Many Chief Financial Officers (CFOs) are grappling with an ever-increasing array of international climate change regulations. This means it may be important for finance chiefs to understand their obligations and put in place systems to ensure these regulations are being met.

In 2017 a step change in climate-related legislation occurred with the publication of the recommendations of the Financial Stability Board's Taskforce on Climate-Related Financial Disclosures (TCFD).

As Sharanjit Paddam, Deloitte Australia's Principal of Consulting explains, these recommendations cover disclosures related to a company's governance, strategy, risk management, as well as metrics and targets related to climate change risks and opportunities.

“It is primarily about the financial impact of those risks and opportunities, and not just about the disclosure of carbon emissions," Paddam says.

“The taskforce has asked companies to disclose how climate change will affect future shareholder returns. It encourages them to identify risks and opportunities and how the company is adapting to them," he adds.

This includes recommendations on disclosing the impact of different scenarios on the company, such as achieving the Paris Agreement target of a temperature rise of less than two degrees Celsius compared to pre-industrial revolution temperatures.

Paddam says the TCFD's focus on financial impacts is a radical change in corporate reporting and presents a significant challenge for many companies who are not accustomed to disclosing this data.

Towards compliance

While the TCFD recommendations are voluntary, stakeholders including large institutional investors, regulators and rating agencies have been strongly encouraging boards of directors to adopt them.

For example, BlackRock, the world's largest fund manager, is threatening to vote out directors who fail to adequately address the threats posed by climate change. Ratings agency Moody's has already indicated climate risk will impact companies' credit ratings and, therefore, their cost of capital.

“We are expecting most companies with significant exposure to climate risk will adopt the recommendations," says Paddam.

“We've already seen big four bank ANZ publish its first climate change disclosures under the new regime. We expect many banks, insurers and asset managers to follow suit, as well as companies from the agricultural, transport, tourism and of course energy and mining sectors," he adds.

The key to implementing the TCFD's recommendations is the underlying processes to identify, measure, manage and mitigate climate risk, as well as strategies to take advantage of opportunities.

Says Paddam: “Once those processes are in place, with proper governance and oversight from the board, and regularly monitored metrics and targets, then disclosure under the standard is relatively straight forward.

“We have found the toughest challenge in companies implementing the TCFD has been the level of coordination required between different teams within the company. Full disclosure requires the finance, risk, strategy and products, and sustainability teams to work closely together in ways that they may not have done in the past."

Emerging issues

Deloitte has highlighted three emerging issues CFOs can consider when formulating their approach to climate change considering the TCFD's recommendations.

The first is understanding and meeting stakeholder expectations.

“Develop an appreciation of the information investors, regulators and ratings agencies need and the level of detail they require when assessing climate change impacts. Initially we expect companies to make very high-level disclosures but over time this will continue to increase as they compete for capital," Paddam explains.

The second issue is scenario testing. Under the TCFD's recommendations, companies are expected to disclose the impact of difference scenarios on their assets and liabilities and future cash flows.

“In many ways, this is a much more prospective view of a company's financials than in the past, and requires businesses to report on aspects of their operations that they may not have done before. Defining the scenarios and pathways to achieving climate change goals over time is critical," he adds.

The third issue is financial versus environmental outcomes. Says Paddam: “I think this is the key for CFOs. While they may assist in transitioning to a low carbon economy, the TCFD recommendations are actually about financial not environmental outcomes. In the past, we have tended to see environmental disclosures as separate from the annual report. But now they are to be part of the mainstream financial reports of the company, and subject to the same governance and reporting frameworks."

CFO focus

For CFOs just starting on the climate change journey, the first step is to develop a high-level understanding of how climate change will impact the company's business, especially financially.

“Determine what the risks are. For instance, there may be heightened risk of weather-related disasters affecting the company's properties or other assets as a result of climate change. Then, explore how higher incidences of cyclones and floods may restrict the business's ability to access markets or deliver products. Also work out how any rapid and deep transition to renewable energy may affect the company's future customers, products and markets," says Paddam.

The approach to take will be different for different industries, and CFOs should focus on identifying the risks and opportunities related to their business sector and understand how these flow into any financial impacts on the company.

This high-level financial impact analysis will then allow the CFO to develop a roadmap for prioritising and addressing each risk and opportunity while considering the effect on relevant stakeholders within and outside the company.

Key Takeaways

• Work through several different climate change scenarios and how they may affect your business and its stakeholders.
• Recognising the firm's approach to climate change can affect its credit rating, cost of capital and reputation with investors.
• Craft and implement processes to identify, measure, manage and mitigate climate risk, and put in place strategies to make the most of any opportunities new climate change regulations uncover.
• Investigate how higher incidences of weather events may affect the firm's ability to access markets or deliver products.