Policy Brief: The Evolving Regulatory Landscape of Financial Climate Risk Disclosure

This Four Twenty Seven Policy Brief provides a summary of key findings from the Task Force of Climate-Related Financial Disclosures Phase I Report and highlights issues of interest to reporters and users of financial disclosures within corporations from the financial and non-financial sector.

What is the Task Force on Climate-Related Financial Disclosures?

In December 2015, the Financial Stability Board created a Task Force on Climate-Related Financial Disclosures (TCFD). The industry-led Task Force, chaired by Michael Bloomberg, is mandated to make recommendations for improving voluntary financial disclosure of climate-related risks. This coordinated international effort comes after investor advocacy organizations, like Ceres, have called attention to the poor quality of climate risk disclosures in financial filings (10-K management disclosures) and the lack of enthusiasm from the Securities and Exchange Commission in enforcing its 2010 guidance on climate change disclosure.

The Task Force released its Phase I report on April 1st. The report provides a high-level review of the existing landscape of climate-related disclosures, establishes fundamental principles for effective disclosures, and defines the scope and objective of the Task Force’s work through 2016. The report comes on the heels of an SEC ruling that ExxonMobil must include a climate change resolution on its annual shareholder proxy at the request of shareholders including the NY State Pension Fund.

Why is this Important?

The ultimate goal of the TCFD is to enable financial market participants to incorporate considerations on climate risks and opportunities into investment, credit and insurance-underwriting decisions, as well as to increase investor engagement with boards and management with respect to corporate climate risk management. This portends momentous change for the most exposed sectors. Over time we believe that the impact of the report has the potential to mainstream climate risk analysis and disclosure reporting requirements across all financial asset classes – equity, commodities, real estate, bonds – and will force a focus on climate resilience for all underlying assets – corporations, energy, agriculture, real estate, cities, and more.

Improved financial disclosures on climate-related risk will enable more informed decision-making within the financial markets and yield positive impacts for the economy. A higher standard on financial disclosures will also enable “appropriate pricing and distribution of risks throughout markets” and reduce financial instability by lowering the risk of an abrupt change in asset values (“transition” risk).

Just as the ultimate goal of the FSB and the G20 is to avoid another major financial crisis, In our view, the Task Force embodies the best climate change financial policy architecture that will promote market efficiency in a context of scientific uncertainty and information asymmetry. While the Task Force recommendations will not be binding, they come at a time when market authorities and financial regulators are looking to gain a greater understanding of climate change impacts on financial markets, and the Task Force recommendations will constitute a critical reference point for consensus on climate risk disclosures, and facilitate international standardization of requirements.

The Current Landscape of Climate Risk Financial Disclosure

The Task Force report finds that current climate risk financial disclosures are fragmented and incomplete, with a lack of agreement on what constitutes materiality. Most disclosures consist of boilerplate language that does not provide decision support or even useful information to investors. They also fail to acknowledge an organization’s specific risk profile and exposure to climate risk. Finally, most disclosures pertain to climate information in general and not to climate-related financial information.

The TCFD report highlights in particular the lack of comparability across disclosures due to ad hoc reporting practices, which prevents analysis of possible systemic risk in financial institutions’ portfolios and in financial markets at large. These findings are consistent with previous reports from Ceres and from the Sustainability Accounting Standard Board (SASB), as noted in their Technical Bulletin on Climate Risk from January 2016.

Proposed Principles for Effective Disclosures

The Task Force lays out seven fundamental principles for effective disclosures:

  1. Present relevant information.
  2. Be specific and complete.
  3. Be clear, balanced, and understandable.
  4. Be consistent over time.
  5. Be comparable among companies within a sector, industry, or portfolio.
  6. Be reliable, verifiable, and objective.
  7. Be provided on a timely basis.

While these principles are fully aligned with general principles of financial disclosures and with previously established climate disclosure framework, notably from the Climate Disclosure Standard Board, they raise a number of practical challenges when applied to climate risk disclosure. Climate science continues to evolve, as does global climate policy, making it difficult to be “consistent” over time. Climate impacts touch businesses and the economy well beyond the walls of any given corporation, but accounting for these indirect risks in a “specific and complete” manner is extremely challenging. An accepted methodology to measure and quantify climate risk will go a long way towards ensuring that disclosures meet these principles, and that the information is “comparable among companies.”

Looking Ahead: Phase II Scope of Work

The Task Force will seek to establish guidance as to what needs to be reported, in what format, and for what purpose.

Climate-Related Risks and Opportunities

The first challenge the TCFD will take on is defining what qualifies as climate-related risks and opportunities. In the framework outlined in the Phase I report, the TCFD echoes the common dichotomy between “physical risks” (e.g. extreme weather events) and carbon-related “non-physical” risks (e.g. carbon regulations, cost of low-carbon technology, asset liability, etc.). In our view, this framework is bound to evolve to better account for the breadth of regulatory, technological, market/economy, and reputational impacts directly related to climate risks and opportunities, including for example: changes in zoning laws, cost of adaptive technologies, changes in commodity pricing, etc.

Governance

Second, the Task Force will ensure climate-related risks and opportunities are considered in the broader context of the reporting entity’s strategic management. The Task Force will encourage disclosures pertaining to the governance process, specifically how boards and executive leadership consider and approach climate risks and opportunities.

Entities: Preparers and Users

Third, the Task Force will develop recommendations for reporting by non-financial companies – mainly publicly-traded corporations – as well as by financial intermediaries, investors, and asset managers that may be exposed to climate change in their portfolio. While recommendations will likely focus on companies above a certain size, they may also apply to privately-held corporations. In the financial sector, the Task Force intends to emphasize risks associated with underlying loans and investments in companies, and possibly into real estate investments as well.

The Task Force is also interested in better understanding how the climate-related disclosures will be used and by whom. The objective is that disclosures be provided in a format such that users across the entire financial value chain can integrate climate risk metrics into existing risk assessment, portfolio analysis, asset allocation, and other financial decision-making processes.

Information to be disclosed

Finally, the Task Force will give particular attention to the information being disclosed. This information may include both quantitative and qualitative disclosures, providing “consistent and comparable data and metrics” to be aggregated across portfolio.Screen Shot 2016-04-04 at 12.01.32 PM

For quantitative metrics, an established accounting system exists for carbon accounting, but no such common methodology is available for physical and indirect impacts of climate change, especially not across a broad range of sectors and asset classes. The Task Force will need to balance the conflicting needs between finding a lowest common denominator metric that can be used across sectors, and disclosing data and metrics that provide relevant insights into sector-specific risks. The Task Force may encourage greater use of scenario and sensitivity analysis to support forward-looking assessments of risks and opportunities.

For qualitative disclosure, the Task Force will consider governance, transition strategies, priorities, and processes. This indicates that companies with a vision and plan for greater climate resilience, together with well-supported Key Performance Indicators showing progress towards established resilience milestones, will be better positioned to protect shareholder value.

Next Steps

The Task Force will be working on Phase II elements through the end of 2016 and will deliver its recommendations to the FSB in December 2016, with a finalized report expected in February 2017. The Task Force intends to integrate and leverage stakeholder input throughout the process and is currently inviting feedback through May 1st in the form of a detailed questionnaire on its website. The questionnaire solicits structured feedback on reporters’ and users’ needs, scope and definition of climate risks and best practices.

The regulatory landscape of climate risk disclosure is evolving rapidly. Corporations and investors will be well advised to stay current on legal and policy changes related to climate change risks, and to deepen their understanding of climate change science and its impacts on their business. While climate change presents a wide array of direct and indirect impacts, many of these impacts can be forecasted and managed. Businesses able to take in new knowledge on climate change will be able to stay ahead of the curve, manage regulator and investor expectations, protect their value, and capitalize on opportunities.

Learn more about how we are helping corporations adapt to their climate risk.

Reference Documents

TCFD Phase I Report

SEC Commission Guidance Regarding Disclosure Related to Climate Change

Ceres Cool Response Report

SASB Technical Bulleting 2016-01

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