Will the Financial Stability Board be a game changer for climate risk disclosures?

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Recognising there are gaps in the information disclosed on the financial impact of climate risk across the investment chain, in December 2016 the industry-led Task Force on Climate-related Financial Disclosures (TCFD) set up by the Financial Stability Board (FSB), issued a series of draft Recommendations (the Recommendations). The aim is to help the financial and non-financial sectors take account of climate-related issues and disclose the financial impact that climate risks have or could have on their organisations.

The Recommendations aim to address a number of major challenges identified by the TCFD, including the lack of a coherent financial reporting framework, making it difficult for investors, creditors and underwriters to use existing disclosures in their financial decisions.

In response, the FSB created the industry-led Task Force on Climate-related Financial Disclosures (TCFD or the Task Force) in 2015 to establish a set of recommendations for consistent “disclosures that will help financial market participants understand their climate risks” (the Recommendations).

The Recommendations aim to address a number of major challenges, including the lack of a coherent financial reporting framework, making it difficult for investors, creditors and underwriters to use existing disclosures in their financial decisions.

The intent of the Recommendations is to present suggested disclosures of climate-related financial risks to enable investors to better assess which companies are most vulnerable to climate risk, which are best prepared, and which are taking action.

Overview of the Recommendations

The Recommendations are structured around four thematic areas that reflect core elements of how organisations operate, these are.

Governance — how climate risk is integrated into the business

Strategy — how climate risks are incorporated into future business decisions

Risk management — the processes used to identify, assess and manage climate-related risks

Metrics — the metrics and targets used to assess and manage risks and opportunities.

Key highlights

  • 1. Adoptable by all organisations

    The Task Force recommends all financial and non-financial organisations with public debt or equity (listed companies) implement its recommendations, and also encourages other organisations to implement the Recommendations as well. All organisations are recommended to provide their Scope 1 and Scope 2 greenhouse gas emissions (GHG) and, if appropriate, Scope 3 GHG emissions and the related risks.

    Note: Scope 3 refers to the emissions associated with the upstream and downstream life cycle of a product, process, or service.

    Upstream activities include operations that relate to the initial stages of producing a good or service, e.g. material sourcing, material processing, supplier activities.

    Downstream activities include operations that relate to processing the materials into a finished product and delivering it to the end user (e.g. transportation, distribution and consumption).

  • 2. Included in financial filings

    Climate-related financial disclosures should be included in mainstream financial filings, and should be subject to appropriate internal governance processes, similar to those used for existing public financial disclosures such as review by the chief financial officer and audit committee. The Recommendations promote quantitative financial disclosures, particularly disclosure of metrics about the financial impact that climate-related risks have or could have on an organisation (e.g. asset impairments, impact on cash flows from operations, net income, and access to capital).

  • 3. Designed to solicit decision-useful, forward-looking information on financial impacts

    The Task Force emphasises a greater need for forward-looking analyses, highlighting climate change scenario analysis as being important for organisations to incorporate into their strategic and financial planning. The Report recommends scenario analysis under different potential future states, including a 2ºC scenario, in order to provide insights into how business strategy deals with climate change, especially for organisations operating or investing in carbon-intensive areas.

  • 4. Strong focus on risks and opportunities related to transition to lower-carbon economy

    The TCFD emphasise the importance of integrating the identification and management of climate-related financial risk into existing risk management frameworks.

    The Report outlines two specific categories for climate-related risks and climate-related opportunities in order to enable consistent categorisation: risks related to the transition to a lower-carbon economy and risks related to the physical impacts of climate change. (refer figure 2).

    Transition risks include policy, legal, technology, reputational and market changes to address mitigation and adaptation requirements related to climate change. Climate-related opportunities include resource efficiency, energy source, products and services, markets and resilience.

  • 5. Information quality controls

    The Task Force recommend that the governance processes should be similar to those used for existing public financial disclosures and would likely involve review by the chief financial officer and audit committee as appropriate.

    For those organisations that do not have publicly traded debt or equity securities, including some asset managers and asset owners, the climate-related financial disclosures should follow similar review and approval protocols currently used by those organisations for similar communications. In the case a recommended disclosure is not made, preparers should provide their rationale for omitting the disclosure.

    Disclosures should be defined, collected, recorded, and analysed in such a way that the information reported is verifiable to ensure it is of high quality. For future-oriented information, this means assumptions used can be traced back to their sources.

    EY - Climate-Related Risks, Opportunities and Financial Impact

Why organisations should act now

Will your business conform to a ‘wait and see’ approach or will it look to maximise gains from the adoption of the Recommendations?

Implementing the Recommendations requires changes to the governance and risk assessment processes and will likely require several years for an organisation to be in a position to generate valuable information for investors and shareholders to help them make informed decisions.

So what now for organisations potentially impacted by climate change?

Timing is critical. Adoption of the Recommendations, which are subject to a 60-day response period, are anticipated to be strong.

With the final recommentation report expected to be issued in June - July 2017, holding off is not an option.

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