Bloomberg recently published “A Guide to the Task Force on Climate-related Financial Disclosures.” It begins by explaining why companies need to disclose climate-related financial information. I’m used to a rationale that climate change impacts will make some assets less valuable or will increase value volatility. For example, coastal real estate assets might be less valuable due to increased flooding, with higher volatility due to catastrophic events like hurricanes.
However, Bloomberg’s latest explainer provides a different rationale than mitigating risk from climate change happening. Instead, it points to the risk of us successfully mitigating climate change by decarbonizing the economy. Here, the risk to companies, investors, and capitalists comes not from the impacts of climate change, but from structural changes in the economy that will be required if we mitigate climate change, specificially changes related to decarbonization.
In December 2019, Bank of England Governor Mark Carney noted that “Changes in climate policies, new technologies and growing physical risks will prompt reassessments of the values of virtually every financial asset.” […] Organizations that invest in activities that may not be viable in the longer term will likely be less resilient to the transition to a lower-carbon economy — and their investors will likely experience lower returns. […] Investors, lenders and insurance underwriters need adequate information on how companies are preparing for a lower-carbon economy.
This argument means firms now face two general sets of climate risks. The first set comes from changes that occur due to worsening climate change impacts, such as fires, droughts and water scarcity, disruption from climate migration, inundated coastal assets, heat waves, and infrastructure problems like brown-outs and black-outs from growing air conditioning and heating demands in extreme weather events.
The second set of risks arises from mitigating or preventing the first set of risks. The current approach reflected in the Bloomberg report views these risks as primarily about asset value. A straightforward example is the value of a coal power plant. As policies change to limit emissions and technologies emerge that substitute for coal power generation, the value of coal plants begins to move toward zero. Companies, investors, and capitalists face the risk of these once-valuable assets becoming worthless, referred to as a “stranded asset.”
One impact of this second set of risks is that capitalists have an incentive to prevent mitigation of climate change, which would preserve the emissions-based value of high pollution assets like fossil fuel infrastructure, airlines, airports, shipping, agriculture, and construction assets.
The logic behind the call for companies to disclose more information about both sets of climate risks seems to be that doing so will give firms a “competitive advantage” over rivals that do not disclose.
A company that communicates its climate resiliency to its investors will have a competitive advantage over those that don’t.Mary Schapiro, Head of the TCFD Secretariat and Vice Chair for Global Public Policy at Bloomberg L.P
But why? Why would disclosing climate resiliency create a competitive advantage? And an advantage for what?
What about disclosure creates competitive advantage?
The Financial Stability Board established the Task Force on Climate-related Financial Disclosure or TCFD in 2015, with the mission to develop voluntary disclosures that “could promote more informed investment, credit [or lending] and insurance underwriting decisions” and, in turn, “would enable stakeholders to understand better the concentrations of carbon-related assets in the financial sector and the financial system’s exposures to climate-related risks.”
Which stakeholders are privileged? The answer seems to be capitalists seeking to invest capital in ways that generate positive returns, though this is framed in terms of an abstract concept of “efficient” capital allocation.
The recommendations emphasized the importance of transparency in pricing risk — including risk related to climate change — to support informed, efficient capital-allocation decisions.
Just as the development of public company transparency regulations like those enforced by the United States Securities and Exchange Commission, the logic underlying the TCFD seems to be that investors need protection from deception by companies seeking capital. And the broader economy needs protection from an inefficient capital allocation outcome–though what efficiency means in this context is left unsaid.
The benefits of disclosure are:
- Easier or better access to capital by increasing investors’ and lenders’ confidence that the company’s climate-related risks are appropriately assessed and managed
- More effectively meeting existing disclosure requirements to report material information in financial filings
- Increased awareness and understanding of climate-related risks and opportunities within the company, resulting in better risk management and more informed strategic planning
- Proactively addressing investors’ demand for climate-related information in a framework that investors are increasingly asking for, which could ultimately reduce the number of climate-related information requests received
Three of four benefits go to investors. One benefit–better risk management and more informed strategic planning–goes to the company.
Together these benefits begin to suggest that disclosure could create a competitive advantage by increasing the firm’s attractiveness to investors, which lowers the firm’s cost of capital compared to non-disclosing rivals, and improving the firm’s internal processes, which could lower costs compared to rivals.
But what should companies disclose to attain these benefits?
What should companies disclose?
What does the TCFD recommend companies do to protect capitalists and economies from poor capital allocation decisions? The recommendations address four areas of corporate management:
- Governance: The organization’s governance and climate-related risks and opportunities.
- Strategy: The actual and potential impacts of climate-related risks and opportunities on the organization’s businesses, strategy and financial planning.
- Risk Management: The processes used by the organization to identify, assess and manage climate-related risks.
- Metrics and Targets: The metrics and targets used to assess and manage relevant climate-related risks and opportunities.
Here there is a bit of a contradiction between disclosure and competitive advantage. Competitive advantage arises from a strategy and execution of that strategy that captures more value for the firm than rivals can. But that advantage is short-lived if the firm discloses the strategy and how it executes the strategy (recommendations 2, 3, and 4).
Disclosing this information will likely erode any advantage the firm gains from improved internal processes, as rivals could adopt those practices and achieve similar cost savings. (However, it is possible that some firms might be unable to execute disclosed strategies and operations due to capability constraints, which would limit the erosion of advantage of disclosed strategies.)
Yet even if the operational benefits are eroded by disclosure, the cost of capital benefits from disclosure could remain. However, this competitive advantage would also soon disappear if rivals are able to adopt the operational benefits, as investors would no longer see a large difference in climate risks between the companies.
Ultimately, then, it seems the argument that disclosure benefits investors holds true more than the argument that disclosure benefits companies through competitive advantage. This presents a problem for the voluntary nature of disclosure: why would firms voluntarily adopt a practice that protects investor interests but does not benefit the firm?
The answer to that question might be that firms won’t adopt the practice.
Bloomberg’s guide includes an interview with Ashley Alder, Chief Executive Officer of the Securities and Futures Commission (SFC) of Hong Kong and Chair of the International Organization of Securities Commissions (IOSCO). Alder alludes to the need for mandatory disclosure, rather than volutnary disclosure, implicitly recognizing that firms might not voluntarily adopt disclosure.
Here in Hong Kong, the size of our capital markets means that what we do has global significance. We want to take a leadership role in this effort. Working through a cross-agency steering group, the Hong Kong government and all the local financial regulators have committed to mandatory TCFD-aligned disclosures by 2025. New Zealand has also committed to this, and we hope other countries in Asia-Pacific will follow suit.
This is unsurprising given Alder heads a regulatory body charged with protecting investors. And it further undermines the concept that voluntary disclosure benefits companies. If it did, companies would presumably do it.
Further, a good deal of the guide is focused on convincing the reader that support for the TCFD guidelines is growing around the world, suggesting a self-consciousness about a lack of enthusiasm from companies.
What about the risks of mitigating climate change?
By the end of the guide, the risks associated with mitigating climate change–risks driven by transitioning the economy off carbon pollution–seem forgotten. Instead, the emphasis is on protecting investments from climate risks in an abstract sense, which likely includes investing in projects that become stranded assets. However, more attention could be paid to how capital allocation continues to support strategies and corporate operations dependent on carbon pollution, and how that allocation itself is a form of undermining progress to stop catastrophic climate change.