Climate risk reporting on the agenda

In September 2020, the New Zealand Government announced that it would be the first country to require its financial sector to report on climate risk.

The regime, being introduced on a comply-or-explain basis, is based on the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) framework, and will require about 200 entities in New Zealand with assets greater than NZ$1 billion (A$941 million) to report on their governance, strategy and risk management, as well as metrics and targets in relation to physical and transitional climate change risk from 2023.

The initiative for mandating climate-related financial disclosures is consistent with consensus views from alliances such as the 72-member Network of Central Banks and Supervisors for Greening the Financial System (NGFS). The alliance has expressed its views concerning the risk of climate change obscuring the assessment of correct monetary policy settings and thus the need for more accurate pricing signals to the market.

This is also expected to help incentivise low-emissions investment. Initiatives along these lines also underpin international obligations of achieving net zero carbon emissions, with New Zealand again comparatively forthright in setting an ambitious emissions reductions trajectory.

The New Zealand Financial Markets Authority will be responsible for the enforcing and independent monitoring of the regime. Of particular significance is the decision that the External Reporting Board (XRB) will develop and issue new reporting standards and implementation materials to assist businesses required to disclose matters relating to climate change. These developments occur at a time of momentous change and make opportune a discussion of the significance of two interrelated trends emerging in the development and transformational power of corporate reporting.

Much of the attention on the interaction between financial institutions and firms in sectors affected by both physical risk and transitioning has pivoted around awareness that climate change will have a profound impact on the economy.

First is the deepening appreciation of the connectivity of risks and the likelihood that climate change will remain the driving force in disclosure. Other factors, primarily biodiversity and ecosystem loss, will increasingly feature in recognition, measurement and disclosure developments.

Second, driven largely through growing acceptance and embedding of the TCFD framework, of which New Zealand is but one of many examples, is the current broadening out of sustainability (both the “e” and “s” of environmental, social and governance). This is a key feature driving the institutional and technical response in corporate disclosure within the “real” economy. Again, the XRB may well be operating at the forefront of such developments.

Elsewhere has been the announcement of the establishment of the Taskforce on Nature-related Financial Disclosures, spearheaded by the WWF and supported by a number of significant global financial institutions and European governments, including the UK, which is expected to release its recommendations in 2021, modelled on those of the TCFD.

Pivotal to these developments is the deepening appreciation of the scale, urgency and interconnected character of risks, for which prior developments in the methods and expectations about financial reporting – and corporate disclosure more broadly – could quite fairly not have been anticipated.

The transformations underway in financial market oversight and disclosure practices are now starting slowly to be matched in institutional, relationship and technical change, affecting a widening range of industry sectors.

Thus far, much of the attention on the interaction between financial institutions and firms in sectors affected by both physical risk and transitioning has pivoted around awareness that climate change will have a profound impact on the economy, leaving financial institutions with high levels of lending portfolio exposure and businesses correspondingly compelled to write down stranded assets.

Although hugely important and a primary factor in driving disclosure and business decision responses in both the financial and real economies, the accompanying imminent risk of wider environmental and social upheavals explains the need for a whole-of-system rethink of corporate reporting.

The World Economic Forum (WEF), in its Global Risks Report 2020 released in January 2020, stresses the coalescence of five environmental risks – climate action failure, human-made environmental disasters, biodiversity loss, extreme weather and natural disasters. These are heightened by expectations of likelihood and intensity of impact.

Consistent with the breadth of the WEF analysis, these trends occur against the backdrop of an assessed escalation in threats to economic prosperity and participation presented by declining social cohesion, digital fragmentation and, most presciently given the events that unfolded in 2020 and continue to do so, vulnerabilities within health systems.

By year’s end, the landscape of corporate reporting had entered a period of unprecedented redevelopment. Significant has been the proposal from Accountancy Europe, which takes as one of its driving contexts the 2020 WEF risks assessment, pointing in particular to the interwoven and reinforcing impact of economic, social and environmental consequences.

In essence, the proposal, which is garnering attention globally from regulators, policymakers and standards-setters, canvasses the idea of the creation of a corporate reporting foundation to provide oversight to both financial and non-financial standard-setting, and to develop and maintain a conceptual framework for connected reporting. Many observers, including CPA Australia, consider this to be a highly suitable foundation for the International Integrated Reporting Council’s (IIRC) Framework, currently under revision.

Elsewhere, the International Financial Reporting Standards Foundation has solicited views on the possible creation of a Sustainability Standard Board, to sit alongside the International Accounting Standards Board – although likely to have a climate-first approach.

Also indicative of the momentum of transformational change was the September 2020 announcement that the IIRC, along with four other framework and standard-setting institutions – CDP, the Climate Disclosure Standards Board, Global Reporting Initiative and the Sustainability Accounting Standards Board – will collaborate in an effort to form the building blocks of a set of metrics on global non-financial reporting within a coherent and comprehensive corporate reporting system.

Domestic standard-setters, such as the XRB, are without doubt entering a period of heightened expectation and potentially expanding remit, while at the same time needing to remain engaged with potential reforms within international institutions from which they derive their technical instruments for application to national markets and domiciled entities.