From conformance to performance, to future-proofing
Climate is a board-level issue. It is widely recognized as being among the most material financial risks facing businesses — and one that will transform business models over the long term. It is therefore fundamentally a question of long-term business strategy and board stewardship, requiring new forms of thinking and culture from the boardroom, the executive and the workforce.
In understanding the role of the board, it’s important to highlight the changing operating landscape for companies and imperative to act. The apparent intensification of natural hazard risk is causing more interruption and damage. Expectations across society — from customers, investors and regulators — are also shifting to align with a lower carbon economy. The direction of travel is increasingly apparent.
There is an urgency to this trend, one driven by the dynamics of the natural world. Society faces a trade-off: The economy can take higher transition risk now by more rapidly moving to a lower carbon state and lower future physical risk due to a reduced energy system in the natural system, or we can delay the transition, continuing to emit carbon and adding to future physical risks. The latter of these options is more likely given current developments.
In all scenarios, “pain will be felt.” [1] Board directors tasked with stewardship will recognize climate as another business risk to be managed and navigated. Yet this risk trend covers almost all economic assets, bringing substantial opportunities.
The role of boards can be categorized into three areas: ensuring regulatory conformance, helping drive organizational performance, and supporting sustainability and futureproofing the organization. Each has a clear link to responding to climate change risks and opportunities as well as the need for continued stewardship.
The broad theory of change on climate and sustainability-related risks is on the disclosure of information first. By assessing the source of risks and their transmission channels, steps can be taken to respond and manage. External stakeholders also have increased visibility of risks and management measures and a basis to evaluate the adequacy of response.
The foundations of climate reporting were first set out by the Taskforce for Climate-related Financial Disclosure (TCFD), covering governance, strategy, risk management, and metrics and targets. Widespread adoption globally has solidified that climate is a financial risk.
Recent consolidation with the International Sustainability Standards Board (ISSB) is designed to bring alignment with emerging best practice but retain compatibility with previous disclosure efforts. It directly builds upon the TCFD recommendations.
Source: WTW analysis - not exhaustive
A return to business fundamentals can be a useful guide in a changing operating landscape. With the macrotrends affecting companies through physical risks, transition risks and liability risks, more accurate assessment of these risks and opportunities should help inform strategy and decision making.
Companies would do well to understand external constituents driving the agenda further, in particular, investors, consumers, employees and supply-chain partners. For example, Glasgow Financial Alliance for Net Zero’s (GFANZ’s) 2022 progress report stated that 550 financial institutions, with $152 trillion (USD) in assets, committed to steer the global economy toward net-zero emissions facilitated by credible, decision-useful climate data and transition plans. Also, a 2021 study by Standard Chartered suggested that 78% of multinationals planned to remove suppliers that could endanger their carbon transition plans by 2025. Further 57% were also prepared to replace emerging market suppliers with developed market suppliers to aid their transition.
While a proliferation of companies have been making public commitments toward environmental, social and governance (ESG) goals, there is a growing concern of greenwashing and actions not being material enough. Part of the issue is that some companies still view this as a moral or corporate social responsibility agenda. For sustainability priorities to be truly embedded, the board needs to understand the risks and also focus on the real tangible benefits, both financial and nonfinancial, associated with coherent climate strategy.
Companies that succeed in embedding the sustainability agenda as part of their business strategies must identify, quantify and communicate to all stakeholders the tangible benefits and risks. Moving beyond the moral imperative that individual directors and management may feel, the risks and benefits must be institutionalized to be truly impactful.
The benefits to businesses identifying targets, plans to get there, and links back to core business strategy and planning are numerous. For a start, increased resilience against physical risks today will result in reduced damage, business interruption and employee impacts. This is not a question of reporting or regulatory compliance but of fundamental business strategy (and transformation in some cases). Boards are used to governing, challenging and overseeing business strategy, and the transition to net zero should be no different.
Transition plans are fast becoming a key focus of climate reporting; indeed, G7 and G20 leaders have come out in support of them, and regulatory frameworks continue to reinforce the expectation for them, building off the TCFD’s 2021 recommendations (including ISSB, CSRD and SEC ). However, we strongly believe that boards and companies that approach transition planning with a compliance mindset will not be successful in future-proofing the business.
The financial sector is increasingly expected to lead and enable the transition to a net-zero state. The GFANZ is perhaps the most widely known manifestation of this pressure. Investors, regulators and other stakeholders have continued to examine the financed emissions of portfolios, the theory being that affecting the cost of capital for activities (brown or green) will provide market signals through pricing and drive change in the real economy. These ideas remain continually tested and evolving.
In October 2023, the Monetary Authority of Singapore progressed these expectations, publishing Guidelines for Financial Institutions on Transition Planning. This is the first example globally of detailed transition planning guidelines for financial institutions from a supervisory authority. A number of key takeaways should be considered from these drafts. Most important is the focus on engagement rather than divestment and the multiyear approach. While there continues to be interest and scrutiny on the financed emissions of portfolios, supporting and navigating the transition is not well represented by a singular carbon metric nor does it follow a straight pathway. Instead, the guidelines encourage financial institutions to set transition finance and engagement targets to “play the role of an effective steward.”
We know that financial sector regulation tends to lead that for general industry and, as mentioned above, prominent regulatory frameworks already include provisions for transition plan disclosures (beyond just financial institutions). Building on those expectations and the work of GFANZ, the Transition Plan Taskforce (TPT) (of which WTW is a member) in October 2023 published a detailed transition plan framework and guidance that consolidates best practice. This is gaining considerable momentum globally, which is important; it is critical to have globally consistent forward-looking transition plans internationally to allow capital to flow into the companies, investments, technological advancements and climate solutions that drive decarbonization and resilience of the real economy at the scale and pace required.
This movement demonstrates that setting targets is no longer sufficient, but credible and ambitious plans on how they will be delivered are now required to give external stakeholder confidence that an organization can survive and thrive in a lower-carbon world. The essence of transition planning is to identify how the business model and value chain may need to change in the short and medium term for the company to deliver its climate ambition and strategic objectives in the long term. In other words, it describes how a company is future-proofing itself as the adverse effects of climate change intensifies and present risks to business models and value chains and as the world transitions to a low-carbon and climate-resilient (and nature-resilient) economy. It requires boards to think strategically about what their businesses need to look like in the future, where they see competitive advantage and what it will take to achieve the desired transformation.
To meet this challenge, boards and directors require new capabilities and skills. However, based on the 2023 WTW-NASDAQ global survey, roughly half of respondents (48%) report their boards currently do not have the skills and expertise to provide oversight of climate risks and opportunities. Unsurprisingly, climate was also identified as the fastest growing area of skills development.
Source: WTW-NASDAQ Survey
Also, the same study highlighted that the full board will continue to be responsible for climate and sustainability issues; however, nearly 60% of the companies were planning to set up a dedicated sustainability committee over the next three years.
Note: Based on those with overlapping responsibilities
To help board members become climate-literate, if not climate experts, Climate Governance Initiative (CGI) and its network of more than 30 country chapters help equip and build capacity in boardrooms to have meaningful conversations on the climate strategy, risks and opportunities.
To this effect, the World Economic Forum (WEF) has outlined eight principles of climate governance, as follows:
Source: WEF and CGI
A version of this article was first published in the Q1 2024 issue of the SID Directors Bulletin published by the Singapore Institute of Directors.
