Climate risk: Are you ready for FY22?

• How are you engaging your leadership with scenario analysis governance? Your senior management needs to recognise scenario analysis as a credible risk assessment tool, with its importance reflected in board meetings.
  
• Do you know the key decisions you should be taking when developing scenarios? Running scenarios at asset or sector level can have a big impact on your results. It also affects the amount of data required, and the effort to analyse it.
• How are you integrating scenario analysis into a wider strategy? How well-aligned your climate strategy is with your wider business strategy will be a key consideration in assessing the robustness of your climate action.

If you run through quantitative scenario analysis, which is built into your wider business strategy, you send a message to investors that you’re taking climate risk management seriously. That will distinguish you from peers that are lagging behind in this space.

The additional documents also provide guidance on risk management integration and disclosure. This outlines processes to understand and identify climate-related risk, and advice on discussing risk management processes in TCFD disclosures.

• What processes have you put in place to identify and understand climate-related risks? You should be using similar processes to identify, monitor and mitigate climate risks as you already use for more traditional enterprise risks.
• How will you set out your risk management processes in your TCFD disclosure? While TCFD compliance requires elaboration on the risk management pillar, best practice is leaning towards also integrating climate risks with the general risk management section of annual reports.
• How will you integrate climate risks with enterprise risk management? The TCFD guidance explains how you can adjust your existing risk taxonomy.

We found in our review of last year’s reports that few organisations are aligning climate risk analysis with enterprise risk management. If you do so, you’re not just going to have compliance covered – you, and your investors, will have a comprehensive and consolidated view of your risks. You’ll also be able to see how risks interconnect and possible knock-on effects – for example, the impact of physical climate hazards on an already vulnerable supply chain.

The TCFD has introduced seven new cross-industry climate-related metric categories that companies have to report against for the 2022 cycle. These cover greenhouse gas emissions, transition risk, physical risk, opportunities, capital deployment, carbon pricing and remuneration. Its guidance includes principles and case studies for selecting effective metrics.

• Have you set targets beyond carbon emissions? You need targets for all your material climate risks.
• How will you measure performance? Provide a baseline to measure against, a timeframe for reaching your targets, KPIs, and a method for tracking progress.
• What’s the story behind your metrics? Provide the context – readers need enough narrative to know what they mean.

Having a clear set of metrics and targets helps calibrate the board’s climate ambition and provides a benchmark against which you can measure decisions. It also provides a framework for communicating progress to both internal and external stakeholders. And it helps you align group and business unit strategies.

Companies that fall within the scope will also be required to provide a more detailed climate transition plan to set out how they’ll adapt as we head toward a low-carbon economy. This should include high-level targets and interim milestones; how you’ll meet your targets; and your governance plans, including how you’re linking performance to remuneration. There’s a strong focus on showing how your transition plan aligns with your business strategy.

We’re expecting the Transition Plan Taskforce (TPT) to publish a regulation-ready transition plan framework by the end of 2022.

• Where will you disclose your transition plan – in your Annual Report and Accounts (ARA) or supplementary disclosures? Whatever you decide, but it needs to be published on the same day as the ARA to meet FCA requirements.
• What are your climate-related opportunities? You should be capturing these in your plan, alongside the risks.
• What assumptions are you making? Disclose any assumptions you’re making and provide transparency for external stakeholders.

Your climate transition plan establishes how you’ll take advantage of a low-carbon economy – where you can save money through resource efficiency; and where you can gain a competitive edge with new low-emission products. It’s an opportunity to establish how you’ll build a resilient, sustainable and profitable business.

With the first disclosures due in January 2023, there’s limited time to get your climate risk reporting in order. We’re finding that transition planning and quantified scenario analysis are proving particularly challenging. But you need to get on top of them as each can have significant implications for strategic decision-making and other financial reporting.

There’s a clear expectation from the FCA that organisations will continue to enhance their climate risk reporting year-on-year. That includes improving alignment with the TCFD and other climate reporting standards. So, you should have clear implementation plans in place to address any gaps. Ideally, you’ll have done that already. If not, it’s time to make it a priority.

Please look out for our next article in this series, where we’ll be looking at the regulatory roadmap for climate risk in 2023 and beyond.