Are climate-related financial disclosures making a difference to business behaviour or the climate?

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Protest sign that states "There are no jobs on a dead planet"

By Dr Mayya Konovalova & Dr Salma Ashour, Department of Accounting

In his speech in Dubai, Chair of the IFRS Foundation Trustees, Erkki Liikanen, announced that COP28 marks the official end of the work of the Task Force on Climate-Related Financial Disclosures (TCFD). This achievement is hailed as a key milestone in information sharing, potentially providing investors, shareholders, and the public with insights into the financial risks posed by climate change for companies. But what has actually been achieved and how does it help in addressing climate change? Let us have a closer look.

Sustainability reporting in general has been traditionally perceived by company managers as an invitation to talk about how they selflessly help the environment, save the planet, and address climate change issues. In the absence of an agreement on which information should be included in these disclosures, it was rather difficult to compare the achievements in saving the planet between different companies. Let alone evaluate the efforts in actually reducing their carbon footprint.

While focusing on their societal and environmental impact, the companies often blamed government policies for slowing down progress on addressing climate change. However, things started to change (or did they?) when the TCFD introduced a new reporting framework in 2017. This framework turned sustainability reporting on its head, requiring companies to disclose how climate change could impact their financial performance, rather than how they impact climate change.

While embracing the TCFD framework has been presented as a hallmark of commitment to environmental stewardship, positioning organisations as leaders in the transition to a more sustainable future, this shift in reporting is still new. We don’t fully understand how companies are adapting to this new requirement. How do they understand the risk that climate change presents to their profits? What are their motivations in presenting such information? And finally, what exactly is achieved through these new requirements to report on companies’ exposure to different climate risk scenarios?

Let us take a look at some of the biggest energy companies in the UK, for which the climate-risk disclosure, in line with TCFD recommendations, became mandatory in April 2022. These are some of the observations we made so far:

  • The number of climate scenarios analysed varies from two (Octopus Energy) to ten (British Gas), with the latter not clearly presenting these ten anywhere in the report. Instead, British Gas condenses them into seven climate-related trends.
  • The time-frame of scenario analysis also varies. British Gas and Octopus Energy refer to short-, medium-, and long-term time horizons, in accordance with the TCFD recommendations, Scottish Power focuses on 2030 only, and E.ON and EDF do not clearly associate risks with specific time spans.
  • Companies also used different metrics for measuring the financial implications of climate-related risks, with Scottish Power using its EBITDA [earnings before interest, tax, depreciation, and amortisation] and British Gas using its gross margin [the percentage of revenue left over after you subtract the cost of producing or selling your goods or services], which are not comparable.
  • E.ON outsourced their climate risk analysis, and the reader is reassured that subject experts analysed the implications of these risks on the company’s strategy, economic and financial performance, concluding that E.ON has “a robust business model and great opportunities for decarbonization for every scenario”. Similarly, Octopus Energy helpfully refers the reader to the expert opinion of Baringa, one of Octopus’s energy price forecasters, who concluded that “on the whole, climate-related risks and opportunities on balance provide more opportunities to the Company than risks and the Company is likely to benefit from a 1.5/2-degree scenario more than the 4-degree scenario pathway”.
  • Meanwhile, OVO chose to delay the publication of their scenario analysis.

As such, the information disclosed by different companies, albeit in the same country and in the same sector, is not comparable. The climate scenarios seem to come from different sources and companies interpret them in various ways. Companies also use different financial metrics, like gross margin percentage vs earnings before interest and tax, to assess their exposure to risks related to these climate scenarios. And yet others are deferring their climate risk analysis, indicating the use of yet another database to come up with their own scenarios.

These issues have important implications for international policymaking related to climate change. First, the impact of the TCFD framework may only affect specific job roles, in particular, those who are tasked with composing potential climate risk scenarios, which in some cases involves an external organisation. It’s crucial to carefully think about which functions are affected by these disclosures and analyse how these initiatives play out in different national contexts.

Next, we need to figure out who is in charge (if anyone) of checking the information companies provide to meet these requirements. Currently, the climate risk scenarios given by the biggest UK energy companies seem to be all over the place, and it’s probably even more chaotic in some other countries.

Lastly, we need to carefully consider the information that becomes available through disclosure initiatives such as the TCFD framework. There’s a risk that the data provided may be distorted, offering a false sense of assurance to those viewing or using this information. The TCFD requirements don’t seem to envisage the accuracy of reported information, and as such appear to add to a raft of standards where transparency is sought for the sake of transparency.

It sounds reassuring that the IFRS Foundation Trustees have announced at COP28 yet another “three commitments to support efficient and resilient capital markets through robust sustainability-related financial disclosures”. But what do these commitments deliver in practical terms? Will these disclosures make a difference in companies’ behaviour or in reversing climate change? This remains to be seen.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of the University of Birmingham.

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