Climate change: Preparing TCFD disclosures for the Annual Report
The historic pledge from the G7 to make climate reporting mandatory is a timely reminder for UK companies to act now to prepare their first TCFD disclosures.
With the UK one of the first major economies to commit to mandatory climate disclosure last year, UK companies now face releasing their first annual reports reflecting the new Task Force on Climate-Related Financial Disclosures (TCFD) reporting requirements. From 1 January 2021, the Financial Conduct Authority (FCA) set out a requirement for all premium listed UK companies to comply with TCFD recommendations and disclose how they are considering the impacts of climate change, and on a comply or explain basis report against the TCFD framework.
The framework aims to drive real and significant change in how companies think about – and prepare for – climate impacts on their business. Rather than a simple reporting exercise, complying means having – and presenting – a clear understanding of the climate change risks and opportunities and, critically, showing how these might impact the financial statements of the organisation.
If your organisation is a premium listed company, now is the time to think about how your reporting will address the framework set out by the Task Force and what your financial auditor might ask you about the new disclosures.
‘Outside-in’ thinking about climate
TCFD demands a new way of thinking about climate risk and potential financial consequences. Companies have for many years been reporting from an ‘inside-out’ perspective – that is, considering how the company contributes to climate change based on its carbon footprint. Now, TCFD requires an ‘outside-in’ perspective which addresses how climate change might affect every part of the business. The whole value chain needs to be considered, including all business assets, employees, facilities, the supply chain and customers.
Designed to apply across all sectors and geographies, the TCFD framework aims to help investors understand an organisation’s material risks and opportunities related to climate change. It will also help companies highlight the likely impacts, both positive and negative, on their businesses as the effects of climate change accelerate and as society transitions towards a low carbon economy. So physical risks, such as the impact of potential changes in the weather, and transition risks associated with moving to a low carbon economy, will play out in different ways for companies. Management will need to understand this, plan for it and account for it.
What auditors will look for
The TCFD reporting framework calls for disclosures in four areas: governance, strategy, risk management and metrics and targets. These areas include 11 recommendations that range from describing the board’s oversight of climate-related risks and opportunities, to disclosing the metrics used to assess those risks and opportunities in line with the organisation's strategy and risk management process.
Auditors reviewing an organisation’s reporting will have to read these new disclosures and check consistency with the financial statements and knowledge obtained in the audit. Although the phrase climate change is not in International Financial Reporting Standard (IFRS) Standards, companies will need to understand how it might affect the business, and materially impact financial statement assumptions. The auditor will need to check when auditing the financial statements that the key assumptions underlying their preparation are also aligned with the TCFD disclosures made in the front half of the annual report. So organisations need to start building a plan for how to manage the reporting process holistically.
Setting the stage
A critical part of preparation is identifying who in the company needs to be involved in the TCFD reporting process. As these considerations take in every aspect of the business, it will need input from across the organisation, not just from those who usually work on environmental, social and governance (ESG) matters. Similarly, it will need insight about risks from all departments, not just from risk management. Governance, controls, compliance and assurance specialists sitting in the three Lines of Defence will be important contributors. And investors should be included: they will no doubt want to share their ideas about the climate impacts they are most interested in hearing about from the reporting.
Communication and education across the business is also critical for laying a foundation for understanding the impact of climate change. It’s vital that the CEO and other business leaders understand the importance of consistently integrating climate thinking into organisational decisions. Another consideration will be what assurance the company takes over what it is doing. Meeting these new TCFD requirements will likely result in organisational change, not simply new reporting, and this is the real value in applying the new framework.
Creating your scenarios
No organisation can say with complete certainty how climate change will impact the business in the short, medium and long term. But organisations can demonstrate they are preparing for the future by considering a range of scenarios, as well as making plans to respond to those contingencies. This is the "focal question" as stated within the TCFD guidance.
With robust scenario analysis, a company can show it has carefully assessed both physical and transition climate-related risks and opportunities, and how those might affect business operations, strategies and the financial quantification. Effective scenarios, as the TCFD noted in its final report in 2017, "provide a way for organisations to consider how the future might look if certain trends continue or certain conditions are met".
Done right, scenario planning and analysis can help alert an organisation to developments and indicators it needs to keep an eye on. Effective analysis also shows investors that a business is paying close attention, with the goal of minimising risks and making the most of potential opportunities.
Strategically managing risks and opportunities
Of course, it’s not enough to just identify risks and opportunities – an organisation also needs the proper governance and leadership to reduce risks where possible and manage those which cannot be fully mitigated through effective strategies, actions and resource allocations. To demonstrate this, it should have processes in place for keeping board members and committees informed about climate-related issues. It should also be able to describe how leadership monitors and manages the company’s performance in those areas. This includes descriptions of positions, roles, committee structures and increasingly more.
Disclosures should address how climate-related issues are considered in developing and acting on business strategies. But it’s the stress testing of these future strategies and the current business model that may lead to potential financial quantifications and any related impacts on the financial statements where material. And it's likely to be the reason a financial auditor will want to assess the audit risk of climate change as part of a robust audit.
Looking to the future
An organisation's goal is to demonstrate to investors that it is considering all the potentially material risks – and opportunities – that climate change might bring, and how these might affect its business assets, operations, models, activities, access to capital, costs, revenues and so on. These considerations must be reported accurately and meet TCFD criteria. Auditors will be looking for evidence that an organisation has taken all risks into account by understanding how these risks, opportunities and scenarios play out and how they might impact its ability to continue to operate as a business and whether climate change is or is not a material risk.
Complying with TCFD reporting requirements is much more than a box-ticking exercise. It is an opportunity for organisations to closely examine their role in society's move towards a low carbon future, and to optimise their current – and future – business model accordingly.
To learn more about preparing for TCFD reporting requirements, download our Task Force for Climate-related Financial Disclosures (TCFD) “Where do I start?” guide, or contact us below.
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