Where climate and sustainability lead; the rest of the SESG1 constellation will follow
Scenario analysis is the first step in structured strategy. This is the way to ensure that strategy is robust, resilient to discontinuous change, and inoculated against strategic shock. So far, no news. Now, however, people who have viewed it as an optional extra need to do it anyway.
“Many bosses claim their firms lack the expertise to do climate-based scenario analysis”, wrote the Economist on 13 March. Many bosses are right: without some skill and experience, climate-related scenario analysis will be a combination of wishful thinking and disingenuous tripe. (Full disclosure: N&A are experts at scenario analysis and offer a climate-related scenario product.)
I shared a Forbes article a few weeks ago which was part of the US Government’s advance trails for making some version of the Task Force on Climate-related Financial Disclosure compliance mandatory.
A week later Janet Yellin herself delivered remarks on the ‘American Jobs Plan’. The title doesn’t entirely convey that this plan is an environmental sustainability policy, but presumably it’s intended to make the programme difficult to oppose. Who in America, after all, could possibly object to American jobs, particularly if they’re going to be delivered to American people.
For me, the meat of the text was a pair of sections: one on mobilising capital in support of achieving climate goals, and one on assessing climate risk. Both of these hang on investors’ ability to meaningfully assess climate-related risk of future events.
Here’s Yellin’s comment on climate disclosure:
It will be important to build on existing work to improve climate-related financial risk disclosure, so that it can better promote investment. In particular, the Financial Stability Board’s Task Force on Climate-related Financial Disclosures provides a solid framework for climate disclosures.
The TCFD has done important work to improve the information that financial institutions and investors have when they decide how to allocate capital. There are now more than 2,000 organizations—including 904 financial firms responsible for $178 trillion in assets—that support the TCFD.
Momentum behind the TCFD is also demonstrated by several jurisdictions moving towards mandatory climate reporting in alignment with the TCFD, as well as the support of 110 financial regulators including 50 central banks. The FSB is working to further improve climate reporting in line with the TCFD and recently encouraged “national or regional authorities that are developing requirements or guidance for climate-related disclosures to consider using the TCFD recommendations as a basis.” This is an important step towards ensuring against fragmentation.
So far, it’s telling us that following TCFD recommendations is a good idea, and that a lot of businesses have already gone in this direction. Note the words, ‘as well as the support of 110 financial regulators including 50 central banks’, though. Here the former central bank boss has brought up regulators advisedly. Regulators, she says, support ‘moving towards mandatory climate reporting’. Towards what are those regulators moving? She doesn’t say, but the answer is that regulators have moved towards mandating compliance with TCFD.
So what will the US Government do with this ‘solid framework for climate disclosures’?
To this end, the SEC is currently reviewing its 2010 guidance on climate-related disclosures. Treasury will work with the SEC as part of its participation in international discussions to promote effective and consistent approaches to disclosure. We are closely following progress of and support the International Financial Reporting Standards Foundation establishing a Sustainability Standards Board that will focus first on developing a climate disclosure standard.
So, a flag for the Sustainability Accounting Standards Board, which offers a less climate-related measure of sustainability than TCFD.
Yellin appears to be signalling that, only a short while after the EU, the UK, New Zealand and Switzerland have gone for TCFD, American businesses will need to add one of the existing standards to their compliance tasks. She also appears to be signalling that this will involve an existing framwork for climate disclosure, and for sustainability disclosure (as opposed to developing a new one, a possibility left open by remarks from the acting SEC Chair).
For a lot of businesses that will mean mere compliance: print out a PDF of one of the global climate scenarios, and write a paper saying that it will have no particular impact on operations. This process will meet a certain level of requirement, but won’t meaningfully engage with climate impact, particularly with discontinuous elements of climate impact and the impact of extraneous discontinuous elements of climate impact. In particular, taking a ‘mere compliance’ approach to this could mean having someone in the compliance end of the business churning out mere compliance for each jurisdiction rather than just doing the thing properly.
Assessing and disclosing well offers advantages which go beyond the cost savings suggested in a statement by the SEC Acting Director of Corporate Finance. Perhaps most important, doing the climate-related scenario analysis properly could mean achieving global compliance.
Moreover, proper business-wide scenario analysis is an opportunity to move the General Counsel’s world beyond compliance, but also to lead sustainability (and environment and social and governance) at Board level.
Some businesses are already creating a bespoke scenario space, designed and calibrated to fit existing and expected future operations.
The scenario analysis they conduct against it involves not only identifying first-order consequences, but interacting second- and third-order consequences which will have an impact on planning and strategy.
Doing this properly will enable and deepen meaningful management of downside risk, but far more importantly it will enable businesses to seek the opportunities attached to upside risk. It moves scenario analysis from a disclosure requirement to a strategic planning tool which almost incidentally produces disclosable outputs.
Sustainability and Environment, Social and Governance: three nouns and one adjective make ‘social’ much harder to define in context. This tells me that the ‘social’ aspect of this needs some careful thought, but for now let’s say it ought to read ‘social equity’.