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The Brexit Vote: Scenarios for Business Leaders and Boards

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This Thursday, the United Kingdom (UK) will vote in a referendum on whether to leave the European Union (EU)—referred to as the “Brexit.” Opinion polls have shifted sharply over the past two weeks to indicate that the likelihood of Brexit has increased substantially, but Frontier Strategy Group continues to believe that the UK will vote to remain in the EU, albeit by a very small margin. Opinion polls have been extremely inaccurate in the past two UK elections and we believe some hesitant voters will choose to remain in the EU in a conservative bias that we saw in both the parliamentary elections last year and in the Scottish referendum. Markets are also interpreting the murder of pro-EU Labour MP Jo Cox as likely to damage the Leave campaign.

A narrow win for the Remain campaign—our baseline scenario—is unlikely to alleviate the grievances of those supporting Brexit and would cause deeper tensions within the UK’s Conservative Party, raising the likelihood of early elections and another referendum in the next couple of years. While the economic impact of these trends would be relatively modest, lingering uncertainty would cause investments to underperform.

Should Brexit happen, however, multinational businesses would be affected in several key ways. Besides the initial financial volatility and somewhat weaker growth in Europe, most of the broader effects of Brexit outside the UK would be slow-moving, although their long-term implications could be significant enough to reshape the European Union. Companies need to be prepared for short-term volatility—particularly of currencies—but should Brexit occur companies can expect to be gradually adapting to its effects for at least the next two to three years.

Financial-market volatility and currency depreciation

The possibility of Brexit has already rattled currency, bond, and equity markets and this volatility will increase in the immediate aftermath of the event should Brexit occur. The British pound could depreciate by as much as another 10–20% against the United States’ dollar (USD) in the aftermath of Brexit, and the euro would also likely lose value, possibly as much as 5–10% against the USD. The scale of the losses would likely be temporary, but neither currency would be likely to recover to pre-Brexit levels. Brexit would also dampen investment confidence, softening commodity prices and causing overall financial market uncertainty. Added to a backdrop of weak global growth and deep concerns about China’s slowdown, Brexit would prompt another bout of volatility that would cloud corporate expectations and complicate 2017 planning for emerging markets generally.

Growth in Europe

Brexit would cause a slowdown in UK investment and business activity. A similar, though smaller, effect would be likely in the EU as a whole. Markets strongly linked to demand from the EU—such as North Africa, Eastern Europe, and parts of Asia—would see a softening of demand for the next 12 months that would affect industrial performance but would not disrupt growth trajectories. The demand effect for other parts of the world would likely be negligible. As corporate leaders gear up for 2017 planning, they would have to dedicate more analytical energy to identifying sources of growth in Asia, the Middle East, Africa, and the Americas to compensate for weaker performance in Europe.

Policy predictability

Brexit would raise a host of trade issues from the future of the Schengen Area to the outlook for the Transatlantic Trade and Investment Partnership, all of which would increase uncertainty over the cost and structure of supply chains that involve the EU. Any tangible effect on supply chains, however, would likely materialize over a period of several years, giving companies ample time to respond. It would, however, raise fundamental organizational issues such as where companies’ European headquarters will be located, tax rates, distribution-chain structure, and other concerns that should be factored into 2017 and longer-range planning as well as profitability targets. Making changes earlier could yield valuable competitive differentiation for cost and talent.

Political risks

Brexit’s most dangerous effect could be to galvanize anti-EU sentiment and populist parties across the EU, setting into effect a series of policy disruptions in the region that could weaken the EU, slow down EU integration, or even lead to other EU members exiting the union. All of this would undermine the EU’s economic outlook, and force multinational corporations to manage political risk in this usually stable region much more closely. While that would be unlikely to have ripple effects globally, it could contribute to greater instability in the Middle East and Eastern Europe if it coincided with increasingly isolationist foreign policy from the United States.

Overall, Brexit would put greater pressure on regions outside of Europe to deliver strong results that can compensate for years of underperformance by the UK and the EU in corporate portfolios. This may be a big challenge in the current global growth environment, requiring an even greater focus on agile strategies that emphasize strong competitive positioning, careful risk management, and a reshaping of how companies plan to win in emerging markets.

In case the UK votes next week to leave the EU, boards and executive teams should ask themselves several urgent questions to effectively prepare their response:

  1. What is our company’s exposure to short-term currency volatility of both the British pound and the euro? How would significant depreciation against the dollar affect our overall revenue and profit targets for this year?
  1. Have we developed alternative international growth strategies that rely less on demand in Europe?
  1. What production and distribution disruptions are we likely to face in our European operations?
  1. How should we adjust our long-term outlook for doing business in Europe? What economic and political risks are now more likely and more significant to our company?

Joel Whitaker is Senior Vice President of Global Research at Frontier Strategy Group (FSG), an information and advisory services firm supporting senior executives in emerging markets.

The Top Risks for the Next 12 Months

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Jim DeLoach

Jim DeLoach

North Carolina State University’s Enterprise Risk Management Initiative and Protiviti have completed their latest survey of C-level executives and directors regarding the macroeconomic, strategic, and operational risks their organizations face. More than 500 board members and C-level executives participated in this year’s study. Noting some common themes, we’ve ranked the risks in order of priority on an overall basis below. Last year’s rankings are included in parentheses:

No. 1 (previously No. 1)—Regulatory changes and scrutiny may increase, noticeably affecting the manner in which organizations’ products or services will be produced or delivered. This risk has been ranked at the top in each of the surveys we’ve conducted over the past four years, and is the top risk in many industry groups. The cost of regulation and its impact on business models remain high in many industries.

No. 2 (previously No. 2)—Economic conditions in markets the organization currently serves may significantly restrict growth opportunities. Declining oil and gas prices, equity markets, and commodity prices, in general, have contributed to economic uncertainty. Short-termism is a concern as business investment has yet to catch up with pre-financial crisis levels. A new normal may be unfolding as businesses adapt their operations to an environment of slower organic growth.

No. 3 (previously No. 3)—The organization may not be sufficiently prepared to manage cyber threats that have the potential to significantly disrupt core operations and/or damage its brand.This risk continues to be an issue of escalating concern. The harsh glare of the public spotlight on high-profile breaches at major retailers, global financial institutions and other organizations has led executives and directors to realize it is most likely not a matter of if a cyber risk event might occur, but when.

No. 4 (previously No. 4)—Succession challenges and the ability to attract and retain top talent may limit the ability to achieve operational targets. As roundtables facilitated by the National Association of Corporate Directors and Protiviti in 2015 indicated, directors understand that talent strategy is inexplicably tied to overall business strategy. Companies need talented people with the requisite knowledge, skills, and core values to execute challenging growth and innovation strategies.

No. 5 (previously No. 7)—Privacy, identity, and information security risks may not be addressed with sufficient resources. The technological complexities giving rise to cybersecurity threats also spawn increased privacy/identity and other information security risks. As the digital world enables individuals to connect and share information, it presents more opportunities for companies to lose sensitive customer and private information, in effect, creating a “moving target” for companies to manage.

No. 6 (previously No. 11)—Rapid speed of disruptive innovations and/or new technologies within the industry may outpace the organization’s ability to compete and/or manage the risk appropriately, without making significant changes to the business model. Innovation can be disruptive if it improves the customer experience in ways that the market does not expect, typically by lowering the price significantly, or by designing a product or service that transforms the way in which the consumer’s needs are fulfilled. Whereas disruptive innovations may have once taken a decade or more to transform an industry, the elapsed time frame is compressing significantly, leaving very little time for reaction. Sustaining a business model in the face of digitally enabled competition requires constant innovation to stay ahead of the change curve.

No. 7 (previously No. 6)—Resistance to change could restrict the organization from making necessary adjustments to the business model and core operations. Positioning the organization as agile, adaptive, and resilient in the face of change is top-of-mind for many executives and directors. It’s a smart move. Early movers that exploit market opportunities and respond to emerging risks are more likely to survive and prosper in a rapidly changing environment.

No. 8 (previously No. 17)—Anticipated volatility in global financial markets and currencies may create significant, challenging issues for an organization to address. There are many forces at work that intensify this risk, e.g., high asset prices, slowing global growth, China’s approach to foreign exchange, declining commodity prices, uncertainty associated with central bank policies, and less confidence in policymakers’ ability to respond to market issues quickly and effectively.

No. 9 (previously No. 5)—The organization’s culture may not sufficiently encourage timely identification and escalation of significant risk issues. The collective impact of the tone at the top, tone in the middle and tone at the bottom on risk management, compliance and responsible business behavior has a huge effect on timely escalation of risk issues to the people who matter. This is a cultural issue requiring constant attention by management and oversight by the board.

No. 10 (previously No. 9)—Sustaining customer loyalty and retention may be increasingly difficult due to evolving customer preferences and/or demographic shifts in the existing customer base. Disruptive innovations and the rapid pace of change continue to drive significant changes in the marketplace. Customer preferences are subject to rapid shifts, making it difficult to retain customers in an environment of slower growth. Sustaining customer loyalty and retention is a high priority for customer-focused organizations because senior executives know that preserving customer loyalty is more cost-effective than acquiring new customers.

A board of directors may want to consider the above risks in evaluating its risk oversight focus for the coming year in the context of the nature of the entity’s risks inherent in its operations. If the company has not identified these issues as risks, directors should consider asking why not.


Jim DeLoach is a managing director with Protiviti, a global consulting firm.

What Boards Should Know About the Paris Agreement

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The twenty-first session of the Conference of Parties (COP) convened in Paris Nov. 30-Dec. 11 last year to negotiate a legally binding international agreement on mitigating the effects of climate change. Known as both COP21 and the 2015 Paris Climate Conference, this historic meeting of parties to the United Nations Framework Convention on Climate Change (UNFCCC) resulted in the first-ever unanimous accord, with 187 countries pledging collective action to cut carbon emissions. Despite a U.S. Supreme Court setback to environmental regulations on February 10, this deal will have significant consequences for business worldwide—consequences that will unfold as governments establish regulations that enact their support for and compliance with the Paris agreement.

The Sustainable Innovation Forum 2015

(Photo: Climate Action/The Sustainable Innovation Forum 2015)

What are the key elements of the agreement?

The COP21 accord seeks to accomplish specific major goals:

  • To restrict the increase of global temperatures to “well below” 2.0°C beyond those of the pre-industrial era, and to endeavor to limit their rise to a maximum of 1.5°C above pre-industrial averages.
  • Curtailing the amount of greenhouse gases (GHGs) generated by human activity to levels that trees, soil, and oceans can absorb naturally by sometime within the latter half of this century.
  • To review each country’s contribution to emissions reduction every five years so they can scale up to the challenge.
  • For wealthy countries to provide “climate financing” that will enable poorer countries to adapt to climate change and switch from fossil fuels to renewable energy sources.

How can countries understand and manage their own emissions?

Like any business goal, understanding and managing emissions requires three basic steps: measurement—determining where you are and where you need to go; management—determining opportunities, challenges and actions; and reporting—monitoring and disclosing performance over time.

Among the most significant outcomes of COP21 are action plans for the ten largest CO2 emitters by country.  These countries include (in order of the size of their emissions) China, the United States, the European Union (28 member states), India, Russia, Japan, South Korea, Canada, Iran, and Saudi Arabia.  The major global economic sectors emitting the highest amounts of GHGs are establishing mitigation objectives (i.e., emission reduction targets) referred to as Intended Nationally Determined Contributions (INDCs).  For instance, the European Union has set a target of at least a 40% reduction by 2030, and the United States is aiming for a 26%–28% reduction by 2025.

Such a global effort will have credibility only if these INDCs are made publicly available. The five-page United States INDC published on the UNFCCC site outlines how the country is planning to measure, manage, and report its performance; it also references existing U.S. laws and standards and draws on the EPA’s Greenhouse Gas Inventory Report: 1990–2013.  This report breaks down responsibility for sources of GHG emissions over time and by major industry sector.

A significant amount of research went into the target of a 26%–28% reduction by 2025.  The U.S. federal government is already taking steps to reduce emissions, and public-private collaborations have developed that will enable these sectors to leverage high-efficiency, low-missions solutions and incentivize market and technology innovations in response to the challenge.

This drive is creating a global wave of new business and investment opportunities and is no longer regarded as a fringe activity. Goldman Sachs produces regular equity research, such as The Low Carbon Economy—GS Sustain equity investor’s guide to a low carbon world, 2015–25 and Standard & Poor’s has an entire team dedicated to analyzing sovereign ratings, corporate credit risk, and carbon efficient indices.

What kind of impact will climate change and the Paris Agreement have on a company’s valuation?

In an update to the Annual Study of Intangible Asset Market Value, Ocean Tomo LLC reveals that the intangible asset value of the S&P 500 grew to an average of 84% by January 1, 2015, which represents an increase of four percentage points over 10 years.  As management of intangible assets has become increasingly critical to a company’s valuation, expectations for transparency about how these ‘intangible’ risks are managed have risen.  These risks now extend to climate change and the costs and benefits of reducing GHG emissions.

Companies can show that they are actively managing climate-change risks and reducing their GHG emissions through research surveys like the CDP (formerly known as the Carbon Disclosure Project).  The CDP was founded in 2000 in order to collect data related to carbon emissions and distribute it to interested investors.  What began as a small group of activists has grown to include more than 800 institutional investors representing assets in excess of US $95 trillion.

Interested investors (asset owners and managers) have demonstrated their support of the CDP by becoming CDP signatories and being involved in a range of investment-related projects.  The list of CDP Signatories and Members includes some of the largest institutional investors, such as Bank of America, BlackRock, BNY Mellon, CalPERS & CalSTRS, Goldman Sachs, Morgan Stanley, Northern Trust, Oppenheimer Funds, State Street, TIAA-CREF, T. Rowe Price, and Wells Fargo.  The CDP is by far the most influential organization specializing in this area, and it maintains a comprehensive public collection of corporate performance information.

Data posted on the CDP website can be organized by country, index, industry, or company, and is also presented in reports such as the following:

These reports can be helpful to any company seeking to establish its own GHG emissions strategy.  Drawing from public sources also allows a company to see the commitments and disclosures of industry peers, what customers may expect, and how suppliers are improving their own efficiency.  In addition, GHG-specific data such as that reported through the CDP is now being integrated into specialized research tools, for example, analyses on Bloomberg’s Sustainable Business & Finance website.  Any company (or investor) with a Bloomberg subscription can quickly compare and contrast a range of GHG-related factors, ranging from policies (i.e., climate change policy, energy efficiency policy, environmental supply chain policy) to specific GHG metrics (i.e., energy consumption per revenue, total GHG emissions per revenue, percentage of renewable energy consumption).

Do corporate and institutional customers care?

Consider the manner in which new market demands ripple through supply chains: ISO 9000, Y2K, Dodd–Frank/Conflict Minerals, etc.  That same dynamic is playing out around GHG emissions.  Once an organization makes a commitment to understand its own GHG footprint, it soon recognizes the degree to which its purchasing decisions influence its overall GHG footprint.

In 2010, Wal­-Mart Stores Inc. announced its goal to eliminate 20 million metric tons of GHG emissions from its global supply chain by the end of 2015.  The company actually exceeded its commitment by eliminating 28.2 million metric tons, which is the equivalent of taking more than 5.9 million cars off the road for an entire year. Wal-Mart achieved this reduction by implementing innovative measures across both its global operations and those of its suppliers: enhancing energy efficiency, executing numerous renewable energy projects, and collaborating with suppliers on the Sustainability Index to track progress toward reducing products’ overall carbon footprint.  By 2017, Wal-Mart will buy 70% of the goods its sells in U.S. stores from suppliers that participate in this Index.

Then, of course, there is the world’s largest single procurement agency, the United States’ General Services Administration (GSA), which spends more than $600 billion annually.  The GSA and the U.S. Department of Defense (DoD) are both actively involved in the management of GHGs in their supply chains.  These and other federal agencies are working closely with the White House Council on Environmental Quality to understand the GHG footprint of the government’s purchasing decisions and to engage and educate suppliers on GHG reduction strategies.  The Federal Supplier Greenhouse Gas Management Scorecard lists the largest suppliers to the US government by spend and identifies whether the supplier discloses its emissions and whether it has set emissions targets.  This information is drawn from public sources, and, like the CDP, this scorecard creates added market pressure on public and private companies to measure, manage, and report on GHG-related activities.

Do consumers care?

In 2015, Cone Communications partnered with Ebiquity to field its third survey of global attitudes, perceptions, and behaviors around sustainability and corporate responsibility.  They conducted an online survey of more than 9,500 consumers in nine of the largest countries as measured by GDP: the United States, Canada, Brazil, the United Kingdom, Germany, France, China, India, and Japan.  The survey broadly described corporate social responsibility (CSR) to respondents as “companies changing their business practices and giving their support to help address the social and environmental issues the world faces today.” Respondents were then asked whether in the preceding 12 months they had:

Corporate Social Responsibility (CSR) graphic

 

What does the agreement mean for your business?

Awareness about fossil fuel use, carbon and GHG emissions, and climate change impact is proliferating in all segments of the economy—public and private companies; federal, state, and local governments; employees, customers, and shareholders; etc.  Today’s management teams and directors need to understand where their company stands on the risk/opportunity spectrum.  To begin or advance the boardroom conversation on climate-change risks and strategies for reducing GHG emissions, consider the following:

  • Look across the company’s value chain. Where is the company most vulnerable geographically?  Which facilities are purchasing power from the highest and lowest carbon emitting electric utilities? Are their GHG reduction opportunities through our electric utility or through other energy providers in our region?
  • Have we taken a public position on reducing GHG emissions? Have we set goals and targets?  If not, why not?  If so, how are we performing? Do we have quantifiable and verifiable information?
  • What positions have our largest customers taken on the issue of GHG emissions? What are their expectations of us as a supplier?
  • Is our industry sector a leader or a laggard? How is our organization doing in comparison with our peers?

As part of the lead-up to COP21, the Science Based Targets (SBT) initiative was formed to actively engage companies in setting GHG emission reduction targets.  A collaboration among the CDP, the UN Global Compact, the World Resources Institute, and the World Wildlife Fund, the SBT initiative publishes the emission reduction targets set by more than 100 of the world’s largest companies.  Here are just a few examples:

  • Coca-Cola Enterprises has committed to a 50% reduction of absolute GHG emissions from their core business operations by 2020, using 2007 as the base year. Coca-Cola Enterprises also commits to a 33% reduction of the GHG emissions associated with manufacturing of their products by 2020, using 2007 as the base year.
  • General Mills has committed to reducing absolute emissions by 28% across their entire value chain from farm to fork to landfill by 2025, using a 2010 base-year. These reductions include total GHG emissions across all relevant categories, with a focus on purchased goods and services (dairy, row crops, and packaging) as well as delivery and distribution.
  • Procter & Gamble has committed to cutting emissions from operations by 30% from 2010 levels by 2020.
  • Sony has committed to reducing GHG emissions from its operations by 42% below fiscal year 2000 levels by fiscal year 2020. The company also has a long-term plan for reducing its environmental footprint to zero by 2050, requiring a 90% reduction in emissions over 2008 levels by 2050.

In October 2015, more than 80 major U.S. corporations signed the American Business Act on Climate Pledge, among them such companies as  Alcoa, American Express, Apple, AT&T, Berkshire Hathaway Energy, Dell, GE, General Motors, Goldman Sachs, Google, Johnson & Johnson, McDonald’s, Nike, Pepsi, Pacific Gas & Electric, Salesforce, Starbucks, UPS, etc.  A range of quantitative GHG-emission reduction goals and targets are available for public review on the SBT website.

In addition, entire industries—such as the fashion and hospitality industries—are working together to set their own targets.  These types of voluntary public commitments are setting precedents and thus expectations for others within and across industries and economic sectors.

Given the pending presidential election in the United States and the existing regulations referenced in the United States’ own INDC, it is unlikely that significant regulatory changes will impact business in 2016.  It is likely, however, that existing standards and Executive Orders will shape the conduct and actions of specific industries.

Growing interest in the federal government’s own footprint and those of its suppliers may constitute the most significant impetus for change. As the GSA and the DoD increasingly seek suppliers with the lowest GHG emissions, these suppliers (public and private) will be incentivized to measure, manage, disclose, and verify their GHG emissions.

The Sustainable Innovation Forum 2015

(Photo: Climate Action/The Sustainable Innovation Forum 2015)

What do directors need to do now?

  1. First and foremost, become familiar with your company’s carbon profile and sustainability image. You need to know the carbon footprint of your company, the company’s plans to reduce that footprint, and the company’s messaging about those plans.
  2. Whether your company is public or private, make sure that its customers know the company’s story. Business-to-business customers expect suppliers to measure, manage, and report on carbon emissions. Directors can ensure that a credible and compelling message is communicated to customers.
  3. Conversely, directors can ensure that the company exhibits GHG consciousness when choosing major suppliers. In a choice between two qualified vendors, why not pick the one that is also better for the sustainability of your business and the planet?
  4. If you serve on the board of a public company, look for the names of your largest investors on the list of CDP signatories, realizing that more and more of these investors are conducting due diligence on carbon emissions in their portfolio companies. Urge your CEO to announce carbon reductions in any communications with your company’s climate-oriented investors.
  5. Develop your business case for carbon reduction and other sustainability measures. Reducing carbon emissions means the reduction in the use of fossil fuels, which translates to cost savings. Diversifying the firm’s energy portfolio to include lower emission sources is also a strategic move in today’s market.  Seeking out and procuring lower-emissions goods and services has become commonplace.  Leverage your procurement spend to help reduce your overall GHG footprint.
  6. Urge management to reach out to sources knowledgeable about climate change in order to learn more from them or even to consider them as possible business partners. Wall Street firms, private equity investors, lenders, insurers, rating agencies, and stock exchanges are all becoming involved in climate issues and can be valuable partners in identifying future risks and opportunities, as well as crafting new strategies.
  7. Ensure your investors understand and appreciate the value of investments your company makes to reduce its carbon footprint and improve the sustainability of its operations.

For more practical guidance on board oversight of this important issue, please use NACD’s Oversight of Corporate Sustainability Activities Handbook.

About BrownFlynn (www.brownflynn.com) and the authors:

BrownFlynn is a corporate sustainability and governance consulting firm with 20 years of experience supporting public and private corporations in the development and implementation of strategic corporate responsibility and sustainability programs.  www.brownflynn.com

Barb Brown, co-founder and principal, has led the firm since 1996, when it was established to address the growing demand from shareholders on intangible issues such as corporate responsibility; sustainability; environmental, social, and governance topics.  Recognized as a pioneer in the industry, Brown is a sought-after speaker, author, and thought leader and has contributed her expertise to a range of professional and industry groups, as well as numerous multinational corporations.

Mike Wallace is managing director at BrownFlynn. An NACD member, he has been a regular contributor to NACD programs and publications.  He has worked in the field of corporate responsibility/sustainability for more than 20 years and has presented on these topics to audiences at NACD Master Classes, the NACD Global Board Leaders’ Summit, and meetings of the Society of Corporate Secretaries, and the National Investor Relations Institute.  He advises public and private companies as well as boards and board committees on these issues.