In December 2020, the Federal Reserve announced that the US will be joining the Network of Central Banks and Supervisors for the Greening the Financial System. Adopting the Task Force for Climate-Related Financial Disclosure (TCFD) framework is likely to be a next step by the Biden Administration, with sweeping implications for US business.
In the following QA, Joseph Lake conveys fundamentals on the TCFD as well as some of the most important related considerations for businesses in the United States.
Joseph Lake is Chief Operating Officer at The Climate Service. Based in New York, he works to embed climate risk and opportunity data into global decision-making through the TCS software as a service. Prior to this appointment, Lake was the Managing Director for Climate Risk at The Economist where he launched The Economist's inaugural Climate Risk Summit and led The Economist Intelligence Unit's (EIU) climate risk consulting services.
Q: What is the TCFD?
The Task Force for Climate-Related Financial Disclosure was established to develop and encourage decision-useful, consistent reporting on the financial impacts of climate change.
It is an industry-led consortium founded in December 2015 by the Financial Stability Board (FSB), an international body that monitors and makes recommendations about the global financial system.
When it was established, the objective of the TCFD was to develop a set of voluntary, consistent disclosure recommendations for use by companies in providing information to investors, lenders, and insurance underwriters about their climate-related financial risks. The resulting framework provides an approach for companies to understand and quantify their risks and opportunities from the changing climate.
Support for the TCFD has grown rapidly since it was established. The TCFD’s recent 2020 Status Report reveals the number of organizations expressing support for the TCFD has grown by more than 85%, reaching over 1,500 organizations globally, including over 1,340 companies with a market capitalization of $12.6 trillion.
In addition, investor and regulator demand for reporting in line with the TCFD has also grown dramatically. Now more than 110 regulators and governmental entities from around the world support the TCFD, including the governments of Belgium, Canada, Chile, France, Japan, New Zealand, Sweden, and the United Kingdom.
Q: What are the top five things businesses need to know about the TCFD?
- It is fundamentally a vehicle for change management. The TCFD’s recommendations are structured into four thematic areas that represent core elements of how organizations operate: governance, strategy, risk management, and metrics and targets. These thematic areas are designed to inform one another. Thus, the TCFD can be viewed as a vehicle to drive the systemic, organization-wide change that will need to occur inside every organization to meet ambitious Net-Zero mandates and other goals. It is important to note that while the TCFD framework was developed by the financial sector, it is relevant and useful to all industries.
- The TCFD provides a framework for understanding climate risk. In the TCFD, risks are broadly categorized into “physical” and “transition.” Physical are risks to assets (facilities, supply chains, etc.), from hazards like extreme temperature, drought, wildfire, flooding, and more. Transition risk refers to the changing legal, regulatory, and market conditions that can impact a business. One example would be the implementation of a nation-wide carbon tax/price on carbon. Assessing and planning for transition risk could, for example, mean diversifying an energy portfolio away from fossil fuels and toward renewable investments.
- Reporting in line with the TCFD may become mandatory in the US. As previously mentioned, regulators and governmental entities around the world support the TCFD, and some jurisdictions are now moving toward mandating reporting consistent with the framework. For example, in 2020, New Zealand announced it will implement mandatory climate risk reporting in line with the TCFD, becoming the first country to do so. It was followed by the UK, and the Biden Administration in the US is also expected to take this action. ven if it does not, investors—from BlackRock to the world’s largest pension funds—are beginning to require climate risk reporting from the companies they invest in, so the TCFD’s approach to climate risk reporting is relevant regardless of how quickly the US acts to mandate it.
- Scenario analysis is one of the most challenging but critical aspects of TCFD reporting. The severity of the physical and transition risks that a company or investors faces depends on how long the world takes to address climate change. Scientists talk about this in terms of “scenarios”; each possible scenario is a path the world could follow as a result of when and how policy is enacted to curb carbon emissions. Scenario analysis—projecting the impact of climate change under different climate scenarios is central to TCFD reporting, and it is used in strategic plans, annual reports, and more. The Climate Service provides scenario analysis for the world’s largest investors, banks, Fortune 500 companies, and governments. You can find more in-depth information about climate scenario analysis and its role in TCFD reporting on The Climate Service website.
- It starts with a question. In TCFD reporting and climate scenario analysis should focus primarily on answering questions of central, strategic import. For example:
- Server farms are highly protected and valued assets trusted with terabytes of data from people and companies around the world. Much is spent on assessing and protecting against cyber risks, but understanding how the locations of these farms will be impacted by rising temperatures or sea-level rise is still nascent; it is a question technology companies may wish to assess with scenario analysis.
- Climate change is expected to trigger trillions in losses in real estate as certain areas become flooded and assets stranded. A Real Estate investor should assess the direct impacts of climate--flooding, wildfire, wildfires--as well as the indirect or market effects--insurability, liquidity, rental market growth-- to develop resilience strategies.
The examples above show how the TCFD framework and approach are relevant and useful in a wide variety of contexts and industries. And when actionable insights are pursued, TCFD-aligned scenario analysis enables informed strategic planning, strengthens resilience, and affords a significant competitive advantage.
How does The Climate Service support TCFD reporting?
Founded in 2017, The Climate Service has developed a software as a service product, the Climanomics® platform, to support reporting and disclosure aligned with the TCFD framework.
Today the platform is trusted by clients including the world’s largest banks, asset managers, real estate investors, Fortune 500 firms, and public bodies including the US Federal Government. Subscribers use the outputs to measure and report their transition and physical risks and opportunities in financial terms under different climate scenarios. The platform covers physical and transition risks, and provides an assessment of assets anywhere in the world, and provides projections over a time horizon of 1-80 years.
In 2020 TCS announced collaborations with IBM and Aon and several other industry-leading companies. These partnerships have allowed us to provide unparalleled speed, increased interoperability, and enhanced analysis in the platform, and to scale our services to meet unprecedented demand.
Can you provide an example of how the Climanomics® platform works?
Yes - we work with one of the largest real estate investment managers in the world to assess the physical risks to its portfolios, providing intelligence to build resilience programs as well as a competitive advantage. Our work has addressed questions such as how ownership structures impact financial risk, how climate affects tenant behavior, rental market growth, and the impact of climate on asset valuation and insurance, among other things.
The results of this work are proving pivotal to the client’s long-term strategic planning, due diligence, and more.
In another example, we have a relationship spanning several years with one of the world’s largest food and beverage corporations. Through this work, we have analyzed the climate risk of thousands of their facilities, dozens of crops they rely on for ingredients, and risks to their suppliers. The objectives have been to identify the assets most at risk, to arm the company’s business units with data specific to their jurisdictions, and to provide overarching intelligence to build resilience and a competitive advantage that will keep the business profitable and thriving during the changes to come.
One of the interesting takeaways we often see in the platform is that most climate risk resides in a small number of assets (similar to the 80/20 rule, or the Pareto Principle). This may be due to location, asset type, or an asset’s strategic importance, and this finding is particularly useful because it helps companies to prioritize investments in adaptation or resilience to maximize risk mitigation benefits.
This graphic illustrates an anonymized example of this effect. It represents the risk by asset location from climate change in millions of U.S. dollars. The underlying models consider the value of a property, hazard risks such as flooding, wildfire, and extreme heat, and the vulnerability of each asset to each of those hazards. This helps companies to identify priority areas for work that will maximize equitable resilience and provide significant returns on investment beyond company boundaries.
What is your advice to businesses that are starting to try to understand their climate risk?
Talk with regulators, companies that have already published TCFD reports, and members of the investor community, and you frequently hear that perfection is the enemy of the good; that TCFD reporting is a journey, and it is iterative. While the process may seem overwhelming, the most important step is always the first. Business leaders need to start on this journey if they haven’t already; doing so will help to ‘flatten the curve’ of their companies' transition to the future, clean economy.