In a two-part series, Dr Glenn Frommer and Theodora Thunder, Principals, The Sustainability Partnership, look at guidance from the Task Force on Climate-related Financial Disclosures on how companies can address one of the toughest challenges of ESG disclosure – reporting on climate-related risks and opportunities.

Regulators, investors and providers of capital increasingly seek and focus on material information around a company’s understanding and management of climate-related issues as they relate to corporate development and long-term profitability. From their perspective, analysing an organisation’s resilience to climate-related shocks and impacts substantially influences their valuation, investment, asset allocation, credit ratings, lending and insurance underwriting decisions. In response and in anticipation of regulatory oversight, there is a global momentum amongst companies to disclose in mainstream reporting the relevant financial data and discussions of the impacts that climate change issues have on financial decision making and planning. This movement is hitting the corporate risk radars in Asia mainly due to international supply chain links, operating capacities and the increased national-level regulatory environment around climate change issues.

The TCFD Framework

In June 2017, the World Business Council for Sustainable Development’s Task Force on Climate-related Financial Disclosures (TCFD) published a set of recommendations designed to help bring clarity, comparability and measurability to climate issues that are often recognised as non-quantifiable and unpredictable. The recommendations serve as a dynamic management tool that moves the conversation of climate risk beyond sustainability into the overall programme of corporate governance and risk management. This supports the delivery of corporate specific, decision-useful and forward-looking information around the financial consequences and opportunities of climate risk that key stakeholders seek. The TCFD proposes a framework of four core elements that solicits disclosures based on the flow of corporate governance, strategy and financial decision making. The framework’s unique strength is its ability to bring the realities of climate change issues into corporate risk decision making and planning – this speaks to the core of corporate secretarial management practice. The framework is flexible in that it facilitates the understanding and application to organisations across multiple sectors and jurisdictions. While the recommendations aim to be ambitious, they are practical for near-term adoption. The objective is to establish for the financial community and internal management a platform from which climate-related risk and opportunities can be appropriately assessed, priced and integrated into finance and business operations.

Four core elements of recommended disclosures

1. Governance In line with best corporate practices, good governance directs the high-level approach, management and disclosure of climate-related risks and opportunities as a component of the broader organisational governance programme. This highlights the board’s understanding, prioritisation, management and oversight of issues, as well as how the board monitors and oversees progress and targets when addressing climate change issues in relation to organisational development. 2. Strategy Strategy discloses the actual and potential impacts of climate-related risks and opportunities where such information is material. Importantly, this includes risks and opportunities identified over the short, medium and long term, and how they influence business and financial planning. The use of scenario analysis can be useful in this element to test resilience of the organisation’s strategy. 3. Risk management Risk management details the organisation’s systems and processes for identifying and assessing material climate-related risks in scope and intensity. This covers both physical and transitional risks. Physical risks concern acute impacts (for example storm surges and flooding), which are often short term and event driven; while chronic impacts (for example rising sea levels and increased air temperatures) refer to the longer-term shifts in climate patterns. Transitional risks arise from the changes in policy, regulations, technologies, investment, insurance and consumer markets that affect corporate planning and future business development. Moreover, depending on the nature, speed and focus of these issues, transitional risks pose varying levels of financial and reputational risk to the organisation. Managing risk is necessarily transparent and accountable and demonstrates how the processes for identifying, assessing and managing climate-related risks and opportunities are integrated into the organisation’s overall risk management programme. Establishing context and issue materiality are necessary steps within the process. Scenario analysis plays an important role as it presents the opportunity to test a range of trajectories in which to evaluate risk appetite and mitigation efficacy over time and in different contexts. 4. Metrics and targets The metrics and targets used to assess and manage relevant climate-related risks and opportunities require transparency, measurability and consistency. The TCFD framework is by design complementary to existing international, industry and national metrics, standards or guidelines. Principally, the company should disclose Scope 1, Scope 2 and, if appropriate, Scope 3 greenhouse gas (GHG) emissions using the World Resources Institute’s GHG Protocol (https://ghgprotocol.org), and discuss the related business risks. Management of climate risks associated with anticipated regulatory requirements and market constraints on water, energy, land use and waste management should also be included in the metrics to demonstrate progress. Discussions should incorporate the targets set to manage risks and report performance against such targets, as well as identify potential opportunities for growth.

Seven principles for disclosures and reporting

To underpin the framework and help guide current and future developments in climate-related financial reporting, seven principles for best disclosure practices are suggested which, when applied, improve the quality and value of data for users. Disclosures should be:

1. representative of relevant information (material and in context)
2. specific and complete
3. clear, balanced and understandable
4. consistent over time
5. comparable within sector, industry or portfolio
6. reliable, verifiable and objective, and
7. provided on a timely basis.

These principles align with already well-established best practices in annual reporting and generally apply to most providers of financial disclosures. They are designed to make clear the linkages between climate-related issues and their governance, strategy, risk management and metrics and targets.

The Hong Kong context

Asia-based corporations should consider the model suggested in the recommendations for financial disclosure of climate-related issues. The exposure and financial consequences in terms of both physical and transitional risks are an increasing reality regardless of company size or turnover. The TCFD framework provides the platform for companies to kick-start the internal process for risk assessment and the dialogue on how climate-related issues are relevant in current governance, strategy and risk management practices. Using the TCFD recommendations places the resilience lens on managing business costs and revenues, the supply chain, business interruptions and the efficiency of resources allocation in terms of climate-related impacts. The further use of scenario analysis to test alternative pathways provides ways for organisations to consider how the future might look if certain trends continue or certain conditions are met. These two benefits serve to inform Hong Kong boards and senior management when making risk management decisions and to initiate the climate dialogue with stakeholders. The TCFD recommendations are consistent with the HKEX Environmental, Social and Governance Reporting Guide requirements and with industry and international standards and guidelines such as the Sustainable Development Goals, Global Reporting Initiative, International Integrated Reporting Council and Sustainability Accounting Standards Board. At the same time, the recommendations are flexible enough to accommodate and support evolving practices and interface with existing internally deployed management systems. This is highly relevant to and facilitates the preparation of ESG reporting. The recommendations are unique amongst the many global frameworks in that they are not stand-alone in use nor do they set key performance indicators, but rather are developed to promote the integrated conversation on corporate risk. Even with first-time or highly qualitative disclosures, corporate constituents can review, recognise and understand how organisations consider and position climate-related issues and the potential financial impacts. The TCFD recommendations provide an opportune entry point for companies to start the step-by-step response to the global regulatory, financial and investment communities’ increased call for more qualitative, inclusive and quantified data on climate issues. Importantly, they provide investors, financial partners and internal management with a more precise understanding and financial assessment of the organisation’s exposure to climate risks over the short, medium and long term. Dr Glenn Frommer and Theodora Thunder, Principals The Sustainability Partnership In part two of this article, to be published in the next edition of CSj, the authors introduce the value and uses of scenario analysis to help understand and price the consequences from climate change–related issues. The Sustainability Partnership advises companies on the end-to-end management of ESG issues and their reporting. For further information contact: Thunder@streeter.com.hk.