Introduction:
In 2015, the Financial Stability Board (FSB) established an industry-led task force- The Task Force on Climate-related Financial Disclosures (TCFD), under the chairmanship of Mark Carney, to recognize the information needed by investors, lenders, and insurances underwriters to evaluate and price the climate-related risks and opportunities. The TCFD was asked to design and develop voluntary and consistent climate-related financial disclosures to aid stakeholders from various industries in realizing the material risks related to climate change.
The final report on TCFD was released in 2017 which included four core elements with eleven recommended disclosures on climate related disclosures which were designed to be applicable to organizations across different sectors and jurisdiction. TCFD members from various organizations representing the private sector, including banks, insurance companies, asset managers, pension funds, large companies, accounting, and consulting firms along with credit rating agencies. The recommendations for climate-related financial disclosure were obtained from member expertise, in addition to stakeholder engagement and existing climate-related disclosure frameworks and standards.
Why was TCFD set up?
The TCFD was created in response to concerns about the potential impact of climate change on the global economy and financial markets. The FSB recognized that climate-related risks could have significant implications for financial stability of stakeholders competing in the market and that there was a lack of standardized and comparable information available to investors, lenders, insurers, and other stakeholders to assess and manage these risks. Therefore, TCFD was set up to attain appropriate pricing for climate-related risks directed towards efficient capital allocations.
Significance of TCFD:
TCFD is unique in its focus on integrating climate-related information into mainstream financial reporting. It provides a framework that encourages organizations to disclose information related to the financial impacts of climate change on their business. While the work of the TCFD builds on existing work, it represents an opportunity to bring climate-related financial reporting to a wider audience.
What makes TCFD different?
- Linking Financial and non-financial information: The TCFD focuses on the financial impact of climate change, and therefore requires organisations to link non-financial information with financial information
- Risk and Opportunity: The recommendations have a strong focus on the risks and opportunities related to the transition to a low carbon economy and the physical risks associated with a changing climate, including the potential financial impact on the organisation.
- Time Horizons: There is uncertainty of when financial impacts of climate change on organisations may be realised, and these timeframes are often further in the future than current business planning horizons. The TCFD encourages organisations to define their time horizons and develop understanding of short-, medium- and long-term impacts.
- Scenario Analysis: The TCFD recommends that organizations conduct scenario analysis to assess the potential impacts of different climate-related scenarios on their business. This forward-looking approach helps companies and investors understand how the organization might perform under different climate-related conditions.
- Financial Filing: The TCFD recommends organisations disclose climate-related financial information in their mainstream annual financial filings. In most jurisdictions, organisations with public debt or equity have a legal obligation to disclose material information in their financial filings – including to disclose material risks.
TCFD as a framework for ESG consultants:
TCFD framework is often used by Environment, Social and Governance (ESG) consultants as a valuable tool to guide and structure climate-related disclosures for organizations as it provides a standardized and globally recognized framework for reporting on climate-related risks and opportunities. ESG consultants can leverage this framework to ensure consistency and comparability in their clients’ disclosures and further help investors and stakeholders seeking clear and uniform information.
TCFD also encourages companies to disclose information which is material to their financial performance. ESG consultants use this framework to identify and prioritize such climate-related issues which are most relevant to the business to make the disclosures in accordance with financial considerations and stakeholder expectations. This framework talks about the importance of four core focus areas in a business which eventually assist in bringing uniformity in disclosure patterns across the industry as well as over different time horizons in the form of short-term, mid-term and long-term impacts of climate-related changes. The table below presents the 4 core areas and the thematic focus of each area:
Governance
Disclosures regarding organisation’s governance around climate-related risks and opportunities.
Strategy
Disclose the actual and anticipated effects of climate-related risks and opportunities on the organization’s strategy, financial planning, and business operations.
Risk Management
Disclosures regarding how the company recognises, evaluates, and handles risks associated with climate change.
Metrics & Target
Disclose the metrics and targets used to evaluate and manage pertinent climate-related risks and opportunities.
Principles for Effective Disclosures:
TCFD recommendations are predicated on a set of fundamental principles which enable high-quality, meaningful disclosures for making decisions, even as the market’s comprehension of the effects of climate change changes over time. The organizations which follow the TCFD’s recommendations are urged to keep these guidelines in mind at the time of creating financial disclosures about climate change which also works as a blueprint for the strategy consultants involved in the process.
The disclosure standards apply to the majority of financial disclosure providers and are generally congruent with other widely used, internationally recognized frameworks for financial reporting. When combined, the principles are intended to help organizations clearly communicate the connections and relationships between their strategy, governance, risk management, KPIs, and targets and climate-related concerns. Principles for effective disclosures are:
- Disclosures should present relevant information.
- Disclosures should be specific in nature with complete meaning.
- Disclosures should be clear, balanced, and understandable.
- Disclosures should be consistent over time.
- Disclosures provide comparable insights into companies within a sector, industry, or portfolio.
- The information disclosed should be reliable, verifiable, and objective.
Disclosures should be released on a timely and cyclical basis.
Scenario Analysis as a tool:
Organizations are required under the TCFD’s Strategy recommendation guidelines to reveal how resilient their plan is to a 2°C or below scenario. One technique that businesses might utilize to better understand their resilience is scenario analysis which is explained as a crucial tool for organizations aiming at reducing their emissions.
Scenario analysis is the suggested tool which can be used to enhance critical strategic thinking which goes behind net-zero transition of an organization. A key feature of scenarios is that they should challenge conventional wisdom about the future. Amongst the uncertainty of climate change, scenarios are intended to explore substitutes which may significantly amend the basis for “business-as-usual” assumptions. Scenario analysis is a fairly new approach which will further develop based on the future developments in data sets, tools, methodologies, and standards, in addition to organizations’ information sharing experiences.
Conclusion
In conclusion, the Task Force on Climate-related Financial Disclosures (TCFD) is a pivotal initiative designed to address the growing need for transparent and consistent reporting on climate-related risks and opportunities within the financial sector. Established by the Financial Stability Board (FSB), the TCFD offers a unique framework that sets it apart in the realm of sustainability reporting.
Key attributes that distinguish TCFD include its voluntary nature, which encourages flexibility and innovation in disclosure practices while providing companies with a globally recognized and standardized approach. Unlike some sustainability frameworks, TCFD places a strong emphasis on the integration of climate-related information into mainstream financial reporting, ensuring that disclosures are material to the financial performance of the organization.
