Recommendations would undermine the goal of improving capital
allocation decisions and promoting efficient markets
Recommendations by a Financial Stability Board (FSB) task force
calling for separate requirements for disclosing climate-related
financial risks could lead investors to misunderstand opportunities
and risks, misprice assets and forego future returns, according to
new analysis by IHS Markit (Nasdaq: INFO), a world leader in
critical information, analytics and solutions.
The recommendations, released in draft form this past December
by the FSB’s Task Force for Climate-related Financial Disclosures
(TCFD), suggest a framework for voluntary disclosures of
climate-related financial risks in public financial filings. The
recommendations apply to all entities with public debt or equity.
The FSB is a body composed of financial regulators, central banks,
finance ministries and international financial organizations. The
FSB reports to the G20, the international forum comprised of 20 of
the world’s largest advanced and emerging economies. The FSB is
expected to present the final TCFD recommendations to the G20
summit in Hamburg in July 2017.
The IHS Markit report, entitled Climate-related Financial Risk
and the Oil and Gas Sector, says some elements of the TCFD
framework could be helpful to investors in understanding how
companies comprehend and manage potential risks related to climate
change. However, the analysis concludes that several of the
recommendations could obscure material information and create a
false sense of certainty around the financial implications of
climate-related risks.
“The TCFD proposal represents a radical departure from
established financial reporting rules and goes against the basic
principles of disclosure,” said Antonia Bullard, IHS Markit vice
president for energy-wide perspectives. “Singling out one type of
risk for separate treatment would prevent financial markets from
accurately assessing, comparing and pricing all risks and
opportunities. That would undermine, not support, the goal of
improving capital allocation decisions and market functioning.”
Among the problems that the IHS Markit report identifies:
Departure from the established concept of materiality in
financial reporting
Disclosing information on climate-related risks as part of
required public financial filings represents a radical departure
from the established concept of materiality, the report finds. It
could lead to unintended consequences, such as investors
downgrading other risks that might have comparable financial
impacts, but are not subject to specific disclosure frameworks.
Use of metrics that do not correlate with financial risk and
opportunity
There is no evidence that the types of metrics referenced by the
TCFD will allow investors to quantify climate-related financial
risks, the report says. The impact of climate-related factors is
more complex and multi-dimensional than typical financial drivers
like commodity prices.
Metrics taken out of context do not allow for proper comparisons
and could lead to inefficient investor choices. Carbon emissions do
not correlate with climate-related financial risk in a
straightforward manner. For example, operational emissions might
decrease due to declining production rather than the result of
improved emissions management, which could have a greater financial
impact than climate-related risk, the report finds.
The TCFD also suggests a direct link between future earning
capacity and emissions in a company’s entire value chain (Scope 3
emissions). However, any link would be highly dependent on company
specifics, such as the countries and sectors where its products are
used and the pace of adoption of relevant climate-related
policies.
“The Task Force acknowledged that further work is needed to
define carbon-related assets and their potential financial
impacts,” Bullard concluded. “There is absolutely no consensus on
the methodologies and metrics that could translate company-level
climate-related metrics into measures of systemic risk.”
In addition, the TCFD recommends the disclosure of
“climate-related opportunities”—such as investments in low-carbon
alternatives—in terms that imply that these opportunities will
generate positive financial outcomes. No such guarantee can exist.
In fact, some “clean energy” investments have high financial risk
and some of the recommended disclosures could lead investors to
misprice assets and increase their financial risk, the report
says.
Misuse of scenarios analysis
The IHS Markit report finds that including financial
implications of long-term scenario analysis in public filings as
recommended in the TCFD draft would mislead investors about the
certainty of those outcomes. This would distort markets, not
enhance them.
Scenarios are not intended to serve as forecasts or generate
financial projections. Any financial disclosures based on scenario
analysis will be contingent upon a large number of assumptions
about markets, technologies, prices, costs, company strategies and
other variables, the report says.
Scenarios from different companies will use different
assumptions and will vary depending on focus, approach and internal
and external resources. Disclosing financial implications from
scenarios created under different conditions cannot provide
comparable information for pricing financial assets and risks, the
report finds.
“IHS Markit has a long experience working with scenarios and
regards them as a valuable tool,” said Daniel Yergin, IHS Markit
vice chairman and a co-author of the report. “But the use of
scenarios as proposed by the TCFD conflates the hypothetical—using
different plausible futures as an exercise to test strategic
thinking—with detailed financial forecasts and projections. “This
would create a false sense of certainty in the face of multiple
possible outcomes.”
Disclosure of confidential business information
The TCFD recommends that oil and gas companies disclose metrics
such as “indicative costs of supply for current and future
projects.” Disclosures of such confidential information would
undermine companies’ competitive positions and harm existing
shareholders, the report says.
In the oil and gas sector, disclosing information about project
plans could reveal a company’s development priorities and impair
its position with host governments, project partners and service
sector companies. In addition, absolute and relative costs shift
constantly in response to market and technology changes. Companies
also could face litigation if future costs do not align with the
projected costs in the disclosures.
“The TCFD recommendations extend beyond the scope of investor
needs and enter the realm of climate policy,” Yergin concluded.
“Climate policy is best designed and implemented by government
agencies with the requisite mandates and expertise, not financial
regulators.”
About the report:
Download the full report, Climate-related Financial Risk and the
Oil and Gas Sector at www.ihs.com/climatefinancialrisk
Research for the report was supported by BP, Chevron,
ConocoPhillips and TOTAL.
The analysis and conclusions of this commentary are those of IHS
Markit and IHS Markit is solely responsible for the commentary and
its contents.
About IHS Markit
(www.ihsmarkit.com)
IHS Markit (Nasdaq: INFO) is a world leader in critical
information, analytics and solutions for the major industries and
markets that drive economies worldwide. The company delivers
next-generation information, analytics and solutions to customers
in business, finance and government, improving their operational
efficiency and providing deep insights that lead to well-informed,
confident decisions. IHS Markit has more than 50,000 key business
and government customers, including 85 percent of the Fortune
Global 500 and the world’s leading financial
institutions. Headquartered in London, IHS Markit is committed
to sustainable, profitable growth.
IHS Markit is a registered trademark of IHS Markit Ltd. All
other company and product names may be trademarks of their
respective owners © 2017 IHS Markit Ltd. All rights reserved.
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