According to the late physicist Stephen Hawking, “One can’t predict the weather more than a few days in advance.” But in several parts of the world, regulatory bodies have indicated that, while they don’t expect businesses to predict the weather, they do expect them to understand and report the impact of climate change on their businesses. Frankly, that is a bit like predicting the weather, except business leaders must look years—not days—into the future.
The European Financial Reporting Advisory Group (EFRAG) and U.S. Securities and Exchange Commission (SEC) are the latest to propose more stringent reporting requirements related to climate-related risk and impact. If approved, EFRAG and the SEC will be following New Zealand and U.K. regulators, which also require climate risk disclosures from their countries’ largest companies.
Why Report: The Origins of the TCFD
Climate change introduces a new dimension of risk for investors, as it has the potential to affect a business’ operations in the short term and its viability in the long term. So, today’s investors seek greater transparency from business leaders about climate-related impacts.
In 2015, the Financial Stability Board created the Task Force on Climate-related Financial Disclosures (TCFD) to develop recommendations for voluntary climate-related financial disclosures. The TCFD aims to provide global financial markets with comprehensive information on the impacts of climate change. The U.K., New Zealand and several countries within the European Union are already incorporating the TCFD’s recommendations into their corporate reporting requirements.
How Does the TCFD Support Your Climate Risk Reporting?
Climate-related risk can mean many different things. For some companies, the increasing frequency of wildfires has implications. For others, water security demands attention. Companies also need to understand and measure how climate change affects different aspects of their operations and business outlook. The TCFD helps business leaders by offering a framework for understanding and reporting climate-related risk.
TCFD recommendations start with four pillars: governance, strategy, risk management, and metrics and targets.
- Governance is about board oversight and the board’s role in managing climate-related risks.
- Strategy looks at actual and potential impacts of climate-related risks and opportunities for the organization’s businesses, strategy and financial planning.
- Risk management establishes processes for identifying, assessing and managing climate-related risk.
- Metrics and targets lay out the KPIs and metrics for the measurement of climate-related risks and opportunities, where such information is material for investors or stakeholders.
There are two categories of risk: transition risk and acute or chronic physical risk.
- Physical risk refers to the events that pose a threat to a business, its assets, supply chain, products or downstream activities. Examples are hurricanes, wildfires and heat waves. Acute risk refers to the increasing severity of weather events, while chronic risk is tied to long-term trends in weather patterns.
- Transition risk relates to a business’ transition toward a low-carbon or less carbon-intensive economy.
Transition risks are organized in four categories: policy/legal, market, technology and reputation risk.
- Policy/legal risk examples are legal obligations, compliance burdens, carbon taxes, EU allowances or renewable targets.
- Market risk is the risk that comes from shifts in supply and demand as economies react. These risks might materialize as raw material scarcity, fossil fuel risk, energy costs or changes in consumer behavior.
- Technology risk is the risk related to emerging technologies and resulting demands or disruptions caused by them.
- Reputation risk is related to climate-related risks and their implications for a company’s brand.
Climate risk reporting also involves the identification of opportunities, such as pursuing greater energy efficiency, using resources more prudently or developing strategies for adaptation to climate change. Investors want to see that businesses are going beyond transparent risk assessments and disclosures to determine ways to reduce the impact of climate change on their operations and finances.
The CDP’s Alignment with TCFD Recommendations
The CDP (formerly known as the Carbon Disclosure Project) operates the global disclosure system that enables investors, businesses, municipalities and governments to manage their environmental impacts. Their work is based on the premise that we cannot address the causes and limit the impact of climate change without clear, comprehensive and transparent information.
To create reporting guidance for their disclosure system, the CDP used the TCFD’s recommendations to design question pathways that help businesses determine their environmental impact. Then they broke those questions down into accessible, actionable metrics, giving businesses a clear view of the information they need to collect and report. The CDP makes resources available to help businesses understand how to report the information on their environmental impact in line with TCFD recommendations.
The CDP’s scoring method allows companies to see what they need to address. Do they need to focus on governance? Do they need to concentrate on evaluating risk? Which best practices will help them move forward?
The Key Takeaways
Preparing for climate risk reporting can be overwhelming. But the TCFD’s framework helps companies take a more comprehensive approach to their identification, analysis and reporting of climate-related risk. After all, full transparency demands that every aspect of risk is addressed.
The CDP Disclosure Framework is closely aligned with the TCFD’s recommendations. In fact, in 2021, over 13,000 companies worldwide used the CDP framework to disclose climate-related information.
For more information on climate risk reporting, watch our webinar Getting Ready for Mandatory Climate Risk Reporting.