FSB task force urges transparency in the battle against climate risk

The Financial Stability Board’s Task Force on Climate-related Financial Disclosures has published its first set of recommendations for companies and financial institutions. These will help investors quantify climate-related risks, says Steve Waygood.

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chart - two chimneys emitting smoke in to the air

Environmentalists were dismayed at Donald Trump’s victory in the US election. During his campaign, Trump vowed to revive the fossil fuel industry, scrap Barack Obama’s environmental protections and cancel the Paris Agreement, which commits governments to hold global temperatures at less than two degrees Celsius above pre-industrial levels. 

But as he settles into the White House, President Trump may find it difficult to reverse the momentum behind the transition to a low-carbon economy. Governments, companies and investors are already taking action to limit fossil fuel emissions and mitigate climate-related risks.

The Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD), chaired by former New York City mayor Michael Bloomberg, is a good example.  The TCFD launched in December 2015 and is backed by companies with a market capitalisation of $1.5 trillion and financial institutions responsible for assets worth a combined $20 trillion. The task force encourages voluntary, consistent disclosures to help investors, lenders and insurance underwriters manage climate risks and identify opportunities.

Steve Waygood, Chief Responsible Investment Officer at Aviva Investors, is a member of the TCFD. “The emergence of the task force proves the business world is serious about tackling climate change,” he says. “This is not some fluffy campaign promoted by a pressure group – it is an initiative backed by some of the world’s biggest companies and financial institutions that want to ensure the transition to a low-carbon economy is managed properly.”

Lacking clarity on companies’ exposures to the risks associated with extreme weather events or climate-related regulatory changes, investors can be left vulnerable to abrupt shifts in asset prices. As Bloomberg put it in a statement co-authored with Bank of England Governor and FSB Chair Mark Carney: “Without the necessary information, market adjustments to climate change will be incomplete, late and potentially destabilising.”

In December 2016, the TFCD published its first set of recommendations on disclosure for companies and other financial institutions. The task force suggests companies run scenario analyses that model potential performance under a range of different climate and policy outcomes, and publish the results as part of their mainstream financial filings. Companies and other financial institutions are encouraged to report how they will incorporate climate-related considerations into four key areas of their businesses: governance, strategy, risk management and targets.

The task force will share the results from a public consultation on its recommendations with the FSB this month, before delivering an updated report to the FSB in June.

In this Q&A, Waygood explains the thinking behind the TFCD’s recommendations and the importance of transparency in the market’s response to climate change.

Why do investors need information on companies’ climate-related exposures?

Climate change is potentially the mother and father of all secular shifts this century. According to research from the Economist Intelligence Unit, commissioned by Aviva Investors, a rise in temperatures of six degrees this century would see $43 trillion wiped off the value of financial markets, discounted to present day value1. That’s 30 per cent of the entire stock of global manageable assets. So it is crucially important for investors to know the companies in which they invest have considered this issue.

Specifically, better disclosure will enable investors to assess the impact of the three main types of climate risk on their portfolios. The first category is the physical risk to investment assets posed by extreme weather events such as floods and droughts. The second is transition risk, which refers to the hazards associated with the transition to a low-carbon economy. The implementation of a global carbon budget, for example, would render the vast majority of fossil fuel reserves ‘stranded’ or unusable, hitting extractive companies’ business models. Third is litigation risk, which is related to the potential effects of compensation claims on carbon extractors and emitters.

Will better disclosure also enable investors to identify opportunities?

Yes. Equipped with more information, asset owners will be able to better engage with the companies they invest in to ensure they are dealing with climate-related risks. But investors will also be able to use this data to put capital to work, identifying new opportunities to profit from the transition to a low-carbon economy across various sectors; from commercial real estate companies that specialise in energy-efficient buildings to automobile firms that are in the vanguard of zero-emissions technology.

We hope better disclosure will incentivise longer-term thinking among investors and bring to an end what Mark Carney has called the “tragedy of the horizon,” a damaging short-termism that fails to take into account risks and opportunities beyond the three-to-five year cycle of most financial-market actors.

The TCFD recommends companies model different climate scenarios. How will this work in practice?

The TCFD believes organisations should use scenario analysis to assess the business, strategic and financial implications of climate-related risks and opportunities – both to better understand those risks and opportunities and to inform stakeholders about how the organisation is positioning itself in relation to them. This is perhaps the single biggest new contribution the task force is making: the suggestion that thousands of companies should produce their own scenarios to give stakeholders a picture of what climate change means for their business.

The TCFD recommends modelling a range of outcomes, starting with a ‘two degree scenario’ – the risk that global temperatures rise two degrees above the pre-industrial average – and scenarios relevant to their specific circumstances. Automobile companies should model scenarios based on changes to emissions regulations, for example. If these companies are going to make the transition to electric cars, what sort of batteries will they use for energy storage? Most electric-car batteries use lithium, which is a non-renewable resource – so what happens if lithium becomes scarce and uneconomic to extract? These are the sorts of details the disclosures need to include.

How have companies responded to the recommendations?

Companies provided feedback on the recommendations at the World Economic Forum in Davos in January. There was overall support for the task force’s emphasis on standardisation and consistency of climate-related disclosures. However, some companies in the oil and gas sector raised concerns over the recommendation that they disclose ‘scope three’ or indirect emissions, such as those associated with the disposal of the waste they create or their employees’ use of transport.  Aviva believes the solution to this issue will lie in standardised conversion factors, which we would like to see the International Accounting Standards Board produce.

The TCFD recommendations are voluntary. Is this sufficient?

While we welcome the recommendations, we don’t believe voluntary disclosures will get us far enough, fast enough to effectively combat climate change. Research shows it is only when governments mandate disclosure that you get it at the scale required to make it consistent and comparable.

We would like the International Organisation of Securities Commissions to coordinate its members’ stock exchange listing rules so as to promote this kind of climate risk disclosure. We would also like to see the Organisation for Economic Cooperation and Development update its Principles of Corporate Governance to make clear it is the responsibility of company boards to govern long-term risks, including climate change.

Does the election of Donald Trump threaten to derail global efforts to combat climate change?

The launch of the TCFD could not be better timed, as it shows there is massive momentum behind the transition to a low-carbon economy in the private sector. During Davos, support for the TCFD initiative was clear, Trump’s election notwithstanding.

While it’s not going to be the easiest political environment in the US for the next four years, I have no doubt Obama and his team have done everything they can to ensure it will be extremely difficult to unwind the Paris Agreement, as Trump has threatened to do. In my view, it is now inevitable we will transition to a zero-carbon economy. The question is whether it happens quick enough to stop runaway climate change, and that’s the concern I have about Trump; he could slow things down. This is why initiatives such as the TCFD are so important.


The Cost of Inaction: recognising the value at risk from climate change

Important information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at February 21, 2017. This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.


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