While it is widely recognised that continued emission of greenhouse gases will cause further warming of the planet, and that this warming will lead to damaging economic and social consequences, the exact timing and severity of physical effects are difficult to estimate, especially in the context of economic decision-making.
One of the essential functions of financial markets is to price risk to support informed, efficient capital-allocation decisions. The financial crisis of 2007-2008 brought home the repercussions that weak corporate governance and risk management practices can have on asset values. This has resulted in increased demand for transparency from organisations on their governance structures, strategies and risk management practices. Described as “the most comprehensive effort to-date to explain and set a path towards enabling future organisational transparency and market resilience in the face of the global phenomenon of climate change,” the industry-led FSB Task Force on Climate-Related Financial Disclosures (TCFD) was founded in 2015 by Mark Carney (the Governor of the Bank of England and Chairman of the Financial Security Board) and Michael Bloomberg to meet this need.
The TCFD has developed guidance for climate-related financial disclosures in annual financial filings to enable investors, lenders, insurers, and other stakeholders to better price risk to support more informed and efficient capital allocation decisions. The TCFD’s recommendations divide climate-related risks into those related to the transition to a lower-carbon economy (policy and legal, technology, market and reputation), and those related the physical impacts of climate change.
There has been an increase in recent years of climate-related litigation claims by property owners, municipalities, states, insurers, shareholders, and public interest organisations. Reasons include the failure of organisations to mitigate impacts of climate change, failure to adapt to climate change, and the insufficiency of disclosure around material financial risks.
Acute physical risks refer to those that are event-driven, including increased severity of extreme weather events, whilst chronic physical risks refer to longer-term shifts in climate patterns. These risks are interconnected. Moreover, the broader category of environmental-related risks are further interconnected with many other risks, such as large-scale involuntary migration and geopolitical conflict. Opportunities include resource efficiency, alternative energy sources, product and service innovation, new market opportunities and organisational resilience.
In most G20 jurisdictions, companies with public debt or equity have a legal obligation to disclose material information in their financial filings — including material climate-related information. The TCFD fosters shareholder engagement and broader use of climate-related financial disclosures, thereby promoting a more informed understanding of climate-related risks and opportunities.
The TCFD believes that thepublication of climate-related financial information in mainstream annual financial filings will help ensure that appropriate controls govern the production and disclosure of the required information.
In April 2017, the Australian Senate Economics References Committee published its report of the Inquiry into Carbon Risk Disclosure in Australia (‘Carbon Risk: A Burning Issue’), which states the need for a coordinated government response to the TCFD recommendations. The Committee urged both the ASIC and the ASX to provide guidance on disclosing carbon risk, and confirmed that the provisions of the Corporations Act 2001 do not “impede” companies from compliance with the guidelines provided by the TCFD. The Committee’s recommendations foreshadow the need for stock exchange, corporate regulator and prudential regulator adjustment to their policy instruments.
In addition, APRA recently identified climate risks as “distinctly financial in nature” with “many of these risks foreseeable, material and actionable now.”
As the government begins implementing the Nationally Determined Contributions (NDCs) under the Paris Agreement, climate change disclosure and transparency is a critical step towards achieving these goals. Australia’s NDC targets, coupled with threats of climate litigation and increasing shareholder action, are driving the increase in climate risk disclosure by Australian companies.
Potential Benefits of Implementing the TCFD’s Recommendations
- Easier or better access to capital by increasing investors’ and lenders’ confidence that the company’s climate-related risks are appropriately assessed and managed.
- More effectively meeting existing disclosure requirements to report material information in financial filings.
- Increased awareness and understanding of climate-related risks and opportunities within the company, resulting in better risk management and more informed strategic planning.
- Proactively addressing investors’ demand for climate-related information in a framework that investors are increasingly asking for, which could ultimately reduce the number of climate-related requests received.
- Asset managers and asset owners (including public- and private-sector pension plans, endowments, and foundations) would better support their clients and beneficiaries in understanding the performance of their assets, considering the risks of their investments, and making more informed investment choices.