AG INSIGHT | 15/10/2019
Climate risk reporting: an essential tool for a net zero and resilient economy
Introducing mandatory requirements for businesses and investors to disclose climate risks and what they are doing about them is an essential part of achieving net zero emissions argues Nick Molho, executive director of the Aldersgate Group.
With a growing number of countries adopting net zero emissions targets – including most recently the UK and Scotland – there is increasing focus on how policy makers will deliver these targets in practice. New regulations, market mechanisms and fiscal incentives will all have a vital role to play in delivering these targets. But getting to net zero emissions and ensuring that our economies can cope with the impacts of climate change will also require businesses and investors to significantly improve their understanding of climate-related risks.
Climate risk reporting: an important tool to get to net zero
A recent cross-industry roundtable convened by the Aldersgate Group showed that the greatest risks companies face going forwards are twofold. On the one hand, they are vulnerable to the risks of a delayed and disorderly transition to a net zero emissions economy, whereby companies fail to adjust their business and investment strategies in line with the tightening regulations (such as rising carbon pricing or taxation) that governments across the world are increasingly likely to introduce to tackle climate change. This risk is particular acute for companies whose business models rely heavily on fossil fuel extraction or use.
On the other hand, companies are also vulnerable to ‘low probability but high impact’ extreme weather events which could cause significant disruption in the form of major infrastructure damage or supply chain disruptions from flooding, drought and extreme storms. The property, food, car manufacturing and insurance sectors are good examples of sectors at risk.
To address these risks, the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures published recommendations back in 2017 (also known in short as the ‘TCFD recommendations’) recommending that businesses and investors should report annually on their exposure to both the physical impacts from climate change and the risks created by the introduction of more ambitious regulations to tackle it. The TCFD recommendations require in particular that companies develop long-term scenarios to help them assess these risks.
The UK Government rapidly showed its support for the adoption of the TCFD recommendations and its recent Green Finance Strategy sets an expectation that by 2022, all listed companies and large asset owners should disclose their exposure to climate risks in line with the TCFD recommendations. Whilst this announcement is a welcome step forward, the Aldersgate Group’s engagement with industry suggests that this won’t be enough to drive the take-up of climate risk disclosure in line with the urgency that tackling and adapting to climate change demands.
Five key priorities to accelerate take-up of climate risk reporting
In this context and following significant cross-industry engagement, the Aldersgate Group recently launched a new briefing in which we set out five key steps to accelerate the take-up of climate risk reporting, which the Government could act on when it carries out its review of the Green Finance Strategy in 2020.
First, we argue that TCFD-aligned reporting should ultimately be made mandatory by the early 2020s for all companies currently captured by the UK’s Streamlined Energy and Carbon Reporting Regime. Once best practice has been established and meaningful reference scenarios have been developed, these disclosure requirements should also extend to smaller businesses so that entire supply chains are ultimately covered. This is important in order to provide a level-playing field across the economy and provide meaningful, consistent and comparable information to investors. We also argue that disclosure should be introduced on a ‘comply or explain’ basis to ensure that where organisations do not report long-term risks related to climate change, they provide a transparent explanation as to why they do not see these risks as material.
Second, we believe that disclosure requirements should be introduced in a way that focuses first and foremost on getting companies to produce ‘decision useful information’. In other words, there must be a clear link between the information that companies are disclosing and the risk management actions that they are then taking. Ultimately, the whole point of comprehensive climate risk disclosure must be to drive business and investor action towards the net zero emissions goal and improve the overall resilience of our infrastructure and supply chains.
Third, we argue that companies require more support to help them develop the long-term scenarios they will need to report in line with the TCFD recommendations. Some support on basic assumptions is needed economy-wide. We recommend for example that the Government commission guidance on the assumptions that can be used when modelling the likely physical impacts of different temperature rise scenarios. Some support is needed on a more sector-specific basis. Here, we call for the creation of a Corporate Reporting Lab, which would essentially provide a safe forum where businesses, trade associations, academic institutions and other relevant institutions can collaborate in developing sector-level guidance on scenario analysis and where different disclosure methodologies can be tried and tested.
Fourth, given the global nature of the financial system and of the challenges caused by climate change, it is essential that the UK Government collaborates closely with international partners when implementing the TCFD disclosure requirements. The European Commission, which recently published guidelines on TCFD implementation as part of the EU Non-Financial Reporting Directive, will in particular remain an important partner in this space.
Finally, action on climate risk reporting is certainly not all down to governments. Investors have a responsibility to be far more proactive on this agenda, by ensuring that the companies they invest in are taking climate risk disclosures seriously and by holding them accountable for inadequate risk management. Institutional investors such as Legal and General Investment Management and Aviva Investors are showing the way in this space.
Time to up our game on climate-risk disclosure
Getting to net zero emissions within three decades or less and adapting to the physical impacts of climate change are essential but monumental tasks. We will only get there if businesses and investors significantly improve their understanding of climate-related risks and fully align their strategies to properly address them. Mandatory climate risk reporting is an essential tool to ensure this happens.