Episode 19: The four pillars of the TCFD - strategy

Episode 19: The four pillars of the TCFD: strategy

Continuing our series on the guidance produced by the Taskforce on Climate-related Financial Disclosures (TCFD), this episode focuses on strategy, the second of the four TCFD pillars. Energetics’ Ghislaine Platell whose climate risk strategy work includes the landmark disclosure by the CBA as seen in their 2019 annual report, hosts the discussion. She is joined by Olivia Kember, Principal Consultant and lead author of Full Disclosure: Improving Corporate Reporting on Climate Risk, and Robyn Ashton, Senior Consultant, built environment expert and climate risk strategist. With experience advising some of Australia’s largest businesses, they explore what constitutes excellence in climate strategy.

Featuring: Olivia Kember, Principal Consultant and Aidan Ashton, Head of Decarbonisation

Our host: Dr Ghislaine Platell, Senior Consultant

Note: The information and commentary in this podcast is of a general nature only and does not take into account the objectives, financial situation or needs of any particular individual or business. Listeners should not rely upon the content in this podcast without first seeking advice from a professional.

Transcript

Speaker 1: 0:04

Welcome to the energetics exchange podcast conversations with energy and climate experts. Please note that the information and commentary in this podcast is of a general nature only, and does not take into account the objectives, financial situation, or needs of any particular individual or business business should not rely on the content in this podcast without first seeking advice from a professional.

Speaker 2: 0:30

Hello, everyone, and welcome to energetics podcast series. I am[inaudible] plateau manager at energetics and a member of energetics climate risk advisory team. Today I'm leading the second in energetics podcast series discussing the guidance of the task force on climate-related financial disclosures or TCFD. But first I'd like to start this podcast by acknowledging and paying respects to all first nations people as the traditional owners of the lands on which we meet today, here in Perth acknowledged the non-gov white Jack people, traditional custodians of this land. We acknowledge the strength of their continuing culture and offer our respects to elders past and present joining me on my colleagues, Alivia Kemba principal consultant, who is in our Sydney office and Robin Ashton, senior manager, who is based in Brisbane, both Olivia and Robin have provided advice to energetics clients on the application of the TCFD today. They will share their thoughts and insights on the second pillar of the TCFD strategy. Hi Olivia. Hi Robin.

Speaker 3: 1:33

Hi Jillian. I'll speak on behalf of the Sydney office and acknowledging that Gadigal people of the urination.

Speaker 2: 1:39

Hi Glenn, as on both in Brisbane, I'd like to, uh, pay respects to be managing people. I'm recognized with country north and south of the Brisbane river and GeoGebra nations. So if we dive straight in, um, the strategy core element is made up of three deceptively short recommendations, but really I think it's quite complex in nature and underpins all of the other recommendations. And so if we take a step back, um, the strategy recommendations, evolve, uh, firstly, to describe the climate related risks and opportunities to the business in question over, uh, three timeframes, the short, medium, and longterm, uh, secondly articulating the impact of these risks and opportunities on business strategy and financial planning, and thirdly, exploring the resilience of the company's current strategy on the multiple climate scenarios, ideally including a two degree world. So there's a lot to unpack in those three recommendations. So Olivia, if we could start with you, what would you say is the purpose of this core element and conversely, what is it not about?

Speaker 3: 2:42

So again, I think what it's not about is, uh, doing scenario analysis, uh, which tends to be the, the, the, the most complicated and interesting part of the exercise in a way, but it's also not actually the real point of the strategy recommendations. Um, the objective of the strategy pillar is really for the company to demonstrate that it has an understanding of climate risks and their strategic significance and that the company's strategy going forward has embedded that understanding. Another thing that the strategy recommendation isn't is just disclosing the results or the results of your scenario analysis. Um, although the TCFD is a sort of disclosure framework, um, the objective is to show how your embedded climate risks into decision-making processes. And so the users of TCFD disclosures when they rank the bits that they most value strategy recommendations, elements of the strategy recommendations make up three of the top 10 most useful parts of TCFD reporting. And, uh, the very most top one of those is how climate related issues have affected business and strategy. So answering that question is really important to readers of your co uh, corporate climate disclosure. Uh, it's also a really hard question to answer, and this has been quite a steep learning curve for companies. The latest TCFD status report shows that, um, companies are having a pretty decent crack at that first recommendation describing the climate related risks and opportunities. They're struggling a bit more with the second one, which is about the impact of those on their strategy and planning. And very few are actually reporting on the resilience of their strategy. Um, I think it was about a hundred out of 1700 disclosures that the TCFD re uh, reviewed got that far, but we're seeing that this is what, uh, uses of TCFD disclosures I'm most interested in, um, when we're seeing this coming through in the, uh, moves by financial regulators and central banks to get, uh, parts of the finance system to engage in scenario analysis so that their, their resilience can actually be understood. And we're seeing it also in initiatives like the climate action 100 plus the institutional Invista, if it, which has got some very, very strategy focused benchmark criteria. So climate action 100 plus is looking for things like, um, is your capital allocation aligned with the Paris agreement? Um, does your scenario planning include a 1.5 degree scenario? So the TCFD strategy recommendations and the parts within that, uh, of great, and I think increasing interest. And so companies really need to get to grips with what's involved in doing a good, um, good doing a good job on this part of the TCFD. Thanks.

Speaker 2: 5:28

So that says, there seems to be a gap between what the investors are looking for and what companies are managing to, to achieve because of the complexity of those recommendations. So if we focus on the first recommendation, which aims to build a solid foundation, really for the rest of the strategy recommendations, um, and it's all about, uh, starting with a robust risk identification process. So, um, the TCFD recommendations describe both physical transition risks. So before we dive a bit deeper, um, Robin, could you explain a little bit about physical risks and then Olivia I'll hand over to you for transition? Sure. So physical climate risks, stem from Eva, discrete events, such as a tropical cyclone or bushfire, which are described as acute or chronic in nature, incrementally worsening over time. And we see this in rising average annual temperatures and disrupted rainfall patterns. A business often won't have sea level rise or extreme rainfall noted on their risk register instead for focused will be on the impact of these climate site hazards such as rising insurance costs, capital expenditure, or increasingly stringent OHNS standards to ensure employee safety. Great, thank you. Um, Olivia

Speaker 3: 6:45

Transition risks different because, um, they are associated with the efforts being made across the economy to decarbonize. And so transition risks can present up and down your value chain, depending on how, um, the suppliers and customers are viewing that decarbonization task. And they can be very influenced by, um, technological progress and, uh, political and policy developments, which was where I think initially the focus has been in considering transition. This didn't really mean what is the policy or what is the carbon price that might force change? What we're seeing now is that, um, transition risks at presenting, you know, particularly say from the investor community in the, even in the absence of policy.

Speaker 2: 7:29

So we're talking about a really broad range of risks here, I think. And, um, I've found in practice that some businesses actually consider climate change as purely one single environmental risk amongst their risk register. Um, and I think you've really highlighted how wide ranging the causes and the impacts of, uh, of these risks can be beyond that of the environment. So to me, that there seems to be value in splitting this, this monster risk down into more discrete and manageable risks, um, particularly to tease apart the potential impacts and also prioritizing the mitigation activities. So Robin, would you like to comment on, um, who you need buy-in and input from within the business to get the best outcome when identifying risks and impacts to a specific business? Absolutely. The risk identification process can be a real eye-opener for many within an organization. Um, and you really need a collaborative approach because essentially you want to expose each level of a business to the learnings of the challenges facing the colleagues. Um, many companies already have processes for identifying and managing risks, but the extent to which these systems kind of comedy climate risk varies a lot. And we find that thinking through climate risk exposure, we've a business can be a resilience building exercise in its own, right, for the sustainability and environmental teams who often have ownership of it's critical work, very secure buy-in from all levels of the business, including operations team, to finance strategy and the C-suite. This can be quite a challenge. Um, a focus should always fall on the incredible value of the process can bring the types of insight you're going from a risk assessment and scenario analysis process can range from informing new design standards to identifying adaptation pathways, not only mitigate a particular risk, but can open up huge opportunities for diversification and growth. If you're able to demonstrate early these benefits and how they can positively impact each area of a business, most stakeholders get on board quite quickly. And I think that's a really useful piece, you know, having everyone on board before you try to, uh, look into what it means for your business in terms of impacts, but then also how it might influence your strategy. So we might move on to the second strategy recommendation, which is looking at exactly that disclosing the impacts to a business strategy and financial planning as well. Um, so the question would be, what does best practice disclosure actually look like? Um, Olivia, have you seen anyone actually do this? Well, this is

Speaker 3: 10:04

Really hard for companies to do well. I'm not going to sort of name names, but I'll talk a little bit about some of the, uh, I think some of the elements that some companies do do very well. What we find is that sort of common standard market practice with regard to the second strategy recommendation is basically to sort of put forward some initiatives as responses to climate risks without really presenting them in a context that allows the reader to work out, whether they're, whether those initiatives are fit for purpose, how significant they really are, how much of a, um, maybe change from BAU they actually represent. Um, but what you see what good companies are doing or what good disclosures are gonna show, uh, um, impacts on strategy and financial planning sort of in two strands. So one of those strands is, well, what is their decarbonization strategy? Is it, uh, uh,[inaudible] gets sort of untethered from a plan to achieve it, or a very short term percentage target that doesn't seem to be aligned with, uh, say Paris agreement, consistent goals, in which case, what you've got there is, uh, an aspiration without a plan. But if you've got a decaf innovation strategy that actually says, here's where we now know we need to get to, here's how we're going to get there. Here are some milestones along the way that we know we need to meet. And here's some decision points, um, around how are we going to do that? Then there's more evidence that that company is actually incorporating its climate risks into its, into its planning, into its capital allocation. Um, and then another way of looking at it is also well what's. What is their broader corporate strategy? Um, how has their investment going to account for climate risks over the longterm? Aside, aside from decarbonisation, are they using a, an internal carbon price? Are they considering what products will actually be in 30 years time and the ways in which those might be different in a, um, in a different climate future?

Speaker 2: 12:00

So I think we're really talking about walking the talk, right. And then, and then potentially also disclosing the outcomes of that process. Thank you. That's really insightful. See if we get, um, if we dive into now scenario analysis, so the third recommendation, um, Olivia will stay with you on this. What is scenario analysis and how does it differ from a forecast?

Speaker 3: 12:25

So I think companies are very used to forecasts of maybe, you know, business as usual over say a one to five-year timeframe. And that's not what we're usually talking about with scenario analysis, which tends to look out potentially out to 2050, um, sometimes a little bit shorter, sometimes even longer, but really the intention is to consider a very different, but plausible climate futures. Um, this is an exercise where you, as a company, want to think, what are the ways that, uh, a really challenging de-carbonization pathway for the world might affect us or in what, or what are the ways in which a really challenging, um, physical climate climate impacts pathway might affect us? And what do we need to know about that and what are we going to do about it? So it's essentially a structured, imaginative exercise that if you have the data and resources, um, to take to the next level where you actually dive into the financial implications of that becomes quite a massive undertaking, but at a very sort of step, one level is about thinking through, say two to three to four different climate worlds and how the company might be affected by the sorts of drivers that are creating climate risk in each of those words.

Speaker 2: 13:42

So are you saying that it really is about, um, exploring the level of uncertainty in the future and helping you to navigate either those, those options or understand the range of possible futures that you're exposed to? Absolutely.

Speaker 3: 13:56

And I mean, there's, there's the uncertainty in terms of things that might only eventuate in one of those climate futures. And then sometimes you find that actually irrespective of, um, which, which climate we'll be looking in, there are some things that are probably going to happen anyway. So this is Robin's territory on the physical side. There's, there's a lot of stuff that's baked in that it doesn't matter which de-carbonization pathway we're on for the next 20, 30 years. We're going to be dealing with, uh, the physical impacts of climate change anyway.

Speaker 2: 14:26

Yeah. So then it's knowing, uh, which, which impacts you need to be ready for regardless. And then which ones you might want to potentially wait and see, or might be, you might be better off preparing for either way. Um, so it's, it really is quite a difficult exercise, I think, to get your head around, um, to, to visualize the future that far ahead, but also to, um, to translate that to actions now soon to prepare for that future. Um, so I think it, it's definitely something that we've seen companies, uh, either attempt, but not fully or robustly, or even not having tackled yet. And so, uh, Robin from the physical point of view, can you comment on the difficulty level, um, of this exercise can, and the short answer is it's hard. Um, and it's hard for, well, going back to Olivia's point in a previous question of it comes down to if you have the data. Um, because scenario analysis requires a bespoke approach where combining relevant business data with current and future climate data, um, and depending on the risks identified achieving harmony between those two data sets to deliver really quite robust and meaningful outcomes can be quite the challenge in terms of business data. We often find for if there's a wealth of information, um, but it doesn't quite bridge the gap between cause and effect. So an example might be where we have extensive maintenance or work order data, which notes, a vert, a repair on an asset place, but it doesn't tell us what caused initial failure in the first place. And that means that we, we find it quite difficult to link that, that outcome, um, to the underlying climate hazard. Additionally, we find for a lot of the, um, impact information that businesses have is backwards facing. So they might only realize that they have a single point of failure because it failed out some point in the past. And that's the only reason they were aware of it, um, to leverage for real value of scenario analysis. We need to take a more future-facing approach and ask those what if questions? And this is where the modeling of shock events or doing things like war games is really useful on the climate side? Well, it has its own chart on challenges, our understanding of climate science in terms of the drivers current and future models and projections, it's evolving on almost a daily basis and new data sets are becoming available, which means for as consultants, we're having to design and redesign our assessment methodologies to reflect these developments. We also have to be careful about managing expectations. We can't predict when or where a bushfire might start, how intensely it might burn or how far it'll spread. And this lack of certainty can be really challenging for businesses, particularly those stakeholders who want a really solid answer around potential financial impacts. And so it's kind of critically important that we as consultants, but also businesses are upfront about the limitations of the analysis, um, and that they disclose fully the methodology and assumptions that sit behind all the numbers that we come up with. We often don't see this, um, as businesses are nervous about disclosing financial impacts, which be uncertain, but it's actually a great way of demonstrating trust transparency and building stakeholder trust. Thanks Robin. And you've mentioned the, uh, shock events and war games in there. Um, I think they're a good way to feel some of those gaps in the climate data, um, to, so, so what would you say is the purpose of those events? Is it to help sort of visualize what could happen and explore, um, the possibilities where, where there's they are gaps? Absolutely. And it's, it's about developing a more intimate understanding of your business of saying, okay, if I knock over an asset in location, a what, what is the domino effect for, um, because that can be really eye-opening to potential risks for they hadn't really considered, and we're not just talking financial impact here. This could be around the safety of your employees or even members of a public. And so I think overall you've really captured how, uh, how difficult this process can be, um, and how you have to be really cautious about how you navigate it as well. So that is, um, it, it's probably important to, to tackle it, but be very aware and transparent about, uh, the limitations around the data, the limitations around, uh, the insights drawn so that you can, um, guide your strategy, but also what investors might, um, understand from what you're disclosing in the way that is, that is robust and, and the complete picture. So, um, I suppose with all this in mind about how difficult it is to, to translate, navigate, understand the data, interpret it, et cetera. Uh, it's no real surprise that that is an area that we commonly get asked for, for help, um, on. And so, um, Olivia, how would you help clients to navigate this difficult sort of, um, pathway? And if I can actually play devil's advocate here for a minute, if it's really hard to do, what's the point in even doing it in doing scenario analysis,

Speaker 3: 19:55

I've got two answers to that. One is companies I go to have to do this anyway. So technically the TCFD is a voluntary initiative, but we're saying now that K stakeholders, whether those are investors, financial regulators, um, some governments have now made it mandatory. And so the expectation is, is solidifying that at some point, you, as a company are going to have to tackle this part of the recommendations. You're going to have to do the scenario. Now listen to this. And so the way to do it is basically slowly steadily in, in lots of little bits. So I really understanding, um, where you're starting from and what your, what the level of, um, sort of climate literacy is in the business and how, how much, um, you as an organization can bite off in one chunk is a good way of making sure that you don't create a over difficult exercise for yourself, but you can develop an approach to scenario analysis, and it might be that you, um, you look at one part of your business, you look at a relatively short timeframe, maybe you pick a few scenarios, which are not too complicated. And then you, you know, you kind of develop the muscle memory each time you do this and you push a bit further and you get a bit better and you can go a bit deeper. And usually each step is going to tell you something useful. And so that also can help you, um, build that buy in that you need to keep going and make more progress. So even if it's a small discreet, uh, qualitative exercise that can help set you up to do something bigger and more complicated future, as long as you've, um, bringing your internal stakeholders on board, um, and you're demonstrating each time that this is actually providing something useful, as opposed to just being a disclosure, tick a box exercise.

Speaker 2: 21:41

I think I'm definitely starting with that qualitative view. And then I'm diving into two different different aspects in more detail. Um, sounds like the way to go. And I think that's probably my takeaway message for today is really to take, uh, an intuitive approach to, to this process. Um, so starting with a really solid foundation of, uh, risk identification, um, because it really builds the, the rest of the picture. Um, and then, uh, understanding what, what types of scenarios might actually be useful to, to explore, um, and to start to break that down into smaller chunks, um, I'm keen to hear what your takeaway messages would be for from today's discussion. So setting with you, Olivia,

Speaker 3: 22:24

I think the most important thing to do is put in the effort, right at the beginning of the process to, um, think of this as the long as a long game, the most useful thing that you can do, if you're embarking on any of these strategy, recommendations is building understanding of exactly what climate risks actually are within the business, because that will allow you to, um, have a foundation where you can like progress your analysis and get that strategic insight at whatever level at each step that you take thereafter. Uh, what we've found that some companies think of climate risk is, you know, is there going to be a carbon price? And we've got this experience in Australia where we had a carbon price and it went away again. And so there's a sort of historical memory that that is what climate risk is, but as we've discussed climate risks a much broader, much deeper can occur throughout the value chain. It's a lot more complicated than. And so sometimes part of what you're doing at the beginning is taking people right back to the beginning to actually understand what the climate sciences, how the world is changing, how a lot of different strands of the economy are changing around climate and bringing all those, uh, the sort of the, that broader story into what then can become eventually a very, uh, bespoke company, specific data driven exercise.

Speaker 2: 23:49

Thanks, Olivia, plenty of insights to take away there. Uh, Robin, what are your last thoughts? Definitely take a collaborative approach. Um, it's imperative that you get buy-in from all areas of a business because insights can really drive real value from this process. Be aware of the limitations of the data and be open about them because ultimately about transparency really helps build trust with your key external stakeholders. Thank you so much. Um, thank you both for joining us today, uh, for what was the very broad topic of the strategy recommendations under the TCFD framework? Um, there's so much more that we could discuss, uh, on this topic. We've only really touched the tip of the iceberg. Um, so if anyone listening has any comments or questions relating to our discussion today, please feel free to contact us through the website or through your energetics account manager. If you're already working with us either way, um, please stay tuned for the next installment of our TCFD series, which will focus on the third core element of the TCFD risk management. Thank you very much.

Speaker 1: 24:57

Energetics exchange podcast conversations with energy and climate experts.