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In 2022, climate-related considerations are a mainstream focus in capital  markets as part of global Environmental, Social and Governance (ESG) reporting initiatives. The most widely adopted framework is a voluntary initiative with key climate-related financial disclosure recommendations known as the Task Force on Climate Related Financial Disclosures (TCFD). However, despite an increased focus on environmental considerations in the capital markets, both the TCFD’s 2021 status report and the European Central Bank’s report, the State of Climate and Environmental Risk Management in the Banking Sector, indicate gaps in current disclosure practices. Meanwhile, a new sustainability reporting framework was announced at the 2021 United Nations Climate Change Conference (COP26).

By GreySpark’s Ivan Varbanov, Senior Consultant, Archie Charlton, Consultant, Keith Lagrange, Manager, and Rachel Lindstrom, Senior Manager

Ivan Varbanov

Voluntary disclosures related to climate change have dramatically increased in the capital markets as integration of sustainability concerns gains momentum. Previously seen as the domain of specialists, or the plot of Hollywood blockbusters, climate-related considerations are now taking the main stage in capital markets decision-making with products, regulations and corporate strategies being impacted. The COP26 conference in November 2021 marked an important milestone with several key announcements, including the launch of a new sustainability framework headed by the International Financial Reporting Standards (IFRS) Foundation. Earlier in the year, the Intergovernmental Panel on Climate Change (IPCC) report, AR26 Climate Change 2021, warned of the immediate need to reduce global emissions, indicating that global temperatures are predicated to rise to a level 1.5 degrees Celsius above pre-industrial levels far more quickly than previously anticipated. However, both the 2021 TCFD status report and the ECB’s report on the state of the climate and environment risk for the banking sector indicated significant gaps in the integration of climate-related risks into capital markets firms’ risk frameworks.

While only time will tell whether COP26 was successful in mustering an effective syndicated global effort to reduce climate change, initiatives such as the TCFD are designed to support the transition to a lower carbon economy – the impacts of which have the potential to result in significant structural change in the capital markets. The financial crisis provided an opportunity for businesses to undertake major changes to corporate purpose and strategy and to embrace more resilient business models to ensure long-term business viability, and, today, as the economy recovers from the COVID-19 pandemic, the need for a thorough business model and strategy review has again become a pressing issue for capital markets firms. In this article GreySpark Partners reviews the climate-related considerations landscape from the perspective of the leading framework for disclosing such information – The Task Force for Climate-related Financial Disclosures (TCFD).

TCFD: A Forward-looking Framework

The Financial Stability Board established the Task Force on Climate-Related Financial Disclosures (TCFD) in 2015. Led by Mark Carney, the Governor of the Bank of England at the time, it focused on how the financial sector could take account of climate-related issues. At first glance, the TCFD framework appears to cover only environmental considerations. However, as part of the TCFD disclosure aspects of a firm’s strategy and business model are required and, therefore, the framework is also aligned with governance – the G in ‘ESG’. Given the TCFD’s structure, which does not prescribe specific metrics, the recommendations can be adopted alongside existing sustainability standards, such as SASB, GRI, CDSB and the CDP). In October 2021, the TCFD released three papers that provide further guidance for disclosure and build on the existing body of work:

The 2021 Status Report indicates clear momentum behind the TCFD, with a 70% increase in the number of firms endorsing the recommendations bringing the total to over 2,600. The UK became the first G20 country to write climate-related financial disclosure into law as part of its larger Net Zero Strategy roadmap, but multiple jurisdictions have also hit significant milestones and proposed and / or finalized laws to make mandatory climate-related disclosures.

TCFD: A Deep Dive

A key element of the TCFD is the categorization of the climate-related risks and opportunities that companies are encouraged to utilize when assessing exposures and undertaking scenario analysis. The risks are split between:

  1. Transition Risks – relating to transitioning to a low
    carbon economy (technology, market, reputation risk etc.); and
  2. Physical Risks – relating to the direct impact of climate change (acute and chronic risks).

The assessment of both risks and opportunities (together called ‘climate-related issues’) requires a business-wide assessment under various conditions, based on the modelling of plausible climate-related scenarios such as, for instance, a global 2°C temperature increase.

Despite the recommended approach, the latest ECB report flags significantly low use of scenario analysis for strategy setting in the banking sector, and the 2021 TCFD report acknowledges that organisations leveraging scenario analysis may face three challenges:

  • Compatibility with business needs (scenarios are designed for global macro assessments);
  • Data availability; and
  • Early stage of maturity in adoption to assess business implications.

As such, the adoption of scenario analysis techniques for assessing climate-related issues is a key challenge for organisations and this is likely to be the main driver underpinning gaps in disclosure. Figure 1 describes the TCFD’s recommendations and overlays them with disclosure coverage.

(click image to enlarge)

Source: TCFD

TCFD Recommendations

The TCFD is structured in four thematic areas, or pillars: Governance, Strategy, Risk Management and Metrics and Targets, described in Figure 2.

(click image to enlarge)

Source: TCFD

The Governance Pillar focuses on the disclosure of information pertaining to the management and oversight of climate-related issues. The 2021 TCFD status report indicates that this is the least disclosed of the four pillars.

GreySpark believes that the low levels of disclosure by capital markets firms is potentially due to gaps in methodologies / expertise in assessing climate risks exposures, confidence in the reliability of data or simply a lack of data. These uncertainties can hinder formation of the governance structures needed to manage emerging climate-related risks in organisations.

The Strategy Pillar prescribes the disclosure of the way that climate-related considerations are incorporated into a firm’s business strategy. Companies must clearly indicate the timeframe within which each identified risk or opportunity is expected to crystalize and provide detailed milestones to track progress.

Disclosure of the resilience of a company’s strategy under different scenarios is the least reported single disclosure according to 2021 TCFD status report, as shown in Figure 2. Low levels of disclosure suggest that firms face challenges in assessing the materiality of climate-related issues and translating it into their strategy.

The Risk Management Pillar focuses on the processes used to identify, assess and manage climate-related risks. In the capital markets, this means incorporating climate-related risk factors into existing enterprise risk management frameworks. Today, risk management frameworks are in the spotlight, following the shockwaves of the collapse of Archegos Capital Management.

In the context of the TCFD, it is pivotal for companies to assess the materiality of climate-related risks as part of their wider risk management framework review. Due to the unique characteristics of climate risk, accurately embedding climate-related risk remains a key challenge for banks and requires innovation around forward-looking modelling and granular climate-related risk data.

The fourth TCFD category, the Metrics and Targets Pillar, requires companies to disclose the specific metrics and targets they use to assess climate-related risks and opportunities. The importance of making the data understandable for the end user is stressed. Companies must also disclose the methodologies behind the metrics used to track progress towards these goals. The TCFD’s October 2021 Guidance stresses the need for ‘Transition Plans’ by which a firm can judge its progress over time.

This pillar requires firms to provide evidence to support the rest of the disclosures and it necessitates an overall awareness of where the firm sits compared to its peers. A lack of data is typically a key reason for the sparsity of disclosures for this pillar.

ISSB Alignment Announced at COP26

At COP26, the International Financial Reporting Standards organisation (IFRS) announced the newly formed International Sustainability Standards Board (ISSB). The ISSB builds on the TCFD recommendations and other standards to lay the groundwork for a single global organisation to address accounting and sustainability information needs.15 While the new framework is still in a prototype phase, firms that have taken steps to incorporate TCFD recommendations will be in an advantageous position when aligning with the new framework.

Capital Markets in Transition …or When Your Strategy Becomes About More Than Just the Business Environment

The capital markets has a key reliance on good quality of information and TCFD’s recommendations paved the way for the integration of climate risk into capital markets decision-making to be made in a more standardized way. Despite being a voluntary initiative, the TCFD has become the de-facto standard for corporate climate-related disclosures, and its recommendations provide a framework for how firms should approach the management of climate-related issues; the required governance structures, how to identify and incorporate material exposures and build metrics to measure and monitor progress. Such practices are in line with increased scrutiny and transparency expectations that are driving the ESG integration megatrend in the capital markets. As part of these emerging initiatives, the TCFD recommendations play a foundational role in the building of a wider future sustainability framework that aims to serve as a litmus test for business resilience.

Materiality assessments and scenario analysis methodologies are still, in many instances, in a developmental stage and data quality is a key issue that firms need to address. The gap between what TCFD recommends and the reality across the industry represents a risk for the efficient allocation of capital in the transition to a low-carbon economy. However, companies that are leading the way in closing this gap and pivoting their strategic decisions in line with climate-related considerations are aligning themselves in an advantageous and assured position, as the momentum of both market and regulatory expectations increasingly demands action.

The best time for firms to undertake a major review of their business models and strategy was 14 years ago in the aftermath of the financial crisis. The second-best time is now.

Ivan Varbanov is a Senior Consultant at GreySpark Partners with experience in Regulatory Change, Front-office Controls and Fintech Advisory projects. Ivan has a keen interest in ESG and is heading the development of the ESG Integration Service Offering at GreySpark Partners.
Archie Charlton joined the GreySpark Partners Graduate Program after completing an MSc in Public Policy and Management, and working part time as a Social Enterprise Consultant alongside his Undergraduate Degree.
Keith Lagrange is a Managing Consultant at GreySpark Partners, with 17 years’ experience working across Regulatory, Strategic and Risk/Control Projects within Investment Banks, Wealth Managers, and Inter-dealer Brokers, delivering both Business Process and Functional Change. His career has spanned the capital markets sector and he has worked in a range of Tier 1 and 2 investment banks, as well as capital markets consulting firms.