Earlier this week, the Government announced that mandatory climate-related financial disclosures will be introduced for large financial services entities. The announcement follows last year's consultation on the issue, and makes New Zealand the first country in the world to mandate reporting on climate risks.

This article provides an overview of the proposals, and our thoughts on them.

‍Who will need to report?

The proposed requirements will apply to larger financial services entities:

• banks, credit unions, and building societies with total assets of over $1 billion
• insurers with over $1 billion in total assets under management, or annual premium income of over $250 million
• licensed fund managers with over $1 billion in total assets under management
• NZX-listed equity and debt issuers
• Crown financial institutions with over $1 billion in total assets under management (this covers ACC and the NZ Super Fund).

Overseas-incorporated entities with New Zealand activities that fall within the above criteria (other than foreign exempt issuers listed on the NZX) will also be need to report.

The requirements will cover about 200 entities, representing about 90% of all assets under management in New Zealand. To me, this suggests the threshold has been set at about the right level. No-one likes additional compliance, but these thresholds should limit the reporting obligations to those who are in a better position to meet them.

We have some immediate questions on the criteria. The fund manager category appears to only cover licensed managers, but the threshold looks to be assessed by reference to both wholesale and retail funds under management. On the one hand this makes sense, but it might lead to arbitrary distinctions – clarity is needed. Unlike the other categories, no size threshold has been proposed for NZX-listed entities. Arguably this is part of the price of being listed, but smaller listed companies already struggle with compliance costs.

Ultimately, the best solution to remove distortions (and help address climate change) might be to expand the scope of entities that need to report.

‍What will be required?

A reporting standard will be developed by the External Reporting Board (who prepare New Zealand's financial reporting standards). Once developed, the Financial Markets Authority will be responsible for monitoring and enforcement.

The standard will be based on the Task Force on Climate-related Financial Disclosures (TCFD) framework. This framework represents accepted international best practice, and entities in New Zealand and overseas already report against it voluntarily. In our view, it’s the right base framework to be adopting.

Disclosures will be structured around four core themes: governance, strategy, risk management, and metrics and targets. The requirements are comprehensive. Amongst many other things they include, for example:

• describing the climate-related risks and opportunities the entity has identified over the short, medium, and long term, and their impact on the entity's businesses, strategy, and financial planning
• describing the entity's processes for identifying, assessing, and managing climate-related risks
• describing the metrics used by the entity to assess climate-related risks and opportunities.

Reporting will be on a "comply or explain" basis. In other words, an entity can choose to explain why they haven't disclosed against a standard, instead of actually doing so. This might sound like a get out of jail free card, but in reality having to explain why something hasn't been done is a powerful motivator to actually do it in the first place. The NZX Corporate Governance Code and related reporting works in broadly the same way, and we've seen listed companies change their corporate governance practices as a result. We'd expect this will have the same result.

‍Reporting is only part of the picture

Putting COVID-19 to one side for a moment, we see climate change as the next big issue for the financial services industry. Customer and investor sentiment around environmental issues has changed such that they now reflect mainstream, rather than niche, views.

Reporting is only part of the picture though. In our view, fund managers and company directors who don't pay enough attention to climate change are already exposed to the risk of legal action, particularly where it reflects a material financial risk. This position is likely to be further tested through the courts over coming years, with litigation based on these types of claims underway in several countries.

‍Next steps

The new disclosure requirement will be incorporated into the Financial Markets Conduct Act 2013 (presumably in part 7, which deals with financial reporting). There's no real indication of the overall timeframes at this stage – including when we'll see the amending legislation and proposed reporting standards. The Government announcements simply say reporting will be required "in 2023 at the earliest".

As with any reform, seeing the detail will be important to understand exactly who the requirements will affect and what will be involved. In the meantime, there is plenty in the TCFD framework to start thinking about.