Climate change has been increasingly impacting our planet with the rise on temperatures, change on precipitation patterns, and increasing stronger wildfires and other natural catastrophic events. Companies also in the last decade have voluntarily increased its reporting on Green House Gases emissions, water and deforestation risks through platforms like CDP, DJSI or MSCI to demonstrate transparency, commitment and leadership.
What was not evident to investors is that climate change was also rapidly transforming the ecosystems on which companies were operating, shifting consumer preferences, increasing reputational risks or influencing policymakers to change legislation which ultimately affects the companies’ valuation and thus the returns expected from their investments.
As an example of current risks, the ‘Flygskam’ or flight-shame move, where flyers are feeling guilty about their carbon footprint, could potentially cost millions for airlines, consumers and companies, while catapulting emission offsetting into a big business according to Citigroup, shaking a whole consolidated and profitable industry. Another example is how multinationals are frequently setting standards that go beyond country legislations to avoid losses due to negative reputation, for instance, risk that a deforestation or conflict minerals case is found in the company’s supply chain (tier 1 or direct suppliers, tier 2 or suppliers of your direct suppliers or even tier 3).
Task Force for Climate-Related Disclosures
The situation was identified by the G20 who decided in 2017 to launch the task force on climate-related financial disclosures (#TCFD), a framework that has been rapidly supported by 850+ public and private-sector organizations including global financial firms responsible for assets in excess of $118 trillion.
As mentioned in TCFD’s latest status report, “the disclosure of climate-related financial information has increased since 2016, but is still insufficient for investors”
The principle is simple, companies using the TCFD report guideline should report Governance, Strategy, Risks Management and Metrics & Targets. In particular, the process should be:
- To analyze the different risks and opportunities the companies are facing under different forward-looking scenarios compared with the business as usual scenario. There are physical risks (acute or extreme weather events and chronic or long-term changes like higher temperatures) and transitional risks (Policy, Technology, Market and Reputation), and the scope its own operations (factories, offices and other assets under control) and full supply chain.
- Calculate the value at stake negative in case of a risk or positive in case of tackling an opportunity. This part is especially important since this result will enable the organization to strengthen the case for the sustainability program.
- Prioritize and create strategies to mitigate risks and profit identified.
- And disclose them voluntarily to its investors.
The reality is a different story and the report still doesn’t precise which scenarios to use RS (Paris NDC), 2 Degree Scenario or 1.5DS making it difficult for investors to benchmark, there is not much experience on how to properly implement it in either the companies or by the investors themselves and besides companies are reluctant to fully disclosure the assessment into their financial reports (10k, annual report..) to avoid a panic effect among its shareholders.
Environmental, Social, and Governance Investing
At the same time environmental, social and governance (ESG) investing, a niche product that was in the past only used by those who were more environmentally conscious, is becoming part of the investing strategies of major asset managers, green bond issuers and even the more conservative pension funds, putting pressure on improving and standardizing the framework and to push policymakers to make it mandatory. As an example, the European Commission in June 2019 incorporated in its guidelines the TCFD recommendations as part of its existing non-financial corporate reporting requirements. Besides ESG indexes like CDP already includes as part of their questionnaire TCFD recommendations and hopefully, a standard reporting system will become the dominant and simplify the work of companies disclosing and the source of information for investors.
It just looks like everything is slowly lining up for the good of the planet, people and profits.
Potentially in a near future, there will be a virtuous circle where investors will be interested in building their portfolios with companies who demonstrate proper management of their risks and exploit their opportunities related with climate change, and at the same time companies will put more effort to attract capital, talent and costumers.
Increasing transparency makes markets more efficient and economies more stable and resilient.— Michael R. Bloomberg, Chair –
Climate change is impacting the planet, people and the financial sector and non-financial disclosures like the TCFD framework will play a key role in securing the finance required for promoting sustainable investments and influence in the companies they invest to reverse climate change.
The question is can we accelerate, please?
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