Investors demand companies to communicate climate change as a financial risk

  • Investor Group on Climate Change called for new financial rules at G20 for companies to report on climate change
  • Companies are getting more specific with climate change disclosures within their normal financial reporting as part of the G20-adopted framework
  • Investors are using this information to avoid companies that are not limiting their impact on climate change

The Investor Group on Climate Change (IGCC) is the Australian and New Zealand investor group focusing on the impact that climate change has on companies and investments. They had a win when the G20 supported an industry-led taskforce which sets up a framework for companies to report on climate change.

CEO of the group, Emma Herd, says BHP, Westpac and AGL have already begun a more systematic approach of incorporating the financial dimensions of climate change into their company reporting. That’s been met with support from the investors and it’s increasingly a core component of corporate engagement between investors and companies.

The framework aims to move from a qualitative-type climate change disclosure framework to a more quantified analysis of the actual financial implications of climate change trends for the company performance.

Emma Herd tells Alan Kohler they have defined climate change risk from a financial perspective and the reporting should be treated with the same level of respect and veracity as financial reporting.

Emma, your group was calling for new financial rules at the G20 for companies to report on climate change. Did you get what you wanted?

It was partly calling on the G20 to support an industry-led taskforce that they’ve actually already commissioned, so we got what we wanted when they supported the taskforce. The taskforce delivered the really comprehensive framework. The next stage now is to look at what the individual nations of the G20 actually do to incorporate the recommendations into their financial disclosure framework. I guess stage one: complete. Stage two: more work to be done.

The only thing I can see in the various communication reports put out from the G20 was some reference to voluntary financial reporting. Is that right? Would that be enough?

The actual taskforce that they set up, which is the very catchily titled Financial Stability Board Task Force on Climate-Related Financial Disclosure, or FSB-TCFD for short … What they actually did was try to put together a voluntary disclosure framework for corporates and for investors themselves to begin reporting on their climate-related risks and opportunities in a much more systemic way.

They haven’t tried to be prescriptive as precisely how you do it within the regulatory frameworks of the individual nations, but what they’ve said is that companies should be looking to do it in a standardised way, using the same language, using the same terms, you’re getting consistency around how they’re calculated. Then, regulators should be looking at how they begin to align their financial disclosure frameworks with some of these recommendations. It’s voluntary. But it’s voluntary in the same way that international accounting standards are voluntary, in that everybody uses them and they end up being reflected in the regulatory regime at the end of the day.

I thought the accounting standards were not voluntary, you had to abide by them, that they’re incorporated in the law.

Definitely the next stage at this point is to actually look at how you align accounting standards with the recommendations here. It’s an iterative process. It’s moving into the mandatory disclosure regime, I guess is the point that I’m making.

The material that you’ve put out indicates that a few big companies, including BHP and AGL are already doing it. What are they doing that you think other companies should do?

There’s two things that they’re doing: One is that they’re actually getting a lot more specific about what they’re reporting in their climate change disclosures within their normal financial reporting. We’ve had about 10, 15 years now, maybe close to 20, of companies putting out sustainability reports. These look at the non-financial performance dimensions of a company across a range of different areas, which give you a much more integrated view of total company performance. Things like gender diversity, corporate governance regimes, their social impact, reputational issues, and environmental performance.

What this framework is aiming to do is to say let’s move from a qualitative-type climate change disclosure framework where companies make statements such as, “We accept the science of climate change and we’re acting to reduce our footprint,” and let’s move into a much more quantified analysis of the actual financial implications of climate change trends for the company performance.

A number of large Australian companies like BHP and Westpac and AGL have actually begun to get a lot more systematic about incorporating financial dimensions of climate change into their company reporting. The thing that those three companies have specifically done, which is definitely the next frontier of this kind of reporting, is to undertake a two degree scenario analysis, specifically. What they do is they look forward. They look at the two-degree commitment that’s embedded in the Paris agreement and they try and translate that into how that will impact the operating environment, the technological trends, and the regulatory factors influencing their company. Then, they undertake a forward-looking analysis about how that will play out in terms of company performance.

That element of it specifically is wholly new within this disclosure framework that we’re talking about under the G20, the TCFD. That element is something which investors themselves are increasingly engaging with companies and saying, we really need you to get real about doing this in a thorough and proper way so that we can compare how well companies that we are investing in are positioned for the kinds of changes that we expect to see as a result of climate change.

Can I just clarify what you mean by the two percent framework? Are we looking for companies to report on how their businesses would be affected if global temperatures did actually rise by more than two percent? That is to say the process that’s undertaken under the Paris agreement fails, or is it that the companies have to report on how they’re affected by the government’s attempting to keep temperatures below the two percent increase?

Both, unfortunately, as a company. What you’re basically looking at is that the Paris agreement itself: one of the core components of the Paris agreement which 190 countries have signed up to is that governments implement policies with the view to limiting global warming to less than two degrees celsius, two degrees being the determined benchmark at which things begin to get really hairy and expensive.

I think I kept saying two percent; I meant two degrees.

No. Two degrees is a lot harder than two percent, that’s for sure. Two degrees is the number that everybody’s using. Once you actually have a number, you can reverse engineer that, so you can reverse engineer it at a country level, you can reverse engineer it at an industry sector level. What’s the global industry sector’s contribution to global emissions? You can take it back to a company level. You can take it back to an asset level. Increasingly what you’re seeing is that having a set of numbers, which of course investors love, means that you can begin to actually work out what is that likely to mean in terms of the kinds of transformation that we need to see within an industry sector, within that country, for that company, for that particular asset, and how resilient is it?

By that you mean what the policies will mean?

It actually includes a number of things. One of the really useful contributions that this disclosure framework has made, the TCFD, is to define what we mean by climate change risk from a financial perspective. They define it as being transition risk and being physical risk. Transition risk includes regulatory responses, but it also includes technological change, which is obviously very pertinent for areas like the energy sector, and it also includes changes in market demand. For example, for fossil fuel exports, what are the implications there? Those three things are bucketed together under transition risk.

Then, physical risk includes the actual effects of climate change. It includes both acute and chronic changes, chronic being the slow boiling, sea level rise, for example, and acute being increasing incidents of extreme weather events and how prepared, say, a large mining site in a remote area might be for a cyclone of unprecedented scale and duration or flooding, for example. By defining those terms and getting consistent about what they mean, it means that also you can couple that with that two degrees number that I mentioned and you can begin to dig a lot deeper in terms of how well companies are responding to what they can expect to see in terms of changes and how strategic are they actually being in positioning their company for these transitional risks and for the physical risks associated with this goal of two degrees, whether or not we actually meet it. How well are they positioned on both fronts?

I guess your members are looking for this so they can figure out which companies to avoid.

Well, that’s exactly right. I don’t think it’s any accident that you’ve seen very strong support from the investor community for both the establishment and the robust implementation of this framework. You will see very strong take up and ongoing pressure from investors in Australia and globally on companies to begin disclosing against this framework. A lot of the shareholder resolution activity that we’ve seen in recent years around climate change resolution have been around disclosure against the TCFD and two-degree scenario analysis.

Even before we get to that, even more importantly, it’s increasingly a core component of corporate engagement between investors and companies. Tell us what your response is to the TCFD, tell us what your two-degree plan is. That is only going to accelerate even more now that you actually have the finalisation of the recommendation of this framework. Voluntary or not, it will increasingly become the basis of investor expectations of company response to climate change.

How would you know whether companies are talking rubbish or not? Do you want it to be included in the audit?

You want it to be treated with the same level of robustness and discipline and veracity that you see in any kind of financial disclosure to market. It’s a legitimate question because on the other side, investors themselves are now under pressure to have the information, the expertise that they need to interrogate the response from the company.

The thing is the financial disclosures are audited.

Yes. One of the core recommendations of the TCFD is integrate this into your financial file and into financial disclosures. Treat it with the same level of respect that you treat your financial reporting and get it audited and assured to the same level.

Interesting. I feel like it’s a long way off, Emma.

I think you’d be surprised. I think a lot of companies have seen this coming. Don’t get me wrong, there are a lot of companies who are still going to be unpleasantly surprised by how quickly this moves, but there are also a lot of companies who are getting across the issues, either because they’ve faced their engagement activity or because they’ve faced activism-type activity or because they’re increasingly see it in their peers and their competitors, and they’re being asked, well, if they can do it, why aren’t you?

I think in the next 12 to 18 months you’ll also see a lot of big Australian companies who have work underway behind the scenes beginning to come out with much more standardised reporting on it. It won’t happen all at once, it will be report by report, year by year, but I think you’ll definitely see that trend continuing to accelerate in terms of companies using consistent language, consistent metric, consistent approaches to communicating climate change as a financial risk.

I see that Energy Australia this morning called for the government to adopt the clean energy target in the Finkel review. Is your group also doing that? Are the investors pretty much unanimous on that subject as well?

Look, I think one of the key messages that investors have delivered into the Finkel review and to the climate change policy review is that you can’t deal with energy without dealing with emissions reductions policy, and that one of the dimensions of the trilemma is lack of certainty around emissions reduction policy. So there’s no doubt that investors have been very strongly arguing for a robust and integrated energy and climate policy response. Obviously, as investors we prefer a market-based carbon pricing response. It’s been our position for over 10 years. The practical realities of politics are such that we need something and we need it now, so if a clean energy target is the basis of today’s discussion, then that’s obviously something that needs to be very strongly looked at. Ultimately we need to get to a robust carbon pricing system.

I read a broker report the other day that suggested that none of it matters anyway because renewables are now cheaper than coal and it’s all just going to be taken care of by the market. Also, we’ve had a big week this week with the Tesla battery going into South Australia, Elon Musk showing up to announce the world’s biggest battery. What do you think of all that?

I think this transition’s going to happen anyway, but the question for government is what kind of transition do you want to have? Do you want to have it rapid, technology driven, market driven, all at once, or do you actually want to try and smooth out the way in which this transition happens in the energy sector? I think what we’re dealing with today is a lack of management of the transition, which is what we’re seeing reflected in pricing, and what we actually need is a plan for how we’re going to manage this issue.

What’s interesting today is right now we’re seeing a lot of those new technologies rapidly entering the market, but the real question that people are dealing with is what happens in the 2020s and 2030s, when a large percentage of our existing coal-fired infrastructure reaches its end of life and you begin to have closures at the same time as you have new technologies coming online? Finkel is not overstating it when he says that this is a once in a generation transition happening in the energy sector. It’s going to happen; the question for government is how do they want it to happen and how are they going to help the Australian community respond to and be impacted by that transition.

Great to talk to you, Emma. Thanks very much.

No worries.