Since the final recommendations of the Task Force for Climate-related Disclosures (TCFD) emerged a few years ago, a plethora of the world’s largest companies have begun detailing varying degrees of information about their financial exposure to climate change.
Despite some innovative work, unfortunately not much of it has met investor’s needs or expectations. Nor has it always occurred in a transparent or consistent manner allowing company performance to be compared on common metrics.
The physical damage wrought by climate change and the inevitable transition occurring in response pose systemic risks to our economy and a financial risk for investors’ portfolios. Managing climate risk requires good data on material impacts, consistently reported to agreed industry standards and a clear articulation of the strategic steps being taken in response.
Given the nature of the threats posed by climate change, it also requires a forward-looking analysis of the potential scenarios likely to be faced by the company and potential financial impacts.
To understand why the first generation of company disclosure has not delivered on these needs, the Investor Group on Climate Change recently canvassed the views of over 50 Australian and New Zealand investors from 22 organisations with collective assets under management of over $1.1 trillion.
We found up to 80 per cent of investors said they were already using company climate risk disclosures in their day-to-day practice despite its infancy, predominantly for company engagement and ESG integration.
That means the demands of investors on climate disclosure are not idle or ancillary, they go to the core of investment strategies. And as our understanding of climate risk matures, this disclosure will only become more intertwined with key portfolio decisions.
Consistent across the investors we canvassed was a view that companies are rarely demonstrating how their financial assessment of climate change impacts is informing their business decisions and strategy.
Investors told us the most important element of the next generation of climate risk disclosure is that companies clearly demonstrate how the assessment is actually changing the way they do business.
In practice that means a company needs to demonstrate in their reporting that its board executives have skills and expertise in climate change and that remuneration is linked to climate-related performance. It also means companies must be demonstrating the links between the risk and opportunities identified and the business strategy response.
Investors also want more reporting on scope 3 emissions (where it is material to the company) and coverage of both transition and physical climate risks, costs and implications. The results should be backed up with auditing and assurance.
Even with these elements added, investors also need this climate risk disclosure to be prepared in a transparent and consistent way. There remains scepticism among investors that climate risk disclosure is not always complete. For example, it is rare for companies to recognise in their disclosure any negative financial impact from climate change, despite the massive systemic risk it poses to the whole of the economy. Oil Search is a notable recent exception in this regard.
Rectifying this will require companies to detail the assumptions and scenarios that are being used about future climate scenarios. And it will require robust and consistent scenarios that reflect the Paris Agreement goal, including pathways to keeping average global warming to 1.5 degrees above pre-industrial levels.
To be fair to corporate Australia, the climate scenarios available don’t always provide enough granular details to make sophisticated risk assessment on an asset-by-asset level. As a result, there is confusion among companies about the best approach to take, such as whether to build in-house scenarios or adopt existing ones from the International Energy Agency (IEA) or Intergovernmental Panel on Climate Change (IPCC).
But frankly, too often companies simply choose the scenario that puts their preferred business model in the best light. It isn’t a coincidence that oil and gas companies have preferred IEA models over IPCC models given the former’s more optimistic pathways for fossil fuels and more pessimistic assumptions of clean technology cost reductions.
This stuation may soon change. Global climate scenarios recently released by the Network of Central Banks and Supervisors for Greening the Financial System can form a good basis for local regulators to build their own set of consistent scenarios for Australia.
But even with these scenarios in place, the strong view of investors is that a consistent approach to adopting them and then disclosing the identified climate risk will not emerge voluntarily. In short, it will require some kind of further intervention.
Around the world different jurisdictions are approaching this problem differently. Some countries like Japan are developing voluntary codes and guidance. Others like New Zealand and Canada are moving to mandatory regimes.
Given the importance of TCFD disclosure to investors, and the severe and systemic risks posed to our economy from climate change, it is time to consider mandatory disclosure regimes in Australia.
But no matter what approach we take, demand from investors for clear, transparent and actionable climate risk disclosure is growing rapidly.
Any company that can show a clear pathway from its understanding of climate risk to its strategy and performance will present as an increasingly valuable investment proposition.
And for those companies that fail to meet investor expectations for full disclosure of their climate change impact and exposure, they can expect to see increasing investor pressure to reform or risk divestment.
Emma Herd is the chief executive of the Investor Group on Climate Change
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