Dodging disaster with climate disclosure

OPINION: Covid-19 has taught us a lot. One of those lessons has been our capacity as government, business and society to respond together and quash a threat on our lives and livelihoods. And so it should be with climate change.

There is an opportunity in front of our government and the business community to work together to truly tackle climate change. To take the lessons of Covid-19 and re-imagine a more sustainable future, to set a policy direction and make investment decisions now that will lower New Zealand’s emissions profile, encourage a more sustainable economy, increase wellbeing and avoid catastrophe later.

But there is a disconnect. While some organisations recognise climate change as a material threat, there has been limited progress understanding the financial implications (and opportunities) of this threat on businesses and their balance sheets. This lack of progress comes at a time when companies face increased scrutiny and pressure on their actions to mitigate climate change and investors are looking for climate-resilient investments.

Currently, the global financial system is built on models that do not reflect the full cost to businesses from the response to climate change, but it must. Globally, Covid-19 saw investments move from equities to cash and other liquid, safe-haven assets and now that capital is looking for a home.

Fund managers in charge of billions of dollars have a duty to act in the best interests of their investors. With heightened risk radars thanks to Covid-19, climate change is looming large as a material financial risk to their investment portfolio.

The move to more sustainable investing is not new. In 15 years, total funds under management with sustainable investing practices – the integration of environmental, social and governance factors – is now estimated at over US$30.7 trillion (NZ$44.7t) and Covid-19 will surely spur it on to higher levels.

Business cannot afford to ignore this shift from the investment community and must start to report climate change risk. This requires a shift from businesses considering transition risk, or "the cost of taking action" to combat climate change, to financial risk assessment which considers climate change’s significant impact on assets, products, markets, insurance, incomes and ultimately the economic viability of a business, or as Margaret Atwood notes, not just "climate change, but everything change".

There are consequences from inadequate information – mispricing of assets and misallocation of capital gives rise to concerns about financial stability since markets can be vulnerable to abrupt corrections. We have also seen from the global financial crisis the negative impact of weak corporate governance on shareholder value. The result is increased demand for transparency from organisations on their risks and risk management practices.

So far, so academic. Accurate reporting of climate change risk does not keep global temperature rise under 1.5C… or does it?

Disclosure of climate-related risk will trigger a virtual circle of understanding and risk management with lenders, insurers and investors better able to assess and price those risks and opportunities. It stands to reason that those companies with a clear plan to mitigate, manage or seek opportunities from climate change will attract capital while those with opaque disclosure to environmental issues will become less attractive to investors looking for safe bets in a warmer world.

There is not yet a unified global reporting standard in relation to climate change, but the Task Force on Climate-related Financial Disclosure (TCFD), the brainchild of ex-Governor of the Bank of England, Mark Carney, has issued recommendations to help companies disclose decision-useful information that will enable markets to understand the financial risks posed by climate change.

Similarly, the Sustainability Accounting Standards Board and Climate Disclosure Standards Board have issued guides and companies would be wise to consult these resources and seek to increase the detail and rigour with which they report over time.

Widespread adoption of climate-related financial disclosure will enable the market to use the same language and metrics with which to assess climate change risk. In turn, this will enable better and more informed decisions about capital allocation and companies will be incentivised to act on tackling and managing climate change.

Far from being conceptual, TCFD reporting has landed. BNZ is committed to voluntarily reporting on climate-related financial risk. Government has consulted on widening the proposed, mandatory climate change risk regime to include not only public companies and finance firms, but government departments and large non-listed companies.

The direction is clear – climate change is a threat and reporting will help change the game. Companies large and small should familiarise themselves with TCFD because disclosure of this nature is likely to become mainstream and trickle into all levels of the economy.

Climate-related financial disclosure will create greater transparency and comparability of a business’ approach to managing climate change risk, and provide the market with a more holistic risk-and-return framework to consider when allocating capital.

In doing so, it will encourage more sustainable investing and give rise to a more resilient financial market that can play an important role in tackling the most significant existential threat to humanity.

Louise Tong is BNZ's general manager of sustainable finance.