First edition of our TCFD blog series: What you should know about TCFD climate reporting in Switzerland and the challenges ahead
In January 2021, the Swiss Federal Council signed up to the Recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), proposing mandatory climate disclosure rules. But what is TCFD and what will it mean for Swiss firms?
Capital markets and corporate reporting rules are the latest battle grounds to combat climate change on the one hand and ensure the financial stability of markets on the other hand. Since its establishment in 2015, TCFD has rapidly gathered international support, most recently that of the Swiss Federal Council. A (if not the) key driver to motivate companies’ adoption of the 11 TCFD recommendations are investors looking to monitor and manage climate risks in their portfolios (and at the same time, to seize transition opportunities arising from the climate crisis). Indeed, TCFD supporters control assets totaling over US$150 trillion, and include all of the world’s systemically important banks, largest asset managers, insurers and pension funds.
One of the essential functions of financial markets is to price risk to support informed, efficient capita-allocation. In light of the economy-disrupting climate change, corresponding risks (and opportunities) must be taken into account. This is where TCFD reporting comes into place, to support investors and other financial stakeholders in assessing and pricing corresponding climate change-related risks and opportunities in their portfolio.
The recommendations put forward by TCFD (in connection with already existing reporting frameworks, such as the GRI Standards, for example) provide a suitable and well-established toolkit to companies seeking to satisfy growing disclosure demands from investors, lenders, and insurance underwriters. The TCFD reports not only enable an assessment of climate-related financial risks and opportunities of companies. Benefits also arise at company level, as a thorough adoption of the TCFD recommendations facilitates guided discussions on strategic questions regarding the company’s plan to remain relevant on the journey towards net zero, i.e. the scientific consensus of emission reductions required by 2050 to keep global warming well below 2°C. Globally, 56% of the world’s 250 largest companies acknowledge that climate change poses a (potential) financial risk. However, among the largest 100 Swiss companies, only 34% recognized it as such in their corporate disclosures, a recent KPMG study found.
The 11 recommendations of the TCFD are grouped into four areas: Governance, Strategy, Risk Management as well as Metrics and Targets. A company reporting under TCFD should explain what climate-related risks and opportunities it experiences in the short, medium and longer term, how it responds to them and what governance and risk management measures it has put in place. To support the evaluation of these measures, targets and metrics should be disclosed in order to prove the company’s progress on its journey towards a net zero future.
While 32% of the 100 largest companies in North America and 20% in Europe have adopted the TCFD recommendations already, in Switzerland this figure is only 15%, according to a recent KPMG study. These low figures are most likely due to the novelty of TCFD reporting. At a global level, for example, there is a jump of 15% among the 5,200 researched firms alone from 2017 to 2020. It is expected that Swiss companies’ adoption of TCFD will grow significantly over the next years; be it because of the increasing pressure from the Swiss Federal Council and regulators, or in response to demands by investors and other financial stakeholders. In fact, the latter is deemed the more likely driving force.
Regardless of whether they are just beginning with climate risk reporting or strengthening their existing reporting and the underlying implementation, companies should consider certain quality standards in order to meet the need of investors, lenders and insurers. KPMG has developed 12 quality criteria covering four categories: governance, identification and impacts of climate-related risks as well as net zero transition reporting to help companies get a better grasp on what should be reported how: (read more about it here)
So, what does good climate risk and net zero reporting look like?
Governance of climate-related risks: Besides clearly defined board responsibility to oversee the company’s response to climate change, the inclusion of climate change / climate-related risks in the chair’s or CEO’s message in the annual report as well as clear acknowledgement of climate change as a (potential) financial risk to the company is an important signal to investors.
Identification of climate-related risks: In order to inspire confidence among investors that the company is actively working to increase resilience to the impact of climate change, a dedicated section on climate risk (considering both physical as well as transitional risks) in the annual report – or a stand-alone disclosure – is recommended.
Impacts of climate-related risks: Scenario analysis is a powerful tool to understand the risks the company is facing due to climate change, allowing it to plan accordingly. The disclosure of such scenario analysis assumptions and results should encompass different global warming scenarios developed by reputable sources and a short, medium and long-term risk profile.
Reporting on net zero transition: Companies should set out a clear “net zero”-ambition (e.g. the Intergovernmental Panel on Climate Change (IPCC) 2050 deadline or emission reductions and net zero targets following the Science Based Targets initiative, SBTi) and a corresponding decarbonization strategy. In order to maintain and boost investor confidence, reporting should include a transparent communication on whether the company is on track to meet its decarbonization targets.
As part of this TCFD blog series, we will deep-dive into the different groups of TCFD recommendations and provide best practice examples following the 12 KPMG quality criteria for climate risk and net zero reporting.
The previously presented findings suggest that Swiss companies need to step up their climate (risk) reporting soon if they want to meet the information needs of their stakeholders. Companies that have not yet embarked on this journey should begin with climate risk disclosures and net zero planning without delay. Sufficient time and resources will be needed, as a “light touch approach” on TCFD disclosures will miss the goal of providing useful information to financial stakeholders. It will also lead the company to fail to fully understand and act on the impacts of climate change.
The best way to kick off climate reporting is to begin by addressing governance questions around board oversight on climate-related risks and opportunities and which corresponding activities are carried out by management to assess and manage such. Following this, the company should establish a process to identify climate-related (physical and transition) risks and opportunities relevant in the short, medium and long term.
As an organization’s maturity in its response to climate-related risk grows, more complex matters will arise. For example, how should the impact of climate risks be quantified and measured? One of the key TCFD recommendations is to use scenario analysis to provide transparency to stakeholders on the firm’s forward-looking climate-related risks and opportunities. however, developing short, medium and longer-term scenarios is inherently complex. Providing forward-looking information can mean a significant cultural change for companies used to providing retrospective (financial) information accompanied by short-term earnings forecasts.
When looking at companies’ reporting on the net zero transition it is not only important to set clear net zero or science-based targets, but even more so to have a sound decarbonization strategy as there are different ways to get to net zero by or before 2050. Many companies have set and communicated bold goals, but only few show how they plan to get there. It is strongly recommended to set a clear direction in this regard to inspire trust and credibility with investors. The idea is to remain flexible for further development as technologies in this field are constantly evolving.
The wide support by financial stakeholders of the TCFD recommendations demonstrates that they rely on disclosure to assess and price climate-related risks and opportunities. Of course, for companies, the Swiss Federal Council’s support of the TCFD means more regulatory requirements. However, most Swiss companies trail their global peers in acknowledging climate change as a potential financial risk and fall short when it comes to TCFD disclosures. Companies that have not yet embarked on their journey should do so without delay, keeping in mind that a "minimum compliance" approach is likely to fall short of stakeholder expectations. Governance and identification of climate-related risks is a good starting point before tackling more complex matters, such as scenario analysis. Lastly, companies should be mindful that bold net zero or science-based targets require a sound decarbonization strategy in order to inspire the trust and confidence of investors and to avoid potential accusations of "greenwashing" which are tantamount to reputational risk.