Recommendations of the TCFD and their implementation
Only by looking at practical examples do interested professionals realise that the task at hand is not insurmountable but a process that needs to be started and progressively expanded.
Since the publication of the TCFD recommendations there have been several guides written to assist with their implementation. Most are detailed and comprehensive and as a result very long, occasionally daunting.
ICAEW’s guide will help our members understand the purpose of the recommendations. Practical examples will show that there are many different ways of organisations aligning themselves with them. We’ll provide pragmatic support to start the process of implementation and improve the disclosures. Ultimately, understanding the financial implications associated with climate change will result in information becoming more decision-useful. Risks and opportunities will be more accurately priced allowing for a more efficient allocation of capital and contributing to a more orderly transition to a low carbon economy.
Need for better information
In April 2015, the Financial Stability Board (FSB) identified the need for better information to support informed investment, lending, and insurance underwriting decisions and to improve understanding and analysis of climate-related risks and opportunities.
It established an industry-led global task force: the Task Force on Climate-related Financial Disclosures (Task Force or TCFD) to develop voluntary, consistent climate-related financial disclosures that would be useful in understanding material risks. The final report released in June 2017 was a set of widely adoptable recommendations for climate related financial disclosures that are applicable to all companies across sectors and jurisdictions.
Risks and opportunities
The recommendations concentrated on risks in two categories:
- Risks related to the transition to a lower carbon economy (transition risk)
- Risks related to the physical impacts of climate change (physical risk)
Transitioning to a lower carbon economy may bring extensive policy, legal, technology and market changes to address mitigation and adaptation requirements creating potential financial and reputational risks to organisations. Physical risks can be acute, for example hurricanes or flooding or chronic, like sustained higher temperatures causing sea level rise.
Efforts to mitigate and adapt to climate change can also produce opportunities for organisations for example through new product development.
The recommendations for how to approach managing the risks above are structured around four themes that represent core elements of how companies operate:
- risk management,
- metrics and targets.
These, with proposed disclosures build the framework of information to understand how reporting companies assess climate-related risks and opportunities. Guidance is provided to all companies in developing these disclosures. In addition, for the financial and certain other sectors the guidance is supplemented with highlighting important sector specific considerations.
The Task Force believes that all organisations should use scenario analysis (identifying and assessing the potential implications of a range of plausible future states under conditions of uncertainty) to help inform strategic and financial planning processes. The process enables organisations to consider all climate related issues in a more structured manner. It is strongly encouraged that organisations disclose the information in their annual filings including the assessment of how resilient their strategies are to a range of plausible climate-related scenarios.
Scenarios are produced mostly by international organisations and are publicly available. They articulate different pathways in either transition or physical risk scenarios.
Conducting scenario analysis is not without its challenges and the TCFD clearly recognises this. It is at an early stage, many organisations are just beginning to explore its use. Sharing experiences will be critical to advancing the use of this essential tool.
The efforts of financial services organisations in this space are necessarily two-fold. They need to assess and disclose the climate-related information of their own activities as well as of their financial interests. These are their clients they lend to, insure, invest in and ultimately own. In the UK the Prudential Regulation Authority has already expressed its expectations on enhancing banks’ and insurers’ approaches to managing the financial risks from climate change. In our opinion the regulatory interest is only likely to become more intense.
Since the publication of the recommendations the TCFD has issued two status reports to promote adoption of the recommendations.
The September 2018 paper looked at the practices related to the core elements of the recommendations. It concluded that disclosures were still in early stages. For this reason the Task Force encourages more companies to use the recommendations as a framework. Even if the effects of climate change is not deemed to be material disclosing government and risk management practices will help users understand that the issues are in the centre of the attention of executive management and the board.
The 2019 report highlights the key challenges associated with implementing the recommendations and outlines some additional work the Task Force would consider undertaking to address these challenges, for example developing process guidance around how to introduce and conduct climate-related scenario analysis.
The success of the recommendations depends on continued, widespread adoption so that is embedded in companies’ risk management and strategic planning.