TCFD: a framework for sustainable markets in an uncertain world

The Task Force on Climate-related Financial Disclosures (TCFD) was set up by the Financial Stability Board (FSB) in 2015 to improve and increase reporting of climate-related financial information. The FSB is an international body that was established after the 2009 G20 to monitor and make recommendations regarding the global finance system. The backdrop was, of course, the financial crisis of 2008, in which the ramifications of weak corporate governance and risk management practices and the effect this can have on asset values was made clear.

It’s an obvious point, but financial markets need to be prepared for any risks associated with climate change, and to stress-test themselves as best they can for policy changes, temperature variations, or indeed events that are very difficult to foresee, such as the Covid-19 pandemic. This is from the organisation’s website:

“Climate change poses both risks and opportunities for business, now and in the future. As the Earth’s temperature rises, increasingly common natural disasters are disrupting ecosystems and human health, causing unanticipated business losses, and threatening assets and infrastructure. In response, governments and private sector entities are considering a range of options for reducing global emissions, which could result in disruptive changes across economic sectors and regions in the near term.”

The key problem is this: it is not clear at present which companies will have the required resilience, or, indeed, those that may prosper as the environment changes, the regulations alter, new technologies respond, and customer behaviour shifts.

To return to Covid, we saw this writ large last spring. Restaurants, anything dependent on global supply chains, airlines, auto parts & equipment and leisure industries were among the most disrupted. Healthcare REITs (real estate investment trusts), insurance, online food and telcos were either not disrupted significantly or prospered (telecommunications actually experienced both disruption and opportunities).

Moreover, the start of the pandemic saw 500 new companies becoming supporters of TCFD, as organisations rushed to show their sustainability credentials, in the wake of customer response to the crisis, which very much tilted towards companies who were seen to be doing their bit in the fight. The annual report in October 2020 reported an 85% increase in companies giving verbal support to TCFD’s recommendations, with 1500 organisations committing to implementing the framework. There is still a gap between the aim and the action, though, as the quality of reporting has only improved by 6% since 2017.

What is the framework?

TCFD wants to provide companies with better information so that they can incorporate climate-related risks and opportunities into their risk management and strategic planning processes. This will advance the cause of ethical and sustainable investment by the market. The framework of recommendations was released in 2017 and is based on four themes:

1.       Governance: describes the board’s oversight of climate-related risks and opportunities and management’s role in assessing and managing climate-related risks and opportunities

2.       Strategy: describes the climate-related risks and opportunities the organisation has identified over the short, medium, and long term; the impact of climate-related risks and opportunities on its businesses, strategy, and financial planning; the resilience of its strategy, taking into consideration different climate-related scenarios

3.       Risk management: outlines its processes for identifying and assessing climate-related risks; for managing climate-related risks; how processes for identifying, assessing, and managing climate-related risks are integrated into its overall risk management

4.       Metrics and targets: discloses the metrics used by the organisation to assess climate-related risks and opportunities in line with its strategy and risk management process; its Scope 1, Scope 2, and, where appropriate, Scope 3 greenhouse gas (GHG) emissions, and the related risks; the targets it uses to manage climate-related risks and opportunities, and performance

The recommendations apply to financial-sector organisations, which have been sub-divided into four types – banks, insurance companies, asset managers, and asset owners – but also to non-financial groups – energy, transportation, materials and buildings, and agriculture, food, and forest products – within which the largest amount of GHG emissions occurs. Therefore, there is supplementary, bespoke guidance for both sets of companies, which in the case of non-financial companies, only comprises advice relating to strategy.

What does this mean for the built environment sector?

For non-financial companies in general, the TCFD assessed three factors most likely to be affected by both transition risk (policy and legal, technology, market, and reputation) and physical risk (acute and chronic) i.e. GHG emissions, and energy and water usage. To cite the report, which can be downloaded here:

“The underlying premise in using these three factors is that climate-related physical and transition risks will likely manifest themselves primarily and broadly in the form of constraints on GHG emissions, effects on energy production and usage, and effects on water availability, usage, and quality. Other factors, such as waste management and land use, are also important, but may not be as determinative across a wide range of industries or may be captured in one of the primary categories.”

The building industry has for some time now been improving its use of materials and waste management, but moreover, there has been a general drive towards improved energy efficiency with production and distribution processes, buildings, machinery and transport. There’s an economic benefit as well, above and beyond increased customer satisfaction and the brand value in the disclosure of climate-related risk – a reduction in operating costs. Advances in technology have also helped: circular economy solutions; improvements in LED lighting; geothermal power; an uptake in retrofitting buildings, among others. This move to more efficient buildings potentially improves the value of fixed assets. It’s a key aspect of resilience planning.

Why is it important?

Beyond the blindingly obvious fact that we need the planet to continue to exist, aligning financial reporting and environmental action makes sense. We live in a profit-driven economy, in which the market plays a huge part. Therefore, checks and balances that are clearly human-centred have a very important role to play in ensuring that businesses don’t just put profits first and the planet a poor second.

Experts in the field argue that reporting transparency is essential to tackling the climate crisis. In a world in which campaigners shine an ever-brighter light on the need for sustainability, and in which governments are then forced into action, with differing levels of willingness, the private sector is attempting to find its place in the environmental scheme of things. Getting awareness of the TCFD out to as wide a layer of organisations as possible can only help in this regard. To return to the financial sector, given it has a key role in all sectors of the market, it needs to consider how to mitigate climate-related risk. This is the context in which the TCFD is gaining momentum.