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A Regulatory Push

* This article has been republished from the Winter 2019 Edition of the GRC Professional Magazine. Click here to download a PDF copy of this article.

Can mandatory standards around financial disclosures related climate change make a difference to businesses’ approach to climate change?

On the second day of the ASIC Forum 2019, the panel, hosted by former ASIC Deputy Chair Peter Kell, focused on just this issue.

In his opening statement before introducing the panel, Kell said:

The absence of standardised framework for disclosing climate-related financial risks makes it difficult for organisations to determine what information should be included in their filings and how it should be presented, even when reporting similar climate-related information disclosures. It is often difficult to compare, due to variances in between voluntary frameworks, and the resulting fragmentation in recording practices and lack of focus on actual impacts have presented investors, lenders, insurance writers, and other users of disclosure, from accessing complete information that can inform their economic decisions.

According to Kell, ASIC, APRA, and the Reserve Bank of Australia all have climate change-related risks on their radar and are speaking with one voice on this issue.

Papers published by ASIC and APRA respectively have taken their cues from the Financial Stability Board’s Task Force on Climate-Related Disclosures (TCFD). The TFCD was well-represented on the panel at the Forum by Dr Fiona Wild, from BHP, a panel member of the TCFD. Dr Wild helped to distil some of the more critical elements for attendees.

KPMG’s Amber Johnson Billings, who also sat on the panel, said regulators have just started in this space, but they could push harder.

“The current disclosures on the market, to a large degree, don’t yet enable enough information for investors to allocate capital efficiently,” Billings said.

She added that this issue is just part of the inconsistencies surrounding disclosure; however, it is also about how to communicate the information effectively.

“The ability for a board to deal with a topic like climate change—which isn’t a single issue—isn’t a risk in and of itself because climate change is something that impacts on the physical realm.”

There was much said at the Event about what the regulator would do because, at the time, ASIC was still in ‘caretaker mode’. But it was an opportunity, nonetheless, to hear from those in the financial services who have taken a sustainability focus, as well as ways climate change risk can be reframed in such a way that it makes sense to boards and management.

A little bit of background

In late December 2018, a media release from ASIC referenced an article submitted to Listed@ASX Magazine that stated the management of climate change risk, or climate risk, was an increasingly-topical issue for companies and investors.

The release highlighted the ASX Corporate Governance Council’s consultation on the Corporate Governance Principles and Recommendations. This followed a proposal, published two months’ prior, to have guidance around climate risk disclosures that noted those with ‘material exposure’ should implement the TCFD’s recommendations.

The Report 593: Climate Risk Disclosure by Australia’s Listed Companies, published some high-level findings, based on disclosures that came from six listed companies, 25 IPO prospectuses and 15,000 annual reports.

Overall, only 17 per cent of those companies identified climate risk as material risk to their operation. The question that perhaps then needs to be asked is: Is general disclosure useful for assessing climate change risk disclosure?

One positive from the report, however, was that a number of companies did consider climate risk, to various degrees, as part of their business plan, and a number of those ASX-listed companies did intend to adopt the TCFD recommendations.

In another report published in 2016 and titled, Recommendations of the Task Force on climate -related Financial Disclosures, they argue the risks related to climate change are largely misunderstood, and that, ultimately, the quality of climate change risk is “…too fragmented, general or not comprehensive enough to be useful to investors.”

ASIC discovered the same, when looking outside of the ASX, with few companies providing any disclosure regarding climate change risk at all. ASIC, however, does stop to indicate recognition that these practices are still evolving both in Australia and the rest of the world.

At of the end of 2018, the regulator’s advice to industry was to ‘continually assess existing and emerging risks, particularly those that relate to climate change’, and to improve corporate governances for better ‘information flows through the companies’.

That being said, regulated entities need to meet their regulatory obligations, such as those like s299(1)(a)(c) under the Corporations Act 2001, and last but certainly not least, disclose useful information to investors.

Back to the Forum

It remains be to seen whether regulatory machinations in the background have managed to nudge the conversation to the fore. Yet, on the first day of the Forum, International Organisation of Securities Commissions (IOSCO) Chairman and the Securities and Futures Chairman Ceo Ashley Adler said he was surprised at how topical climate change and climate change-related risks were in Australia.

Adler was in Sydney for the ASIC forum and the IOSOCO meeting that immediately preceded the corporate regulator’s event.

“I see climate change is a big issue, and I was a little bit surprised when I got here that it’s so high up the agenda. It has rocketed up the agenda in the last few months in the UK, with demonstrations in London. There is serious. It’s about sustainability, and that is very easy to talk about. There is huge amount done in this area in the non-official sector, and there is undoubtedly huge investor demand, particularly from younger investors around this. Even hard-bitten hedge funds will come to us in Hong Kong and say, well actually, we do have demand around this.”

Adler said the issue of sustainability is one of the non-traditional areas being considered by the international securities regulator but added that it was a challenging space. Yet, increasing focus from regulators, the Organisation for Economic Cooperation and Development (OECD), the G20, and the challenges around the Paris Agreement illustrate it is clearly a critical issue.

The problem Adler highlighted, however, is that it is ‘an incredibly broad subject.’ For him, unpacking sustainability from regulatory perspective is a challenge—but a necessary one.

“The major questions over the next few months are: how do you describe the intersection between, for example, climate change disclosure?”

He asked and continued,“ How do you describe the intersection between that and regulation? And by ‘regulation’, I don’t mean voluntary codes that complain or explain, I mean the regulation we’re used to, as regulators, against which are rules which can be enforced?”

The taskforce to which Adler was referring is the TCFD, whose focus is to help companies understand the market expectations of financial disclosures ‘in order to measure and respond to climate change risks’.

APRA’s Information Paper on Climate Change Awareness was published in March of this year. In it, APRA writes:

A critical paradigm shift has occurred due to the work of industry, domestic and international supervisors and regulators, as well as other key stakeholders. Climate change is increasingly seen as a material prudential risk. A shift from awareness towards action in response to these risks is underway.

APRA’s report found that all ADIs, general insurers and superannuation entities have claimed to be taking steps to address climate change-related risks, while only half of Private Health Insurers (PHIs), and 20 per cent of life insurers are taking steps to address climate change-related risks.

When APRA looked at those who would consider climate change-related financial risks to be material, 50 per cent of general insurers saw it as material, while just over 40 per cent of ADI’s and superannuation respondents said the risk was material. A slightly smaller percentage did not think it was material yet agreed it could be material in the future.

Close to 50 per cent of general insurers saw that climate change-related risks would be material, with a smaller percentage believing it was material yet, but it would be in the future.

Interestingly enough, while only 60 per cent of PHI’s were taking steps to address climate change-related risks, all of them believe that, while climate change risk is not currently material, it will be in the future. 80 per cent of life insurers agreed with PHI’s about the materiality of climate, but 10 per cent don’t believe it is a material risk. This is interesting, as 40 per cent have been taking steps to address climate change-related risks.

The report found that the top climate change-related financial risks were around reputation and floods.

APRA writes:

The high focus on reputational risk aligns with entity commentary that communities, customers and investors, as well as regulatory expectations, are driving their response to climate risks.

When it comes to climate change disclosures—the critical question at the ASIC Forum—superannuation and the ADI’s were ahead of the game with 70 per cent. General insurers came in at just over 40 per cent, life insurers at 40 per cent, and PHIs at the very bottom with 20 per cent.

The majority of the disclosures surround operational risk, strategic risk and investment risk, which leans heavily on reputational concern.

This is the question Kell’s panel sought to address, or at least to attempt to get panel attendees thinking about where they sit and how they handle such disclosures.

But why is it a voluntary framework?

Dr Fiona Wild, whose remit at BHP Billiton focuses on climate change sustainability, said there was hope financial disclosures under the TCFD would actually become mandatory; however, she added that the FSB has always been very clear that it was meant to be a voluntary framework.

“If you have a voluntary framework, you need to make it flexible enough that people who are already doing a really good job at disclosure have room to move and do a better job. But you also need to make the entry point relatively straightforward to encourage people to participate, because the problem with a voluntary framework is that it’s the easiest thing to do for someone to say, ‘I volunteer not to do that’.”

This means enabling a framework that encroaches on those doing very little and encourages them to take the first step.

Wild believes that some jurisdictions will make it mandatory; however, there are some steps that need to be taken ensure the quality of disclosures is such that it allows climate-related risks and opportunities to be disclosed in a way that is meaningful to the financial markets.

Wild believes that if it is mandated at too early a stage, it might have a negative impact on the quality of disclosures.

“Whereas I think if you encourage a broad range of disclosures, you can kind of learn from each other and market will start to move towards those that are the most useful and the most relevant.” she explained.

Wild indicated that she saw the voluntary framework as a ‘gateway’ to finding the best possible mandatory framework.

France was an example of jurisdiction given by the panel that already had mandatory disclosure.

In 2017, EY published a report looking at whether all investors had met their obligations under the French Obligations Article 173-VI. In fact, it was phrased as a question: Have investors met their ESG and clime reporting under 173-VI?

The authors of the EY report wrote:

In August 2015, France took a ground-breaking step by becoming the first country in the world to impose ESG and climate reporting requirements on asset owners and managers.

The report continues that:

The implementation decree of Article 173-VI of the French “Energy Transition for Green Growth” law, dated January 2016, sets three requirements: i) providing a general description of the investor’s ESG policy, ii) disclosing the resources allocated to ESG analysis, and iii) explaining the methodology and the results of the climate risk analysis.

Banque de France then published their first TCFD report earlier this year.

It will be interesting to see what mandatory standards would look like in an Australian context and how well the impacted entities will comply with these standards.

And, as always, how much of a challenge will it be for risk and compliance professionals to communicate this effectively to their boards?

* This article has been republished from the Winter 2019 Edition of the GRC Professional Magazine. Click here to download a PDF copy of this article.

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