Investors want better communication from companies about how climate change will impact their assets.
At the United Nations Climate Change Conference in Paris (COP21) in late 2015, Bank of England governor and chairman of the Financial Stability Board (FSB) Mark Carney announced that billionaire businessman Michael Bloomberg would head the FSB’s newly created Task Force on Climate-Related Financial Disclosures (TCFD).
The FSB is charged by the Group of 20 (G20) nations with protecting the stability of the world’s financial system, which Bloomberg is in no doubt is at serious risk to climate change.
“Everything has a financial component to it,” he said at COP21, warning that the effects of climate change are having a real economic impact on companies and, of course, investors.
However, according to a study by the Smith School of Enterprise and the Environment at the University of Oxford, only 34 per cent of investors understand the 2oC [COP21 set 1.5oC] target to avert dangerous warming, and just 20 per cent believe sufficient information exists to properly analyse corporate exposure to climate change.
Transparency and disclosure
According to CPA Australia’s policy advisor for environmental, social and corporate governance, Dr John Purcell, listed companies in Australia could improve disclosure by taking better advantage of the ASX Corporate Governance Council’s Principles and Recommendations, particularly Recommendation 7.4, which arose in response to increasing focus by investors on a listed entity’s ability to create and preserve value.
“These are existing regulatory opportunities through which listed companies and their directors can explore the scope for providing better discourse and disclosure of their climate change risks,” Purcell maintains.
He says that although many companies have through statutory requirements captured comprehensive data and built it into their public disclosure, “there is a gap between what is reported to government and what is voluntarily disclosed”.
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“The types of entities that do [openly] report are those that see themselves as market leaders in this type of disclosure, are concerned about managing reputational risk, or see climate change issues as something their investors are particularly concerned about,” he says.
“You find this in accounting,” he continues, “where the old systems of measurement, evaluation and risk appraisals lag behind the pressures and demands emerging in the operating environment. Over time, though, skills and systems catch up and that gap begins to lessen.”
A key problem impacting effective communication is a lag in even understanding categories of climate change risk: stranded assets, litigation exposure, or regulatory change in target markets.
“The range of risks is complicated and the other feature we increasingly have to contend with is the interrelationship between different types of risk,” Purcell says.
Pablo Berrutti, head of responsible investment at Colonial First State Global Asset Management, agrees.
“Investors are not a homogenous group,” he states.
“While there are many who try to understand the risk of stranded assets from fossil fuels, for example, there are other factors in play such as the global economic slowdown and falling cost of renewables that collude to change the market dynamics and prospects for some commodities.”
How companies choose to communicate the issues depends on how mature an issue is for them and its potential impact.
"In accounting, the old systems of measurement, evaluation and risk appraisals lag behind the pressures and demands emerging in the operating environment." Dr John Purcell
“In the case of US and European gas majors we’ve seen resolutions accepting and providing greater disclosure because their investors called for it,” Berrutti says.
“A lot of it relates to scenario analysis and portfolio stress-testing, not dissimilar to bank stress-testing post-GFC. Investors are really looking to ensure that capital management decisions are appropriate, and in the case of gas and oil companies that has to do with exploration, expansion or new production.”
In other sectors, such as automobile manufacturing, it could relate to the supply chain or development of battery or hydrogen-powered vehicles.
“For those types of companies, a fossil fuel stress test or carbon footprint won’t tell you much – investors need quality disclosure on how the business is being positioned for a carbon-constrained world,” he says.
Purcell believes there is still a general belief that the problems can be diverted to the future.
“In Australia, we’ve been distracted,” he says. “We’ve had a period of policy uncertainty in a period where international governments have gathered pace.”
Adds Berrutti: “Carbon pricing in Australia disappeared very quickly [and with it] the way investors would normally incorporate something like a carbon emissions cost, such as putting it into a model.
"Then you would put a growth rate into the price and make an assumption around that, but dealing with the issue in the absence of a long-term policy framework as to how emissions are going to be reduced makes it very difficult.”
There is general consensus that improving carbon disclosure across the economy would enable investors to make more informed decisions and to better assess carbon risk.
But in terms of the overall reporting of climate risks, Purcell insists that there has to be a degree of standardisation around risk classification and measurement, albeit not necessarily along the lines of the highly prescriptive and detailed corporate disclosures that have typified some US legislation and which don’t necessarily focus on the true nature of risk.
“You can end up with disclosure outcomes that have a huge amount of detail but miss addressing the fundamental risks that will upset corporations’ capacity to survive,” he says.
“The difficulty is that communication to investors has to be appropriate to specific sectors,” Pablo Berrutti, Colonial First State Global Asset Management
“Standardisation within frameworks and measurement processes need to be overlaid by considerations of materiality, investor need, and investor literacy.”
Berrutti believes integrated reporting – an initiative long-advocated by CPA Australia – is an integral part of the answer.
“The difficulty is that communication to investors has to be appropriate to specific sectors,” he says.
“Integrated reporting puts the onus on a company to identify material issues and explain how it goes through the process to manage the risks.
“We like that kind of disclosure because it helps us understand how the company is thinking, and then we can just make calls as investors on whether we think the strategy is a good one – if we think they get the issues or not.
“Foot-printing is largely standardised now and reserves reporting is generally in place and just needs a carbon factor applied to it so you can work out the emissions that are in the ground. But in general, to get to the heart of the issue, which is around corporate strategy, it’s something like the integrated reporting initiative that will add the most value for investors.”
Focus on the future
CEO of the Investor Group on Climate Change Emma Herd says the Paris Agreement has fundamentally changed the investment landscape and all companies need to start stress-testing their commercial strategy for a two degree scenario and disclose to the market the risks and opportunities for their business.
“It’s true that many investors haven’t really thought about the connection between their investment and climate change,” notes Australian Council of Superannuation Investors (ACSI) CEO Louise Davidson, “but our members have become quite focused on climate change in their portfolios.”
According to Davidson, in addition to annual reports and six-monthly updates, an increasing amount of super fund-relevant information is being put online for beneficiaries about how to mitigate risks and leverage emerging opportunities.
“I think the Paris talks were important not only in terms of outcome, but in the constructive role investors played,” she says.
“Investors – along with other parts of business – were instrumental in countries signing up to their commitments.”
“Australian business now needs to move from qualitative statements on support for climate change to quantitative assessments of the financial impacts,” Herd adds.
Purcell ultimately agrees, with one qualification
“From an accounting perspective, quantification feeds into considerations like asset impairment and impact on future earnings,” he says.
“It’s a commendable direction, but when you’re working in an area of uncertainty I think there is still significant need for a qualitative discussion about what the numbers mean and a narrative around the areas of uncertainty where quantification is not possible.”
“Australian business now needs to move from qualitative statements on support for climate change to quantitative assessments of the financial impacts,” Emma Herd, CEO, Investor Group on Climate Change
Purcell is also adamant that the nature of climate change risk and the agreement in Paris are of themselves insufficient to drive significant change in global markets, although he – along with Berrutti, Herd and Davidson – believes the ongoing work of the TCFD will accelerate the influence of investors on climate change-related corporate communications.
“It is beholden on governments to send appropriate messages to their markets that change is expected within a reasonable timeframe, or the targets will not be met,” he warns.
“Waiting for crisis to compel change in markets has been attempted in the past – the GFC, for example. Major corporate collapses and significant upheavals are what cause markets to adjust. I think with climate change the stakes are too high and the complexities too great to allow that to happen.
“Relying on enlightened self-interest to be the only mechanism for change is naïve.”
7 principles for disclosure
In March this year the FSB’s Task Force on Climate-Related Financial Disclosures identified the core principles for effective disclosure in climate risk reporting that will underpin its recommendations, to be released publicly in February 2017. They are:
- Present relevant information
- Be specific and complete
- Be clear, balanced, and understandable
- Be consistent over time
- Be comparable among companies within a sector, industry, or portfolio
- Be reliable, verifiable, and objective
- Be provided on a timely basis.
Can integrated reporting finds its way?