TCFD disclosures in focus: Best practices and benchmarking for asset management companies

Environmental, Social, and Governance (ESG) disclosures are an umbrella term referring to the practice of providing non-financial information about a company’s impact and performance in the following areas:

• Environmental refers to the company's impact on the environment including metrics such as carbon emissions, biodiversity and waste management.
• Social encompasses the company's relationship with employees, customers, those working in its suppliers  and communities affected by its activities.
• Governance covers the systems the company sets up to govern the environmental and social matters including internal practices such risk assessment systems, board composition and remuneration to executives and how it monitors them.

ESG disclosures are often expected to use “double materiality” which considers both the effect a company has on the society and environment as well as the impact on its own financial performance.

In contrast, TCFD disclosures specifically focus on just climate-related risks and opportunities, offering a framework for companies to disclose the financial impacts of climate change. While ESG disclosures aim to present a holistic view of sustainability, TCFD disclosures are designed to provide clear and comparable information about how climate-related risks and opportunities are managed and integrated into financial planning and how those risks affect the company which is reporting. 

TCFD disclosures tend to use a “single materiality” which means considering how the climate-related risks and opportunities impact a company’s financial performance and position.

The Financial Conduct Authority (FCA) listing rules mandate that all commercial companies with listed equity must disclose information in line with the TCFD framework [2].

The TCFD framework is principles-based. The FCA’s rules require that in-scope reporting entities must apply a ‘comply or explain’ basis [2] for disclosure; complying with each of the required TCFD’s recommended disclosures; or explaining non-compliance against each of the requirements [3].

Companies are required to report the extent to which they are aligned with the TCFD’s recommended disclosures. This is often as referred to as a “Statement of compliance” which should be clear and concise and easy to identify in the annual report. The statement of compliance should specify [3]:

• Which recommendations and disclosures have been adhered to, and which have not.
• For those not complied with, a brief explanation for the non-compliance and when or under what circumstances the company expects to achieve compliance.

The TCFD framework is structured around four key pillars [4]:

• Governance: This pillar focuses on the organisation's governance around climate-related risks and opportunities. It includes the board's oversight and management's role in assessing and managing these risks and opportunities and how they are integrated into the company’s strategy.
• Strategy: This pillar addresses the actual and potential impacts of climate-related risks and opportunities on the organisation's businesses, strategy, and financial planning. It involves describing the climate-related risks and opportunities identified over the short, medium, and long term, how they affect the company and the resilience of the organisation's strategy under different climate scenarios.
• Risk Management: This pillar involves disclosing how the organisation identifies, assesses, and manages climate-related risks. It includes the processes for identifying and assessing these risks (rather than the list of risks identified), managing them, and integrating them into the organisation's overall risk management.
• Metrics and Targets: This pillar focuses on the metrics and targets used to assess and manage relevant climate-related risks and opportunities. It includes disclosing the metrics used, such as greenhouse gas (GHG) emissions, and the targets set by the organisation to manage climate-related risks and opportunities.

The key challenges identified by FRC on TCFD reports they reviewed were with regards to[4]:

1. Clarity of Statements of Compliance: The FRC identified that many companies struggled with providing clear statements of compliance with the TCFD framework. Amongst issues identified were

• companies not reporting in line with TCFD despite being in scope,
• providing unclear disclosures that did not identify areas of non-compliance,
• relying on references to information disclosed outside the annual report,
• not explaining steps being taken to address areas of non-compliance with an expected timeframe,

2. Conciseness and Specificity: The FRC expects more concise and company-specific information as opposed to boilerplate disclosures. Encouragingly the FRC noted that less can, in some cases be more and that material information should not be obscured by less important detail.

The FRC also challenged companies to explain inconsistencies between their disclosures and TCFD framework, or a lack of clarity in relation to the following pillars:

• strategy, including climate-related risks and opportunities,
• metrics and targets.

Outside of the TCFD report, the FRC challenged companies over the level of prominence given to green initiatives in the strategic report and the consideration of climate change in impairment assumptions.

The TCFD framework has not stipulated any timeframe as short, medium and long-term but instead advises the companies to define their own time frames. The time frames chosen by the companies should be based on factors such as the life of their assets, the profile of the climate related risks they face and the sectors and geographies in which they operate[5].

Benchmarking insight: We have looked at 21 FTSE-listed asset management company financial statements for 2023. While some companies classify risks into short, medium or long-term, this classification is often arbitrary or without definition of what each of these terms mean. The best disclosures of climate-related risks not only include a clear definition of what timeframe is deemed as “short”, “medium” or “long-term” but explain how this is linked to the company’s operations and assets. We encourage companies to look at their overall business model and outside the current portfolio when assessing long-term risks.

Within the United Kingdom, the information is covered by the requirements for external auditors to review information contained within the Strategic and/or Directors’ report and responsibilities relating to the audit of ‘other information’. There is no requirement to obtain third-party limited or reasonable assurance on climate-related disclosures in the financial statements[5].

Benchmarking insight: While there is no requirement for independence assurance, from our study, we noted that 10 out of 21 companies have engaged independent third parties to provide limited assurance on the data in their climate-related disclosures in the financial statements. According to the latest study published by FRC, 57% of the FTSE 350 companies obtained assurance on their sustainability disclosures compared to just 47% of asset management FTSE companies in our study [8].

When it comes to metrics and targets, the TCFD framework provides specific guidance for asset managers. According to the recommendations, asset managers should [6]

1. Describe metrics used to assess climate-related risks and opportunities in each product or investment strategy.

2. Where appropriate, asset managers should provide metrics considered in investment decisions and monitoring.

3. Describe the extent to which their assets under management and products and investment strategies, where relevant, are aligned with a below 2°C scenario.

4. Disclose GHG emissions for their assets under management and the weighted average carbon intensity (WACI) for each product or investment strategy in line with Global GHG Accounting and Reporting   Standard for the Financial Industry developed by the Partnership for Carbon Accounting Financials (PCAF Standard) or a comparable methodology. The FCA’s expectations have increased in this aspect as compared to the period following initial implementation of the framework[9].

Benchmarking insight: In our benchmarking study, we noted that majority of the asset management companies report WACI using a measure of tCO₂e per million of revenue. From the 15 companies that reported WACI using tCO₂e of Scope 1 and 2 emissions per million of revenue of the portfolio company, the average was 135 tCo₂e per million of revenue.

There is a huge contrast between traditional financial reporting and the requirements of climate-related reporting.  Climate-related data is less under the company’s control and generally more uncertain compared to financial reporting information. Furthermore, data collection seldom yields full coverage as some investees or investors may not reply to survey requests and public data is patchy. This leaves reporters having to produce estimates for missing data and make judgements about the accuracy, consistency and reliability of data. Another challenge often faced by companies is that data from investees is not available in time for the investors’ own reporting and thus data used is for earlier years.

The key to navigating this challenge is clear communication in the climate-related disclosures regarding the quality of data. As with any reporting, transparency is key to credibility. Relevant, detailed and high-quality explanations about the estimates used, the judgements made, and the time periods covered by the data will manage expectations and offer some protection from liability and greenwashing claims. We see that some of the best TCFD reports show how data quality and coverage vary between each product of investment strategy.

Benchmarking insight: Under PCAF standards, a data quality score can be created and disclosed to provide a comparable benchmarking of data quality. This score ranges from 5 to 1 with 1 being the highest data quality score [7]. In our benchmarking study, we noted that only 4 asset management companies disclosed their PCAF data quality score. Their average data quality score was 2.6 – how does your company compare to the average? 

Some other metrics that help the users assess the quality of data can include information which indicate the following by asset classes or geographies: the proportion of assets covered and the periods for which data applies. It is also considered best practice to disclose whether systems to improve data quality are being considered. 

The feedback from FRC re-emphasises that more is not always better. The reporters are encouraged to think critically about the quality of the information reported as opposed to volume. More concise and company-specific disclosures are needed instead of generic ones. Additionally, the FRC stressed that important information should not be hidden by too much detail.

The FRC has been critical of blanket statements such as a commitment to being 'carbon neutral by 2050' but without providing any details or targets to help users understand how this will be achieved. Companies should tailor their risk disclosures to their specific circumstances, avoiding generic or blanket statements. This involves conducting a thorough analysis of the risks that are truly relevant to their operations and providing detailed, company-specific information. For example, for asset management companies we often see that the risk is centred around loss of readers with a sustainability focus. Companies can improve disclosure in this area by indicating the classes of investors they consider in this respect and the proportion of funds under management they represent.  This would help investors to assess how the sustainability measures of the company (or lack of these measures) could impact the attraction and retention of funds. This level of detail is often lacking in reports, but it is essential for meaningful and credible disclosures.

Benchmarking insight: As part of the benchmarking study, we collected data on the number of pages and the level of compliance with TCFD recommendations (marked out of 11 for the recommended TCFD disclosures). However, we noted that companies have demonstrated compliance with all 11 recommendations with as few as 11 pages while the average number of pages of TCFD report in our study was 28. The data suggests that out of the companies that stated full compliance with TCFD disclosures, 57% did so with less than 30 pages of disclosure. Therefore, this further reaffirms that quality is to be prized over quantity.