Managing climate risk: aligning with the TCFD

Managing climate risk: aligning with the TCFD
27th April 2020 Robyn Lockyer
Robyn Lockyer
In Blog

Over the past six months, investors have been “turning up the heat” on climate change, as expectations shift on companies’ assessment and disclosure of their exposure to, and management of, climate-related risks.

In December, the Bank of England unveiled plans to introduce a mandatory climate “stress testing” for major banks and insurers from 2021, and before departing as the institution’s Governor, Mark Carney warned that the investment world must step up its climate planning. Similarly, BlackRock – the world’s largest asset manager, with almost $7 trillion under management – warned it would take a “harsh view” of any company failing to disclose data on the risks they face from climate change. With the S&P Dow Jones having also recently debuted their Paris-Aligned and Climate Transition indices – further formalising assessment of companies’ performance against climate objectives – the pressure is on business to act.

What are the TCFD recommendations?

The Task Force on Climate-related Financial Disclosures (TCFD) was established in 2015 following a review of how the financial sector accounted for climate-related issues. It’s mandate was to develop a set of key recommendations that would help promote effective disclosure to investors and other stakeholders on climate-related financial impacts, in order to better inform investment decision making.

The TCFD’s recommendations were published in 2017 and propose recommended disclosures for companies on the impact of material climate-related risks*, in the following areas of a company’s business:

  1. Governance: the organisation’s governance around climate-related risks and opportunities;
  2. Strategy: the actual and potential impacts of climate-related risks and opportunities on the organisation’s businesses, strategy, and financial planning;
  3. Risk Management: the processes used by the organisation to identify, assess, and manage climate-related risks;
  4. Metrics and Targets: the metrics and targets used to assess and manage relevant climate-related risks and opportunities.

(*Including physical climate risks, such as rise in natural catastrophes and chronic environmental shifts; and transition risks, such as regulatory, market, technological and reputational risks)

As published in their first Green Finance Strategy last year, the UK Government expects all listed companies and large asset owners to be disclosing in line with the TCFD recommendations by 2022.

How are businesses responding?

The latest progress report from the Task Force (June 2019) found encouraging signs from companies that have traditionally engaged on climate-related issues, with most disclosure being integrated into the annual and/or sustainability report. Others have made reference to their disclosures within existing CDP reporting.

However, given the urgency of responding to the climate crisis and need to meet Paris Agreement goals, the Task Force has urged for enhanced disclose and decision-useful information about climate-related risks, strategies, and governance frameworks.

As a first step, many companies have undertaken a gap analysis of existing internal practices with the recommended TCFD disclosures. Others have undertaken a high-level exercise to assess climate-related risks to their strategies and business models with respect to a specific climate scenario – for example, a 2°C scenario, whereby physical and transition risks to the business are evaluated.

Some FMCGs have started with climate risk assessments of their key commodities, with the aim of rolling this out across all product categories used by the business. For example, as well as summarising the potential impacts of climate change in 2oC and 4oC scenarios, Unilever use their most recent Annual Report (2019) to also explain their assessment of climate impacts on yields of both soybean oil and on black tea. This is complemented by further discussion on climate risk strategy, governance, assumptions, and how Unilever intend to manage the risks and opportunities associated with physical and transition climate risks over the short-medium term.

Demonstrating such alignment with the TCFD recommendations is, not entirely straightforward. There is widespread recognition of the difficulties in accurately determining financial impacts on businesses across varying climate scenarios. Many are finding it challenging to develop scenarios that are “business-relevant”, and with sufficient granularity to inform reasonable impacts. From conversations that Sancroft has had with investor audiences, we can say that honest and transparent reporting is crucial here. Investors have told us that they understand the TCFD is complex, and getting to grips with it will take time. Reporting that some might consider ‘immature’ will be accepted at first, providing the organisation is clear about where it stands, and what immediate steps it will take to improve its approach.

It is also recognised that clarity is needed on a best-practice approach that demonstrates the resilience of business strategies under various future scenarios. With this in mind, the Task Force has committed to publishing further guidance on scenario planning, however no release date for this has yet been set.

What can your business do?

In short, if climate-related risks are not properly assessed and managed, climate change will result in a significant loss of value. We urge businesses to continually improve their climate-related disclosures and, like the Task Force, recognise that this is a journey. Ultimately, businesses need to:

  • Build adequate governance and risk management structures, and internal processes, to manage climate-related issues;
  • Integrate the long-term impacts and challenges of climate change into risk and materiality assessments;
  • Provide more clarity on the potential financial impacts of climate-related issues, e.g. businesses are expected to provide better metrics and scenario analysis.
  • Provide information on the resilience of organisations’ strategies – the Task Force reports that currently the majority of those companies that are using scenario analysis do not disclose information on the resilience of their strategies.
  • Involve multiple functions across the business – ensuring buy-in from the executive team, risk management and finance teams, is critical in mainstreaming climate risk.

To learn more about the TCFD recommendations, assessing your climate-related risks and opportunities, and aligning your disclosure, please get in touch with Ivaylo.dimov@sancroft.com.