Highlights from the IoD breakfast event on climate-related disclosures

Published by the Institute of Directors. The original article can be found here.

Reporting requirements, impacts, and opportunities

In January 2020, when the IoD published its annual list of ‘top of mind’ issues for directors, climate change was firmly in pole position.

“But the year proceeded to take an unexpected turn and another crisis dominated the headlines for a while and still does,” IoD chief executive Kirsten (KP) Patterson told the organisation’s Breakfast Event on Climate-Related Financial Disclosures (CRFD).

“Climate change didn’t get the memo, though, and continued to challenge large swathes of the globe with raging fires, rising sea levels and extreme weather events. Mitigating climate change is still firmly on the agenda and provokes plenty of discussion in New Zealand.”

Much of that discussion is around the government’s announcement, in September, that New Zealand would become the first country in the world to require the financial sector to report on climate risks.

Around 200 large New Zealand entities will have to report on their exposure to climate risk based on standards devised by the External Reporting Board (XRB), which are, in turn, aligned with the Task Force on Climate-related Financial Disclosures (TCFD) framework. This is expected to be mandatory for reporting periods that end in 2023. The UK has also announced it will move to the TCFD framework, from 2025.

The purpose of the event was to discuss the impact of the new reporting requirements for business, as well as for the wider governance community.

It brought together three speakers, with different areas of expertise around climate change reporting: XRB deputy chair Jane Taylor; Barry Coates, founder and chief executive of Mindful Money, a charity promoting ethical investment; and Mike Roan, chief financial officer for Meridian Energy, the first organisation in New Zealand to have released a climate change risk report.

“Our boards play a crucial role in the long-term sustainability of the organisations they serve, as well as the society in which they operate,” said KP in her opening presentation. “That requires a proactive approach to reducing environmental impact and managing climate-related risks.”

Effective reporting relies on good quality information

While Jane Taylor wears a number of governance hats, she was specifically representing the XRB at the event. She said that for climate-based reporting to be a success, key consumers of the reports – including investors, shareholders and the public at large – must have confidence in the quality and usefulness of the information provided.

“It is essential that such reports add to our understanding of the potential impacts of climate change and help us make more informed decisions about the associated risks and opportunities, as well as the inherent uncertainties that we must manage in the future. To be useful, information must be relevant, consistent, understandable and, critically, comparable.

“If we are to accelerate our transition to a low carbon economy, climate-related financial disclosures – or CRFDs - are actually central to core strategy and risk management. This is not just another compliance function, as has been suggested by some commentators recently. I respectfully suggest that anyone who thinks it is, needs to reassess, and quickly,” Ms Taylor said.

The XRB is a Crown entity, responsible for developing an overarching reporting strategy and issuing financial reporting auditing assurance and ethical standards.

It adopts international standards as a starting point and Ms Taylor notes this is particularly important for entities operating in offshore capital markets where compliance with internationally-recognised standards is generally considered essential for fundraising.

International framework, local context

“But we also need solutions that recognise the importance of Aotearoa New Zealand’s uniqueness, including our partnership with Māori, so entities across all sectors can report with credibility and consistency both locally and internationally. The challenge is to ensure that our CRFD standards are firmly based on the international Financial Stability Board Taskforce’s TCFD framework, but at the same time provide information that is relevant to our Kaupapa.”

Ms Taylor said the TCFD’s framework and recommendations aim to support international alignment on a low-carbon transition. “This is vital to promote more informed decision-making in areas like investment, credit and insurance underwriting, as well as helping stakeholders to better understand the financial system’s exposure to climate-related risk.

“The recommendations cover four key themes - governance, strategy, risk management, and metrics and targets – and eleven disclosure groups, including transitional risks, market risks and physical risks, as well as opportunities, such as resource efficiency and organisational resilience."

Striking the right balance

“Report preparers will struggle if there is too much flexibility or lack of clarity about what’s required, and the information provided will be inconsistent and not comparable. This, in turn, will undermine its credibility. On the other hand, an overly prescriptive approach will lead to cookie-cutter responses that do not allow an entity to tell its own story and, in the worst case, may miss significant risks or scenarios altogether.

“Information is valuable when it is consistent, comparable and decision-useful. By this I mean forward looking: Where are we going? Common baseline assumptions and narratives are important in this respect and credibility is key.”

Ms Taylor said it was essential to resolve the tension between prescription, which she said is often endemic to financial reporting standards, and relevance.

“XRB’s task is to develop standards suitable for Aotearoa New Zealand, which are also internationally comparable and credible. This means taking into account the extent to which climate issues are specific to New Zealand, our adaptation policies and transition risks, the close relationship between public and private sector reporting and the critical importance of comparing how entities within and between sectors are managing climate-related risk,” she said.

“We recognise that developing these standards will be a balancing act and that there will be cost-benefit challenges along the way,” said Ms Taylor. “The standard setting process will need to be iterative and consultative.”

“Consultation with as broad a range of stakeholders as possible will be key. We will engage with investors to learn more about the information they need, as well as different industries to understand their specific issues and whether there is need for more tailored disclosures in some areas.”

“We will also consult with report producers to understand the challenges in pulling together the required information, the associated costs, as well as any issues around data volatility,” Ms Taylor said.

While climate reporting is expected to be mandatory for reporting periods that end in 2023, she said XRB will issue guidance before then, to enable entities to start preparing their frameworks.

Ms Taylor invited feedback. “We really do want to hear a range of views. I know some of you will have embarked on your journey already. We’re keen to hear how that’s going, what challenges it’s throwing up and how can we learn from you.

“That way we’ll not only build a standard that’s meaningful and useful but that will also accelerate Aotearoa’s journey to a low carbon economy – because that is the really big prize here. This isn’t just about reporting. This is about meaningful action.”

Investors are driving change

Mindful Money CEO Barry Coates led Oxfam NZ from 2003-2014, is a former Green list MP, and won the Sustainable Business Network Sustainability Champion award for 2016. He sits on a number of boards.

Mr Coates' discussion focused on the ‘why’ of CRFD.

“Why? Because investors matter. Internationally, the investor community is playing a major role in pushing companies to take more action on environmental, social and governance issues with more emphasis on climate change action and climate reporting.”

Mr Coates cited risk management as another major ‘why’ factor, noting that organisations currently place a lot of attention on managing the most obvious issues.

“What does not get managed nearly as closely is the 85 per cent of shareholder value that is ‘below the waterline’ and a lot of that is in company reputation. It’s in brand name, it’s in all the things companies lose very quickly when they get things wrong – and investors know that.

“That is why this whole area of environmental, social, and governance (ESG) management has become so prevalent in the investment community. If you look at the membership of the Principles of Responsible Investment, the overarching international body affiliated with the United Nations, it now represents around $110 trillion dollars of assets under management. These techniques of ESG management have become absolutely crucial for investors, and we are seeing that increasingly in New Zealand.”

Business purpose beyond shareholder returns

Mr Coates pointed out that Larry Fink, CEO of BlackRock, the world’s largest asset manager, has been championing the issue of ‘business purpose’.

“The US Business Round Table recently talked about maximising shareholder returns being only one of the criteria that should be part of business purpose. Larry Fink has said that climate change will cause a transformative allocation of capital towards sustainable investment.

“There is another reason. Mandating risk is legally required, it is part of fiduciary duty. However, until recently, this has not been equated with ESG risk or climate change and many boards of directors have not focused on non-financial issues.”

Mr Coates recommended reading the Sustainable Finance Forum’s toolkit for directors, produced as part of their Roadmap for Action, which lays out the role of directors in managing climate risk.

“That is important for investors – they also bear the legal responsibilities to consider ESG risk and climate risks as part of their fiduciary duty.” Critically, said Mr Coates, investors are recognising that ESG is also good for returns. He said while a high proportion of Kiwisaver funds are currently invested in fossil fuels, research shows that 74 per cent of the public want to avoid such investments.

“There’s a big gap between what funds are doing and what investors would like them to do, but that gap is closing rapidly as more funds go fossil fuel free and new default Kiwisaver funds will soon be required to do the same. We are seeing a big shift in funds management to manage climate risk.”

Manage risk or lose value

Mr Coates said that while divesting is one way to manage climate risk, another is through working with companies to improve their climate performance – and it was interesting to note that some funds investing in fossil fuels had underperformed expectations.

“That pattern is repeating across a number of different ESG factors. One of the main reasons investors are concerned about climate risk is because they are worried about their returns, because companies are climate-exposed. Either in production or in other forms of climate risk, they are paying the financial penalty for doing so. If you don’t manage climate risk, then your returns will suffer.

“This is very instructive because it takes the whole argument away from just being ‘this is important from an ethical point of view’ or because it’s required for risk management, to saying ‘this is good for business’ – managing risk is good for returns.”

“The government’s proposed TCFD rule captures all funds managing assets of over a billion dollars. That covers a lot of fund managers in New Zealand. We’re seeing an increasing interest in this agenda and everyone is eagerly awaiting the XRB’s work.

“There is one other aspect to this. This is not only a cost and burden, it’s an opportunity for those who get it right. The NZ Super Fund did their TCFD-aligned report recently – and it’s compelling reading. They found two things. One, they met the targets they had set a couple of years early, so they’ve doubled their targets for a 40 per cent reduction in carbon intensity by 2025 and an 80 per cent reduction in exposure to fossil fuel reserves and stranded assets.

“That is a statement of commitment from the Super Fund. But they also found, from the partial targets they put in place, they returned an extra $800 million to us tax payers, through additional returns. From a business perspective, climate management and reporting is simply good practice, particularly starting early and learning. For those who are bold, there are opportunities.”

Integrating TCFD reporting into your strategy

Financial returns, reputation and talent are the three key reasons that TCFD reporting will benefit businesses, Meridian Energy CFO Mike Roan told the audience.

“One of the most valuable things you can do, is a TCFD report,” he said. “At one level a TCFD is just an artefact. For us it was just a 14 page report, it was not onerous to produce, but the value it creates is that it makes you think about the future and, specifically, about how the climate will affect the future of your business as it allows you to present that information back to your investors.”

Mr Roan was speaking in the same week that BlackRock announced that its shares in Meridian had grown to over five per cent. BlackRock is investing through its iShare Global Clean Energy ETF (ICLN) fund and Meridian is now ICLN’s largest investment globally.

Mr Roan shared key insights from Meridian’s experience of developing its TCFD report, including defining the role of the board and the role of management.

“TCFD reporting is the introduction of climate-related opportunities and risks into your corporate strategy. There is nothing more valuable you will do in a business than frame up your strategy, because everything you do should flow from this. A strategy tries to define where you can create the most value and minimise risk, given the choices you’ve got for the future. You’ll learn a lot along the way – as we have.”

Tomorrow's leaders care about the climate

“When you think about your strategy, it affects not just your financial returns but also your reputation and your ability to attract talent. Reputation is defined by the things you do or don’t do. As a business, if you are not thinking about the climate and how it might impact your reputation it is likely you’ll get flattened because you’ll be surprised by a risk that you had not contemplated.

“Today’s youth are tomorrow’s leaders - those most worried about the impacts of climate change on their lives are the leaders of tomorrow and because they care they will be attracted to businesses that are doing things that help manage the effect of climate on their own lives. So, if you want to attract the best talent, then adopting and thinking about climate as part of the way your business operates has tremendous value.”

The role of the board in implementation

This should be straightforward. “The board’s role is the same as always, to ask questions - demanding persistent questions - and the business will learn as those questions are asked.

“Our board asked questions of us, long before I arrived. Back in 2004, Meridian became renewable – spin forward and the same level of questions emerge at every board meeting, they produce constant change in the way we do things.

“Being renewable for some time flows to integrated reporting, greenhouse gas (GHG) inventories, TCFD reporting and green finance programmes and there are many other social elements. I could not say anything more valuable to you than the role of the board is to be persistent in the questions that you raise, to be demanding in relation to the inclusion of climate thinking within the business.”

In terms of management supporting the board, Mr Roan said it was vital to be completely open.

“Be humble with the board and admit the things you don’t know because there is a lot to explore here together. Be really clear as a management team what you are adding to your business plans, and what you are adding to the other initiatives that your business undertakes, so the board can understand where you are being successful and where your choices are not proving as successful as you might hope.

“There is a discovery process; the clarity of writing down the things you are going to do and reporting on the things that you do will help you discover what success looks like and also where you got it a little wrong. Be open about that, be humble. We don’t know everything there is to know about the future – but we sure can make a difference if we put measures in place and we act on them.”

This panel discussion was an adjunct to the Climate Change and Business Conference 2020 held 11-12 November. See all conference sessions on demand