The Financial Reporting Impact of Climate Change: Challenges and Opportunities

Climate change is a pressing global issue that has far-reaching implications across various sectors. One area significantly affected by climate change, yet often overlooked, is financial reporting. 

What are climated-related risks?

Climate-related risks refer to the potential negative impact that arise from the changing climate and can affect various aspects of society, the economy, and the environment. These risks stem from the interconnected nature of climate change and its far-reaching consequences. Climate-related risks can be categorised into several key areas:

Physical risks

• Extreme weather events: Increasingly frequent and intense events like hurricanes, floods, droughts, wildfires, and storms can damage infrastructure, disrupt supply chains, and lead to property damage.
• Rising sea level: Rising sea levels can lead to coastal erosion, inundation of low-lying areas, and damage to coastal infrastructure, impacting property values and insurance costs.
• Extreme temperatures: Heatwaves and cold snaps can affect agricultural yields, energy demand, and human health, leading to increased mortality rates and healthcare costs.

Transition risks

• Policy and legal changes: Changes in government policies, regulations, and international agreements aimed at reducing greenhouse gas emissions and promoting sustainable practices can impact industries reliant on fossil fuels or resource-intensive processes.
• Technological disruption: Advancements in clean energy technologies and shifts towards renewable energy sources can render traditional energy sources obsolete, leading to stranded assets and economic losses.
• Market shifts: Changing consumer preferences and investor demands for sustainable products and practices can lead to shifts in demand for certain goods and services, affecting businesses' market competitiveness.

Liability risks

• Legal action: Individuals, communities, or governments affected by climate-related events may seek legal action against companies or entities they deem responsible for contributing to climate change or failing to adequately address its impact.
• Product liability: Companies may face legal challenges if their products or services are found to contribute significantly to greenhouse gas emissions or other environmental damages.

Financial risks

• Asset impairment: Physical risks, policy changes, or technological shifts can lead to the devaluation of assets, particularly in industries vulnerable to climate impacts or those with high carbon footprints.
• Credit risks: Companies heavily reliant on fossil fuels or other carbon-intensive practices could face challenges in obtaining credit or loans as financial institutions become more cautious about lending to high-risk industries.
• Insurance costs: Increasing frequency and severity of climate-related events can lead to higher insurance premiums, making it financially burdensome for businesses and individuals to manage risks.

Supply chain risks

• Resource scarcity: Climate impacts like water scarcity or disrupted agricultural production can disrupt supply chains, leading to shortages of raw materials and increased costs.
• Logistical disruptions: Extreme weather events can disrupt transportation networks, leading to delays in the delivery of goods and services.

Reputational and social risks

• Public perception: Companies that are perceived as not addressing climate-related risks adequately may face reputational damage, leading to decreased consumer trust and loyalty.
• Social license to operate: Companies that are seen as contributing to or exacerbating climate change can face protests, boycotts, or public opposition, potentially impacting their ability to operate in certain regions.

Why are climate-related financial disclosures important?

Climate-related financial disclosures are important for several reasons, primarily centred around transparency, risk management, investor confidence, and the promotion of sustainable business practices. Here's why climate-related financial disclosures are of significance.

Transparency and accountability

Climate-related disclosures provide transparency into a company's strategies, risks, and opportunities related to climate change. This transparency helps stakeholders, including investors, customers, employees, and regulatory bodies, understand how a company is addressing climate-related challenges.

Risk identification and management

Climate-related disclosures allow companies to identify and assess climate-related risks to their operations, supply chains, and financial performance. This enables proactive risk management and adaptation strategies. By understanding and disclosing these risks, companies can make informed decisions to minimise potential financial losses and disruptions caused by climate impacts.

Investor confidence

Investors are increasingly considering environmental, social, and governance (ESG) factors, including climate-related risks, when making investment decisions. Detailed disclosures provide investors with the information they need to evaluate a company's resilience to climate-related challenges. Clear and comprehensive climate-related disclosures can attract ESG-focused investors, potentially leading to increased investment and improved access to capital.

Regulatory compliance

Many jurisdictions are implementing or considering regulations that require companies to disclose climate-related information. By proactively disclosing climate-related financial information, companies can stay ahead of regulatory changes and avoid penalties for non-compliance.

Business opportunities

Climate-related disclosures can highlight business opportunities arising from the transition to a low-carbon economy. These opportunities include investments in clean technologies, energy efficiency, sustainable supply chains, and innovative products and services.

Long-term strategy

Climate change is a long-term challenge that can affect a company's operations over extended timeframes. Disclosures encourage companies to integrate climate considerations into their long-term strategic planning and decision-making processes.

Stakeholder engagement

Meaningful climate-related disclosures foster engagement with various stakeholders. Investors, customers, employees, and communities are more likely to support and collaborate with companies that demonstrate their commitment to addressing climate-related issues.

Competitive advantage

Companies that effectively manage climate-related risks and capitalise on related opportunities can gain a competitive advantage in a changing market. Such companies are better positioned to adapt to evolving customer preferences and regulatory requirements.

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What disclosure frameworks are available for companies to report climate and sustainability related matters?

In recent years there has been significant progress in the development of sustainability reporting standards which includes the Corporate Sustainability Reporting Directive (CSRD) in Europe, the international sustainability disclosure standards by the International Sustainability Standards Board (ISSB) and the climate proposal by the United States Securities and Exchange Commission (SEC).

Some of the key frameworks used globally for sustainability reporting

Task Force on Climate-related Financial Disclosures (TCFD)

The TCFD, established by the Financial Stability Board (FSB), has been a major driver in shaping climate-related reporting. Its recommendations provide a widely recognised framework for companies to disclose climate-related financial risks and opportunities. The TCFD framework encourages companies to disclose information in four key areas: Governance, Strategy, Risk Management, and Metrics & Targets.

Sustainability Accounting Standards Board (SASB)

SASB offers industry-specific standards for disclosing financially material sustainability information. These standards help companies identify and communicate key sustainability issues that could impact their financial performance. SASB's framework includes climate-related metrics tailored to 77 different industries.

Carbon Disclosure Project (CDP)

CDP is a global non-profit that encourages companies, cities, and governments to disclose their environmental impacts. It provides a comprehensive platform for reporting on climate-related information, including carbon emissions, water usage, and deforestation risks.

Global Reporting Initiative (GRI)

GRI's sustainability reporting standards are widely used for disclosing a range of ESG information. GRI Standards are a set of guidelines that can be used to report on a variety of sustainability topics, such as climate change, human rights, and water management.

GRI appeals to a range of stakeholders, including civil society, consumers, employees, investors, and policymakers. GRI is continually evolving its framework to address the evolving landscape of sustainability reporting, including climate-related disclosures.

International Financial Reporting Standards (IFRS)

In June 2023, International Sustainability Standards Board (ISSB) has issued its inaugural standards—IFRS S1 and IFRS S2. These standards are intended to be a comprehensive global baseline of sustainability-related disclosures and are designed to ensure that companies provide sustainability-related information alongside financial statements.

The ISSB aims to harmonise sustainability disclosure, reduce burdens, complexity and confusion for companies. The standards complement existing financial reporting and other standards which address climate-related and other sustainability issues.

EU’s Corporate Sustainability Reporting Directive (CSRD)

The directive was released in December 2022 and is applicable to enterprises listed within the EU or those with substantial operations within its boundaries, regardless of their global location. The directive mandates organisations to disclose aspects concerning sustainability, including climate change, biodiversity decline, and human rights.

It necessitates linking these aspects with the company's financial prospects and vulnerabilities, along with their effects on both the society and the environment. Furthermore, entities have to disclose strategies and plans for managing sustainability performance and financial performance entities.

Climate reporting developments in Singapore 

In Singapore, climate reporting requirements has evolved significantly in recent years to address the pressing need for transparency and accountability in combating climate change. The Singapore government has introduced a series of regulatory initiatives to encourage businesses and organisations to assess and disclose their environmental impact.

Under the Carbon Pricing Act, large emitters are required to report their greenhouse gas emissions annually, and they may face a carbon tax if they exceed specified emissions thresholds.

Additionally, the Singapore Exchange (SGX) introduced a phased approach to mandatory climate reporting based on the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).

A proposal was also put forth by Singapore's regulatory bodies, namely the Accounting and Corporate Regulatory Authority (ACRA) and Singapore Exchange Regulation (SGX RegCo), which requires that both public and sizable private companies in Singapore must furnish climate-related disclosures in adherence to the disclosure standards of the ISSB.

Based on recommendations from the Sustainability Reporting Advisory Committee (SRAC), a collaborative effort by these two regulators, this initiative establishes a roadmap for sustainability reporting for Singaporean enterprises. According to the proposed guidelines, commencing in the fiscal year 2025, climate-related disclosures will be obligatory for all listed entities, including those incorporated abroad, as well as business trusts and Real Estate Investment Trusts (REITs).

Non-listed companies with annual revenues exceeding $1 billion are expected to commence climate-related reporting in FY2027.

Furthermore, regulators intend to assess the feasibility of extending these climate disclosure requirements to non-listed firms with revenues of at least $100 million, with reporting anticipated to begin around FY2030, following a review in 2027.

The proposals also include a stipulation for external assurance on greenhouse gas (GHG) emissions reporting within Scope 1 and 2, with listed issuers expected to comply from FY2027 and large private companies from FY2029.

These developments reflect the growing recognition of the importance of climate-related information in financial reporting and the need for standardised reporting to ensure transparency and comparability.

It's essential to stay updated with the latest developments in this rapidly evolving field to ensure compliance and alignment with best practices in climate-related reporting.