Change of mindset
It has been a long time coming, but many of the principal players in the global financial sector – famous for its aversion to standard risks, but blind to climate effects – have finally begun to accept that climate change is perhaps the biggest risk of all.
Now the boot is on the other foot and the business and financial establishment is on the verge of a massive about-turn. Instead of climate-related investments being seen as risky ventures, forwardlooking managers have woken up to the far bigger risks posed by failing to invest in measures that benefit the climate.
At a meeting of the Task Force on Climate-Related Financial Disclosures in Tokyo last October, Mark Carney came up with
this stark warning: “Changes in climate policies, new technologies and growing physical risks will prompt reassessments of the values of virtually every financial asset. Firms that align their business models to the transition to a net-zero world will be rewarded handsomely. Those that fail to adapt will cease to exist. The longer that meaningful adjustment is delayed, the greater the disruption will be.”
Ricardo’s Jamie Pitcairn, technical director for the circular economy and sustainability, concurs.
“It’s more than just corporate social relations – it’s about the continued existence of your business and what changes need to be made to your business model, as business as usual is not an option”
Even before the turn of the millennium it had become clear that normal market forces, all too often focused purely on short-term gain, were unlikely to persuade major companies to acknowledge climate risks in their future planning. Yet a group of enlightened central banks could see the threat to long-term financial stability and, through the international G20 organization, established the Task Force
on Climate-Related Financial Disclosures, or TCFD.
Comprised of 32 members, from a variety of international financial institutions both public and private, the TCFD has developed a standardized framework for companies to ascertain and disclose the climate-related risks expected to confront their organization in
Although TCFD reporting is technically still voluntary, it is expected to become near universal within two or three years, adds Carl Telford, manager of strategy and futures at Ricardo Strategic Consulting: “National central banks are already supporting TCFD through the financial system. In the UK every bank and pension fund and every insurance company has to go through the process, and this will force it into the real economy.” For individuals, adds Telford, “your risks are coming from the companies you are exposed to – and after BlackRock’s move in January I expect most other companies to follow suit. It will be a massive risk for companies that don’t do it, and they will no longer be seen as investment-grade stock. After all, as an investor, would you put money into a company that doesn’t
understand its own risks?”
The pressure will build internationally, too, he elaborates. “As soon as there is regulation in one or two G20 markets, you’ll see the rush. Global companies based in India and China, for instance, are heavily reliant on overseas investors. They’ll do it.”
How does TCFD operate?
Tim Curtis is at pains to point out that the TCFD process is much more than a tickbox exercise. “Because of the pressure oncompanies to disclose this information in their financial and strategic reports, we know from experience that you have to look at everything from materiality and scenario planning to the strategic and financial impacts.”
Curtis argues that it is much better to acknowledge your risks and be clear that you have a plan: “That’s what is seen as good management.”
The Task Force has issued a series of communications to help companies with their climate-risk reporting. The process is linked in to a firm’s policies on environmental and social governance: it is here that the notion of financial materiality comes into play, factoring in influences which could have an effect on the company’s future position. How climate change will be material to a company’s operations will depend on a wide range of factors, including the nature of its business, its geographical location, and its supply chain.
TCFD also asks companies to carry out scenario analysis to explore how they would respond to a range of hypothetical future scenarios such as a 2-degree rise in temperatures, a 1-metre rise in sea levels, or a carbon price of, say, $100 a tonne.
The TCFD process draws in the toplevel managers and specialists within the company, the underlying objective being to ensure that there is a senior management function in the boardroom overseeing climate risks. The Bank of England has mandated this as compulsory for banks and insurance companies in the UK since October 2019.
Cataloguing the risks and opportunities
It is something of a lazy management cliché that behind every risk there is an opportunity. Yet for all the disastrous consequences it threatens us with, climate change does present big opportunities for those who acknowledge it and have the courage to adapt their
business models in good time. Tesla is a good example of a company ahead of the game in the migration to electric vehicles, and even Britain’s National Health Service says a transition to net-zero carbon emissions could save it money.
“That’s why today we are mobilizing our1.3 million staff to take action for a greener NHS,” said chief executive Sir Simon Stevens, “and it’s why we’ll be working with the world’s leading experts to help set a practical, evidence-based and ambitious date for the NHS to reach net zero.” As for the fossil fuel industry, as has been widely discussed, a zero-carbon world represents an existential threat to their business. “Oil and gas assets total some $20 trillion,” observes Jamie Pitcairn, “but if we are stick to the Paris figure of a 1.5-degree temperature rise, 80 percent of these assets will become worthless – they will become stranded assets. As an investor, you would have to consider that.”
Yet if that same company were to put forward a coherent transition plan to divest from fossil fuels, its appeal to investors would be transformed. The imperative of disclosure and early action to diversify is clear for to all to see. In February this year incoming BP CEO
Bernard Looney surprised the City with a pledge that the oil major would aim for net-zero carbon emissions by 2050: however, in the absence of concrete plans to achieve this, the market reaction has so far been muted.
On the other side of the coin are the opportunities that clear TCFD declarations open up for investments. The knowledge that TCFD declarations are to a common format and adhere to strict rules gives provides a further layer of respectability to investments in climate-mitigating programmes, boosting their appeal to investment fund managers and private investors alike.
“Better TCFD disclosure is an opportunity,” adds Mark Carney. “Research by the Bank of England and PwC finds a positive correlation between companies’ stock price and the number of TCFD disclosures that firms make. This could be because investors reward companies that are leaders in managing climate-related risks or simply because TCFD adoption identifies companies that are more naturally disposed to longer-term strategic thinking and planning.”