This blog is going to be a bit of a diversion for me. Some of you may wonder why a self-confessed, no-carbon energy geek is encroaching into the territory of my colleagues in the financial services sector. Well, for two reasons.
First, throughout my career in the energy sector, doing the right thing when it comes to sustainability has always involved trade-offs—or a so-called “trilemma.” Trilemma is a concept that describes the trade-off between the security and cost of energy and its impact on the climate. The contention has been that you can have two out of the three, but not all three. However, misquoting Meatloaf, “Two out of three ain’t good enough.”
Second, nothing happens, including the pursuit of net zero, without investment.
This second point about investment, along with what is happening in the financial services sector around climate risk, has especially grabbed my attention. There is a growing need to measure and disclose exposure to climate-related risks, and this is driving investment, as well as changing corporate behavior, within the financial services sector and beyond.
Back in April 2019, for example, the Bank of England laid out expectations for firms in terms of managing financial risks related to climate change in a Supervisory Statement (SS3/19). The statement addresses concerns with respect to the following risks:
- Physical risks arising from climate and weather-related events
- Transitional risks arising from the transition towards a lower-carbon economy
Another example is the global Task Force on Climate-Related Financial Disclosures (TCFD), which has a similar aim. The task force published a set of recommendations to drive consistency in the disclosure of information by companies about their exposure to physical and transitional risks (and liabilities) resulting from climate change. These recommendations also focus on helping companies align their disclosure with investors’ climate risk expectations.
Why is an energy geek so interested in this?
Well, it looks like the investor community and insurance sector will begin pricing exposure to climate risk into the cost of capital and insurance. This will directly affect the cost of doing business in the energy sector and all other sectors, placing climate risk exposure and related costs firmly on the priority lists of executives. Further, clear and consistent disclosure also will begin to affect reputation and a company’s ability to secure investment, win business, and gain customer trust.
Those companies that have been hiding behind “greenwashing”—the practice of creating a misleading impression about one’s sustainability efforts—will face exposure. In addition, investment in initiatives that genuinely move companies forward on their net zero journeys will begin to show a return on investment. Doing the right thing will no longer be a decision that involves moral and ethical trade-offs; it also will be the right thing to do economically. (Read my colleague Charlotta Walk’s related blog, ‘Greenwashing’ is a bad strategy: We need sustainable finance.)
I believe this will do more to change corporate attitudes towards the climate crisis than any regulatory compliance mandates. All too often, businesses view compliance as an overhead cost rather than a nudge to do the right thing. The challenge (and opportunity) in addressing the climate crisis is to re-engineer one’s business to take advantage of “green” financial practices and win customers by demonstrating a strong commitment to sustainability.
The bottom line is that companies across industries will face pressure to factor climate response into their strategies. They also will need to adjust their business models to mitigate climate risk exposure and take advantage of opportunities to drive sustainability.
As part of this, businesses also will need to understand the climate risks they face across their supply chains and take action to reduce their exposure to these risks—whether the risks are physical, transitional or reputational. The pressing need to address supply chain risks will incentivize all companies to take climate change more seriously.
Business leaders already recognize that they need to address climate risk, with many committing to becoming net zero by 2030. Reaching net zero ahead of the curve is even better. However, doing so requires the ability to accurately assess and disclose exposure to climate risks.
Clearly, the identification and management of risks to financial systems arising from the climate crisis is a hot topic. To find out more about the role that digital technology and data can play in identifying and managing climate risks, leave a comment below or get in touch with me.