The guidance offers clarification on key aspects of the TCFD’s recommendations on climate reporting.
By Paul A. Davies, Michael D. Green, and James Bee
On 14 October 2021, the Task Force on Climate-related Financial Disclosures (TCFD) released a new guidance document on climate-related metrics, targets, and transition plans (the Guidance). The Guidance seeks to support organisations that make TCFD-aligned disclosures in preparing decision-useful metrics, targets, and transition plan information and linking that information to estimates of financial impact. The Guidance builds on a consultation paper on the same topic that the TCFD released in June 2021.
Background
The TCFD released its initial recommendations in 2017 (the Recommendations). Since then, the Recommendations have rapidly become a preeminent framework for companies seeking to engage in climate reporting. The Guidance comes in response to feedback the TCFD has received in relation to its “Metrics and Targets” recommendation — namely that a majority of companies find the recommendation “somewhat difficult” or “very difficult” to implement. At the same time, public company reporting shows that climate-related metrics and targets are among the most common areas of disclosures. The Guidance follows two consultation documents on the same issues (released in October 2020 and June 2021), and applies to companies of all sizes in a wide range of jurisdictions.
Climate-Related Metrics
The Guidance seeks to provide information regarding the characteristics of effective climate-related metrics, describing the type of information that companies should consider disclosing and setting out categories of metrics appropriate for disclosure across industries.
Effective metrics are considered to be those that are (i) decision useful, (ii) clear and understandable, (iii) reliable, verifiable, and objective, and (iv) consistent over time. The Guidance advises companies that effective disclosure of metrics generally involves supporting the metrics with a corroborating and contextual narrative to assist reviewers in understanding the meaning of the raw data and the basis on which the data has been prepared. This element of disclosure is highlighted as being particularly important when disclosing details on climate-related scenario analysis — one of the key Recommendations.
Based on the discussion of what constitutes an effective metric, the Guidance identifies seven categories of metrics that the TCFD believes are appropriate across most or all industries, alongside examples of metrics that could be used for each category. These are:
- GHG Emissions (e.g., Scope 1, Scope 2, and Scope 3 emissions, financed emissions by asset class, weighted average carbon intensity)
- Transition Risks (e.g., concentration of credit exposure to carbon-related assets, percentage of revenue from coal mining)
- Physical Risks (e.g., number and value of mortgage loans in 100-year flood zones, revenue associated with water withdrawn and consumed in regions of high or extremely high baseline water stress)
- Climate-Related Opportunities (e.g., number of zero-emission vehicles, revenues from products or services that support the transition to a low-carbon economy)
- Capital Deployment (e.g., percentage of annual revenue invested in R&D of low-carbon products, investment in climate adaptation measures)
- Internal Carbon Prices (e.g., internal carbon price, shadow carbon price)
- Remuneration (e.g., portion of employees’ annual discretionary bonus linked to investments in climate-related products, weighting of climate goals on long-term incentive scorecards for executive directors).
Climate-Related Targets
The Guidance provides an overview of the types of information that the TCFD views as useful to disclose in relation to climate-related targets, as well as the provision of example targets that would be appropriate for use alongside the aforementioned seven universal climate-related metrics.
The Guidance identifies that appropriate targets will vary considerably across companies, and does not prescribe whether companies should, for example, set targets solely on the basis of their Scope 1 and Scope 2 emissions, or whether Scope 3 should also be included.
According to the Guidance, effective climate-related targets are:
- Aligned with the company’s strategy and risk management goals
- Linked to relevant metrics that the company records
- Quantified and measurable (examples of quantified targets for each of the seven universal climate metrics are provided)
- Clearly specified over time (with time horizons, baselines, and interim targets clearly displayed)
- Understandable and contextualised
- Periodically reviewed
- Reported annually (at least)
Despite the focus on quantifiable targets, the Guidance suggests that companies should use qualitative information to ground any targets and help relay the context of the target, why the target is meaningful, and the company’s strategy to ensure that it meets the target. The Guidance also identifies that many reviewers of climate-related targets benefit from the targets being disclosed in an easily comparable way, and on that basis the Guidance recommends that companies use standardised templates to disclose information, such as the template that FTSE Russell developed to make GHG emissions disclosures.
Finally, the Guidance encourages companies to not assume that their climate-related targets contain confidential business information, and includes a list of points for companies to consider when making that determination.
Transition Plans
As defined by the Guidance, a transition plan is an aspect of an organisation’s overall business strategy that lays out a set of targets and actions supporting its transition to a low-carbon economy. The Guidance discusses the characteristics of an effective transition plan, focusing on similar issues to those identified in relation to climate-related targets — e.g., credible, aligned with the organisation’s strategy, and anchored in quantifiable and measured data.
The Guidance also provides a table containing a number of elements that the TCFD would consider to be appropriate to include in a transition plan. Whilst this table may prove helpful to organisations seeking to disclose, the Guidance notes that the TCFD recognises that the transition will have industry-specific nuances. As such, creating a comprehensive and universally applicable list is impossible. The TCFD calls on industry associations and others to develop industry-specific guidance in this regard.
Given the global popularity of the Recommendations and the wider work of the TCFD, many will welcome the clarity the Guidance provides in relation to metrics and targets and transition plans.
Latham & Watkins will continue to monitor developments in this area.