As the COVID-19 pandemic rages on, conversations around meaningful ESG action have continued to intensify. Investors especially are paying closer attention to issues around climate change and how it is embedded in overall business strategies. Even before the pandemic, this pressure existed. In 2015, the Task Force on Climate-Related Financial Disclosures (TCFD) was introduced by the Financial Stability Board (FSB). The aim of the regulation was to promote and advance dependable climate-related financial risk disclosures for use by issuers, financial institutions especially banks, and investors in providing information to stakeholders. Per the regulation, one of the expected outcomes was to increase the quantity of reliable information on financial institutions’ exposure to climate-related risks. It is also aimed to increase understanding of climate risks and facilitate financing the transition to a more stable and sustainable economy, eventually strengthening the financial system overall. TCFD is hinged on four disclosure requirements:
How Are Countries Adopting TCFD Regulation in Europe?
TCFD recommendations have initiated a positive movement across many European jurisdictions to better integrate climate issues into financial reporting beyond mere ESG issues reporting. Many countries have started to make this mandatory for issuers in their respective regions across the globe. Below, we will focus on a few countries in Europe to see how this is gradually gaining traction.
In the United Kingdom, it has now become a requirement for all large companies listed on the London Stock Exchange (LSE) and financial institutions to comply with TCFD requirements or explain why they refrain from doing so. This announcement was made by the UK Government’s Finance Minister, Rishi Sunakon on November 9, 2020. The country is one of the first in the world to require compliance with TCFD standards, and has outlined a plan that will see most other companies reporting against the TCFD bill by 2023.
France seems to be determined to consolidate its position as a global leader in company climate disclosures with a fresh set of obligatory targets requiring stockholders or investors to declare how sustainable their assets are. In addition, the new targets will require corporate bodies to disclose their greenhouse emissions targets for every half-decade. In a recent Diligent Institute report, Aligning Pay, People and Planet, we discovered that according to our sample, issuers in France lead in the implementation of ESG-related metrics in Europe. In 2015, when France hosted U.N. climate talks to move the world away from fossil fuel, France took the lead in requiring financial institutions listed on its premium exchanges and public investment firms to disclose their respective exposure to climate risks. In June 2020, France subsequently made it obligatory for quoted companies to comply with the requirements of the TCFD, placing it ahead of the United Kingdom.
Germany lags a bit behind in the push for TCFD recommendation compliance. Though there is not much being done directly, the German government announced in March 2021 the inauguration of a new sustainable finance stratagem aimed at rallying wealth flows to sustainable funds, which will reduce climate risk towards the barest minimum. It will also fortify financial market permanency. The government also announced requirements and guidelines for sustainability reporting for companies. The strategy is also expected to promote the redirecting of central investments towards sustainable investment areas. Private investors will be included as well, as development of a sustainability labelling system for private investors is on it’s way.
On January 12, 2021, the Swiss government made great strides in becoming a strong supporter of TCFD. To demonstrate its support, the government recommended greater disclosure of and transparency around climate-related financial risks. This development is seen as part of a wider policy shift towards more sustainable finance. The new momentum is expected to increase the number of companies that comply with TCFD. It is worth mentioning that a majority of Swiss companies are already doing this on a voluntary basis. There is an expectation that in 2022, the Swiss government in consultation with the private sector and financial industry association may be introducing a bill that will make it binding and mandatory.
Across Europe, there are countries such as the Netherlands whereby there is no specific announced measure, but most issuers are voluntarily following TCFD recommendations.
What Are the Challenges Associated with TCFD Implementation?
One of the main challenges in the implementation of the TCFD Bill is a lack of education on the topic at the board level. ESG is a vast and growing topic area, and regulatory bodies are still struggling to define their scope.
One other challenge that could be encountered is internal harmonisation between teams within an organization and a tendency for departments to operate in silos; these issues are being aggravated by a lack of a shared linguistic when approaching climate hazards and opportunities. In a workshop organised by the Climate Disclosure Standard Board( CDSB) in 2018, participants echoed these sentiments and concerns. The participants expressed concern that there are significant technical barricades in measuring hazards related to financial effects, especially physical risk manifesting in the long-term. In addition, these are also compounded by incomplete data and a lack of tools and methodologies which act as barriers. Though there is a gradual shift towards mandatory actions by various jurisdictions and their regulatory bodies, participants expressed worry that there will be a potential lack of motivation without mandatory regulation. Boards also face a potential shortage of time to consider these issues holistically.
How Can Boards Support TCFD Implementation?
Governance is one of the core pillars necessary for successful TCFD regulation implementation, meaning that the board plays a pivotal role. Boards should endeavour to increase oversight of management by setting a clear strategy and description of who has the decisive responsibility of climate risks. The metrics and Key Performance Indicators (KPI) must be measurable and timely with key information on the metrics so that stakeholders such as investors can easily understand them. In service of this goal, boards could look into appointing directors with environmental backgrounds. Boards could also create a committee to oversee climate risks or strengthen existing committees to effectively oversee this responsibility. Audit Committees, for example, could be empowered to ask the right questions about the quality of reporting from the executive team regarding internal control risk management related to climate.
To effectively incentivise management to work towards a more sustainable business strategy, there must also be a link between the KPIs and executive remuneration. By aligning the two, it is well documented that you could keep management in line with environmental KPIs.