Welcome to the third part of our ESG insight series, produced by Edelman’s EMEA ESG team. This time we’re focussing on the implications of the climate reporting horserace for companies.
Climate disclosure leads the way for mandatory reporting:
In most countries, comprehensive ESG reporting is voluntary, causing a variation in ESG reporting which leads to a state of selective reporting, making it difficult for investors to accurately collect and compare financially material information.
Climate change is often viewed as the most pressing ESG issue facing society. So, it’s no surprise that regulators and governments are focussing their efforts towards creating mandatory, and therefore comparable, climate-related standards.
Last year culminated in commitment, and we’re now starting to see action. In the run up to COP26 the UK announced that from April 2022 large private companies must report climate-related financial information in line with the guidelines from the Task Force on Climate-Related Financial Disclosures (TCFD).
What is the TCFD:
- The TCFD was created in 2015 by the Financial Sustainability Board to develop consistent and comparable climate risk and opportunity measurements that increase transparency and engagement between investors and the companies they invest in.
- By combining climate data disclosure with forward facing scenario planning, TCFD reporting ensures companies identify financially impactful risks and uncertainties, but also develop long-term strategies to deal with climate risk.
Climate disclosure in the UK:
The UK’s TCFD legislative mandate applies to an estimated 1,300 private companies – including listed companies, banks, insurers and AIM companies with more than 500 employees, as well as LLPs and non-listed companies with +500 employees and a turnover of +£500m.
The standards are designed to ensure that organisations take meaningful climate action, and to do so they need to understand their climate risks and start planning ways to mitigate them. Naturally, this requires the collection and analysis of ESG data and an immediate concern for some is how to evaluate Scope 1-3 emissions. It’s a valid point, as data collection can be challenging and time consuming, and is often coupled with insufficient expertise.
Many businesses lack historic data to compare their current progress against, so developing quantitative impactful climate models will take time. This is where the TCFD excels, and why the UK requirements focus on developing strategic action and governance-related activities versus immediate and exclusive data reporting.
UK disclosure requirements:
|Thematic Areas||Governance||Strategy||Risk Management||Metrics and targets|
Describe the board’s oversight of climate-related risks and opportunities.
Describe management’s role in assessing and managing climate-related risks and opportunities.
Describe the climate-related risks and opportunities the organisation has identified over the short, medium, and long term.
Describe the impact of climate-related risks and opportunities on the organisation’s businesses, strategy, and financial planning
Describe processes for identifying, assessing, and managing climate-related risks.
Describe how processes for identifying, assessing, and managing climate-related risks are integrated into the overall risk management.
Disclose the metrics used to assess climate-related risks and opportunities in line with the business strategy and risk management process.
Disclose Scope 1, Scope 2 and, if appropriate, Scope 3 GHG emissions and the related risks.
Describe the targets used to manage climate-related risks and opportunities and performance against targets.
The reporting requirements in the UK place value on a company that deeply understands which parts of its supply and value chain are most exposed to climate risks. This approach is supported by investors because climate aware organisations are best positioned to mitigate risks and adapt to opportunities, which ultimately improves business performance.
Support for the uptake of TCFD reporting is widespread. Last year more than 2,600 organisations globally aligned with the TCFD framework and more than 1,000 financial institutions support the TCFD, representing $194 trillion in assets. In the next year, it will become apparent who are the leaders and laggards, and there is an opportunity for UK companies to influence best practice climate reporting. Especially as other countries start to enforce their own style of climate disclosure reporting that incorporate TCFD reporting – particularly in the USA. Here’s why.
Climate disclosure in the USA:
In Q1 2022, the USA Securities Exchange Commission (SEC) proposed new mandatory disclosure standards that, in many ways, are inspired by the TCFD framework. The proposal focusses on climate-related risks and the likely material impact on a business’ results of operations, financial conditions, or outlook over the short, medium and long term.
However, compared with the mandatory reporting in the UK, the SEC’s proposal will apply to significantly more companies as it focuses on securities registrants. Given the depth of USA capital markets, this could include a global set of companies who are not domiciled there – an important extraterritorial dimension.
For those companies concerned, the proposed rule is in broad alignment with existing ESG disclosure already provided voluntarily by many companies through frameworks such as TCFD and the GHG Protocol. And as the proposal is inspired by TCFD, there is a strong focus on companies disclosing in detail the governance of these climate-related risks and relevant risk management processes.
This climate-related risk information will be required in periodic reporting, such as Form 10-K with annual updates and independent attestation mandatory for Scopes 1 and 2 for the largest filers. And most importantly perhaps, the SEC will expect to see assurance of climate data – the company’s financial accounting firm can provide the external assurance, as long as the firm has the requisite expertise.
If passed, the rules will require reporting in 2024, so there is time for companies to prepare and potentially use UK TCFD reporting as examples to draw from. Plus, there will be a one-year delayed requirement for Scope 3 disclosure and companies will retain discretion on how to determine the ‘materiality’ of their Scope 3 emissions. This reflects a pragmatic approach from the SEC because, as mentioned above, data collection is challenging, and the collection and analysis of Scope 3 emission data is particularly prone to error and double counting.
Finally, and again inspired by TCFD, the SEC will expect qualitative information and narrative on the following points:
- How climate-related risks identified have a material impact on a business and financial statements over the short, medium and long term;
- How these risks affect the strategy, business model and/or business outlook;
- What processes are in place for managing these risks and whether they are integrated into the overall risk management;
- Details of the climate transition plan, including metrics and targets that identify and manage risks – in line with the TCFD;
- If scenario planning, a description of scenarios used, including parameters, assumptions, analytical choices and projected financial impacts; and
- Disclose information about internal carbon pricing and programming.
All qualitative requirements mean companies need to build in sufficient time and process to telling their climate mitigation story, and not over-rely on quantitative information of emissions alone.
TCFD in the year ahead:
The TCFD’s qualitative and quantitative disclosure balance encourages companies to embed climate risk into their business strategy, which has made the TCFD one of the most used climate-related disclosure framework globally. This successful uptake has enabled climate reporting to advance ahead of other ESG disclosures, e.g. ‘Social’ disclosures, meaning policy developments, such as the EU’s social taxonomy, are playing catch-up.
It is our expectation that all UK businesses should plan to fully disclose against the TCFD guidelines, as mandatory reporting requirements will continue to expand. For those UK business who have existing or planned USA capital markets activity, TCFD preparedness will enable readiness for the upcoming SEC rules.
Incorporating all ESG risks into the core of the business plan as soon as possible will give companies a competitive advantage, and show shareholders, investors, and regulators that a business is taking ESG action seriously.
Get in touch with the ESG team to find out more about ESG trends and how we can help you, or your clients.