Q&A: Climate risk expert Tom Wood explains mandatory TCFD disclosures
In light of the UK government requiring climate-related risk disclosures from April 6th 2022, we caught up with one of our experts, Tom Wood, who discusses what this means for the 1,300 companies and financial institutions involved.
Tom Wood is a Carbon Accounting Lead at Emitwise, working with global organisations on their GHG inventory calculations and insights. He joined Emitwise with 15 years of experience in GHG management, climate risks, and other sustainability consultancy. He’s helped major public and private-sector organisations align to the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), including a UK government-owned financial institution’s first mandatory disclosure.
How have the TCFD recommendations evolved since you first started working with them?
The TCFD is an international body that set out recommendations in 2015 on how companies should manage and disclose their climate-related financial risks. The UK is the first G20 country to mandate organisations to follow these recommendations, with many others expected to follow in the next year.
There have been other organisations, often government-owned, that have been mandated to make these disclosures before this year. In addition, some leading companies have chosen to align to TCFD recommendations and disclose in advance of any mandate. I personally worked with one of the first organisations that the government mandated to align and disclose. The UK government has now mandated that a larger number of companies are required to make disclosures.
The mandate for TCFD disclosures from April 2022 covers:
- All UK companies that are currently required to produce a non-financial information statement, being UK companies that have more than 500 employees and have either transferable securities admitted to trading on a UK regulated market or are banking companies or insurance companies (Relevant Public Interest Entities (PIEs));
- UK registered companies with securities admitted to AIM with more than 500 employees;
- UK registered companies not included in the categories above, which have more than 500 employees and a turnover of more than £500m;
- Large LLPs, which are not traded or banking LLPs, and have more than 500 employees and a turnover of more than £500m and;
- Traded or banking LLPs which have more than 500 employees.
The purpose of the disclosures is to analyse climate-related risk to business. What does that look like in practice?
The recommendations from the TCFD encourage companies to undertake scenario analysis. They get businesses to ask the question: “What if?”
If a future climate-change related event occurs, how will this impact your business? The TCFD encourages companies to consider this in qualitative and quantitative (particularly financial) terms.
This scenario analysis is not about picking one future scenario and testing your business’ resilience to that. It’s acknowledging that there’s a lot of uncertainty around climate change, its impacts, and the policies that will emerge relating to it. It makes businesses look at various different outcomes and how they will be impacted accordingly.
How are we defining “climate-related risk” here?
The important thing to note about the TCFD recommendations is that there’s two sides to how it suggests you consider risk:
- Physical climate change risks e.g. if a flood or wildfire occurs more often.
- Transitional climate change risks e.g. if there is a change in policy, law or public/stakeholder perception as part of the transition to a low-carbon economy, in any location of operation.
Let’s say you’re a giant manufacturing business with operations around the world. You’ll need to look at both the chances of physical climate change effects in the countries you operate in, as well as the likelihood that their governments could introduce some new regulation, carbon target or taxes. The risks will vary significantly between countries.
What is the ultimate purpose of disclosing climate-related risks?
It all comes down to the risk that climate change poses for investments. The TCFD was established in the wake of the 2009 financial crisis, because climate change was identified as a significant threat to the global financial system. The disclosures will provide clarity on an organisation’s potential risks and their governance and strategy for mitigating these risks. Investors can then decide whether they’re happy with the response, whether to demand further action, or even put their money elsewhere.
Even though this is a government mandate, it will mainly be investors who read these disclosures and decide how safe their money is.
Of course, many investments are risky. Just because a venture has significant climate-related risks attached to it doesn’t mean that investors won’t invest. But it gives more transparency to investors on a company’s risk profile through the lens of climate change.
How detailed should we expect these disclosures to be?
The legal requirement in the UK is that the organisation has to make a disclosure aligned with the TCFD recommendations. It’s ultimately likely to be investors who decide if that disclosure, and a company’s potential risk mitigation response, is of sufficient quality.
For most organisations, there will be a gradual increase in maturity of their disclosure over a number of years. Initially, it might be a basic qualitative assessment of risks and their current governance arrangements. They then might set out their plans for better risk assessment in the next disclosure period.
But ultimately, businesses want to attract investors, and the more transparent and detailed they can be in their disclosure, the more trust they’ll build with them. Over time, we should see these disclosures get competitively more granular and data-driven.
What does a “good” climate-related risk disclosure look like?
A fundamental requirement for any organisation to understand and begin managing their transitional climate change risks is a full and detailed understanding of their direct and indirect value chain carbon emissions. This will require a granular view of indirect ‘scope 3 emissions’ from upstream and downstream sources that take into account different countries of operations, supply chains, and markets for products.
If you want to give a fully transparent, detailed disclosure to build investor trust, you need that granular, comprehensive view of your full value chain.
Without it, you can just qualitatively disclose that you suspect you may have some high risk in relation to the downstream use of your products, or a particular raw material supplier, but you won’t have the data that justifies that assumption.
Understanding your baseline emissions is the foundation of your transitional climate risk analysis. It doesn’t tell you the risk in itself, but it gives you the full perspective you need to then consider your qualitative and quantitative risk under your various future scenarios.
Can you give us an example of how scope 3 emissions data would allow you to better analyse risk?
Let’s say you’re an organisation looking at your raw material supply chain.
Because you have full visibility into your entire value chain (including scope 3), you can see that you’re currently procuring huge quantities of raw materials that have a high emissions intensity from a supplier in one particular country.
When you look into that country’s legislative plans, you discover that they have draft policies being developed that suggest there might be a new carbon price coming.
By combining these two pieces of information, you can presume that you have high risk here. Why? Because you’re buying significant amounts of raw materials responsible for a high amount of emissions that are soon going to be priced by the new carbon tax.
This will increase your raw material costs, which provides a material climate-related risk to disclose to your investors. Of course, they’ll also likely want to see your strategy and plans for mitigating such risks – perhaps by engaging that supplier in an emissions cutting partnership, or by changing to a less emissions-intensive supplier.
What steps do businesses need to take to get to this level of disclosure?
Organisations need to start by ensuring they have a robust baseline in relation to their transitional climate change risks, which basically means a comprehensive, granular and accurate GHG emissions inventory, or “carbon footprint”.
It also must be possible to track the evolution of these emissions over time and how they respond to interventions. This should include appropriate breakdowns by location of operation, supplier, and product market. These will allow you to later consider the potential risks related to those emissions.
A software-based solution like Emitwise is perfect for capturing this level of complexity and ensuring an efficient and accurate process for baseline and repeat monitoring.
The same is true for physical risks, but that’s a fundamentally different topic and a different solution is needed; organisations should start by capturing a robust baseline of past and present incidents of weather/climate-related hazards. They can then use this to build a future assessment considering climate change scenarios.
Like I said, not every company will be prepared for this during their first disclosure, especially in accessing their scope 3 emissions data. I hope that this initial reporting period is a wake up call for businesses and investors alike, and that we see a greater push to more accurately measure and mitigate risk in future disclosures.
Learn more about what we do at Emitwise here.