July 8, 2021
July 8, 2021
The climate risks we are facing are starker than ever.
This summer, the physical risks of a warming planet are on full display. The megadrought and record-shattering heatwaves punishing the western United States are forcing farmers to plow under crops, cities to implement water restrictions, and energy companies to warn of possible blackouts. On the opposite side of the country, the National Oceanic and Atmospheric Administration is predicting another above-average hurricane season after last year’s record-breaking lashing.
Transition risks are starting to play out as well. The momentum behind the transition to a net-zero economy is accelerating dramatically, with cities, states, and global businesses—including the nation’s six largest banks—setting ambitious commitments that are transforming electricity sourcing, transportation, and building use. Just last year, the market capitalization of clean energy companies increased by almost $1 trillion, while more than 100 US oil and gas companies declared bankruptcy.
Yet the risk that has truly come to the fore over the past few months, especially for corporate directors, is regulatory risk. The US federal government, under President Joseph R. Biden Jr., is forging ahead with executive orders, proposed legislation, and regulatory proposals aimed at cutting US greenhouse gas emissions by at least half by 2030 and to zero by 2050. In just the past few months, the Federal Reserve System, the US Securities and Exchange Commission (SEC), and other key US regulatory bodies have made concrete moves to prioritize climate change as a systemic economic risk that all businesses—and their boards—should be overseeing.
This dramatic pendulum swing will have enormous consequences for all publicly traded companies. It will also impact investors, including private equity firms, as outlined in Ceres’ recent report The Changing Climate for Private Equity. Earlier this year, the SEC said it would propose new rules for corporate climate risk disclosure. Ceres, along with investors representing $41 trillion of assets under management, submitted comments supporting mandatory disclosure.
Underscoring movement at the state and industry levels, the New York State Department of Financial Services issued first-of-its-kind formal guidance last fall calling for regulated insurers and banking institutions to start integrating climate risks into their governance, risk management, and business strategies. The Federal Reserve is also exploring measures to better understand how climate change will affect key financial institutions and overall financial market stability. Among the potential measures are mandatory climate scenario stress tests, which will help the Fed evaluate individual firms’ and overall market resilience against climate-related shocks.
As much of a pivot as this is, a recent report from Ceres underscores that these steps are still in their infancy and that there is likely more to come from US regulators.
So, given the increasing focus on these three climate risks—physical, transition, and regulatory—what should the board do, other than broaden and strengthen its expertise on climate and clean energy issues?
1. Understand the climate risk exposure to their enterprises. Directors should work with management to ensure the organization is assessing the complex risks of climate change through appropriate tools, including scenario analysis. Qualitative and quantitative scenario analyses are recommended by the Task Force on Climate-Related Financial Disclosures, one of the voluntary standards that the SEC is considering as a model for mandatory climate disclosures.
It is important for any scenario analyses to reflect risks that the company faces both from climate change and from how the company’s activities could exacerbate the climate crisis. The idea of systemic risk is that there is no place to hide. Where a company exacerbates risk, it will ricochet back to the business.
2. Drive discussions on how climate-risk exposure impacts organizational strategy. The results of climate-risk assessments should then be integrated into the risk-management systems used by the company, where they can be considered alongside traditional risks and can factor into decision-making around infrastructure investment, product development, and supply chain logistics.
Since the role of the board is to position the company for long-term performance, directors should ensure that insights the company obtains on climate-risk exposure are factored into decisions on strategy and resilience.
3. Engage with stakeholders. Once the risk-management systems are in place and strategy determinations have been made, the board should encourage management to proactively engage with stakeholders—especially investors and regulators—not only to communicate the company’s approach to climate risk but also to get a sense of their evolving expectations. These stakeholders often express their views quite clearly, but companies need to ensure that they listen for and process that information in order to address issues early and well. Waiting too long can lead to public confrontation, as in the recent Exxon Mobil Corp. proxy vote, and to the rushed implementation of new strategies.
4. Support regulations and policymaking that allow for a planned transition. Transition to a net-zero future is inevitable; the only question is whether it will be orderly or chaotic. Climate change is a truly global challenge—emissions anywhere in the world affect us all, and no company can mitigate its risk by acting alone. Policies and regulations can spur the collective action needed for an orderly transition, which is in the best interests not only of the climate but also of the economy. Rather than seeing regulation in a negative light, boards should help management understand that a lack of climate regulation is a truly risky proposition and ensure that any corporate lobbying aligns with both climate science and with company commitments to decrease emissions.
The overall message should be clear: directors can help enable a planned net-zero transition with their company leading the charge or stand by while an unplanned net-zero transition puts their company in the rearview mirror.
Melissa Paschall is manager of governance with the Ceres Accelerator for Sustainable Capital Markets and Steven M. Rothstein is managing director of the Ceres Accelerator for Sustainable Capital Markets.
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