The Taskforce on Climate-related Financial Disclosures (TCFD) recommends information companies should disclose so investors, lenders, insurance underwriters, and other stakeholders can adequately access and price financial risks and financial impact related to climate change.
The TCFD was established in 2015 by the Financial Stability Board (FSB), an international body formed in response to the global financial crisis. Its mission: strengthen financial systems and increase the stability of international financial markets by coordinating national monetary authorities and international standard-setting bodies.
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Why do we need the TCFD?
In its own words, we need the TCFD because “one of the essential functions of financial markets is to price risk to support informed, efficient capital-allocation decisions. […] Without the right information, investors and others may incorrectly price or value assets, leading to a misallocation of capital.”
In other words, because climate change has a significant impact on the long-term value of a company, allocators of capital need to understand a company’s potential climate-related risks to understand investment risks. And to put it another way, climate change and the financial health of companies are inextricably connected.
How does the TCFD relate to ESG?
It’s fair to say that the TCFD is the favored framework that guides voluntary climate disclosures and the roughly dozen regulations that have emerged across the U.S., Europe, and Asia. However, compared to ESG (environmental, social, and governance)—the oft-used term to evaluate a company’s future financial performance—TCFD limits its focus to climate. That just means TCFD focuses on the “E” and the “G” without respect to the “S”. And while climate has quickly emerged as the most urgent and material focus for environmental “E” disclosure, it is not the only one. Biodiversity, air and water quality, and pollution are all central to ESG programs but fall outside the scope of TCFD.
Who uses the TCFD?
The groundswell in global momentum for TCFD reporting is massive. The TCFD began as a voluntary set of recommendations intended to guide investor-grade risk disclosures and is now the common thread across international legislation on climate disclosure, including the U.S., E.U., U.K., Switzerland, Singapore, Hong Kong, New Zealand, and Japan. That’s a big deal!
As of October 2021, it had over 2,600 global supporters, including over 1,000 financial institutions. These supporters span 89 countries and represent almost all sectors of the economy with a combined market cap of $25 trillion. In 2020, the U.K. was the first to announce mandated climate disclosure aligned with the TCFD by 2025. The U.S. recently followed suit and aligned most of the proposed SEC rule with the framework.
Beyond governments, international standard setters like the International Financial Reporting Standards (IFRS) are also incorporating TCFD recommendations in the much-awaited International Sustainability Standards Board (ISSB) framework, expected to come out later in 2022. All this to say, the TCFD is the clear front-runner in climate-related disclosures and is here to stay.
What does the TCFD include?
The TCFD is comprised of 11 recommended disclosures structured around these four core operational themes:
Specifically “around climate-related risks and opportunities.”
These disclosures demonstrate how deep climate-risk assessment and management should go. More robust oversight from governing bodies like boards and upper-level management should convey a sense of organizational resilience.
“The actual and potential impacts of climate-related risks and opportunities on the organization’s businesses, strategy, and financial planning where material.” These disclosures detail physical risks like increased flooding or other extreme weather events and transitional risks like changes in brand reputation or customer sentiment, along with how the company intends to navigate or mitigate such risks.
3. Risk management
How the organization “identifies, assesses, and manages climate-related risks.” These disclosures are all about processes and demonstrate how a company has formally integrated climate risk into its risk-management practice.
4. Metrics and targets
“Used to assess and manage relevant climate-related risks and opportunities where material.” A departure from the qualitative nature of the framework, these disclosures require organizations to include quantitative data to ground climate-related risks and opportunities to measurable performance and targets.
The TCFD further guides companies on a couple of common sense decision-making practices it calls “principles for effective disclosure.” These include things like disclosing information that is relevant, specific, complete, understandable, consistent over time, comparable to companies within a shared sector industry or portfolio, verifiable, and on a timely basis.
So for the public and large companies mandated by the emerging climate disclosure laws across the globe, you’ll find yourselves well served by adopting the TCFD framework today in preparation for future regulations and climate scenarios.