"An old adage is that which is measured can be managed" - Mark Carney, September 2015
With those words, the Task Force on Climate-related Financial Disclosures was born. It was asked to design a voluntary standard for how companies should disclose climate-related information. Over the past year, the Task Force has been working to deliver that standard and, in December 2016, it published its recommendations.
The Task Force's work should be welcomed. Their framework will help companies think through and disclose how climate change will affect them financially. In turn, that will help institutional investors manage the risks to our pensions and savings and policymakers keep the financial system stable.
Nevertheless, a number of issues still need to be resolved. The most pressing is to ensure companies actually use the framework - almost a third of companies surveyed don't want to implement the recommendations, according to the Task Force's own outreach. Clarity is also needed on how this voluntary framework interacts with mandatory reporting requirements, which means policymakers must respond.
E3G also have significant concerns about whether or not the guidelines will extract certain important information. Physical risks are already having a negative financial impact on companies, yet their importance is downplayed and political risks, of the sort that could lead to financial system meltdown, are nowhere to be seen. Few people in the debate appear to be raising these concerns, so it's worth exploring them further here.
The Task Force only explicitly asks companies to prepare a 2°C scenario analysis, despite noting that range of scenarios would be preferable. This approach is likely to encourage companies to place more emphasis on risks from the transition to a low carbon economy than risks from physical impacts of climate change.
That is problematic for at least two reasons. First, it is not clear that transition risks will have a larger financial impact than physical risks on aggregate. Indeed, evidence suggests the exact opposite could be true. Research from the University of Cambridge Institute for Sustainable Leadership has shown that a climate policy failure scenario will have large negative impacts on typical institutional investors' portfolios, which cannot be fully hedged. By contrast, under a two degree scenario financial portfolios perform significantly better. Similar conclusions have been found elsewhere, with eye-watering if uncertain estimates of the potential value-at-risk from climate change impacts.
Second, the physical impacts of climate change affect a broader range of companies than the 'usual suspects' targeted by the Task Force. These physical risks aren't some distant threat either. At the time of writing heat waves, that risk health, well-being and productivity have struck Australia and floods, which can ruin homes and infrastructure and disrupt global supply chains, have hit California.
Optimists might hope that governments would have clear plans on how to respond to these risks. They would be a disappointed. To take the UK as an example, its Government's 2017 Climate Change Risk Assessment report indicates that urgent government action is needed to protect the UK's communities and economy from climate impacts (Figure 1).
A prudent approach to managing climate risk is to 'aim for 2°C, plan for 4°C'. As things stand, the Task Force's advice appears to be 'plan for 2°C'. That is far from enough. In the next iteration of its recommendations the Task Force should explicitly ask companies to publish a scenario plan for a 'high-impact' scenario, consistent with upper estimates of scientific projections of potential temperature increases.
The Task Force also appears, ironically, to have excluded the very risk that has financial policymakers so worried - the risk of an abrupt and disorderly transition to a low carbon economy. According to the Bank of England and others, that scenario would transpire if countries rapidly implement policies to severely constrict the emissions of greenhouse gases. Yet the Task Force does not ask for companies to make any assessment of their exposure to the political risk that current climate policy trajectories in many countries are inconsistent with their commitments under the Paris Agreement.
Giving an indication of these risks would not be difficult. The Paris Agreement has established the direction of travel for climate policies and countries' plans are in plain sight. As such, the Task Force should ask for companies' exposures to these political risks by jurisdiction.
As things stand then, under the Task Force's framework companies are unlikely to measure the risks of climate policy failure or rapid climate policy 'success'. That doesn't bode well for their management.