Four practical actions for driving climate change risk maturity through TCFD reporting

TCFD is a requirement for many businesses and an area of increasing interest for their stakeholders, so it is important to get it right. But more than that, it can also be a real driver for achieving improvements in the way firms work.

What is TCFD?

The Task Force on Climate-related Financial Disclosures (TCFD) recommendations published in June 2017 were the first of their kind, designed to provide a framework for companies to disclose critical climate-related financial information. 

The recommendations provide a framework for financial institutions to develop more effective disclosures through existing and new reporting processes. 

For some companies, reporting is mandatory, the Companies (Strategic Report), climate-related Financial Disclosure Regulations 2022 and the Limited Liability Partnerships, Climate-related Financial Disclosure Regulations 2022, cover large corporates (>500 employees and >£500m operating income), and the FCA ESG sourcebook initially covered just listed entities, but was extended to larger regulated financial institutions, including asset managers with AUM >£50bn for FY’s beginning 1 January 2022, and extended to asset managers with >£5bn for FY’s beginning 1 January 2023, to be reported by 30 June the following year. This is slightly different to the Companies Act requirement which requires the TCFD report to be included within a firm’s annual report. PRA regulated firms, not in the scope of these requirements, are also expected to engage with the TCFD framework, as indicated in the Supervisory Statement SS 3/19.

Adherence, either on a voluntary or mandatory basis, has helped improve risk management practices, transparency, and investment decision-making.  

The Challenges

According to research published by the TCFD in October 2023, insurance companies and banks have had the highest levels of reporting on  risk management recommendations, which may be attributed to financial regulators’ general emphasis on risk management  processes.

Asset managers and asset owners have reported facing more challenges with their climate-related reporting due to receiving insufficient information from investee companies. Asset managers highlighted insufficient information from public companies as the biggest challenge (62%), followed by private investments (49%), while asset owners identified information on private investments (84%) as the most difficult to report on.

Through our experience providing climate change risk management and reporting support to FS firms, we have discovered four key actions that firms can take to improve their TCFD reporting and risk management of climate-related risks:

1. Carry out a gap analysis against TCFD

Firms that wish to improve their climate change disclosures can carry out a gap analysis  comparing their current disclosures with the 2021 TCFD recommendation, the 2021 sector guidance, the FCA’s and the Financial Reporting Council (FRC) thematic reviews and the TCFD status annual reports. This can help determine whether there are gaps or errors in the latest or planned disclosure, ensuring the disclosures can be made more relevant and comprehensive.

An end-to-end gap and governance analysis provides senior management and the Board with comfort that the process is fit for purpose and provides a strong platform for improving the maturity of the disclosures.

2. Ensure your climate change risk management framework is fit-for-purpose

Industry practices have evolved since the first requirements were introduced in 2019, with new data and tools now available. Likewise, PRA and FCA expectations from firms have evolved and regulators expect firms to take a step forward after spending the last three years developing their frameworks. Key areas where firms must take steps to remove barriers are governance and oversight, engagement, and data management.

At this point, ensuring climate risk management controls are aligned with the regulatory framework and the PRA’s feedback is crucial. Those falling behind need to develop a robust implementation and a roadmap to integration, and this should be readily available to demonstrate to the PRA that they are appropriately managing both the internal and systemic risks associated with climate change, should they require it.

Assessing whether the risk assessment, risk appetite statement and metrics are aligned can help to improve TCFD disclosures, as not only do these controls need to be consistently explained in several of the TCFD recommendations, but also the metrics form the basis of the targets recommended disclosures. 
 

3. Obtain assurance over the TCFD disclosures

The increased global focus on climate-related financial disclosures has required that the second and third lines of defence, as well as independent assurers, play a fundamental role in ensuring  disclosures  have been prepared in accordance with appropriate methodologies reducing the risk of information being inaccurate, misleading, or exaggerated.

The second line of defence, such as the risk, finance, and compliance function, has a role to play in supporting and overseeing the first line in their management of sustainability related risks and publication of TCFD disclosures.

The internal audit function, as the third line of defence, has also the capacity to review and contribute to the improvement of TCFD Disclosures. The reviews and conclusions made by internal auditors can provide assurance to the Board  that the process, methodologies and controls involved in making TCFD disclosures are operating effectively. In doing this, they drive maturity of the controls and improve confidence in the disclosures made. 

We have seen the benefit of adding an additional layer of oversight and transparency to the disclosures and reducing the risk of greenwashing. 
 

4. Keep the climate change components of the ESG strategy up to date

Better climate change risk management improves business performance and leads firms to developing ESG and climate change strategic plans that align with broader business goals. Climate change, as well as other material ESG aspects, are normally part of any robust ESG strategy and framework.  

We are seeing that whilst some firms have implemented an ESG strategy, it is uncertain whether the plan is being progressed and the objectives are achievable. In addition, whilst firms may have designed a climate change strategy, it may be unclear whether it is being implemented effectively.

TCFD disclosures are a mechanism in which Firms can communicate to their stakeholders their climate change strategy and how they are progressing with reducing their climate-related risk and impact, enhancing green finance, and getting closer to direct and indirect net zero emissions. As a result, there is a close link between the ESG Strategy and the outcomes of it that would go into the TCFD disclosures. 

Conclusion

TCFD is only the first step in the sustainability reporting journey. In the next couple of years, it will be incorporated into the International Sustainability Standards Board (ISSB) and International Financial Reporting Standards (IFRS) S1, for climate-related disclosures, and IFRS S2, for wider sustainability disclosures. This will be a step up in the reporting requirements, so it is important that firms are ready for this transition. 

Internal Auditors can use these four practical actions to support their firms in improving their management of climate change risks and opportunities under the current TCFD model and to transition to the new Standards when these are endorsed. We have observed that these are good practices that have helped many firms improve their position, demonstrating that when implemented correctly they will contribute to making reporting more efficient and effective.