Although countries have committed to climate actions and scaling up climate finance, these commitments have not yet triggered the necessary investment or led to the measures required to manage the physical risks linked to the increased frequency and severity of climate-related events. Companies, big and small, have an important role to play.
To scale up private climate finance, investors must be able to identify corporations that are serious about climate action and have better information on where to direct their investments to have the biggest impact on climate goals. For this, high-quality sustainability reporting and information disclosure by corporations on their climate actions are critical. The end goal of such a disclosure process is to act as a robust management tool for companies. It increases their awareness of the impact of climate change on their activities and pushes them to develop strategies, policies, and metrics to address climate physical risks and transition risks, mitigating the adverse impacts of their activities.
Climate disclosure is gradually becoming mandatory, and already, the scope of companies engaging in disclosure practices is growing, with non-listed companies being increasingly included. There has also been a shift in reporting content from “single materiality,” which refers to the reporting of climate change impacts on businesses’ financial performance, toward “double materiality,” which reports the impact of the private entity on climate change as well as accounting for the financial effect of climate change and related actions.
What Should Be Expected from Companies?
To succeed, companies need to design a climate disclosure framework covering four main areas. First is governance or how the entity is structured, so that it can identify climate-related risks and define adequate approaches. Second is strategy, namely the institution’s strategic approach to responding to climate-related risks and defining opportunities. Third is risk management, which should articulate how climate-related risks are categorized and quantified. Finally, a good framework must include clear metrics and targets, for example to show how much the entity will decrease greenhouse gas (GHG) emissions and how this will be measured and tracked.
Initiatives such as the Global Reporting Initiative (GRI), the Task Force on Climate-Related Financial Disclosures (TCFD), the International Sustainability Standards Board (ISSB), and the European Union Corporate Sustainability Reporting Directive (CSRD) provide a diverse range of standards for disclosure. The TCFD and ISSB require entities to disclose on single materiality, while the GRI and CSRD have expanded their scope to reflect double materiality. With standards rapidly evolving, interoperability is important, and companies need to start preparing now given that harmonized sustainability reporting is on the horizon. Companies must choose and adjust to their preferred disclosure approach.
What are the Challenges Faced by Companies in Reporting Climate Actions?
Reporting climate actions requires specialized human resources. This implies that small and medium-sized companies may not be able to afford the financial and human resources to meet the requirements, while large companies face increasing costs of reporting all the required information. Data availability and reliability are another challenge for climate disclosure because audited data are lacking, and there are data gaps throughout the supply chains of most businesses. These challenges can hinder the scope and accuracy of climate action reporting, making it difficult for companies to meet the growing requirements. Despite the complexities, there is a path for companies to overcome these challenges.
The first step in disclosure preparation is the identification of material issues. This includes monitoring energy consumption, waste management practices, and the computation of GHG emissions, including Scope 3 GHG emissions, which are all indirect emissions that occur in the value chain of the reporting company, a task that is not exempt from challenges, in particular for smaller companies.
Once material issues are identified, investments are needed for collecting consolidated data for the preparation of environmental, social, and governance reports. The requirements are increasingly stringent, and regulatory frameworks vary across jurisdictions, so close monitoring of the evolving environment will support enhanced compliance.
The Enabling Environment
Company efforts will only succeed if set in the right framework supported by the right enabling environment. Financial regulators and supervisors, such as securities and exchange commissions, financial services agencies, ministries of finance, and central banks, are the architects of sustainability reporting and climate-related disclosure. They are key in setting rules to guide companies in complying with the growing requirements and standards.
Policy makers need to clarify which entities should report and what to report. Taking a gradual approach is also crucial to collectively building the proper framework while giving enough time for companies to adjust and develop the necessary internal processes and governance to comply with rules.
This is a new and challenging field for companies, but good practices are gradually emerging. For instance, capacity-building programs are crucial, and many countries offer onboarding programs on sustainability requirements to directors of listed companies. Tax relief, as provided by the Malaysian government, is a way to incentivize companies when sustainability reporting is optional to push them to be ready before it becomes mandatory. Environment agencies or ministries, as in the case of Japan, can also play a critical role in making information on cross-sector emission factors available so that GHG emissions can be calculated more efficiently.
It is only a matter of time before corporate climate disclosure shifts from voluntary to mandatory reporting, which means that now is the time for companies to assess their current reporting strategies and take the necessary steps to comply with regulatory standards and meet the expectations of investors. By planning ahead, such as investing in identifying material issues, tracking GHG emissions, and collecting consolidated data, companies will be better prepared once a standardized global or country framework for sustainability reporting is established.
This blog was prepared following Episode 5 of the ADBI Webinar Series on the Economics of Climate Change.
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Learn about the ADBI-ADB Asian Climate Finance Dialogue Project
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