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Climate in the boardroom

Climate change is a huge risk to the global economy, with major consequences for all businesses and individuals across the world. Expectations from stakeholders, especially in the investment space, require directors to rapidly grow their understanding of climate issues and ensure their businesses are using the available tools and guidance to move towards a net zero emissions future, say Justin Smith, Executive Head of Business Development at WWF, and Louise Naude, Senior Manager: Climate Change Portfolio with WWF and a Presidential Climate Change Commissioner.

The first words in the new report released by the Intergovernmental Panel on Climate Change (IPCC) in August 2021, are: “It is unequivocal.” It thereby acknowledges that the climate crisis is unequivocally caused by human activities and is affecting every corner of our planet’s land, air and sea space already. Climate change, together with biodiversity loss, is clearly one of the biggest and most systemic challenges of our time. While climate change will affect everyone’s lives, its impacts fall most heavily on the world’s most vulnerable populations.

Tackling climate change and its effects requires globally coordinated action and a global shift in thinking, with actions to back this up, such as drastically reducing our reliance on fossil fuels. The impacts of climate change on organisations are still to be fully understood as both companies and investors grapple with quantifying the risks and opportunities presented by climate change. Despite the clear goals of the Paris Agreement, and the urgent need for each country to put in place the necessary plans to curb emissions, progress is much too slow, and the threats of climate change are becoming ever more critical.

Climate change, together with biodiversity loss, is clearly one of the biggest and most systemic challenges of our time. While climate change will affect everyone’s lives, its impacts fall most heavily on the world’s most vulnerable populations.

The recent communiqué from G20 Finance Ministers contains a number of positive elements, not least the recognition that tackling climate change and biodiversity loss, and promoting environmental protection, are urgent global priorities. Support for policy measures such as introducing a global carbon pricing scheme and phasing out “inefficient fossil-fuel subsidies” to address climate change is encouraging, as is the promotion of disclosure requirements consistent with recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD).

The recently published IPBES-IPCC co-sponsored workshop report on biodiversity and climate change – a collaboration between the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services and the Intergovernmental Panel on Climate Change – shows that climate and nature are two sides of the same coin and that both crises must be solved together.  Previous policies have largely tackled biodiversity loss and climate change independently of each other. Addressing the synergies between mitigating biodiversity loss and climate change, while also considering their social impacts, offers the opportunity to maximise benefits and meet global development goals.

Climate-related risks

The third EY Global Climate Risk Disclosure Barometer provides a global snapshot of the increasing corporate focus on climate risks and opportunities as pressure from all stakeholders moves them up the boardroom and executive agenda. For directors and business leaders, climate risk and opportunities should be more than a reporting or disclosure matter. In particular, organisations should understand that Scope 1 and 2 emissions are unlikely to be the only source of their climate risk factors. They should look up and down their entire value chain to identify vulnerabilities and opportunities for growth.

One of the risks associated with the move to a low-carbon economy is transition risk. A failure on the part of companies to take this risk into account can result in reduced creditworthiness, the ability to attract investment and secure long-term loans, and appeal to insurers, among others.

Another type of risk that can come about as a result of climate change is physical risk. This includes the increased likelihood of extreme weather events such as floods, droughts, and wildfires. Physical risks can result in interruptions in day-to-day business activity as well as have a detrimental impact on supply chains, market position, and the business’s overall value. Worth noting here is that the vulnerable members of society are usually the ones who are most affected by physical risks – their jobs, livelihoods, and homes can be destroyed by such risks, which can lead to increased inequality and poverty, which could in turn lead to increased social unrest and crime.

Examples of transition risks include:

  1. The impact on the company’s viability as a result of regulatory change, which will be harshest on companies that have put in the least effort in terms of incorporating climate-related risks into their operations

  2. A change in consumer or market preferences – as more people become climate-conscious, they gravitate towards more eco-friendly products and services, which could result in losses for those companies that are lagging behind

  3. The risk that a company’s assets are retired before the end of their useful life, making them stranded assets – this could be as a result of these assets being deemed no longer useful due to their significant carbon emissions in a low- carbon economy

Climate-related opportunities

Climate change is a threat, but it can also create opportunities for companies and investors. Companies can become more resilient to the impacts of climate change by focusing on their operations and supply chains. For example, they can focus on their resource efficiency, thereby reducing their operational costs. Companies can also focus on building more resilient supply chains by shifting exposure from suppliers that are heavily exposed to fossil fuels to lower carbon emitters.

Adversity creates opportunities to innovate. Innovation, such as in clean energy or low-carbon technologies, can lead to new products and services to either meet new customer or investor demands or to build resilience against the impacts of climate change. Companies that respond to the impacts of climate change through innovation and resilience often create competitive advantages relative to their peers. Instead of simply reacting to the uncertainty of climate change impacts, companies that go beyond the response and are proactive about using their advantage to track new risks impacting their industry, shaping the correct strategic response, and strengthening their agility and resilience, stand the chance of building an uncertainty advantage.

Investors can allocate capital to companies that would benefit from a transition to a low-carbon economy, or they can provide funding to investment products such as green bonds or low-carbon indexes. Green bonds, for example, provide capital allocators with the opportunity to fund projects that focus on positive climate- related or environmental outcomes, thereby meeting increasing stakeholder pressure to invest more responsibly.

Investors are taking notice

The top-line numbers from the Global Sustainable Investment Alliance’s biennial review back the now-conventional wisdom that interest is surging in environmental, social and governance (ESG) investing. Sustainable investing had grown to $35 trillion globally by early 2020, a 15% increase from 2018, and constituting 36% of all professionally managed assets. Together with this growth has come a substantial shift in financing away from coal and fossil fuels as divestment scales up to trillions of US dollars, led by investment managers, asset owners, pension funds and individual investor voices. South African banks too have been part of this shift, with significant improvements in their energy policies and climate change approaches in the last few years.

As a developing country, South Africa is particularly vulnerable to the effects of climate change and there are multiple sectors underpinning the economy that are susceptible to its impacts, including mining, agriculture and transport. The science shows that parts of South Africa are likely to warm at twice the global rate and that our water-stressed country is likely to become more arid in the west, with an increased risk of extreme biodiversity loss and degradation of critical catchment areas and an increased risk of heat stress. If we do not adapt or mitigate the risks we face, it could have a devastating effect on the economy and an already impoverished and unequal society.

South Africa is also specifically exposed in terms of the transition to a low-carbon economy. As a country that is still very reliant on coal for both energy – the country generates about 90% of its electricity from coal – and economic gain, South Africa runs the risk of being left behind in the transition process. The country could face trade impacts due to reduced demand for high-carbon and carbon-intensive exports such as thermal coal and locally produced iron and steel, as well as internal combustion engines. There is also a significant danger of border adjustment taxes being instituted by countries putting a price on carbon in their budgets, which will make South Africa’s exports less competitive.

The Task Force on Climate-Related Financial Disclosures (TCFD)

Recognising the financial risk that climate change presents to the global economy and that financial markets need high-quality information on the impacts of climate change, the Financial Stability Board – an international body that monitors and makes recommendations about the global financial system – created the Task Force on Climate-Related Financial Disclosures (TCFD) in 2015, to improve and increase reporting of climate-related financial information. The TCFD recommends that a company disclose the organisation’s governance around climate-related risks and opportunities, and the actual and potential impacts of climate-related risks and opportunities on the organisation’s business, strategy, and financial planning, where such information is material. It also recommends reporting on how the organisation identifies, assesses and manages climate-related risks, and the metrics and targets used to assess and manage relevant climate- related risks and opportunities, where such information is material.

There has been significant momentum around adoption of and support for its recommendations. By October 2020, the number of organisations expressing support for the TCFD has grown by more than 85%, reaching over 1 500 organisations globally, including financial institutions responsible for assets of $150 trillion.

Investor demand for companies to report information in line with the TCFD recommendations has also grown dramatically. For example, as part of Climate Action 100+, more than 500 investors with over $47 trillion in assets under management are engaging the world’s largest corporate greenhouse gas (GHG) emitters to strengthen their climate-related disclosures by implementing the TCFD recommendations. In addition, many large asset managers and asset owners have asked or encouraged investee companies to broadly report in line with the TCFD recommendations and reflect this in their investment practices or policies. This is particularly true for the banking and extractive resource industries, where the greatest level of investor pressure has been focused to date. The narrative around climate-related risk disclosure among public companies has rapidly changed over the course of the past year and has seen the major South African banks and South African resources companies release separate TCFD reports.

For both corporates and investors, it is important to have a thorough understanding of what climate change means for their own business models, but also that of the financial system. This is required to strengthen the resilience and sustainability of both individual companies and the financial system. The TCFD recommendations have fast become global best practice for institutions looking to integrate climate-related risks into their governance, strategic and operational processes.

In response to the scale and urgency of the climate crisis, Unilever has committed to net zero emissions from all products by 2039 – from the sourcing of materials, up to the point of sale of its in-store products. To achieve this goal, Unilever recognises that it must work jointly with partners across its value chain to collectively drive lower levels of GHG emissions.

The company has set aside $1.2 billion in research and development funds for biotechnology and low-carbon chemistry technologies that support that goal and open new market opportunities.

Net zero commitments

With some 120 countries committing to achieving net zero emissions by 2050, regulators around the world are pushing through mandates that make climate change mitigation central to listed corporations’ due care and diligence, with the TCFD recommendations now the clear preferred disclosure framework. For economies to reach net zero in time to keep global average temperatures from reaching catastrophic levels, an unprecedented and rapid reduction in global emissions will likely be required.

The transition to a low-carbon economy is expected to create significant structural changes. The built environment is expected to transform, using low-carbon materials such as timber and green retrofit projects. In the process, many industries are likely to experience a major reallocation of investment. Based on current market shifts, capital is tipped to move from industries involved in producing fossil fuels and those with energy-intensive business models to suppliers and producers of clean technology innovation, low-carbon solutions, alternative energy sources, low-emissions products and services, and technologies that are expected to play an important role in decarbonising energy, transport and manufacturing.

Making a net zero commitment and setting out short-term actions send a strong signal to policymakers, market regulators, peers, investees and other actors of long-term strategic plans.

Playing a role in getting the planet to net zero involves understanding where an organisation sits in the context of global net zero and how it can align to science-based targets, which provide companies with a clearly defined path to reduce emissions in line with the Paris Agreement goals. Ideally, organisations should explore the potential to take ambitious climate action, setting a net zero target in line with a 1.5°C future. Cities and companies
in the Alliance for Climate Action South Africa, convened by the National Business Initiative (NBI), C40 Cities and WWF, stand up for a ‘net zero by 2050’ economy and are taking their own action to get us there (see list of resources opposite).

The skills gap in South African boardrooms

Directors need to factor climate change into their deliberations about strategy, risk management, and opportunities as part of their duty of care. Both the Companies Act and King IV create a basis for the expectation that directors should have the necessary skill and experience to carry out their duties, and that this should extend to a broad range of matters that could significantly affect the organisation’s ability to create value.

This has two implications for boards. Firstly, all directors should have a foundational understanding of climate change and other key ESG issues. Secondly, given the complexity associated with climate and biodiversity issues, and growing expectations around disclosure, appropriate risk management and engagement with stakeholders, directors with specific experience should be recruited or developed. This is especially true for those directors serving on board committees with delegated responsibility for climate and other ESG issues.

Globally, very few directors have expertise in climate change and ESG issues. New York University’s Stern Center for Sustainable Business found that only three of 1 188 board members at the 100 largest US companies had specific climate expertise (0.2%).2 These numbers may help to explain the gap between what companies think they are doing about cutting carbon emissions and what they really are doing.

Very little director training on climate and ESG issues seems to be available in South Africa, and more effort will need to be made
by the Institute of Directors and similar organisations to close this gap. This will ensure that more directors are able to engage with investors on ESG issues in a competent manner, play the necessary internal oversight role, ensure the alignment of executive compensation with ESG performance and the identification, assessment, mitigation, and disclosure of climate and other ESG risks, including physical, reputational and transitional.

More questions are being asked by investor activist organisations, such as Just Share, around the qualifications of directors in terms of climate change, and how companies determine and properly disclose what constitutes ‘relevant climate change experience’ as well as how they assess whether directors face conflicts of interest. This has arisen particularly for boards of financial institutions looking to sharpen their policies around climate financing and investment, and divest from certain sectors, sometimes while directors from the very same boards are employed in those sectors.

Investor activism on climate affecting South African boardrooms

Sasol and the South African banking sector have been a particular focal point of climate-related investor activism, with substantial learning and shifts resulting thanks to the efforts of Just Share and a group of forward-thinking asset managers.

In 2018, 2019 and 2020, Sasol refused to table climate risk-related shareholder resolutions filed by shareholders. In 2020, despite having been the first company in South Africa to table shareholder-proposed resolutions on climate risk in 2019, Standard Bank also refused to table a shareholder resolution filed by Just Share and the RAITH Foundation. Both companies stated that they had received legal advice that the tabling of such resolutions was impermissible. While neither company disclosed its legal opinion, the arguments centred on a view that, in terms of the law, shareholders may not usurp the powers vested in the board of directors to manage the business and affairs of a company, except where the company’s memorandum of incorporation or the Companies Act 71 of 2008 provides otherwise.

Just Share received a legal opinion from senior counsel on shareholder rights to file climate risk-related resolutions, which concluded that the Companies Act must be interpreted in a manner that promotes compliance with the Bill of Rights, and in accordance with a number of other purposes of the Act, including encouraging transparency and high standards of corporate governance. Given the seriousness of climate change, it would be best to promote transparency and sound corporate governance, and balance the rights of shareholders and directors, by allowing shareholders to call for further information on this issue. If there are disagreements over the validity of a shareholder resolution, those should arguably be aired at the shareholders’ meeting and put to a vote.

The courts are likely to find that shareholders are entitled to file binding resolutions relating to disclosure on climate change matters. In May 2021, Standard Bank conceded that shareholders were, in fact, entitled to file non-binding resolutions on climate- related matters.

Corporate leadership

With its new policy on energy financing released in April 2021, Nedbank has stepped out ahead of other banks globally, and locally demonstrated the leadership we need from businesses in South Africa. What sets Nedbank’s policy apart are the concrete commitments to exit financing of fossil-fuel exploration, extraction and production by specified dates.

Other banks have focused only on coal-fired power plants in their divestment policies, with various caveats regarding technology, plant size or jurisdiction, keeping the door open for them to capitalise on coal. In contrast, Nedbank sends a clear market signal – turning off the pump of investments is the leverage point to ultimately throttle fossil fuels while ramping up investment in the growth areas of renewables and embedded generation. Nedbank’s policy is a global pacesetter that will hopefully pull other banks and financial institutions in its slipstream, and for that it should be commended.

As the Final Report on the Independent Review on the Economics of Biodiversity led by Professor Sir Partha Dasgupta reminds us, we are part of nature, not separate from it. If global leaders are serious about preventing the next pandemic, addressing the challenge of climate change, and achieving an economic recovery that will help to deliver the Sustainable Development Goals, they must acknowledge that our economies, livelihoods and wellbeing all depend on our most precious asset: nature. As consumers, investors and professionals, we should continue to engage the corporate and investor sectors in our efforts to influence the redirection of financial flows as a powerful lever to release money for sustainable investments. At the same time, we should withdraw the resources that underpin environmentally, socially, or economically harmful impacts.

 

Resources for companies

 


References:

  1. www.ipbes.net (2021). Launch of IPBES-IPCC Co-Sponsored Workshop Report on Biodiversity and Climate Change.
    Accessible at: https://ipbes.net/events/launch-ipbes-ipcc-co-sponsored-workshop-report-biodiversity-and-climate-change

  2.  Whelan, T. (2021). U.S. Corporate Boards Suffer from Inadequate Expertise in Financially Material ESG Matters.
    Accessible at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3758584


Source: Trialogue Business in Society Handbook 2021

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