Climate-related financial disclosures—requirements that force companies to determine and disclose how climate change could affect their future profitability—are becoming the new global norm. And for good reason: better information helps investors, lenders, and insurers redirect capital to businesses and projects that are aligned with global climate goals. Tightening disclosure rules will be a major focus at this year’s Conference of Parties (aka, COP26) in Glasgow.
To remain competitive in a global low-carbon economy, our recent report—Sink or Swim—finds that Canada needs to not only catch up with global disclosure rules but lead and exceed them. In particular, this blog explores why sectors facing declining global demand (e.g., oil and gas, fossil-fuel-powered vehicles, and coal) need metrics that clearly separate companies that are transition aligned from those that are not.
What is climate-related financial disclosure, and why does it matter?
Publicly traded companies are legally required to disclose information on their financial performance. These disclosures ensure that investors, lenders, and insurers have the clear and consistent information needed to make decisions. Disclosure rules help markets price risk and mitigate big shocks or market corrections. Standards for such rules are set by global bodies like the International Financial Reporting Standards Board (IFRS), and are adopted by countries around the world, including Canada.
In a warming world, climate-related disclosures serve the same purpose. They give markets a clear picture of how climate change will affect individual companies, including whether they are prepared for a low-carbon future. This information can steer capital toward companies that are aligned with global climate goals, and away from those that are not.
But unlike their financial counterparts, climate-related disclosures have so far been voluntary and uncoordinated. Hundreds of different standards have emerged in the absence of a harmonized approach—producing inconsistent, incomplete, and noisy data. It’s a huge problem that can mask poor performance while making it hard for genuine leaders to stand out.
Will harmonized, mandatory climate-related disclosure at the global level soon be a reality?
The rulebook for global finance is changing rapidly. Several governments, including the European Union, the United Kingdom, China, New Zealand, and Switzerland are making climate-related disclosures mandatory for publicly traded companies, and also for large privately listed companies and financial institutions. Other countries in the G7—including Canada—have committed to following suit. The US SEC is expected to make a decision on mandatory climate-related disclosures for publicly traded companies in late 2021 or early 2022.
Global standards are also starting to converge. The International Sustainability Standards Board, a new international standard-setting body under the umbrella of the IFRS, is launching at COP26 in Glasgow. It’ll be tasked with creating a set of harmonized, baseline disclosure standards using the framework provided by the Task Force for Climate-related Financial Disclosures (the gold standard). New global standards are developing at an unprecedented speed, expected as early as mid-2022.
While it’s still unclear what these baseline disclosure standards will look like, there’s a strong chance they’ll require companies to disclose their greenhouse gas emissions as a minimum (Scope 1, 2, and maybe 3), along with future emissions-reduction targets and plans to achieve them. They may also include intensity-based metrics that make it easier to compare transition readiness across companies, such as greenhouse gas emissions per unit of revenue or output.
What does this mean for Canada?
These shifts in the global disclosure rules pose significant challenges for Canada, where companies appear ill-prepared. While more publicly traded companies are disclosing climate-related information than ever before, the majority still do not. Nearly one third of Canadian publicly traded companies still don’t disclose their greenhouse gas emissions. Disclosures among privately listed firms are even patchier.
Why is Canada lagging behind? In part, because Canadian governments and regulators have yet to define climate-disclosure rules. Multiple levels of government have issued reports and commitments in support of clearer and more consistent disclosure but such disclosure still remains voluntary for companies and financial institutions.
Falling behind global disclosure rules would have serious implications for an emissions-intensive economy like Canada. Nearly 70 per cent of Canada’s goods exports and 60 per cent of foreign direct investment are in sectors vulnerable to the global transition. If company-level data in Canada is hazy, investors could paint emissions-intensive sectors with a broad brush—potentially raising capital costs or fueling divestment.
In the short term, this could cut off capital for leading and innovative companies within these sectors that are already transitioning or have clear strategies to do so. Further out, it could hamper Canada’s long-term competitiveness and prosperity.
How should Canada respond?
All of this suggests two lessons for governments and regulators. The first is uncontroversial: Canada needs to catch up with its trading partners by introducing baseline standards that are consistent and comparable. These standards should align with the requirements being developed internationally and by Canada’s closest trading partners (the United States in particular). The good news is that the ball is now rolling, but the country still has a long way to go.
The second lesson is that global baseline standards may not be nuanced enough to secure Canadian competitiveness in a low-carbon economy, particularly for transitioning emissions-intensive sectors. Creating a set of complementary and standardized metrics—even if it is only initially done in Canada—could make it easier for investors and consumers to interpret the information and keep capital flowing.
Where should Canada go above and beyond international metrics?
An international baseline for disclosures—based on the TCFD framework—could provide a solid foundation for Canadian companies to build on. Yet such a baseline may not be nuanced enough for all companies in Canada.
Sectors facing declining global demand in the transition, such as oil and gas, fossil-fuel-powered vehicle manufacturers, and coal, need additional metrics. Reducing greenhouse gas emissions in these sectors, while still an important transition strategy, will not protect companies from shrinking markets. Instead, cutting costs and getting into new business lines will be essential for these companies to successfully transition.
Sink or Swim proposes a series of metrics and targets for demand-decline sectors that can help investors, lenders, and insurers better understand which companies are transition-aligned. Metrics that include revenues from transition-aligned products—such as biofuels, renewables, and carbon capture, utilization, and storage—can give a better sense on whether companies are diversifying into new business lines. At the same time, metrics on breakeven production costs and measures to reduce these costs—such as energy efficiency and automation—provide important information on whether a company or project can withstand declining prices. Forward-looking targets along these same lines could help, along with company-specific plans to achieve them.
Enhanced metrics and targets for demand-decline sectors aren’t a new idea. The Institutional Investors Group on Climate Change (IIGCC) recently proposed a sector-specific disclosure standard for oil and gas that includes things like capital expenditures, production plans, and diversification. Recent guidance by the TCFD also includes the possibility of metrics based on production costs, breakeven prices, and revenue streams from transition-aligned business lines.
While climate-related disclosures are only one part of the broader push to build a low-carbon economy, they are an essential element. They also create high stakes for Canada. Acting too slowly could mean that global markets don’t have the information they need to identify which Canadian companies are aligned with the transition, and which companies are not.
To ensure Canadian companies maintain access to global capital markets, Canada must first catch up with global developments by moving quickly toward harmonized, mandatory disclosure. What’s more, Canada needs to develop a set of standardized transition metrics, targets, and taxonomies that reflect the nuances of its most emissions-intensive sectors.