Opinion

TCFD and its Discontents

What needs to happen in order for mandatory TCFD reporting to truly contribute towards the transition to a net-zero economy?

Target audiences: Policymakers, financial institutions, investors, consumers

Purpose: Raise awareness and drive interest; encourage people to engage in discussion

On 9th November 2020, the UK Government announced its intention to make TCFD-aligned disclosures mandatory across the economy by 2025, with a significant portion of mandatory requirements in place by 2023. This has been widely touted as a means for the UK to establish its leadership position in the transition to a net-zero economy on the global stage ahead of COP26, the UN’s Climate Change Summit, due to be hosted in Glasgow later this year (pandemic permitting). But what does mandating TCFD disclosures mean in practice for firms, and will it actually enable a swifter, more effective and more measurable transition to net-zero?

Established by the Financial Stability Board (FSB), the Task Force on Climate-related Financial Disclosures (TCFD) developed recommendations for effective climate-related disclosures to understand the exposure of firms of climate-related risks (including both physical and transition risks). TCFD disclosures focus on 4 thematic areas: Governance, Strategy, Risk Management and Metrics & Targets. TCFD is also the leading international initiative to drive the collection and use of climate risk and the impact of firms’ activities data. It has international recognition and credibility and was co-developed with representatives from the global accounting and finance communities to ensure relevance.

To date, these recommendations have been adopted on a voluntary basis by a range of firms around the world, and for various reasons: a genuine desire to manage their own transition to net-zero, investor demand or interest, and management of public relations.  Increasingly, however, they are also being adopted on a mandatory basis by governments. New Zealand, for example, was an early leader in making TCFD disclosures mandatory for certain parts of its financial services sector. The EU recommends that compliance with its Non-Financial Reporting Directive is in line with TCFD. It is widely anticipated that other countries will follow suit, and at the multinational level, discussions are being had as to whether it should become a mandatory accounting reporting standard.

Mandatory TCFD disclosures represent an important step forward in the journey to net-zero. They force firms to formally think about and engage with climate-related risks and their impact on strategy, business models and operations. They also build these considerations into the formal governance structures of the firm. These are all positive impacts. Nevertheless, there remain a number of significant issues with TCFD disclosures that hold them back, at present, from being a driver of fundamental change in the full internalisation of climate risk within our pricing and risk models – not only pricing of financial assets but also of the consumer goods produced by firms.

There are currently no standards around inputs to TCFD disclosures or the assumptions underlying scenario analyses – which can lead to greenwashing and to perverse outcomes. An oil and gas company, for example, may undertake TCFD scenario analysis showing that they will be able to happily continue extracting oil with no risk of stranded assets, based on an assumption that perfect carbon capture and sequestration technology will become available. TCFD reports are not machine-readable – they are narrative, text-based documents. They are also hard to find, often buried on firms’ websites, in documents of various formats. Furthermore, there are no data standards required in compliance.

As a consequence, usage of voluntary TCFD reports at present is dependent on teams of analysts locating them, then applying subjective views to create standard comparable data for their analysis. This means that very few stakeholders who want to use the data – lenders, insurers, consumers, investors, governments – can actually use it. If TCFD is to become more widespread and mandatory, it will essentially become a costly exercise for reporting firms, with no real utility and no ability to drive net-zero outcomes, unless these issues can be addressed. 

Icebreaker One is developing the shared data infrastructure that will help financial institutions and other types of firms to access the data they need in order to successfully transition to a net-zero economy. This includes the outputs of climate-related disclosures such as TCFD, which in turn form vital inputs to pricing and risk management, enabling the full internalisation of climate-related risks. 

Credits: Photo by Landon Arnold on Unsplash