When the Government of Canada released its pandemic bridge financing program for big businesses last year, it included a bunch of familiar strings attached. And also one that is less common: climate reporting.
The financing program, called the Large Employer Emergency Financing Facility (LEEFF), requires companies to publish a climate-related financial disclosure report once a year. This report needs to show how the organization manages its climate-related risks and opportunities.
LEEFF is just one program, and it caters to larger businesses. But all signs indicate that climate reporting is here to stay and will become more and more common.
The Paris Agreement, net zero, and the environment
Climate-change reporting has been a long time coming. A byproduct of the environmental movement, it has progressed in fits and starts over the past 30 years.
The most recent turning point came in 2015, when 197 countries adopted the Paris Agreement. Part of the United Nations Framework Convention on Climate Change, the agreement commits world leaders to limit global warming. The key performance indicator: keeping global average temperatures below 2 degrees Celsius above pre-industrial levels—and preferably 1.5 degrees. The current increase is about 1 degree.
But while Paris marked a breakthrough, it was more starting point than final destination. To further limit emissions, many countries have since committed to net-zero emissions by 2050. Getting to net zero means a country produces the same amount of greenhouse gases as it takes out of the atmosphere, such as by planting forests.
Countries differ on how to reduce climate change—even those like Canada that signed the Paris Agreement. Some countries have changed their approach midstream. The U.S. signed the agreement under the Obama administration and then withdrew under the Trump administration. Under the Biden administration, the U.S. rejoined Paris and is working with Canada to reach net zero by 2050. And even within Canada, provinces continue to debate the best approach among themselves and with the federal government.
“Climate risk is investment risk”
The governments that signed the Paris Agreement could compel businesses to help stop climate change. In Canada, for example, carbon pricing regimes exist across the country for both individuals and businesses.
Yet some businesses have embraced environmental sustainability of their own accord.
Microsoft has pledged to become carbon negative by 2030. More than 50 companies have signed the Climate Pledge organized by Amazon, committing to reach net zero by 2040.
And Canadian asset manager Brookfield plans to raise $7.5 billion for a climate-focused fund. The fund reflects Brookfield's larger strategy. It has emerged as a global leader on climate reporting and last year hired one of the business world's leading voices on climate: former Bank of Canada Governor Mark Carney.
Perhaps it is BlackRock CEO Larry Fink who has said it best, and generated the most headlines.
“Climate risk is investment risk,” wrote Fink in his annual letter to CEOs in 2020, adding that BlackRock would exit investments that present a high-sustainability risk, such as thermal coal producers. The company would also launch new investment products that screen for fossil fuels, he said, and integrate sustainability in portfolio construction.
Why climate change is risky for business
While some companies are adopting environmental sustainability to be good corporate citizens, BlackRock's statement makes clear that the environment is serious business. Investors are responding to a business reality: the financial results of a company may look rosy today, but they could suffer in the future if the company doesn't protect itself.
Yet investors and lenders are pushing the immediate agenda. Unless businesses embrace the need to build climate change into their strategy and planning, they will pay higher costs for capital or, in some cases, will not be able to raise capital at all. At the same time, they will create significant value for investors.
Some of those investors are making a different case: become a good corporate citizens, or else. Institutional investors and advocacy groups have pressed large financial institutions to strengthen their climate policies. European institutions see these tactics more often—witness the showdown in March between HSBC and 15 of its investors—but Canadian advocacy for socially responsible investing is on the upswing.
Greenwashing and the reporting solution
The financial reporting that fuels the world of financing only works because businesses have agreed on reporting standards. If money makes the investing world turn, trust lubricates its gears.
That's why climate reporting has gained momentum. Any business holding a financial stake in another—via equity investment or loan—needs to know its risk profile. Climate is just another form of risk. The way businesses increasingly view the situation, reporting on climate should be no different than for other risks.
At the same time, reporting on the environment suffers from two obstacles: there are too many and diverse frameworks, and the frameworks are voluntary. While some companies—mainly larger ones—have adopted a framework, they may focus on metrics that portray them in a positive light. Critics call this ‘greenwashing.'
The lack of unanimity on climate reporting is quickly coming to a head. In March, one of most important financial reporting organizations in the world said it plans to move forward with the creation of a parallel body for non-financial reporting. In its announcement, the International Financial Reporting Standards Foundation cited overwhelming demand for a sustainability standards board.
ESG: Three letters to report non-financials
If it seems like the terminology around climate risk can get confusing, that's because it can be. The business community uses a series of related terms when discussing the environment and other forms of non-financial reporting.
‘Climate risk' speaks for itself: the risk to businesses related to climate change.
‘Sustainability' is also misleading. By itself, the word refers to more than just the environment. For investing and reporting, sustainability comprises three discrete categories: environment; social (how the business deals with social issues, like its employees, external political trends or humanitarian issues in its supply chains), and governance. Together they are known as ESG. Environment is just one—very high-profile—source of risk.
Taskforce on Climate-Related Financial Disclosures
While no one framework has gained universal acceptance for climate reporting, more than 1500 companies worldwide have adopted the recommendations of the Taskforce on Climate-Related Financial Disclosures (TCFD). Among them are Canada's eight largest pension funds.
Released in 2017, the TCFD recommendations incorporate input from large banks, insurance companies, asset managers, pension funds, large non-financial companies, accounting and consulting firms, and credit rating agencies.
Some countries have already mandated reporting to align with the TCFD. In the UK, many listed companies will be required to report in accordance with the Recommendations from 2021, with new ones added in 2022 and 2023. In New Zealand, reporting will be required from around 200 financial sector organizations from 2023.
The four areas of climate risk reporting
The TCFD recommendations focus on four areas:
The organization's climate risks and opportunities, and management's role in assessing and managing them. Different from the governance putting the ‘G,' in ESG, this refers specifically to governance on climate risk.
The actual and potential impacts of climate-related risks and opportunities on the organization's business, strategy, and financial planning. Included is the resilience of the organization against climate scenarios and how the company would respond.
- Risk management
The processes used by the organization to assess, manage, and report on climate-related risks. Included is how the organization determines about the relative significance of different risks and how leadership makes decisions about addressing the risks.
- Metrics and targets
The key numbers used to assess, manage, and report on climate-related risks. Included could be greenhouse gas emissions, whether climate-related metrics impact remuneration, and revenue targets for products and services in a lower-carbon economy. Businesses often use specialized systems to track these metrics.
Defining climate risk
The TCFD recommendations are not just a popular choice for companies that need a framework for climate reporting right away. They also help companies with no immediate needs understand how to approach the subject.
Among the key themes to consider is the difference between physical risks and transition risks. Physical risks are the business interruptions arising directly from climate change—such as wildfires or lower agricultural yields. Transition risks come from the world's gradual move to a lower carbon economy.
Transition risks can be wide-ranging. They include technology risks, such as the phasing out of internal combustion engines; political and legal risks, such as carbon taxes; reputational risks, such as activists, investors, or even employees demanding climate-friendly policies; and market risks, due to changing consumer lifestyles.
Climate risks inhabit short-, mid-, and long-term windows. As a result, companies may struggle to assess how much risk they add to the organization. But those who consider climate risk strategically now will put themselves in the best position when running their business, raising money, and reporting on their progress to anyone who needs to know.
To learn how BDO's Accounting Advisory and Consulting Services can help you report on your climate risks, reach out to:
Armand Capisciolto, National Accounting Standards Partner
Pierre Taillefer, Partner, Risk Advisory Services Leader
Stephen Payne, Partner, Technology Advisory