With the consultation on the External Reporting Board's (XRB) proposed draft standards on climate-related disclosures having closed on 27 September 2022, we've reflected on what the next few years might look like for climate reporting entities (CREs).
Learning, developing and analysing three climate scenarios in quick time, one of which (the mandatory "greater than three degrees of warming by 2100" scenario) will likely require an analysis of long-term time horizons, as well as learning how to measure Gross Greenhouse Gas (GHG) emissions - in particular, scope 3 emissions - will likely be a steep learning curve.
However, due to the new ground being broken (New Zealand is the first country in the world to make comprehensive climate reporting mandatory), the XRB and regulator (Financial Markets Authority (FMA) appear to understand that time, support, and space will be needed for CREs to get their disclosures right.
Going by the signals, CREs should not be afraid of embarking on an iterative "learn by doing" approach in developing best practice over several climate statements - the regulator understands that information will improve over time.
Developing best practice will take time
The time pressure within the Financial Sector (Climate-related Disclosures and Other Matters) Amendment Act 2021 (Act) itself is substantial. With the XRB on track to release its final climate standards in December 2022, CREs with a balance date of 31 December will need to begin collecting information from January 2023 and publish their first climate statement by the end of April 2024.
However, there are a number of signals, in the Act, from the FMA and from the XRB that these new obligations will be staggered, both in absolute terms and in the enforcement approach, to give CREs some time and space to engage in genuine and good faith efforts while increasing the quantity and quality of their disclosures over time. These signals include:
- The Act has staggered one of its core obligations so that CREs are not required to obtain an assurance engagement in respect of disclosed GHG emissions until accounting periods that begin on or after 27 October 2024.
- The XRB's draft climate standards include first time adoption provisions (NZ CS 2), which exempts CREs from disclosing certain information in their first climate statement. We expect the intention of this is to enable CREs to focus on certain disclosures at the outset and then integrate further disclosures over time.
- The FMA has set out in its Climate Disclosures regime: Implementation approach document an express intention not to default to taking formal enforcement action against CREs that are engaging in good faith attempts to comply with the applicable climate standards in the first several years of the regime. The FMA has indicated that, during the early stage of the regime, its focus will be on supporting CREs and primary users in developing good practice and only expects to take enforcement action where there has been serious misconduct, such as failure to produce a climate statement, or where a climate statement is false or misleading.
- The XRB has emphasised the importance of taking an exploratory mindset to scenario analysis, starting out with qualitative, written narratives and building quantification and sophistication over time.
These signals are supported by commentary in the Taskforce on Climate-related Financial Disclosures (TCFD) Recommendations (which the XRB has modelled its draft climate standards on) as well as the regulatory perimeter of the Act itself, which was deliberately crafted to apply only to New Zealand's largest and best resourced organisations which were perceived as best placed to break this new ground.
CREs can take some comfort that, while the expectations are significant, the FMA and the XRB have indicated a willingness to work with CREs to assist and support them in establishing good practice and appear to both be comfortable with the idea that scenarios may not be perfectly defined and modeled, quantitative analysis may not be perfectly complete and comprehensive and disclosures may not be perfectly presented during the early stages. Instead, the initial expectations on CREs seems to be that they:
- Engage meaningfully and in good faith with the process of preparing climate statements
- Provide the best available information they are able to obtain in the circumstances
- Continuously improve the quantity and quality of their analysis with a view towards contributing to the development and improvement of best practice over time.
Embrace better decision-making
The best climate statements will be the ones that a CRE's board and management use to inform their day-to-day decision-making, much in the same way financial reporting does.
We think that climate statements can add value by enhancing a CRE's ability to understand its own risk profile and appropriately respond with internal governance, risk management and strategy measures, supported by targets which are likely to improve the CRE's long term resilience.
Many CREs may find a smart way to contribute to the emerging good practice in this space could be by using the disclosures internally as a risk mitigation and planning tool and seeing whether the information disclosed, and its presentation, lends itself to being easily used in decision-making.
Given the cost and resources required to produce the climate statements, it makes good sense for businesses to embrace the learning curve and use the statements as a tool to enhance other business outcomes. This may achieve silver linings for businesses as well as tangible action taken in achieving the core purposes of the Act to:
- Enable decision-makers to ensure that the effects of climate change are routinely considered in business, investment, lending and insurance underwriting decisions
- Help CREs better demonstrate responsibility and foresight in their consideration of climate issues
- Lead to smarter, more efficient allocation of capital
- Help smooth the transition to a more sustainable, low-emissions economy.
This article was co-written by Scott Abel (partner), Lara Wood (special counsel), Simon Jensen (consultant) and Michelle Tustin (solicitor).
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