Since we released our first article on climate-related disclosures in August 2021, there has been a substantial number of developments – not just to the Financial Sector (Climate-related Disclosures and Other Matters) Amendment Bill (Bill) itself and how it will be applied, but also developments that signal the direction of travel on how climate change could impact financial regulation more broadly. The pace of progress potentially lends weight to the declaration of 38 national governments globally (including our own) and hundreds of councils, towns and municipalities in 10 other countries with jurisdiction over 1 billion people, that the issue of climate change is indeed an emergency.1
This article updates our previous article by traversing the developments to the Bill, the practical implementation of climate-related financial disclosures in New Zealand, and how climate change could start to impact financial regulation on a broader scale.
Bill passed into law
The Bill received its royal assent on 27 October 2021, becoming the Financial Sector (Climate-related Disclosures and Other Matters) Amendment Act 2021 (Act).
While the Act comes into force on 27 October 2022, two of its core obligations (preparing climate statements and keeping records) will realistically only apply from April 2024. This is because climate reporting entities (CREs) will be obligated to release climate statements (and keep records in respect of those statements) in relation to financial years that begin on and from the date that the External Reporting Board (XRB) releases its final climate standards (NZ CS 1), which is expected in December 2022. On that basis, CREs with a balance date of 31 December will need to prepare their first climate statement for the financial year 1 January – 31 December 2023, and disclose that statement four months after the end of that balance date.
Changes to the Bill since August 2021
Commencement of obligations relating to assurance engagements
Assurance engagements are a mechanism in the Act that are designed to independently verify a CRE's calculated greenhouse gas (GHG) emissions as disclosed in their climate statement.
CREs that do (or are required to) make disclosures on their GHG emissions have a two year grace period, following the initial obligation to prepare climate statements, until they are required to have their disclosed GHG emissions confirmed through an assurance engagement. The rationale for this delay is two-fold:
- As climate assurance engagements are a relatively new type of professional service, New Zealand's labour/skills market simply does not yet have the capacity to ensure that all CREs will have access to assurance practitioners by the time the first climate statements will likely be required to be released (from April 2024), and this grace period will give the New Zealand market time to build this expertise
- There is still some debate relating to the most appropriate framework for assurance practitioners. While the role of an assurance practitioner has many similarities to that of an auditor (ie verifying the accuracy of disclosures), the subject matter of what is being verified is quite different to what auditors are used to and there is still some work to do in determining whether assurance engagements should be undertaken by accountants only or whether there is scope for the creation of another professional service industry – and if so, the frameworks for ensuring that a new 'assurance industry' is credible.
The Act narrowed the regulatory perimeter compared to the original Bill that went to Select Committee. Listed equity or debt issuers, where the total value of the entity's debt/equity issued is under $60 million are no longer defined as CREs. Limiting the application of the Act so that smaller listed issuers are excluded was raised in a number of submissions and reflects the policy that this framework is intended to apply to 'large' entities. The Act also made some technical amendments regarding how to treat CREs that amalgamate into new entities by confirming that, if two CREs amalgamate into a new entity, that new entity is to be treated as a CRE from day one, not two years after its inception (on the basis that, under other circumstances, an entity is only a CRE if it meets the applicable size threshold in each of its two previous accounting periods).
Comply or explain
The initial Bill enabled entities that met the definition of CRE to be exempted from the requirement to disclose climate statements if the CRE determined that it is not materially affected by climate change. However, the Act as passed has taken the 'explain' out of its initial 'comply or explain' approach. All CREs will be required to comply with the Act. To the extent that a CRE has determined that it is not materially affected by climate change, we would expect that its forward-looking scenario analysis would not identify many (or any) material risks and opportunities, and that the disclosures contained in the climate statement may reflect minimal changes to the CRE's existing governance, risk management, strategy and metrics and targets as a result. Nevertheless, the obligation to engage in the analysis and make the disclosures does exist.
External Reporting Board (XRB) consultations
The XRB, the entity responsible for creating and publishing the applicable climate standards (NZ CS 1), released its Climate-related Disclosures – Governance and Risk Management Consultation Document (Consultation Document) in October 2021. The Consultation Document outlines the XRB's proposed approach to how NZ CS 1 will mandate standards in respect of a CRE's governance and risk management frameworks. The Consultation Document confirms that the XRB intends to strongly align NZ CS 1 with the recommendations of the Taskforce for Climate-related Financial Disclosures (TCFD), with only minimal deviations from that framework (including, for example, the inclusion of potential as well as current investors as primary users of the climate statements). This is consistent with the XRB's stated objective in the Consultation Document that NZ CS 1 be internationally comparable.
The Consultation Document is currently geared towards the 'inward impact' of climate change on a CRE – the impact of climate risks and opportunities on the CRE's business. However, the XRB has acknowledged that leading global markets (such as the EU, through its proposed Corporate Sustainability Reporting Directive (CSRD)) are moving towards the concept of 'double materiality' by introducing the concept of 'outward impact' – not only the impact of climate change on the CRE's business, but the impact of the CRE's business in contributing to, or mitigating the effects of climate change (eg through its GHG emissions or lending / investing / underwriting decisions). The XRB is still considering whether to include this in NZ CS 1.
The XRB intends to release another consultation document on its intended approach to incorporating strategy and metrics and targets frameworks into NZ CS 1 later this month, and is aiming to have NZ CS 1 finalised in December 2022.
FMA preparation and enforcement approach
The proposed implementation approach of the Financial Market Authority (FMA) outlined in its document Climate-related Disclosures regime: Implementation approach, released in November 2021, reflects the comments we made in our August article about facilitating a 'learn-by-doing approach'. The document indicates that the FMA will not move to 'steady state guidance' until 2026 and will instead focus on setting expectations and supporting the public and CREs in responding to compliance issues and enquiries before then. The extent to which the FMA can move to a more traditional supervisory and enforcement approach may depend on whether CREs are given access to centralised repositories of data and modelling to assist them with their forward-looking scenario analysis, or whether they will each be forced to build that capability internally (which could mean CREs might need more time).
MBIE may look to produce regulations relating to matters like:
- Possible exemption powers
- The creation of a framework for assurance engagements (see our comments above)
- Infringement notices
- Possible fees to fund the FMA's supervisory work.
Based on the FMA's key implementation work streams and indicative timeline in the FMA's Implementation approach document mentioned above, MBIE could be working on regulations from now until the end of 2023, which could create tight timeframes for CREs that could be required to publish their first climate statement as early as April 2024.
The TCFD recommendations (upon which New Zealand's climate reporting standard NZ CS 1 will be based), continues to gain exponential traction globally. The TCFD status report dated October 2021 provides that, at the time of publication, the market capitalisation of TCFD supporting firms had increased 99% compared to 2020. Firms that are voluntarily reporting in accordance with the TCFD recommendations are particularly focusing on making the 'strategy' related disclosures (one of the four types of disclosures in the TCFD recommendations, as described in our August article), though there is still some lag in firms disclosing their strategy against various climate-related scenarios.
The TCFD status report states that 1,069 global financial institutions, responsible for assets of US$194 trillion have expressed support for TCFD, signalling that climate-related disclosures are increasingly establishing themselves as a necessary disclosure for firms seeking to attract capital globally.
While New Zealand established itself as the first country to require firms to make climate-related financial disclosures in legislation, governments, regulators and supervisors in Brazil, the EU, Hong Kong, Japan, Singapore, Switzerland and the UK have since announced some form of legal requirements for domestic organisations to publish reports that align with the TCFD recommendations.
The recommendations themselves also continue to evolve, with the TCFD publishing two pieces of additional guidance in October 2021 relating to guidance on metrics, targets and transition plans and updates to its implementation guidance.
Emission Reduction Plan update
The government announced in September 2021 that it would not meet its statutory deadline of 31 December 2021 for delivering a proposed Emissions Reduction Plan (ERP) and would instead release its plan in May 2022 to correspond with the government's fiscal budget. While the rationale given for the delay was due to the impacts of the August 2021 Covid outbreak, the interesting choice to align the release of the ERP, which in many ways resembles a 'carbon budget', with the fiscal budget could be interpreted as an early signal that the government intends for the status of its 'carbon budget' to sit alongside its fiscal budget. The elevation of the status of climate-related data to a similar level of importance as financial data in decision-making is something that has gained traction in markets that lead the world in the climate space such as the EU, where it is an express purpose of their proposed CSRD that the status of sustainability information (notably a wider concept than climate reporting alone) be elevated to be on-par with financial information.2 This is also consistent with new and emerging economic concepts that advocate for systems for allocating resources in a manner that ensures society's consumption does not cause living standards to fall below the 'social foundation' (through fiscal budgets), and at the same time, ensures that society's consumption does not rise above the 'ecological ceiling' and result in society consuming more resources than the earth can sustain (through carbon budgets).3
Climate Changed 2021
In November 2021, the Reserve Bank of New Zealand (RBNZ) cemented its commitment as the lead regulator of the Council of Financial Regulators (COFR) to advance the 'climate change' work stream 'to facilitate a smooth transition to a low-carbon and climate-resilient economy, while supporting the soundness and efficiency of the financial system' with the release of its report Climate Changed 2021 and beyond. The title was deliberately chosen to signal that, in RBNZ's view, the climate has already changed and that the risk and opportunities to the financial system associated with those changes is part of the RBNZ's core business. The report re-iterates the RBNZ's commitment to understand and integrate these risks into the RBNZ's core functions.
The report confirms that the RBNZ is working on the following climate-related initiatives that will impact the entities that it prudentially regulates:
- Developing a guidance note on climate change risk management, embedding climate risk into supervisory frameworks and looking to the recommendations of the Network for Greening the Financial System to integrate climate risk into financial stability monitoring and micro-supervision
- Building its capability in climate-relating stress testing over the next 18 months with a view to undertake a full climate change scenario-based stress test – a move signalled in our August article – as well as further integrating climate change into broader stress tests
- Introducing climate-risk questions into its supervisor engagements with directors and senior managers,
as well as assessing how the RBNZ's approach to monetary policy should account for climate change.
The Glasgow Climate Pact, which was agreed to at the 26th Conference of the Parties under the United Nations Framework Convention on Climate Change (COP 26), did not contain any commitment to a global (or even applicable to only Annex I countries) uptake of climate-related financial disclosures. However, there were expressions of regret that the level of 'mitigation and adaptation' finance that is being offered to developing and least developed nations has fallen well short of the US$100 billion per year that was pledged and calls for more financial commitments (though notably light on actual financial commitments).
We note that the text of the Glasgow Climate Pact calls for both public and private financial institutions to enhance and scale up the mobilisation of finance towards mitigation and adaptation projects.4 The inclusion of this drafting could signal to investors, lenders and insurance underwriters an increasing expectation from the governments of the world that private finance flow towards businesses and activities that contribute to mitigation of and adaptation to climate change, rather than businesses and activities that contribute towards increasing GHG emissions. To the extent that the private finance industry heeds this call, this could increase the demand for climate-related financial disclosures.
The other core takeaway from COP 26 and the new wave of climate pledges from both governments and private sector organisations was a significant shift in the focus of climate targets from 2050 to 2030 – again signalling that the pace of change is accelerating quickly. A shorter timeframe to meet ambitious targets will be sure to impact the expectations that the New Zealand government and our financial regulators have of our financial institutions and large listed businesses over the next decade.
Finally, as a result of COP 26, new commitments were made by the world's governments, including New Zealand's updated Nationally Determined Contribution to reduce greenhouse gas emissions by 41% below 2005 levels by 2030 (using an 'emissions budget' approach) and a commitment of $1.3 billion over four years to support countries most vulnerable to the effects of climate change (which will prioritise Pacific nations).5 Based on the sum total of new commitments, the scenario pathway consistent with less than 2 degrees of warming (as described in our August article) might now be within reach (based on targets pledged, not on policies actually enacted). Analysts have calculated that, as long as every commitment made to date is implemented in full and on time, global warming could be limited to 1.8 degrees by 2100.6
Some of the predictions that were made in our August article have already been announced, and there is a clear signal, both in policy and regulatory spaces, of a sea of change in the expectations of the government, financial regulators, investors, as well as the public, which is rising, and rising quickly. CREs will now be required to meet the new expectations in the next few years. CREs will need to start engaging with what is required of them as soon as possible, not only to ensure compliance, but also to develop the resources and agility to manage more upcoming expectations, whether those expectations are imposed by government or regulators, or by their shareholders, customers, and the public at large. We anticipate it might also be in the interests of non-CREs to actively consider the obligations in the Act to ensure they do not fall behind in meeting rising expectations as well.
1 To see climate emergency declarations go to Climate emergency declarations in 2,071 jurisdictions and local governments cover 1 billion citizens - Climate Emergency Declaration.
3 See the work of Kate Ratworth A Safe and Just Space for Humanity" (Oxfam, 2012) and Doughnut Economics: Seven ways to think like a 21st century economist (Chelsea Green Publishing, Vermont, 2017).
4 Glasgow Climate Pact at 19.
5 See the full list of New Zealand's increased commitments at COP 26 here.
6 See the analysis of the Independent Energy Agency here. Climate Action Tracker's analysis, which describes an assumption that long term (2050) commitments will be made in full and on time as an 'optimistic scenario' has calculated that, based on the analysis of the near-term commitments made (2030), the commitments at COP 26 could result in global warming in the vicinity of 2.4 degrees by 2100, and that based on actual (not committed) policies, it will be 2.7 degrees.