Climate change has become a global issue, and companies and financial institutions need to appropriately assess and manage risks related to climate change. The Task Force on Climate-related Financial Disclosures (TCFD) provides guidance on climate-related disclosures to encourage companies and financial institutions to assess climate change risks from an economic perspective and disclose them appropriately.
In this article, we will discuss in detail the role of TCFD, its relevance to risk management, and the importance of climate change risks.
Overview of TCFD
In order for companies to achieve long-term growth and sustainability, they need to properly assess and take measures against risks related to climate change and environmental change. The Task Force on Climate-related Financial Disclosures (TCFD) is an international initiative established in 2015 to address this challenge. The TCFD aims to provide a framework for companies to disclose climate-related risk information. In addition, it serves as a source of information for investors and financial institutions to make sustainable investment decisions.
It includes 4 main items, they are:
- Governance: Describe the structure and role of the executive board in risk management (monitoring, evaluation, management, etc.)
- Strategy: Disclose climate risks and their impact to the organization’s business plan, iff the adverse impact needs to describe resilience.
- Risk Management: Information on how businesses identify, assess, and manage climate change risks.
- Metrics and Targets: Share what types of metrics/targets are used to monitor and identify risks.
The Relationship between TCFD and Risk Management
The relationship between TCFD and risk management is inextricably linked, and the following factors play an important role:
First, the TCFD recommends scenario analysis to assess future risks from climate change. Clearly, risk management is essential for companies to assess their exposure to future climate-related risks and opportunities and develop strategies based on them. And, by conducting risk assessments in accordance with TCFD guidance, companies can anticipate risks and take appropriate measures.
Second, the TCFD highlights the impact of climate-related risks on a company’s financial performance. Risk management is a direct component of a company’s long-term value and sustainability. Obviously, proper risk management is essential to increase a company’s credibility and transparency. Besides, it helps gain the trust of investors and shareholders.
Moreover, the TCFD also recommends that companies disclose climate-related risk information. Investors and financial institutions use this information to make sustainable investment decisions. In fact, risk management is an important tool for companies to provide transparent and reliable information to investors.
Supporting the TCFD and implementing disclosures in accordance with this framework provides important benefits for companies. The benefits of this include providing a framework for properly managing risk and finding opportunities. Also, by complying with the TCFD, companies can demonstrate their leadership on climate change. From that, they can meet the expectations of investors and customers.
As of June 26th 2023, 4,637 companies and institutions, including financial institutions, have expressed their support worldwide.
TCFD Supports the Assessment of Climate Change Risks
The TCFD provides a framework for encouraging companies to assess risks and opportunities related to climate change. Assessing climate change risks is an important process for companies to understand their vulnerabilities and opportunities against future climate change scenarios and to take appropriate measures against them.
The purpose of the TCFD is to help investors, financial institutions, and other stakeholders assess a company’s sustainability and future value by disclosing information to help companies assess and address climate change risks. And, assessing climate change risks is an important step in helping companies review their strategies, implement appropriate risk management practices, and build sustainable business models.
The TCFD recommends that the following factors be considered in assessing climate change risks:
1. Scenario Analysis
Scenario analysis is a technique for predicting the likelihood and impact of future climate change. The TCFD recommends that companies adopt multiple scenarios (e.g., a scenario to reduce GHG emissions to achieve a second increase, a scenario to achieve a fourth increase, etc.) and assess risks and opportunities based on them. In fact, scenario analysis can help identify a company’s vulnerability to future changes and develop appropriate strategies.
2. Assessing Physical Risks
Physical risks are risks caused by extreme weather events due to climate change and changes in climate patterns. Companies need to assess the extent to which their facilities and supply chains may be affected by these risks. And, this includes geographic vulnerability analysis and disaster risk mapping.
3. Assessing Transition Risk
Transition risk is a risk caused by climate change-related regulatory changes, technological innovations, market changes, etc. Companies need to assess the impact of future climate-related policy and regulatory changes on their operations. Besides, it’s also important to identify new business opportunities to address climate change.
4. Assessing the Financial Impact
In addition, the TCFD recommends assessing the impact of climate change risks on a company’s financial performance. Companies need to develop appropriate financial plans and risk management strategies to prepare for future risks. Moreover, it is important to improve the profitability and competitiveness of companies by pursuing climate-related opportunities.
The TCFD-based Risk Management in Practice
The TCFD-based risk management practice provides a comprehensive approach to identifying and addressing risks related to climate change. Now, these following are examples of how to implement risk management based on the TCFD:
1. Risk Assessment and Scenario Analysis
Companies should conduct scenario analysis to identify risks and opportunities from future climate change. For example, they should adopt multiple scenarios (e.g., greenhouse gas emission reduction scenarios) and assess companies’ vulnerability based on each scenario. Additionally, we identify physical risks (e.g., weather events) and transition risks (e.g., regulatory changes) and assess their impact on sustainability and financial performance.
2. Develop a Risk Management Strategy
Based on the results of the risk assessment, the company develops a risk management strategy. For sure, appropriate strategies must be selected and implemented, including risk avoidance, risk reduction, risk transformation (hedging), and risk acceptance. Moreover, risk management strategies also include adapting to physical risks, responding to transition risks, and pursuing new business opportunities.
3. Monitoring and Reporting
Risk management is a continuous process, and continuous monitoring and reporting are important. Therefore, companies should regularly monitor the implementation of risk management strategies and evaluate the results. In addition, they are required to make disclosure reports based on the requirements of the TCFD. Beside that, they have to transparently communicate the progress and initiatives of risk management to investors and related parties.
4. Collaboration with Various Stakeholders
Obviously, risk management based on TCFD is important not only internally but also in collaboration with external stakeholders. Through dialogue and collaboration with investors, financial institutions, governments, NGOs, and others, companies promote a shared understanding of climate change risks and contribute to the development of sustainable solutions.
Future Prospects of TCFD
Recently, the TCFD has had a significant impact on the evolution of risk management in financial markets. It is an important framework for addressing risks and opportunities arising from climate change. For instance, the future prospects include the following:
1. Dissemination and Enhancement of TCFD
Currently, TCFD initiatives are spreading around the world, but it would become even more widespread and strengthened in the future. Financial institutions and companies will make further progress in addressing climate change risks by assessing and disclosing risks in accordance with the guidance of the TCFD.
2. Widespread Adoption of Net Zero Targets
Under the Paris Agreement, many countries and companies have set net zero goals. It aims to reduce greenhouse gas emissions to virtually zero. Then, net zero targets will become more prevalent, and specific strategies and initiatives to achieve them will become increasingly important.
3. Expansion of the Scope of Application
Currently, the TCFD is mainly for listed companies and financial institutions. In the future, the scope of application may be expanded to various organizations such as small and medium-sized enterprises and local governments. This will encourage broader organizations to assess climate change risks and take action to address them.
4. Integrating Climate Change Risks and Financial Systems
Going forward, we need to better understand the impact of climate change risks on the financial system as a whole. In the future, we will further develop the TCFD and increase efforts by financial institutions and supervisors to properly assess climate change risks and ensure the stability of the system as a whole.
5. Building a Sustainable Financial System
In order to respond to climate change, it is necessary to build a sustainable financial system. They require financial institutions and investors to invest and lend with an emphasis on environmental, social, and governance (ESG) perspectives. Moreover, there is also the potential for issuance of sustainable financial products, such as green bonds and market development.
6. Expand Impact Investing
Last but not least, the evolution of the TCFD will increase investment and lending in consideration of climate change risks. Investors and financial institutions can create a positive impact on both the environment and the economy by demonstrating leadership on climate change and increasing investment in sustainable companies and projects.
Conclusion
The Task Force on Climate-related Financial Disclosures (TCFD) plays an important role in assessing and managing risks related to climate change. We can practice the TCFD-based risk management by identifying risks, formulating countermeasures with a comprehensive approach, monitoring and reporting, and continuously working with stakeholders. Therefore, we can address climate change risks and build a sustainable business model.
In the future, the TCFD guidelines and guidance may evolve further, and risk management practices may advance. Companies and financial institutions need to properly assess climate risks and identify opportunities to ensure long-term sustainability and competitiveness. Of course, the collaboration with governments and international organizations is also important, and the development of unified international standards and policy support will make achieving the TCFD goals more achievable.
