Understanding climate risk reporting
On the 9th November 2020, the UK Government’s Finance Minister, Rishi Sunak, announced that climate risk reporting will become mandatory for large companies and financial institutions in the UK. This will come into effect for some companies as early as 2021.
What does mandatory climate risk reporting mean for UK organisations?
Climate risk is investment risk. The magnitude of this realisation will be significant for companies as the UK Government commits to adopting, and going beyond, the reporting requirements set out by the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures (TCFD).
To date, 1,400 companies voluntarily comply with the TCFD recommendations, and this announcement signals the next step in making reporting compulsory.
Companies will be required to go through a formal process of identifying and then disclosing details of material risks and opportunities arising from climate change under differing future climate scenarios. Examples of these climate scenarios may include the physical (weather) environment in a ~2°C world vs ~4°C world or the transition (policy) environment in a 1.5°C world.
What is the TCFD?
The Task Force on Climate-related Financial Disclosures is the first international initiative to examine climate change in the context of financial stability. It was formed after a review by the G20’s Financial Stability Board into how the financial sector can best take account of climate-related issues.
Learn more about the TCFD recommendations
Who will be affected?
Types of organisations that will be required to disclose their financial exposure to climate change include:
- Listed commercial companies
- UK-registered large private companies (as defined by the Companies Act 2006, i.e. meeting at least two of the following criteria: turnover of more than £36m; balance sheet total of more than £18m; more than 250 employees)
- Banks and building societies
- Insurance companies
- Asset managers
- Life insurers and FCA-regulated pension schemes
- Occupational pension schemes
Further clarity on applicability, including to any UK subsidiaries of non-UK headquartered companies, is expected in early 2021.
Climate Change is “a crisis that involves the whole world and from which no one will be able to self-isolate” – Mark Carney,
Former Governor of the Bank of England, Nov 2020
When will disclosures become mandatory?
Full mandatory climate-related financial disclosure requirements will come into force across the UK economy by 2025, with a significant portion of requirements in place by 2023 and some as early as 2021. Future consultations will decide when each of the categories will have to comply.
The implementation approach will vary for each of the organisation categories (listed above). For example, 66% of ‘listed commercial companies will potentially (subject to consultations and statutory requirements) be required to disclose by 2021, while 50% of ‘UK-registered large private companies’ could be required to disclose by 2022.
Why are they becoming mandatory now?
2020 has proven that organisations with strong sustainability credentials have significantly outperformed conventional funds through the acute shocks posed by the pandemic, and this is expected to continue. Therefore, the UK Government has acted to support the flow of accurate climate-related information along the investment chain to encourage better business, risk and investment decisions, helping markets allocate capital to the right projects at the right price.
How to align with the TCFD framework
We recommend starting simple with an effective organisational approach and an open mind-set to go beyond conventional strategic thinking, as set out in the latest TCFD guidance released on the 29th October 2020.
From our experience of working on climate risk and implementing the recommendations of TCFD over the last five years, we recommend the following approach to tackling climate-related risk disclosure.
We have broken this down into three bitesize chunks: Engagement, Modelling and Strategy.
Example screening questions:
- Would it matter if a mandatory carbon tax of £20tCO2e was introduced?
- Would it matter maximum if peak temperatures increased by 20%?
Climate risk engagement
Education is key to working with stakeholders to demystify the challenges and understand the financial and commercial impacts of climate change.
The first step is to screen the risks and opportunities that climate change poses to each area of the organisation. An effective way to achieve this is to use an approach that allows stakeholders to drive what is most important to their organisation. This provides significantly more value and transparency over an approach where a third-party tells stakeholders what they perceive to be the key risks and opportunities.
You must also ask the right screening questions. Questions should be framed to ensure that they can be answered based on simple business continuity with no climate change expertise required. This provides a firm platform for everyone to answer and comment on examples.
The screening will result in a list of climate risks of concern or opportunities of interest that are of most relevance and have the greatest impact on the organisation.
Modelling climate risk
A big part of the disclosure will be the quantification of climate risk, although it is crucial not to get too hung up on this.
There are plug-in climate risk models available across the market to support you to model the climate risks for your organisation. The key question to ask is what does the organisation need from scenario analysis? One key model output is to see locations where the climate risks are highest to your organisation, however, an over-reliance on risk type and location can lead to ‘well, so what?’.
The TCFD Strategy recommendations also call for the disclosure of the impact of the climate-related risks and opportunities on financial planning. While the TCFD recognise the difficulty of translating forward-looking scenarios into meaningful financial implications, its latest guidance suggests that it is important to provide a broad conceptualization of possible financial pathways at a ≥10-year time horizon.
Developing a narrative of the quantitative outputs allows organisations to gain clear insights into scenarios of concern, for example, ££m expected revenue loss by 2030 from increased maximum temperatures in California, causing server downtime of up to 11 days. The scenarios then work in the organisation’s favour to stress test the resilience of business operations (physically and financially) helping organisations achieve a preferred future, or even act on climate opportunities.
Climate risk strategy
The final and most important part of climate risk disclosure is the strategy that underpins the path forward. This should be based on the findings of the engagement and the results of the modelling.
The strategy should bring together all four areas of the TCFD recommendations: Governance, Strategy, Risk Management, Metrics & Targets to ensure appropriate steps are taken toward resilience in a fast-changing, uncertain world.
The strategy will help the organisation leverage recommendation areas in future strategic planning, business continuity processes and public disclosure, without the need for reinventing governance processes.
What to do now
In line with the October 2020 TCFD guidance and this latest announcement by the UK Government, Anthesis expects consultation guidance to be released in early 2021, with actions required as early as 2021.
The engagement exercise alone is a significant, valuable, and critical step in preparing any organisation for the impending regulatory requirements of climate risk disclosure and we would advise beginning this as soon as possible.
If you are interested in finding out more about our approach to climate risk reporting, get in touch:
We'd love to hear from you
Anthesis has offices in the U.S., Canada, UK, France, Ireland, Italy, Germany, Sweden, Spain, Portugal, Andorra, Finland, Colombia, Brazil, China, the Philippines and the Middle East.