TCFD May Have Legs!
TCFD – the Task Force on Climate-related Financial Disclosures backed by Michael Bloomberg – appears to have legs. Unlike the approach advocated by its closest cousin, the Sustainability Accounting Standards Board, TCFD’s approach increasingly is gaining credibility with analysts and institutional investors. It no longer is unusual for a company’s IR professionals to be asked, “What are you doing on TCFD?” While it is largely a check-the-box question today and we would not drop everything to start drafting material for your next 10-Q or 10-K, we do think that most companies – from industrials to financial and service-centric businesses – should take notice and consider what their disclosures might look like under TCFD, as it is much easier to craft good disclosures where ground work has been put in place.
There are over 100 recognized groups either soliciting climate-related (or, sometimes, broader “environmental, social and governance”-related) information or advocating its disclosure and providing a self-produced disclosure framework. Some have relatively long histories and participation, e.g., the Global Reporting Initiative and the Carbon Disclosure Project, while others are new to the game. All have agendas, some being to press their particular climate and political objectives and others being as simple as to profit from publishing ratings of companies’ ESG status and activities. A CEO at a major U.S. corporation recently described these organizations as “shadow regulators” intent on manipulating companies into behavior consistent with their beliefs.
TCFD was formed by the Financial Stability Board. Its mission is to develop voluntary, consistent climate-related financial disclosures that would be useful to investors and others in understanding material risks and opportunities. Rather than proposing industry-by-industry granular disclosures, a la SASB, TCFD proposed an overall, more-or-less principle-based, structure for disclosure. Its disclosure framework comes upon the heels of heightened interest in climate change and some recent quantitative analysis tying good ESG reporting to better stock market performance. See, e.g., Goldman Sachs’ 2017 publication, The PM’s Guide to the ESG Revolution.
What does TCFD require and how can companies put their toes in the water? TCFD has published several pieces on this – see, www.fsb-tcfd.org – and, borrowing from their descriptions, there are four principal disclosures:
- Governance: Disclose the organization’s governance around climate-related risks and opportunities.
- Strategy: Disclose the actual and potential impacts of climate-related risks and opportunities on the organization’s businesses, strategy, and financial planning, where such information is material.
- Risk Management: Disclose how the organization identifies, assesses, and manages climate-related risks.
- Metrics and Targets: Disclose the metrics and targets used to assess and manage relevant climate-related risks and opportunities where such information is material.
For all of these topics TCFD has provided examples of items that can be discussed. But, as noted above, the recommended disclosures are much more principle-based than the alternatives.
For now, we would focus on governance and strategy disclosure. We have crafted disclosure in this area, and we have found that most companies, particularly those that participate in the GRI, have given the topic enough thought to provide support for good disclosure. We also have found that, for now, analysts and investors are simply looking for some indication of progress on this topic, and disclosure based upon existing work should suffice.
The last two items (risk management and metrics and targets) are more challenging, and our experience is that only the industries and companies with substantial sustainability initiatives can provide this disclosure without extensive effort. And while the metrics suggested by TCFD may be helpful, they clearly are accepting of other alternatives, and we expect those to develop over time. For example, working with major investors, the investor-owned electric utility industry, through the Edison Electric Institute, has developed a very refined “dashboard” of appropriate data so that there will be comparability of reporting across the industry. Other industries may follow.
While at least one of the alternative proposals advocates that disclosures be included in MD&As, TCFD appears to be satisfied if the disclosures are contained anywhere in a document filed with the SEC, including in the “Business” section. We view this as a much better location in SEC-filed documents as it likely eliminates, or at least reduces, a range of issues, such as whether the disclosures would have to be covered in auditors’ comfort letters.
Also, please do not be lured into believing that disclosure of this nature will not be required of non-industrial companies, such as financial institutions, retailers, service providers and similar companies not generally associated with smokestacks. The expectation of the TCFD, and we believe of institutional investors and analysts generally, is that even these companies warrant disclosures based upon factors such as their locations and customers and vendors. For example, a retailer with significant coastal locations or locations in markets with more-expensive-than-average energy resources may need to make some disclosures, and a financial institution with disproportionate exposure to the energy industry or to loans in coastal locations similarly may need to make disclosures, albeit in both cases much less extensive than what an industrial company might make.
For now, we recommend that companies take a more in-depth look at the TCFD’s published materials and focus on disclosures related to at least governance and strategy. What has your company done to determine its climate-related risks, or that it does not have significant ones, and what governance structure has been implemented to make sure that this analysis has been performed and is being kept relatively current? Are you reporting to your board on a periodic basis? How are you dealing with climate change and other sustainability issues generally? These are easy questions to start with.
While we do not see the TCFD progressing at a sprinter’s pace, we do believe that it has legs and, over time, will become increasingly relevant.