Robert Shuwerk responds to industry opposition to the TCFD recommendations.

The Financial Stability Board’s task force on climate-related financial disclosure (TCFD) spent much of 2016 consulting with industry and stakeholders to produce a set of standardized disclosure recommendations, drawing upon the more than 400 existing climate and sustainability-related reporting regimes. Among other things, the recommendations ask companies to analyze and disclose how a 2°C scenario might impact their businesses.  Those recommendations are now being considered for approval by the G20.

On the eve of that consideration, IHS Markit has voiced industry’s opposition.  (IHS-Markit, Climate-Related Financial Risk and the Oil and Gas Sector (May 2017). In this blog, we respond to IHS’s principal contentions.

IHS Claim

Carbon Tracker Response
1 Management, not regulators or task forces, should determine what risks are material and worthy of disclosure. There are precedents in capital markets regulations for itemized disclosures of risk-related information.
2 The recommendations represent an unprecedented level of new disclosure.  “Scenario analysis” is a basic tool for any market assessment process and it can provide the backdrop for sensitivity or value at risk analysis that are part of the existing disclosure toolkit for market-risk sensitive financial instruments. 
3 Scenario analysis cannot result in quantified company-level impact and if it did, it would provide a false sense of predictability, resulting in a suboptimal allocation of capital. Scenario analysis can lead to quantified, company level outputs.  There is no reason to believe more data will mislead markets.  If data moves markets, it is material. 
4 Such disclosure requires companies to reveal commercially sensitive information.   Commercial sensitivity concerns must be balanced against the investing public’s interest in information and are present for many disclosure requirements, there is no reason to believe a balance could not be struck here. 


Below, we discuss each argument in detail, identifying precedents primarily from the US capital markets context and focusing on the fossil fuel sector (though the TCFD recommendations consider all publicly-traded firms).

  1. Management and regulator roles in assessing climate risk

IHS argues that management should define what is material, not regulators or investors. For risk factor disclosures, it is typically left to management to identify which risks are included.

However, even here, the SEC has already offered guidance on where and how management should consider climate-related risk.   Similar guidance has been propounded for cyber-security risks and other substantive issues.  While these are guidance documents, that guidance channels how companies approach discussion of those risks.

IHS seems concerned that companies not be told that climate related risks may be material.  IHS’s argument ignores the fact that most fossil fuel companies’ managements have already acknowledged that climate risk is material.[1]  For the fossil fuel sector the identification of risk is a settled issue, the question is how its implications are assessed and disclosed.

In going beyond risk identification to specifying how the risk should be disclosed, some recommendations seek management’s views.  Others specify metrics and targets to be discussed.  The latter recommendations are less akin to “risk factor” disclosure and more analogous to other areas of corporate reporting that include mandatory, itemized disclosures to help investors better understand risks.  These abound for extractives companies and include:

  • SEC, Item 104: This specifies what and how mining companies must disclose health and safety and other violations.  Mining companies are forced to disclose even those violations they deem immaterial.
  • SEC Item 1202: SEC views reserves balances as material for oil and gas companies and thus provides a fixed price formula and method for estimating economic recoverability of mineral resources.  Management may have other views on the likelihood of those deposits being economically producible, but they are not permitted to drive the formula.

In short, where capital markets regulators have viewed generic risk factor disclosure as insufficient they have not hesitated to both offer guidance that circumscribes management’s discretion and identify new itemized disclosure requirements.

  1. Precedents for scenario analysis

 IHS takes particular aim at the scenario analysis component of the recommendations, arguing that scenario analysis cannot be repurposed for disclosures and that investors do not expect companies to quantify the risks.  IHS does acknowledge that scenario analysis is important for challenging “group think”.  However, they believe it not specific enough to generate company level analysis.

The TCFD recommendations contain a scenario analysis component  (including a 2°C scenario) and suggest one output should be a quantification of risk.  However, they do not specify the form or methodology that the scenario analysis should take.

IHS seems to argue that companies are not normally required to quantify risk and then, more specifically, that scenario analysis could not yield a quantifiable result.  We would disagree on both fronts.

With respect to the first point, requiring quantification of forward-looking risks is not entirely novel.  For example, the SEC’s Item 303 (management discussion and analysis) requires management to quantify financial risks from known trends if “reasonably available.”  Similar standards also apply to loss contingencies, and impairments are, in effect, another form of quantifying expected losses due to market or other changes.

With respect to the second point, a key value of conducting a 2°C scenario analysis lies in its potential to consider how a 2°C-compliant commodity demand profile would make attractive projects in the planning case appear unattractive.  Chevron acknowledged as much in its recent report, identifying how lower demand would likely lead to lower prices, rendering projects at the margin uncompetitive:

Image source: Chevron report“Managing climate change risks”, 2017

A valuable output of scenario analysis, therefore, would be to reveal the delta between those projects that are attractive in the company planning case and those that aren’t—the delta between P1 and P2 in Chevron’s illustrative example.  A hypothetical “market-clearing price,” used not as a forecast but as a means of sorting company projects along the cost curve, could be used to demarcate the risk.  Companies could then generate quantitative assessments of the value of their 2°C-compliant and full potential portfolios using traditional tools such as sensitivity analysis (a separate recommendation of the Task Force).[2]

To our knowledge, there is no explicit requirement for “scenario analysis” in any capital markets disclosure regime.  But this is a semantic issue more than anything. Any attempt to forecast the future has an element of testing different possibilities and alternative outcomes – scenarios – embedded in that. It’s a question of making important possibilities transparent.  Two tools that might be used in conjunction with scenario analysis—sensitivity analysis or value at risk—are already incorporated into required disclosure. Consider, for example, the SEC’s Item 305 (quantitative and qualitative disclosures about market risk), which requires companies to quantify, through a sensitivity or value at risk analysis, the risk to their positions in market risk-sensitive instruments and then disclose the results.

  1. Unlikely to mislead markets

IHS contends that climate scenario analysis outputs might lead “reasonable investors” to “misprice assets and make suboptimal decisions.”

A core competence of the markets is ingesting new information, which involves an assessment of the materiality and quality of that information.  IHS offers no reason to believe that the markets could not do the same with scenario analysis, as one of many perspectives on the potential investment.

We would also note the asymmetry of IHS’s argument; the market is already exposed to company-developed long-term scenarios of continued, robust fossil fuel demand—if investors are susceptible to “mispricing” companies based on the disclosure of scenarios, the same would have to be said of those disclosures.

One need look no further than US coal company predictions in regulatory filings of a “coal supercycle” that never materialized.  Arguably, those predictions helped fund the leveraging up of US coal company balance sheets that ultimately led to a wave of bankruptcies.[3]

Given this context, it is illogical to assume that additional information on the downside risks would somehow “mislead” the markets.  Asking companies to provide scenario analysis of a plausible downside case is simply a way of mitigating this informational asymmetry.

Finally, we note that if, as IHS argues, companies would likely be re-priced based upon the TCFD recommended disclosures, this is a concession that the information is material and may not be fully incorporated into the markets already.

  1. Commercial sensitivity a balance of priorities

IHS is concerned that scenario analysis would force companies to reveal commercially sensitive information, that is, information that, if disclosed, could result in competitive harm to the disclosing company.

There is no generally accepted definition of commercially sensitive information. However, the notion is that companies should not be required to disclose information that would hamper competition.

We note at the outset that this problem is not specific to climate-related financial disclosure, but is a consideration with any disclosure requirement.

There is reason to believe that the claim of commercial sensitivity has been overused.  For example, Rio Tinto utilizes a proxy price on carbon to assess climate risk, but for commercial sensitivity reasons does not disclose it.[4]  In contrast, BHP Billiton freely discloses their carbon prices.[5]

Concerns about commercial sensitivity are always balanced against the needs of the investing public.  All useful, material information has the potential to be commercially sensitive–if it is useful to investors, it is also likely useful to competitors.

It is not the case, as might be inferred from IHS’s paper, that commercial sensitivity concerns always prevail.  For example, in promulgating its conflict’s minerals rule that required extractives companies to disclose certain project level payments to local governments, the SEC elected to not include an exclusion for commercially sensitive information in the rule, despite heavy lobbying from industry.[6]

Additionally, whatever impact more granular disclosure would have on companies is also mitigated by the fact that for the extractives industries, numerous third party databases with asset and project level cost information already exist, they are just not readily accessible to the public.  Moreover, pricing competitors’ projects in granular detail is a regular part of the oil and gas business, so there is some question as to the marginal impact that a disclosure requirement would have.  It is likely that there is some level of detail above the asset level which meets the information needs of the investing public whilst not revealing more than what competitors already suspect.

Concerns about commercial sensitivity are likely premature, given the voluntary nature of the TCFD recommendations.  Should those recommendations ever be incorporated into mandatory regulation, however, we would suspect that the right balance could be struck between commercial sensitivity concerns and the need for decision-useful disclosure.  Throughout the aforementioned conflicts minerals rulemaking process, for example, the American Petroleum Institute indicated that for disclosure purposes, one potential solution would be to aggregate project level payments to country level. One could imagine a similar level of aggregation of company projects into “break-even” price bands that provide more granularity of the quality of company assets whilst still offering companies a measure of protection.

Robert Schuwerk, US Senior Counsel

Carbon Tracker Initiative

[1] See, e.g., Chevron 2016 10-K at 21-22, ExxonMobil 2016 10-K at 3; ConocoPhillips 2016 10-K at 25; Anadarko 2016 10-K at 35.

[2] Carbon Tracker, Sense & Sensitivity, Maximising Value with a 2D Portfolio (2016).

[3] Carbon Tracker, No Rhyme or Reason: Unreasonable Projections in a World Confronting Climate Change (2016).

[4] Rio Tinto, Climate Change Report, at 23 (2016).

[5] BHP Billiton, Climate Change: Portfolio Analysis, at 11 (2015).

[6] Enforcement of this rule has been suspended because of an adverse judicial decision on other grounds.