Who is correct? That question will keep recurring following signals from the UK government in its July 2019 Green Finance Strategy that large asset owners and listed companies must within two years report in line with the Taskforce for Climate-Related Financial Disclosures (TCFD). Leading climate finance activist Mark Carney, the former Bank of England governor involved in the TCFD launch, also warned that the bank itself could make climate risk reporting mandatory.
A reliable assessment of the risk of energy suppliers to the climate would need to account for the carbon capture role, as well as many other factors. Such assessments need to satisfy two criteria. Firstly, evidence must be visible that the companies themselves take the risk seriously. Secondly, sound judgement on future policy and technology development is required. However, climate risk disclosure is still absent from the financial filings of many companies in carbon-intensive sectors, suggesting neither of those conditions are in place.
“I don’t think that most companies have understood and accepted climate change as a mainstream risk yet”, comments Nina Seega, Research Director for Sustainable Finance at the Cambridge Institute for Sustainability Leadership (CISL). Some have taken up the practice, confirming their recognition of the risk. But existing climate risk reporting uses inconsistent techniques and questionable assumptions, according to both CISL and TCFD. Across the spectrum of major listed energy-intensive companies, reporting on the issue is in a state of flux, they find.
Considerable further work is required if climate risk reporting becomes mandatory. To comply with future rules that may oblige climate risk reporting aligned with TCFD, corporations would not only need to acknowledge the various types of climate risk (such as physical risk of flooding or transitional risk arising from economic, technology and policy change) but also state in financial reports whether climate change is a material risk.
They would also disclose potential impacts of climate-related risks and opportunities under various warming scenarios (three degrees Celsius, for example), a demanding task that most companies have not yet accomplished, according to TCFD analysis. However, Seega indicates they come under pressure not only after reporting becomes compulsory but right now: “The onus is on the company directors to reflect on material risks… if company directors are making claims out of thin air, they could become legally liable”, she states.
Yet CISL studies show the challenge only gradually accepted and in a piecemeal way. For instance, some oil and gas majors, such as Exxon Mobil, pay significant attention to the development of large-scale carbon capture and storage in their response to climate risk. This, it suggests, will capture and store 40 percent of carbon emissions at a plant in Gorgon, Australia. However, TFCD recommendations state that such viewpoints are more reliable if accompanied by rigorous quantitative/qualitative scenario analysis relating to key drivers and trends affecting their assets. Yet many reports do not present scenario analysis in the form it recommends.
In their defence, analysis of this type is not straightforward, particularly in such a politically sensitive field. Government policies experience u-turns. New technology may take longer to scale up than expected, and physical risk calculation is subject to varying assumptions. Analysts making flood risk assessments, for example, use a range of different criteria as well as varying data granularity for each zone evaluated. Two companies in the real estate sector might therefore assess flood risk differently in a particular city.
That is because detail available on existing flood defences differs, as does the time horizon of the model, assessment of duration of floods, as well as depth and water remaining after rain has passed. This affects the consistency and credibility of assessments. “The cruder the data is, the more likely you are to miss extremes”, says Matthias Graf, Head of Catastrophe Research and Development at Zurich Insurance. Hence, both corporations and investment firms are still finding their way using information with which they are unfamiliar.
Evaluations of risk over a whole country might require unearthing detailed data not yet available from insurers. “Insurance companies need to estimate the extent of risk for a full portfolio and thus may use flood models covering an entire country. It’s costly to do this for each river location” says Matthias Graf. To achieve this aim, it would be necessary to ensure that all locations are assessed in the same way and also that one model used for one area is not more sophisticated than another model for another area.
That said, there is a view in the asset management sector that, given the urgency of climate targets, a no-nonsense approach can be crafted across industry at the same time as more sophisticated methodologies develop. “If investors read information that they do not think is realistic, they will engage with the boards. It’s essential to move the financial system on this issue”, says Nina Seega.
One such asset manager, Legal & General Investment Management (LGIM), has already taken such action using pragmatic techniques as outlined in its Climate Impact Pledge. It claims to have elicited change from companies such as Occidental Petroleum, BP, Shell and Equinor while also threatening exclusions on the basis of reporting quality. “For every company this is a journey…however, we have divested where we have seen companies that are insufficiently transparent”, says Nick Stansbury, Head of Commodity Research.
At the same time, various voluntary disclosure institutions, ranging from the Sustainability Accounting Standards Board (SASB) to the Global Reporting Initiative (GRI) are gradually converging on methods for historic reporting that could be used across finance and industry. Still under discussion, however, are concerns such as inclusion of the supply chain in greenhouse gas emissions numbers. Divergences in such reporting are being ironed out more quickly because, like conventional accounting, it relies more on past data and transactions than on insight.
Climate risk scenario analysis, though, continues to provoke controversy. As a skill, it will take more time to emerge and may not have matured before the announcement of any new reporting rules by government or central banks . Hence, one expectation among some managers running responsible investment funds, such as LGIM, is the will to report using credible assumptions. As far as carbon capture and storage is concerned, the credible timeline for a commercially viable large-scale technology continues to be disputed. “Given the current cost profile of carbon capture and storage, it is difficult to assume dramatic or rapid progress”, asserts Nick Stansbury.