Public companies in most jurisdictions have existing obligations under national laws to assess, manage, and report on financially-material climate risks.
Requirements for climate-related risks to be reported are becoming increasingly common
Mandatory climate-related disclosures are increasingly being introduced in jurisdictions around the world. In June 2021, the G7 issued a communique announcing its support for moving towards mandatory disclosures aligned with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD),1 and regulators and governments have begun to introduce rules requiring certain companies to make TCFD-aligned disclosures.2 The requirements differ between jurisdictions, but common themes include reporting on climate-related risks and opportunities, the mechanisms for identifying and managing these risks and opportunities, and metrics and targets for greenhouse gas emissions. For example, the Hong Kong and Singapore stock exchanges have introduced requirements in the listing rules for issuers to disclose climate-related financial risks on a ‘comply or explain’ basis;3 the U.K. and New Zealand governments have passed regulations requiring financial institutions (and, in the case of the UK, all large companies) to disclose climate-related risks;4 in the US, the Securities and Exchange Commission has proposed rules to enhance and standardise climate-related disclosures.5
International standards have also begun to be developed. The IFRS Foundation’s International Sustainability Standards Board (ISSB) produced its finalised standards in June 2023, which are designed to meet investors’ information needs in assessing an issuer’s enterprise value, enabling efficient allocation of resources through the capital market.6 These standards require disclosures which are generally aligned with the recommendations of the TCFD, including narrative disclosures on governance, strategy, risk management, and metrics and targets. If the ISSB standards become mandatory, as indicated by the G7 nations,7 disclosing on these aspects will effectively require reporting entities to put governance systems in place to identify and manage sustainability risks and opportunities generally, and in particular, climate change-related risks and opportunities.
The European Financial Reporting Advisory Group (EFRAG) has published a set of European sustainability reporting standards (ESRS), in line with the requirements of the upcoming Corporate Sustainability Reporting Directive (CSRD), which will increase the scope and quality of the existing EU sustainability reporting regulations.8
Investors are calling for climate-related risk disclosures
Investors are increasingly calling for specific climate-related financial disclosures in the financial filings, in line with the TCFD recommendations.
In 2021, BlackRock, an investor with $8.67 trillion assets under management,9 called on investee companies to disclose a plan for how their business model will be compatible with a net-zero economy, to state how this plan is incorporated into the company’s long-term strategy, and to confirm that it has been reviewed by the board of directors.10 These disclosure requests are in addition to BlackRock’s 2020 policies that ask its investee companies to report in alignment with the TCFD recommendations and the Sustainability Accounting Standards Board (SASB).11 In January 2022, Larry Fink, BlackRock’s CEO, restated the importance of climate risk to its investment and its request for investee companies to issue TCFD-aligned reports.12
Investors are also requesting that their investee companies produce financial statements which show how the climate risks and impacts which the company has identified will affect its finances, including by making adjustments to critical assumptions, including sensitivity analysis, and the implications on the company’s dividend-paying capacity.13 The extent to which companies’ CAPEX is aligned with their stated transition plans and net-zero goals is also under scrutiny from investors.14
Climate risk is a material risk
While jurisdictional specificities exist, corporate reporting and securities law frameworks generally require listed companies to disclose information that is materially relevant to their financial performance and prospects in narrative reports and financial statements.
A materiality requirement also covers disclosures in the financial statements. In November 2019, International Accounting Standards Board member Nick Anderson explained how climate risks fall within the existing principles-based requirements under International Financial Reporting Standards (IFRS):
Climate-related risks and other emerging risks are predominantly discussed outside the financial statements. However, as set out in [IFRS Practice Statement 2] Making Materiality Judgements, qualitative external factors, such as the industry in which the company operates, and investor expectations may make some risks ‘material’ and may warrant disclosures in financial statements, regardless of their numerical impact.15
In November 2020, the IFRS Foundation published guidance titled the Effects of climate-related matters on financial statements, which states that material climate-related financial information should be reported under IAS 1 Presentation of Financial Statements, IAS 2 Inventories, IAS 12 Income Taxes, IAS 16 Property, Plant and Equipment, IAS 38 Intangible Assets, IAS 36 Impairment of Assets, IAS 37 Provisions, Contingent Liabilities and Contingent Assets, IFRS 7 Financial Instruments: Disclosures, IFRS 9 Financial Instruments, and IFRS 13 Fair Value Measurement; and, in addition to this specific disclosure, that companies whose financial position or financial performance is particularly affected by climate-related matters must provide overarching disclosure.16
These climate-related disclosure standards have significant consequences for boards. Directors have obligations to approve or attest to the accuracy and completeness of disclosures made in financial filings. Directors on audit committees will likewise have additional responsibilities to engage in testing and overseeing the robustness of the climate scenario assumptions underpinning key aspects of the audit process.17
While some directors may be concerned about liability exposure from making disclosures in accordance with the TCFD reporting framework, a 2017 report by the CCLI explained how such concerns are misplaced:
It is true that under some disclosure regimes, directors may be primarily liable where they are involved in misleading disclosures by their company. In others, liability may be accessorial (i.e., to that of the company), or as an adjunct of the directors’ duties to exercise due care and diligence in the best interests of their company. However, this concern about liability exposure both misunderstands the nature of the TCFD recommendations and potentially misrepresents the application of securities disclosure laws in many jurisdictions.18
Simply put, disclosure in accordance with the TCFD recommendations could in fact be used as a strategy to ensure compliance with directors’ duties and disclosure obligations.
In short, disclosure of forward-looking risks associated with climate change – with adequate specificity and relevance, and with appropriate cautionary language around associated limitations or uncertainties – is the best (if not only) way to minimise liability exposure for misleading disclosure. Whilst appropriate analysis and disclosure will be company-specific, the TCFD recommendations represent an influential touchstone for the processes required to robustly assess climate risks (and opportunities), and to communicate them to the market in a true and fair manner.19