Climate-Related Disclosures

Climate-Related Disclosures are official reports and statements from companies that explain how climate change could impact their business, and vice-versa. Think of it as a company's “climate report card.” For decades, investors mainly looked at financial statements like the income statement and balance sheet. But in a world grappling with rising temperatures and shifting regulations, a company's exposure to climate change is a very real financial risk. These disclosures aim to make those risks transparent. They cover a wide range of information, from a company's direct greenhouse gas emissions (GHG) to its strategy for a low-carbon future. The goal is to provide investors, lenders, and insurers with consistent and comparable information to make better decisions. Rather than being a fluffy, feel-good exercise, these disclosures are becoming a critical component of understanding a company's long-term health and intrinsic value.

A core tenet of value investing is to understand a business inside and out and to assess its long-term prospects. Climate-related disclosures are a new, powerful lens for doing just that. They help you uncover hidden risks and opportunities that won't always appear on a traditional balance sheet. Ignoring them is like trying to drive a car by only looking in the rearview mirror. These risks generally fall into two buckets:

• Physical Risks: This is the most straightforward category. It includes the direct impact of climate change on a company's assets. Think of a coastal factory threatened by rising sea levels, a farm's crop yield devastated by drought, or supply chains disrupted by more frequent and intense hurricanes. These events can destroy billions in value and cripple operations.
• Transition Risks: These are the financial risks that come from the world's shift toward a greener economy. They are often more subtle but can be just as damaging.
  1. Policy and Legal: Governments might introduce a carbon tax, making a company's operations more expensive. New regulations could mandate costly upgrades or even ban certain products.
  2. Technology: A company betting its future on fossil fuels could see its assets become worthless as renewable energy technology becomes cheaper and more efficient. These are known as stranded assets.
  3. Market and Reputation: Consumer preferences are changing. A company seen as a “polluter” might lose customers to more eco-conscious rivals.

By carefully reading these disclosures, a value investor can better estimate a company's true, long-term earning power and avoid falling into a “value trap” where a cheap stock is cheap for a very good, climate-related reason.

For years, reporting was a bit of a free-for-all, with companies using different methods, making comparisons difficult. Thankfully, things are getting standardized. Here are the key players you should know.

The Task Force on Climate-related Financial Disclosures (TCFD) was a game-changer. Created by the G20's Financial Stability Board, its recommendations created a foundational framework that has been widely adopted by companies voluntarily. It encourages companies to structure their disclosures around four core pillars:

• Governance: Who is overseeing climate risks and opportunities? Is the board of directors involved?
• Strategy: What are the actual risks and opportunities the company has identified, and how will they affect the business and its financial planning?
• Risk Management: How does the company identify, assess, and manage these climate-related risks?
• Metrics and Targets: What data is the company using to measure its risks? What are its targets for reducing emissions or increasing renewable energy use?

The TCFD's structure is logical and has become the blueprint for most new mandatory reporting rules.

To end the “alphabet soup” problem, the IFRS Foundation (the folks behind global accounting standards) launched the International Sustainability Standards Board (ISSB). The ISSB has released its first set of standards, creating a new global baseline for sustainability reporting. The two key ones are:

1. IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information: This sets out the overall framework for how a company should report on all its sustainability-related risks and opportunities.
2. IFRS S2 Climate-related Disclosures: This is the big one for climate. It's built directly on the TCFD framework and sets out the specific requirements for what companies must disclose about their climate risks.

The goal is to have these disclosures sit right alongside financial statements, giving investors a complete picture of a company's performance.

While the ISSB creates a global baseline, major economic blocs are also implementing their own detailed rules.

• European Union: The EU's Corporate Sustainability Reporting Directive (CSRD) is one of the most comprehensive and ambitious sets of rules in the world. It requires tens of thousands of EU companies (and some non-EU companies with significant activity there) to provide detailed disclosures on a wide range of environmental, social, and governance (ESG) topics, including climate.
• United States: The U.S. Securities and Exchange Commission (SEC) has also introduced rules requiring public companies to include specific climate-related disclosures in their registration statements and annual reports. The focus is squarely on providing investors with consistent, reliable, and comparable information about financial risks posed by climate change.

The key takeaway is that these disclosures are rapidly moving from voluntary to mandatory.

Reading these reports is not just about ticking a “green” box; it's about making better investment decisions.

Be skeptical of glossy sustainability reports full of pictures of windmills and forests. Focus on the data. Look for the “Metrics and Targets” section.

• What are the numbers? Check for specific figures on Scope 1, 2, and 3 GHG emissions. (Scope 1 = direct emissions; Scope 2 = from purchased electricity; Scope 3 = all other indirect emissions, often the largest part).
• Are the targets credible? A pledge to be “net-zero” by 2050 is easy to make. How are they actually going to get there? Look for clear, short-to-medium-term targets and details on the capital they plan to invest to achieve them.

Use the disclosures to stress-test your investment thesis.

• Risk Example: You're analyzing an oil and gas company. Its climate disclosure might reveal (or try to obscure) how much of its oil reserves would become unprofitable stranded assets under a scenario where the world aggressively pursues its climate goals. This is a massive risk to its future earnings.
• Opportunity Example: You're looking at a car manufacturer. Its disclosure details a multi-billion dollar investment in a new battery technology and a clear roadmap to phase out internal combustion engines. This could signal a significant competitive advantage and growth runway in the coming decade.

This field is still evolving. Data quality can be inconsistent between companies, and “greenwashing”—making a company seem more environmentally friendly than it really is—is a real problem. Therefore, climate-related disclosures should not be your only tool. They are a powerful new input for your overall fundamental analysis, to be used alongside traditional financial metrics to build a complete, forward-looking picture of a company's prospects.