Organizations’ climate transition plans will be central to delivering an orderly shift to a low-greenhouse gas (GHG) and climate-resilient global economy. While there is growing regulatory momentum across the world for businesses to disclose their roadmaps to net zero, transition planning can also represent a business opportunity. You can approach it as you would another aspect of business strategy.
Transition-related risks, and opportunities, are arising from the societal and economic progress towards a low-carbon and more climate-friendly future. These risks speak to the business uncertainties around net-zero transition, such as policy, legal and market changes which could see some companies face significant moves in asset values and cashflows and/or higher costs of doing business.
You can manage the impact of climate change on the business, such as losses to physical assets as a result of more intense weather, in a number of ways. These include buying insurance, considering alternative risk transfer options, selling or sunsetting emitting assets or moving assets. You’ll both reduce your contribution and increase your resilience to a warming world by moving to a business model that generates a lower carbon footprint and lower greenhouse gas emissions.
Deciding the right strategy for your organization could require you switch a more system-wide dynamic approach to understanding your transition risks, one that enables you to better understand the connections between risks, their cause and effects.
Quantifying the climate risks that could erode the value of your business is the first step towards developing transition plans that manage and mitigate these exposures and maximize the opportunities. By using modeling and analytical tools to quantify climate risks and integrating this into business and financial planning, you can:
This insight – which calls on expert perspective shared in WTW’s webinar From risk to opportunity: Harnessing climate transition insights for business success and wider WTW perspectives – looks at how can you develop transition plans that do just this.
Below, we cover:
There is increasing regulatory impetus for climate risk quantification and robust transition plans. 2023 saw the International Sustainability Standards Board (ISSB) finalize its International Financial Reporting Standards (IFRS) with the publication of Standard 1 Sustainability-related disclosure standard and Standard 2 Climate-related disclosure standards (IFRS S1 and S2), with IFRS S2 including provisions around disclosing transition plans.
In addition, the Corporate Sustainability Reporting Directive (CSRD) will mean all listed and large companies in the EU will need to disclose a transition plan aligned to 1.5 degrees Celsius global warming scenario in their annual reports on a comply or explain basis.
In the U.S., meanwhile, the Securities Exchange Commission (SEC) climate proposal will require organizations to disclose transition plans if they have adopted one as part of their climate-related risk management strategy.
2023 also saw the publication of the Transition Plan Taskforce (TPT) Disclosure Framework, guidance designed to support organizations developing strategic and rounded transition plans in response to IFRS S2 requirements. While a U.K.-based initiative, TPT requirements purposely align with IFRS S2 reporting requirements and with the transition plan guidance developed by the Glasgow Finance Alliance for Net Zero (GFANZ), in support of the growing international convergence around what constitutes robust and credible transition plans.
One of the first considerations in developing your transition plan is the metrics your organization should use to baseline its position and define its roadmap to net zero. Here, emissions-based metrics have the advantage of appearing relatively objective and straightforward for external stakeholders to verify.
However, as a 2023 joint report from WTW and the Institution of International Finance recognizes, there remains little consensus in this area. The report also highlights how GHG emissions are not likely to represent a comprehensive indicator of an organization’s exposure to transition risk, in part because emissions, “suffer from systematic reporting biases, tend to be backward-looking, and may not accurately capture how a firm’s profitability is likely to be affected by an increase in the cost of emissions (including that brought about by the imposition of a carbon tax).”
There is also a low correlation between financial risk and carbon intensity.[1]
The goal of quantifying transition risk is to put meaningful numbers against your exposures and the options for mitigating transition risks, as well as revealing the opportunities. Transition risk quantification, then, is ultimately about making financially-sound decisions for the long-term success of the business.
One approach here is to apply analytical techniques to quantify transition risk as a financial risk that can be modelled as an impact on cash flows. Using this methodology enables the business to define transition risk as the difference in your future value between a business-as-usual scenario and a given number of transition scenarios. You can then feed these outputs into transition plan disclosures and, more crucially, into strategic decision-making to support resilience and growth.
Let’s consider a hypothetical airport organization to show how this works. To arrive at a financial definition of transition risk, you might first capture the airport’s input costs – such as energy, labor and other opex and infrastructure costs, and carbon costs – as well as revenues, such as landing fees from airlines and non-aeronautical revenue from sales and rentals. You might then analyse the financial impact of different future transition scenarios by evaluating the company valuation based on the difference in cashflows between business-as-usual and alternative scenarios impacting input costs and revenues. WTW expresses this as Climate Transition Value at Risk (CTVaR).
Credible transition plans map out the actions you will take in the short and medium term to capture opportunities, minimize future risks and protect and enhance long-term value for your stakeholders, as well as society, the economy and natural environment.
As TPT reinforces in its Disclosure Framework, transition plans should also be characterized by accountability. This means ensuring your organization’s planned actions are underpinned by robust governance and quantified using time-bound metrics and targets (including financial). Again, analytics and modeling can help you assess possible changes to the business model and value chain to achieve your climate ambitions through a financial impact lens.
If you embed these analytics, complete with financial metrics, into risk quantification and strategic action, disclosing resulting business strategies in transition plans could serve to increase investor confidence. This could be seen in contrast with the disclosure of strategies that only serve to reduce a firms own emissions, which alone may not necessarily demonstrate value creation under the current market and regulatory landscape.
Using climate transition analytics to inform transition/business strategy might involve three key steps:
TPT is among those – including WTW – recognizing that transition planning is business strategy. Ultimately, the essence of transition planning is to identify what needs to change (and how) in the short and medium term for your organization to deliver its climate ambition and strategic objectives in the long term. This could include changes to your business plan, operations, products and services, policies and conditions, financial plans, stakeholder engagement plans, governance and organizational structures, skills and/or culture.
Your organization may need to move beyond any narrow data and tick-box mindsets to make the changes it needs to pre-empt both the evolving climate disclosure requirements and the changing attributes of businesses built for long-term success under net zero transition.
For smarter ways to identify, quantify and manage climate transition risks and opportunities, get in touch.
