ERM can help you unlock the connection between financial markets and corporate decarbonization, ref. WBCSD's Climate-related Corporate (CPAS)

ERM can help you unlock the connection between financial markets and corporate decarbonization, ref. WBCSD's Climate-related Corporate (CPAS)


Nat Vanitchyangkul Tom Reichert Rahul Mehta Jaydeep S. Santoshkumar Kulkarni Neha B. Subhradeb Pramanik Rutuja Tendolkar Rati Bhattacharya Steve Duckworth Jaideep Das Yulia Dobrolyubova Andrew Radcliff Matt Klein Piers Touzel Tatsuya Noma Michelle Elias Parishrut Tripathi Tanvi Katti

In the wake of evolving global commitments and stringent mandates, the business landscape stands on the cusp of a profound transformation. With the imminent repercussions outlined in reports such as the COP27's Integrity Matters Report and the ISSB Standards IFRS S1 and IFRS S2, alongside the revelations from COP28's outcome report on Recognition and Accountability, a mere compliance-centric approach will fall short of industry demands.

The changing landscape requires businesses to make big changes beyond their usual methods. Embracing an approach that melds reporting, disclosure, corporate strategy, and transition planning, companies are beckoned to recalibrate their corporate governance, re-evaluate integrated risks and opportunities, and ardently pursue science-informed net-zero targets. In this dynamic milieu, the commitment to measure and manage performance incessantly emerges as the linchpin for sustained success and credibility.

Overcoming Misalignment in Financial Markets and Business Goals

While the realms of climate risk and opportunity present significant implications for businesses, they have not been fully assimilated into current decision-making processes. Moreover, the predominant focus of financial accounting remains retrospective, with a notable absence of comprehensive integration that considers future impacts.

Key Influencing Factors from Financial Markets to Business

§  Incentive Discrepancies: The prevailing misalignment between financial markets and businesses largely emanates from incentive structures that fail to advocate for transformative actions.

§  Valuation Model Limitations: Current valuation frameworks inadequately encompass the comprehensive spectrum of climate-related risks, performances, and opportunities, thereby presenting a skewed perspective.

§  Investment Strategy Oversights: Within the buy-side sector, there exists a notable absence of systematic integration of climate considerations into investment strategies, undermining the holistic evaluation of potential risks and returns.

§  Evaluation Gaps: Concurrently, sell-side analysts frequently overlook the criticality of integrating climate variables, resulting in evaluations that are not fully reflective of the evolving business landscape.

§  Banking Sector Discrepancies: The banking industry's lending decision processes often lack a structured integration of climate parameters, potentially overlooking crucial factors that could influence creditworthiness and sustainability.

§  Inconsistent Rating Systems: The contemporary credit and sustainability ratings present ambiguous signals, further complicating the alignment between financial markets and businesses' climate-related commitments and performances.

 

Key Influencing Factors from Business to Financial Markets

§  Informational Discrepancies: The observed misalignment from business to financial markets primarily stems from a shortfall in delivering decision-useful information that accurately reflects evolving realities.

§  Underestimation of Change Dynamics: The pace and magnitude of requisite transformations are often miscalculated, leading to misaligned expectations and strategic missteps.

§  Limitations of Traditional Valuation Models: Prevailing business performance metrics, such as net present value and discounted cash-flow models, inadequately account for the multifaceted implications of climate-related impacts, thereby presenting an incomplete financial picture.

§  Strategic Integration Deficits: The incorporation of climate risks and opportunities remains inadequately embedded within core business strategies, limiting holistic organizational responsiveness.

§  Complexity of Climate Management Landscape: The proliferation of diverse voluntary initiatives, frameworks, standards, and metrics introduces complexities, rendering the task of managing climate performance intricate and multifarious.

§  Regulatory Focus on Compliance: Existing disclosure regulations inadvertently foster a compliance-centric approach to transparency, potentially stifling proactive and comprehensive reporting endeavours.

Need Of the Hour - Managing Misalignments to Foster Transformation

To proficiently address the divergence between financial markets and businesses, it is essential to verify the functionality of Climate-related CPAS. Such effectiveness hinges upon the CPAS readiness of a business and consistent adherence to the principles inherent in the beyond-compliance paradigm.

§  Corporate Governance: To effectively address climate-related risks in corporate strategy, the Board of Directors requires specialized skills and integration mechanisms, such as sub-committees or external Advisory Boards. Climate considerations should be integral to governance, risk assessment, and decision-making processes. Aligning organizational goals with climate objectives necessitates their incorporation into performance metrics and incentives.

§  Integrated risk and opportunities assessment: Integrating climate risks into Enterprise Risk Management is vital for the company and its supply chains, necessitating a comprehensive assessment that goes beyond impact and likelihood. The company should evaluate the financial ramifications of climate factors and identify growth opportunities through decarbonization transitions.

§  Set Science- Informed Net-Zero Target: To address the imperative of halving global emissions by 2030 and achieving net zero emissions by 2050, it is essential to establish a science-backed net-zero target, possibly through frameworks like the Science-Based Targets Initiative (SBTi). Once this target gains approval, it becomes crucial for the organization to transparently disclose its emissions on an annual basis and continuously monitor progress towards the established goal, making necessary updates as required.

§  Corporate Strategy and Transition plan: Incorporating climate transition plans into corporate strategy directs investments toward decarbonization-focused R&D and operational enhancements. Organizations can leverage GFANZ Guidance and the Transition Plan Taskforce for effective planning. The focus on avoided emissions can spur innovation in low-carbon solutions, while internal carbon pricing can reinforce sustainability initiatives.

 

§  Measure and Manage performance: Effective decision-making hinges on aligning metrics and KPIs with organizational objectives and measuring emissions using standards like the Greenhouse Gas Protocol and PACT's product-level framework. Organizations must invest in robust data infrastructure and internal controls for timely, accurate information dissemination.

§  Assurance, Reporting & Disclosure: Adopting ISSB S1 and S2 standards for climate disclosure is essential. Integrating climate data with financial reporting enhances decision-making and appeals to financial markets, bolstering decarbonization. Organizations should also engage in assurance activities and articulate their climate commitment in investor communications for enhanced credibility.

 

CPAS in Action: Realizing Business Value and Sustainability Synergy

With a growing awareness and proactive approach, businesses are gaining a profound understanding of climate risks, fortifying the resilience of their operations and supply chains. This not only curtails financial vulnerabilities and shields against unforeseen climate-related losses but also positions them ahead of regulatory shifts by aligning rigorous financial accounting principles with carbon accountability. Such integration of climate considerations into corporate blueprints is not merely a defensive strategy but an impetus for transformation, propelling swift strides towards decarbonization.

Moreover, emerging paradigms, like the innovative concept of avoided emissions accounting, present fresh avenues for sustainable innovation. By harnessing the potential of granular product-level carbon accounting, companies can refine their carbon-reduction strategies, bolster Scope 3 reporting accuracy, and transparently track their sustainability journey. As these endeavours furnish financial markets with finance-grade, reliable, and pertinent information, businesses stand to gain a distinct edge in valuation compared to their counterparts. This virtuous cycle further augments their attractiveness, potentially leading to a reduced cost of capital over time, all while championing a brighter, greener future.

For years, ERM has proudly partnered with the WBCSD, diligently assisting businesses in actualizing their sustainability ambitions by engaging with every echelon of their organizations. If your business is poised for a transformative journey or if you're contemplating initiating one and seek expert guidance, I invite you to connect with me at india@erm.com or with the partners tagged in the beginning of this post.  Allow us to facilitate your sustainability aspirations with an initial CPAS readiness assessment and collaboratively craft a bespoke, beyond-compliance strategy tailored to your organizational needs. Your sustainability journey deserves the best; let us guide you every step of the way.

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