Local standard setters have backed the G20’s push to include climate-related risks to current and future earnings in financial statements – and it will be audited.
By Susan Muldowney and Lachlan Colquhoun
It appears the time has come for major companies – and their auditors – to get serious about assessing and disclosing climate-related financial risks. In September 2018, London-based environmental law firm ClientEarth reported four major UK businesses to the country’s Financial Reporting Council (FRC) over alleged failures to address climate change trends and risks in their accounts to shareholders.
ClientEarth’s claims against budget airline giant EasyJet, infrastructure company Balfour Beatty, gas producer EnQuest and metals engineering firm Bodycote add to widespread investor pressure for companies with material exposure to climate change to account for it in their financial statements. The companies’ auditors – PwC, KPMG, EY and Deloitte respectively – are also under scrutiny, with ClientEarth requesting an explanation from the Big Four as to why their clients’ reports were deemed legally compliant.
“I think it’s shocking that companies still aren’t getting to grips with the extent to which climate change has implications for their business,” says ClientEarth lawyer Daniel Wiseman.
The push for companies to disclose climate-related financial risks has gained serious momentum since mid-2017, when the G20 Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) recommended a reporting framework for companies in sectors most likely to be affected by climate-related risk.
As ClientEarth awaits a response from the UK’s FRC in relation to its complaint, Wiseman hopes an example will be set for other companies to embrace the TCFD’s reporting requirements.
“We want companies to be reporting this information so that they can better manage it and set their business up for success,” he says. “Reporting can help them to navigate climate challenges and provide this detail to investors, so they can allocate their capital more efficiently and more accurately support the low-carbon emission transition with their investments.”
Chaired by US businessman, politician and philanthropist Michael Bloomberg, the TCFD was established in December 2015 to develop a consistent framework for climate-related financial risk disclosures. As of February 2019, more than 580 organisations worldwide were signatories, including close to 50 from Australia. Contact Energy is currently the only New Zealand-headquartered signatory. As New Zealand is not part of the G20, local regulators and business leaders have experienced less international pressure to become early adopters.
Financial reporting considerations:
- Asset impairment. Changes in the useful life of assets.
- Changes in the fair valuation of assets due to climate-related and emerging risks.
- Increased costs and/or reduced demand for products and services affecting impairment calculations and/or requiring recognition of provisions for onerous contracts.
- Potential provisions and contingent liabilities arising from ﬁnes and penalties.
- Changes in expected credit losses for loans and other ﬁnancial assets.
Warren Allen, CEO of New Zealand’s External Reporting Board, says more companies are expected to sign up following the introduction of the country’s Zero Carbon Bill, which will establish an independent Climate Commission with the power to set emissions targets.
“I expect the Bill will draw much more attention to the responsibility of reporting on climate risk,” Allen says. “For companies with material exposure to climate risk, such as the big carbon emitters, we’ve possibly not seen enough disclosure to date.”
Organisations it identifies as most likely to be affected by climate risk include financial sector entities with indirect exposures (banks, insurance groups, asset owners and asset managers) and entities with direct exposures (energy, transportation, material and buildings and agriculture, food and forest products).
Putting climate risk in financial statements
In December 2018, the Australian Accounting Standards Board (AASB) and Auditing and Assurance Standards Board (AUASB) released a joint bulletin on the impact of climate-related and other emerging risk disclosures. This bulletin proposes that entities no longer treat climate-related risks only as a corporate social responsibility issue but also include them in their financial statements.
This has spurred many interesting conversations, says AASB chair and chief executive Kris Peach FCA.
The AASB’s Practice Statement 2: Making Materiality Judgements complements the TCFD’s recommendations, but with one important difference: the AASB guidance deals only with what should be included in the financial statements, while the TCFD and ASX guidance is focused on disclosures outside the financial statements.
Because financial statements must be audited, this means corporates would be facing questions from auditors on climate risk, in addition to the discussions they are already having with investors.
Practice Statement 2 recommends a framework built around the concept of ‘materiality’ of any risk, beginning with the question: “Could investors reasonably expect that climate-related risks or other emerging risks have a significant impact on the entity and would that risk qualitatively influence investors’ decisions, regardless of the quantitative impact on the financial statements?”
“Investors are telling us that climate risk is very important to their decision-making and they have been very active in their discussions since the bulletin was released, asking us to tell them more,” says Peach.
“The bulletin has been very important in getting people to not only think about what they need to disclose in terms of risk, but also where they need to make those disclosures.”
Investors are already factoring climate risks into their valuations, she says. Financial statements need to reflect this and demonstrate the assumptions corporates are using in areas such as impairment testing.
Considerations in assessing materiality
Peach cites mining, energy, transportation, agriculture and financial services as sectors clearly exposed to climate risk, but believes it won’t be until the next reporting season – when impacts of the voluntary TCFD regime can be seen – that a fuller picture will emerge.
“If you think about the financial sector, they lend money to companies which will be impacted by climate change, so the assessment for them is what impact will this have on my loan client and then on their ability to repay the loan,” says Peach.
“There is also the issue of provisions for credit losses which need to be factored, and it’s clear to me that people in this sector are asking some very pertinent questions and are highly aware.”
Peach expects change may be incremental to start with, but will gain momentum rapidly. “My message to accountants is that this is a great opportunity to get out into the business and talk to people about this, gather and use data to gain some clarity on the real impacts, and start the lines of communication,” she says.
Feeling the heat
A September 2018 report from the Australian Securities and Investments Commission (ASIC) examined climate risk disclosures by 60 companies in the ASX 300 and found that only 17% identified climate change as a material risk to their business.
Yet many Australian companies have already felt the glare of the climate-reporting spotlight. In August 2017, the Commonwealth Bank of Australia (CBA) was accused by activist shareholders of breaching the Corporations Act by not adequately revealing its climate-related risks to investors. (The case was withdrawn after CBA acknowledged its exposure to significant climate-change risks and pledged to adopt the TCFD recommendations.)
At the time of writing, A$50 billion superannuation fund REST was facing a lawsuit over allegations its trustees had breached their duties by failing to factor climate change into investment decisions.
Meanwhile, campaigning by investor initiative Climate Action 100+, which comprises more than 320 investors who control US$33 trillion of assets, preceded Australia’s largest coal miner, Glencore, announcing in February that it plans to cap its future coal production in Australia at 2019 levels.
Emma Herd, chief executive officer at the Investor Group on Climate Change and a member of the Climate Action 100+ steering committee, describes climate-risk reporting as “strategy 101”, but notes that it can be a complicated process.
“The challenge has been taking something that is fundamentally a scientific and environmental issue, understanding the economic implications and then translating it to the portfolio or asset-level investment,” she says.
“The interesting thing about the TCFD is that it’s a framework for reporting and also a process that can be applied to deliver a whole suite of benefits from a financial management perspective.
“It asks you to set out your governance approach, your strategy, your risk metrics, your material financial risks and how you are managing them.”
Herd believes the process of completing the report, if done properly, should deliver much wider benefits to the company undertaking it than simply releasing a glossy sustainability document.
“Before the TCFD, companies didn’t use the language of transition or physical risk,” she says. “They didn’t have a way, even within physical risks, of separating out acute and chronic risks – the things we face today versus the long-term slow changes that will impact your asset over time.
“The TCFD has given us a whole framework for thinking about climate change as a financial risk and it’s hugely accelerated decision-making and climate-change responses.”
CASE STUDY: Driving collaboration at ANZ Banking Group
Banking Group was among the first 100 companies worldwide to commit to the TCFD, and the first bank in Australasia. It has aligned its climate reporting to the framework since 2018.
Ben Walker, head of sustainable development at ANZ, says most of the bank’s material climate-related risks stem from its lending to business and retail customers that could be impacted by climate change, or changes to laws or policies such as carbon pricing.
“We’re providing more reporting into the sectors deemed by TCFD to face the greatest climate risk and we’re putting this into the public domain to see if it’s useful to our stakeholders,” he says.
Reporting on emerging risks is a challenge, says Walker, so scenario testing has been valuable. ANZ joined an international United Nations project with 15 other banks last year to develop new models for analysing climate risk and translating them into financial metrics.
“The idea is to establish better ways to quantify risk. We look at what might happen to a particular portfolio in a hypothetical scenario. If there are more climate-related adverse events, such as year-long droughts or wildfires, what might be the impact on our agriculture customers and their revenues? What would that do to the probability of default for our customers in that sector?” In addition to gaining greater insight into its climate-related risks, the process of detailed climate reporting has fostered collaboration between various functional areas within the bank.
“They hadn’t previously come together in such an organised way,” Walker says. “I’m talking about risk teams, relationship managers, corporate affairs, accounting and finance, and our stress testing and modelling teams.
“The collaboration process means we’ve got better insights and more diverse views from those different disciplines working together. We think it can only help to enhance our response.”
Walker recommends that other companies bring together a core working group from different functional areas to begin planning for the adoption of the TCFD framework.
“Don’t just make it a sustainability initiative, because regulators are clearly outlining their expectation that climate risk be embedded in your business as usual,” he says.
“Speak to your customers, suppliers and business partners about how they are responding to climate challenges and pick somewhere manageable to start. You’ll be able to identify fairly quickly where your more material risks are.”
CASE STUDY: Getting ready for more extreme weather at Suncorp Group
Insurance companies are in the business of modelling risk, so it’s no surprise Queensland’s big insurer Suncorp was among the first 250 companies globally to sign up to the TCFD. It was also the first insurer in Australia to do so, and began using the framework for climate-risk reporting in its 2018 annual review.
The plan for 2019-20, says Andrew White, Suncorp’s executive manager, risk–stress testing, is to broaden its disclosure to include climate-change scenario analysis.
While physical risks, such as extreme weather, present the biggest climate risks for the insurer, White says transition risks may become material over the medium term. “There is a lot of uncertainty associated with these risks, given the many pathways available to transition to a zero-carbon economy,” he says.
Suncorp works with universities, reinsurers and natural peril specialists to take a long-term view of climate risks and the impacts they can have on business fundamentals, such as pricing.
White says TCFD guidance has helped to shape the organisation’s thinking about this complex issue.
“As a financial service provider, we support many industries operating in different geographies, so a challenge we faced was understanding how
to best apply the guidance and determine where our assessment of risks and opportunities should start and end,” he says.
Before the TCFD framework, Suncorp managed many of its climate-related risks through its existing risk-management framework.
“Our insurance business is regularly exposed to extreme weather events and we have engaged with government and councils to help build resilience to this in vulnerable communities,” says White, citing Suncorp’s Protecting the North initiative to mitigate risks presented by cyclones, and its lobbying of various levels of government to urgently fund the Roma flood levee to reduce flood risk.
“Through a TCFD lens, we are encouraged to re-examine the drivers of risk and to explore opportunities that will come with change,” says White. “Climate-change scenario analysis will help us deepen our risk assessment and develop a more meaningful response.”
White says the insurer’s accounting and finance team plays a vital role in helping management understand the financial benefits and costs that may come with climate change.
“Having the right level of awareness of climate science can assist accounting and finance teams to ask the right questions of the business, thereby deepening management’s understanding of the key opportunities and challenges.”
White’s advice for other businesses embarking on climate risk reporting is to be pragmatic.
“It’s important to look at the risks your business already identifies and manages, try to understand how these risks might change and what controls can be put in place,” he says.
“Like all forecasts and the management of future risks, it’s important to be clear about what assumptions the business is making. It’s a complex field, so developing external relationships with relevant experts can be helpful, as long as the business has a clear idea of what it hopes to understand, manage and report.”
CASE STUDY: Seeking new opportunities at origin energy
The energy sector accounts for about twothirds of carbon emissions globally. In Australia, electricity generation represents one-third of the nation’s carbon emissions. In its 2017 Sustainability Report, Origin Energy expressed confidence in the country’s ability to achieve net zero emissions for the electricity sector by 2050 and pledged to be part of a cleaner energy future.
Understanding its own exposure to climate risk and opportunities will be vital to achieving this. It is also key to Origin’s governance framework and overall business strategy, says Peter Rice, general manager capital markets, which includes Origin’s investor relations team responsible for reporting the energy company’s TCFD obligations.
Rice says that before signing up to the TCFD in 2018, Origin set science-based emissions targets that would halve its direct emissions and reduce its Scope 3 emissions (defined as indirect emissions due to the activities of an organisation) by 25% by 2032. It also aimed to have more than 25% renewables and storage in its power generation mix by 2020.
“Many of the TCFD recommendations were already in place at Origin, or were in the process of being implemented, prior to the recommendations being released,” Rice says.
“Having said that, we firmly believe that the TCFD framework has helped in communicating our position so that our investors and other stakeholders can better understand the risks and opportunities.”
A more thorough knowledge of emerging climate-related risks is helping the energy company to future-proof its business, says Rice. The company’s ‘five-pillar climate change strategy’ includes its exit from coal-fired generation by 2032 and a significant growth of renewables and storage in its portfolio.
For tips on climate-risk reporting, Rice suggests companies look at what other organisations have disclosed and conduct a scenario analysis to help define appropriate targets.
“Don’t forget to balance disclosure of both risks and opportunities,” he says. “Too often, these issues are seen only through a risk lens.”