The business implications of climate change are complex and vary across sectors. A company can at the same time face both significant climate-related business opportunities and significant financial risks in different parts of its value chain.
In order to reduce greenhouse gas emissions to meet the Paris agreement, a large part of the world’s known fossil fuel reserves will need to remain in the ground. That is challenging for the financial system because investors hold bonds and shares connected to those assets. EUR trillions of assets run the risk of becoming stranded.
For example, Germany plans to close all the country’s 84 coal-fired power plants by 2038. In July 2019, an influential group of investors, which are members of the Institutional Investors Group on Climate change and the Climate Action 100+, asked big European construction materials companies to commit to a target of reducing their net carbon dioxide emissions to zero by 2050.
Climate change affects the availability of water resources, fertility of soil and in general living conditions. This leads to what the Governor of the Bank of England, Mark Carney has called “liability risk” – that is the risk that big greenhouse gas emitters are sued by those suffering from climate change and will face court-ordered damages. Several US states, major cities and charities have begun to take legal action against fossil fuel companies, for example. Climate refugees and unpredictable political actions would add to this.
Opportunities for some
The transition towards a carbon neutral world will, though, see many winners, as well as those actors facing mainly risks. Business solutions that replace emissions-intensive products and services, or that are net emission negative, are in increasing demand as efforts intensify to keep climate change at a tolerable level.
Corporates in the renewable resources, energy efficiency, circular economy, assets sharing and carbon sinks management business have the opportunity to do good business and at the same time be part of the solution. The investments in low- and no-carbon solutions needed to meet the Paris agreement alone are huge, estimated at an additional EUR 180 billion annually. This market will see many sustainable and innovative businesses be successful. Green bonds, green loans and other forms of new sustainable finance will be available to finance business expansion.
The time to act is now
Few companies have a history in assessing ESG-related risks and opportunities in financial terms. Information provided to the capital markets is therefore starting from a modest level. Yet, the stakes for both corporates and investors are high. The challenge will multiply for financial institutions, which will need information on the financial consequences of ESG factors from individual companies and across asset classes and investment vehicles.
It is clear that governments take seriously their responsibility to act on climate change and other ESG issues. And the financial sector will have to respond to the requirements that will shortly be imposed on it. But above all, investors’ demands are increasing. Information needs to come from the real economy: non-financial companies that manufacture, trade and deliver products and services.
From a company perspective, when interacting with the capital markets it is crucial to speak in the language of investors and lenders on ESG factors. What is the information need of the capital markets driven by risk-adjusted return expectations and sustainable finance regulation? Which are the company’s key financial opportunities and risks, how are they managed and what is their expected financial relevance? Which business-integrated ESG targets have been set, why are they financially material and how is progress measured? How does governance, policies and board oversight ensure steady progress towards targets and what is the actual outcome? New reporting guidance and requirements support disclosing this information that a sustainable capital market needs.
Not acting positively and constructively on existing or upcoming non-financial reporting requirements could have a number of negative consequences:
– More difficult access to capital
– Lower stock valuation due to increased risk profile because of insufficient information
– Measures related to non-compliance
– Worse financial performance due to untimely action on the business risks and opportunities following from climate change
The time to act is now: to consider the strategic consequences from climate change and other financially-material ESG factors; to build systems and processes to meet current and upcoming regulatory and investor requirements; and to disclose ESG impacts and risks in mainstream reporting.