Investors will have new expectations from the C-suite and the board
Data on climate metrics is fast becoming a key constituent of annual reports, especially since the G20 Task Force on Climate-related Financial Disclosures (TCFD), backed by economic heavyweights Mark Carney and Michael Bloomberg, launched its recommendations on climate-related financial disclosures. As the driver of global disclosure, CDP welcomes these recommendations to mainstream climate risk and is adopting them in their entirety as part of its ‘reimagining disclosure’ initiative.
The TCFD provides clear instructions for businesses to include information on the climate-related material risks they face in their annual financial reporting. This means investors will expect C-level executives and boards to demonstrate company governance, strategy and risk management of climate change, and the metrics used to track environmental performance.
For many companies the question has become not whether to manage climate risk and opportunities but how to do it. So what is the process, and what metrics and targets will corporates be expected to report to investors?
The climate strategy framework
There are four essential components of the TCFD recommendations that companies will have to consider:
• Governance: Climate-related risks and opportunities, board and senior management engagement in climate issues
• Strategy: Actual and potential impacts of climate-related risks and opportunities to the organization’s business model
• Risk management: The processes used to identify, assess and manage climate-related risks
• Metrics and targets: The tools to measure, assess and manage relevant climate-related risks and opportunities.
Metrics to measure performance
Underpinning this framework is a set of metrics that companies will need to use to measure and assess corporate climate action and exposure, such as scenario analysis, low-carbon transition plans and science-based targets (SBTs).
SBTs are corporate decarbonization targets that are aligned with keeping global temperature rise below 2°C. They allow companies to future-proof growth by specifying how much and how quickly they need to reduce their greenhouse gas emissions. In this way, they show intent and progress toward mitigating the risks attached to transitioning to a low-carbon economy. ‘Scenario analysis’ refers to the need for companies to disclose financial planning for the potential impact of different degrees of climate change on their business.
Other common metrics used by companies reporting to CDP that help investors assess corporate climate performance include total capital expenditure in low-carbon investment, operational efficiency measures on energy and water use, the percentage of production in water-stressed areas and carbon pricing.
Pricing carbon risks
About 40 national jurisdictions and more than 20 cities, states and regions are putting a price on greenhouse gas emissions, according to the World Bank. As carbon markets become ubiquitous, their likely impacts cannot be ignored, and companies should consider introducing an internal carbon price to assess their exposure. China’s plan to introduce a national carbon market is certain to prove particularly disruptive, with more than a fifth of the country’s electricity already traded in its nascent regional markets. Companies should set an internal carbon price that is high enough to materially affect investment decisions and drive down greenhouse gas emissions.
Worryingly, CDP analyses demonstrate that many of the world’s leading companies remain significantly exposed to material risks from carbon pricing. Ten of the biggest international mining companies, including Glencore and Rio Tinto, are collectively exposed to more than $8 bn in costs from carbon price schemes by 2020. Meanwhile, European utilities such as RWE and EDF have €14 bn ($17 bn) of earnings at risk.
A new normal
Recent months have seen shareholder activity around climate change escalate. At Exxon in May 2017, 62 percent of shareholders called for disclosure on climate risk, while the world’s largest asset manager, BlackRock, now makes it a top engagement priority to ask companies how they are assessing the risks and opportunities climate change may pose to their operations.
This is evidence that investors increasingly see environmental data as a proxy to identify leaders and laggards in the transition to a low-carbon economy. It is paramount for companies to understand the metrics they will need to use to put an adequate climate change strategy in place.
Dr Tony Rooke is head of reporting at CDP, the world’s leading global platform for environmental disclosure