ROWAN CLARKE, Investor Relations

As the investment community increasingly uses ESG information, there has been growing pressure for ESG frameworks and standards to evolve. The International Sustainability Standards Board (ISSB) is currently finalising a requirement for companies to report on their climate-related risks and opportunities, with a decision expected in June 2023.

The Task Force on Climate-related Financial Disclosures (TCFD) Framework is widely endorsed by the investment community, and the reporting requirements proposed by the ISSB will closely align with this Framework. In this blog, we outline the TCFD Framework and explain some of the common challenges faced by companies who have adopted its principles.

The Core Elements

There are four key elements that are included in the TCFD Framework to address the management of climate-related risks and opportunities. These elements include:

1. Governance – what is the approach to governance around climate-related risks and opportunities?
2. Strategy – what are the actual and potential impacts of climate-related risks and opportunities?
3. Risk Management – how are climate-related risks identified, assessed, and managed?
4. Metrics & Targets – what metrics and targets are used to assess and manage relevant climate-related risks and opportunities?

The Task Force doesn’t expect companies to completely align with all aspects of the Framework in the first year, but rather, has suggested a three-step approach that builds disclosure capabilities over time, comprising:

Phase 1

Initially, companies should disclose foundational information relating to Governance and Risk Management.

Phase 2

Once a foundation is laid, disclosure should include elements that are typically viewed as extremely useful by investors. Phase 2 adds elements relating to Metrics & Targets, along with Strategy.

Phase 3

The final phase progresses to a deeper alignment with the Framework. It includes climate-related scenario analysis to inform the resilience of business strategy. Where Phase 2 adds disclosure of Scope 1 and 2 GHG emissions, Phase 3 may include Scope 3 GHG emissions.

Among the challenges for implementing the TCFD Framework, there are several that are commonly mentioned.

Challenge 1 – Board-level Support for TCFD

For companies that operate in sectors where peers are yet to adopt climate-related reporting, the first challenge is getting senior leaders onside to endorse the Framework.

It is important to remind them that investors will not assume the absence of climate-risk if they choose not to disclose this information. In Phase 1, Governance involves explaining how the board oversees climate-related issues, along with management’s role in assessing and managing those issues. Senior leaders need to understand that adopting a Framework will demonstrate their accountability for climate-related issues, allowing them to shape how the company is viewed on these matters by the investment community.

Challenge 2 – Scenario Analysis

The TCFD Framework encourages companies to carry out climate-change scenario analyses to “describe the resilience of the organisation’s strategy based on a review of various climate-related scenarios, including scenarios for climate warming of up to 2°C.”

The Task Force (and ASIC) have noted a reluctance by companies to disclose this information.

While scenario analysis can be a difficult task for many companies who are just starting out, reporting capabilities will naturally mature over time. Importantly, scenario analysis should only be contemplated during Phase 3. It can be a useful exercise to initially engage with stakeholders to define what scenarios should be considered.

A company may start by analysing two scenarios that use opposite ends of the temperature spectrum. However, as capabilities build, three or four scenarios should be modelled. The role of scenario analysis is not to consider a good vs. bad proposition, but to explore fundamentally different yet probable futures and examine how all climate scenarios shape the resilience of a company’s business model.

Challenge 3 – Scope 3 Emissions

Disclosure of GHG emissions falls under Metrics & Targets. Scope 3 GHG emissions are generated across the value-chain yet fall outside a company’s nexus of direct control. Take a mining company for example; their Scope 3 GHG emissions will come from downstream activities like processing of raw materials and consumers using final products, along with upstream activities like purchased inputs used in mining activities and third-party transportation of those inputs.

Aside from Scope 1 and 2 GHG emissions, many companies find the thought of measuring Scope 3 emissions, extremely daunting.

While the Task Force encourages companies to consider disclosing these GHG emissions, it is not mandated in Phase 3. For companies where Scope 3 GHG emissions are a significant portion of total emissions, it can be helpful to initially focus on one or two categories likes business travel or employee commuting, before moving on to calculate complex categories such as GHGs emitted by customers from using sold products, in a future reporting period.

Online resources (e.g., The GHG Protocol) are also available which provide useful tools to measure Scope 3 GHG emissions.

Conclusion

Climate-change reporting is currently a hot topic with the SEC scheduled to release their own disclosure requirements for US companies, in the next few weeks. As global pressure for transparency intensifies, it will be difficult for companies to simply turn a blind eye and ignore making climate-related disclosures. Aligning with the TCFD Framework is a practical first step that all companies should consider when reporting on these matters.