Emily Kreps is global director of capital markets at CDP
The year 2020 delivered many unprecedented challenges. However, for the biggest systemic challenge facing the world – climate change – 2020 ended on a more positive note than it started.
In November, chancellor Rishi Sunak announced that by 2025 Britain would become the first country in the world to make climate risk assessments mandatory for listed companies, large private companies, pension schemes, insurance companies and banks, in line with the Taskforce on Climate-related Financial Disclosures – a reporting framework. The UK is introducing the requirements as part of a strategy to bolster green financial services, and it will encourage other countries to follow suit ahead of the UN climate change conference that it will host in Glasgow this year.
Investors have become increasingly concerned about the financial risks of climate change to their portfolios, arguing that many companies are failing to fully outline the risks they face from global warming. A key goal of the UK’s incoming requirements is to provide investors more information about which companies are prepared for the shift to a low-carbon economy, and which are not.
As Larry Fink, head of BlackRock, told chief executives last year: “Climate risk is investment risk”. Standardised disclosure of climate risk would mean investors can allocate capital to the best performers, and companies can benchmark their climate performance against peers. The result is a “virtuous cycle” in which capital markets become a powerful vehicle driving improved climate outcomes.
However, given the scale of the climate crisis, is corporate disclosure enough? It is, simple to label disclosure as a negligible rather than a transformational solution. On their own, disclosure rules may do little to cut emissions, or to help achieve the UK’s goal of net zero emissions by 2050. However, we cannot manage what we do not measure, and so disclosure must be the natural starting point of any effective corporate environmental action.
Transparency is the engine of change. We see that the more companies disclose their environmental data, the more likely they are to take action. Of the suppliers responding to CDP, 38% have emission reduction targets in place for the first time. By their third year of disclosure, some 69% of companies have set a target. Similarly, 28% of first-time water disclosers assess the business growth implications of water security, rising to 40% by year three of disclosure.
Another point of concern is that the new rules will not require firms to disclose the emissions generated by the products they sell, or from their supply chain (so-called Scope Three emissions). This is particularly concerning for high-impact sectors like financial services that also hold the key to driving huge amounts of capital into low carbon technology and sustainable business. CDP data indicates that if all financial services companies disclosed on the indirect emissions that they finance in the wider economy, the sector’s emissions would be 69 times higher than the current known level. Of almost 300 financial services companies that disclosed through CDP in 2019, less than a fifth reported a figure for the emissions they finance through their investments. This presents a vital data gap, which needs closer attention. Some work on this front is already underway, including a recent call to action by COP president, Alok Sharma, and former Bank of England governor Mark Carney to financial institutions ahead of COP to set targets and action plans to reduce emissions and build resilience.
The lack of historic disclosure regulation, and the very broad terms of the TCFD has meant that, to date, climate-risk reporting across many companies has lacked consistency, comparability and reliability — impeding the ability of markets to allocate resources effectively. Standardised disclosure is required for effective decision making by investors, purchasers and the wider market, because it is objective, comparable data in the same format that does not require additional analysis to normalise different reporting metrics and make comparisons on a like-for-like basis.
Although the new UK rules on disclosure may not be a panacea, they are an essential step. The transparent sharing of reliable data is vital to managing global challenges effectively. Consistent, comparable and reliable information on how companies manage risks will not only improve capital market efficiency, and unlock sustainable, inclusive economic growth. It can help avert a climate catastrophe.