TCFD - Supplemental Guidance for the Financial Sector

With the intention to promote international financial stability, the Financial Stability Board (FSB), which is based in Basel, Switzerland, created TCFD (Task Force on Climate-related Financial Disclosures). As the name suggests, TCFD pertains to reporting on the financial risks connected to climate change. The economic implications of climate change are now well-realized and well-understood by both companies and investors. Investors are willing to look at the impact that a company has on climate change, whereas companies too want to provide this information in order to cater to Investors’ demands. However, it will be easier for stakeholders to assess the company’s performance on climate change if it is consistent and can be subjected to a peer analysis. This is where TCFD steps in as it aims to improve consistency, reliability and uniformity across the data provided by companies to enhance informed investment and expose climate-related risks of the financial system. TCFD has developed climate-related disclosure recommendations as well as a reporting framework basis the recommendations. TCFD’s 11 disclosure requirements can be categorized into 4 heads-

a. Governance

b. Strategy

c. Risk Management

d. Metrics and Targets

Stakeholder awareness was the linchpin of TCFD which was developed to enable stakeholders to understand better the concentrations of carbon-related assets in the financial sector. The FSB’s proposal recognized the following benefits which TCFD shall bring along:

- Will facilitate an early assessment of climate risks

- A systematic approach to assessing the source of data

- Bring in market discipline

The financial sector was categorized industry-wise into banks, insurance companies, asset managers and asset owners. TCFD realized that the financial industry needed supplemental guidance in certain areas in addition to its recommended guidance to all sectors.

A] Banks

When banks lend or perform other financial intermediary activities, they are exposed to a lot of climate-related risks and opportunities (CRO) through their borrowers, customers or counterparties. TCFD has provided supplemental guidance to banks in the areas of-

Strategy: Banks should provide a description and clarity on material concentrations of credit exposure to carbon-related assets. They should disclose the climate-related risks in their business activities.

Risk Management: Banks should classify the risks into credit risk, market risk, liquidity risk and operational risk.

Metrics and Targets: They should describe the metrics used (such as credit exposure, equity and debt holdings, trading positions etc) to assess the impact of (transition and physical) climate-related risks on their business activities in the short, medium and long-term. The metrics can further be sub-classified by factors such as geography, industry, credit quality and average tenor. They should provide the percentage and amount of carbon-related assets relative to total assets.

B] Insurance Companies

When we think of CRO, insurance companies do cross our minds as being in the top three industries that are greatly affected. There is no doubt to the fact that an increase in global warming will directly lead to an increase in natural climatic disasters. With temperatures rising each passing day, the risk of climate-based catastrophes has also accelerated and it will be interesting to see how these risks are evaluated and managed by insurance companies while providing insurance. The following supplemental guidance is provided by TCFD-

Strategy: The potential consequences of CRO should be described by insurance companies through qualitative and quantitative information on its core business, products and services offered and how it shall impact the clients. They should also bring to light if novel insurance plans such as insurance of green infrastructure etc will be rolled out by the company. In performing climate-related scenario analysis on underwriting activities, insurance companies should input various parameters and compare. For instance exposure to 2°C and exposure to >2°C.

Risk Management: Processes used to identify and assess CRO (physical, transition and liability risks) on re-/insurance portfolios classified basis geography, business and product segment and risk models on product development and pricing should be described.

C] Asset Owners and Asset Managers

Asset owners which include public and private sector pension plans, re-insurance companies, endowments and foundations either invest directly or through asset managers. They can largely benefit from the returns on their investments associated with climate change and in order to attain the benefit, they can influence companies where they invest to disclose CRO in a proficient manner. Encompassed with fiduciary responsibility, asset managers handle the assets of clients on their behalf and CRO as a subject is extremely relevant to them as it needs to be managed in clients’ portfolios. Whether you invest yourself as an asset owner or invest through an asset manager, a set of supplemental guidance set forth for both of them is similar.

Strategy: Asset managers or owners should showcase their transition in investment strategy along the lines of transition to a low-carbon economy. They should set out relevant investment strategies stemming from CRO. The usage of climate-related scenario analysis is encouraged.

Risk Management: A description of engagement with investees to promote CRO disclosure and improve data availability is recommended. They should set forth their plans to position their total portfolio in accordance with the climate change transition.

Metrics and targets: They should describe the changing metrics used to assess CRO in their investment strategy. They should try to provide weighted average carbon intensity wherever possible.

TCFD, as an ESG reporting framework is already well-known and adopted by several countries. With the ESG trend accelerating worldwide, the popularity of TCFD is bound to increase among ESG enthusiasts.

You can now understand and implement TCFD recommendations and reporting framework by enrolling into our recognized Directors’ Institute- CPD accredited ESG expert certification.