Suddenly, we find ourselves in a world with the distinct possibility of reaching consensus on achieving the ambitions of the Paris Agreement for the very first time. President elect, Joe Biden, has committed to returning the USA to the Paris Agreement on his first day in office, and 53% of the world’s emissions are covered by a Net Zero target indicative of the strong, decisive action we can expect on Nationally Determined Contribution updates at COP26 in November 2021.
And with this trend, transition risks and opportunities are burgeoning, with greater uptake in corporate front half disclosure, principally via the Task Force on Climate-related Financial Disclosures (TCFD) framework, becoming the vehicle for observing the consequential risks, opportunities and related metrics and targets of corporates.
However, the majority of company responses we are seeing to date, are qualitative disclosures. If corporates are quantifying risks, it is generally focused on the notional impact of a carbon price upon their operations. Though without quantification of the risks and opportunities, boards will find it hard to compare climate change against their wider enterprise risks; and for investors to make informed decisions about the allocation of their capital.
These findings are supported by the TCFD’s latest Scenario Analysis Guidance, where they have declared ‘quantification... is a necessary goal in a mature process.’
Why is the market so reluctant to quantify climate risk?
In our experience, there are 2 key reasons given
1. Perception of being more transparent to the market than sector peers
Some corporates believe that by disclosing quantified risks and opportunities, they could open themselves to scrutiny that their peers will not receive. The genesis of this concern may be well founded, but with the directional winds blowing very clearly, one should expect more questions of those who do not quantify in the coming years, than those who do.
2. Difficulty with defining likelihood under scenarios
Scenario analysis, by definition, is not forecasting, so the quantified risk is not a foregone conclusion, but one potential set of outcomes if the conceived events were to materialise. As such, there persists a high degree of uncertainty, making it challenging to assign a probability to a specific event or series of events related to climate change.
However, pivoting to the strategic intent of the TCFD, which is to drive the right strategic behaviour, quantification is less about understanding the exact numbers and more about understanding what events may prove significant for the purposes of strategic decision making. These outputs are what allow companies to make informed decisions in terms of the allocation of capital, and to build resilient, adaptive businesses over the longer term.
What do investors want?
In addition to understanding the assumptions sitting behind a corporate’s resilience, investors are also interested in two key facets of a company’s disclosure which are undoubtedly enhanced via quantification and should be positives for companies who have met this strategic intent:
- Understanding management’s ability to foresee and respond to emerging risks by building resiliency into their operations, for example, via the way they articulate clear adaptation strategies; and
- Via the ability to price the value creation of the new opportunities presented by the low carbon transition and defined by management in their core business strategies.
In this new world order, we can expect more robust and challenging scrutiny from investors, regulators and auditors alike. To meet the market expectations, quantification is king.