In a few months, the TCFD will release the final version of their recommendations. Here is what companies can do now to get ahead of the pack and prepare for the new reporting cycle.
1. Bring together your sustainability, governance and compliance colleagues to agree on roles
A recent report by WBCSD on sustainability and risk management in the corporate sector showed that there is a clear disconnect between what the sustainability functions in companies consider as material risks for their business and the processes and procedures of the risk management and legal teams. One of the reasons behind this ineffective practice is the lack of communication and understanding of mutual roles among different teams.
One of the key goals of the Task Force is to raise climate change issues from the sustainability department to the board level. But this will only happen if integrated management processes are put in place within your organization.
2. Get climate change integrated into the governance process with board buy-in, and the audit and risk committees on board
What’s new about the work of the Task Force is that it asks boards to understand and integrate climate-related issues in strategic and financial decisions. A good way to start this process is to identify the CEO, senior executive or board committee responsible for climate policies, strategy and information and define a process for the board’s oversight of these issues.
It is also important to get the risk committee of your organization involved, as they will already be looking at the financial impacts of external risks on your business. Making them understand how climate change poses a threat to your business is a key step to ensuring your disclosure is aligned with the recommendations.
Finally, audit committees should scrutinise climate-related financial information with the same rigour they use for financial information. Applying the same process and quality assurance to climate disclosure will make a difference in the way you understand and communicate climate risk.
3. Adapt existing ERM and risk management processes to take account of climate risk: quantify, stress test and use scenarios
Companies need to start preparing for the impacts that a changing climate could have on their business.
An example of best practice for the integration of sustainability issues within ERM processes is highlighted in the WBCSD report on sustainability and risk management in the corporate sector: “Sustainability documentation coupled with traditional risk identification and analysis tools can provide risk managers with information to support integrated risk assessments[…]. Sharing materiality assessment results and associated quantitative data with the risk function is critical.”
4. Use the same quality assurance and compliance approaches for climate-related financial information as for finance, management and governance disclosures
Companies need to ensure their quality assurance and compliance approaches for climate-related financial disclosures are as rigorous as they are for financial disclosures. They can do so by setting up internal controls and external assurance processes, as these efforts enhance and support objectivity, credibility, while reassuring report readers that disclosures are reliable.
External assurance engagements can support businesses in identifying and disclosing significant issue assessment processes and, where practical, involve internal teams in charge of sustainability measurement, valuation and reporting as well as internal audit, risk management and related functions.
5. Look at existing tools you already use to help you collect and report climate-related financial information such as the CDP questionnaire and the CDSB Climate Change Reporting Framework
The work of the Task Force builds on what many other organizations in the reporting space have been doing for decades. This is evidenced in the cross-references to existing reporting regimes, and will be crucial to ensure a rapid scaling up of climate disclosure across the corporate sector.
With nearly 6,000 companies currently disclosing their climate data through the CDP platform, many are already providing helpful governance, risk, strategy and emissions disclosures. But there are opportunities to develop financial and forward looking disclosures, and to take a more integrated approach.
Organizations can use the CDSB Climate Change Reporting Framework to prepare for the Task Force recommendations. It is the only framework that focuses specifically on how companies can integrate climate change into mainstream financial filings. Its principles and requirements for disclosure mirror the ones described by the Task Force, making it the most aligned with recommendations.
6. Look specifically at the financial impact of climate risk and how it relates to revenues, expenditures, assets, liabilities and capital
Given the scale, unpredictability and long-term nature of climate change-related issues, understanding financial exposure can be challenging.
The Task Force highlights two types of climate risks: physical and transitional. Physical risks may include extreme weather events, such as drought and flooding, and the longer-term impact of increasing average temperatures. Transitional risks, on the other hand, include the global transition to a low-carbon economy, new regulations and innovations in energy efficiency.
These risks may have impacts across the entire structure of a business. Revenues may be affected by shifting customer demands and new regulatory requirements, while costs can be impacted by the availability and price of raw materials.
Investors and stakeholders need greater clarity on how companies are assessing these risks and how they are planning to respond. Understanding and communicating potential financial impacts of climate-related risks will support more informed investment, lending, and insurance underwriting decisions.
7. Get feedback from engaged investors about what information they need to know about climate-related financial risks
Investors play an important role in the disclosure process, as the primary users of the information companies disclose. They have developed strategies for incorporating screens, tilting, ESG integration, impact investing and shareholder engagement based on sustainability information. However, acting on these strategies depends on appropriate governance mechanisms to generate decision-useful information.
In the past few years, we have seen the investor community calling for better quality information and highlighting the lack of comparability between sustainability information reported. These issues affect their decision-making processes and reflect on the relationship they create with companies. Engaging with investors will help make the disclosure process more useful for both parties and will benefit stakeholder and shareholder relationships.
8. Prepare the information you report as if it were going to be assured, even if you decide not to do so right now
Companies must consider the fundamental principles for effective disclosure outlined by the TCFD and outline how they can be applied to their practices and processes. Relevance, balance, completeness, consistency and comparability must be reflected through processes exploring relevant subject matter, sector specifics, business needs and technical requirements. These principles support effective disclosures and implementing them can support future assurance engagements.
A report by WBCSD, “Generating Value from External Assurance of Sustainability Reporting”, outlined the benefits companies receive from using external assurance. It acknowledged that the relationship between service provider and client, and the processes and procedures developed through that relationship, are often key determining factors in establishing assurance engagements that truly support enhanced credibility, trust and the preparation of decision-useful information.
9. Assess your business against various scenarios
While some businesses are being affected by climate risks today, most are likely to encounter the most significant effects over the medium to longer term, with uncertainty related to timing and scale.
As the Task Force report stresses, “scenario analysis is a process for identifying and assessing a potential range of outcomes of future events under conditions of uncertainty”. These scenarios enable businesses to explore how climate change may affect them.
Businesses should utilise a selection of scenarios which cover a reasonable range of future outcomes to help inform their strategic and financial planning processes. The TCFD recommends using a 2°C scenario in addition to two or three which are most relevant to the circumstance of the business in question, such as those related to Nationally Determined Contributions and business-as-usual.
Organizations should begin by focusing these scenarios on a specific asset or aspect of their business, before expanding to wider operations and, eventually, their whole business.
10. Look at the existing structure of your annual report and think about how you can incorporate the recommendations into your discussion of risks, management discussion and analysis (MD&A), and governance sections
The first step for companies to strengthen the relationship between climate change and overall corporate strategy, performance and prospects is to apply the concept of connectivity. As we highlighted in our analysis of the FTSE 350 companies’ environmental reporting and GHG disclosures in annual reports, this helps to show a holistic picture of the factors that affect the organization’s ability to create value over time.
A key element of the Task Force’s work is the recommendation to include climate-related financial information in mainstream reports. Companies need to think about how to best use the existing structure of their mainstream annual reports to integrate these new disclosures.
Think of integration and connectivity as your north star: your annual report should tell a clear and coherent story, joining the dots between governance, risks, risk management, strategy, targets and performance.
The consistency and comparability of disclosures could be enhanced through the development of key performance indicators (KPIs) that are connected to financial information, consistent over successive periods and with accepted industry benchmarks and focused on material matters.
Delivering on the recommendations will be a journey for many organizations, but there is a lot that you can do now to be prepared and stand out among your peers.