ESG Insights for Legal Department IV: “Is TNFD the Next TCFD?”

This is the transcript of the forth episode of T&P’s video series “ESG Insights for Legal Departments.” Please visit T&P’s website for the video in Japanese.

Goi: Let’s delve into the realms of both TCFD and TNFD in this fourth episode. TNFD’s emergence on September 18, 2023, was anticipated with bated breath by numerous corporate personnel in charge of sustainability. Many were concerned about similarities or disparities between the TCFD—bearing somewhat akin abbreviations—and the newer TNFD, contemplating their distinctive features and consequential influence on corporate landscapes. Allow us to revisit the challenges posed by the TCFD.

Hashimoto: Commencing in June 2017, the TCFD—centered on greenhouse gas (GHG) emissions—comprises four pillars: governance, strategy, risk management, and metrics and targets, recommending disclosure of 11 key items. This framework, particularly the ‘strategy’ element necessitating scenario analysis, posed a distinct challenge for Japanese entities, prompting support from the Ministry of the Environment.

Goi: As of the close of September 2023, global endorsement for TCFD stands at 4,831 companies and institutions, with 1,454 hailing from Japan—comprising a bit shy of 30% of the whole world. What could be the driving force behind this poppularity?

Hashimoto: Government-sponsored initiatives such as the TCFD Consortium and the Financial Services Agency’s Disclosure Working Group (DWG), alongside acknowledgment within the Tokyo Stock Exchange’s Corporate Governance Code, likely contributed to this surge in support.

Goi: In light of the January 31, 2023, revision to the Cabinet Office Ordinance governing corporate information disclosure—effectively incorporating TCFD 4 pillars into securities reports—might we anticipate a similar response to TNFD? Let us juxtapose the TCFD and TNFD outlines while tracing their respective trajectories.

Hashimoto: TCFD, formulated by the Financial Stability Board (FSB) and comprising G20 financial supervisory authorities, endeavors to stabilize global finance. Originating from financial institutions’ call for data to construct portfolio, its primary objective is to illuminate the discernible climate change risk, and thus to enable financial markets to judiciously allocate money.

Yasuhiko: In contrast, TNFD, which includes national governments and United Nations entities, its objective is furnishing businesses and capital market decision-makers with crucial insights to manage their operational and portfolio risks. Notably, the TNFD draws strong parallels to the Kunming-Montreal Biodiversity Framework (GBF), signifying a robust promotion of GBF.

Goi: How do the foundational tenets of TCFD and TNFD diverge? Do they adhere to principles or rules? Embrace single or double materiality?

Hashimoto: TCFD operates on principles and embraces the concept of single materiality, focusing on providing financial institutions with indispensable information. It meticulously considers the risks and opportunities posed by the specific topic of global warming, spotlighting its impact on enterprise value.

Yasuhiko: TNFD allows companies to draft qualitative information at their discretion, lending it a principle-driven approach. However, it intertwines with numerous quantitative metrics, lending a semblance of a rule-based framework. Embracing double materiality, it seeks to furnish essential information not just to investors but to other stakeholders as well, emphasizing corporate impacts on the atmosphere, water, soil, and beyond.

Goi: Both TCFD and TNFD proffer general and sector-specific guidance. Can you provide an overview?

Hashimoto: In the framework of TCFD, each company determines its materiality. There are companies where climate change may not be material to their own operations. However, TCFD regards climate-related risks as non-diversifiable risk across almost all industries. Therefore, irrespective of individual companies’ materiality assessments, TCFD encourages disclosure of climate-related risks across all sectors. Among the four pillars, governance and risk management are universally recommended for disclosure, while for strategy, metrics and targets, disclosure is recommended if deemed material. Moreover, certain sectors face particularly significant climate-related risks: energy, transportation, materials/buildings, agriculture/food/forestry products. Sector-specific guidance has been issued. Within the TCFD consortium, there is even more detailed guidance available tailored to specific industries

Yasuhiko: The stance of TNFD is a bit unclear. However, when you think about it, since almost every industry is in some way influenced by nature and also influences nature, it might not be appropriate to consider any pillars that could be omitted. Sectors where natural-related risks are particularly important have been identified. Currently, guidance for specific sectors is being issued only for financial institutions. It’s anticipated that guidance will be released in the future for food, apparel/textiles, and materials/buildings.

Goi: How does each handle scenario analysis?

Hashimoto: TCFD, under its strategic pillar, recommends scenario analysis as a disclosure component and issues guidance for scenario analysis. However, companies perceiving climate change non-material, need not disclose this aspect.

Yasuhiko: Similarly, TNFD recommends scenario analysis under its strategic pillar, having also published corresponding guidance.

Goi: Are there discrepancies in metrics between TCFD and TNFD?

Hashimoto: TCFD emphasizes the disclosure of Scope 1 and Scope 2 GHG emissions within its ‘Metics and Targets,’ potentially extending to Scope 3 in select cases.

Yasuhiko: TNFD’s fourth pillar, “Metrics and Targets,” also recommends disclosing quantitative metrics. While GHG emissions are taken care by TCFD, TNFD appears to be shifting its focus to other metrics. These include items related to the atmosphere, water, soil, and so forth. In addition to the 14 Core metrics, there are many other metrics. However, since it operates on a “comply or explain basis”, companies can choose not to disclose these metrics by reasoning that they didn’t assess them as material to their own business. The metrics frequently intersect with those outlined by SASB and GRI. For enterprises that have already aligned their disclosures with these voluntary standards, the endeavor might not pose an excessive burden. Conversely, for entities yet to embark on such disclosures, the preparations required for disclosure are anticipated to constitute a substantial undertaking.

Goi: Can we anticipate Japanese corporate backing for TNFD akin to TCFD?

Yasuhiko: By November 2023, over 1,200 global entities are part of the TNFD forum, of which 162 hail from Japan. It is too early to say if the number goes up or stable. The single-topic GHG emphasis of TCFD gathered that many numbers of companies’ endorsements. Given the expansive nature of TNFD, if TNFD attracts more companies, I would not be surprised. More important point here would be serious assessment of materiality and endorsement’s merit. In the case of TCFD, the endorsements stemmed from unique circumstances within financial institutions and government-led promotion. I believe it’s inappropriate to join based solely on peer pressure or simply because it has been done in the past.

Goi: Despite many Japanese companies support for TCFD, actual information disclosure under its framework diverges. The Tokyo Stock Exchange (TSE) conducted a survey of the 400 constituent companies in the JPX-Nikkei Index 400. Among these 400 companies, 102 have disclosed all 11 recommended TCFD items. On the other hand, 82 companies have not referenced any of these items. In essence, one-fifth have not provided specific disclosures. Do you think this situation is likely to change in the future?

Hashimoto: It depends on the disclosure regulations. While TCFD is a voluntary disclosure framework, its recommended disclosures have been incorporated into IFRS S1 and S2. The functions of TCFD will also be taken over by the IFRS Foundation in 2024. IFRS S1 recommends disclosure of all sustainability-related risks and opportunities affecting investors. If a company deems climate change as one of those risks or opportunities, they would be required to disclose using IFRS S2.
In Japan, IFRS S1 and S2 are expected to be adapted through deliberations and adjustments by the Sustainability Standards Board of Japan (SSBJ), becoming Japan’s versions of S1 and S2, and will be incorporated into Japan’s disclosure regulations. In essence, this direction signifies a move towards mandating the disclosure of sustainability information aligned with Japan’s versions of S1 and S2 standards within the securities reports.

Goi: Securities report or Yuho currently mandates disclose “sustainability-related ideas and initiatives.” Is this current framework going to change post the establishment of the Japanese version of S1/S2 standards?

Hashimoto: The SSBJ deliberates on this; it remains uncertain. But let’s explore the future possibility in line with what we have seen so far. It’s likely that, companies that assess climate change as a material topic are required disclosure of climate change risks in accordance with Japan’s version of the S2 standard. On the other hand, some companies might opt not to disclose all four pillars, stating that global warming isn’t deemed material to their operations.

Goi: Can a company claim non-materiality, despite its endorsement of TCFD?

Hashimoto: Theoretically plausible, yet prudent materiality selection and review are advisable. S2 Regulation is not a regulation that we are used to before. The extent of disclosure, mandated by regulation, depends on the company’s materiality assessment. Compliance of regulation starts with vigorous materiality assessment.

Goi: Might TNFD become a part of ISSB and become disclosure regulation in Japan?

Yasuhiko: It’s still uncertain. However, within the ISSB, biodiversity holds a position of priority within their agenda. Anticipating standards akin to TNFD being encompassed within ISSB standards, possibly through an iteration like IFRS S3 subsequent to S1 and S2, is entirely plausible. Yet, the evolution of Japanese adaptations of ISSB standards and their integration into disclosure regulations will undoubtedly consume time. Companies are facing a pivotal decision: to proactively engage in disclosure by embracing voluntary standards or await the mandate of disclosures before taking action. It is imperative for them to delineate their strategic path forward.

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