The future of TCFD

This year large asset managers hit the deadline for the first Taskforce for Climate-related Financial Disclosures (TCFD) reports, making it a good opportunity to take stock of this risk assessment tool. 

While the large asset owners had to produce their first TCFD reports in 2022, the addition of asset managers means there is a more complete picture for how this risk assessment tool has impacted institutional investors.

The publication deadline was 30 June for managers with assets under management of more than £50bn. The second phase has now taken affect with those with more than £5bn expected to report on 30 June 2024.

Maria Nazarova-Doyle, global head of sustainable investment at IFM, said: “The TCFD is a very helpful framework to improve governance structures and create business strategy which involves climate-change risks and opportunities.”

The aim of the framework is to improve how an organisation manages climate risks. “It enables an asset owner or manager to update their processes and systems to take account of the impact of climate-change on the organisation,” said Nazarova-Doyle.

The aim of TCFD is to embed this way of thinking in how an asset manager and owners runs their portfolios, she added. 

“Having a mandate which changed behaviours has been a force for good,” added Stuart O’Brien, partner at Sackers. 

But while taking on this type of framework has encouraged a better consideration of climate risk, the reports produced have not been great. 

“It is not clear how helpful it is for a member to have a 60-page technical report or details on the carbon footprint of the scheme’s LDI portfolio,” said O’Brien.

Garbage in, garbage out

One of the key ways TCFD endeavours to get businesses to think about the climate risks to their business is through scenario analysis. 

While the TCFD says both a qualitative and quantitative approach would work, many trustees have used the latter when considering the impact on their investments. 

But this assessment of climate change risk has been criticised. Nazarova-Doyle said: “Quantitative scenario analysis is often not fit for purpose.”

Organisations are trying to find a quick fix solution to assess climate risk. “Too many think they can simply put some numbers in a spreadsheet, press some buttons and voila! – we’ll be able to estimate the full effects of climate change,” said Nazarova-Doyle. 

Climate change is too complex a problem to be reliably modelled in this simplistic manner – there are too many variables and to many inter-connected parts. 

“Like other scenario analysis tools, this type of modelling is very susceptible to the quality of data fed into it – it’s an example of garbage in, garbage out,” she added. 

Qualitative not quantitative

While using quantitative models like this can be a good exercise, they should not be relied upon. 

“I would prefer organisations to take a more qualitative approach to thinking strategically about climate change by estimating the overall impacts rather than relying on a number produced by spreadsheet,” said Nazarova-Doyle. 

O’Brien agreed: “There is a sense that small, quoted percentage deviations over long time-horizons can, at best, be seen as spurious accuracy and, at worst, lull schemes and their members into a false sense of security.” 

“When you think qualitatively about climate change in a wider sense, you get a much better feel for all the variables,” added Nazarova-Doyle.

A better way forward?

The next step is the integration of climate- and nature-related risk from both asset owners and managers.

Kate Fowler, associate director of policy & advocacy at Federated Hermes, said: “There needs to be a clear plan. That could be understanding whether an organisation is trying to mitigate climate risk or identify opportunities.” 

As well as setting a target, there also needs to be a route on how to get there. “That is not entirely in the control of the financial institution – there also needs to be the right policy environment,” she added.

The financial institution does, however, need to understand what financial levers it has at its disposal to achieve those goals.

Quantitative metrics like weighted-average carbon intensity for a portfolio can be altered, for example, by changing the allocation to a particular company in a portfolio. “But nothing has actually changed in the real world,” said Fowler. 

By moving beyond these portfolio level metrics and down to the company level, organisations can understand what the risks the individual corporate faces, whether it has set credible targets and if has a strategy to get there. 

“Once institutions have assessed the risks associated with different companies, there a number of different levers available to organisations to influence the corporates and integrate that understanding of climate risk,” said Fowler. 

One is capital allocation. As well as minimising investment in high carbon emitters, managers and owners can decide to allocate to climate- and nature-based solutions. 

“The second lever is public policy – advocating for better government policy and using our voice to support companies taking the right action,” said Fowler.

But the most important tool is effective engagement. Fowler said: “If we feel a company is financially exposed to risk from climate change and nature loss, we use our investors’ right to evaluate and mitigate those losses.” 

Focus on stewardship

O’Brien agreed: “To make TCFD effective over the long term, we need to focus on stewardship.” 

Trustees are not changing their investment allocations to become more sustainable so the most meaningful outlet is to take proper ownership of the assets already owned. 

“That means engaging with companies, using your voting rights effectively,” said O’Brien. 

That is challenging for schemes because the investment chain is so disintermediated that trustees are long way from the underlying companies held in the portfolio. 

“Trustees have to get better at holding their managers to account in terms of the engagement efforts their managers are undertaking,” said O’Brien. 

It is not enough for an asset manager to have signed up to the stewardship code, they need to start asking managers for the details of how seriously they are taking their engagement activities and how seriously they are driving the underlying companies to net zero, he added. 

There is work to be done to better align the interests of asset owners and managers. The recent asset owner stewardship review identified several areas of concern. 

Speaking about the report, Leanne Clements, head of responsible investment for People’s Partnership, said: “Urgent action is needed from the entire stewardship chain to address the misalignment issue identified in this research.” 

A complete dismantling of failed status quo approaches to stewardship is needed by the fund management industry, with voting escalation not seen as a “last resort” approach used on an exceptions basis, but rather a powerful signal to companies of what investors expect of them, she added. 

TNFD could improve risk assessment

The introduction of the Taskforce for Nature-related Financial Disclosures could help asset managers and owners to think more holistically about both climate and nature related risks and opportunities. 

Nazarova-Doyle said: “Using these two frameworks will give a more complete picture and over time it would be good to see the two frameworks merged so asset managers and owners have one system of measuring environmental risks and opportunities as well as reporting.”