This blog post provides 5 tips to effectively integrate climate-related risks and disclosures into financial reporting. Key focus areas include materiality assessment, transparent assumptions, value chain analysis, aligning financial and sustainability data, and leveraging diverse data sources. Implementing these practices can help companies meet evolving regulatory requirements and optimize long-term business value.
With the significant uptick in sustainability legislative activity in recent years, climate risk is the sleeping giant that few companies have come to grips with. Addressing this would be wise, not only because it’s a legal requirement, but because unfortunately the predicted climate change impacts have arrived, and represent a real threat to business, the community, and the ecosystem on which we depend.
Climate risk data encompasses a wide range of information related to the potential impacts of climate change on a company, industry, or economy. This includes data on physical risks, such as exposure to extreme weather events like floods, droughts, and storms, as well as impacts on assets, operations, and supply chains due to changes in temperature, precipitation, and sea levels. Transition risks, such as exposure to policy and regulatory changes (e.g., carbon pricing, emissions reduction targets), the impacts of technological changes (e.g., the shift to renewable energy), and changing market dynamics and consumer preferences, are also crucial components of climate risk data. Additionally, liability risks, including potential lawsuits or compensation claims related to climate change impacts, are an important consideration.
This climate risk data can be sourced from various channels, including internal company assessments and risk management processes, climate science and modeling data from research institutions and government agencies, industry-specific studies and benchmarks, voluntary disclosure frameworks like the Task Force on Climate-related Financial Disclosures (TCFD), and specialized third-party data providers that offer climate risk analytics.
The key point is that climate risk data goes beyond just environmental metrics – it aims to quantify the financial implications of climate change for the business. This makes it relevant for financial reporting and decision-making, not just sustainability and ESG reporting.
A new document provides an insight into how some companies are doing this. The International Accounting Standards Board (IASB) manages the International Financial Reporting Standards (IFRS), a global accounting standard. The IFRS has recently released Sustainability Disclosure Standards, providing guidance on how to report on sustainability and climate issues. These standards are increasingly being mandated by national legislative authorities. Some companies already address these requirements through their adoption of IFRS predecessors, the TCFD and Sustainability Accounting Standards Board (SASB) standards.
The IASB has just released a draft for comment titled “Climate-related and Other Uncertainties in the Financial Statements: Proposed Illustrative Examples.” This offers insights into how companies can approach climate risk assessment within the framework of financial reporting.
Key Lessons To Guide Your Climate Risk Assessment:
Materiality Assessment
The IFRS requires companies to undertake a Materiality Assessment, addressing the financial risk of climate to the company. Materiality is a key concept in financial and sustainability disclosure reporting. It refers to the threshold or criteria used to determine what information is significant or important enough to be included in a company’s financial statements or sustainability reports. The concept of materiality is based on the idea that not all information is equally relevant or useful to the intended users of the financial or sustainability information. Materiality helps companies focus on disclosing the most critical and decision-useful information.
In the context of climate-related financial reporting, the key aspects of materiality are:
- Financial impact: The IFRS standards require companies to assess whether climate-related risks and opportunities have a material financial impact on the company. This could include impacts on assets, liabilities, revenues, expenses, etc.
- Qualitative factors: In addition to quantitative financial impacts, companies should also consider qualitative factors that could make climate-related information material, such as regulatory changes, stakeholder expectations, or reputational risks.
- Industry-specific context: The materiality of climate-related information can vary significantly by industry. Companies in high-emitting or climate-vulnerable sectors need to pay closer attention to climate-related materiality.
- Stakeholder perspectives: Companies should understand the information needs and expectations of key stakeholders, such as investors, when assessing materiality. What may be considered material by investors may differ from internal management perspectives.
- Future impacts: Materiality assessments should consider not just current impacts, but also potential future impacts of climate change that could affect the company over the short, medium and long-term.
By conducting a comprehensive materiality assessment, companies can ensure they are disclosing the most critical climate-related information that is decision-useful for investors and other stakeholders. This helps enhance transparency and accountability around climate risk management.
It recommends that this assessment incorporates qualitative factors. For example, factors like regulatory environment and public expectations can influence whether certain information needs to be disclosed, even if the quantitative impact seems minimal. And, consider industry-specific risks; entities operating in industries particularly vulnerable to climate risks, such as energy or manufacturing, should focus on climate risk when assessing materiality. Industry context plays a critical role in determining materiality, for example, infrastructure that may be vulnerable to extreme weather events, or processes that are vulnerable to global supply chain disruptions.
Disclosure of Assumptions and Uncertainties
Transparency in key assumptions: Clearly disclose the assumptions made about climate-related risks that could affect the financial statements. In an area of such uncertainty and variability, assumptions are crucial to help understand risk and probability. This may include assumptions about future regulations, commodity prices, and technological advancements.
Sensitivity Analysis: Assumptions can have a significant impact on risk assessment. This can involve presenting different scenarios where assumptions about climate risks lead to varying outcomes in asset valuation or liability recognition.
Value Chain and Scope 3 Emissions
Comprehensive Reporting Beyond Direct Operations: Assess and report on climate risks not just within the organization but across the value chain. This includes Scope 3 emissions, which are indirect emissions that occur in the value chain of the reporting company, including both upstream and downstream activities. Some of the most significant risks can be present upstream or downstream of operations.
Collaboration with Suppliers and Customers: Engage with suppliers and customers to collect data on climate-related risks throughout the value chain. This collaboration is essential for accurately assessing and reporting on Scope 3 emissions. Sustainability management systems and technology platforms should include the ability to effectively engage with the supply chain, both to gather feedback and to promote standards and expectations.
Consistency Across Financial Reports
Align Financial and Sustainability Reporting: Ensure that the information disclosed in financial statements is consistent with the sustainability disclosures provided in other parts of the company’s general-purpose financial reports. This alignment is crucial to avoid contradictions that could undermine the credibility of the reporting. Most frameworks now request climate risk data to be disclosed as an integrated component of annual corporate reporting.
Holistic Approach: Adopt a holistic approach to reporting by considering how financial and non-financial information is interrelated. For instance, a company’s strategy to reduce greenhouse gas emissions should be reflected not only in its sustainability reports but also in how it accounts for and discloses related financial impacts.
Multiple Data Sources
Stakeholders and Third-Party Data: Understand and address the expectations of various stakeholders, including investors, regulators, and customers, regarding climate-related disclosures. Proactive engagement with stakeholders can help identify material risks that may not be immediately apparent through internal assessments alone. Third-party data providers can also provide valuable insights by drawing upon independent and objective data sources, and integrated into risk assessments to challenge or confirm assumptions.
Conclusion
Conducting a thorough climate risk assessment involves a multi-faceted approach that integrates both qualitative and quantitative factors, considers risks throughout the value chain, and ensures consistency across financial and sustainability reports. These steps can enhance the reliability and transparency of your climate-related financial disclosures, aligning them with the evolving expectations of regulators and other stakeholders. Climate risk disclosure can become not simply a matter of compliance, but a way to genuinely optimize operations and ensure long-term business value.
Technology platforms can help to address all of the best practices described above. From carbon accounting, data collection, to stakeholder engagement, cross-function integration, and value chain engagement, an enterprise-wide platform to manage sustainability and non-financial data is essential to streamline the integration of climate risk data into financial reporting. Please do contact Benchmark Gensuite if you’d like to discuss how we can assist with these aspects. Please do contact Benchmark Gensuite if you’d like to discuss how we can assist with these aspects.Â
The full report, including illustrative examples, and the opportunity to comment by December, is here.
Hidden Cost of Emissions: The European Central Bank says banks are charging monthly interest rates to firms with no emissions reduction targets that are, on average, 20 basis points higher than those granted to companies with targets. Banks also appear to differentiate their lending rates based on their clients’ prospective carbon emissions, not just their current ones. The Netherlands Central Bank in a separate study came to the same conclusion. Watch this space for the next blog post discussing this.
