The Taskforce on Climate-related Financial Disclosures (TCFD) recommendations provide a framework through which organisations of all sizes—and all industries—can systematically assess, manage and disclose climate-related financial risks and opportunities. A core element of the recommendations is understanding the resilience of the enterprise to identified climate-related risks and opportunities, which can be progressed through modelling of financial outcomes. In turn, this modelling facilitates informed decision-making, enhances strategic resilience, and fosters sustainable business practices; thereby promoting greater trust among both investors, stakeholders and the broader community.
As the new sustainability standard, IFRS S2 Climate-related disclosures, released by the International Sustainability Standards Board (ISSB) earlier this year, was based on the TCFD recommendations, organisations that have made progress in this space will be well-prepared to meet their climate-related disclosure obligations once they are mandated by the Australian Government.
TCFD’s modelling approach
Modelling serves as the means to the end of reaping the TCFD recommendations’ disclosure benefits. Indirect benefits of this process can include optimised risk assessment, informed capital allocation and enhanced strategic planning.
Modelling is bespoke, however, and should be tailored to the nature of the organisation, industry and nuanced climate-related risks. Depending on what sector an organisation is in, the climate-related risks will manifest quite differently - what has the potential to financially hinder one company and/or industry may inadvertently benefit another. Hence, the TCFD’s modelling guidance is malleable to accommodate these variations.
Modelling benefits businesses, investors and stakeholders by assessing the materiality of climate-related risks against relevant scenarios, evaluating the business impacts and identifying potential responses.
1. Assess the materiality of climate-related risks
Modelling begins with identifying the climate-related risks - both physical and transitional risks. This entails the exercise of assessing the risk’s materiality and, in turn, assigning each risk a rating based on its significance, its likelihood of occurrence and ultimately its consequences for the business.
While insights differ per industry, the risk factors that may warrant financial modelling include energy transition scenarios, predicted changes in weather patterns, potential regulatory and policy changes, market sentiment and technological advancements, among other variables.
2. Identify and define the range of scenarios
To assess the significance of these risks, a process is conducted to identify plausible future scenarios for modelling. Determining the appropriate scenarios requires drawing on a plethora of industry-relevant insights and sources.
Based on the insights derived from this process, the enterprise's resilience can be stress-tested by adjusting the relevant variables in the financial model accordingly. Scenarios adopted should include consideration of changing climatic and economic conditions under a 2°C or lower scenario in addition to two or three other scenarios relevant to the organisation's circumstances.
Assurance activities may give rise to the organisational considerations of whether a new financial model is required to sufficiently cater for the predicted scenarios, or whether an existing financial model is adequate. A key component of both is being able to meticulously document and hold a record of assumptions and the methodologies used to derive them for the sake of disclosure.
3. Evaluate the business impacts
Fundamentally, modelling is about testing how resilient the enterprise's strategy and organisational direction are to identified risks, manipulating the underlying operating assumptions to determine the level of value likely generated for investors in the coming years.
The TCFD’s quantitative modelling guidance primarily concerns itself with the long-term, leading companies to ask of their direction: Will my business stand up over the upcoming decades and how do the climate-related risks impact the strategic visions that we’ve established? If impacted materially, what controls are currently in place and which future treatments should be implemented to help mitigate these risks?
As the TCFD recommendations are centred around the financial implications of climate-related risk, such evaluations work to price risk, assess potential commercial performance, operational impacts and overall sustainability, among other relevant factors - and whether the organisation has adequate resources and measures in place, or the capacity thereof, to best safeguard themselves.
4. Identify potential responses
Upon determining the relevant risk scenarios and opportunities, it's then about integrating the findings into the business and adjusting capital allocation accordingly. It’s also about ensuring that the necessary information is disseminated through the business to all stakeholders who—either do or, in principle, will—play a role in the organisation’s response to the identified climate-related risks.
There is a large spectrum of possible changes that may be made in response to the data - one organisation may be required to invest in renewable energy sources to mitigate the impact of carbon pricing, while another may diversify its supply chain to address potential extreme weather conditions. Ultimately, the modelling analysis provides the framework for determining the necessary, contextual responses required to address potential climate-related financial risks.
The time to act is now
Prompt action is necessary given the climate’s volatility and its financial repercussions on businesses.
The Australian Government has clearly communicated its intention to introduce mandatory climate-related disclosures for certain Australian organisations as soon as the 2024-2025 financial year. Now is the time to consider your organisation’s need to understand the frameworks, and begin putting the systems and data in place to support the modelling, allowing you to pressure test it in a safe environment.
To take a step toward implementing a systemised modelling approach and addressing climate-related financial risks, consider going through our TCFD checklist. This resource outlines the recommended disclosures and general guidelines from the TCFD, covering governance, strategy, risk management and metrics.
Here to help
Our national sustainability team can support your organisation to:
- Determine the scope and applicability of the TCFD recommendations
- Conduct gap analyses between your current climate-related processes, controls and disclosures against the TCFD expectations and requirements
- Calculate scope 1, 2 and 3 emissions, and
- Draft and prepare TCFD reports.
Contact us today.