In this special report, Michael Hayes, KPMG Global Head of Renewables, Bridget Beals, Co-Head of Climate Risk and Decarbonisation Strategy, KPMG UK and Conor Holland of our Sustainable Futures team discuss the nature and extent of climate risk for corporations and why the identification, quantification and reporting of these risks – and the mitigating actions being undertaken – are of fundamental importance to the climate agenda.
Such measurement and reporting should lead to transformative strategies being adopted by corporations, which could result in a significant reduction in global greenhouse gas emissions and, potentially significant value creation. Conversely, failure to appropriately measure and report climate risks will leave investors and other key stakeholders unable to correctly price the financial impact of climate change, which in turn may lead to financial crises as the devastating impacts of climate change are felt across business models where the detrimental impacts are not priced into valuations.
Under the 2015 Paris Agreement, global political leaders adopted a goal of limiting the increase in global average temperatures to well below 2°C above pre-industrial levels. Readers will appreciate that without urgent and immediate action to limit global warming, the effect of climate change may be profound in its breadth and magnitude, permeating across industries and geographies.
To achieve this goal the global community agreed to implement major structural transitions around the world to decarbonise the global economy. National signatories committed to Nationally Determined Contributions (NDCs) which set out targets for emissions reductions which are updated every five years. In addition, companies are under pressure to demonstrate that their business models are adapting for the urgent transition to a low carbon economy and are increasingly adopting science-based targets (SBT) to mirror this Paris aligned emissions reduction trajectory.
Crucially, the EU has taken major steps to build a sustainable finance ecosystem through the EU Green Deal which sets ambitious targets for 2030 regarding GHG emission reductions, renewable energy, energy efficiency and a long-term vision for a climate-neutral economy by 2050; as well as setting our classification and disclosure requirements for assets under the EU Sustainable Taxonomy and Corporate Sustainability Reporting Directive. With the EU Commission estimating delivering on the Green Deal will require EUR260b of investment by 2030, companies and financial institutions have a critical role to play in the transition to a low-carbon and climate-resilient economy.
Climate risk – what does it mean for corporations?
It is clear that many governments have become very focused on climate change and, in particular, are considering relevant policies and regulation that could help mitigate the climate crises. Increasing government intervention on the climate agenda is a fact that global corporations can no longer ignore as many of these new policies and regulations will directly impact their businesses.
However, corporations also need to recognise the various other relevant influences on the climate agenda including, investors, who are increasingly challenging the performance of their investee companies with respect to climate related risks, as well as employees, customers, and other parts of their supply chain.
In this regard, it is critical that corporations understand and address two separate but very much interrelated aspects of the climate agenda:
- The impact of their business activities on the climate, including (but not limited to) their direct and indirect emissions . This has resulted in the era of Net-Zero and Science Based Target commitments whereby corporations undertake to implement strategies to significantly decarbonise their businesses. Solutions such as renewable energy procurement, energy efficiency, circular economy and many others are all relevant in helping corporations to achieve this objective.
- The second aspect, which is very much interrelated with the first, is the exposure each corporation has to climate related risk. To the extent that companies’ business models are visibly exposed to transition risks (such as a shift to a low-carbon economy) or physical risks (such as extreme weather conditions), investors, inter alia other stakeholders, are now particularly focused on whether valuations sufficiently incorporate those risks and, crucially, understanding what companies are doing to mitigate and adapt to them. Consequently, institutional investors, regulators, accountancy bodies and auditors are increasingly interested in the impact of climate change on entities’ business models, cash flows, financial position, and financial performance.
The reality is that a business can be low carbon but also be fully exposed to climate risk.
It is therefore critical that companies appropriately measure and disclose climate-related risks and opportunities linked to their operations, ensuring that they understand where pressure is likely to evolve on their business operations and demonstrating management’s ability to front foot the requisite change. In addition, there is likely to be enhanced pressure to report on progress in achieving Net-Zero targets. In the remainder of this report, we focus on the significance of reporting and measurement of climate risk and why it could be transformative for the climate agenda.
We are recommending much more financially orientated measurement techniques and disclosures which we believe will drive much greater action on climate action by corporations. This will require climate risk to be embedded and integrated into an organisations’ broader governance and risk management framework and integrated into key decision-making processes, including into capital allocation and investment decisions.
Climate risk & corporate reporting
Many readers will be aware that there are already myriad climate-related reporting frameworks across the EU available for adoption. However, the voluntary nature of these frameworks means that companies are free to apply them or not. Consequently, in isolation, these frameworks do not ensure the comparability of information measured and disclosed by different companies. As such, there is a need for mandatory common reporting standards to ensure that information is comparable and that all relevant information is disclosed. The development of mandatory common sustainability reporting standards is necessary to progress to a situation in which climate, and broader sustainability information, has a status comparable to that of financial information.
There has been a very significant increase in demand for climate related information in recent years, especially on the part of the investment community. Indeed, as we look ahead to a post Covid-19 world, it is clear that information on broader environmental impacts is also relevant in the context of mitigating future pandemics with the adverse impacts of human behaviour on ecosystems increasingly linked to the occurrence and spread of infectious diseases.
As previously noted, the increase in demand for sustainability related information is driven by the changing nature of risks to companies’ business models and growing investor awareness of the financial implications of these risks. This is especially the case for climate-related financial risks. Moreover, with the growing awareness of investors that climate risks can put the financial performance of companies at risk, and the growing market for investment products that explicitly seek to conform to measurable climate-related targets, companies will come under increasing pressure to not only report on climate risk, but also quantify climate risks and opportunities their business faces and document their plans for climate action within the organisation, commensurate with those risks. Key stakeholder such as investors, customers, business partners and regulators will want to see a defined strategy from companies with whom they engage in order to satisfy their own climate risk and decarbonization agenda, including whether a particular investment or transaction should be made or not.
Corporate Sustainability Reporting Directive
To ensure all large and public EU companies integrate climate risk – and other sustainability factors – into their financial related decisions and reporting, the EU has recently issued their proposed changes to strengthen the nature and extent of sustainability reporting over the coming years – the Corporate Sustainability Reporting Directive (CSRD).
The proposed changes to sustainability reporting are profound and will be fundamental and directly support the European Commission’s stated objective of directing investment towards more sustainable activities across the European Union. The CSRD proposals significantly enhance the scope of entities required to provide mandatory non-financial reporting to cover all large undertakings as well as all those listed on EU regulated markets, save for micro-entities.
Moreover, the CRSD sets out in far greater detail the non-financial information that entities should report and introduces mandated EU sustainability standards with a first set of standards due for adoption by 31 October 2022. The proposal aims to ensure that there is adequate publicly available information about the risks that climate and sustainability issues present for companies, and the impacts of companies themselves on the environment. The CSRD should facilitate allocation of capital to companies and activities that address climate risk and decarbonisation challenges. This is, therefore, a very positive step in European corporate reporting and addressing some of the current gaps in climate related reporting.
Climate first – what is needed
Given the urgency associated with climate risk, sustainability‑reporting standards for climate-related information will likely be the priority. Having regard to climate-related information, stakeholders are interested in knowing about undertakings’ physical and transition risks, and about their resilience to different climate scenarios including key assumptions made in defining these scenarios and risk thresholds. They are also interested in the level and scope of GHG emissions, including the extent to which the companies use carbon offsets to meet decarbonisation targets, as well as information on the implementation of other decarbonisation strategies.
Climate related standards should therefore specify the information companies should report in relation to those matters. Achieving a carbon neutral economy requires action across all sectors in the economy. In particular, reducing energy use and increasing energy efficiency is key in this respect as energy is used across supply chains. Energy aspects should therefore be duly considered in sustainability reporting standards, especially in relation to environmental matters.
Evolution of reporting frameworks
As outlined in this article, effective measurement, quantifications and disclosure of climate-related risks is crucial to enabling investors make more informed asset allocation decisions and to allow markets correctly price the financial impact of climate change, which in turn ensures the reallocation of capital necessary to transition to a low-carbon economy.
As such, we consider it imperative that the current corporate reporting frameworks evolve to introduce mandatory climate related reporting standards that facilitate the measurement and quantification of climate related risks, addressing both the impact on the climate from an entity’s business activities and the impact to the entity from climate related risks. In this regard, we note that the proposed CSRD is heavily pivoted toward enhancing non-financial disclosures.
While this is most certainly a welcome development in providing an enhanced mandatory reporting framework for non-financial information, it is, in our view, it is more important that the future development of climate related standards address the profound valuation risks associated with climate change. It is not enough to focus on “upfront” disclosures only: climate risk is more than a non-financial disclosure matter – it is a key valuation risk.
Get in touch
If you have any queries on corporate climate reporting, please contact our Sustainable Futures team. We'd be delighted to hear from you.