When Climate comes to bear

Climate reporting can be an important area of ESG reporting for professional investors and financial analysts. By providing information on a company’s exposure to climate-related risks and opportunities, climate reporting can help assess a company’s long-term sustainability and financial performance. Investors should look for climate reporting that is standardized, forward-looking, aligned with corporate strategy and risk management, transparent and accurate.

ESG is mainstream, climate reporting well on its way there

ESG has gained considerable importance in the capital markets in recent years. According to the Global Sustainable Investing Alliance (GSIA), by 2020, 35% of all professionally managed assets worldwide, i.e. 35.3 tr. USD, sustainable. In terms of disclosure by companies, ESG is well on its way to becoming mainstream. A survey by KPMG found that 96% of the world’s 250 largest companies by revenue publish ESG reports. In addition, the political agenda, particularly in Europe – cue CSRD and ESRS – is ensuring that more companies are required to report on ESG, massively increasing the pool of available ESG data.

It is reasonable to assume that most investors and financial analysts know that ESG reports are available for the companies they monitor (which does not mean that they use available ESG data). For example, in a 2020 CFA Institute survey of its members, 32% of respondents viewed a company’s ESG performance as a key indicator of management quality.

What hides behind climate reports and why are they important?

Companies already publish climate data on a large scale. On their websites, you come across keywords such as CDP, SBTi or TCFD. What is behind these terms? CDP, SBTi and TCFD are three of the most important frameworks and initiatives related to climate reporting and action:

1. the Carbon Disclosure Project (CDP) is a global nonprofit organization that operates a disclosure system that enables companies, cities, states, and regions to measure and manage their environmental impacts. It provides a framework for reporting on climate change, water security, and deforestation, among other environmental issues.

2. the Science Based Targets initiative (SBTi) is a partnership of diverse nongovernmental organizations designed to help companies set science-based targets for reducing greenhouse gas emissions.

3. the Task Force on Climate-related Financial Disclosures (TCFD) is an initiative of the Financial Stability Board (FSB) that aims to provide companies with a framework for disclosing monetary information about their climate-related risks and opportunities.

Why do climate reports contain important information for investors and financial analysts?

Climate reporting is an increasingly important area of ESG reporting, as climate change represents a significant risk for many companies and industries. Climate reporting distinguishes between physical risks and transitory risks. This can be illustrated with an example:

The Heisenberg company (fictitious) sets up a production plant in a region that has been known for years for water shortages and droughts. Heisenberg requires extraordinary amounts of water to manufacture its products at this location. However, with increasingly climatically induced water scarcity, manifest physical risks arise for Heisenberg, e.g., in such a way that ever deeper drilling for groundwater is necessary, requiring substantial investments (until at some point the water may be completely depleted). But Heisenberg also faces significant transitory risks, e.g., such that laws regulating water withdrawals are tightened and political pressure is exerted to award water quotas to end users, farmers, and other consumers. This can lead to a shortage of water for Heisenberg, which entails a curtailment of production – not to mention that the water shortage will drive up the price, so production costs for Heisenberg will rise anyway.

However, good and transparent climate reports are particularly useful for investors and financial analysts because …

– … climate reporting is becoming increasingly standardized. As the importance of climate reporting has grown, so have efforts to standardize reporting. Cross-industry frameworks and standards such as TCFD, CDP, SBTi, but also industry-specific standards such as those of the Net Zero Coalition contribute to comparability and quantification of disclosures.

– … climate reports can provide investors with valuable information about a company’s exposure to climate-related risks and opportunities. Investors can use this information to better evaluate a company’s long-term sustainability and financial performance.

– … because climate reporting is forward-looking: it provides a clear and accurate picture of a company’s current performance and provides information on how the company plans to address climate-related risks and opportunities in the future.

– … because climate reporting is aligned with the company’s overall strategy and reflects its specific risks and opportunities.

– … they are transparent and accurate: Investors should look for transparent and accurate climate reporting with clear and consistent metrics and data. Companies should disclose their assumptions, methodologies and data sources so that investors can assess the quality of the information provided.

This article was published in Bond Guide – Corporate Bond Platform (May 2023).

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