How will understanding climate risk move you from ambition to action?

In a trend that reflects last year’s Barometer, certain markets and sectors continue to push ahead with their climate-related disclosures, while others work to catch up.

From a market perspective, Japan, South Korea, the Americas and most of Europe are all performing strongly and leading the way in terms of the quality of their disclosures. This is unsurprising, since these countries and regions can draw on several years of mandatory TCFD disclosures, which have readied companies for the ISSB’s more detailed requirements.

On the other hand, the Middle East and Southeast Asia have improved their performance compared with last year and positioned themselves for further progress but are still trailing behind. Governments have an opportunity to strengthen their climate disclosure requirements to accelerate progress. By adopting mandatory climate disclosure requirements, they can potentially change the currently low scores to a significant extent.

As for sectors, this year’s report once again highlights that those companies with the most exposure to transition risk tended to post higher scores for their disclosures, in terms of both quality and coverage. Energy tops the league for quality and coverage, though its quality performance is largely matched by financial institutions such as exchanges, other financial services providers, ratings agencies and credit bureaus, whose score has risen notably year-on-year, from 46% to 54%. In fact, quality has improved across the board, with the biggest changes seen in real estate, mining, agriculture, and materials and building, as well as financial institutions. The shift in scores comes from stakeholders, such as regulators and investors including financial institutions, putting pressure on businesses in carbon intensive sectors to disclose their decarbonization plans and progress.  From the point of view of financial institutions, funding drives the bulk of their businesses, and investors are putting pressure on them to reduce their brown lending.

Alongside the improvement in quality, there has also been a steep year-on-year rise in the disclosure coverage score. Coverage has climbed from 84% in 2022, to 90% in 2023.  Nevertheless, some pressing concerns remain, particularly around the granularity and quality of disclosures, and whether the regulatory environment around disclosures is yet driving genuine action beyond the reporting itself.

The average score for the quality of governance disclosures has increased from 46% to 52% since 2022 – partly due to regulatory pressure – but that figure is still too low. Transition planning also remains patchy, with only just over half (53%) of companies providing some kind of coherent plan. The research found that companies are still more focused on risks than opportunities when it comes to climate disclosures. While 77% of those assessed have conducted analyses on risk, just 68% have done so on opportunities, a slight improvement on 2022.

In addition to companies’ disclosure performance against TCFD recommendations, this year’s research also included three core elements that will shape the reporting landscape for the next few years.

ISSB preparedness

For the first time, this year’s research looked at companies’ readiness for meeting the requirements for IFRS S2 Climate-related Disclosures. These findings stood out:

• In relation to governance, companies are adopting the increased ISSB disclosure requirement and disclosing which skills and competencies are required at board level to oversee climate-related strategies.
• Looking at strategy, companies are moving toward additional disclosure around scenarios that include detailed analysis and its inputs. In addition, companies have started to include value chain emission reduction targets within their overall reduction targets.
• From a metrics and targets perspective, companies are moving toward disclosing their Scope 3 emissions for the most material categories.

Leading companies are typically looking at how climate could impact their business strategy, rather than using reporting frameworks solely for disclosure. Climate issues are becoming core to top-line business strategy, and companies that have understood the links between climate risk and their business growth strategy are well positioned to address the new requirements of IFRS S2. Examples of pacesetter companies that are using climate disclosures to drive strategy can be found in the full report.

Transition planning

While greater engagement with sustainability disclosures is still needed, companies are now faced with a stark challenge: to design and implement an effective transition plan that takes into account real-world scenarios and commits real resource to the effort.

Yet the Barometer shows that only 53% of the surveyed companies are providing disclosure against some kind of transition plan. This figure should be significantly higher since a well-structured transition strategy helps companies to stay in line with, or ahead of relevant, policy goals for the organization.

Climate risk reflection in financial statements

Companies face heightened demand for greater scope and detail in their climate-related disclosures. Therefore, the most pressing question for them in the coming years will inevitably center on how their risks and strategic responses are reflected in their financial statements. The 2023 Barometer shows that just over a quarter of companies (26%) are including the quantitative impacts of climate-related risks in their financial statements – which reflects the general trend for climate strategy and risk management to remain largely separate from corporate reporting. This is set to become a tension point since reflecting climate risk in reporting should not be a mere form-filling task, but a comprehensive, forward-looking effort to understand the anticipated financial impact. As such, it should be assessed in the context of the company’s value chain and wider market dynamics.

The overall picture painted by the EY Global Climate Risk Barometer should ring alarm bells. Big year-on-year increases in certain statistics are rightly a cause for celebration, but for many sectors and geographies the improvement is from a low baseline, and progress is too slow.

The report identifies three actions that companies should take urgently:

1. Shift the mindset from burden to action: The “pacesetter” companies use disclosure to drive behavior rather than see it as a compliance burden. Detailed, coherent and measurable data in disclosures is typically matched by the rigor and energy around strategy and action.

2. Master the data to serve your carbon agenda: Use data to drive action and reduce emissions. Put in place governance structures to harness and manage data in such a way that it is always integrated into strategic and operational risk management.

3. Elevate the discussion to drive impact: To truly inform the overall business strategy, address climate data and related impacts at board level. This, in turn, allows leaders to take a holistic approach that encompasses operations, people, supply chain and technology.