' questions will find it starts to affect their financial credibility.
What's positive is that the disclosure gap between investor expectations and the climate risk information companies are providing is closing slowly.
Increased familiarity with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) is driving modest momentum: The percentage of companies (in all industries) disclosing information aligned with TCFD standards grew by between 4 percent and 10 percent across the four areas of business between 2016 and 2018. We expect to see even greater alignment in 2020 as other organizations incorporate TCFD's into their frameworks and regulations.
But — and it's a big but — companies are still failing on one of the most important aspects of TCFD: using scenario analysis to project the impacts of future risks on their resilience and strategy.
Why is scenario analysis lagging behind?
There are two main reasons for this. First off, scenario analysis is difficult and time-consuming. The TCFD asks companies to "describe the potential impact of different climate scenarios, including a 2 degrees Celsius scenario, on the organization's businesses, strategy and financial planning."
But which scenarios to choose? How do you then translate those into financial impacts and ultimately integrate the results — which could appear uncomfortably close to guesswork — into strategy and planning?
Second, there's the epidemic of survey fatigue. There is a whole universe of different standards out there, each asking for information that takes a chunk of time to prepare. Rightly, executives will question why all these resources are being directed away from core business activities and whether TCFD alignment should take priority over other reporting benchmarks.
Financial credibility at stake
The retort to those executives is fairly simple: projecting future risks is key for investors and regulators, and there will be penalties for failing to meet standards.
Last year, Mark Carney floated the idea of making TCFD reporting mandatory if companies aren't willing to step up. New Zealand started consulting on a mandatory regime less than a month later. The United Kingdom, Australia, Canada, France, Japan and the EU are not far behind, while PRI signatories will find their membership dependent on TCFD compliance from this year.
Clearly, this is not a passing regulatory fad, and companies failing to get to grips with the TCFD recommendations may not have much time to get it right.
The fact that Moody's reconsidered ExxonMobil's AAA rating — alongside that of other companies — over this past year offers a clear steer that the scale of a company's efforts to meet its global carbon targets will affect its creditworthiness.
And this risk extends beyond fossil fuel companies to those that do not necessarily emit a lot of carbon but instead facilitate those that do. In 2018, Moody's identified 11 sectors with a combined $2.2 trillion in rated debt that were at risk of carbon-related downgrades.
So what to do?
Putting in the time to get scenario analysis right will go a long way to tackling some difficult questions relating to climate-related risks and impacts. Asking investors what information they need is a good first step and helps concentrate on what is genuinely material.
Then pick a scenario: The TCFD recommends organizations analyze a 2 degrees C scenario and at least one more. This could be business as usual, an emission trajectory in line with your host country's Paris Agreement pledge, or increasing climate activism and litigation, depending on feedback from investors or best practice case studies of companies in your sector.
Finally, concentrating efforts on a specific asset or business activity, ideally one of interest to investors, is an effective way of working out the kinks in your TCFD process before expanding across the company.
Following these steps should reduce the fear factor and help turn scenario analysis from a burden into a truly effective tool.
The original research for this article appeared in Verisk Maplecroft's 2020 Environmental Risk Outlook.
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