The article is authored by Natalia Carvalho, Lorraine McCann, Ciara Sheehan.
The impact of climate change is undeniable. More and more businesses, governments and regulators are recognising the physical impact of climate change and are preparing to address the climate-related risks. Ahead of the United Nations Climate Change Conference of the Parties (COP26), more than 190 world leaders will discuss the progress made on limiting global warming to 1.5°C since the 2015 Paris Agreement. While a carbon emission reduction rate of 7.7% per annum is needed to keep warming to 2°C, the global carbon intensity decreased just 2.4% in 2019. There will be a need, therefore, for meaningful action over the next decade to ensure carbon emissions are significantly reduced.
The EU Green Deal sets out a commitment for Europe to be climate neutral by 2050. Ireland’s Climate Action Bill includes budgets and targets for a five-year plan that seeks to reduce greenhouse gas (GHG) emissions, setting a pathway of transition to a climate resilient, biodiversity rich and climate neutral economy by 2050.
As global and national climate commitments increase, it is fundamental that investors understand the risks and opportunities presented by climate change in their investment decisions. The Task Force on Climate-related Financial Disclosures (TCFD) provides recommendations and report guidance to organisations on how to disclose climate-related topics in their financial reporting.
Framework helps better prepare for financial risks
The TCFD framework provides standardised disclosures, assisting organisations to determine what information should be included in their annual reports and how it should be presented. The core elements of climate-related financial disclosures include governance, strategy, risk management, metrics and targets. By adopting the TCFD recommendations and including climate-related issues into mainstream annual financial reports, organisations will be better equipped to quantify and prepare for the financial risks associated with climate change.
The 2021 EY Global Climate Risk Disclosure Barometer¹ revealed that companies have made limited progress in addressing the quality and coverage of climate-related financial disclosures. The research was conducted to evaluate the uptake of the TCFD across highly impacted sectors. It revealed that the coverage of disclosures remains ahead of quality, with an average coverage of 70% and only 42% average quality score across the TCFD recommendations.
An interesting finding of the research was that across the four elements of the TCFD, companies scored better on governance, metrics and targets, compared to climate-related strategy and risk management. The results suggest that companies feel more comfortable sharing their carbon emissions targets than their carbon reduction pathways. Perhaps this indicates the challenges in understanding Scope 3 emissions and how complex it can be to set a full value chain reduction pathway.
Among the 42 jurisdictions included in the assessment, the UK demonstrated the highest quality score, with an average of 67% compared to the collective average of 40%. This finding is likely related to TCFD reporting becoming mandatory across the UK next year. Ireland achieved a quality score of 25% compared to some European piers. Additionally, the lowest performing markets included China (26%), Middle East (21%) and South East Asia (19%). The results likely indicate that the involvement of local market authorities is a key driver to improved quality reports.
Ireland shows improved coverage
Although Ireland’s quality score remains low, the country has improved its coverage in recent years, increasing to 63% in 2020 from 38% in 2019. The recent progress made on the Climate Action Bill demonstrates Ireland’s commitment to improving climate-related performance. Increased future regulation to adopt the TCFD regulations could lead to more accurate disclosures of climate-related risks and opportunities.
To better understand the climate-related risks and opportunities, a scenario analysis is an essential element of the TCFD framework. By performing a scenario analysis, companies will be more prepared to develop their strategy and build their risk management portfolio in accordance with the core elements of the TCFD framework. Additionally, a defined pathway to reducing their carbon emissions in line with science-based targets requires companies to understand climate risks and opportunities beyond their own footprint, making data management, analysis and forecast indispensable.
Increased transparency is needed to emphasise the physical, social and financial impacts of climate change. Early preparation and transparency will result in market leadership, improved stakeholder relationships, reduced risks and greater impact. In fact, the transition to a lower-carbon economy will affect most economic sectors and industries. By leading this agenda, organisations will be prepared to respond to increasing regulations and global commitments. To avoid a disruptive transition, better information on climate-related risks and opportunities is required to support informed investments and decisions.
The TCFD framework provides valuable recommendations to support a smooth transition to a lower carbon economy. It recognises the challenges associated with measuring the impact of climate change. It is believed that reporting practices and techniques will continue to improve and evolve over time with the increase in data analytics and frequency of reference to climate-related issues in annual financial reports. It will also improve the quality of climate-related disclosures and help businesses achieve their decarbonisation goals.