How can we get ahead if we fall behind in managing climate risk?

New analysis suggests Oceania companies must accelerate the development of their climate risk disclosure and management capabilities.

The fifth EY Global Climate Risk Barometer Study includes an analysis of 1,536 companies from 13 Taskforces on Climate-related Financial Disclosures (TCFD) aligned sectors across 51 countries, including Australia and New Zealand. Globally, the Barometer is tracking a considerable increase in the quality of disclosures of organisations and substantial improvement in coverage. Around 44 companies analysed now have greater than 95% coverage. The quality of disclosures has visibly improved from last year across all four pillars, with a strong improvement in strategy (the lowest pillar last year). Countries leading in quality are the United Kingdom, Germany, France and Spain, where scores now sit at 59% and above.

However, in Oceania, progress has stalled. Although the region continues to sit in the middle of the pack, some other countries are racing ahead.
In Australia, while coverage is ahead of the global average, with a strong cohort of companies already at 100%, quality scores are extremely varied. Although Governance and Strategy quality scores are just above the global average, Risk Management and Metrics and Targets lag behind the rest of the world. This suggests that some companies may be ticking boxes but not getting to the substance behind the numbers.

In New Zealand, both coverage and quality scores are behind global averages. Although these scores partly reflect the smaller size of companies analysed, they should be ringing warning bells for regulators and entities alike.

Global versus Australia and New Zealand annual improvements in quality and coverage

On a sector basis, New Zealand largely mirrors global results, with high-emission industries, like energy, materials and buildings, leading in both coverage and quality as these companies tackle the decarbonisation challenge. In contrast, in Australia, the energy sector trails third last in quality. The top three sectors are banks, insurance and other financial institutions, likely as a result of the sector’s efforts to meet the pending requirements of the Australian Prudential Regulation Authority’s (APRA) CPS 230 resilience framework.

Getting ready for International Sustainability Standards Board (ISSB) standards

This year, the Barometer assessed whether companies are ready to adopt the IFRS S2 Climate-related Disclosures. This is of particular interest in Australia, where Treasury intends to be an early adopter of climate reporting requirements that align with the new ISSB standards. Australia’s largest listed and unlisted companies, financial institutions and those currently reporting under the National Greenhouse and Energy Reporting (NGER) Act will be captured for annual reporting periods on or after 1 January 2024.

This will make Australia one of the first jurisdictions in the world to adopt IFRS S2, requiring participants to capture additional requirements over and above the TCFD’s recommendations. New requirements will include assurance of disclosures, initially focussing on emissions and governance-related disclosures, and expanding to reasonable assurance of all disclosures by FY28 for the largest entities.

The Barometer finds Australian companies are beginning to prepare for this reality, with ISSB coverage slightly ahead of the average global performance. However, the results suggest many companies still have a long way to go. The mandate to disclose the financial impact of climate change, and decarbonisation risks and opportunities will require sustainability data to be sufficiently robust to withstand internal and external audit – and available within much more pressing timeframes.

For most organisations, this represents a significant advancement along the sustainability reporting maturity curve.

Scenario planning is becoming increasingly complex

IFRS S2 requires companies to explain the resilience of their strategy and business model to both physical and transition risks and opportunities. To achieve this, IFRS S2 mandates that companies conduct climate-related scenario analysis to evaluate their climate resilience – and that this analysis must be reflected in both financial reporting and strategy development.

The intention is that the results of scenario analysis will give companies deeper insight into how they can fine-tune their overall strategies and business models to enhance risk management procedures that are fit to tackle climate change challenges. To this point, if scenario analysis is not being used as part of strategy development, IFRS S2 disclosure requires organisations to explain why the scenario is not relevant for setting strategy.

Globally, 58% of companies analysed are conducting scenario analysis – up from 49% in the previous year. However, only 41% of these are conducting quantitative analysis. Australia is on par with these global trends – although levels of quantitative analysis are lower at 36%. In New Zealand, the proportion of companies undertaking scenario analysis is significantly lower at 36%, although quantitative assessment makes up a large portion (28% of total companies).

Australia is also ahead of the global average at disclosing financial impacts qualitatively – but not quantitatively.

Credible, detailed carbon transition action plans are required

This year, for the first time, the Barometer focused on the disclosure of decarbonisation strategies or transition plans. We asked companies whether they have a time-bound action plan that clearly outlines how the entity will pivot its existing assets, operations and entire business model towards a trajectory that aligns with the latest climate science recommendations to limit global warming to 1.5°C.

Having a credible transition plan is one of the key focus themes under both the TCFD’s recommendations and from an ISSB readiness point of view. The Barometer found that around 50% of global and local companies analysed have disclosed a timeline, roadmap and targets aimed at achieving net zero strategy. However, these disclosures typically lack the detailed action plans and capital allocations required to convince stakeholders that a decarbonisation strategy is credible and likely to be successful. Simply stating a target and noting actions to achieve that target are no longer sufficient. Reporting must also demonstrate that capital has been allocated to all carbon transition activities.

Some of the areas where companies should consider disclosing more are:

• How they are integrating their decarbonisation strategy with their overall business strategy
• Detailed descriptions of actionable initiatives to drive the transition to a low-carbon economy
• Capital allocations on the balance sheet for decarbonisation action plan initiatives

Granular focus on the value chain and Scope 3 emissions

IFRS S2 specifically requires companies to disclose the absolute gross greenhouse gas emissions they generated during the reporting period. While Scope 3 emissions are permitted to be excluded in the first year of applying the standard, Australian businesses will soon need to be able to calculate and address indirect upstream and downstream emissions for all material categories – emissions over which they may have limited influence.

The Barometer found that, globally, the majority (54%) of companies are already disclosing their Scope 3 emissions and 34% are including value chain emissions reduction in their strategy disclosure. Australian companies are slightly behind on average, indicating a significant gap in reporting that will need to be closed in a short space of time.

Two years to close the disclosure gap

In Australia especially, disclosure standards are about to become dramatically higher. Based on the current trajectory tracked by the Barometer, organisations are not improving fast enough to close the gap.

The few large companies that are currently scoring highly against TCFD recommendations should comfortably transition to the more stringent IFRS S2 standards. For these front-runners, climate risk disclosure is completely embedded – not separate. Sustainability teams are integrated across all functions and engaging with Finance and Strategy at a very high level.

It is heartening to see the progress of these companies in the Barometer scores, but they are the exception. It has taken them considerable time and effort to arrive at this level of maturity.

Australia’s roadmap for mandatory disclosure requirements

The big take out is that poorer Barometer performers and smaller companies have a very long way to go. Two or three years may seem like a long time, but developing a mature climate risk disclosure capability is not a quick shift. The mandate to disclose the financial impact of climate change, and decarbonisation risks and opportunities will necessitate sustainability data being sufficiently robust to withstand internal and external audit – and available within much more pressing timeframes. For Group 2 and 3 organisations especially, this will represent a big step up the sustainability reporting maturity curve.

The work of figuring out how non-financial information affects financial information is extremely sophisticated, complex and resource intensive. Non-financial reporting requires us to consider what current data could mean in the future. This is important. What might not appear financially material today can very quickly become a business-critical issue tomorrow. From a standing start, finance teams will find it challenging to calculate the quantum of climate impacts and determine their materiality.

The level of disclosure being brought in by IFRS S2 will require massive investment in systems and capabilities. It will also call for new levels of cross-organisational cooperation, new thinking and new approaches. Many functions will need to become involved in climate risk disclosure for the first time, requiring considerable upskilling.

Act now. Don’t wait for regulation.

There is little doubt that Oceania will be the scene of real urgency to manage its high-emission sectors that are exposed to developments in international carbon taxonomy. This is especially true in Australia, where the new Safeguard Mechanism Reforms have put a price on carbon for the first time since 2014 for many companies. Despite this, the Barometer finds the majority of businesses in Oceania are failing to grasp the climate risk disclosure nettle.

There are multiple reasons for this apparent hesitancy. With many fires to put out, some organisations are resisting putting in the time and effort to develop quantitative scenario analysis capabilities or Scope 3 assessments. Others still don’t see the value of disclosing early. Often, management is ready, but boards are shutting down calls for heavy investment in a capability that is not yet a regulatory requirement.

Some are waiting until they have a good story to tell. This is a mistake. For investors and banks, a lack of disclosure is synonymous with an inability to manage climate risk. Stakeholders are not necessarily looking for a “good story” now. They want to know that the financial impact of climate risk has been assessed and strategies are in place to mitigate it.

Although Oceania has yet to develop its own taxonomy, the Australian Sustainable Finance Institute began the Australian Taxonomy Development Project in July 2023, which will enable companies to better identify opportunities to create sustainable assets and activities. In the interim, the challenge will remain to reflect the potential value of risk and opportunities in the financial statements in the absence of a mature mandatory taxonomy.
All businesses likely to be captured by increasingly stringent climate risk disclosure standards should be assessing their level of preparedness now.