Chris Carter - Freelance Sustainability Strategist
What is TCFD
It is widely accepted that our continued emissions of greenhouse gasses will contribute to climate change and potential global warming above 2° Celsius (2°C). It is expected that such environmental changes could lead to disastrous social and economic consequences. The long-term nature and sheer scale of the problem makes it exceptionally challenging, particularly with economic decision making. Our current understanding of the potential financial risks posed by climate change is still at an early stage, whether it is its impact on companies, investors or the financial system as a whole. Therefore, making it imperative for climate related financial reporting and disclosures.
The Task Force on Climate-related Financial Disclosures (TCFD), launched in Paris at COP21 in 2015 by the Financial Stability Board (FSB) and Mark Carney, who was acting as the UN Special Envoy on Climate Action and Finance and later as the UK Finance Adviser for COP26. The FSB is an international body with the objective to protect the global financial system from systemic risks such as climate change. While TCFD is designed to provide guidance to qualifying market participants on the disclosure of information based around the financial implications of climate-related risks and opportunities. The objective is that these risks and opportunities become integrated into business and investment decisions. Fundamentally, the long-term impacts of climate change are complex and ultimately unpredictable. The risks, such as physical and transitional, could well have impacts across the entire structure of a business. Which may also include shifting revenues affected by physical risks to assets or changing customer demands.
Why is it useful?
As a result of the pressure on policymakers to create new legislation to drive a low-carbon transition, there is increasing demand for useful climate-related information by a range of market participants, particularly in the financial industry. Consumers of this data such as investors or insurers are consistently demanding access to risk information that is clear, consistent, comparable and reliable. Additionally, the last decade has seen increased emphasis on corporate governance due to the past negative impacts that weak governance has had on shareholder value. As a result, there is increased demand for transparency from businesses on their risk exposure as well as their risk management practices, with this now being extended to include those risks related to climate change.
It is well known that inadequate information about risks can lead to the misallocation of capital through the mis-pricing of assets. For example, we have previously made reference to the potential of a carbon bubble existing through years of investment in carbon intensive assets without accounting for their true future values. These bubbles could lead to financial instability across an entire industry since financial markets can be vulnerable to abrupt corrections. Financial markets ultimately will require high-quality information to react to the potential financial impacts of climate change. Which necessitates a comprehensive understanding of the risks and opportunities presented by climate change, climate-related policy and emerging technologies in our evolving world.
TCFD divides climate-related risks into two major categories. First is risks related to the transition to a lower-carbon economy. The second is risks related to the physical impacts of climate change. While the expectation is that the process of mitigating and adapting to climate change will ultimately create opportunities for organisations. An example of this would be the cost savings and resource efficiency developed through the adoption of new low-carbon energy sources. Or the development of new services which brings access to new markets and the creation of new revenue streams. These opportunities will undoubtedly become clearer and grow depending on the region, market and industry in which a business operates. In addition, with TCFD, companies are expected to quantify greenhouse emissions across their value chains, such as operations, supply chains and products in use. As a result, financial institutions would be required to quantify carbon emissions linked to their entire lending and investment portfolios. This is a complex undertaking spanning across multiple divisions such as equities, loans or investments in other asset classes such as infrastructure and real estate.
Who is required to disclose?
In 2022, the United Kingdom will become the first G20 country to make TCFD-aligned reporting mandatory for large companies and financial institutions to report on climate related risks and opportunities. While the UK is the first to make TCFD aligned reporting mandatory, the expectations are that many other countries such as the USA will follow soon. The companies in scope include traded companies, banks, insurance companies, as well as private companies with over 500 employees and £500 million in turnover. There are around 1,300 companies and financial institutions that fall within this category, all of whom will be required to disclose climate-related financial information, which is in line with the guidelines from TCFD.
The UK’s objective for requiring mandatory disclosures is to increase the quantity and quality of climate-related reporting across the national business community, which includes some of the most economic and environmentally significant companies globally. The expectation is that this will ensure businesses consider the risks and opportunities they face as a result of climate change. This reporting requirement will expectantly support them internally to set out emission reduction plans and boost their sustainability credentials.
On the reverse side, the new requirements will benefit investors and businesses, as they can fully understand the financial implications of the potential exposure to climate change and correctly evaluate climate-related financial risks. Thus allowing investors and businesses to confidently support the low-carbon transition of the UK’s economy. As TCFD provides a common set of requirements, companies are provided with a consistent approach to assess how a changing climate may impact their business strategy. It also makes disclosures more comparable, allowing companies to identify how well they are placed within the market to further harness opportunities from this transition to net zero.
TCFD recommendations were primarily focussed on the financial sector. However, only around half of these organisations explicitly supported the initiative. Rather environmental champions across a number of industries such as energy, manufacturing and transport pushed ahead to endorse the seriousness of their businesses approach to climate change risk as well as the broader financial threat it represents for the global economy. Ultimately, no matter what sector your business is in, it is clear that the TCFD will have downward implications. As larger organisations are required to disclose, a knock-on effect can be expected as these entities will need to understand the impacts of their supply chains and business dealings, therefore requiring suppliers, clients and business affiliates to provide information as well. This knock-on effect shouldn’t only affect downstream, as there will undoubtedly be cross-border implications, particularly due to global trade and the need to report on supply chains. Furthermore, companies who perform particularly well or who champion a ‘Sustainability’ or ‘Green’ ethos at their core business policy would want to show their performance through these public disclosure mechanisms as well.