A call to action

The Government’s standard setter, the External Reporting Board (XRB), has served notice that it will soon launch public consultations on mandatory standards for climate-related financial disclosures (CRD).  The XRB’s first CRD initial draft discussion document, concerning the disclosure topics of governance and risk management, will be released on Wednesday, 20 October 2021, with the deadline for close of consultations on the document being Monday, 22 November 2021.  The XRB has been actively urging interested parties to participate in the consultations.  This invitation should not be overlooked by those who want to have their say on what form a mandatory CRD regime should take in New Zealand, especially as our country has been officially advertised as the world’s pioneer in trailblazing this particular regulatory reporting path.

Mandatory climate-related financial disclosures: who is directly affected?*

• Around 200 entities in New Zealand would be required to produce climate-related disclosures.
• All registered banks, credit unions, and building societies with total assets of more than $1 billion.
• All managers of registered investment schemes with greater than $1 billion in total assets.
• All licensed insurers with greater than $1 billion in total assets under management or annual premium income greater than $250 million.
• All large equity and debt issuers listed on the NZX with market capitalisation of more than $60 million.
• Some Crown financial institutions.

Notes:

• Managers of registered investment schemes would be required to make disclosures on a fund-by-fund basis. This would ensure investors receive the information needed to understand the impact of climate change on the future performance of their investment.
• Overseas incorporated organisations would be required to make disclosures if their New Zealand business is over the thresholds outlined above. This would ensure their New Zealand stakeholders’ needs are met.
• The thresholds would be increased from time to time to reflect the movements in the consumers price index.

*Primary source: Ministry of Business, Innovation & Employment, September 2021

The XRB’s approach to developing a set of mandatory standards for CRD is directly derived from the model framework developed and recommended by the international Task Force on Climate-related Financial Disclosures (TCFD), itself a creation of the Financial Standards Board (FSB).  The TCFD set out its conclusions in a final report, Recommendations of the Task Force on Climate-related Financial Disclosures, published on 15 June 2017.  The Government announced on 15 September 2020 that the TCFD’s recommended CRD framework would apply in New Zealand by 2023 at earliest and that the XRB would be the means by which this new mandatory reporting regime would be implemented.  The XRB provides a dedicated page on its website to keep the public updated on its progress with implementing the CRD regime under the TCFD framework.

The legal basis for the incoming CRD regime lies within the Financial Sector (Climate-related Disclosures and Other Matters) Amendment Bill (Bill), which is presently proceeding through the Parliamentary legislative process.  An useful summary of the Bill’s background and intent can be found in a Cabinet paper cover sheet of late May 2021.  The Ministry of Business, Innovation and Employment (MBIE) maintains a comprehensive CRD information resource page on its website.

The TCFD framework

The core of the TCFD framework for CRD is a set of four “pillars” under which eleven recommended disclosures are organised (derived from TCFD Final Report, p. 14):

Pillar 1: Governance - Disclose the organisation’s governance around climate related risks and opportunities.

1. Describe the board’s oversight of climate-related risks and opportunities.
2. Describe management’s role in assessing and managing climate-related risks and opportunities.

Pillar 2: Strategy - Disclose the actual and potential impacts of climate-related risks and opportunities on the organisation’s businesses, strategy, and financial planning where such information is material.

1. Describe the climate-related risks and opportunities the organisation has identified over the short, medium, and long term.
2. Describe the impact of climate related risks and opportunities on the organisation’s businesses, strategy, and financial planning.
3. Describe the resilience of the organisation’s strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario.

Pillar 3: Risk Management - Disclose how the organisation identifies, assesses, and manages climate-related risks.

1. Describe the organisation’s processes for identifying and assessing climate-related risks.
2. Describe the organisation’s processes for managing climate-related risks.
3. Describe how processes for identifying, assessing, and managing climate-related risks are integrated into the organisation’s overall risk management.

Pillar 4: Metrics & Targets - Disclose the metrics and targets used to assess and manage relevant climate-related risks and opportunities where such information is material.

1. Disclose the metrics used by the organisation to assess climate related risks and opportunities in line with its strategy and risk management process.
2. Disclose Scope 1, Scope 2, and, if appropriate, Scope 3 greenhouse gas (GHG) emissions, and the related risks.
3. Describe the targets used by the organisation to manage climate-related risks and opportunities and performance against targets.

The TCFD’s four pillars approach will form the basis under which the XRB will commence with rolling out a series of proposed CRD standards, beginning with the aforementioned initial draft on the governance and risk management pillars.  The XRB plans to follow up in March 2022 with an initial draft on the strategy and metrics & targets pillars, and in July 2022 with a comprehensive formal exposure draft, both of which will also come with opportunities for public consultations.

Changes since the Government’s first announcement on CRD

Things are moving along quickly for the Bill now, with the Final Report on the proposed legislation being publicly released by the  Parliamentary Economic Development, Science and Innovation Committee in mid-August.  Those who will or could potentially become climate reporting entities (CREs) should be taking an active interest in what the Bill now looks like given that the Select Committee has published its amended version of the Bill’s clauses in the Final Report.  The independent External Reporting Board (XRB) will exercise considerable powers under the enacted Bill.

The Bill will introduce a new Part 7A amendment to the Financial Markets Conduct Act 2013 (FMCA) to accommodate proposed CRD.  Of particular interest to listed debt issuers, licensed MIS Managers and their Supervisors will be inclusion of the new defining clause 461O Meaning of climate reporting entity, especially subclauses that state:

“(1) In this Act, a person who is an FMC reporting entity that, under section 461K, is considered to have a higher level of public accountability than other FMC reporting entities is a climate reporting entity if that person is 1 or more of the following:

(a) a listed issuer that—

(i) is a large listed issuer; and

(ii) is not an excluded listed issuer: ….

(2) In this Act, a manager of a registered scheme (other than a restricted scheme) is a climate reporting entity in respect of the scheme if—

(a) the manager is a large manager; and

(b) section 461K(1)(b) applies to the manager in respect of the scheme.” (Select Committee Final Report excerpt pp. 9-10)

A “large listed issuer” is defined under section 461OA Definitions relating to listed issuers principally as having a market capitalisation exceeding $60 million as at the balance dates of each of the two preceding accounting periods, in which case it qualifies as a large listed issuer CRE.  A “large manager” is defined under 461Q Meaning of large manager, which essentially sets exceeding $1 billion of assets under management, subject to various qualifications, as the threshold for becoming classified as a MIS Manager CRE.  Incorporation of the Bill’s amendments into the FMCA will bring climate change disclosure obligations of large listed issuer CREs and MIS Manager CREs, among some other CRE types, under the regulatory ambit of the FMA and the licensed Supervisor regime.

Estimates of the costs imposed by the new CRD regime

The question of CRD compliance costs for MIS Managers who will become CREs under the enacted Bill is addressed in two reports provided to the Select Committee by the Ministry of Business, Innovation & Employment (MBIE).  In the first such report, dated  26 May 2021, under section D. Issues that submitters might raise, subsections I. Compliance costs generally and II. Compliance for investment scheme managers (pp. 13-4) canvass the cost impacts arising from CRD compliance that are likely to impact on MIS Manager CREs, who will have to undertake such disclosures on a per fund and not on a per scheme basis.  Clause 56 of subsection II states:

“A market-leading data provider estimated that providing carbon and climate-risk related metrics for a fund manager’s investment portfolio typically costs between $80,000 and $190,000 per scheme. Using this information and other information obtained from fund managers, officials estimated that the compliance costs would lead to a 0.9% decrease in operating profit for scheme managers at the $1 billion threshold. For investment scheme managers with multiple funds, officials estimated through fund managers that the additional costs for disclosure on a fund-by-fund basis was about 1% of the total cost of disclosing on aggregate funds. This is because collecting data for an aggregate portfolio also provides all of the necessary information to produce fund-by-fund disclosures, spreading the cost across the full range of funds.” (MBIE May report, p. 14)

In a second MBIE report to the Select Committee, dated 5 July 2021, the question of compliance costs is again addressed (p. 7) with the comment of officials stated as, “The XRB will be able to consider broader compliance issues for fund managers as part of its standards-setting role” (MBIE July report, p. 7).  The second report is also interesting because it sets out the full original compliance cost advice analysis provided by MBIE in a final section entitled, Appendix 1: Section on compliance costs in the MfE-MBIE Regulatory Impact Statement (July 2020).  In the Appendix some initial costings are tabulated, with note 18 commenting as follows:

“The increase in costs for managers of registered schemes are likely to be passed on to investors through increased fees. Assuming these costs are directly and evenly passed on to KiwiSaver members, we estimate a $0.65 increase in fees per member per year, or an increase of 0.40%. There are 14 KiwiSaver providers with assets under management greater than $1 billion, resulting in a total increase in costs of $1,820,000 spread across their approximately 2.8 million members.” (MBIE July report, p. 46)

Access to CRD professional expertise critical

A significant business risk to entities that will or potentially could become CREs is that they may not have access to all the necessary professional expertise that they will need to meet their legal compliance obligations under mandatory regulatory reporting requirements imposed as the CRD regime phases into full effect and thereafter.  Entities with pending CRE status will need to address their CRD compliance obligations by employing suitably qualified internal human resources, or retaining the services of outsourced expertise, or some combination of both.  It is quite likely that there will be a scarcity of such expert resources within the New Zealand labour market, which is an entirely foreseeable business risk.  Boards and senior management of entities that will be exposed to CRE status will be responsible and accountable for how well they manage this potential expertise scarcity risk between now and early 2023.  If not undertaken already, it may be prudent immediately to begin the process of acquiring access to suitable CRD expertise, rather than leave things to the last minute.

Conclusion

“Mandatory climate-related financial disclosure (CRD) might seem a way off, but as of now 2023 is less than sixteen months away, and so there is no room for complacency on the part of entities faced with CRE status based on either as they currently stand, or as they are likely to become in the short-to-medium term future,” said Matthew Band, General Manager of Corporate Trustee Services at Trustees Executors.

“The necessary legislation inevitably will be passed and from next month onwards the XRB will be rolling out discussion documents and draft standards for public consultations.”

“It is imperative that interested parties should thoroughly engage with the XRB and have their say on what New Zealand’s CRD regime should be like.”

“As a licensed Supervisor, we will be involved with monitoring the CRD reporting compliance of our supervised CRE clients and will ourselves need to build up our own expertise and understanding of the new regulatory environment.”

“It is our expectation that our clients who are facing pending CRE status are already actively assessing what kinds of expertise they are going to require to meet their legal obligations under the new regulatory reporting environment and how they are going to secure and access that expertise.”

“We should also keep in mind that the CRD regime is concerned not just with the financial risks of climate change, but - as per the TCFD framework upon which it is based - also the financial opportunities, which underscores the fundamentally positive aspect of this new mode of regulatory reporting.”

“The basic message the CRD regime is sending out to CREs is to manage climate change risks effectively and seize the opportunities provided.”

For comment or more information, or to be added to the free email subscriber list of “The Supervisor”, please contact Matt at [email protected].