Climate change has been increasingly impacting our planet with the rise in temperatures, change on precipitation patterns, and increasing stronger wildfires and other natural catastrophic events.
Companies voluntarily increased their reporting on carbon emissions, water and deforestation risks. Platforms such as CDP, Sustainalytics or MSCI allows companies 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.
There are shifts in consumer preferences, increased reputational risks or pressures on policymakers to change legislation. This situation ultimately affects companies’ valuation and thus the returns expected from their investments.
As an example of current risks is the ‘Flygskam’ or flight-shame movement. Flygskam is a growing phenomenon where flyers feel guilty about the carbon footprint of travelling by plane. This trend could potentially cost millions to airlines, consumers and companies. Furthermore, it could catapult 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, the risk that a deforestation or conflict minerals case is found in a company’s supply chain.
This extended company responsibility goes beyond the company fence and reaches tier 1 suppliers (or company’s direct suppliers), or even sometimes to tier 2 or 3 suppliers.
Task Force on Climate-Related Disclosures (TCFD)
The situation was identified by the G20 who decided in 2017 to launch the task force on climate-related financial disclosures (TCFD).
Support for the TCFD framework has exceeded any original expectations. Almost 1,500 organizations have expressed their support. Among them more than 1,340 companies with a market capitalization of $12.6 trillion and financial institutions
responsible for assets of $150 trillion are included.
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:
- Analyzing the different risks and opportunities companies face 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). There are also transitional risks (Policy, Technology, Market and Reputation). Furthermore the scope its own operations (factories, offices and other assets under control) and full supply chain.
- Calculating the value at stake. The value will be 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 opportunities identified.
- And disclose them voluntarily to its investors (see my article about corporate sustainability reporting)
Increasing transparency makes markets more efficient and economies more stable and resilient.— Michael R. Bloomberg, Chair –
TCFD real life implementation
The reality is a different story and the report still doesn’t specify which scenarios to use.
Analyzing RS (Paris NDCs), 2 Degree Scenario or 1.5DS are the common ones.
Lack of specific rules about which scenario to use makes it difficult for investors to benchmark.
“TCFD reporting is not all straightforward – it requires time and effort to undertake scenario analysis.”Vanessa Havard-Williams, global head of environment law at law firm Linklaters
Besides, there is not much experience on how to implement the recommendations in companies or how to interprete it by investors.
Furthermore, companies are reluctant to openly disclose the assessment into their financial reports to avoid a panic effect among its shareholders.
Environmental, Social, and Governance Investing (ESG Investing)
Environmental, social and governance investing or ESG Investing used to be a niche product.
Those who were more environmentally conscious were the only investing in them.
However, these days ESG is becoming part of the investing strategies of major asset managers, green bond issuers and even the more conservative pension funds.
ESG investing is 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, the UK announced in November 2020 to make TCFD-aligned disclosures mandatory across the economy by 2025.
Besides ESG indexes such as CDP already include as part of their questionnaire TCFD recommendations.
Hopefully, a standard reporting framework and platform will become dominant and simplify the work of companies disclosing and the source of information for investors.
Why should the citizens of this world keep companies around whose sole purpose is the enrichment of a few people?Paul Polman, Chair of IMAGINE and ex-Unilever CEO
It is a virtuous circle where investors will be interested in building their portfolios with companies who demonstrate proper management of their risks.
Companies who exploit their opportunities related to climate change.
Additionally, companies will put more effort to attract capital, talent and costumers. They will do so by reducing their environmental impact and by developing low-carbon products and services.
It just looks like everything is lining up for companies to create value for the triple bottom line: planet, people and profits.
Climate change is impacting the planet and the ecosystems on which companies operate.
The financial sector needs to realign their investment strategies and consider ESG investing when building their portfolios.
Non-financial disclosures like the TCFD framework provide investors with key information about risks and opportunities faced by the companies they invest in.
Finally, companies seeking to attract capital, talent and costumers, reduce their environmental impact and develop low-carbon products and services.
As a conclusion TCFD is saving the world, the question is can we accelerate its implementation, please?
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