In the first article of this series we explored the rapidly increasing focus on corporate resilience as an outcome of COVID-19, and touched on other motives propelling businesses in a more sustainable direction. We also learned that while many leading companies are merging sustainability with strategy, the vast majority are yet to embark on their climate journey in a meaningful way. This inaction can ultimately quash the gains of a low-carbon transition and render the Paris climate goals unattainable.
To motivate corporate climate action, rolling out robust green policies and reporting frameworks is just as critical as removing bad ones. Today, the catalyst for a more environmentally sound business model can be broadly summarised under three interrelated drivers: compliance, company value, and licence to operate.
But how strong are the sustainability drivers for business in light of other agendas and incentives - such as adapting to the changes brought by COVID-19, or fossil fuel subsidies? Does it make more sense to plug away at the 'business as usual' – or to brave the challenge of completely transforming an organisation? What exactly do stakeholders expect and what are the risks of either approach?
Gradually, then suddenly: Compliance and ambition is driving out carbon
In Ernest Hemingway's book The Sun Also Rises, the character Mike Campbell is asked how he went bankrupt: “Gradually, then suddenly," he replies. This is also used in relation to looming tipping points. The state of government action on climate change shows exactly that; national climate action plans are increasingly translated into laws and policies. The momentum of carbon pricing policies is growing, for example, as countries are pressured to raise ambition and reduce emissions. Worldwide, the risks of a changing climate is increasingly obvious, and renewable energy policies are being introduced at various levels (cities, countries, and companies).
A dense web of climate legislation covers companies in different sectors at super-national, country and federal level. The European Union's Emissions Trading Scheme (EU ETS), for example, has capped high emitting industries for 15 years. In the U.S, the Clean Air Act regulates a large number of sources of heavy industry emissions, including oil and gas. In the UK, the Streamlined Energy and Carbon Reporting (SECR) Scheme requires some 12,000 companies to disclose their energy and carbon emissions.
And ambition continues to grow, with Europe leading the charge: The European Green Deal aims to make Europe the first climate neutral, circular and competitive continent by 2050 – it is now being discussed as the jumping board for the economic recovery. The EU's forthcoming Sustainable Finance Strategy and taxonomy on sustainable finance will create ripple effects in the investment community. Reporting requirements are also tightening across the EU, with the Non-Financial Reporting Directive being revamped.
Measuring value in a changing climate: Is going green always good?
Transitional risks will follow hot on the heels of ambitious climate policies: carbon pricing, regulation, technological disruption, and a drop in demand for carbon-intensive products are already disrupting markets. Companies operating in multiple countries need to understand and quantify the very real impacts of this evolution, and the long-term effects of the Paris climate agreement on their business model.
Efforts to drive down emissions and combat climate change can radically affect the value of companies – and greening complex supply chains will require a transformation of an entire system of value and stakeholders. But many managers still seem largely unaware of the risks and opportunities.
Which brings us to company worth.
An old-fashioned argument may have run like this: 'we can ignore all but the legal requirements of environmental regulation' or 'going green is only for good economic times'. But climate change can no longer be ignored when assessing corporate worth, which is calculated based on tangible things like buildings and inventories, as well as intangible assets such as governance, reputation, talent and environmental stewardship. The intangible asset class can today account for up to 80% of a company's worth, in particular in the service sector, according to the world's leading asset owners. Also, climate change-related physical risks, which directly affect tangible assets, could wipe millions off the value of some of the world's biggest companies.
An ever-growing number of climate-conscious investors are relying on ESG (Environmental, Social and Governance) analytics, which is a fast-moving agenda.
Rebecca Self, South Pole's Director of Sustainable Finance, explains:
"Governance, including corporate board committees and legal obligations, has always been in the spotlight for most investors, and they can refer to annual reports, for example, to see how a company is doing. Things like operational carbon emissions and employee metrics can now be measured, and investors can use these quantifiable impacts to make value judgments."
Against the backdrop of transitional and physical risks arising from global warming, investors are now using their financial clout to push for change in business. Progress is also being made in codifying some of the less tangible ESG issues, e.g. disclosure standards, so they can be compared between companies, which in turn will accelerate divestment and the greening of investment portfolios.
The most prominent interventions have come from the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and the Sustainability Accounting Standards Board (SASB). The TCFD framework includes scenario assessments that consider the negative physical impacts under a range of global warming trajectories, and the 'transition' risks and potential of the low-carbon economy. To date, over 1000 businesses have committed and there are calls by policy-makers for the TCFD to become mandatory. The SASB builds on the U.S. financial accounting framework by specifying material ESG issues affecting the bottom line, in a number of industry sectors.
Stakeholder demands continue to challenge social licence to operate
A company's 'social licence to operate' includes its brand reputation and market potential. Citizens are demanding change on both local and global levels, including through movements like those galvanized by Greta Thunberg. Today's customers are more eco-savvy and boycott the products of companies who do not share their values. Global talent is gravitating towards purpose-led businesses.
There is a lot at stake. Sustainability is a top concern and requirement for millenials, who currently account for about a quarter of the global population and represent the world's most powerful group of consumers. Their influence will continue to grow as they enter decision-making positions across public and private sectors.
This focus on the wider stakeholder community has been long recognised by the ex-Unilever CEO, Paul Polman. Under his leadership, the company became a beacon for purpose-driven capitalism, and took into consideration the views of its wider stakeholder base to transform its business model. This is shared by a surprising number of business leaders: 181 members of the highly influential Business Roundtable in the U.S, including diverse corporations such as Apple, Walmart and Conoco, signed a one-page declaration to promote an economy that serves all stakeholders, saying: “We commit to deliver value to all of them, for the future success of our companies, our communities and our country."
Corporate inaction is no longer acceptable to investors, either. They are demanding clearer and more comparable ESG disclosures. Blackrock CEO, Larry Fink, made global headlines earlier this year when he requested companies to report against the SASB and TCFD disclosure frameworks. Overall, a corporate focus on ESG is seen to reduce a company's risk profile, with its cost of access to debt capital. Also, the use of green bonds is becoming more widespread - fixed-income instruments with money destined for climate and environmental projects. Also, sustainability funds have outperformed their peers since the COVID-19 crisis began and across the first quarter in 2020, both in developed and emerging markets. This reflects the long-term resilience built into companies, with good governance at their core.
What happens next?
Will these interconnected drivers - compliance, company value, and licence to operate - be enough to make sustainable business models the new normal post-COVID-19?
A number of immediate challenges arise for businesses from increased expectations. They must understand their material sustainability issues, design a far reaching vision and strategy, set goals that are ambitious and realistic , and take action to realise them. This must all be communicated via well understood metrics and language – to investors, customers and civil society.
How these actions should be prioritised and implemented in practice will be outlined in future articles, as we continue to explore the key steps along the journey to climate leadership.
South Pole offers support along the entire Climate Journey to help tailor solutions for companies to reduce emissions within their boundaries, but also finance global avoidance and removal activities, either through certified carbon credits or investments through impact funds. We help empower frontrunners to take results-based climate action, today.