The competitive advantage of climate risk awareness

Andrew Cornell

Past Managing Editor, bluenotes

A critical and growing mass of influential companies has moved well beyond debate on climate change to dealing with how it should be measured and reported to shareholders and regulators.

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In the just-released 2018 Status Report presented by the industry-led Task Force on Climate-related Financial Disclosures (TCFD) to the global Financial Stability Board (FSB), the number of firms supporting TCFD recommendations grew to more than 500, their market capitalisations totalling $US7.9 trillion.

"Those companies that meet this need (by investors for greater information) may have a competitive advantage over others” – TCFD report

This includes financial firms responsible for assets of nearly $US100 trillion and compares with 100 firms when the recommendations were launched in June 2017.

According to FSB chairman and Bank of England governor Mark Carney the numbers demonstrate “climate-disclosure is becoming mainstream”.

“As preparers, financial institutions and investors ‘learn by doing’, a virtuous cycle will be created where more and better information creates the imperatives for others to adopt the TCFD and for everyone to up their game on the quality of information they provide,” Carney says.

The TCFD report provides an overview of current disclosure practices and their alignment with the core elements of the TCFD recommendations, supporting the sense of growing momentum for climate-related disclosures in the corporate world.

The imprimatur of the FSB (a body constituted under the auspices of the global banking supervisory body the Bank for International Settlements) further emphasises the seriousness of regulators around climate-related risks.

The TCFD status update included ANZ as one case study of how companies are reporting their exposures and strategies. This is an edited version of the report’s analysis of ANZ’s reporting.

ANZ operates in Asia, the Pacific, Europe, North America, and the Middle East and serves retail, commercial, and institutional clients. Its presence in the Pacific, in particular, implies that ANZ is exposed to areas vulnerable to rising sea levels.

The documents reviewed for this assessment include ANZ’s Climate-related Financial Disclosures and Climate Change Statement.

Introduction

ANZ is an early supporter of the TCFD recommendations and one of the members of the United Nations Environment Program Finance Initiative (UNEP FI) pilot project on implementing the TCFD Recommendations for banks. All 16 banks participating in this pilot have committed to publishing an initial TCFD disclosure by mid-2019.

Disclosure example: strategy

ANZ’s Climate-related Financial Disclosures report covers each of the four major categories of the TCFD recommendations. The strategy section discusses the potential implications of two scenarios for ANZ’s customers most-exposed to transition risk, i.e., ANZ’s lending book. In addition, the Climate Change Statement describes ANZ’s policy on financing fossil fuel industries.

Disclosure assessment: strategy

The initial focus has been on customers in the thermal coal supply chain. The analysis provides insight into the extent to which ANZ’s customers—and, hence, ANZ as a lender—are exposed to various climate-related scenarios, how these customers are preparing for the energy transition, and how ANZ can support customers to transition to a low-carbon economy.

ANZ discusses its policy towards financing fossil fuel industries, addressing implicitly investors’ potential concern for stranded assets. Although ANZ has an ambition to contribute to the energy transition, the bank also understands that fossil fuels will continue to play a significant role in the energy mix for the coming decades.

The focus is therefore on supporting alternatives to fossil fuels, such as energy efficiency measures and renewable energies, and on the most carbon efficient fossil fuel plants.

Investors would benefit from a wider coverage of customers (beyond coal supply chain) and risks, in particular physical risks.

For instance, is ANZ still willing to provide mortgages for residential and commercial real estate in flood-prone areas? How would a business-as-usual scenario (likely leading to more than 3°C degrees of global warming) affect risk-return trade-offs?

Disclosure assessment: metrics and targets

ANZ provides some evidence for recent improvements in energy efficiency and may be used to assess ANZ’s exposure to higher carbon prices.

Investors would benefit from a more comprehensive discussion of financed emissions. In particular, how are they measured (which scopes are included)? Which sectors and asset classes are included?

Would it be possible to add forward-looking information?

Counting

Clearly there are costs in the move to less carbon-intensive and more-sustainable economies. These costs are real but are a focus for many vested interests and political groups opposed to a shift to renewable energy. In a world of higher energy prices, costs are going to be a significant factor in debate.

Offsetting this antagonism is the failure of existing measurement to fully factor in the costs of present-day emissions, what economists refer to as ‘negative externalities’ – the price societies pay which are not compensated for by the producers or other beneficiaries.

This is most obvious in developing nations where, for example, environmental damage or poor air quality are paid for by citizens but not explicitly by polluters.

However negative externalities are also evident in developed economies. For example, a fire at the Hazelwood coal mine in the Australian state of Victoria resulted in extensive rehabilitation costs and severe health impacts – which included costs to the state.

Japan had long been lowering the carbon intensity of its economy by shifting from fossil-fuel based generation to nuclear power. However the Tohoku earthquake and tsunami of 2011, which resulted in one of the world’s worst nuclear accidents, resulted in not just the shutdown of the Japanese nuclear generation sector but multi-billion dollar, multi-generation costs for the Tohoku region in particular but the Japanese taxpayer in general.

Tepco, the Japanese generator and owner of the Fukushima Daiichi plant which melted down, will not be responsible for those costs.

That is not to ignore the real cost of shifting the carbon intensity of economies.

The TCFD report notes “for many investors, climate change poses significant financial challenges and opportunities”.

“The expected transition to a lower-carbon economy is estimated to require around $US3.5 trillion, on average, in energy sector investments a year for the foreseeable future, generating new investment opportunities,” the report says.

“At the same time, the risk-return profile of companies exposed to climate-related risks may change significantly because of physical impacts of climate change, climate policy, or new technologies.”

“In fact, one study estimated the value at risk to the total global stock of manageable assets because of climate change ranges from $US4.2 trillion to $US43 trillion between now and the end of the century.”

Sketch

In its analysis, the TCFD sketches out the broad scope of potential costs – implying there may well be greater efforts to shift the costs of negative externalities away from the taxpayers towards emitters and/or their investors.

But according to the TCFD “much of the impact on future assets will come through weaker growth and lower asset returns across the board”.

“This suggests investors may not be able to avoid climate-related risks by moving out of certain asset classes as a wide range of asset types could be affected,” the study says.

“Companies that invest in activities that are susceptible to climate-related risks may be less resilient to the transition to a lower-carbon economy; and their investors may experience lower returns. Compounding the effect on longer term returns is the risk that present valuations do not adequately factor in climate-related risks because of insufficient information.”

The subtext here is a greater variety of regulators and investor groups will demand more and more precise information on a much broader range of climate change risks – including some kind of assessment of what is measurable and not measurable.

To date, although awareness might be relatively high, relatively few companies are taking actions to manage it as a key financial risk by, for example, linking it to board remuneration, based on 2017 Carbon Disclosure Project (CDP) disclosures.

In financial services, the demand for clarity and action is already evident in positions taken by regulators such as the BIS, the Bank of England and the Australian Prudential Regulation Authority – regardless of the policies of whatever government of the day.

As bluenotes outlined last week, investors are also demanding action.

But it’s not all stick: the TCFD notes “those companies that meet this need (by investors for greater information) may have a competitive advantage over others”.

Andrew Cornell is Managing Editor of bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.