In contrast, improved corporate climate governance can reduce risks and unlock opportunities
The transition towards a low-carbon, climate-resilient economy is increasingly shaping business globally and across the economies where the EBRD invests. There is now broad recognition that climate change is a systemic source of risk to business and financial stability, and that companies need to strengthen their corporate climate governance in order to adjust to this shifting market context.
Yet the majority of companies in emerging markets have little visibility on what their climate risk exposure might be. We see this in the gulf between levels of governance and disclosure of climate-related risks and opportunities in developed and emerging markets.
Two thirds of FTSE 100 companies mention the Task Force for Climate-Related Financial Disclosures (TCFD) in their reporting and, as of mid-September, 82% of the 2,495 TCFD supporters came from developed markets. This compares to just 16% from emerging markets with companies from a handful of countries dominating the emerging market share. Similarly, of the 1200 companies that have reported using the SASB disclosure framework 84% are from developed markets and just 14% from emerging markets.
The disparity in understanding is also visible in recent surveys. While 91% of chief risk officers from leading global banks view climate change as the top emerging risk over the next five years, only 43% of respondents to a recent EBRD survey of banks in our economies consider the climate impacts of their portfolios as a potential source of risk.
This governance and disclosure gap is concerning for a number of reasons.
The push from regulators and investors for greater transparency and comparability in climate-related financial disclosures is accelerating fast. Regulators are introducing mandatory disclosures to ensure climate-related risks do not become a systemic risk to the financial system. Climate-related reporting is or will soon become mandatory in a number of jurisdictions, including France, New Zealand, Switzerland, the UK, China and Brazil.
Elsewhere, the EU Sustainable Finance Strategy mandates the information financial and non-financial companies must disclose about their environmental performance and the US plans to incorporate climate-related financial risk into regulatory and supervisory practices through improved financial disclosures.
The process of developing global standards building on these various initiatives is underway. A recent G7 Finance Ministers and Central Bank Governors’ Communiqué supported moving towards mandatory climate-related financial disclosures for companies, based on the TCFD framework and welcomed the efforts of the IFRS Foundation to develop a global baseline standard. IFRS accounting rules for the financial statements of public companies are already required for use by more than 140 countries. IFRS will now look to extend these rules to include climate while ensuring compatibility between its own approach and those of different jurisdictions.
Elsewhere, asset managers and institutional investors are taking climate-related governance and disclosures increasingly seriously. Their demands for information on material financial risks and opportunities arising from climate change and climate action are both a way to ensure they make informed investment decisions and a response to clients’ preferences about where their money is invested. At the same time, concerns about greenwashing are growing and scrutiny of the claims made for a whole range of products is intensifying.
The governance and disclosure gap has real near-term implications for emerging market corporates’ access to and cost of capital. Credit ratings agencies regularly upgrade or downgrade entities based on their exposure to and management of climate-related risks and opportunities. Asset managers are threatening to vote against management and board directors of corporates making insufficient progress on disclosures and may ultimately divest.
Over the medium-term, the worry is that a lack of governance and disclosure may lead to a climate Minsky moment. In other words, that an abrupt realisation of the risks accumulating in emerging markets causes a rapid revaluation of public companies’ creditworthiness, destabilising financial systems and further weakening countries’ ability to respond to the climate crisis.
In contrast, investing in better governance and financial disclosure can reduce risk, increase corporate valuation and enhance access to finance. Research suggests that for emerging market corporates looking to respond to investor demands for good governance and for investors assessing governance quality, it is disclosure that best predicts value. Given their economies exposure to climate risks and the cost of corporate governance regulations for firms, this indicates that emerging market regulators may do well to focus on climate-related financial disclosures.
Even if national investors continue to be main source of finance for many companies, strengthening corporate climate governance can help them better assess, manage and disclose information about climate-related risks and opportunities, and integrate these actions into their risk management and business strategies.
The EBRD has a key role to play as a bridge between major investors in developed markets and emerging markets corporates looking for finance. Improving corporate climate governance among our clients is an important aspect of our climate activities as set out in our Green Economy Transition Approach 2020-25 and Climate Ambition Statement.
As an organisation committed to driving economic growth across the economies where it operates and to aligning all of its investments with the goals of the Paris Agreement, the EBRD is duty bound to consider the climate impact of all our investment decisions and to help our clients to better understand the associated risks. This is particularly true in those regions and sectors most in need of increased levels of public and private investment where the risks from the already changing climate are higher and the transition to a low-carbon and climate-resilient future is more challenging.
We will do this by expanding our work through a new Corporate Climate Governance Client Advisory Facility supporting financial and non-financial companies to strengthen their corporate climate governance practices and to access the capital markets through climate bonds and equity investments. We will continue to engage with relevant policymakers and supervisory bodies including through international fora such as the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), the emerging regulatory regime for EU sustainable finance, and the G20 Sustainable Finance Working Groups.
Contact us to find out more about the facility:
Craig Davies, Head of Climate Resilience Investments, DaviesC@ebrd.com
Marta Modelewska, Climate Resilience Investments, ModelewM@ebrd.com