Investing for a sustainable future

There is little doubt that systemic change is required to the way business and society operates if a drastic reduction in global greenhouse gas (GHG) emissions aligned with the goals of the Paris Agreement1 is to be achieved.  Transitioning to a net zero economy requires significant capital investment and the providers of that capital want to understand the climate-related financial risks and long-term viability of the organisations asking them for money. They are not alone. The Institutional Investors Group on Climate Change2 recently noted:

Financial statements that leave out material climate impacts misinform executives and shareholders and thus, result in misdirected capital.

They draw the comparison of setting the future course of an organisation based on misleading information, with that of a pilot using the wrong charts — which is potentially disastrous.

Are disclosures of these risks regulated today?

It is clear that more needs to be done to bring transparency to these risks, but regulation and guidance on ensuring that material climate-related factors are properly reflected in financial statements does already exist.

Sir Jon Thompson, Financial Reporting Council CEO said:
 
Not only do Boards of UK companies have a responsibility to report their impact on the environment and the risks of climate change to their business, but investors expect them to operate sustainably. 

The FRC has high standards for company disclosure, including regarding climate change. Company reports and accounts are essential to understanding how the corporate world is responding to the challenge of climate change.’3

Who’s interested?

It’s not only the directors and boards of organisations that should be interested in understanding climate-related risk. Sir Jon Thompson went on to say:

‘Auditors have a responsibility to properly challenge management to assess and report the impact of climate change on their business.’

When enhanced disclosure becomes mandatory, auditors will need to consider:

  • Paris alignment – the resilience of the organisation’s strategy to different climate-related scenarios, including one with a temperature increase of 2°C or lower
  • Consistency – between the narrative disclosures around climate risks and the financial statements — this will highlight any greenwashing
  • Dividend resilience – that capital/solvency ratios reflect climate risk and that dividends are appropriately funded.4

Investors play a pivotal role in driving the future direction of most organisations. In respect of becoming Paris-aligned, investors can hold directors (and auditors) accountable by:

  • Engaging – making sure the board address the need for change
  • Voting – against resolutions or reappointments which don’t support the necessary changes
  • Divesting – signalling a lack of confidence in the organisation’s future.

Does any reporting guidance exist today?

Embracing the recommendations of the Taskforce for Climate-related Financial Disclosure (TCFD) is a good option for future-proofing reporting requirements. Its Final Report includes four good reasons. The reporting recommendations are:

•          Adoptable by all organisations, including financial sector organisations

•          Can be included in financial filings

•          Designed to solicit decision-useful, forward-looking information on financial impacts

•          Strong focus on risks and opportunities related to transition to a lower-carbon economy

The Task Force structured its recommendations around four thematic areas that represent core elements of how organisations operate: governance, strategy, risk management, and metrics and targets. The intention is to provide information that will help investors and others understand how organisations assess climate-related risks and opportunities.

The other point about TCFD reporting is that it will be mandatory. The Financial Conduct Authority (FCA) has confirmed that, from 1 January 2021, premium listed companies in the UK (two-thirds of the market capitalisation of equities on the UK Official List) will be required to make disclosures consistent with the recommendations of the TCFD. In addition, the Chancellor, Rishi Sunak, announced that the UK will become the first country in the world to make TCFD-aligned disclosures fully mandatory across the economy by 2025.

What can I do to support sustainable investing?

As an investor yourself — either directly through investing in shares or funds, or indirectly through your pension savings — being certain that organisations are managing and disclosing these risk is of paramount importance to protecting your future income. You can be an active investor: use your voice either by voting positively for change or divesting your interests. Make sure you know where your pension savings are being invested and lobby for Environmental, Social and Governance (ESG/ethical options to be made available. Apart from protecting your future income, you’ll also be protecting the planet.

REFERENCES

  1. Global Warming of 1.5 ºC, IPCC
  2. Investor Expectations for Paris-aligned Accounts, The Institutional Investors Group on Climate Change
  3. 2020, FRC assesses company and auditor responses to climate change, Finance Reporting Council
  4. 2017, Recommendations of the Task Force on Climate-related Financial Disclosures, Task Force on Climate-related Financial Disclosures

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