How should businesses put the TCFD recommendations to work?
Compelling businesses to disclose their climate risk exposure was never going to be a swift or simple process. New climate reporting guidelines from the Task Force on Climate-related Financial Disclosures (TCFD) provide a framework for these disclosures – but whether compliance should be mandatory or voluntary has been a hot topic. Would a hard or soft approach work better for increasing the flow of information to the market?
The TCFD recommendations apply to a huge range of organisations, covering financial and non-financial sectors and cutting across industry types and countries. Given that climate know-how differs dramatically among these organisations, many have viewed the voluntary framing of the TCFD recommendations as the best means of achieving widespread adoption. On this view, organisations at the forefront of adoption will reap the reputational benefits and change the paradigm so that the laggards will face pressure to catch up with the new disclosure norm.
Others argue that if the TCFD recommendations are not mandatory, those same laggards will fail to comply within the urgent timeframe.
However, the window within which these recommendations will remain voluntary seems to be shrinking fast. The TCFD will continue to exist beyond the publication of the final recommendations – with a new mandate to work on implementation. And major names like Aviva and others are already calling for them to become mandatory.
Mandatory risk reporting – are the rules already written?
While the final TCFD recommendations are expressed to be voluntary, what this means in practice is not quite so clear-cut.
What is incredibly important – as the TCFD recommendations explicitly recognise – is that in most G20 jurisdictions, many companies already have a legal obligation to disclose material risks in their financial reports. This includes climate-related risks where they are material to the business.
This fact is often overlooked, but it makes the ongoing mandatory-or-voluntary discussion in part overstated. In the UK for example, listed companies must provide a strategic report that contains:
• a fair review of the company’s business;
• a description of the principal risks and uncertainties facing the company; and
• the main trends and factors likely to affect the future development, performance and position of the company's business.
These requirements relate to core business information – and while they do not expressly refer to climate, the acknowledged financial impact of climate-related risks means they also fall within the disclosure requirement. The TCFD recommendations are a clear affirmation of this expectation by industry.
As the TCFD recommendations note, companies will also need to consider that climate-related risks might have direct impacts on their financial accounts. To ensure consistency with climate-related risks identified in the strategic report, companies may need to consider relevant adjustments to cash flow models used for asset valuations and potential impairments to assets.
Companies therefore already have clear legal obligations to report material risks – including climate-related risks. The TCFD recommendations provide the best practice standard for doing so. In light of this, it is difficult to see any good justification for companies not to report climate risks using the TCFD recommendations.
Managing risk, identifying opportunities
Just as the low carbon transition presents significant risk, it also creates significant opportunities for organisations focused on climate change mitigation and adaptation solutions. The TCFD recommendations give equal attention to climate-related opportunities.
“What gets measured gets managed” is a familiar mantra in carbon accounting circles, and the same is true here. The information directors will discover through complying with the TCFD recommendations will be crucial in identifying risks and opportunities. This will make it much easier for businesses to align themselves with the low carbon transition.
And just as risk reporting laws apply across different countries, so too do directors’ legal duties to act in the best interests of the company, and to exercise due care in assessing and managing risks and opportunities. For many – if not all – companies in carbon-intensive sectors, failing to manage climate risk can mean liability on the part of the directors or the company.
To dispel any fears that TCFD compliance will expose directors to liability, a new legal report argues the opposite is true. Legal experts say the TCFD recommendations not only provide an excellent best practice framework for governance of climate risk – they are currently the best insurance policy against being sued over climate risk disclosure.
Compliance with these recommendations will be strong evidence that directors are meeting their existing legal duties. Non-compliance on the other hand, may signal a breach of the law.
Where to now?
It remains to be seen how the interaction between a (voluntary) best practice framework for reporting risk and a (mandatory) risk reporting requirement will play out – and it may play out differently across jurisdictions. But as a market-led initiative, the TCFD recommendations provide a clear indication of an emerging legal standard and send a strong signal to policymakers.
Relevant organisations should be going full speed ahead to clarify how they will comply with the TCFD recommendations. Compliance helps reduce liability risk for companies and directors. Following the recommendations will lead companies to disclose adequately, manage climate risk effectively, and take advantage of emerging opportunities.
David Cooke is a Company and Financial Lawyer at ClientEarth.