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Boards feel the heat from investors on climate risk

Mitigation of climate risk is moving to the top of the agenda for senior management and company boards

Nine institutional investors, managing some $3 trillion in assets, recently announced plans to develop climate risk disclosure tools. The pledge, made in March 2018, is seen by many as proof that discussions about climate change and the transition to a clean energy economy are being elevated to the top of the corporate agenda. The tools are being developed in line with the Task Force on Climate-related Financial Disclosure (TCFD), an initiative set up in 2015 by the Financial Stability Board (FSB), a body of the G20 group of the world’s largest economies led by Bank of England governor Mark Carney. TCFD is a direct response to Carney’s concerns about the “systemic risk” climate change poses to the financial sector. Chaired by Michael Bloomberg, US businessman and former mayor of New York, its mandate includes developing voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers and other stakeholders. The latest news follows the announcement in December 2017 that 237 companies, with a combined value of more than $6.3 trillion, had committed to support the TCFD. Among others, they include financial services groups such as Citigroup, DNB, HSBC and Nordea, energy giants such as EDF, Royal Dutch Shell and Statoil, transport firm Maersk, and consumer goods firms such as Coca Cola and Unilever. “The TCFD has legitimised climate change as an issue for senior management,” says Rory Sullivan, a sustainable investment consultant and a member of the Transition Pathway Initiative, a group set up by investors to assess how companies are preparing for the transition to a low-carbon economy. “It also provides an agreed framework within which companies and investors can articulate how they are responding to climate change,” he adds. The TCFD published its final recommendations in June, 2017. It calls for investors and companies to disclose climate information across four themes: governance, strategy, risk management, and metrics and targets. It suggests they use scenario analyses to deal with the uncertainties around climate change, the effects of future climate policies, the emergence of low-carbon technologies, and changing consumer preferences. And, crucially, it suggests these disclosures are presented in an organisation’s main report and accounts, rather than relegated to a separate sustainability report.

We are investing for future generations and would like companies to move from words to numbers in assessing climate risk in their investments, risk management, and reporting

Investor community support

The TCFD’s work has received strong endorsement from the investor community. Norges Bank Investment Management (NBIM), which manages Norway’s giant sovereign wealth fund, has incorporated the TFCD’s recommendations into its climate change strategy document, which sets out its expectations for companies on climate change. “We are investing for future generations and would like companies to move from words to numbers in assessing climate risk in their investments, risk management, and reporting,” said Yngve Slyngstad, CEO of NBIM at the launch of the $3 trillion investor initiative on climate risk disclosure, organised by UN Environment. The majority of companies, however, have not yet committed words to the subject, let alone numbers. A survey in October 2017 by KPMG, one of the big-four accounting firms, of 4900 of the world’s largest companies found that only 28% acknowledged in their annual financial reports the risk posed by climate change and that just 4% provided analysis of the potential business value at risk. “Our survey shows that, even among the world’s largest companies, very few are providing investors with adequate indications of value at risk from climate change,” said José Luis Blasco, KPMG’s global head of sustainability services. Not enough action
Even among those companies that are actively disclosing information on environmental issues, there is a gulf between acknowledging climate risk and taking action to manage it. The CDP — formerly the Carbon Disclosure Project, which collects environmental data on behalf of investors — looked at how companies are disclosing information on the four themes identified by the TFCD. An analysis of climate information disclosed by 1681 companies to the CDP platform found that 83% recognised the physical risks posed by climate change. Only one in ten companies, however, reported that they provided incentives for board members to manage climate-related risks and opportunities. “This shows a gap between disclosure and action,” says Jane Stevensen, task force engagement director at CDP. “Companies have had, for a while, very well-informed sustainability departments. It is now time for this information to make the leap from there to the board.” She adds, “TCFD offers a very simple diagram of how companies should approach the issue. It’s like an onion, with governance wrapped around the whole thing. The headline is: this should be a board responsibility.”

Huge challenge

Still, there is a mountain to climb. In a latest assessment of bank financing of “extreme” fossil fuels, such as tar sands, coal mining and ultra-deepwater oil, a coalition of environmental groups found that lending to the sector had risen between 2016 and 2017, from $104 billion to $115 billion, after declining in the prior year. This was largely due to a substantial increase in the financing of tar sands projects and pipelines in Canada. “There’s a lot of TCFD rhetoric currently,” says Grieg Aitken, climate campaigner at Banktrack, one of the groups behind the 2018 Banking on Climate Change report. “We weren’t exactly holding our breath in the first year of the TCFD … but the report shows the scale of the challenge.” Investors are, however, confident that disclosure will encourage action among companies. “Reporting can be a tool for change, and investors are becoming more knowledgeable about it,” says Christina Olivecrona, senior sustainability analyst at AP2, one of Sweden’s national pension funds. “Investors will read the reports with a more critical eye … and the rating agencies and other service providers will also scrutinise them more.” Jan Erik Saugestad, CEO of Storebrand, the largest private asset manager in Norway, agrees. “Disclosure will contribute to the right kind of discussions at the levels that take decisions. The recommendation is that this has to be incorporated into governance structure, strategy work, risk management and, in the end, it recommends that metrics and targets are established.” He admits there are differences between companies, but insists that he sees, “An increasing willingness to understand the complexity and the risks associated with different scenarios.” He gives the example of the oil and gas sector where a number of companies are explicitly talking about peak oil demand and the implications for their businesses of regulatory changes associated with climate change.

Coal investment drop

“The response in the utility sector is another good example,” says Saugestad. “Corporates are clearly changing their strategies, divesting or avoiding investing in coal and rather investing in solar and wind capacity. That’s one sector where you’ve seen some pretty dramatic shifts.” He points to data from CoalSwarm, a campaigning group opposing investments in coal. “New investments in coal plants have dropped more than 70% in the last two years — that’s an example of things actually happening on the ground.” Saugestad also argues that the TCFD looks at climate risk from a different perspective to socially responsible investors in the past. They tended to look at the impact that companies have on the climate, while the TCFD instead looks at the impact of different climate risk scenarios on companies and on their performance as investments. “In that respect, the TCFD framework is taking a more corporate/investment perspective,” he says. Emma Sjöström from the Stockholm School of Economics in Sweden agrees that because the recommendations apply to investors and companies, efforts by investors to understand their future exposure to climate risk and opportunities will see them apply pressure to companies to provide the necessary disclosures. As investors set targets and metrics to reduce their climate exposures, that will encourage companies to act, she adds. “TCFD will be helpful for engagement processes because it will generate more consistent data, more reliable data and you will be able to follow progress over time,” says Sjöström. It will also allow investors to more easily compare companies against their peers. “It will illuminate who are the stars and who are the laggards,” she says.

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What is climate risk?

Climate change and the attempts of international bodies and governments to deal with it will affect the financial performance of many companies for various reasons. Below is a summary of the main types of climate risk.

1. Policies and investments
to deliver a low-carbon emissions economy are likely to:‒ Reduce market demand for higher carbon products/commodities‒ Increase demand for energy-efficient, lower-carbon products and services‒ Introduce new technologies that may disrupt markets
2. Reputation
Growing expectations for responsible conduct from stakeholders, including investors, lenders, and consumers may lead to the:‒ Opportunity to enhance reputation and brand value‒ Risk of loss of trust and confidence in management 3. Legal
More requirements at international, national and state level are likely to:‒ Increase input/operating costs for high carbon activities‒ Make it more difficult to secure operating licences for high carbon activities‒ Increase concerns about liabilities 4. Physical Risks
Chronic changes and more frequent and severe extremes of climate will:‒ Increase business interruption and damage across operations and supply chains with consequences for input costs, revenues, asset values, and insurance claims

Source: World Bank

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Corporate behaviour

Sullivan of the pathway initiative says that it is difficult to attribute changes within companies directly to the process begun by the TCFD, but he points to disclosure from oil major Shell as an important marker of how it could encourage firms to explain how they might adapt their strategies to prosper in the low-carbon transition. In November 2017, Shell announced a target of reducing the carbon footprint of its energy products by 20% by 2035 and by around half by 2050. Shell’s commitment is, “Not just about setting out scenarios, but it’s about setting out where you want to be in the future. It gives investors and others a framework to evaluate how far the company has progressed,” says Sullivan. The ultimate goal for the climate disclosure process is to encourage investors to shift from high-carbon assets to low-carbon investments. Olivecrona at AP2 is confident this process will take place. “TCFD promotes forward-looking disclosure and as companies report we will have information on how companies are contributing to the low-carbon economy. That will help us.” For CDP’s Stevensen, TCFD is also about arming a wide variety of parties with the knowledge they need to push for change. “What the TCFD does is provide information to a very broad range of stakeholders, such as investors, who have the clout to change behaviour.”

Writer: Mark Nicholls

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his article is part of the Nordic Clean Energy Series
, published by FORESIGHT Climate & Energy to support Nordic Clean Energy Week. A week where energy leaders from around the globe gather in Copenhagen and Malmö to discuss the policies, business and technological solutions and challenges involved in tackling climate change.

Learn more about the week - Nordic Clean Energy Week

Take a look at FORESIGHT’s Nordic Clean Energy Special Edition
published in May 2018.