07 Feb TCFD in the UK:What your CFO needs to know
Mark Carney’s TCFD represents another step towards standardizing climate transparency in markets, but most companies continue to miss the nuance of what stakeholders are really looking for. Although the number of UK companies disclosing with TCFD quadrupled between 2017 and 2020, only 35% of companies are really disclosing with the full framework (FTI, 2021). It’s therefore unsurprising that investors have ranked “improved quality and disclosure of information” as their most preferred change in ESG in the next five years (SustainAbility 2020).
The struggle to disclose well with TCFD is understandable. With the CDP, CDSB, IIRC and SASB each setting standards for climate reporting, there has been a lot of noise in the system. For companies without major resources, developing reliable disclosures is difficult to do overnight.
Nonetheless, the UK plans to make TCFD regulations mandatory for all large publicly quoted companies by autumn 2022. The time to address these problems is fast running out. To help with these changes, we have identified three key areas where companies struggle, in the aim of helping CFO’s and boards prepare for these new reporting requirements.
Scenario analysis may be the common stock of boardrooms, but applying techniques usually used for financial planning has caused companies some difficulties. 46% of UK firms fail to use climate scenario analysis and many of the rest fail to differentiate between climate scenarios. Companies may be guilty of losing sight of the overall aim: to demonstrate resilience of strategy and operations under different climate scenarios.
To achieve this, we recommend companies consider at least two contrasting scenarios: one where rapid and global decarbonisation achieves a desired 2°C outcome by 2050 and another where a business-as-usual approach leads to a 4ºC outcome. By evaluating the business-as-usual outcome, firms will consider how rising sea levels and extreme weather events associated with a 4ºC world could cause a physical threat to their business practice. Contrastingly, the 2°C outcome will encourage firms to understand the transition risks faced by transforming their organisation into a net-zero company.
The TCFD recommends starting with qualitative scenario narratives to develop an understanding of the risks and opportunities under either scenario, introducing quantitative information as the organisation gains greater experience with these tools. What is crucial is for businesses to understand where their most material risks are, requiring a deep understanding of supply chain, operations, logistics and sales.
Developing the corporate capacity required to make sense of scenario analysis requires leadership from the top-down. At present, determining the materiality of climate risks is typically left as a management issue. However, isolated departments and undefined metrics can cause executives to incorrectly assume that climate risks may be treated like any other business threat.
By applying standard risk assessments to climate scenarios, a uniquely long-term problem, firms severely underestimate the materiality of climate risks. To mitigate against this, boardrooms should deliver an annual statement defining relevant audiences and timelines. As Russel Picot, TCFD advisor said: “you move this conversation into the boardroom and potentially you are driving an entirely different form of conversation.” Boards who take a longer-term approach are better placed to evaluate and report how climate scenarios may “materially” affect their business, in line with the intended spirit of the framework.
Whilst greater board involvement will go some way towards improving the status quo, highly pressured executives and managers may continue to treat climate risk assessment as a box-ticking exercise. By following the lead of the FTSE 100 and implementing ESG metrics into compensation packages, boards can help to ensure that management and executives value climate targets as equal to financial ones. This helps companies to bridge the “say-do gap”, making disclosures less a last-minute reporting exercise and rather, as intended, a time for reflection of where governance, strategy, risk management and metrics & targets have been impactful and where they may be better integrated in the future.
Additionally, some companies struggle to understand the extent of their required disclosures. TCFD 2017 guidance recommends “disclosure of Scope 1, Scope 2 and (if appropriate) scope 3”. Whilst the “appropriateness” of requirements may seem a little vague, the goal of the TCFD is to encourage firms to understand (and make transparent) the material risks to their financial statements. Scope 3 is a shadow requirement and most companies will be looked on unfavourably for not tackling it, when this is a key area affected by a 2°C or 4 °C scenario.
In a 2021 public consultation update, the TCFD noted that the maturation of data and methodologies means that “disclosure is particularly important for organisations where Scope 3 emissions account for 40% or more of the total emissions of the organization”. For industries such as packaging, FMCG, food and fashion who produce >75% of their emissions in Scope 3, quantifying these emissions will undoubtedly become an important part of TCFD reporting.
As the TCFD rapidly shifts from a voluntary approach to a regulatory one, firms will benefit by planning to meet these changes head on. While these changes may seem daunting, it’s important to remember the TCFD is not designed to be another box-ticking exercise, rather providing an opportunity for the companies who embrace the sustainability challenge to protect and optimise the future of their business.