A game changer for net zero: Climate-related Financial Disclosures

This blog is going to be a bit of a diversion for me. Some of you may well wonder what a self-confessed no-carbon energy geek is doing encroaching onto the territory of my colleagues in the financial services sector.  Well, that’s down to two things. 

First, for as long as I’ve been in energy, doing the right thing when it comes to sustainability has involved trade-offs – neatly articulated in the so-called ‘trilemma’. Okay, ‘trilemma’ maybe an unfamiliar word to those outside the world of new energy, but it captures the trade-off that has existed for a long time between energy security, what it costs and its contribution to climate change. You can pretty much have two out of the three but have to trade-off the third. But, misquoting Meatloaf, “Two out of three ain’t good enough”.

Second, nothing happens without investment!

It’s this second point about investment and what’s happening in the financial sector around climate risk that’s been grabbing my attention. What’s interesting is how the growing need to measure and disclose exposure to climate related risks might drive corporate behaviours beyond the financial sector itself.

Back in April 2019 the Bank of England, under then governor Mark Carney, set out its expectations for firms on governance, risk management, scenario analysis and disclosure in its Supervisory Statement (SS3/19), snazzily titled, “Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change”.

In this Supervisory Statement the Bank of England sets out its concerns about the implications to the financial system of:

• Physical risks: risks arising from climate and weather-related events
• Transitional risks: risks arising from the process of the adjustment towards a lower-carbon economy
   

There’s also the Task-force on Climate-related Financial Disclosures (TCFD) who have published a suite of recommendations to support consistency in disclosure of information by companies providing information to investors, lenders, insurers and other relevant stakeholders about their exposure to physical and transitional risks and about their liabilities arising from climate change. The recommendations are also intended to help companies align their disclosures with investors’ needs and understand what the financial markets want from disclosure in order to measure and respond effectively to climate change risks.

But, why’s an energy geek so interested in this? 

Well, it looks like the investor community and insurance sector will start pricing exposure to climate risk into the cost of capital and into insurance. That’s going to go straight to the cost of doing business, which will place it firmly on the board’s agenda. But, more than that, clear and consistent disclosure (a sort of GAAP for climate risk) will go straight to reputation and an organisation’s ability to secure investment, win business and gain customers’ trust. 

Those companies that have been hiding behind ‘greenwashing’ will be exposed – and all of a sudden, investment in initiatives that genuinely move people forwards on their net zero journeys will start to show return on investment. Doing the right thing will no longer be a decision that involves moral and ethical trade-offs, it will also be the right thing to do economically.

I believe this will do more to change corporate attitudes to addressing the climate crisis than any requirement to comply with regulations. Compliance is all too often seen as an overhead cost rather than a nudge to do the right thing. The challenge is always to find the opportunity and, in the case of addressing the climate crisis, to re-engineer one’s business to be able to access green finance and secure customers by demonstrating that you are a sustainable company.

Companies will need to factor climate response into their strategies and how they will transition their business models to mitigate exposure to climate risk and take the opportunities that it creates. As part of this, businesses will also need to understand the climate risks to which they are exposed throughout their supply chains and take action to reduce their exposure to the risks - be they physical, transitional or reputational. Addressing supply chain risk will incentivise all companies to take climate risk seriously. Leading suppliers are already recognising that they need to address climate risk, with many committing to be net zero by 2030, and that being genuinely ahead of the curve could provide a competitive advantage. But that requires the ability to accurately assess and disclose exposure to climate risks.

If you are in any doubt about the implications of transitional climate risks, NextEra (the world’s largest solar and wind power generator) has recently been reported has having surpassed ExxonMobil (once the world’s biggest public company) in stock market value.

It’s clear that the identification and management of the risks to the financial system arising from the climate crisis is a hot topic! 

To find out more about the role that digital technology can play in identifying and managing climate risk and how to have confidence in the data that you’re using to track your exposure to climate risk, leave a comment below or get in touch with me.