We wrote an initial blog on the Task Force on Climate Related Financial Disclosure (TCFD) in November 2020, explaining how this is becoming the global standard for requiring the financial sector to reflect the real picture of climate-related risks in such a way that they become part of all financial decision making. That initial blog is here.
The TCFD is becoming increasingly influential, already applies from 1 January 2021 to premium listed companies, and will be applied to banks, building societies, insurance companies, asset managers, pension providers and other listed companies. Importantly, it is an approach to influencing financial disclosures that is increasingly accepted internationally. In this further update, we set out a short note on two important recent reports.
INSURING THE CLIMATE TRANSITION
In a report from January 2021, ‘INSURING THE CLIMATE TRANSITION – Enhancing the insurance industry’s assessment of climate change futures’, the United Nations Environment Programme’s Principles for Sustainable Insurance Initiative delivered the latest findings of 22 leading insurers and reinsurers.
They looked at methodologies for insurers that would implement the TCFD framework. They reviewed climate change-related risks and opportunities under three main headings -
Physical risks related to changes in weather patterns, temperature and hydrological conditions;
Transition risks towards a net-zero emissions economy and related fundamental changes in, for example, energy, food and transport systems;
Potential litigation risks pertaining to climate change and breach of underlying legal frameworks on both the business and corporate levels.
For physical risks, the report reflects confidence that the insurance industry is already familiar and comfortable with using risk models and detailed data, and has done so for several decades. The three cases studies looked at for the report were -
Riverine and coastal floods in Canada;
Riverine floods in European urban centres (London and Oslo);
Tropical cyclones in Japan and the US Gulf Coast.
For transition risks, the report was less confident that the insurance industry used consistent quantitative methods to assess future impacts. The examples of cases studies were –
Changes in energy production in France and Poland;
Evolution of real estate in Australia.
Litigation risks, a real scenario for an insurance industry facing potential claims for climate change litigation and breaches of underlying legal frameworks, do not appear yet to be assessed by the insurance industry in the same systematic manner. This is further reflected in the pursuit of two different approaches to trying to quantify the risks.
The first involved an assessment of how likely it was that litigation would be brought, the chance of a ruling in favour of the plaintiff and the costs of the remedy sought. The second was based on an assessment exercise being developed by the Bank of England’s Prudential Regulation Authority based on seven hypothetical model rulings.
Perhaps this report is a corrective to the view that addressing climate change is an exercise that mainly addresses emissions reduction measures from energy production of transport. This report underlines the impacts of the issue on the United Nations Environment Programme, on financial markets, on insurance, on physical infrastructure. Because those impacts are clear and present to the insurance industry, it is not surprising that Mark Carney, UN Special Envoy on Climate Action & Finance and UK Prime Minister’s Finance Adviser for COP 26, started with the insurance industry when embarking on the development of the TCFD framework.
In his Foreword to the report, Mark Carney wrote –
…”in order to meet net zero, we must transition the whole economy – that means every company, bank, insurer and investor must adjust their business models, develop credible plans for the transition and implement them. For private markets to anticipate and smooth the transition to a net-zero world, they need the right frameworks across reporting, risk management and returns. By COP26, these frameworks must be built so that every professional financial decision takes climate change into account.
In order to bring climate risks and resilience into the heart of financial decision-making, climate disclosure (reporting) must become comprehensive; climate risk management must be transformed, and sustainable investing (returns) must go mainstream.”
‘ACCOUNTABILITY EMERGENCY’
A further TCFD-related report was published by the law firm ClientEarth in February 2021, entitled ‘Accountability Emergency – a review of UK-listed companies’ climate change-related reporting’.
For this report, lawyers from ClientEarth reviewed the entire FTSE100, and the largest 150 companies on the FTSE250 Stock Exchange listings, studied each company’s most recent annual account, and developed a quantitative assessment of how company disclosures measured up against existing disclosure requirements.
The results of this report showed that -
4% of the 250 companies reviewed made a clear reference to climate-related factors in their financial accounts.
4% of audit reports clearly disclosed whether the auditors had considered climate change-related factors in their audit.
40% of companies clearly referred to climate change in their discussion of principal risks and uncertainties.
31% of companies clearly disclosed a target to reduce their GHG emissions by reference to alignment with the goals of the Paris Agreement, ‘net-zero’ objectives or ‘science-based targets’.
15% of companies did not disclose information about Scope 1 and Scope 2 GHG emissions.
This report should make for uncomfortable reading in a large number of boardrooms and their auditors, and may be of interest to regulators promoting TCFD principles and insurers considering ‘litigation risk’.