At the WSJ’s CFO Network Annual Meeting this week, the WSJ reported, speakers warned that finance chiefs were “underestimating how climate-related risks, such as extreme weather and changing consumer views on environmental issues, could affect their companies’ bottom lines, and they need to make climate risk assessments a bigger priority.” As reported by the NYT, a member of the CFTC has cautioned that it is “‘abundantly clear that climate change poses financial risk to the stability of the financial system,’” comparing the financial risks from climate change “to those posed by the mortgage meltdown that triggered the 2008 financial crisis.” And, in a survey conducted by a major investment bank of over 600 investors with about $21.5 trillion in assets globally, large investors indicated that they “expect environmental factors will become more pertinent to their investments than traditional financial criteria over the next five years, with more than 80 percent indicating it would be a ‘material risk’ not to integrate ESG factors.” NGOs and other stakeholders have emphasized that transparency is important to allow investors and the financial markets to understand companies’ risk management and corporate governance practices and to make informed decisions regarding capital allocation. In that context, the 2019 status report on disclosure by companies regarding climate-related risks and opportunities, just released by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures, sheds some light on the extent of the progress companies are making in helping investors and others better understand those risks. 

In his correspondence introducing the TCFD report, Chair Michael Bloomberg observed “that the Task Force finds that important progress is being made. Our review of over 1,000 companies showed that, for some recommended disclosures, the percentage of companies disclosing information increased up to nearly 15% over a two-year period. The results of our survey indicate that many companies are putting significant thought and effort into implementing the recommendations, and that many investors have seen this work pay off in the form of increases in the availability and quality of disclosure. However, progress must be accelerated. Today’s disclosures remain far from the scale the markets need to channel investment to sustainable and resilient solutions, opportunities, and business models. I believe in the power of transparency to spur action on climate change through market forces.”

As the report itself indicates, the TCFD was “concerned that not enough companies are disclosing decision-useful climate-related financial information.”

Given the current poor prognosis that established climate goals will be achieved on a timely basis, the 2019 report advises that

“[n]ow more than ever it is critical for companies to consider the impact of climate change and associated mitigation and adaptation efforts on their strategies and operations and disclose related material information. Companies that invest in activities that may not be viable in the longer term may be less resilient to risks related to climate change; and their investors may experience lower financial returns. Compounding the effect on longer-term returns is the risk that present valuations do not adequately factor in climate-related risks because of insufficient information. As such, investors need better information on how companies—across a wide range of sectors—have prepared or are preparing for a lower-carbon economy; and those companies that meet this need may have a competitive advantage over others.”

To prepare its report, the TCFD used artificial intelligence technology to review reports for over 1,100 large companies in eight industries over a three-year period.  The TCFD also conducted a survey (485 respondents) of companies’ implementation of the 2017 TCFD recommendations as well as users’ views on the whether the climate-related disclosures were decision-useful.  Below are some of the key findings:

  • Companies traditionally engaged on climate-related issues demonstrated “that disclosing climate-related information consistent with the TCFD recommendations is possible and is a journey of continuing improvement.” However, given the urgency of the matter, more companies needed to consider the issues and make related disclosures.
  • Although progress has been made to with regard to the “availability and quality of climate-related financial information,” only about “25% of companies disclosed information aligned with more than five of the 11 recommended disclosures and only 4% of companies disclosed information aligned with at least 10 of the recommended disclosures.”
  • Since 2016, the biggest increase (10%) in  response rate for a disclosure recommendation was in disclosure of “climate-related risks and opportunities…and the impact of climate-related risks and opportunities on the company’s businesses, strategy, and financial planning.” None of the disclosure recommendations had a disclosure rate of 50% or more, “even those related to governance and risk management, which the Task Force recommends all companies disclose.”
  • Disclosure increased with company size and varied across geographical regions, with Europe being the highest.
  • More clarity on the potential financial impact of climate change was the topic most often identified by users as needing improvement.
  • Disclosures were made in multiple types of reports (g., financial filings, annual reports, integrated reports and sustainability reports), although the incidence of inclusion in financial filings or annual reports increased by almost 50% compared to 30% in sustainability reports.
  • Sixty percent of companies that used scenario analyses to assess the resilience of their climate-risk strategies did not disclose information about resilience; only 9% of companies in 2018 disclosed information on strategy resilience. Since 2016, there was only a 3% increase in the percentage of companies disclosing information on the resilience of their strategies. The TCFD viewed the omission as significant, but attributed it primarily to the early stage of the learning curve for these analyses.
  • The banking industry generally had the highest percentages across all recommended disclosures, but some other industries had higher percentages for specific individual disclosures.
  • Involvement of multiple functions was considered critical to mainstreaming climate-related issues, including executive, sustainability and corporate responsibility, and especially risk management and finance.
  • Although many companies are following different frameworks, of those survey respondents that decided to implement the TCFD framework, the vast majority were still “on the journey”: 7% reported complete implementation; 9% expected to be complete in one year, 58% expected to complete in two to three years, and 21% expected more than three years.
  • The survey identified a number of implementation challenges, including that climate was embedded within processes and difficult to discuss separately (49%), that assumptions often contained confidential information and were therefore difficult to disclose (although the report indicates that the TCFD did not intend that confidential information be disclosed) (46%), and that there were no standardized metrics for the particular industry (42%).
  • The TCFD identified these characteristics as necessary for the disclosures to be effective:  they should be relevant; specific and complete; clear, balanced and understandable; consistent over time; comparable within the industry sector;  reliable, verifiable and objective; and timely.
  • Companies were advised to apply appropriate internal governance processes to preparation and review of the disclosures.

For companies just beginning to evaluate the impact of climate change or that determined that climate would not have a material impact on their businesses, the TCFD encouraged them to at least disclose information on their governance and risk management practices. The TCFD believed that mainstreaming adoption of the recommendations would help make the information more decision-useful and “risks and opportunities will be more accurately priced.” The report includes a number of helpful samples of disclosure from various industry sectors.

The TCFD advocates that the climate-related disclosures be included as part of public financial filings, such as SEC filings, particularly where the risks are material and may need to be disclosed under reporting obligations. Although more companies included the disclosure in sustainability reports, increasingly, the disclosure is being included in financial filings or annual reports.

In the survey, the top two reasons cited for implementation of the TCFD framework were reputational benefits (good corporate citizenship) and investor requests. Almost half of companies responding to the survey said climate-related risks were considered material today, and almost a quarter said climate-related risks would be material in the next 1 to 2 years or 3 to 5 years.  Over 80% of companies indicated that implementation of the recommendations encouraged their companies to enhance their climate-related disclosures, 71% said that it encouraged the use of scenario analysis and 68% cited increased board and senior management attention to climate issues.

Most companies responding to the survey reported that each recommendation (other than Governance) was “somewhat difficult” or “very difficult” to implement, with Strategy being the most difficult—especially with regard to scenario analyses.  (Risk Management and Metrics and Targets were identified as difficult to a lesser extent.) The TCFD viewed the use of scenario analyses to test the resilience of a company’s strategy to be a key recommendation that was “critical for improving the disclosure of decision-useful, climate-related information on a company’s strategy.” Why?  Because, in light of the uncertainties of climate change, the TCFD believed that companies needed to describe how well their strategies would hold up “over a range of plausible future climate states.” But, in response to the survey, only 43% of companies that used scenario analyses said that they disclosed resilience information. Why not?  The TCFD identified the following four challenges:

  • “Lack of appropriately granular, business-relevant data and tools supporting scenario analysis;
  • Difficulty determining scenarios, particularly business-oriented scenarios, and connecting climate-related scenarios to business requirements;
  • Difficulties quantifying climate-related risks and opportunities on business operations and finances; and
  • Challenges around how to characterize resiliency.”

While some of the necessary data and tools exist, the TCFD acknowledged that further work was required on developing business-relevant scenarios.  In addition, although the TCFD recognized that the financial impact of climate-related issues was not always clear, it noted that the 2017 report “highlighted four major categories of financial impact that companies should consider—revenues, expenditures, assets and liabilities, and capital and financing—and provided examples of specific elements under each category.”

Perhaps the toughest challenge was related to determining the types of information to disclose to demonstrate strategy resilience.  In that regard, the TCFD suggested that companies describe the characteristics of their strategies that allow them to adapt to material climate-related changes. In addition, information about the resiliency of a strategy

“should allow investors to understand how the company is positioning itself given identified, material climate-related risks and opportunities. In this context, investors are likely to need information on the range of scenarios considered by a company; implications of each scenario for the business; strategic options considered; and the reasoning around the strategy adopted. Another factor that may warrant disclosure is the company’s ability—and flexibility—to adjust its strategy in response to emerging climate conditions, including alternative ways to use resources and the robustness and redundancy of business processes.”

The TCFD plans to promote and monitor implementation of its disclosure recommendations and is considering clarifying parts of its supplemental guidance, developing guidance regarding scenario analysis and identifying relevant scenarios. While work to address some of these challenges is underway, fortunately, the report includes a number of samples of scenario and resilience disclosure as resources.

About 76% of users of the information that responded to the survey indicated that their organizations used climate-related financial disclosures for financial decision-making, primarily investing and lending. Most users rated the information “very useful,” except for Governance information, which 52% rated “somewhat useful” and 48% rated “very useful.” In terms of suggested improvements, 76% wanted to see more clarity on the financial impact of climate-related issues, 72% requested an increase in the availability of disclosure, 72% requested disclosure of standard industry-specific climate-related metrics, 57% requested disclosure of scenarios and assumptions used, and 52% requested centralization of all the climate-related disclosure in a single report. To encourage more disclosure of useful information, the TCFD advocated that users engage with companies about the information that would be most useful.

Posted by Cydney Posner