From Green to Gold: 5 Ways CFOs Can Benefit from Climate Risk Disclosure

Chief Financial Officers (CFOs) are facing growing pressure from stakeholders to address climate change. Activists demand commitments to shrink carbon footprints; investors expect companies to operate green while maintaining strong profitability; and regulators—including the U.S. Securities and Exchange Commission (SEC)—are preparing to require companies to disclose climate risks in detail.

Faced with such pressure, finance executives often rely on a set of tools that do not match up. They lack a single detailed framework for measuring climate risk that is globally recognized across industries, markets, and jurisdictions.

Instead, CFOs must choose among multiple systems that use different calculation methods and data definitions. As a result, they often end up with only a rough grasp of climate risk, according to accountants and sustainability measurement experts.

"The lack of standards, and the differences between standards, can create obstacles to climate risk management," said a panel of the Commodity Futures Trading Commission (CFTC). "It is extremely difficult for a single institution to obtain all the data needed to build a detailed dataset."

Nevertheless, CFOs can still gain useful insights into the impacts of climate change through a range of strategies, from scenario planning and identifying a company's most severe vulnerabilities, to relying on high-integrity data and distinguishing estimates from facts.

These insights can reveal how CFOs can use "green financing" to curb risks, eliminate waste, and lower the cost of capital, according to accountants and sustainability measurement experts. With a clearer view of a company's environmental, social, and governance (ESG) performance, CFOs can also improve capital allocation by identifying merger and acquisition opportunities or business lines that are difficult to transition to low-carbon operations and are suitable for divestiture.

"More and more people are seeing the opportunities that come with ESG—creating new products, developing new materials, finding new ways to bring products to market," said Robert Hirth, vice chairman of the Sustainability Accounting Standards Board (SASB). "The demand for this kind of reporting is absolutely growing," Hirth predicted that lenders and insurers will at some point routinely require finance executives to provide ESG performance data.

Accountants and sustainability experts say CFOs may uncover significant vulnerabilities when measuring the impacts of climate change. For example, Fannie Mae and Freddie Mac, two government-sponsored enterprises, guaranteed $6.88 trillion in mortgage debt in 2019 without incorporating flood risk into their guarantee fees. Additionally, the CFTC's Climate-Related Market Risk Subcommittee said in a September report that the value of global fossil fuel companies' assets could decline by $250 billion to $1.2 trillion during the transition to alternative energy.

Meanwhile, CFOs who identify and curb climate risks—or help accelerate the clean energy transition—can lower their companies' cost of capital. A high-profile example of sustainable business returns is Tesla, whose stock price has risen more than sevenfold since the beginning of 2020. Smaller companies focused on battery technology and solar or wind power have also seen remarkable gains. In the less prominent municipal bond market, most counties pay lower underwriting fees and bond yields than those vulnerable to climate change.

Meanwhile, sustainable business lending is growing. JPMorgan Chase and Bank of America recently committed $2.5 trillion and $1.5 trillion, respectively, to low-carbon business and sustainability over the next decade.

CFOs who delay "going green" may soon get a push from U.S. regulators. SEC Chairman Gary Gensler aims to require companies to disclose their response to climate change risks, including details on metrics such as greenhouse gas emissions. Treasury Secretary Janet Yellen supported the SEC's disclosure push in April and said the Treasury would consider promoting the Biden administration's greenhouse gas reduction goals through taxes, international cooperation, and economic policy. In addition, the Federal Reserve announced in January the formation of a supervisory climate committee to "develop appropriate plans to ensure the resilience of regulated companies to climate-related financial risks."

High hurdles

CFOs face several challenges when following regulatory pressure and attempting to turn climate change data into actionable metrics for strategic planning such as capital allocation and risk management. When considering the impacts of climate change, finance executives need toshift to longer time horizons. According to Rebecca Self, sustainable finance director at carbon finance consultancy South Pole, they should not focus on quarterly or year-end reports but rather consider periods of ten years or decades ahead. CFOs also need to keep in mind that when extending forecast horizons, they need toadapt to greater imprecision and uncertainty。

"Accountants are used to dealing with very strict audit requirements, compliance requirements—very precise reporting," said Self, herself an accountant and former CFO of HSBC Holdings' sustainable finance unit. "Turning that toward climate change and long-term scenarios like the Paris Agreement is really challenging."

Furthermore, finance executives shouldrecognize that vulnerability to climate change often varies greatly within a company, far more than credit, interest rate, currency, and other types of risk. For example, a petrochemical plant near the Louisiana coast faces greater risk than a company headquarters located on higher ground. "Physical climate risk can be very detailed, down to building type and building structure," Self said in an interview. CFOs need to delve into "very granular matters," including whether a building has ground-level steps.

Measuring climate risk also requiresconsidering complex indirect costs to stakeholders such as suppliers, employees, and neighboring communities. "As public companies begin to report on ESG, they also face more pressure to report on their supply chains," Hirth said during a webcast hosted by the American Institute of CPAs last month. Investors and customers will ask CFOs "how their supply chains help them achieve their net-zero goals."

When choosing methods to measure a company's climate impact, finance executivesmust pick from a pile of inconsistent frameworksthat vary in scope and depth of detail. Hirth called the multitude of systems the "alphabet soup of ESG reporting." Some companies use up to four different frameworks simultaneously. In a recent study, the International Federation of Accountants (IFAC) said companies in the United States and Germany most often follow the system created by the Global Reporting Initiative, while companies in the United Kingdom and France tend to favor the UN Sustainable Development Goals.

Because so many systems are used, climate data, measurement techniques, and risk analysis methods vary widely, the CFTC panel said. "Significant gaps across sectors and asset classes hinder not only climate risk management but also operational and investment analysis that relies on data-driven processes," the panel said. "Information is not comparable, leading to measurement divergence."

The Bank for International Settlements (BIS) said current measurement systems are particularly ill-suited for banks. "Existing analyses typically do not translate changes in climate-related variables into changes in banks' credit, market, liquidity, or operational risk exposures or losses on bank balance sheets," the BIS said in a recent study. The accounting profession has not yet translated climate change data into numbers that accurately measure the full range of financial risks, said Arnaud Pico, global head of risk practice at financial software provider Finastra. "Potential financial risks on a broader scale are only treated marginally—or not at all."

Building consensus

Industry and government standard-setters aim to establish a unified system for ESG disclosures, but reaching consensus may take time, Hirth said. "The next few years could be a bit difficult as we try to move from all these different frameworks to an agreement." IFAC, while pointing out inconsistencies in reporting methods, said most companies fail to obtain high-quality independent assurance on their sustainability reports, threatening market stability. "Low-quality assurance is an emerging investor protection and financial stability risk," IFAC said, adding that only 51% of 1,400 companies globally provide assurance on their ESG reports, with many relying on consultants rather than professional accountants.

When measuring climate risk, CFOs need to capture several types of data beyond their enterprise resource planning systems. Finance executivesneed to determine what data to capture and how to define it. Even for greenhouse gas emissions, organizations follow different definitions. "Some companies have entered into supply arrangements with contractual commitments to report greenhouse gas emissions," said Wes Bricker, vice chair and assurance leader at PwC, in an interview. "What if I have multiple clients using different definitions?" Bricker served as SEC chief accountant from 2015 to 2019.

By overcoming the above challenges, CFOs can make progress in reliably translating climate change data into GAAP and IFRS treatments for goodwill, intangible assets, inventory valuation, and other topics, accountants and sustainability experts said. "Ultimately, these metrics determine your capital management and profitability," said Kelly Herred, director of catastrophe research and development at Liberty Mutual. "If you can understand when climate change becomes so significant that it changes your risk appetite, then you can truly make decisions based on that."

CFOs can take several steps to turn the obligation to report climate change risks into an opportunity to gain improved business insights, accountants and sustainability measurement experts said.

1. Prefer credible, accessible data

Finance executives should first focus on data that can be captured and confirmed as credible, Bricker said. For example, CFOs can determine a company's greenhouse gas emissions through a combination of verifiable data and estimates, clearly distinguishing between the two as in any financial report. "Start with what we know, identify what we don't know, and create estimates, clearly labeling what is known and what is estimated," Bricker said. Finance executives should also clearly define the several types of data used to measure climate risk and ensure the definitions are used consistently inside and outside the company. "CFOs can have a truly positive impact on curbing climate change costs by helping internal users and external stakeholders focus on what matters," Bricker said. They are "increasingly communicating with external stakeholders so they understand the business report, what it conveys, and where disclosures are located."

2. Set short-term milestones while pursuing long-term goals

CFOs can ensure measurable progress in shrinking a company's carbon footprint by defining several near-term milestones within a long-term planning horizon, accountants and sustainability experts said. A series of short-term goals can reassure employees, investors, and other stakeholders that the company is on track, or help determine when to adjust to achieve targets. "I see CFOs focusing on long-term planning horizons and setting near-term milestones—additional measurement and accountability—to see if they are on track," Bricker said.

3. Use scenario planning to frame long-term uncertainty

Through scenario planning, finance executives can pursue their carbon emission goals over the coming decades within a range of high and low potential costs and opportunities. This analysis "does not pretend to be a perfect vision or forecast of the future," Self said. "It's about running different scenarios, asking long-term 'what if' questions to help inform today's decisions."

4. Rank vulnerabilities and focus on the biggest risks

CFOs can limit analysis costs and cycles by focusing on identifying a company's greatest physical climate risks—whether drought, flood, heat, or storms—and prioritizing them across locations and business lines, accountants and sustainability experts said. Such analysis, using geospatial and other data, may reveal high risk in a few places, Self said, consistent with the Pareto principle showing that most risk is concentrated in about 20% of a portfolio. Companies "should focus on where losses actually occur" and "where our scientific certainty is highest," Herred said this month in a Liberty Mutual panel discussion. For example, estimates of storm surge flood risk are relatively reliable through 2030 and may justify moving warehousing or other operations to higher ground. By identifying the biggest risks early, CFOs can avoid unnecessary research and confidently say, "'I need to do a deeper investigation at this particular location,'" Self said. Without ranking, "you could almost go deeper and deeper indefinitely, down to very fine details."

5. Focus on specific metrics

Of the U.S. companies in the IFAC study that publish ESG disclosures, 31% provide reporting based on the framework recommended by the Task Force on Climate-related Financial Disclosures (TCFD). Created by the Financial Stability Board at the request of the G20, the TCFD describes 11 types of disclosures across four areas: governance, strategy, risk management, and metrics and targets. The TCFD provides only a framework, not in-depth detail for measuring climate risk. For specific measurement guidance, Bricker recommends CFOs follow SASB standards, which describe sustainability disclosures for 77 industries across 11 sectors. According to IFAC, 48% of U.S. companies use SASB. CFOs should go with rather than resist the rising trend of ESG disclosure, Hirth said. "Ultimately, you have to tell your story to attract investors and satisfy your individual stakeholders." Finance executives should view sustainability disclosure "as a way to focus on what makes you a better company—lowering risk, making you more attractive to customers, more attractive to employees, and leading to a better supply chain."