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The link between TCFD disclosure and company change is flawed

Investors must rethink their requests to companies and stop over emphasising the role of disclosure, argues Thomas O'Neill

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The time has come to question whether institutional investors' continued emphasis on climate disclosure is justified. 

Take, for example, the recommendations of the Task force on Climate-related Financial Disclosures (TCFD), which have been at the centre of investor dialogue with companies. Do you think that if every company disclosed TCFD perfectly, it would facilitate a 50% drop in emissions by 2030? 

I contend that the case for disclosure directly impacting companies does not exist, and although disclosure can help hold companies to account, the TCFD-articulated link between disclosure, market forces and company change is flawed.  

We found that asking companies to disclose their political expenditure in the hope it would change their climate lobbying was incredibly ineffective

One reason is intrinsic: climate risk mitigation focuses on the risk posed by climate to the financial returns of individual companies, not the risk these companies pose to climate change. While they sometimes converge, often they do not. For example, a company may respond to the risk it faces from rising sea levels or government carbon quotas by relocating to a territory where it faces neither. In undertaking this move, it could keep its emissions constant, or increase them. Similarly, some listed companies have sold off risky coal assets to unscrupulous actors with the intent of running them down to the end of their technical life or until they are regulated out of existence. 

The second reason is that diversified institutional investors cannot effectively hedge against climate risk – their exposure to the whole market gives them a natural interest in the market's net growth and the ecological conditions that make this possible. The value of these wide ranging portfolios are more closely tied to the future production of value globally than the financial risks associated with any one company. 

Another flaw in disclosure theory is its practical implementation. For climate disclosure to have a real economy impact, it requires all the following outcomes: 

  1. The standardisation and universalisation of climate risk disclosure; 
  2. For investors to screen their holdings using common ESG criteria; 
  3. For this screening to depress the share prices of GHG-intensive companies; 
  4. For these revaluations to lead companies to reform their real-world activities. 

Yet, these criteria do not hold. Investors overwhelmingly view climate risk disclosure as uninformative and imprecise. ESG ratings are wildly inconsistent. While there is some evidence that ESG screening can depress the share price of companies, especially small, immature companies in illiquid markets, there is no empirical evidence demonstrating that these price fluctuations lead companies to change to their real-world activities. The academic literature supports this, with Emma Sjöström's research suggesting “greater CSR disclosure does not generally inspire a change in corporate activities beyond disclosure”.  

If climate risk management is a poor proxy for achieving real-world outcomes, we would do far better to refocus our efforts on those real-world outcomes themselves. Universal Owner's research found that engagement was most effective when the requests were linked to real-world change – especially on companies' business models and political lobbying activities. The Australasian Centre for Corporate Responsibility, for example, makes specific, timely and achievable demands that institutional investors can hold companies to – such as closing coal production by defined dates, aligning business models with their own 1.5°C scenarios, and leaving trade associations that undermine Australia's climate ambition. These engagements have arguably had more climate impact than most of the world's largest asset managers.

In contrast, we found that asking companies to disclose their political expenditure in the hope it would change their climate lobbying was incredibly ineffective. Companies resist wide-ranging political disclosure because it can expose them to legal and other risks unrelated to climate – and because it informs competitors about jurisdictions they plan expansion into. The ask also contains no mechanism to compel behaviour change. Asking companies to publicly 'audit' and align their climate lobbying with their values, on the other hand, exposes existing contradictions and has often precipitated companies (i.e., BP and Royal Dutch Shell) leaving egregious trade associations. 

Then there is the argument that disclosure is a necessary part of a company's 'sustainability journey'. But it’s been exactly 20 years since my friend and Chair of CDP, Paul Dickinson, began stuffing envelopes asking firms to disclose their climate risks to investors – companies have had more than enough time to realise that climate change is everyone's business. Investor engagement is critical to ensure that the real-world decisions companies make today are consistent with a 50% fall in emissions by 2030. The excuse of 'not wanting to be prescriptive' will not stand the test of time.  

Thomas O'Neill is the founder of the think-tank Universal Owner