Climate risk reporting and sustainable finance has been centre stage for Canadian and European regulators in recent months. There is a trend towards increasing standardization driven by investor and market expectations, with regulators observing from the sidelines and/or stepping in to steer or cheer on these developments as they see fit.
EU expert group In January 2018, the EU High-Level Expert Group on Sustainable Finance released recommendations on a number of priorities for the EU to promote and enhance sustainable finance through EU policy. Major recommendations included clarifying investor and director duties regarding sustainability with focus on environmental, social and governance (ESG) issues, promoting enhanced disclosure on ESG, promoting a taxonomy of sustainable finance products and increasing standardization (green bonds, social bonds, ESG rating methodology etc.) and incentivizing investment in sustainable infrastructure. A key focus of the EU recommendations was on climate change and creating the financial conditions to facilitate the transition to a low carbon economy.
The report of the EU High-Level Expert Group will likely inform new policy initiatives that could drive the development of the sustainable finance industry in Europe for the next decade or more. Emergent approaches will likely have a more global effect as well by influencing how the relatively nascent sustainable finance market evolves and by informing best practices.
Canadian miners interested in pursuing sustainable finance options for accessing capital should keep an eye on these developments. They will point to areas of possible regulation in future and also offer opportunities for access to capital or investment that may be emerging.
Climate Related Financial Disclosure Recommendations
The carbon risk aspect of the recommendations of the EU High-Level Expert Group ties into new expectations around climate related financial disclosure flowing from the Financial Stability Board (FSB), a global banking regulator.
In 2015, the FSB (at the direction of Chairman Mark Carney) initiated a Task Force on Climate-Related Financial Disclosure (TCFD). The TCFD was headed by Michael Bloomberg and released recommendations in the summer of 2017 regarding how companies should evaluate and formulate financially material disclosure of climate change risks affecting their business.
The TCFD recommended qualitative disclosure in the following areas relating to climate related risks: strategy; governance; risk management; metrics and targets. Such disclosures would presumably be made in financial disclosures or possibly through sustainability reporting.
The TCFD also recommended that (all) companies undertake a quantitative analysis of the financial impact of climate change risks (what are called transition risks and physical risks) on the business. This quantitative aspect of the reporting is tied to a stress testing-style methodology referred to as “scenario analysis,” linked to the 2° Celsius caps on global climate change sought by the Paris Agreement (“Scenario Analysis”). A transition risk would include the risk of new regulations that increase the costs of goods or services and lower demand. It can also include product or service substitution that results from market forces or the introduction of new regulations (i.e. reduced fuel consumption due to carbon taxes or shifts to electric vehicles). A physical risk would include extreme weather events, flooding or other physical changes tied to climate change. The theory of the TCFD is that these types of risk (transition and physical) may, if they materialize over a long-term horizon, have financially material implications for businesses engaged in certain activities, including in particular lending and insurance. Where material implications are identified in applicable scenarios, it could necessitate disclosure in financial statements.
The precise methodology for implementation of scenario analysis was not specified by the TCFD. A pilot project for TCFD implementation relating to the financial sector was organized by the United Nations Environment Program (UNEP) in 2017. The results of the pilot were released in an implementation guidance report published in May 2018. The implementation guidance sets out an approach to scenario analysis for financial institutions in accordance with the recommendations of the TCFD. The methodology proposes that the results of this analysis should be factored into financial risk analysis. If the analysis shows that there could be a financially material impact to the company in the event a particular scenario occurs, this information would potentially be disclosable in financial statements as material information.
It must be emphasized that the nature and scope of such disclosure remains to be seen and will be subject to company specific considerations including in relation to materiality. It does highlight the complexity of the disclosure contemplated by the TCFD.
Climate disclosure in Canada and Ontario
In April 2018, roundtables were held in Toronto by both the Ontario and Canadian governments, responding to these new developments. One meeting was organized by the Federal Ministers of Finance and Environment with Mark Carney in attendance. The second was organized by Ontario Premier Kathleen Wynne with Michael Bloomberg in attendance.
Invitees to both sessions included Canadian companies from various industries. No policy developments were announced, but the meetings shone a spotlight on the interest of governments in these issues. They also coincided with an ongoing review of securities disclosure requirements in Ontario including in relation to climate related material risks. The outcome of that review is pending. The sessions pointed to the “interested observer” role of governments in relation to these emerging sustainability reporting and investment trends.
While no new regulations are on the horizon in Canada, the growing interest of key stakeholders including government in the standardization of sustainable finance and reporting is telling. At the least, it illustrates the weight of new and emerging standards in these areas like the TCFD. For the Canadian mining sector, sustainable finance creates new opportunities for access to capital – such as green or social bonds. It also flags the importance of sustainability ratings and indices and the marketplace generally in driving evolving expectations. Reporting issuers in the Canadian mining sector should keep in mind these trends, which present both opportunities and possible expectations from investors.
MICHAEL TORRANCE is chief sustainability officer for BMO Financial Group.