What are climate-related financial disclosures? An ultimate guide for property-related assets

Disclosing climate-related financial risk is the accounting challenge of the decade.

In the UK, premium listed companies and financial institutions are now required to disclose on how they identify, assess, and manage climate-related risks and opportunities. Such risks arise from physical hazards, such as flooding, as well as the regulatory, technological, market, or reputational challenges associated with transitioning to a Net Zero economy. Investors (and customers) can now use these disclosure reports to ensure they only invest in (or buy from) organisations that align with their own ESG strategy or principles.

So what does this mean for the real estate market? Mandatory disclosures have an immediate impact on eligible mortgage lenders, real estate funds, asset managers, and other businesses with property-related assets. Real estate is the world’s largest asset class, but it is also one of the slowest to decarbonise, contributing 22% of emissions in the UK alone according to Kamma’s analysis. These businesses need to provide accurate, timely, and transparent disclosures on emissions so that the sector can decarbonise in line with the government’s Net Zero targets.

This guide equips companies and financial institutions with the what, where, who and why of climate-related financial disclosures and how to overcome property data challenges.

What will it cover?

1. What are climate-related financial disclosures?
2. Where do climate-related financial disclosures apply?
3. Why were climate-related financial disclosures introduced?
4. Who has to make climate-related financial disclosures?
   • Task Force on Climate-related Financial Disclosures (TCFD) Framework
   • International Sustainability Standards Board (ISSB) framework
   • The Partnership for Carbon Accounting Financials (PCAF) standard
   • Regulation in the UK
5. The data behind financed emissions disclosures in the UK property sector
6. About Kamma

What are climate-related financial disclosures?

Climate-related financial disclosures are a reporting mechanism that exposes information about a company’s business activities, financial performance, governance practices, operating strategy and future direction in regard to climate-related risks and opportunities. They’re underpinned by a plethora of government-backed regulations and standards.

The outcome of these disclosures is more consistent and aligned information coming from the business sector. This can be used to inform investment decision-making, policy, and mobilise private capital towards Net Zero targets. Disclosures alone won’t drive reductions in carbon emissions or improvements to governance practices, but by making it a legal obligation, companies are held to higher standards of transparency and accountability on climate performance.

Where do climate-related financial disclosures apply?

Eventually, climate-related financial disclosures are expected to be adopted worldwide. According to Carbon Cloud, the markets mandating disclosures by 2025 will represent 56% of global GDP.

Many companies already voluntarily disclose climate performance, but a growing number of countries around the world enforce mandatory disclosure requirements for companies over a certain size. The UK, Japan and New Zealand now ensure that the largest publicly traded companies disclose TCFD-aligned climate information, and the US and the EU have both approved similar mandates.

Outside of these nations, the tide is already turning. Belgium, France, Chile, Canada, Hong Kong, Singapore, Switzerland and Brazil all have bills or proposals in the works, and it’s likely that mandates will appear in other markets over the coming years.

Why were climate-related financial disclosures introduced?

In 2021, G7 countries formed plans to force companies and financial institutions to share their exposure to climate-related risk and opportunities. The aim was to safeguard the financial system from climate change shocks. By highlighting what can happen when large companies aren’t required to disclose key data, the 2008 financial crisis exposed the importance of stress tests and regulation in capital markets. Now, much in the same way, the climate crisis requires governments around the world to take another look at the data companies disclose with the aim of accelerating progress towards Net Zero.

Investors now recognise that climate risks are financial risks, and they’re doing their due diligence on companies to make sure they’re up to standard. A PwC report showed that 79% of investors agree that a company’s approach to ESG risks and opportunities is an important factor in investment decision-making.

While it is difficult to measure, manage, and analyse climate performance, often because of poor quality data, it is useful for investors to differentiate between safe and risky investments. This means that disclosures must be built on comparable, high-quality data.

Much of the momentum of disclosures is driven by heightened stakeholder demand, which itself is driven forward by three key dynamics:

Push towards standardisation. The lack of comparable climate data across industries blinds investors and financial decision-makers. Disclosures aim to standardise corporate climate data to make it understandable and straightforward to investors and regulators.

Promote national accountability. Countries that made climate commitments at COP21 need support from industry to fulfil these commitments. High-quality data is essential to identifying climate risks and managing them effectively.

Institutionalise sustainable business practices. Environmental impact is now critical to a company’s viability, and disclosures help to hold companies accountable and give investors confidence in the future of a company. Higher standards also prevent greenwashing, which describes the practice of using misinformation to exaggerate a company’s sustainability or environmental position.

Who has to make climate-related financial disclosures?

As disclosures become increasingly important to the stability of financial markets, a broad set of regulations are being introduced by governments, regulators and standard-setting bodies to align the business sector. Among these, TCFD is the most prominent framework offering guidance on regulation, but the International Financial Reporting Standards’ ISSB and the UK’s Transition Plan Taskforce (TPT), among others, will also play a major role. These nascent frameworks, standards and proposals align with the TCFD recommendations but categorise information and define material risk – that is, risk to a business’ operations – differently.

Task Force on Climate-related Financial Disclosures (TCFD)

Coinciding with COP21 and the signing of the Paris Agreement in 2015, the TCFD framework was created by the Financial Stability Board (FSB) to help companies and other organisations form consistent disclosures on climate-related financial risks and opportunities. These were, at first, designed to elicit voluntary disclosures with useful information to investors, lenders, and underwriters in understanding material risks.

The latest set of TCFD recommendations was published in 2017 and laid out a framework of four pillars – governance, strategy, risk management, and metrics and targets – with eleven corresponding disclosure recommendations.

To date, TCFD is the most popular framework used for reporting. It serves as a crucial starting point for companies required to formulate climate governance procedures or create climate-related targets and goals. It’s also used to create policy mandates on disclosures and is acting as a key reference point for the formation of ISSB framework and other disclosures standards.

International Sustainability Standards Board (ISSB) framework

In the wake of the 2008 financial crisis, the IFRS set the international standard for the accounting practices of public companies. Not only did this de-risk and shore up the markets, but it also made the financial statements of companies consistent, transparent, and easily comparable around the world. The climate crisis is now getting the same treatment. 

First announced by the IFRS at COP26 in Glasgow, the ISSB has now carried out a 120-day consultation during Q2 of 2022 on two exposure drafts covering both climate and general sustainability-related disclosures. The board’s aim is to give international investors with global investment portfolios high quality, transparent, reliable, and comparable reporting standards. The feedback was reviewed in late September and the proposals are currently being amended. Once adopted by the international regime, it will commit the business sector to stricter requirements, so preparation must begin now.

The Partnership for Carbon Accounting Financials (PCAF) standard

The UK guidelines specify that companies need to disclose Scope 1 and 2 emissions with Scope 3 remaining optional in the first year. However, the ISSB requirements will most likely extend to Scope 3 emissions, irrespective of whether they are material or not. It will also require forward-looking analysis under different scenarios for decarbonisation. Data collection for Scope 3 is often more complicated because it requires sourcing data from external customers and suppliers, so preparation must start early.

Banks and other financial institutions generally produce low Scope 1 and Scope 2 emissions, but their Scope 3 exposure is very high due to ‘financed emissions’. These are emissions generated as a result of financial services, investments and lending by investors and organisations that provide financial services. For mortgage lenders or property portfolio owners, Scope 3 emissions can easily dwarf all other emissions they must report on. Overlooking financed emissions accelerates climate change and exposes financers to reputational and financial risks. 

Initially launched in 2015, the Partnership for Carbon Accounting Financials (PCAF), which aligns with TCFD and other frameworks, is designed to enable financial institutions to consistently measure and disclose the GHG emissions financed by their investments and lending activities, including commercial real estate, mortgages and project finance. A PCAF quality score is calculated to represent the accuracy of the emissions, which is submitted as part of the disclosure. Submitting an objectively higher PCAF score offers more confidence to both regulators and investors. 

Regulation in the UK

In October 2021, the publication of the UK Government’s Net Zero Strategy made them the first G20 member to adopt mandatory TCFD-aligned disclosure requirements. While TCFD and eventually ISSB play a key role in setting standards for regulation, they do not determine who is required to disclose what and when. This is decided by government-backed regulatory bodies that pick and choose suitable disclosure requirements for their jurisdiction. 

The Financial Conduct Authority (FCA) requires premium list companies to include a statement in their annual financial report setting out whether they have included climate-related financial disclosures, and if not, why not. The so-called Listing Rule 9.8.6R(8) applies to these companies for financial years starting on or after January 2021.

Since April 2022, more than 1,300 of the country’s largest private companies, LLPs, banks,  and insurers incorporate TCFD-aligned disclosures into their annual reports. Under guidance of the Department for Business, Energy and Industrial (BEIS), these rules now apply to the UK’s largest traded companies, banks and insurers, as well as private companies with over 500 employees and/or £500 million in turnover.

The UK’s Transition Plan Taskforce (TPT), also launched in April 2022, has published guidance on how to develop and implement gold-standard transition plans that reduce risk and strengthen disclosures. This body will in no doubt be set up to accommodate increasingly higher levels of scrutiny that companies will experience, such as when the ISSB’s forthcoming global baseline standards are adopted into legislation.

The data behind financed emissions disclosures in the UK property sector

The property sector needs to rapidly decarbonise. In its Autumn Statement, the UK recommitted to reducing the country’s final energy consumption from buildings and industry by 15% by 2030 against 2021 levels. 

One of the biggest challenges that the property sector faces is in the collection and modelling of data relating to the physical and transitional risks. For businesses and institutions that own, finance and invest in property portfolios, wrongly disclosing on financed emissions not only leads to misrepresentative reporting, but also mischaracterises the risk exposure of the book back.

One such challenge is Energy Performance Certificate (EPC) ratings. These provide valuable information about the energy efficiency of homes, including how much energy they use per square metre and what level of carbon dioxide emissions they create. Ratings are given from A to G – with A being the most efficient, and G the least.

Homes in the Private Rented Sector (PRS) have been required to reach the E rating (or above) since 2018, and from the end of 2025 will be required to meet C or above for all new tenancies if the new Minimum Energy Efficiency Standards, or MEES, is passed into law. Homeowners must also provide an EPC rating when selling a property to another residential buyer, but there are no current minimum requirements to meet for the sale to take place.

The EPC also provides a potential rating indicating how much more energy-efficient a home could be with retrofitted measures such as insulation or improved fittings. While the given rating is based on standard assumptions about energy use and occupants, introducing a margin of error, an EPC rating nevertheless provides property-level data about housing stock in the UK that could be crucial for the impact of climate risk on their customers.

However, there are several challenges associated with using EPC data to disclose financed emissions:

Inaccurate location data

The lack of standardisation in how constituent parts of an address are recorded can lead to around 20% of properties not being accurately identified; a considerable blind spot.  This challenge is compounded by poor EPC coverage, whereby 47% of UK properties do not have an active certificate. Together these challenges leave substantial gaps in portfolio assessment. Inability to geolocate properties means that a greater proportion of emissions in the portfolio are derived through modelling, leaving a greater margin for inaccuracy.

Outdated methodology

EPC assessments, and much of the publicly available property data based on them, operate using a decade-old methodology. Everything from the carbon intensity of electricity to the expected fuel saving from solar panels is based on 2012 data, accounting for none of the changes in the market, or the recent spike in the cost of energy. It also means that emissions from electricity are usually overstated by a threefold average. The grid has decarbonised significantly over the last ten years. Not accounting for the impact this has on carbon intensity factors leads to financed emissions and risk disclosures that are significantly overstated, delivering worse PCAF scores. 

It is also worth considering how many homes will require retrofitting to meet energy efficiency standards (and the associated costs). For example, data makes it possible for a lender to gauge what proportion of its borrowers will be likely to fall into mortgage impairment. Inaccurate data can then lead to miscalculated projected losses incurred by mortgage lenders, creating more volatility within the mortgage lending market.

Calculating emissions for the purpose of disclosures means collecting more data on emissions, understanding weaknesses in data sets, and recalibrating for accuracy. It’s of paramount importance that businesses in this space are able to understand the risks involved and use accurate data to represent their property-assets truthfully and reach more informed decisions.

About Kamma

We recommend that companies begin to prepare for mandatory disclosures now. Gathering, managing, and modelling accurate data can take time to bake into company processes, and many companies will need them to be fully functional and ready for the 2023 reporting year.

Kamma has built the country’s most advanced dataset, creating an environmental profile for every property in the UK. Our clients benefit from the most up-to-date data available to file disclosures, which we can help apply to the following use cases:

1. Transition and physical risk analysis
   • Assess energy efficiency and MEES compliance of a mortgage book or property portfolio
   • Integrate CBES and NGFS scenarios into analysis
   • Assess flood, subsidence, and coastal erosion risk
   • Demonstrate effective management of transition risk to PRA in line with SS 3/19
2. Benchmarking
   • Score green assets to qualify more loans for green securitisation and ESG investment 
   • Benchmark emissions footprint against industry, market and segment data
   • Benchmark progress over time
3. Reporting
   • Report on financed emissions metrics in line with 2020 PCAF Global Greenhouse Gas Reporting standards
   • Improve PCAF scores with a truer representation of the portfolios’ carbon footprint
   • Comply with ISSB, FCA, and PRA requirements with accurate data as the foundation of the optimum transition to Net Zero
4. Road to Net Zero
   • Report on the carbon emissions of a property portfolio, including Scope 1, 2 and 3 emissions, and embodied carbon
   • Segment the major sources and opportunities to improve emissions
   • Articulate a data-driven road to Net Zero

If you want to know more about climate-related financial disclosures, or how Kamma overcomes challenges associated with property data, get in touch now and sign up to our mailing list to stay up to date.