5 Actions on TCFD
As TCFD is increasingly becoming mandatory, or at least a common measurement standard used by government and investors, many companies find it challenging to develop clear, objective, verifiable disclosures. Here are 5 recommendations for companies as they seek to implement TCFD.
As the consequences of climate change proliferate globally – including evergreater financial risks – both companies and financial markets require greater transparency and better insights into climate-related risks and opportunities in order to effectively allocate capital and set strategies. However, there continue to be several issues that slow down any company’s journey to truly understanding the impacts of such risks. These are as follows:
- A dearth of granular, high-quality data on which to make climate-related decisions. The will is there, but the data is not.
- Awareness on the nature of climaterelated risks likely to impact their operations and business. Risks may arise due to physical climate changes, such as temperature or rainfall or due to shifts in policies, markets and technologies during a global netzero transition. Having this complete understanding based on different future scenarios is of utmost importance for a climate resilient future business planning.
- Lack of skilled resources who have an in depth understanding of the risks and knowledge on what it takes to assess and manage the risks and impacts.
- Companies have limited access to relevant tools and methodologies. Only a few climate tools, databases and methodologies are freely available for companies to use.
As various concerned actors debated how to address these issues, they coalesced around the concept of “double materiality” – an extension of the accounting principle of materiality. Basically, the financial concept of materiality states that all items reasonably likely to impact investors’ decision-making must be recorded or reported in detail in a business’s financial statements. Double materiality takes this further: not only must impacts on the company be considered material, but also the impacts of the company on the environment and people. Such impacts are often clumped together and labeled as ESG (Environmental, Social and Governance).
The challenge lies in how the above-mentioned gaps can be plugged effectively. The Task Force on Climate-related Financial Disclosures (TCFD), established in 2015 by the Financial Stability Board, has emerged as one of the most prominent climate-related risk disclosure frameworks, even becoming part of the regulatory framework in various regions. For example, large institutions in the UK must disclose climate-related financial information on a mandatory basis since 2022. The US Securities and Exchange Committee is incorporating elements of TCFD into it’s disclosure requirements. France has made TCFD disclosure mandatory for it’s larger companies. Further more, Switzerland has introduced mandatory TCFD reporting for large public companies, banks and insurance companies starting from 1 January 2024. Among other frameworks, TCFD has also been considered in the development of the upcoming European Corporate Sustainability Reporting Directive. It is highly likely that the TCFD recommendations will become either mandatory in many jurisdictions, or at least a common measurement standard used by investors and governments.
Regulatory pressure is not the only reason why companies should implement TCFD recommendations, though. Given our experience with different clients disclosing climate metrics, it has been observed that various relevant stakeholders – investors, lenders, consumers and especially insurers who face higher risks due to climate change – are also now becoming increasingly conscious about the climate resilience of products/services, and thus expect effective reporting.
Even if companies are not currently incorporated TCFD into their reporting, they must still have certain processes and systems to monitor, evaluate and improve their sustainability and wider ESG practices to meet investor expectations. And increasingly, investors themselves are following TCFD disclosure requirements and thus are asking the companies they invest in to disclose using the TCFD framework.
Disclosing TCFD aligned climate information can benefit companies in several ways, including:
- the framework provides a structured process to integrate climate-related risk thinking into strategic decision making;
- climate-related scenario analysis can help companies to understand climate resilience in several different climate futures;
- resulting data provides the context to develop capabilities within the firm to understand where the company is most exposed to climate risk across its value chain, where opportunities may lie and which actions can be taken to mitigate the material impacts identified; and
- uncovering opportunities for efficiency gains, innovation, technological advancement and improved social impact.
Indeed, many companies view this as an opportunity: in 2021, over 2,600 organisations with a combined market capitalization of over $25.1 trillion had committed to support TCFD1.
The implementation of TCFD recommendations has proven challenging for some companies, however. The bar is quite high – developing effective disclosures that are clear, verifiable and objective – especially considering that they must begin with the basics: gathering data effectively. This first step can be difficult for those with complex internal structures, long value chains or muddled accountability for sustainability. However, what we have noticed as we work with clients is that by focusing on five key areas, companies can advance significantly towards implementing TCFD recommendations effectively.
Broad engagement with internal stakeholders and defining a robust governance framework
Given the complexity of climate change and the political, economic and technological changes that it drives, companies must take an integrated approach to improving climate-related financial disclosures, one that transcends department, hierarchy or function. Indeed, in order to execute TCFD recommendations properly, the team should have a full grasp of:
- the geographical spread of the company’s assets and most importantly its value chain;
- insight into the specific operational footprint and processes deployed at each asset;
- investor requirements;
- customer and stakeholder perspectives;
- insight into how the company would integrate any risks or opportunities into financial planning;
- regulatory context for each operational asset; and
- the market and technology shifts affecting the industry and geographies in which the company operates.
Given the comprehensive nature of the risks, a multidisciplinary team with representation from all major departments and business lines, i.e. strategy teams, operations, supply chain, HR, facilities management, OpEx, etc., is recommended. Specific roles and responsibilities along with key performance indicators (KPIs) should be defined for each personnel within this team to ensure a strong internal collaboration. Moreover, based on the job roles defined, it will be essential to provide necessary trainings to ensure organisational sustainability.
Furthermore, it is key to get the company’s management as well as the Board of Directors involved at a very early stage of the project. This will enhance the acceptance of the required governance changes (e.g. Board’s oversight) and results in a smooth implementation of new processes and dissemination of responsibilities.
Top down and bottom up gap analysis
Companies should start their TCFD journey by conducting a comprehensive gap analysis, as it gives a clear picture of existing alignment to TCFD recommendations and where improvements can be made. This sets the context and allows for connections with the broader change management framework of the company.
Board oversight and governance is a key element of the TCFD recommendations, and thus it is important to understand the perspectives and knowledge of climate change risks and their impacts over time at this level.
However, as is often the case within risk management, the detail is of paramount importance. Therefore, a bottom-up assessment that identifies gaps in processes, risk identification and mitigation strategies, scenario development and target setting is also necessary.
The intended outcomes for the gap analysis should be:
- To see how the company is already equipped and positioned in terms of sustainability reporting (e.g. is the company already reporting against SASB, GRI, CSRD?). There may be significant overlap with other ESG reporting standards;
- To assess the company’s current engagement in terms of carbon accounting and climate action;
- To understand the breadth and efficacy of the company’s current risk management practices;
- o check the responsibility of the Board of Directors and management in their assessing and managing climate-related risks and opportunities;
- To understand what additional resources (data collection, skills, knowledge) are needed to meet TCFD disclosure requirements (e.g. is there enough knowledge of climate risks in the company to answer to TCFD requirements?); and
- To develop a complete plan of action to build capabilities of employees in climate-related reporting.
Embed into standard business risk management approaches
Climate change will have wide-ranging implications that will affect companies’ supply chains, products, operations, customers, and employees. To identify potentially material climate risk impacts (liability risks, operational risks), companies should integrate these risks in their existing risk management process and concurrently make modifications to consider the unique characteristics of climate risks. For example, some of the risks will materialise only over time horizons that go far beyond the length of typical business planning cycles.
Furthermore, given the uncertainty on how key risk drivers will develop over coming decades, scenarios which represent different hypothetical outcomes must be considered. For this purpose, projections for relevant variables, such as the carbon price, should be based on established climate scenarios developed by the Intergovernmental Panel on Climate Change, International Energy Agency, and Network of Central Banks and Supervisors for Greening the Financial System (NGFS). Conducting thorough scenario analysis is key for the business to understand how resilient their business strategy would be considering different future developments.
Once transition and physical risks are identified, firms must first determine which are material to the company and how they plan to manage and mitigate these risks. It is important to keep in mind that it is not possible to apply a common methodology to estimate the financial impact of the examined climate risks and opportunities, as it depends on the characteristics of the risks and opportunities under consideration. For instance, transitional risks such as the increased operating costs due to higher carbon prices should be calculated directly based on the projected and expected carbon prices (included in the examined scenarios), while other long-term physical risks such as increased temperatures are more case and site specific.
Additionally, when analysing how the company might be affected, there should be a significant focus on the opportunities that may arise from a just transition to a low-carbon economy or from physical impacts of a changing climate. Much value can be generated for stakeholders and shareholders by providing solutions to climate-related challenges.
Develop a climate strategy with quantifiable metrics
Developing a transition plan and an adaptation plan is essential to address climate risks and opportunities in the company’s strategy. After identifying the latter, the company should develop a climate strategy that maps out milestones and targets to navigate smoothly in different future scenarios. This strategy should have quantifiable metrics and targets, be credible and have realistic actions and financial plans. Ensuring the latter is key not only for the reputation of the company but for the longevity of the company. This process is iterative as a climate strategy should be reviewed periodically to ensure that the goals are achieved.
Tailor your disclosures to your risk profile and audience
Finally, companies must engage with their stakeholders on how they plan to implement recommendations of the TCFD. Though TCFD may be thought of as an outward-facing disclosure mechanism, the disclosure reporting is a primary tool for stakeholder and shareholder decision making processes. The reporting should therefore provide an overview of the company’s exposure to positive and negative climaterelated impacts with a focus on its governance, strategy, processes for managing climate-related risks as well as showing key performance indicators and targets related to emissions (e.g. Scope 1, 2 and 3).
Furthermore, companies will need to carefully assess the financial implications of their TCFD analysis on the following key areas: impact on their EBITDA, asset impairments, writedowns, stranded assets, and other factors which will have direct impact on their value, their reputation (which also impacts their value), and perhaps on their overall viability. Afterall, this is how TCFD disclosures will ultimately be interpreted and scrutinised.
The overall goal is to create disclosures that contain relevant information and that are comparable, consistent, reliable, and forward-looking. There is no one framework for reporting; it must be customised to the company and its specific footprint. We recommend finding an appropriate balance between qualitative and quantitative information to fully capture the whole picture.
In sum
While we recommend to focus on the following steps for the TCFD implementation, these do not need to happen at once and you can continuously progress on your TCFD journey over time:
- Mobilise and motivate the organisation. Ensure internal alignment with active stake-holder engagement and adequate supporting processes.
- Assess the company’s readiness with regard to the different requirements, and ensure appropriate actions are planned to fill the gaps (aligning with ESG reporting standards, data management for GHG accounting, building the necessary leadership skills, adapting the governance and operational model, etc.).
- Break down the general climate risk into specific material risks, qualify and if possible quantify the potential impacts on the organisation, and include mitigation measures and barriers in the corporate risk management process.
- Link the specific risks for the company to a corporate decarbonisation strategy based on credible targets (e.g. within SBTi framework), and an identified set of actions and transformations to achieve them.
SOURCES:
- Task Force on Climate-Related Financial Disclosures. (2021). 2021 Status Report. https://assets.bbhub.io/company/sites/60/2022/03/GPP_TCFD_Status_Report_2021_Book_v17.pdf
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