Given a lack of adequate climate-related corporate disclosures and the growing urgency around climate change, Barbara Davidson asks if it is time to mandate
This article was first published in the October 2019 UK edition of Accounting and Business magazine.
We are all aware that action is needed to address the effects of climate change. In 2018 the world’s largest companies reported US$1 trillion at risk from climate impacts. Recent scientific information calls for making ‘finance flows consistent with low greenhouse gas emissions and climate-resilient development’. The European Commission (EC) estimates that €180bn a year in additional investments is needed to meet EU climate and energy targets alone.
To evaluate and respond to climate risks and opportunities, investors need good data. A variety of organisations recognise this. The Global Reporting Initiative, the Sustainability Accounting Standards Board, the CDP (formerly Carbon Disclosure Project), and the Climate Disclosure Standards Board (collectively, the NGOs) are among the more prominent bodies to develop frameworks and standards for companies to use to provide such information.
Public policy efforts are also growing, including recommendations by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) for disclosing climate-risks and opportunities, the EU’s guidelines on reporting climate-related information and a recently formed Project Task Force on Climate-related Reporting.
While many companies support these endeavours, there has been limited uptake. Investors are frustrated by the lack of transparency and inconsistent information around the financial impacts of climate change on businesses and the resilience of company strategies, both of which are critical inputs to investment valuations and decisions. In response, there is talk about mandating corporate climate-related disclosures. But is now the right time? And if so, should a single body oversee this?
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Too much too soon?
|Argument against mandating||Response|
|Determining the financial impact of climate-related risks is complex and costly. The lack of standard metrics and uncertainty in how to demonstrate resilience under different climate scenarios limit uptake.||The EC’s technical expert group on sustainable finance is developing a taxonomy for environmentally sustainable activities. The TCFD published a technical supplement on scenario analysis and is considering further guidance. Investors appreciate that this is an iterative process and that disclosures will improve over time.|
|There is an additional cost and burden of providing these disclosures, without a corresponding benefit.||Only material information should be disclosed. Identifying this data can help improve risk management and dialogue with investors, and lower capital costs.|
|There is already disclosure overload. Requirements cannot be too broad or disclosures won’t be relevant; too narrow and they won’t be comparable.||Mandate a basic set of requirements with sector-specific guidance (eg for climate-related issues), and engage with investors to understand their needs.|
|What would be the scope of these disclosures – sustainability, climate risk and/or ESG issues? How do we define sustainability? Should a company’s environmental impact be included or just climate-related risks?||Urgency dictates a focus on climate-related risks and opportunities. Other ESG disclosures can be added over time. In the interim, companies can voluntarily provide supplementary information.|
|Supporting global disclosures may mean making a political statement, which could affect the ability to agree on a single set of standards.||Investors will filter out companies that choose to ignore an internationally recognised set of standards.|
|To be effective there must be an enforcement process.||Similar to IFRS, countries could mandate disclosures via changes to legislation.|
To mandate or not?
Investors need reliable information that is easy to find and comparable across entities. This non-financial (or extra-financial) information is typically outside financial accounting and reporting boundaries. It is not standardised, making it less comparable. It is frequently located in separate, company-specific sustainability reports, and is rarely assured. Mandating a single set of disclosures would:
- force companies to incorporate material climate or environmental, social and governance (ESG) matters into their governance framework, and liaise across functions, including senior management, to evaluate risks, impacts and strategies
- increase transparency and improve stakeholder dialogue
- help investors identify opportunities, such as technologies that can contribute to a low-carbon economy, so lowering the cost of capital
- ensure information is prepared to similar levels as accounting information, is assured and is included within annual reports.
This cannot be fixed overnight. It takes time for companies to gather the information. Those that have started implementing the TCFD recommendations need two or three more years to get them right. Despite this, some argue that it is still too soon to go down the mandatory disclosure path. See panel opposite for their arguments and respective responses.
Standards and enforcement
The current variety of guidance, standards and frameworks causes confusion among companies and investors. A single set of disclosure standards would eliminate this, while also reducing costs. Although the NGOs in this space have been working to identify areas of alignment, they have different missions and governance structures. Some target different stakeholders. These distinctions may inhibit their ability to merge or to cede responsibility to a single organisation.
One solution would be to leverage existing accounting standard-setting infrastructure. For example, the International Accounting Standards Board (IASB) develops standards to bring ‘transparency, accountability and efficiency’ to global financial markets. It is familiar with the growing pains that non-financial reporting is experiencing. It has strong due process, a funding procedure, a clear governance structure, and focuses on a primary stakeholder group: investors. It would not have to reinvent the wheel; it could consolidate and codify the wealth of existing guidance from NGOs and governments, drawing from their vast knowledge and experience. It could address concerns around issues such as materiality. However, this is not currently within accounting standard-setters’ remits, so agreeing on their role in this process could present a significant barrier.
The ‘long-term’ effects of climate change are happening today. A clear understanding of the associated financial risks, as well as opportunities and strategies, is key to ensuring effective financial markets. Voluntary measures, while laudable, have not yielded sufficient information in a timely fashion.
Urgent action is required. Stakeholder support is strong and there is ‘political will’ in many countries for a single mandatory set of disclosures. Oversight by a single body will help us move forward.
Whatever happens next, the effects of climate change will not wait. So why not act now while we still can?
Barbara Davidson has 20 years’ experience in international financial markets and was formerly head of investor engagement at the IASB.