It’s clear to many companies and investors that the physical impacts of climate change and the transition to a low-carbon economy pose financial risks if companies are not prepared. But financial reporting on those risks has not been always consistent or clear.
After 18 months of work, an industry-led task force has recommended ways companies across multiple sectors can inform their lenders, investors, insurance underwriters, and other stakeholders about climate risks—and opportunities—for their businesses. The framework is voluntary, but already more than 100 companies, including Bank of America, BHP Billiton, Dow Chemical Company, and Royal Dutch Shell, are supporting the recommendations.
The Financial Stability Board’s Task Force on Climate-related Financial Disclosures focused on corporate governance, strategy, risk management, and climate-related metrics and targets. The final recommendations provide guidance to companies on how to translate climate risks and opportunities into traditional financial terms, like revenues, expenditures, assets, and liabilities, and how to integrate climate risks into existing business continuity and enterprise risk management systems.
One of the most important recommendations is that more companies conduct a scenario analysis. Looking out over the horizon, companies should analyze what climate change will mean for their facilities, operations, supply and distribution chains, as well as demand for their products and services over a range of plausible scenarios. For example, how might sea-level rise and increased frequency and severity of heat, drought, and other extreme weather pose financial risks to the business over time? Or how will moving to a low-carbon energy economy present significant opportunities or challenges for the business? The task force recommendations are flexible because each company may use scenario analysis to develop an individual strategy to capitalize on opportunities and manage transition risks. The financial impacts of climate change will vary depending on the intensity of climate impacts (for physical risks) and on the timing and nature of policy and market changes (for transition risks). That’s why a scenario analysis to stress-test the resilience of a company’s business model and portfolio across a range of plausible scenarios is critical.
Some companies are conducting this scenario analysis in a thoughtful and public way. BHP Billiton, a global mining company, issued a recent scenario analysis explaining the resilience of its portfolio to several climate-related scenarios. Companies should continue to work together, including through the task force, on adopting consistent frameworks and best practices for these scenario analyses.
Another key aspect of the recommendations is the focus on climate-related metrics and targets. If more companies consistently disclose measurable data, then lenders, investors, and others can compare across industries and companies within an industry. This provides ratings agencies and investors with an opportunity to identify company leaders within an industry and industries that may be attractive investment opportunities.
The Financial Stability Board, which was established by the finance ministers of the world’s top 20 economies after the 2008 financial crisis, convened the task force to address the vulnerability of the global financial system to climate-related disruption. If a “carbon bubble” – an overvaluation of carbon-intensive assets – exists due to a lack of transparency and inadequate financial reporting on climate change, investors and lenders need to be protected.
Greater transparency in financial reporting has numerous potential benefits, including:
Public policy and private investment go hand in hand in achieving the emissions reductions needed to avert the worst impacts of climate change. We need public policy to establish the market signals for greater investment in energy and water efficient technologies. We need private investment to drive technological advancements that will help us achieve our emissions reductions goals faster and at lower cost. By promoting transparency in the financial markets, the task force recommendations make it easier for investors and lenders to focus on companies that are helping us achieve our emissions reductions goals. They also help ensure the resilience of the global financial system to climate change impacts and should be commended as an example of industry leadership on a dynamic and accelerating challenge.