Jonathan Acosta-Smith, Benjamin Guin, Mauricio Salgado-Moreno and Quynh-Anh Vo
Over the past years, a growing consensus has acknowledged the need to construct a ‘system [wherein] every financial decision takes climate change into account‘. While such a system is still far from reality, market participants already produce and demand an increasing amount of climate-related information. Equally, many authorities around the world are considering mandatory climate-related reporting. These developments raise myriad unanswered questions. We focus on the following in a recent working paper:
- How have voluntary, climate-related disclosures of UK financial institutions changed over time?
- Can prudential regulators influence current climate-reporting levels just by announcing a future shift to mandatory reporting?
This post summarises the main insights from this paper.
A novel data set on disclosures of financial firms in the UK
In order to answer the above questions, we build a novel data set of voluntary, firm-level climate-related disclosures that are in line with the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD). These recommendations, published in 2017, are organised into four themes, beneath which are 11 more granular recommendations on the information to be disclosed.
Our approach consists of four consecutive steps summarised in Figure 1.
Figure 1: Machine learning pipeline
First, we manually collect corporate reports of the biggest banks, building societies and insurance companies between 2016 and 2020 in the UK. Second, we extract the information from each page of the reports, identifying potential climate-related pages using natural language processing (NLP) techniques. Third, we reduce the size of our truncated sample by identifying pages that are truly climate-related using a machine learning classifier and a supervised learning approach. Finally, we train 11 independent classifiers to identify the information disclosed on each corporate report’s climate-related page that is closely in line with each of the individual TCFD recommendations.
Our machine-learning approach allows us to measure the extent of voluntary disclosures in several ways. We can simply count the number of corporate report pages that contain disclosed information in line with the 11 TCFD recommendations. We can also construct binary variables indicating if a UK financial firm discloses specific climate-related information in a given year. Lastly, we can also compute the average number of disclosed recommendations within each TCFD specific theme (ie governance, strategy, risk management as well as metrics and targets), or count the total number of recommendations that firms provided information on.
Consequently, our novel data set allows us to obtain a detailed picture of the voluntary, climate-related disclosures in the UK, and its evolution over time.
Evolution and determinants of climate-related disclosures in the UK
Looking at the evolution of climate-related disclosures by UK banking and insurance companies in our data set, we can see an encouraging trend. Not only have these sectors all increased the average number of climate-related pages in their corporate reports since 2016, but they have also published more pages providing greater information in line with the recommendations issued by the TCFD.
Figure 2: Climate-related pages and TCFD recommendations
Interestingly, while more financial institutions in the UK disclose information in line with the TCFD recommendations each year, Figure 3 shows that the majority of these disclosures are done at the group level, rather than at a subsidiary level. This finding can be useful for regulators when considering policy for consolidated level of disclosures.
Figure 3: TCFD recommendations disclosed
Across both banking and insurance sectors, climate reporting in line with TCFD recommendations has been quite similar, as can be seen in Figure 4. While in 2016, only about 30% of institutions in each sector disclosed climate-related information, by 2020 the shares of reporting institutions reached over 70% (at the group level) across the four TCFD themes.
Figure 4: TCFD disclosure themes at the group level
We consider how different characteristics of financial institutions are related to disclosure levels. We observe that institutional size (measured via total assets) seems to matter the most. Figure 5 shows the large positive correlation between institutional size and the number of TCFD recommendations disclosed.
Figure 5: Firm’s size and TCFD disclosures by sector
Background on UK regulatory policy announcements
A general pattern we observe in the figures above is that there is a significant increase in climate-related information published after 2018. There are several potential explanations for this. A first set of potential reasons relate to ‘global‘ factors, while a second set relate to UK ‘internal‘ factors.
Global factors behind this increase in climate reporting could arise both from unusually large and devastating natural disasters (eg, the extreme wildfires in Australia in 2019), and/or from pressure by international climate groups (eg FridaysForFuture and Extinction Rebellion).
However, this increase in climate disclosures could also be driven by UK internal regulatory changes discussed and announced between 2018 and 2020. Over this period, in the UK, the Prudential Regulation Authority (PRA) issued a set of announcements and publications to encourage the management of climate-related financial risks (Table 1).
Table 1: Climate-related policy publication by the PRA
For example, in 2018 the PRA published a consultation paper (CP23/18) proposing that financial institutions under its supervision develop and maintain an appropriate approach to disclosing climate-related financial risks. In 2019, a supervisory statement (SS3/19) mentioned the TCFD framework as an example for financial institutions to consider when developing their approach to climate reporting. And in July 2020, the PRA issued a so-called ‘Dear CEO letter‘ with the explicit purpose of managing expectations by announcing a concrete timeline for financial firms to incorporate climate reporting in line with TCFD recommendations. Concretely, this letter made clear that ‘firms should have fully embedded their approaches to managing climate-related financial risks by the end of 2021’.
The role of policy announcements for climate disclosures
We examine whether any of the aforementioned policy publications affected financial institutions’ climate-related disclosures. Our empirical strategy allows us to analyse how institutions affected by the policy announcements change their climate-related disclosures relative to those not directly affected by the announcements.
In particular, we employ a difference-in-differences approach in the spirit of Bolton and Kacperczyk (2021). We construct the treatment group as the subset of financial institutions whose level of disclosure was below the average level of disclosure when the TCFD recommendations were published in 2017. The intuition behind this approach is as follows: institutions already disclosing sufficient climate information by 2017 – ie our control group – would not have been affected by these policy announcements, because they had already decided to disclose prior to any of the policy publications.
Our regression specification allows us to control for the global factors mentioned before, as we include institution and sector-time fixed effects. Additionally, we further control for other possible characteristics, such as institutional size (total assets), profitability (ROE), and leverage. In other words, our empirical setting allows us to identify the contribution of the internal UK policy announcements on UK financial institutions’ climate-related disclosures.
We find evidence of a statistically significant effect on treated institutions’ decisions to disclose climate-related information across all four TCFD recommendation themes, but only after the 2020 Dear CEO letter. Specifically, we find that those institutions that previously disclosed less catch up in terms of their disclosures after the Dear CEO letter (as can be seen in Figure 6 where the three vertical lines represent publication dates of the three policy communications we consider).
Figure 6: Evolution of two disclosure measures between control and treated firms
A: Sum of TCFD recommendations
B. Pages with TCFD recommendations
These results are robust to a battery of tests, reported in detail in our working paper, including using a different regression approach, group specifications, and inclusion of ownership as an additional control.
In this blog post, we have studied the levels of climate-related disclosures in the UK financial sector and their evolution over time. We use NLP and machine-learning techniques to generate a novel data set that collates the reporting information directly from corporate reports.
We find an increasing trend in climate disclosures across all TCFD themes, and across both banking and insurance sectors. We also find evidence of a significant effect of policy announcements on institutions’ decisions to disclose climate-related information.
Our findings provide some interesting insights for policymakers who are considering mandatory climate-related disclosure. Our results suggest that prior to regulatory interventions, only a fraction of firms disclosed climate-related information in line with TCFD, and these were mostly larger institutions. This gap in voluntary disclosures creates a case for regulatory intervention to encourage smaller institutions to disclose too. Indeed, our results suggest that regulators setting clear timelines for mandatory disclosures can help accelerate the trend, which leads to convergence across institutions.
Jonathan Acosta-Smith works at the OECD, Benjamin Guin works in the Bank’s Strategy and Policy Approach Division, Mauricio Salgado-Moreno works in the Bank’s Monetary and Financial Conditions Division and Quynh-Anh Vo works in the Bank’s Banks Resilience Division.
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