Fast-track your alignment
How can ESG affect your portfolios? Historically, investors have warned that inadequate company reporting and communication on climate risk hinders efforts to align portfolios with the transition to a low-carbon future.
The financial risks of climate change are becoming increasingly visible in global markets as the Earth’s global average temperature continues to rise and extreme weather patterns intensify. In 2019 the Economist Intelligence Unit found that climate change could directly cost the world economy $7.9 tn by mid-century as increased drought, flooding and crop failures hamper growth and threaten infrastructure.
Investors need to understand how their portfolios could be impacted by the financial risks presented by climate change. They also need to understand how companies are positioning themselves to take advantage of new opportunities in the transition to a low-carbon future, which could lead to disruptive change for many business sectors in the near term.
The Task Force on Climate-related Financial Disclosures (TCFD) was established in 2015 by the Financial Stability Board to provide recommendations for more effective disclosure that could provide the consistent visibility investors need to channel investment to sustainable and resilient solutions, opportunities and business models.
Backing for TCFD reporting recommendations has significantly surpassed initial expectations, with the number of supporting companies exceeding 1,500 in 2020 – more than five times that in 2017. This is expected to accelerate further, with major financial market participants including BlackRock and the Canada Pension Plan Investment Board asking companies to report in line with TCFD, and countries including New Zealand and the UK adding their requests.
What do IR teams need to know about TCFD? Investors’ requests for disclosure on ESG risks and opportunities are intensifying. While some require a holistic view of all things ESG, others are asking companies to provide very specific information about how climate change considerations are being integrated into their business strategy. If your organization falls into the latter, by aligning with and supporting TCFD, IR teams can demonstrate that companies are taking action to build more resilient business models through disclosing their management of climate risks and opportunities in a standardized way.
The TCFD recommends the use of scenario analysis to assess climate risks and opportunities and asks organizations to report on the extent to which adequate governance, strategy, risk management, metrics and targets are in place to address climate issues.
Being TCFD-aligned means you have assessed the transition and physical risks of climate change and you have a better understanding of the resilience of your organization under different climate change scenarios. It further means that you understand the opportunities associated with the low-carbon transition.
What are transition and physical climate risks? Strong global action to tackle the effects of climate change could result in policy, legal, technology and market changes as we transition to a low-carbon economy. These are known as transition risks and include such things as regulation (like carbon taxes, emissions trading schemes and other fossil fuel taxes) designed to impose a price on carbon emissions. Our carbon-pricing analysis shows that major companies listed on the S&P 500® face up to $122 bn in unpriced carbon costs by 2025 (11 percent of earnings), while for major global companies listed on the S&P Global 1200 index this rises to $284 bn (13 percent of earnings)1.
At the same time, however, a transition to a low-carbon economy could provide a number of opportunities, especially for companies with products and services that enable the transition.
Past or continued inaction on climate change, on the other hand, could result in physical risks. These include issues like extreme weather events, heatwaves, water stress and sea-level rises that may become more prevalent due to climate change and pose risks to assets, operations, supply chains and investment portfolios. Our physical risk analysis shows that water stress, heatwaves and wildfire are the greatest drivers of physical risk for major US and global companies2.
What steps do I need to take? Publishing a TCFD report means quantifying your company’s carbon footprint, applying scenario analysis to understand the potential impact of physical and transition climate risks on the business model, and identifying opportunities in the low-carbon transition. Consider setting robust, science-based targets to strengthen your organization’s commitment to managing climate-related issues.
Finally, you should report the results of your assessment to the investment community. Climate-related disclosures should ideally be made alongside the financial results in your annual report.
For more information about aligning with the recommendations of the TCFD, check out our guidance: I need to align with TCFD.
1Hundreds of billions in unpriced carbon costs expected by 2050 Source: S&P Global Trucost, 2020 2Water stress, heatwave and wildfire dominate physical risk exposure Source: S&P Global Trucost, 2020
