FINANCIAL REPORTING AND IR

In addition to its impact on our environment, climate change is also emerging as a threat to the stability of the global financial system. Regulators and investors increasingly recognize that climate-related financial risks can have a significant impact on a company, ultimately influencing its viability, value and risk profile. While publicly traded companies have a legal obligation to disclose material risks to investors, there is currently no recognized best practice to identify, quantify and report climate-related financial risks.

Investors, lenders, insurers and other financial stakeholders increasingly understand that climate-related risks need to be factored into market pricing. Transparency regarding climate-related risks is important to enable the market to appropriately price risk. To effectively price climate-related risk, stakeholders need much more and much better information on the financial risks companies face from climate change.

At the request of the G20, the Financial Stability Board (FSB), chaired by Mark Carney – former Governor of the Bank of Canada and current Governor of the Bank of England – established the Task Force on Climate-related Financial Disclosures to review how the financial sector can best account for climate-related issues.

The objective of the Task Force is to undertake a coordinated assessment of what constitutes efficient and effective disclosure and design a set of recommendations for voluntary company financial disclosures of climate-related risks, reflecting the needs of investors, lenders, insurers, and other financial stakeholders. The Task Force membership spans private providers of capital, major issuers, accounting firms and rating agencies, thereby presenting a unique opportunity to form a collaborative partnership between the users and preparers of financial reports.

On April 1, 2016, the Task Force published its Phase I Report. This report contains a high-level review of the existing landscape with respect to climate-related disclosures and also sets out the scope and objectives of the Task Force’s work. A final report is expected by the end of 2016.

What are climate-related financial risks?
The Task Force is focusing on three broad categories of risks that incorporate many specific underlying risks.

Physical risks include the financial impacts of the physical effects of climate change. These include disruption to a company’s operations and value chain from extreme weather, such as floods, droughts, heat waves and hurricanes. Physical risks can be event-driven but also include longer-term changes in precipitation, temperature and weather patterns. The impact of physical risks is often top of mind given widespread media coverage and can vary significantly by industry.

Liability risks include the financial impacts of legislation to limit carbon emissions, such as carbon taxes or trading systems. They also include the increasing potential for corporations to be held legally liable for contributing to climate change, or failing to act on it.

Transitional risks include the financial impacts of failing to make a successful commercial transition to the low carbon economy. Under the Paris Agreement of 2015, many countries have agreed to reduce carbon emissions dramatically in coming decades. This requires rapid decarburization of the global economy and will lead to disruption and transformation of markets. There are significant risks for corporations that fail to adapt quickly enough.

Potential impact on Canadian reporting environment

Climate-related disclosures are not a new concept in Canada. A review of the recent public disclosures of 30 of Canada’s largest companies found that 93% provide some disclosure related to their carbon footprint; however, few disclose climate-related financial risk. To respond to increasing scrutiny by financial stakeholders, Canadian companies must go beyond traditional carbon footprint disclosures to identify and disclose climate-related risks.

While the FSB and its Task Force are issuing voluntary guidelines, with the backing of the G20, central bankers and some of the biggest names in the global financial community, the guidelines that emerge are likely to become de facto global best practices. 

Investors around the world are signing on to various initiatives calling for greater disclosure of companies’ environmental, social and governance (ESG) performance. The Principles for Responsible Investment (PRI), supported by the United Nations, is working to understand ESG factors and support its international network of investor signatories in integrating these principles into their investment and ownership decisions. Overseen by the PRI, the Montreal Carbon Pledge – with 120 investor signatories representing over US$10 trillion in assets – commits investors to undertake and disclose the carbon footprint of their investment portfolios. Likewise, the CDP (formally the Carbon Disclosure Project) signatories – with more than 822 institutional investors representing over US$95 trillion in assets – asks companies worldwide through an annual questionnaire to disclose their carbon emissions and how they are managing climate-change issues.

Here in Canada, a recent report by the Responsible Investment Association found that $1 trillion in assets is being managed using one or more responsible investment strategies. Layering onto Canadian investor activity are developments at the federal and provincial government levels, with movements toward additional carbon regulations and cap and trade systems.

The exact FSB disclosures to be recommended by the Task Force remain unclear. However, anything on the agendas of investors is likely to end up on the agendas of IR professionals.

What can IR professionals do? While the Task Force’s final report will be released in late 2016, IR professionals should consider starting now to identify climate-related risks within their companies, with a focus on the physical, liability and transitional risks prioritized by the Task Force, in order to be in a position to provide stakeholders with a clear picture of how the company is managing and responding to climate-related risks.

Andy Brown, CPA, CA is a Senior Manager, and Rob Brouwer, FCPA, CPA is Canadian Managing Partner, Clients and Markets, for KPMG LLP in Canada.