How can companies use climate-related disclosure to drive genuine impact?

The fourth EY Global Climate Risk Disclosure Barometer provides snapshot of climate-related disclosures by companies around the world. The 2022 report presents the findings from EY analysis of disclosures by over 1,500 companies across 47 countries against the recommendations by the Task Force on Climate-related Financial Disclosures (TCFD), with 103 Australian and 40 New Zealand companies in the mix.

Overall, climate-related disclosures are becoming more complete and more detailed; however, disclosures often lack depth and sophistication when it comes to the financial impacts of climate change and an alignment to financial reporting. The report presents a range of actions companies can take to improve their approach to understanding and disclosing climate risks. It also highlights the importance of treating disclosure as a meaningful step towards larger decarbonisation goals and opportunities.

Regional and sector differences

Australian companies have traditionally led climate-related disclosures, but while they are still ahead when it comes to coverage and quality, other regions are catching up.

Oceania companies scored highest on TCFD governance recommendations, with strategy coming in lowest overall. Companies performed poorest on the TCFD metrics and targets recommendations. Specifically, the supporting disclosure that recommends organisations describe the targets used to manage climate-related risks and opportunities, and how they then measure progress against those targets.

The results from this year’s assessment demonstrate where different sectors are on their climate journey. The energy and insurance sectors, for example, have typically been conducting climate scenario analysis for many years. For the energy sector, unsurprisingly this has focused on transition risk associated with decarbonisation. Meanwhile, the insurance sector’s focus on the impacts of physical climate risks builds on existing disaster risk modelling practices. As a result, the energy and insurance sectors are more mature than other sectors in their ability to conduct scenario analysis and integrate this work into their climate and business strategies.

On the flip side, sectors such as telecommunications and agriculture, food and forestry have historically been less exposed to climate risks, and are therefore early on their journey to understanding the implications of climate risks on their businesses.

Regulatory attention also has a role to play. We have seen in the banking and other financial sectors that companies generally scored better across the board for TCFD recommendations, in part due to the highly regulated and compliance-focused nature of the financial services sector.

Moving towards mandatory disclosures

If regulatory attention is anything to go by, we can expect to see developments in this space leading to better climate-related disclosures, and ultimately action, in Oceania.

New Zealand recently introduced mandatory disclosures, and both major political parties are relatively aligned on the need for action on climate change. While the choice and focus of policy mechanisms vary, the tone from the top has given New Zealand companies greater certainty over the years.

In contrast, the historical lack of government-mandated obligations to disclose climate-related risks, in combination with the lack of policy certainty at the federal level in Australia, has made it difficult for companies to set targets and allocate resources to address climate change. However, the Labor Government recently announced its plan to work with regulators to introduce mandatory disclosures in line with global standards.

Australian Treasurer, Jim Chalmers, and regulators, the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC), have endorsed the International Sustainability Standards Board (ISSB) as the main reporting regime for climate-related disclosures. This is a positive step forward for corporate reporting in Australia and an indication of the direction of climate action.

A standardised reporting framework, coupled with the legislated emission reduction targets and imminent amendments to the Safeguard Mechanism, could give companies some certainty regarding what they need to be working towards. The Safeguard Mechanism may not apply to all companies across Australia, but it is a significant step on the road to 2030, and we expect to see much stronger company targets and more ambitious action stemming from this.

Beyond disclosures, APRA and ASIC are turning their attention to ESG generally. This year, APRA issued guidance for banks, insurers and pension funds on managing and disclosing climate-related risks, including physical, transition and liability exposures. And ASIC warned companies against making misleading and deceptive statements in relation to sustainability-related products, and published guidance on how to avoid greenwashing. These developments are indicative of a collaborative approach from the regulators as companies grapple with the climate challenge.

Overall, we expect that greater policy certainty and mandatory disclosures in Australia will lead to a greater organisational focus on climate risks, and an increase in coverage and quality of disclosures in other sectors.

Stakeholder pressure driving disclosure of transition plans

Investor pressure has historically been the key driver for better climate risk disclosure. Shareholders are increasingly asking ESG-related questions at AGMs. We are also seeing resolutions raised by activist investors getting more support from institutional investors. These pressures are driving companies to publish their transition plans and go beyond disclosure to action. Stakeholders are demanding transition plans with substance: they want to see information on capital allocation, targets and roadmaps for how companies plan to achieve their goals.

While stakeholder pressure is pushing the big emitters to consider their decarbonisation strategies, there is a growing gap between companies that face this demand and those that do not.

Our analysis found that two-thirds of companies disclose their decarbonisation strategy, and that the Oceania figure is higher than the overall global score (60.59%). This is in line with the overall better performance by companies in Oceania compared to globally.

Striking a balance between coverage and quality

The plethora of disclosure frameworks and guidance can at times be tricky for many companies to balance with other obligations. This can present challenges as they endeavour to publicly disclose the required information while ensuring it is accurate and credible, and can be problematic with forward-looking information. Companies need to balance presenting their ambitions and opportunities while avoiding greenwashing and ensuring disclosures align to a coherent strategy.

While coverage scores reviewed in this assessment continue to increase year-on-year, quality scores have largely plateaued. This slowing of progress could partially be attributed to a more highly litigated environment and greater regulatory scrutiny – making companies less inclined to make detailed disclosures for fear of being targets of legal action for greenwashing.

In the coming years, we expect to see greater assurance over climate disclosures beyond numbers, and with a greater focus on assumptions, the underlying processes for scenario analysis, and transition action plans. Obtaining assurance over these disclosures will provide external credibility to reporting and comfort internally that the company is not disclosing incorrect or unsubstantiated information.

Using scenario analysis to inform risk management and strategy

As a greater number of resources become available to companies for conducting scenario analysis and risk identification, and as companies become more sophisticated at developing assumptions and modelling, the challenge lies in translating this information into strategy and financial impact.

There is often a disconnect between risk and opportunity assessments for the purposes of disclosure. Companies are using reference scenarios that make it easy to compare across their sector, but these scenario assumptions may not always agree with the core business strategy. In these situations, companies often go with more bespoke scenarios to develop meaningful results for their business; however, this adds to the perennial challenge of comparability and decision-usefulness for stakeholders.

There is a much greater recognition of physical risks (both acute and chronic) than transition risks. In both Australia and New Zealand, physical and market risks were the most identified risk types. Interestingly, reputation risk was more common in Australia, with regulation (emerging and current) being a more salient risk in New Zealand. This can be attributed to the size and visibility of the industries in Australia, such as extractives, and the more established regulatory environment in New Zealand.

Greater integration across business units is key to success

Ultimately, the exercise in understanding climate-related risks, opportunities and impacts should feed into an organisation’s strategy and inform decarbonisation plans in a meaningful way. This means that climate-related disclosures should not be a periphery responsibility of those sitting in climate and sustainability or corporate affairs functions – it should be a whole-of-organisation activity, bringing the financial and strategy functions along the journey.

An organisation’s climate-related disclosures are just the tip of the iceberg. Producing climate-related disclosures should help a company consider the financial implications of climate risks and opportunities, and boards and senior management teams should use disclosures to inform stakeholders, particularly investors, about how they are understanding and managing risks in practice. Scenario analysis should not simply be a theoretical analysis of the potential impacts of climate change on the current business model.