Between July and August 2018, risk managers across the globe from many companies reporting into CDP probably did a spit take. (That’s the comedy gag where someone drinks water and spits it out upon hearing something shocking). For those risk managers, the new CDP questions about climate risk—financial planning & “substantive” strategy impacts and required fields for dollar estimates of potential impacts—were just that surprising. Some risk managers embraced the changes, while others heavily pumped the brakes on such disclosures.
However, these new risk questions are here to stay due to two major trends going into 2019:
- Requirements for corporate climate risk disclosures enter uncomfortable territory as financial planning, “substantial risks” and other potentially sensitive questions become more common.
- Climate risk disclosures are increasingly scrutinized by investors and academics against the TCFD recommendations and for overall comprehensiveness of the risk review.
To help sustainability practitioners avoid splattering coffee on their shirts in 2019, below is a list of FAQs. Answering these will help sustainability professionals anticipate key questions from risk and finance colleagues to make them more comfortable with these new questions (which likely need to be drafted soon). These are focused primarily on the disclosure stage of the risk assessment process (item 5 in the below chart):
Q: Why do we need to disclose additional detail on climate risk?
A: TCFD’s recommendations are meant to provide investors with decision-driving data on the impacts of climate change on companies and industries. New risk disclosure requests from CDP reflect the information that investors are increasingly asking for.
Importantly, TCFD recommendations consider short-, medium- and long-term risks associated with climate change. Medium- and long-term risk evaluations need to start to be evaluated if they are not currently.
Q: Climate change risks haven’t manifested themselves as material risks for my company yet. How should we disclose this potential risk?
A: First and foremost, if a company isn’t earnestly evaluating medium- and long-term risks, they should consider it. Not only for alignment with TCFD, but also for its strategic value. Furthermore, even though a risk isn’t material now doesn’t mean it won’t be in the future (e.g., sea-level rise). To quote the Recommendations:
“The Task Force encourages organizations where climate-related issues could be material in the future to begin disclosing climate-related financial information outside financial filings to facilitate the incorporation of such information into financial filings once climate-related issues are determined to be material.”
Q: Climate change is a very complex, uncertain and long-term risk. How are we supposed to be confident in our risk disclosures on such a topic?
A: Many strategically significant risks and opportunities have those same characteristics: long-term asset leases, supply & demand forecasts, R&D cycles, etc. But climate entrepreneurs and NGOs understand that integrating the science and economic consequences of climate change can be more demanding than traditional risk management teams can handle solo. New tools are being introduced almost every week to support companies in assessing these risks.
Scenario analysis in the industry standard tool to address the uncertainty of climate change. It’s likely a familiar tool for risk managers: use a potential range of outcomes of future events under different uncertain parameters. For climate risk evaluations, the scenarios are generally associated with degree outcomes (e.g., the 2° Paris Accord goal) and reflect both physical outcomes of that temperature increase and the associated economic and policy transition that is likely needed to reach that temperature. A recent guide from the Institutional Investors Group on Climate Change (IIGCC) dives deeper into how to integrate the concept into your risk management practice.
We will be diving more into scenario analysis with CDP in Q1 2019. Look for the invite soon!
Q: Should we be concerned about disclosing information with this future uncertainty?
A: No. While it is appropriate to question the potential inaccuracy of impact forecasts associated with climate change, U.S. provisions (and other legal jurisdictions) “protect companies and directors from liability for forward-looking statements made in good faith”. “Safe harbor” provisions also protect organizations “from liability where forward-looking statements are qualified with meaningful cautionary language identifying important factors that could cause actual results to materially differ from those stated”.
That said, companies should be concerned about failing to evaluate climate risks earnestly and robustly. To quote the CCLI report:
“Companies and their directors are likely to face greater liability exposure in many jurisdictions if they fail to assess and (where material) meaningfully disclose the financial risks associated with climate change and their impact on company performance and prospects.”
Q: How do different regions of the world treat climate risk disclosure?
A: As with most things in business, different countries require different disclosures. A recent report from the Principles of Responsible Investment (PRI) provides detail into the differences. Below is a particularly interesting table from the report that summarizes how climate-related risk is covered in each market’s regulation and policy on corporate disclosure.
Source: Principles for Responsible Investment: Climate Disclosure Country Reviews
Q: How should we consider reporting on climate risk within financial reports in the U.S.?
A: In 2010, the SEC issued a report titled Commission Guidance Regarding Disclosure Related to Climate Change which aimed to provide guidance to companies for how to disclose climate risks. The report details three topics that might trigger companies to disclose climate change impacts:
- Impact of legislation, regulation and international accords
- Indirect impacts due to the above
- Physical impacts
While the SEC does not explicitly require climate risk disclosures and isn’t anticipated to enforce the 2010 guidance, if any risk is deemed material you need to disclose it accordingly. The following “Items” within a company’s financial disclosures might be appropriate areas to disclose climate risk.
Q: Companies have been disclosing risks to CDP for a decade. Is there a concern about the accuracy of the risk disclosure of the private sector?
A: Yes. In a September 2015 speech, Mark Carney (governor of the Bank of England) discussed the “mismatch between the short-term nature of financial decision-making and the long-term impacts of climate change”, what was coined the “Tragedy of the Horizons”. Recent findings from Nature Climate Change indicate that this mismatch is quantitatively evident in CDP’s questionnaires. Estimates of financial costs range in the trillions of dollars, however the aggregate total for CDP’s 1,959 companies reporting on physical risk only totaled in the tens of billions. This raises the question about the comprehensiveness of the private sector’s current evaluation methods and potentially exposing billions of dollars of assets.
While new trends in sustainability reporting and risk management are calling for risk and sustainability teams to work together in ways they haven’t in the past, the conversation will only make companies more resilient. In a recent webinar with CDP, we highlighted ways in which organizations can update risk management processes and incorporate tools to better understand the strategic and financial impacts of climate change. Check it out here.
Contributed By: Nathan Shuler, Sustainability Solutions Architect, Schneider Electric Energy & Sustainability Services