Accounting for climate risk

By Richard Gordon

In heavily regulated industries, the perceived wisdom is that it is often better to get ahead of the regulators and voluntarily adopt a new policy than sit back and wait for the Government to set the rules.

Because sure as day follows night, regulators want to regulate; it’s their reason for being. And new regulations may not fit businesses as well as self-imposed ones.

Right now, the Government is thinking about mandatory rules for businesses to disclose climate change impacts, threats, risks and opportunities. In 2018, the Productivity Commission recommended a mandatory, principles-based disclosure regime.

Last month the Government – in the form of Commerce Minister Kris Faafoi and Climate Change Minister James Shaw – said it was investigating this recommendation and is considering how best to achieve climate-related financial risk disclosures.

The Government doesn’t have to look very far to find guidance on climate risk disclosure as an international framework on climate disclosure already exists.

Called the Taskforce on Climate-related Financial Disclosure (TCFD), it was developed by a consortium of businesses and NGOs formed under the Financial Stability Board, an international body that monitors and makes recommendations about the global financial system. The Taskforce first met in 2015 and released the framework in June 2017.

Since then, TCFD has been widely endorsed by many of the world’s largest investors as a critical step forward to ensure the allocation of capital and asset pricing in the face of growing climate related risks.

The TCFD sets out voluntary corporate climate change disclosure recommendations to help investors, lenders and insurers adequately assess climate change-related financial risks and opportunities.

The New Zealand Government is considering the use of the TCFD and is now consulting stakeholders on whether it should adopt the framework on a “comply or explain why not” basis. Organisations that would be expected to use the TCFD principles include listed issuers, banks, general insurers, asset owners and asset managers. The Government is also considering whether small entities should be excluded from the comply or explain regime.

International experience with TCFD

While many listed companies in global markets, including New Zealand, have improved their public disclosure on carbon emissions and carbon management, most, according to research firm MSCI, have left the issue of carbon risk and strategy unaddressed.

Most companies have not yet found a way to disclose carbon emissions targets, the resilience of their business strategies to climate-related scenarios or the impact of climate change on their assets and revenues.

Interest in TCFD is growing in this country, largely through the efforts of the McGuinness Institute, a Wellington-based non-partisan think tank.

Recently, two New Zealand listed companies – Meridian and Z Energy – took their climate change reporting a step further and published statements on their climate-related risk.

Mandatory reporting requirements for New Zealand businesses are, compared to other jurisdictions, relatively light. Only financial statements are required to be filed, and only for a select number of companies.

By comparison, by 2020 approximately 12,000 UK companies will publicly report on greenhouse gas (GHG) emissions in their directors’ report as part of their annual filing with the Companies House. If New Zealand adopted the same threshold and practices of the UK, all the Deloitte Top 200 companies would be required to report GHG emissions to the Companies Register.

By 2022 all UK listed companies and large asset owners are expected to disclose in line with TCFD recommendations.

Business impact on low-carbon economy

At this point you may be asking why governments are seeking greater climate impact, opportunity and risk disclosure from businesses.

As mentioned above, investors want to understand how resilient or flexible a business strategy is when viewed through the optics of several climate change scenarios, which involve potentially catastrophic impacts on agriculture, coastlines, eco-systems and humanity.

Secondly, the sheer scale of transitioning to a low-carbon and climate-resilient economy will require significant financial investment and technology.

There is a school of thought that believes market forces and business will have a greater impact on transitioning to a low-carbon economy than government policy or civil society.

For example, the United Nations Sustainable Development Goals (SDG) acknowledge the role of market forces. SDG 12 on Sustainable Consumption and Production encourages “companies to adopt sustainable practices and integrate sustainable information into their reporting cycles”.

Global capital markets will be critical to making progress on Climate Action (SDG 13) and will be positioned to contribute to and benefit from significant investment in a successful global transition to a low-carbon and climate-resilient economy.

Capital is more likely to seek out those companies that are disclosing their climate strategies, their risk and their economic growth opportunities.

(Next month we dig deeper into the TCFD and examine its core principles.)

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