AG INSIGHT | 29/06/2017
The FSB Task Force recommendations mark a crucial step in the battle against climate change
The Financial Stability Board’s Task Force on Climate-related Financial Disclosures today issues its final recommendations. The project represents a significant milestone on the path towards a low-carbon economy, says Task Force member Steve Waygood, Chief Responsible Investment Officer at Aviva Investors.
Today marks the launch of the final recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD), the culmination of 18 months of hard work by representatives from some of the world’s biggest companies and financial institutions.
The TCFD was created in December 2015 to develop a set of voluntary disclosures on climate-related risks for use by companies in providing information to investors, lenders, insurers and other stakeholders. Chaired by former New York City Mayor Michael Bloomberg, the initiative is backed by companies with a total market capitalisation of $1.5 trillion and financial institutions responsible for assets worth a combined $20 trillion.
The TCFD’s members hail from a range of industries, including oil and gas, mining, chemicals and consumer products; as well as banks, asset managers, pension funds, professional services firms and insurers. These organisations are keenly aware that action on climate change is not just a matter for environmentalists and niche pressure groups – it is crucial to the long-term health of companies, markets and economies.
The launch of the final recommendations could not be better timed, as it shows there is strong business-led momentum behind the low-carbon transition despite President Trump’s withdrawal of the USA from the Paris Agreement. By outlining a standardised framework for disclosures on climate risks, the TCFD promotes better-informed investment, credit and insurance-underwriting decisions. If heeded, these guidelines will contribute to more resilient and sustainable financial markets over the long term.
Climate risks and scenarios
The TCFD suggests organisations take steps to incorporate climate-related considerations into four business areas: governance, strategy, risk management and targets. More specifically, it identifies three main categories of climate risk that should be assessed and monitored.
The first is the physical risk to investment assets posed by extreme weather events such as fires, floods and droughts. The second is transition risk, which refers to the hazards associated with the transition to a low-carbon economy. The implementation of a global carbon budget, for example, would render the vast majority of fossil fuel reserves ‘stranded’ or unusable, hitting extractive companies’ business models. Third is litigation risk, which relates to the potential effects of compensation claims on carbon extractors and emitters.
Such hazards can be difficult to quantify. This is why the TCFD focuses on scenario modelling as a crucial aspect of climate-risk management. Working with scientists and experts in many other fields, the Task Force has produced detailed advice on creating scenarios that will encourage financial-market actors to think strategically about the impact of climate risks on their organisations and how they can respond to them.
The TCFD recommends modelling a range of outcomes, starting with a ‘two degree scenario’ – the risk that global temperatures rise two degrees above the pre-industrial average, the potentially catastrophic event the Paris Agreement is designed to avoid – as well as scenarios relevant to their specific circumstances.
Automobile companies should model scenarios based on changes to emissions regulations, for example. If these companies are going to start making electric cars, what sort of batteries will they use for energy storage? Most electric-car batteries use lithium, a non-renewable resource. So what happens if lithium becomes scarce and uneconomic to extract? This is the level of detail the disclosures need to include.
At Aviva we are fully conscious of the need to identify and mitigate climate related risks. As an insurer we partly underwrite the physical risks from climate change – fire and flood damage, for example – and, as a long-term investor, our asset-management business is exposed to the investment risks associated with the impact of climate change on financial markets.
In 2015 we unveiled a climate-change strategy that commits us to five key ‘pillars’ of action up to 2020: to integrate climate risk into investment decisions; to invest in lower-carbon infrastructure; to support strong policy action on climate change; to engage in active stewardship on climate risk; and to divest where necessary. We welcome the TCFD recommendations and are already taking steps to comply with them. Our annual report and accounts include a detailed response to our initial consultations with the Task Force earlier this year.
However, we believe more needs to be done to extend the valuable work the TCFD has accomplished. We are sceptical that voluntary disclosures will get us far enough, fast enough to effectively combat climate change; research shows it is only when governments mandate disclosure that it becomes widespread, consistent and comparable.
To support the efforts of the TCFD, we would like the International Organisation of Securities Commissions to change its listing rules to promote climate-related disclosure. We would also like to see the Organisation for Economic Cooperation and Development update its Principles of Corporate Governance to make clear it is the responsibility of company boards to govern long-term risks, including climate change.
In future, it is imperative credit-ratings agencies include climate-related measures in their assessments if the TCFD recommendations are to gain sufficient traction. We note with interest that the European Commission is aiming to integrate environmental, social and governance metrics into credit ratings as part of its Capital Markets Union Action Plan, a project we support.
Seizing the opportunity
But while further action is needed, the TCFD recommendations amount to a significant step forward. One of the project’s main achievements is that it has brought together a range of actors – heads of state, policymakers, corporate CEOs, environmentalists, scientists and financial investors – to devise a holistic and comprehensive response to the question of how we can ensure our economies remain robust and sustainable through the low-carbon transition.
Aviva CEO Mark Wilson and Aviva Investors CEO Euan Munro have both signed an open letter to the G20 heads of state asking them to acknowledge and endorse the TCFD recommendations at their forthcoming meeting. The statesmen and women in Hamburg have an opportunity to send a powerful message that the world is ready to act on climate change. We urge them to seize it.
Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at June 23, 2017. This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.