Companies implementing a new international climate change reporting framework may find the heaviest lift involves crafting long-term scenario analyses of potential climate-related risks and opportunities, according to industry and climate disclosure experts.
For some companies, particularly those outside the energy sector, adopting the 2017 voluntary recommendations of the Financial Stability Board's Task Force on Climate-related Financial Disclosures, or TCFD, will require them to perform a climate-related risk analysis for the first time. Doing so can present many challenges, particularly for early adopters, say experts. For instance, companies such as Citigroup Inc. and Spanish banking group BBVA have complained about data gaps and other problems in adapting climate models to their business structure or picking among a plethora of scenario options.
Conducting a climate scenario analysis is beyond the "bread and butter" practices of many companies, so it is "something that they're trying to figure out," said Aditi Maheshwari, who is on the climate finance and policy team of World Bank Group's International Finance Corp.
The stakes are high. Companies want to show investors they are not only aware of future risks and opportunities but have strategies and processes in place to remain resilient if any of those scenarios come true, said Lois Guthrie, World Business Council for Sustainable Development director of redefining value.
The TCFD recommendations are a voluntary, common international framework meant to help companies and investors make informed decisions about their exposure to climate-related risks and opportunities and in a manner that would allow apples-to-apples comparisons across companies and sectors.
The TCFD suggested four areas companies should cover in their disclosures: governance, strategy, risk management, and the use of metrics and targets. Within those four areas, the TCFD listed 11 types of disclosures companies should provide, including plans for dealing with long-term risks and taking advantages of opportunities identified through the use of scenario analysis.
Helping to drive TCFD implementation is a group of hundreds of global investors with more than $32 trillion in assets under management and shareholders that continue to propose climate disclosure resolutions at publicly traded companies' annual meetings.
Experts and a number of companies have indicated that fully implementing the TCFD's recommendations could take years — the task force itself envisioned doing so could take up to five years. However, about 20 companies, most are European, have pledged to report climate-related information in line with the TCFD's recommendations "as fully as practicable" within three years of the date of commitment. Those companies include Unilever, Iberdrola SA, Aviva PLC, Cathay Financial Holding Co. Ltd., Enagas SA, Hannon Armstrong & Co., Landsec, Marks & Spencer PLC and Wipro Ltd.
Moreover, TCFD implementation pilots have formed for the oil and gas, banking, insurance, and metals and mining sectors. The results of a pilot program for investment companies is expected to be published in early 2019. And Guthrie said the World Business Council for Sustainable Development in December launched TCFD preparer forums for the electric utilities and chemicals sectors.
The challenges of analyzing climate-related scenarios
The task force in September 2018 said most of the roughly 1,700 companies it reviewed appeared to have implemented at least one component of the framework but few had gone so far as to describe the resilience of their business and other strategies under various climate-related scenarios.
While many big corporations have outlined their climate-related goals and objectives, scenario analysis is a new area for many of those companies and so will likely evolve and improve over time, Curtis Ravenel, Global Head of Sustainable Business & Finance at Bloomberg and a member of the TCFD Secretariat, said in an interview. "The words 'scenario analysis' scares people even though we think it's a journey and, at the start, qualitative (reporting) is fine," Ravenel said.
To help address the scenario-related challenges, some companies have started by examining only certain aspects of their business. Citigroup, for instance, used the results of the banking pilot program to assess its potential climate-related lending risks to electric utilities and oil and gas exploration and production companies in the U.S. and Canada. But the bank found the data lacking even when conducting this limited review, and its report stressed that the ability of some entities to assess their climate risks relies in part on whether companies in their portfolio have released key data.
"As companies disclose more climate-related information, Citi expects that banks’ assessments of borrowers’ risks from climate change will continue to improve," Citigroup said in its report.
This data challenge for financial institutions was one of several implementation hurdles noted in a November 2018 report by the Institutional Investors Group on Climate Change, or IIGCC.
"Investors sit at a central point in this process," Russell Picot, chair of the trustee board of the HSBC Bank (UK) Pension Fund and chair of IIGCC’s Investor Practices Programme, said in a statement in the report. "We need disclosure of the risks and opportunities by the companies and assets we invest in, and we ourselves as institutions are expected to improve our own disclosures in order to provide a full system-wide picture of risk."
Picking the right scenarios
The IIGCC noted companies have a wide range of scenario analyses to choose from and can disclose their findings in a variety of ways. The most frequently used ones are those outlined by the United Nation's Intergovernmental Panel on Climate Change, which focuses on the physical risks of climate change, and the energy market transition scenarios outlined by the International Energy Agency. But IIGCC listed nearly 10 other scenarios that have been used.
Companies have many options for defining the characteristics of a meaningful scenario analysis, which leaves companies worried they could pick a method that will not satisfy investors, Guthrie said.
Because "there's no particular right or wrong way of doing something, you're bound to ask yourself: How will I know when I've done it right?" said Guthrie, whose organization headed up a TCFD implementation pilot program for the oil and gas sector. Companies worry whether investors will ultimately "agree that this is the sort of information that they want," she said.
International insurance and asset management group Axa started developing climate scenario analyses in 2016 and published its first TCFD report in April 2018.
The TCFD work, especially scenario stress testing, scenario alignment, 2-degree stress testing, climate value at risk, and warming potential, involved concepts "that are very difficult to measure and they don't always bring intuitive results," Axa Group Sustainability Business Officer Sylvain Vanston, said at a September 2018 climate event in San Francisco. Axa expects to publish its third TCFD report in the spring of 2019, Vanston said at the event.
Other challenges experts and companies have identified include the need to modify models built for macroeconomic and policy assessments and predict potential financial impacts on individual companies or industries.
Misaligned time horizons can also be a problem. For banks, for example, their lending time horizons tend to be five years or less while the scenario analysis looks out over decades to at least 2040. Further complicating matters for financial institutions, the diversity of banks' portfolios can make assessing risk difficult creating the potential that risk could be underestimated, said a recent report by French not-for-profit group Climate Chance and Finance for Tomorrow, the green finance arm of lobby group Paris Europe.