Investors and lenders are increasingly challenging the performance of their investee companies and borrowers regarding climate risks, as are employees, customers, and other parts of their supply chain. Businesses are making Net-Zero and Science-Based Target commitments and decarbonising their businesses, with renewable-energy procurement, energy efficiency, and the circular economy supporting this objective. Mike Hayes and Conor Holland of our Sustainable Futures practice explain.
As business models are exposed to transition risks, such as a shift to a low-carbon economy, or physical risks, such as extreme weather, investors and other stakeholders are assessing whether valuations sufficiently incorporate those risks and, crucially, understanding what companies are doing to mitigate and adapt to them.
Unsurprisingly, institutional investors, regulators, accountancy bodies and auditors are increasingly interested in the impact of climate change on 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.
We recommend more financially orientated measurement techniques and disclosures to achieve greater action on climate action by business. This means that climate risk is embedded into a broad governance and risk management framework, and integrated into key decision-making processes, including capital allocation and investment decisions.
To ensure that all large and public EU companies integrate climate risk and other sustainability factors into their finance-related decisions and reporting, the EU has issued proposals to strengthen sustainability reporting with the Corporate Sustainability Reporting Directive (CSRD). The proposals significantly enhance the scope of entities required to provide mandatory non-financial reporting. Moreover, the CSRD sets out the non-financial information that entities should report, and introduces mandated sustainability standards due for adoption by 31 October 2022.
Given the urgency associated with climate risk, sustainability reporting standards for climate-related information will likely be the priority. Stakeholders are interested in knowing about physical and transition risks, and resilience to different climate scenarios, including key assumptions. They are also interested in the level and scope of GHG emissions, including the use of carbon offsets to meet decarbonisation targets, as well as information on other decarbonisation strategies.
Climate-related standards should therefore specify the information that companies should report. Reducing energy use and increasing energy efficiency is key in this respect, as energy is used across supply chains. Energy aspects should therefore be considered in sustainability reporting. Such information helps investors make better asset allocation decisions, and allows markets to price the financial impact of climate change, thus helping the reallocation of capital transition to a low-carbon economy.
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 climate from business 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.
Finally, it is important that the future development of climate-related standards addresses the profound valuation risks associated with climate change. It is not enough to focus ONLY on ‘upfront’ disclosures. Climate risk is more than a non-financial disclosure matter – it is a key valuation risk.
This article originally appeared in Business Plus magazine and is reproduced here with their kind permission.
The pace of change is challenging leaders like never before. To find out more about how KPMG perspectives and fresh thinking can help you focus on what’s next for your business or organisation, please get in touch with Mike Hayes or Conor Holland of our Sustainable Futures practice. We’d be delighted to hear from you.