As corporate regulators focus more closely on climate-related risks, investors will benefit from greater standardisation in reporting, writes Matthew Picone, vice-president and portfolio manager for Acadian Asset Management.
In recent months, Australia came one step closer to establishing a reporting standard on climate-change risks, when ASIC updated its guidance for businesses.
In August, ASIC announced that it will undertake surveillance of climate-related disclosure practices for listed entities, naming climate change as a “systemic risk” for businesses. It will be expecting to see climate change disclosures in operating and financial reporting (OFRs) and prospectuses. Businesses that don’t act now may risk greater regulatory scrutiny and could fall behind their competitors.
Many of ASIC’s recommendations focus on the reporting standards developed by the G20 Financial Stability Board’s Taskforce on Climate-Related Financial Disclosure (TCFD).
Unlike many other global ESG reporting frameworks, the TCFD focuses specifically on climate-related financial risks and has been endorsed by large global investors.
Earlier this year, the UN Principles of Responsible Investment (PRI), a group which includes 2,300 asset owners and investment managers, announced that it would require its signatories to report on climate risks in line with those outlined by the TCFD.
Additionally, a group of 36 central banks and supervisors under the Network for Greening the Financial System (NGFS), which includes the Reserve Bank of Australia, the Bank of France, Bank of England and the People’s Bank of China, recommended financial market participants improve their disclose of climate-related risks, starting with those outlined by the TCFD.
Disclosure among larger businesses improving
It is encouraging to see such progress in Australia, which has already made significant leaps forward in recent years when it comes to climate-related disclosures.
Emissions disclosure among larger companies is strong and improving, with 47 of the top 50 ASX-listed companies currently reporting an acceptable level of emissions data. This compares to 39 five years ago and just 28 reporting emissions 10 years ago.
There is, however, more work to be done, with disclosure rates for more detailed reporting – including information on emissions targets – at the lower end, with only 30 of the top 50 stating adequate reduction targets. General disclosure outside the largest companies is also weaker, with only 109 companies listed in the ASX 300 reporting emissions data.
While adherence to the TCFD framework itself is voluntary, the consideration, management and disclosure of material risks that companies are exposed to are a legal obligation for company directors in Australia. This includes any physical and transitional risks associated with climate change, specific issues covered by TCFD recommendations.
Scenario testing presents challenges
Outside of standard metric reporting, another key TCFD recommendation relates to scenario testing. This is a method for developing strategic plans that are more flexible, by accounting for a range of future states.
The predominant scenario is one that limits the rise in global temperatures to no more than 2 degrees Celsius, as stated in the Paris Agreement. Some global companies, however, have taken this a step further and analysed the potential impact of more severe climate change of 3 or 4 degrees on their businesses.
In principal, scenario analysis helps businesses better understand the risks and opportunities of climate change, make smarter decisions and meet their obligations to shareholders.
However, it is a challenging and much less reported aspect of the TCFD recommendations. Some of these challenges include the assumptions used to determine the level of emissions reductions required in varying scenarios and the exposure of physical risks including the prediction of localised impacts, such as where an extreme weather event will occur.
There have been several methodologies used by companies and investors alike and there is still more work to be done to develop a standard framework that can be used by all.
The role of investment managers
Along with regulators, we believe investment managers can play an important role in improving the breadth and quality of climate-related risk disclosure, which can then be used to manage risks in our clients’ portfolios.
Acadian has previously joined nearly 400 institutional investors representing more than US$22 trillion in assets in signing the “Paris Agreement” letter, originated by the PRI, asking regulators to encourage disclosure, reconsider fossil fuel subsidies and adopt TCFD recommendations.
We are also active in discussing ESG considerations with companies through a range of direct and collaborative engagement efforts regarding material aspects of sustainable and responsible investment. An important part of this strategy relates to the promotion of reporting standards closely aligned to the TCFD.
As a systematic manager which uses hard data to make investment decisions, we believe any improvements that can help investment managers make meaningful comparisons between the companies in which they invest will be beneficial.
However, we also believe that managers should continue to do their own research on companies’ exposure to climate risks in addition to company disclosures, particularly when much of the data produced is voluntary in nature.
Matthew Picone is vice-president and portfolio manager for Acadian Asset Management
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