Topics:   ESG,Risk Management

Topics:   ESG,Risk Management

October 27, 2021

Three Questions Directors Should Ask About the Transition to Net Zero

October 27, 2021

Public and large private companies are increasingly under pressure to publicly disclose their plans to transition to net-zero carbon emissions. US Securities and Exchange Commission (SEC) chair Gary Gensler has asked agency staff to submit a proposal for mandatory climate-risk disclosures for SEC consideration by the end of this year.

Business as usual is no longer tenable. Global greenhouse gas emissions must be halved by 2030 to meet the Paris Agreement and Biden administration goal of reaching net-zero emissions by 2050—yet carbon emissions are still rising.

Corporate momentum on net-zero initiatives is building. More than one-fifth of the world’s largest corporations have pledged to reach net-zero carbon emissions by 2050. Organizations such as the Glasgow Financial Alliance for Net Zero, made up of more than 300 financial institutions responsible for approximately $90 trillion in assets, are setting science-based targets for 2025 and 2030 to mobilize finance at scale.

Companies that are among the first to figure out how to transition to a low-carbon economy will not only benefit from lower capital costs. They will also build competitive advantages that are hard to challenge: capturing new value as sectors reshape, progressing along steep experience curves, deepening customer relationships as they partner to solve for the whole value chain, and innovating their business systems.

By contrast, those organizations caught unprepared will not only risk contributing to a climate disaster—they will also risk falling behind better-equipped rivals through more expensive financing, lagging know-how, declining demand for non-decarbonized products, exclusion from new value systems, and damaged reputations.

So, as boards take stock of increasingly apparent climate risks, every director should raise questions that probe if their management teams are preparing for both the risks and opportunities on the way to a net-zero world. Based on our recent research, here are three questions that can help:

1. Is the company climate-resilient? Risk to the company should not be the only perspective, though it is essential to provide continuity of service and to understand where innovating processes and products can lead to new opportunities and lower risk.

On the physical side, while companies may already have insurance against extreme weather events, they may not be protected against future cost increases of that insurance as weather risks increase: operationally committed to their properties, companies may find themselves protected against weather risk but not climate risk.

On the transition side, directors need to ask management to present their plans for transitioning to a net-zero economy and the risks those plans entail.

What Directors Should Do: Confirm the company has people with the right skills to determine if the business is climate-resilient in both physical and transition risk. Probe if the team is making adequate climate-related disclosures to stakeholders. Verify that the management team is examining a wide range of transition scenarios. Consider: beyond the business itself, whom is the company relying on, and how well are they prepared for a low-carbon economy?

2. Is the business designed for maximum impact in a net-zero economy? To get to a net-zero world, companies need to engineer emissions out of their entire business systems, including their supply chains and customers’ use of their products. Reaching this goal may involve embracing opportunities for new scope in adjacent spaces and new ways of establishing strategic control of the value chain. Opportunities for profitability—and value—are shifting as businesses that are currently low margin become strategically valuable once revamped for a low-carbon future. Pressure to repurpose scrap material for another life, for example, could transform the waste and scrap industry while increasing costs for the businesses depending on it.

What Directors Should Do: Ask management if they are analyzing where value will migrate in their industry within a net-zero world—and if the company is prioritizing the right space. Is the team examining its entire value chain for new opportunities? Is it looking just at its own transition—or at the business opportunities of helping its customers with theirs?

3. Does the company have the support required for its plans? To reach net zero by 2050, every company will require investors, banks, suppliers, customers, employees, and policymakers to support its transition to a less carbon-emitting business. To persuade a wide range of stakeholders to back their plans, management teams need to select and track trusted emissions metrics aligned with the progress they are targeting in order to tell their stories. Metrics that recognize the dynamics of transition, such as those measuring carbon intensity or implied temperature rise, may prove more useful than focusing only on absolute emissions.

What Directors Should Do: Make sure management chooses metrics that support the path they have chosen, from the set of metrics recommended by the Task Force on Climate-related Financial Disclosures (TCFD). Multiple bodies and standard-setters, from the G20 Finance Ministers and Central Bank Governors to the International Financial Reporting Standards Foundation, have made statements in support of the TCFD framework as a shared international framework.

It is natural, and necessary, for the board to approach climate change with a risk mindset. But also applying an impact mindset can help ensure that the business can embrace the opportunities of the transition and establish a strong and defensible position on the path to net zero, in terms of both climate and financial impact.

John Colas and Simon Glynn are partners and co-leads of climate and sustainability at Oliver Wyman.

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Comments

Nir KossovskyNovember 03, 2021

There is a fourth compound question from an ESG Risk Management perspective which is just as important: who are the stakeholder groups calling for net zero (if they are actually ALL calling for net zero), what is their expectation for conformance and timing, and how heterogeneous are those expectations. One size does not fit all.