If climate disclosures are improving, why isn’t decarbonization accelerating? If climate disclosures are improving, why isn’t decarbonization accelerating?

By Mathew Nelson

EY Global Climate Change and Sustainability Services Leader

Leading a purpose-driven team that shares a common passion for creating positive impact. Workplace diversity and equality advocate. Engineer. Father of two boys. Australian Football League fan.

8 minute read 9 Jul 2021

The 2021 EY Global Climate Risk Disclosure Barometer shows why organizations should accelerate the implementation of climate strategies.

In brief
  • Organizations are continuing to improve the quality and coverage of climate risk disclosure reporting.
  • Only 41% of the sample are conducting scenario analysis, and only 15% feature climate change in their financial statements.
  • Climate risks and opportunities should be front and center as organizations plan their future growth strategies and report progress.

The EY Global Climate Risk Disclosure Barometer (pdf) provides a global snapshot of the increasing corporate focus on climate risks and opportunities as pressure from stakeholders moves them up the boardroom and executive agenda.  

The research draws on public disclosures of companies on the uptake of the Task Force on Climate-related Financial Disclosures (TCFD) across highly impacted sectors. The disclosures of more than 1,100 companies across 42 countries were included in the assessment.  

The research found that companies have continued to make progress in addressing the quality and coverage of climate-related financial disclosures, driven by more regulators making TCFD reporting mandatory, pressure from investors, and the fact that the annual CDP response now incorporates TCFD recommendations.

In line with 2019 results, coverage remains ahead of quality, with an average coverage of 70% of the TCFD recommendations. However, the average quality score across the organizations was only 42% of the maximum quality score across the 11 recommendations.

Almost 50% of organizations in the research have 100% coverage, but only 3% received a score of 100% quality – clearly demonstrating room for improvement. The data indicates that while more companies are indeed reporting on climate-related risks and opportunities, they may be doing so as a “tick box” exercise.

Reporting should connect better with risks and opportunities

The research findings suggest many organizations are reporting on metrics that don’t correlate directly to risks. For example, disclosing Scope 1 and 2 emissions has no bearing on exposure to physical risks, such as a factory or data center being at increased risk of fire or flood. A more rigorous level of assessment will likely be required to develop the climate-related financial disclosures that drive behavioral change.

Equally, current climate risk assessments can often be limited to certain parts of the business and may only include qualitative analysis. Yet we know that the impact of physical and transition risks on products and services, supply chains and operations can materially affect operating costs and revenues across the enterprise.

Giving sufficient coverage to both the risks and opportunities posed by climate change may help organizations to accurately assess potential impacts, including the impact on strategy (both positively and negatively).

Climate scenarios can be critical to robust risk assessment

Because climate-related risks are inherently more complex and long-term than most traditional business risks, scenario analysis is essential for organizations to understand the physical, economic and regulatory connection between future climate impacts and business and supply chain activities.

The research shows only 41% of organizations in the sample are conducting scenario analysis – a figure that is concerning. While scenario analysis is more complex than other elements of disclosure, it is perhaps the most important aspect of the TCFD framework, as it turns theory into tangible, actionable strategies.

Scenario analysis

41%

of organizations in the sample are conducting scenario analysis.

This is clearly the view of regulators and advisory bodies. 2020 saw an increase in scenario guidance from the Intergovernmental Panel on Climate Change,1 central banks via the Network of Central Banks and Supervisors for Greening the Financial System (NGFS)2 and even market and prudential regulators.

Scenario analysis should inform risk assessment, strategy development and investment decisions – and feed into internal remuneration and incentives. Any climate-related financial disclosures should be included in mainstream financial filings – and climate risk information should be included in financial statement estimates and assumptions, including asset impairment models or asset depreciation models.

Scenario analysis should inform risk assessment, strategy development and investment decisions – and feed into internal remuneration and incentives.

However, the research found only 15% of the sample feature climate change in their financial statements, suggesting that organizations lack robust data on the financial impact of scenarios or have not yet fully worked through the implications of these impacts across the business.

In the future, regulators and capital markets will be unlikely to accept that companies have performed an accurate risk or opportunity assessment without carrying out a robust level of scenario analysis.

To satisfy their stakeholders, organizations should be able to articulate the relative size and time frame around physical and transition risks in their geography and industry, ideally constructing worst case, base case and most likely case scenarios.

Understanding the biggest emission-reduction levers up and down the value chain

Understanding climate risks and opportunities goes beyond an organization’s own footprint and can involve more complex data management, analysis and forecasting. For most organizations, the emissions from up and down the value chain (Scope 3) are much higher than those from their own operations (Scope 1 and Scope 2). The biggest levers are likely to come either from downstream manufacturing or transport, or the upstream processing, use or transport of products.

This is not just an issue in emission-intensive industries such as iron ore mining, where significant Scope 3 emissions come from a customer turning the product into steel. The global apparel and footwear sector produces more greenhouse gas emissions than the shipping and aviation sectors combined3 – the vast majority through Scope 3 emissions.

As a result, the most powerful emission-reduction levers are rarely intuitive. A major pharmacy brand discovered that 80% of its emissions were associated with the amount of time consumers used its products in the shower. Often, non-meat food production emissions derive largely from transport. For the Information and Communication Technology  (ICT) sector, a major plank of its decarbonization strategy is likely to be encouraging carbon consciousness among end users.

Not surprisingly, stakeholder scrutiny around value chain emissions is growing, especially in carbon-intensive and consumer-facing industries. Science-based target guidance states that “if a company’s Scope 3 emissions account for at least 40% of total Scope 1, 2 and 3 emissions, a Scope 3 target should be set.”4

The challenge is that, when it comes to carbon, most organizations currently have opaque supply chains. It is incumbent on organizations to work with their suppliers and offer incentives to make them part of the decarbonization process. Just as organizations are examining their supply chains for human rights violations, they should be putting equal energy into analyzing and reducing supply chain emissions.

Next steps for climate-related reporting

At a time when political will and global public opinion are focused on profound climate action, climate risks and opportunities should be front and center as organizations plan their future growth strategies.

Some organizations are reluctant to act on climate change due to the many uncertainties around the nature and timing of transition risk, as well as its physical impacts. However, organizations frequently make calls on the likely future of emerging technologies without knowing their exact time horizons.

As the science on climate change has become more detailed than ever – and resoundingly clear – the requirement for immediate action has emerged. Organizations that fail to act as the net-zero transition gathers pace may be exposed to climate-related risks and underprepared for the associated climate-related opportunities.

As organizations consider their next steps toward climate adaptation, organizations should be able to answer the following questions:

  • What is the extent of the risks and opportunities my organization is facing as a result of climate change?
  • How should my organizational strategy change to respond to the identified risks and opportunities from climate change? And what strategic initiatives will be required?
  • What should I do to execute on my decarbonization journey?
  • How do I communicate with the market on the extent of my risks and opportunities, the proposed changes to my strategy and the progress on my decarbonization journey?

Summary

Scope 1 and 2 emissions are unlikely to be the only – or even the greatest – source of climate risk factors, especially because they have no bearing on exposure to physical climate risk. Organizations should look up and down their entire value chain to identify vulnerabilities and opportunities for growth, and find – and use – their most powerful climate management levers. This will involve understanding the resilience of business strategies and assets under a range of possible climate scenarios.

About this article

By Mathew Nelson

EY Global Climate Change and Sustainability Services Leader

Leading a purpose-driven team that shares a common passion for creating positive impact. Workplace diversity and equality advocate. Engineer. Father of two boys. Australian Football League fan.