SUMMARY
The Task Force on Climate-related Financial Disclosures (“TCFD”) was established by the Financial Stability Board in December 2015 to develop a set of voluntary and consistent climate-related disclosure recommendations for use by organisations to provide information to investors, lenders, insurance underwriters and other stakeholders about climate-related financial risks.
The TCFD assists organisations in understanding what financial markets want from disclosures, in order to measure and respond to climate change risks and encourage firms to align disclosures with investor’s needs.
Since 2017, the TCFD has published three status reports setting out a framework for organisations to use, to ensure the effects of climate change are considered in its business and investment decisions.
This article outlines the TCFD’s recommendations, the potential impact and risks of climate change and the actions organisations are required to take in order to manage climate change risks.
2017 STATUS REPORT
In June 2017, the TCFD published a Status Report setting out its recommendations on climate-related financial disclosures after an extensive consultation period with the public. The TCFD provides a framework for organisations to develop more effective climate-related financial disclosures.
The TCFD’s recommendations are structured around four thematic areas:
- governance: around climate-related risks and opportunities;
- strategy: actual and potential impacts of climate-related risks and opportunities on an organisation’s business, strategy and financial planning;
- risk management: processes used by organisations to identify, assess and manage climate-related risks; and
- metrics and targets: metrics and targets used to asses and manage relevant climate-related risks and opportunities.
CLIMATE CHANGE – IMPACT AND RELATED RISKS
In the report the TCFD split climate-related risks into two categories:
- risks related to transitioning to a lower carbon economy; and
- risks related to physical impacts of climate change.
Transition risks include:
- policy and legal risks: evolving policy actions may attempt to contribute to the adverse effects of climate change or seek to promote adaptation to climate change.
Increase in climate-related litigation claims as a result of an organisation’s failure to mitigate risks of climate change, adapt to climate change and insufficient disclosures around material financial risks;
- technology risks: technological improvements or innovations can have a significant impact on organisations;
- market risk: shifts in supply and demand for certain financial instruments, products and services; and
- reputation risk: changing customer and community perceptions of an organisation’s contribution or detraction from the transition to a lower carbon economy.
Physical risks include:
- acute risks: event driven risks including, extreme weather events, such as cyclones, hurricanes or floods; and
- chronic risk: longer term shifts in climate patterns that may cause sea level rise or chronic heat waves.
CLIMATE CHANGE RELATED OPPORTUNITIES
Climate change opportunities are presented through an organisation’s effort to mitigate and adapt to climate change.
The TCFD identified the following areas of opportunity:
- resource efficiency: reduction in operating costs by improving efficiency across the production and distribution process;
- energy source: transition to low emission alternatives for energy usage;
- products and services: development of new low emission products and services may improve competition and shift consumer and production preferences;
- markets: organisations may seek opportunities in new markets or types of assets to diversity activities; and
- reliance: development of adaptive capacity to respond to climate change to manage associated risks and seize opportunities.
FINANCIAL IMPACT
The financial impact of climate-related issues is driven by climate-related risks and opportunities and the strategic and risk management decisions on managing such risks. The transition to a lower carbon economy poses significant financial challenges.
The TCFD outlined four major categories of financial impact:
Income statement
- revenues: transition and physical risk may affect demand for products and services. Organisations should consider the potential impact on revenues and identify potential opportunities for enhancing or developing new revenues;
- expenditures: an organisation’s response to climate-related risks and opportunities depend on an organisation’s costs structure. Lower cost suppliers may be more resilient to changes in cost resulting from climate-related issues and more flexible in its ability to address such issues;
Balance sheet
- assets and liabilities: supply and demand changes from policies, technology and market dynamics related to climate change could affect the valuation of an organisation’s assets and liabilities; and
- capital and financing: climate-related risks and opportunities may change the profile of an organisation’s debt and equity structure.
2018 STATUS REPORT
In September 2018, the TCFD published a 2018 Status Report. The report recognised that further work is required for disclosures to contain more decision-useful climate-related information. The report highlighted that:
- the majority of organisations disclose some climate-related information;
- financial implications are often not disclosed;
- information on strategy resilience under different climate-related scenarios is limited;
- disclosures vary across industries and regions; and
- disclosures are often made in multiple reports.
2019 STATUS REPORT
In May 2019, the TCFD published a 2019 Status Report. The report provides an overview of the organisations that adopted the TCFD’s recommendations. Concerns were raised that not enough organisations are disclosing decision-useful climate-related financial information. The report highlighted that:
- disclosure of climate-related financial information increased, but still remains insufficient for investors;
- further clarification is required on the potential financial impact of climate-related issues on organisations;
- many organisations using scenario analysis, did not disclose information on the resilience of their strategies; and
- mainstreaming climate-related issues requires involvement of multiple functions.
The TCFD has developed seven principles for effective disclosures to assist organisations. Disclosures should:
- represent relevant information
- be specific and complete
- be clear, balanced and understandable
- be consistent over time
- be comparable among companies within a sector, industry or portfolio
- be reliable, verifiable and objective
- be provided in a timely manner
2020 STATUS REPORT
The TCFD will publish another Status Report in September 2020. In the meantime, additional work is being considered and the TCFD aims to:
- clarify elements of the TCFD’s supplemental guidance contained in the 2017 Status Report;
- develop process guidance on introducing and conducting climate-related scenario analysis; and
- identify business relevant and accessible climate-related scenarios.
NEXT STEPS
Organisations should begin to consider the impact of climate-related issues and its current governance, strategy and risk management practices. Adopting the TCFD’s framework ensures the effects of climate change are considered in an organisation’s business and investment decisions. The TCFD recommends organisations? use scenario analysis to identify and assess the potential implications of climate-related risks and opportunities.
For more information, and any guidance or advice on climate change reporting, External in-house counselTM, your specialist outsourced legal team, are here to help.
