How progress in TCFD disclosures can advance climate reporting

TCFD pillars

Average coverage and quality scores for Governance and Risk Management remain stronger than for Strategy or Metrics & Targets. While financial institutions have largely assigned responsibility for managing climate-related risks in their organization and started to embed climate within their risk management frameworks, articulating the effects of these risks on their strategy and business model, and quantifying the financial impact remains challenging.

Sectors

On average, Banking and Capital Markets (BCM) remains the highest scoring of the sectors reviewed, largely on account of having mobilized earlier than others. However, insurers and asset managers have begun to narrow the gap. The largest asset managers and owners now face similar stakeholder and regulatory pressures, particularly in the UK, where they have now been brought into scope of the mandatory climate-related reporting guidelines included in the FCA ESG Sourcebook. PE houses score significantly lower on average, which is in keeping with their generally more limited levels of public disclosures.

Although the coverage and quality of their disclosures vary, over 70% of the institutions in our sample disclose at least some quantitative information related to their financed emissions (emissions associated with lending and investment activities).

This is a significant improvement on last year (up from 48%), particularly among insurers (19% to 80%) and asset managers (29% to 80%), demonstrating that financial sector firms are collectively giving more attention to – and taking greater responsibility for – the activities they finance through their lending and investment businesses. Improving availability and quality of data, and the increasing maturity of methodologies underpinning such assessments, are also helping to enhance disclosures.

Firms disclosing their financed emissions have, unsurprisingly, started with the real economy sectors prioritized by the Partnership for Carbon Accounting Financials (PCAF), the prevailing calculation methodology in the financial sector. This means firms have started by disclosing emissions associated with the highest emitting industries: Energy, Power and Utilities, and Auto Manufacturing. 38% of our sample disclosed financed emissions for Power and Utilities, 30% for Energy, and 24% for Auto Manufacturers. Note that not all disclosures were broken down by sector so these figures may be understated. Other sectors commonly reported upon include industrials such as Steel and Manufacturing.

To date, we note significantly fewer companies disclose emissions arising from capital markets financing (facilitated emissions), or those associated with insurance activities. This is unsurprising; the PCAF standard on insurance-associated emissions was only finalized in late 2022 and the final standard for facilitated emissions is expected in late 2023. We therefore expect to see a sharper focus on these areas in future reporting cycles as companies implement PCAF guidance and can benefit from a greater breadth of disclosures available.

An overwhelming majority of financial institutions in our sample (90%) disclose that they have carried out some form of climate-related scenario analysis. Most include high-level qualitative discussions on the assumptions made in the analysis. However, there are significant differences in quality, scope, and extent of the analysis disclosed.

While most companies conduct scenario analysis, only 50% disclose quantitative outputs and results. This requires strong conviction in the underlying input data, methodologies and assumptions, and many financial institutions are understandably exercising caution ahead of disclosing sensitivities relating to financial position.

We also note shortcomings in the disclosure of what the analysis implies for firm-wide resilience. Only a third (35%) of our sample specifically translate scenario analysis into an assessment of the resilience of their strategy and business model to climate-related risks over time - the primary purpose of scenario analysis prescribed by IFRS S2 and TCFD.

Understanding the actual and potential risks and opportunities that firms may face is the ultimate purpose of these disclosure frameworks, so improvement on resilience reporting is crucial. Sharper focus on this from not just the ISSB but also the ECB, in the form of requirements on financial sector adaptation and risk management, looks set to drive improvements in disclosures.

Our analysis shows that a growing number of financial institutions are obtaining assurance over a wider range of climate-related disclosures. More than 75% of sampled companies obtained at least a limited level of assurance over one or more sustainability-relevant metric, with approximately half doing so for more than one KPI. Within this group, a minority of firms have sought reasonable assurance.

This represents a notable year-on-year increase in the prevalence of assurance from last year (<50%). This is likely linked to the planned introduction of mandatory assurance requirements over certain sustainability disclosures in several jurisdictions including the EU (via CSRD) and the US (via the SEC’s proposed Climate Rule).

In addition, growing stakeholder reliance on climate-related disclosures for decision making is creating greater expectations for verified information. There are currently no assurance requirements under ISSB, but it is expected that individual regulators will introduce assurance requirements as part of their adoption process. This is a promising trend which indicates a positive direction of travel toward more reliable disclosure from financial institutions.

Conclusion

Financial institutions are dedicating substantial resources to comply with TCFD recommendations, and the integration of ISSB standards will expand disclosure requirements. EY analysis reveals improved climate-related disclosures in key areas across sectors and regions, with Insurance and Wealth & Asset Managers narrowing the gap with Banking and Capital Markets. Despite progress, Private Equity lags. Areas needing enhancement include reporting on climate-related risks and business model implications. Proactive measures to address these gaps will enhance TCFD alignment, prepare firms for ISSB adoption, and align them with regulatory and investor expectations.

This article is co-authored by Richard Walsh, Partner, ESG Assurance Lead, Climate Change and Sustainability Services, Ernst & Young LLP; Emily Frenay, Director, Reporting and Disclosures Lead, Climate Change and Sustainability Services, Ernst & Young LLP; Carl Vanderwerff, Reporting and Disclosure Lead, Climate Change and Sustainability Services, Ernst & Young LLP; Matt Hopkins, TCFD Lead, Climate Change and Sustainability Services, Ernst & Young LLP; Stephanie Lipman, ISSB Lead, Climate Change and Sustainability Services, Ernst & Young LLP and Alice Jetin Duceux, Reporting and Disclosure Solution, Climate Change and Sustainability Services, Ernst & Young LLP.

Summary

The global landscape of climate disclosures is evolving fast. As new standards emerge, the importance of complying with existing TCFD recommendations and requirements is only intensifying. In particular, TCFD alignment can be a useful indicator of readiness for the new ISSB climates standard (IFRS S2).

Against this backdrop, EY teams updated their Climate-Related Disclosures Performance Analyzer to assess 2022/23 reports. The results show definite improvements in the quality and coverage of reporting across the finance sector, whilst reinforcing areas where shortcomings persist.