In this important piece, Katherine Blue, U.S. Sustainability Services Leader at KPMG, reflects on how far we have to go to achieve fully informed decision-making on corporate sustainability performance.
Tim Nixon, Managing Editor, Sustainability: Why does your recent survey on corporate reporting focus on climate change as a headline?
Katherine: The FSB, (Financial Stability Board), whose role is to ensure the ongoing stability of the global financial system, took the view that investors, lenders, and insurers are not being provided with sufficient information to accurately price the risks of climate change into their decisions. This lack of financial data was seen as hampering the ability of these financial market players to understand and manage a growing risk, which in turn has implications for the overall financial system.
The FSB presented its recommendations on how corporations should disclose their climate related financial risks in July 2017. Several major financial organizations have since announced efforts to better identify climate risk in their investment and lending portfolios and have pressured corporations to improve disclosure.
Through our survey, we wanted to understand just how big the gap was between the type of disclosure that the TCFD recommends and what corporations are reporting now.
Tim: What did it find on the rate of disclosure?
Katherine: We found that the gap between TCFD (Task Force on Climate-Related Financial Disclosures) recommendation and what corporations are currently doing is significant. Worldwide, almost three-quarters of the largest companies by revenue do not acknowledge climate change as a financial risk to their business, nor do they provide investors with estimates of the value that might be at risk from climate-related impacts.
In the U.S., the picture is better with 53 of the top 100 corporations by revenue acknowledging climate risk in their financial reporting. This puts the U.S. among the top five countries worldwide for corporate acknowledgement of climate risk. This may be due to the U.S. Securities & Exchange Commission (SEC) regulation that requires disclosure related to climate change in SEC filings. It may also be driven by the focus on efficient management and avoidance of risk in U.S. corporate culture in order to prevent charges of negligence and potential litigation.
Many that do acknowledge that climate change is a financial risk are not disclosing their likely financial impact. Worldwide, roughly one-third of corporations that acknowledge the risk, don’t discuss the impacts in their reporting. And, just under two-thirds of companies provide a narrative description of climate-related risks. Again, the findings are more optimistic in the U.S. All of the companies that acknowledge climate change as a risk provide a narrative description of the potential impacts stemming from climate change related risks. However, less than five percent of surveyed companies worldwide quantify the risk in financial terms or model it using scenario analysis.
In the U.S., the increase in corporate responsibility reporting and the inclusion of corporate responsibility information, including climate-related impacts, in annual reports has been driven by three key factors:
- Intensifying investor and shareholder interest in sustainability;
- The requirement for climate change-related disclosure in SEC filings;
- The industry-specific standards published by the Sustainability Accounting Standards Board (SASB) providing guidance on the types of CR disclosures organizations should include in mandatory financial SEC filings.
Tim: Why is putting disclosure in financial terms important?
Katherine: Financial stakeholders (i.e. investors, lenders, and insurers) require investment grade forward-looking financial data that can be used to make informed decisions. This said, they increasingly expect climate-related disclosures to be included among the other financial disclosures. Pressure from activist shareholders and stakeholders, both internal and external, is growing quickly in the U.S. and abroad.
It is a case of when, not if, transparency on climate-related risk will be the norm in financial reporting. It is in the best interest of corporations (and their shareholders) to proactively prepare and disclose. Companies that lag behind could see significant impacts such as shareholder action to force disclosure, loss of investors, higher cost of capital, and more costly insurance coverage.
Additionally, investors are coming to understand that issues such as water scarcity and human rights not only have an impact on communities and the environment, but also pose a financial risk to businesses. Companies will be expected to be transparent not only about their own performance on these topics, but also about the financial risks and opportunities they face from them and the likely effects on the business’s value creation in both the short and long-term.
Tim: How possible is it to put it in financial terms?
Katherine: In much the same way corporations assess the potential financial impacts of any other risk. Companies collect all available information to understand the extent to which risks will affect the business and in turn what the potential impact is on concepts such as operating costs and revenues, access to capital, capital expenditures, and capital allocation.
Potential financial impacts, stemming from climate change focused financial risks could include:
- Reduced or increased operating costs (e.g. key products are no longer available as a result of climate change)
- Transitional costs associated with developing and/or shifting to new production locations and production methods
- Increased or decreased production capacity, yielding a corresponding impact to revenues (e.g. workers efficiency drops in excessive heat and fully loaded planes struggle to take off in excessive heat)
- Increased or decreased value of fixed assets (e.g. proximity to flood zones)
- Increased or decreased exposure to fossil fuel prices
- Transitional costs associated with implementing and / or procuring low carbon energy
- Increased or decreased reliability / resiliency of supply chain
- Increased or decreased ability to operate under adverse conditions (e.g. weather (short-term events), climate (long term changes), social unrest, etc.)
TCFD recommends scenario analysis as a basis for climate risk assessment. To that end, the first step to effective disclosure is for finance teams to gain an understanding of the material environmental and climate issues that have the potential to affect the company’s financial performance.
Tim: Is climate disclosure more important for some companies than others?
Katherine: KPMG supports the TCFD and their recommendation that all companies should assess their financial vulnerability to climate risk or identify potential opportunities and their corresponding impact to financial stakeholders, to determine the extent to which these risks and opportunities are material.
However, there are certain sectors and industry groups that are seen as having an inherently higher exposure to financial risk from climate-related impacts due to the nature of their business and their impact on and by energy, water and carbon emissions. The TCFD has proposed supplemental guidance for the following sectors: banking, insurance, asset owners and asset managers in the financial sector and non-financial sectors categorized in the industry groups energy, transportation, buildings and materials (including Real estate), and agriculture, food and forest products.
In addition to the general indication that companies in these sectors and industry groups would be expected to disclose on their climate-related risks and opportunities, there are additional company-level factors that could make climate disclosure more important for some companies over others. These could include factors such as geographic location of operations, geographic markets, energy mix used for production, available technology, and product portfolio.
Tim: How is the recent guidance from the TCFD affecting corporate disclosure rates?
Katherine: As the guidance from the TFCD was only recently released it is too early to determine how the recommendations are affecting or will affect disclosure rates. It is too early to see any material impact from TCFD’s recommendations on corporate disclosure rates. However, KPMG will continue to monitor disclosure every two years as part of our Corporate Responsibility Reporting survey and will track changes in reporting over time.
It’s important to note that the recommendations of the TCFD apply to the disclosure of climate risk in annual financial reports (i.e. the annual report and 10k), not in corporate responsibility reports.
Tim: Does the TCFD guidance make it easier to disclose?
Katherine: In simple terms, yes. By establishing a standardized approach to disclosure that can be applied by all companies in all sectors, the TCFD guidance makes it easier to disclose. However, that does not mean the disclosure itself will be easy, especially for companies that are starting from behind.
Like any new approach to reporting and disclosure, it takes time to develop the systems and processes, and build the necessary capacity and experience within the organization. However, these challenges should not be seen as a deterrent. As noted above, it is our view that investors, lenders, and insurers will increasingly demand this type of disclosure until it becomes the standard practice.
Tim: What sectors are you seeing the most increase in disclosure?
Katherine: As I stated earlier, we have only just started to monitor disclosure increases, so it is too early to identify this just yet.
Tim: Where is there the most urgency for more?
Katherine: Sectors seen as most exposed to financial risk from climate related impacts include financial services, energy, transportation, buildings and materials, and agriculture, food and forest Products.
Tim: What are the increasing benefits of disclosure?
Katherine: Sector leaders in disclosure are less likely to see shareholder action to force disclosure, less likely to lose investors, and to face potential lower cost of capital and insurance coverage.
The process of identifying and quantifying climate risks (and opportunities) has obvious benefits in terms of knowledge. When a company is fully aware of its vulnerability to climate-related impacts, it can act to reduce the exposure posed by those risks, and potentially unlock commercial opportunities. Companies that understand and respond to their climate-related impacts may be better able to comply with (and potentially shape or influence) new regulation as it is developed.
Companies can adapt by considering the issues they are facing globally and understanding how those issues impact business models. Failing to consider the full suite of material issues, which may negatively impact a business, increases the likelihood that businesses will experience significant and avoidable financial stress and insolvency.
Tim: What will the challenges on disclosure look like in 2030?
Katherine: Making predictions more than five years into the future is effectively speculation. As Yogi Berra said, “it’s hard to make predictions, especially about the future.”
The disclosure of climate risk will likely be standard practice by 2030, at least among the largest companies that historically lead the charge. Such disclosure is likely to be mandated by law and/or regulation in many countries by 2030. As a result, conforming to multiple disclosure requirements in multiple markets and jurisdictions may prove challenging.
One driving force of the TCFD was to establish a common (voluntary) framework early in order to provide a model for future mandatory regulations. Building from the TFCD, the disclosure of risks and challenges will likely be codified and homogenized across many businesses sectors.
Climate change and its impacts are unpredictable, non-linear, and systemic. Modern day humans have not seen climate change at this scale or pace. As a result, we have no existing climate models of what to expect; it’s effectively educated prediction. Planning for businesses will be difficult, which is why regularly updated scenario analysis using the latest scientific climate models is important.
Market transformation is highly unpredictable. The impacts of climate change could result in new carbon limiting regulation such as a cap and trade market or carbon tax. Market demand and other market forces are moving at a far quicker pace than many expected, while technological advancement is transforming markets far more radically and rapidly than expected. For example, solar and wind are rapidly becoming cost-effective energy options and achieving cost parity with coal in many markets, far sooner than many analysts expected. As a result, a major challenge in 2030 will include ensuring that disclosure keeps pace with the changes in physical and market impacts of climate change.