Climate Risk: What should SMEs be doing now?
The earth’s climate is changing, and in response the governments of the world agreed to take significant measures to eliminate carbon emissions.
By 2030, in just nine years’ time, the world is scheduled to reduce carbon emissions by half and then by 2050 carbon emissions are intended to be effectively eliminated, with a ‘net zero’ carbon emission target. Achieving this will require systemic transformation of the world economy and of the businesses that operate within it.
There is no precedent for a global effort of this scale and magnitude, and regulators and international bodies are setting iterative milestones rather than hard objectives to keep the transformation aligned with the net zero target. A key early milestone is the identification and accurate disclosure of climate risk exposure so catastrophic pitfalls can be avoided by both investors and firms.
The current working guidance for this is the report of the Task Force on Climate Related Financial Disclosures[i] which lays out expectations for disclosure of climate risk. Effective climate risk disclosures should follow these principles:
- Represent relevant information,
- Be specific and complete,
- Be clear, balanced and understandable,
- Be consistent over time,
- Be comparable among companies in a sector, industry or portfolio,
- Be reliable, verifiable and objective, and
- Be provided on a timely basis.
Though this report was published in June of 2017, the Financial Stability Board of the Bank of International Settlements is tracking progress of their recommendations’ implementation[ii] and they are finding progress quite slow. Currently the UK government is accepting responses to a consultation proposing that climate risk disclosures become mandatory for all listed companies by 2022[iii]; Zenith Audit UK’s response to this consultation will be available on our website shortly.
We believe it is likely that climate risk disclosures will become mandatory over the next 18 months in the UK.
What does this mean for small and medium enterprises with reporting requirements?
Firms in the financial services sector, including banks, asset managers and insurers will have to take the lead. They will need to create a body of data sourced from their operating systems that quantifies their climate risk to the extent possible, so it aligns with the seven principles above. A suitable record is likely to align the firm’s assets which are exposed to climate risk with the controls in place to mitigate those risks. The record should allow for consideration of not only physical climate risks, such as hurricanes and rising sea levels, but also for direct and indirect impacts of new rules and the economic transition. This record should be the source for a specific climate risk report. Assumptions used should be documented and calculation methodologies should be clear and explainable. This will provide a specific, relevant and objective report that is repeatable and, importantly, is comparable to reports of other firms in the sector.
Once the climate risk report is created it should be given the same level of scrutiny and importance as other key risk-based reports. The data used to create the report should be verified by audit and the report should be presented to a Board level committee for noting within a reasonable timeframe of the publication of the disclosure. Operational and supervisory controls in the creation and review of the report, and in the publication of the climate risk disclosure, should be subject to validation by audit as well.
We hear so much about climate change these days that climate risk may seem like another buzzword. However, the increased risks from extreme weather events are real and irreversible and we are at the very beginning of the regulatory and economic transformation. Failure to take action to stay current with the reporting requirements will surely put your organisation further and further behind. Putting the infrastructure in place to meet the disclosure expectations, or identifying a provider who can help, are highly recommended.