About the TCFD Recommendations
Globally, investors and shareholders have raised concerns about the lack of forward-looking assessments of climate related issues, including information on how vulnerable organizations may be to climate risks and advice on how they could mitigate these vulnerabilities. For organizations, the absence of an internationally recognized framework for disclosure prevents them from deciding what information is reported and how it is presented.
In response, the FSB created the industry-led Task Force on Climate-related Financial Disclosures (also known as the “Task Force” or “TCFD”) in 2015 to establish a set of recommendations for consistent “disclosures that will help financial market participants understand their climate risks.”
In June 2017, a series of recommendations (Recommendations) was issued to address gaps in the information disclosed on the financial impact of climate risk across the investment chain. The Recommendations address a number of major challenges identified by the Task Force, including a lack of a coherent financial reporting framework, which makes it difficult for investors, creditors and underwriters to use existing disclosures in their financial decisions.
With the release of the Recommendations and associated sector-specific guidance in June 2017, organizations have the opportunity to apply a more rigorous and consistent approach to assessing and disclosing the financial impact of climate risks in their financial filings.
The Recommendations are structured around four themes that reflect core elements of how organizations operate — governance, strategy, risk management, and metrics and targets.
- Governance: How climate risks can be integrated into the business
- Strategy: How climate risks can be 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
Benefits of adopting the Recommendations
Implementing the Recommendations may require changes to governance and risk assessment processes and may take several years for an organization to be in a position to generate valuable information for investors and shareholders to help them make informed decisions. The earlier your organization embarks on this journey the better, as it provides a platform to help educate directors and management about the climate risks and helps leadership to engage with investors and shareholders on the impacts and opportunities for your organization.
As well as satisfying investors’ demands there may be benefits for businesses who implement all of the Recommendations. They are:
- Climate risks (transition risks and physical risks) are embedded in an organization’s risk management process and risk register
Familiarization for scenario analysis
- Improved capability in quantitative modelling and data analytics
- Greater rigor and sophistication in the use of data sets and assumptions supporting the definition of scenarios
- Consistency of messaging across different external reporting mediums (e.g., investor relations, financial reporting, corporate reporting, sustainability reporting)
Shift the focus areas of external stakeholders
- Content of disclosures is more aligned with interest of long-term investors
- Focus of investors and shareholders shifts towards forward-looking assumptions and methodology, opportunities and strategy
Educational journey and fiduciary duty
- Increased directors’ awareness of their fiduciary duty
- Education journey for board members and investor relations teams
Implications for the CFO
While the TCFD Recommendations are voluntary, companies who adopt the Recommendations are asked that disclosures be reported in financial filings, or for asset managers and owners that don’t prepare standard corporate financial reporting, in existing financial reporting to investors. Specifically, the Report recommends all companies report on governance and risk management processes relating to climate risk, due to the systemic (non-diversifiable) nature of the risk.
These governance processes should undergo the same review procedures as other financial reporting processes by the CFO and audit committee. Those companies that assess climate risk to be material to their activities, and companies in certain sectors and where annual revenue exceeds US$1b, should also include recommended disclosures relating to strategy, targets and metrics, including the results of climate scenario modeling.
The TCFD Recommendations were developed because the FSB considers climate change to represent a systemic financial risk to the economy that is not being adequately addressed by business.
Climate risks are more complex and longer-term in nature than most traditional businesses risks, and this has contributed to a lack of understanding and measurement on their potential impacts. Climate risks are further categorized as transition risks and physical risks, both of which have the potential to impact financial statements (as shown in Figure 1). Where an organization does not have a clear understanding of the range and magnitude of potential financial impacts from climate change, this may be increasingly detrimental to its financial performance.
Climate-related risks, opportunities and financial impact
Source: Financial Stability Board, Final Report: Recommendations of the Task Force on Climate-related Financial Disclosures, FSB, 2017.
The adoption of the Recommendations will potentially require changes to existing financial risk processes and disclosures. For example, CFOs may need to be better informed regarding the climate risks that the company may be exposed to, and the time period over which their impacts are anticipated.
Due to the forward looking nature of this analysis, risk assessments should be updated regularly to assess technology, regulation, consumer and physical changes that may impact the materiality of the risk. For example, solar electricity generation falling below the cost of grid (or other stand-alone options) in certain regions and countries, will likely have an impact on growth of other electricity sources such as coal-fired generation. Depending on the materiality and the timeframe, climate risks should be considered in terms of future revenue and cost expectations, provisioning and liability, and asset depreciation.
For CFOs in particular, they will likely be expected to report back confidently to the Board on how the company is managing its climate-related financial risk. To do this, CFOs should be ready to answer the following key questions:
- What are your governance and risk management processes for assessing the financial implications of climate change risk?
- In what ways will climate change risk impact the organization?
- What could the financial impacts of climate-related risk be under a business-as-usual and a two-degree scenario? Are these financial impacts material and if so how are they disclosed in financial filings? If no, are governance and risk management processes disclosed to show these risks have been assessed?
If these questions cannot be answered confidently, flags should be raised and you should consider taking immediate action within your business to address concerns.
EY can assist businesses seeking to build a strategy to respond to climate-related financial risk. Our Climate Change and Sustainability Services (CCaSS) professionals work alongside our risk, governance and financial reporting teams, and can provide you with company-specific climate risk analysis and implementation advice that meets the TCFD disclosure Recommendations.
Our climate change scenario risk analysis services can be tailored to meet the requirements of the TCFD Recommendations, which requires organizations to model the transition and physical impacts of at least one two degree scenario. This results of these risk assessments are designed to meet the requirements of the organization and can be qualitative or quantitative in nature.