Bringing climate-related reporting in from the cold
June 29, 2017
After eighteen months of drafting and consultation, the Financial Stability Board (FSB) Task Force on Climate-related Financial Disclosures, commonly known at the TCFD, has now released its final report of recommendations. The brainchild of Mark Carney, Chair of the FSB and Bank of England Governor, the recommendations seek to improve decision-making by investors, lenders and insurers in respect of the climate change impacts on companies and so manage the potential risks to financial stability. But will a nearly 200-page report drafted in under a year by 32 private sector individuals, including this author, really have such an impact?
Well, the answer is yes. The recommendations cover the broad areas of how boards and management govern climate change and how they integrate it into their strategy, businesses, financial plans and risk management. It also asks that companies disclose various metrics and targets relating to climate change, ranging from carbon emissions to executive remuneration.
Perhaps the most innovative aspect is the proposal that companies consider how their businesses will fare under different climate scenarios, including the 2oC outcome that the Paris Agreement seeks to meet.
The eagle-eyed will notice a few differences to the draft Phase II report, in response to the public consultation. The most substantial of these relates to materiality: the report clarifies that the recommended disclosures on strategy and metrics & targets are subject to materiality tests, and in the case of non-financial companies, need only be disclosed where annual revenues exceed $1 billion. Where these are non-material they can be disclosed outside of annual report and accounts. The disclosures for governance and risk management remain for all companies regardless of materiality. There has also been some simplification of metrics & targets for non-financial sectors, to provide clarity and consistency; an encouragement for further development of metrics in the financial sector, clarifying the link to financial impacts; and providing additional guidance and standard scenarios to ease implementation.
So, what happens next? After all, the recommendations are voluntary, so why might companies adopt them if governments, at least in the short term, are unlikely to regulate?
The answer lies in the power of the markets, and more precisely that of investors. Asset owners, such as pension funds whose equity and debt holdings make up a large chunk of the capital markets, sit at the top of the investment and credit chain. They sit to win or lose by the decisions they make in respect of the companies they invest in, and how these companies in turn manage the physical and transition risks - and opportunities - arising from climate change. The early signs are that they, and the asset managers who represent them, are taking this seriously: a slew of heavyweights, from Blackrock to Aviva, Axa and Legal & General, have all issued statements making climate a top engagement priority and promising action if companies do not disclose in line with the TCFD recommendations. And in recent weeks they have turned words into action, for example with Exxon and Occidental in the US.
But it's not just investors who will bring pressure to bear on companies, requiring them to better disclose the impacts of our changing climate. Ratings agencies, who were already making progress with ESG and green bond ratings, also have the opportunity to see how better disclosure by companies can enable them to consider the financial impacts of climate change in credit and equity ratings. In addition, stock exchanges and securities regulators will have the ability to encourage or mandate better climate disclosure in listings; take the Brazilian exchange, B3, as an example where a voluntary “disclose or explain” approach has resulted in some 70% of listed companies making ESG disclosures.
And finally, I turn to my own profession. The consultancies and auditors can work at two levels: firstly with the main accounting standards boards translating climate-related disclosures into financial ones; and secondly with clients both advising on the implementation of the recommendations and working with them to integrate these disclosures into financial reports.
It is only through these four market “levers” - investors, ratings agencies, stock exchanges and consultancies - that we can bridge the gap between voluntary disclosure and mandatory reporting. And it’s entirely appropriate to take this path, giving the market the opportunity to develop consistent, comparable disclosures and providing companies the encouragement to do so. After all, a carrot is easier to eat than a stick.