The Task Force on Climate-Related Financial Disclosures (TCFD) guidelines are a set of recommendations for consistent disclosures that aim to help businesses understand their climate-related risks, identify new opportunities and evaluate overall financial impacts. In this article, we have summarized these risks, opportunities and impacts as these form the basis to the specific guidelines that are summarized in a follow-up article.
Climate-Related Risks
Transition Risks
These risks come from policy, legal, technology, and market changes that address mitigation and adaptation requirements related to climate change:
- Policy Risk: Policy actions around climate change are evolving rapidly. In general, their objectives are to limit actions that contribute to climate change and / or to promote adaptation to climate change. The uncertain nature and timing of the policy changes have a financial impact on businesses.
- Legal Risk: Reasons for litigation can include the failure of organizations to mitigate its climate-related impacts, failure to adopt resilience measures, and insufficient disclosures of material financial risks. Litigation risk is also likely to increase as the loss and damage from climate events grows.
- Technology Risk: Technological improvements or innovations for transitioning to a lower-carbon, energy-efficient economy can be disruptive to organizations as some organizations will adopt them faster than others. The timing of these changes also poses a risk.
- Market Risk: Climate change is bound to create shifts in supply and demand for certain commodities, products, and services as climate-related risks and opportunities are evaluated by organizations and acted upon.
- Reputation Risk: Customers now have access to more information about organizations and their efforts, or lack thereof, to transition to a lower carbon economy. Organizations have to be especially careful to back any claims with concrete action.
Physical Risks
Risks like damage to assets, water supply disruption, extreme temperature variations and supply chain disruptions have severe financial implications for organizations.
- Acute Risk: Such risks are driven by extreme weather events, such as hurricanes, wildfires or floods.
- Chronic Risk: These are risks from longer-term shifts in climate patterns that may cause sea level rise or chronic heat waves.
Climate-Related Opportunities
Resource Efficiency
Energy efficiency measures across operations and better management of materials, water and waste have the potential for cost savings in addition to curtailing total emissions.
Energy Source
Organizations are rapidly transitioning to clean or low emissions energy for their facilities and fleets. Organizations can capitalize on the steadily declining clean energy costs by securing favorable energy purchase contracts to ensure total cost savings.
Products and Services
Many organizations are choosing to innovate and develop low-emission products and services in order to win over consumers and gain a competitive edge. Such products should be designed by ensuring a lower carbon footprint analysis so that their claims are legitimate.
Markets
Opportunities exist for organizations to access new markets through collaborations with governments and financial institutions in developed and developing countries as they transition to a lower-carbon economy.
Resilience
Building climate resilience also presents opportunities to organizations, especially those that depend on utility and infrastructure networks or natural resources as well as those that require long-term financing and depend on extensive distribution networks etc.
Financial Impacts
There continues to be limited knowledge of climate-related risks and opportunities within many organizations. There is, of course, a tendency to focus on near-term risks which undercuts the strategic nature of many of the climate impacts. Adding to these is the challenging nature of putting a number on such risks and opportunities. TCFD identifies some of the ways to get past these limitations by clearly defining the financial impact categories.
Income Statement
- Revenue: Demand for products and services is affected by transition and physical risks. For each of the risk categories listed above, what is the potential impact on revenue? Can the opportunities listed above yield new revenue streams? As an example, consider how any carbon pricing will affect your organization’s revenue. Or how your organization can capitalize on a climate friendly product.
- Expenditure: Where do climate-related risks and opportunities fit into the organization’s cost structure? Are your lower-cost suppliers more resilient and more flexible to climate-related issues? By providing answers to such questions, organizations can better inform investors about their profitability and investment potential.
- Capital: What are your capital expenditure plans and the debt or equity needed to fund these plans? Are these plans resilient to climate risks? Will the capital markets be willing to fund your organization given the exposure to any climate-related risks? Transparency of these plans will position businesses for better access to capital markets, especially in the current ESG atmosphere, and perhaps even better financing terms.
Balance Sheet
- Assets and Liabilities. How will the valuation of your assets and liabilities be affected by the supply and demand changes from the policy, technology, and market dynamics related to climate change? Will any of your long-lived assets and reserves be affected by climate-related issues? There are bound to be climate impacts on existing and future operations that require new investment, restructuring and write-downs that will affect the organization’s balance sheets.
Understanding the climate-related risks, opportunities and financial impacts is the first step towards conducting the TCFD disclosures of your organization’s governance, strategy, risk management, and metrics & targets. Not only do these disclosures provide information to investors and other stakeholders but they also provide a clear-eyed thinking to the organization as to how they will be affected by climate change. And, as they say, by understanding the problem you are already halfway to the solution.