United States: Will Climate Disclosures Translate Into Climate Action?

In light of the billions that even the SEC's economic analysis estimates would be spent complying with its proposed climate disclosure regulations (see this PubCo post, this PubCo post and this PubCo post), will those disclosures catalyze real climate action? In this recent EY Global Climate Risk Barometer, accounting firm EY analyzed why, notwithstanding the vast amounts spent on climate disclosures, they "are still not translating into practical strategies to accelerate decarbonization." In fact, EY pointed out, "global energy-related carbon dioxide emissions rose by 6% in 2021 to 36.3 billion tonnes [a metric unit of mass equal to 2,240 lbs], their highest-ever level, according to the International Energy Agency." Will companies be able to "close the major disconnect between the disclosures they are making" and "their own transformation journeys"? Is integrating climate risk into the financial statements the key? Is climate risk disclosure just a "box-ticking exercise" or, by enabling accountability, can climate disclosures help to accelerate "the decarbonization process"?

For its report, EY performed a comprehensive analysis of disclosures, based on the widely used TCFD framework, made by more than 1,500 companies across 47 countries. The analysis applied a "robust scoring methodology" to assess coverage and quality. Of the corporate reports analyzed, EY found that the average score for coverage of the TCFD recommendations was 84% (up from 70% last year), but the average score for quality was just 44% (a slight increase from 42% last year). The only element of the TCFD framework that reflected an appreciable quality improvement in EY's analysis was strategy, increasing from 38% last year to 42% in 2022. The other TCFD components measured—governance, risk management, targets and metrics—showed no or only slight gains in quality. EY interpreted the "wide gap between coverage and quality [to suggest] that, while more companies are reporting on climate risk, they are not actually providing meaningful disclosures around the challenges they face."

In terms of markets, the UK (coverage at 99% and quality at 62%), followed by Japan (coverage at 96% and quality at 56%), fared the best. Looking at industry sectors, EY found that sectors with the most exposure to transition risk—such as energy (coverage at 93% and quality at 51%)—scored the highest, responding to "the demands of their investors, who want greater transparency around their decarbonization strategies." Over 80% of companies surveyed in the energy sector also disclosed their strategies—either a specific net-zero strategy, transition plan or decarbonization strategy. By comparison, the average across industry sectors was only 61%. Asset managers and insurance also face significant climate risk, which may account for the improvements in their disclosures recorded year over year, EY suggested. For example, insurance showed an increase in coverage from 57% last year to 90% this year and in quality from 38% to 51%. Retail, health and consumer goods (combined into a single sector) reflected an increase in coverage from 67% last year to 86% this year, but only an increase in quality from 42% last year to 44% this year. The telecom and tech sector showed an increase in coverage from 79% last year to 87% in 2022, but a decline in quality from 50% last year to 46% this year.

EY also reported that 49% of companies surveyed indicated that they had conducted scenario analyses, most often using best- and worst-case scenarios; 75% performed risk analyses (49% physical risk and 51% transition risk) and about 62% performed opportunity analyses, most often identifying "products and services" that may be opportunities.

For the most part, according to the report, coverage and quality disclosure improved year over year. But progress in integration of climate reporting into financial statements? Not so much. EY found that only 29% of companies surveyed referenced climate-related matters in their financial statements, with 54% of references being qualitative and only 46% quantitative. "Companies," EY suggested, "are struggling to bring the information together in a financially material and meaningful way." EY concluded that, although companies were "improving the coverage and quantity of their climate disclosures"—but still not to a level that investors, regulators and other stakeholders would like—companies were making only "limited progress on integrating their climate reporting with their financial statements. This key finding may help to explain why disclosures do not appear to be accelerating the decarbonization process: Their financial relevance is not clear."

Why do companies fail to refer to climate-related matters in their financial statements? EY suggested that finance teams may not understand enough about climate risks to incorporate that information into the financial statements. In addition, EY pointed to the "mismatch in time horizons," the horizon for the financials being much shorter than that applicable to climate risk. And, EY suggested, "the uncertainty and variability involved with climate scenarios present challenges when it comes to including these scenarios in financial models."

Still, EY stressed the importance of disclosures about climate risk management as a "critical step forward" in the decarbonization process. Why? Because it "enables companies to be held accountable —by themselves and others." EY advised that corporate reporting can be used to support "decarbonization strategies" by prioritizing the standards and metrics that are material to the company's business, focusing on "telling a sharp, integrated story about the financial risks and opportunities that climate change presents to the business," benchmarking the company's disclosures against those of its customers, competitors and suppliers, and preparing for the implementation of new voluntary and regulatory standards by implementing the "appropriate processes and governance to respond to the higher levels of scrutiny" that will accompany these standards.

Nevertheless, disclosure alone is not enough to cannot bring about decarbonization. Many other steps are necessary, including these identified by EY:

• "Setting meaningful targets and tracking progress against them
• Reassessing strategy on a regular basis, using scenario analysis to stress-test assumptions
• Collaborating with partners to achieve ambitious decarbonization targets
• Exploring opportunities to transform business portfolios while reducing emissions."

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