Leaning Into TCFD
With increasing regulatory requirements concerning climate-related impacts, this framework is emerging in importance
As we move into drier and warmer temperatures across much of the United States, we will soon see images of wildfires. Most likely, those wildfires will be across the western United States, and unfortunately, odds are they will move from the forest into the built environment. Much of the west and southwest continue to be what the National Oceanic and Atmospheric Administration (NOAA) classifies as Severe to Exceptional Drought. This is quite evident as you look at the latest drought monitor map released by the agency on July 7, 2022:
The relationship between drought and wildfires is well documented across North America. In fact, the association is often cited in research papers, a sample of which can be viewed through the United States Department of Agriculture’s website (link).
Now let’s look at one more map; this one is the US Population Density by County from the 2020 US Census:
Of that population, we know from Pew research that 36% of the nation’s households are rental property, and a staggering 65% of households headed by people under 35 are rented versus owned. With those facts in mind, we can state a thesis that the majority of rental assets across the United States are in the counties with the highest population density.
Knowing the relationship between drought and wildfire and comparing where those properties are located and where droughts are occurring, we can begin to assess the risk of those assets to wildfire. In fact, in May of 2022, a study by the First Street Foundation shows nearly 30 million residential and commercial properties across the US that face some risk of wildfire damage in the next 30 years.
Each of those assets represents a financial risk to the asset owner; if the asset is damaged by wildfire, the owner may take a loss on their investment or, at a minimum, incur additional costs through increased insurance premiums.
This exercise I just walked you through is precisely the type of analysis and disclosure called for by the Task Force on Climate-Related Financial Disclosures (TCFD). This framework gives investors transparency into the financial risks and opportunities posed by climate change. It helps investors understand the potential financial implications of those assets, from direct physical climate risks such as the wildfire risk outlined above to the potential financial implications that could impact an asset associated with transitioning to a lower-carbon economy.
The TCFD Framework is built on governance, strategy, risk management, metrics, and targets. The first of these is governance and includes:
The organization board’s oversight of climate-related risks and opportunities
Management’s role in assessing and managing climate-related risks and opportunities
In order to provide this governance requires the ability to evaluate the climate-related risks and opportunities for each asset, which is exactly what we just did for the climate risk of wildfires. Of course, there are risks beyond wildfires, but there are several tools and platforms available that can help determine what the potential physical and climate-related risks are based on the location of the asset.
The second part of that assessment includes the potential asset impact of a low carbon energy transition. While we often consider the risk to an asset if something physically happens to it, it is rare to consider what occurs if technology changes. This is what is being evaluated in regards to a low carbon transition, which implies that relying on carbon-intense energy sources may result in increased operational expense or even asset obsolescence.
To understand this better, it may be helpful to consider what has to occur to decarbonize a building. The first step is the elimination of scope one emissions, which essentially means the elimination of burning energy on-site in order to produce energy. This is primarily the use of natural gas in most assets, although it could also include heating oil, coal, or propane.
In real estate sustainability, we refer to this as electrification. This includes moving heating and cooking appliances from gas to electric and incorporating heat pumps and induction stovetops. This is also where smart devices or proptech have a role to play. The inclusion of proptech in design and development provides the asset with an increased ability to interact more efficiently with the electric grid. These devices can often shift loads, for example, the ability to use on-site generated solar energy while the sun provides an energy source, but the ability to shift to the grid for energy when overcast or after the sun has set. There a numerous smart devices which can be included in the design that can interact with the grid and take advantage of strategies such as pre-cooling or pre-heating during non-peak hours, saving both costs and helping the local utility with energy capacity needs.
Transition risk can also include potential regulatory development related to climate change or energy. In addition, we include under this umbrella reputational risk, referring to the exposure the organization may have as climate change importance increases for consumers.
Strategy disclosures under TCFD include:
The climate-related risks and opportunities the organization has identified over the short, medium, and long term
The impact of climate-related risks and opportunities on the organization’s businesses, strategy, and financial planning
A description of the resilience of the organization’s strategy taking into consideration different climate-related scenarios, including a 2°C or lower scenario
Key to the strategy, just as in governance, is the organization’s pre-acquisition or pre-development evaluation of the property. Understanding and mitigating risks, as well as planning for opportunities to improve the asset’s financial state, loom large.
Scenario planning aids in TCFD alignment and lends itself towards other frameworks such as GRESB while allowing an organization to more fully explore risks and mitigation opportunities.
The Risk Management Component of TCFD alignment builds on governance and strategy:
Development of a process to identify and assess climate-related risks and description of those processes as part of the disclosure
Development of a process for managing the identified climate-related risks and disclosure of these processes as part of the disclosure
Incorporation of the climate-related risk identification, assessment, and management processes into the organization’s overall risk management practices
Those of you who have met me have likely heard me make the comment when managing ESG, you have responsibility for all and authority for none. The umbrella of ESG covers so many different business functions that the individual charged with developing and managing an ESG program has to interact with nearly every department and gain the cooperation of that department to support the overall organizational ESG mission. Notice how I said, gain their cooperation…
It is rare and likely would not succeed if we had the ability to “order” each business unit to support the organization’s ESG goals. Believe it or not, just because you tell someone to do something doesn’t mean they will do it and certainly doesn’t guarantee they will do it. I know, shocker. But what does work is collaborating and educating—meeting with each business unit and learning their challenges and priorities—listening attentively and with empathy to what is important to their business unit and their goals. Once you understand what each business unit leader is attempting to accomplish, you can begin to educate them about the specific elements of ESG that might help them achieve their goals. Put into their language, allow them to align the relevance to their business unit’s function.
In this case, we are outlining a need to integrate our climate-related risk identification, assessment, and management processes into the organization’s overall risk management practices. To accomplish this, you need the help of your risk management team, and you need them to put together why incorporating these principles into their own processes helps them as well.
The four inherent functions of risk management are risk identification, risk assessment, risk mitigation, and risk monitoring. Sound familiar? In the field of risk management, this is called the risk management cycle, and it is the identical steps that TCFD also calls for in climate-risk disclosure and assessment. This means your organization’s risk management professionals will likely recognize and be comfortable with the measures you recommend regarding managing the risk.
Also, key is framing the topic into business terms that the business unit you are collaborating with understands and identifies with. While as ESG professionals, we may be able to clearly see the connection between climate conditions and asset risk, those who may not understand ESG as well may not.
I started this week by discussing droughts and the relationship between drought-impacted areas and wildfires. I then demonstrated the relationship between drought-impacted regions and areas of high population density. Where there are people, there are buildings, and where there is a building and a risk of wildfire, there is a risk of loss. Without discussing climate change or resiliency, I just laid out the case that the financial investment is at stake. I laid out the assessment of how that conclusion was arrived at and what was impacted by the risk, and I could then lay out the specific strategy for that asset to mitigate the identified risk. Do you think using that approach, your risk management team might understand their role and why they need to integrate climate risk into their standard risk management practices?
The fourth area that is called out in TCFD is the disclosure of metrics and targets that are used to assess and manage the relevant climate-related risks and opportunities:
Identification and disclosure of the metrics used by the organization to assess climate-related risks and opportunities and demonstrate the alignment with the overall organizational strategy and risk management process
Disclosure of Scope 1, Scope 2, and, if appropriate, Scope 3 Greenhouse Gas (GHG) emissions
Description of the targets used by the organization to manage the climate-related risks and opportunities as well as performance against those targets
As in other areas of sustainability management, a foundation of data anchors TCFD as well. This underscores why data coverage and data quality are such critical components of your ESG program. If you do not have the data (data coverage), you obviously cannot measure it as you cannot measure what you do not have. Likewise, if you cannot measure it, you cannot report or disclose it to others as you have nothing to refer to. Similarly, the quality of the data underscores its value. Data that we have a high degree of confidence in provides the ability to make decisions and act with certainty. You would not want to give me money that you expected a return on if my strategy to get that return was based on incorrect data points - neither do your investors.
TCFD sums up success in seven principles:
The disclosure should represent relevant information
It should be specific and complete
The disclosure should be clear, balanced, and understandable
It should be consistent over time
The disclosure should be comparable among companies within a sector industry or portfolio
It should be reliable, verifiable, and objective
The disclosure should be provided on a timely basis
The TCFD framework has increasingly become the key framework by which impact analysis, risk, and opportunity are measured. From the EU and UK Taxonomy to the SEC proposed rules on climate-related disclosures, it is quickly becoming the standard. ESG professionals need to take note and should be determining how to align with the framework if they are not already.
You can help reduce the impact of the built environment by sharing this blog with your peers. Together we can impact the 39% of greenhouse gasses attributed to the built environment. It starts with awareness, and we succeed with teamwork.
Stay well!
Chris Laughman is the ThirtyNine Blog author, a blog dedicated to reducing the impact of the built environment. When not blogging, Chris is helping the real estate industry minimize energy and water impact as the Vice President of Sustainability for Conservice, the Utility Experts. Whether Multifamily, Single Family, Student Housing, Commercial, or Military, we simplify utility billing and expense management by doing it for you. Our insight into your utility consumption provides an opportunity to identify risks. Leveraging innovation and experience, we ignite solutions with real impacts and track performance to ensure the trendline stays laser-focused on the goal. At Conservice, we have developed a true bill-to-boardroom solution to help truly make a difference. We have before us a tremendous opportunity. Standing shoulder to shoulder, we will get this done. Contact me at claughman@conservice.com for more information.
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