As climate change awareness intensifies, investors, lenders, insurers, and other stakeholders are factoring climate-related risks into decisions. Therefore, corporations are expected to disclose relevant information about the financial impacts of climate change on their businesses.
However, such information is not readily available, and many companies are struggling to identify, quantify, and report these risks.
Back in 2010, the U.S. Securities and Exchange Commission issued public-company guidance to address the disclosure of material impacts of climate change. This was intended to incentivize investment in sustainable businesses, while responding to growing investor awareness of the importance of climate change.
In 2015, Mark Carney, chairman of the Financial Stability Board (FSB) and chair and governor of the Bank of England, formed the Task Force on Climate-related Financial Disclosures (TCFD), the first international initiative to examine climate change in the context of financial stability.
Despite these developments, there has been little change in how companies disclose climate-related information. The KPMG Survey of Corporate Responsibility Reporting 2017 found that three-quarters of the largest companies worldwide by revenue (the G250) don’t acknowledge climate change as a financial risk. And nearly half of the largest 100 U.S. companies by revenue (the N100) don’t acknowledge financial risks of climate change in annual reports.
Furthermore, no companies that do recognize these risks publicly quantify them in financial terms or model their potential financial impact using scenario analysis.
So, what are climate-related financial risks, and why is disclosure increasing in importance
The TCFD describes two climate risk categories: transition and physical risks, according to KPMG’s FSB Task Force on Climate Related Financial Disclosures report.
Transition risks include the financial and reputational impact of failing to make a successful commercial transition to the low-carbon economy. This could include policy actions that attempt to mitigate climate change or encourage adaptation to it, litigation claims against companies for contributing to climate change (or failing to act on it), or risks of the displacement of existing technologies with new technologies and infrastructure and changes in market dynamics.
Physical risks include the financial impacts of the physical effects of climate change. This could include disruption to a corporation’s operations from extreme weather or impacts from longer-term shifts in climate patterns.
The TCFD has highlighted opportunities that can be realized by companies through efforts to mitigate and adapt to climate change, including:
In July 2017, the TCFD submitted recommendations to the G20, offering guidance on how organizations should disclose climate-related risk in public financial filings. The recommendations are designed to generate actionable, forward-looking information on climate-related financial impacts and increase the focus on risks and opportunities related to a transition to a lower-carbon economy.
Why aren’t companies disclosing climate information? Most have never had to before, and there are no widely established processes for the scenario-based climate risk reporting that the TCFD recommends.
Companies must first acknowledge the existence of climate risks and work to understand their likelihood and potential business impact. Without awareness by top management or external pressures driving disclosure, climate does not get elevated as an enterprise risk in the same way financial or operational risks might. Climate-related financial risks should also be pinpointed for attention by boards of directors, and companies should adapt their risk management processes to identify and manage them.
Companies should also assess climate-related financial risks and opportunities. The TCFD recommends scenario analysis to assess potential business, strategic, and financial implications of climate-related risks and opportunities and that public disclosures provide technical guidance.
We are witnessing some progress. Companies are adopting science-based targets (23% of both the G250 and the N100). Such targets can help companies demonstrate to their investors, suppliers, workforces, and the public their preparedness to transition to a low-carbon economy and can be an important first step in adopting TCFD recommendations.
The use of these targets should increase as investors seek assurance that companies are prepared for a low-carbon future.
Katherine Blue is U.S. sustainability services leader at KPMG LLP. This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP.