TCFD: A Roadmap to Sustainable Business
Updated: Dec 14, 2020
The Taskforce for Climate-related Financial Disclosure (TCFD) and their recommendations have quickly taken centre stage in the financial sector's strategy to mitigate the effects of climate change. The recommendations provide a consistent blueprint to help organisations to become more sustainable businesses by navigating through the risks associated with climate change and the transition to net zero. The benefits of climate change disclosure are only just beginning to become obvious. Whilst there is reason for cautious optimism, the long journey to creating a sustainable economy for the future will require lots of hard work and a common direction. TCFD recommendations look well placed to help businesses to move in that direction.
What is the TCFD?
In 2015 the TCFD was launched by the Financial Stability Board (FSB) which was then chaired by Mark Carney, ex-Governor of the Bank of England. In 2017, it released a list of recommendations and provided a framework for organisations to disclose the impacts of climate change and the transition to net-zero on their future financial performance. The intention is to provide a more consistent and comparable way for companies to disclose climate related information.
Figure 1: The TCFD was launched in 2015 and was chaired by Mark Carney, former chair of the Bank of England. Source: Pixabay
The TCFD recommendations are divided into four categories: Governance, Strategy, Risk Management and Metrics and Targets. Organisations are encouraged to explain how their board incorporate climate change into decision making and what strategy is in place to prepare for the challenges of climate change. The disclosure of the processes and metrics used to identify and measure the effects of climate change risks and opportunities are also encouraged.
To fully engage with the recommendations, companies need to evaluate their operations against snapshots of what the future may look like. This is called scenario analysis. The most widely accepted, scientifically backed predictions of what the future may look like are set out by the 2019 IPCC report. TCFD recommends disclosures to include scenario analysis with specific reference to the 1.5 and 2 degrees Celsius scenarios mapped out by the report. The IPCC report is an analysis of what the global climate will likely look like in the future and also considers the actions needed to reach various scenarios. Companies can use the IPCC report to evaluate how their operations will be affected in the world described by the IPCC report.
How does TCFD disclosure create change?
The creation of the TCFD recommendations aim to support the transition to a sustainable, net-zero economy in several ways. Firstly, quality disclosures help those in the financial sector to better understand the value of an organisation. Quality disclosure helps to incorporate climate-related risk into the valuation of an organisation, meaning investors and lenders can better understand whether their investments are being made in sustainable companies.
Equally, by self-analysing, companies can better understand the value of their assets by considering how climate change and the transition to net-zero will affect them. Pricing these risks now helps to avoid the sudden change of an asset values in the future. In general, inadequate information about risks can lead to a mispricing of assets and misallocation of capital, potentially giving rise to concerns about financial stability, since markets can be vulnerable to abrupt corrections.
“Increasing transparency makes markets more efficient, and economies more stable and resilient.”
—Michael R. Bloomberg, TCFD Chair
The real estate sector is a prime example of this, with asset owners and investors particularly exposed to asset revaluations due to climate change factors. It’s easy to imagine how an increase in the likelihood of a natural disasters such as flooding could affect the value of a building. An asset which is at risk of increased flooding in the future due to climate change-related extreme weather should have a lower value than if it wasn’t exposed to this risk. Yet recent research by AEW suggesting that investors are not yet pricing climate risks into asset acquisitions. This leaves asset owner and investors exposed to the risk of a rapid revaluation of their built assets once natural disasters strike, as well as growing insurance premiums in the future. TCFD disclosures, like other ESG disclosures, can help asset owners to identify the future risks to their assets and incorporate this into their valuations. Once risks are identified they become manageable.
Figure 2: Businesses face a variety of climate change-related risks in the future. Source: Pixabay
The pricing of climate-related risk is essential for a healthy financial sector and economy, yet quality TCFD disclosure also benefits the non-financial businesses which fully engage with the recommendations. TCFD disclosure encourages organisations to critically review their business processes to better understand the risks and opportunities associated with climate change and the transition to net-zero. There are various transitional and physical risks associated with climate change and net zero commitments which all businesses need to understand to be adequately prepared for the future.
As with any ESG disclosure, the more an organisation interacts with the TCFD recommendations, the more they are likely to gain. When disclosures are treated as a tick box exercise rather than a tool to move an organisations culture away from ‘business as usual’, organisations tend to miss out on the benefits which quality disclosure brings.
The future of TCFD disclosure
Although we are in the early stages of the climate-related disclosure journey, there are already signs of progress. Firstly, the momentum behind mandatory TCFD disclosure, as well as investor pressure on companies to disclose climate-related risk, means the number of companies using the TCFD recommendations will continue to rise. More companies making TCFD disclosures means more companies making climate-related improvements.
Along with an increasing number of companies making TCFD disclosures, another important challenge is to improve the quality of TCFD disclosures. After all, it’s quality disclosures which will really tackle climate change and better prepare businesses for the future. There are signs of progress in this area too. Since the TCFD recommendations were released in 2017, there has been a marked improvement in the quality of TCFD disclosures, with companies increasingly disclosing information which aligns with TCFD standards, according to analysis of TCFD data.
The report does however highlight that whilst organisations are making disclosures against the recommendations, companies are still failing to fully utilise scenario analysis. This is likely due to a lack of familiarity with the process, meaning it can be time-consuming and difficult to implement. Business must become better at using TCFD recommended scenario analysis as it’s essential for maximizing the potential benefits of disclosure. This should happen naturally to an extent as businesses become more familiar with these disclosures in the future, although leading board-level decision makers who fully embrace TCFD disclosure must lead the way.
Over the next few years there will be an increase in organisations who will integrate TCFD disclosure into their reporting. We are at the beginning of the journey and the important thing at this point is for organisations to come onboard with the process. Although early reports may lack quality, it’s important that organisations begin the journey to completely understanding the risks and opportunities they face which are associated with climate change and the transition to net zero.
Climate change and the threat that it poses to the global economy has long been over looked. However, in recent years there has been cause for optimism as momentum behind understanding and quantifying climate change related risk has steadily grown. The creation of the TCFD is a key milestone in this journey and their recommendations provide the roadmap which businesses can use to manoeuvre through the various risks and challenges associated with climate change as well as the transition to net zero. The successful businesses of the future would do well to start the journey towards becoming a successful and sustainable business of the future sooner rather than later. Full alignment with the recommendations of the TCFD will make that journey significantly easier.
Co-authored by Governex and Harry Vigus
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