How CFOs can help companies weather climate change has been saved
Perspectives
How CFOs can help companies weather climate change
CFO Insights
In this issue of CFO Insights, we’ll explore the multitude of forces pressuring companies to act now on climate change and examine some of the ways CFOs can fortify their companies against the expected economic damage it could generate.
Explore content
- Introduction
- A gathering storm
- An imperative to act
- Rising to meet climate opportunities/challenges
- Contact us
Introduction
As the environmental impact of climate change becomes more and more visible, finance leaders around the world are on the front lines of calculating the risks and bolstering their companies’ financial resilience in the midst of such ongoing threats.
Both the North American CFO Signals™ survey for the fourth quarter of 20191 and the Autumn 2019 European CFO Survey2 asked finance executives what their companies are doing to address climate change risks, to what extent different stakeholders are pressuring them to act, and what specific steps their companies have taken. Among North American CFOs, more than 70 percent said their company is under at least moderate pressure to act from at least one stakeholder group. Sixty-one percent of European CFOs (representing 19 countries) reported that they feel pressure to act from three or more stakeholders.3
The increasing frequency and severity of climate-related disasters has raised the specter of unforeseen losses. By the US government’s count, the country endured 14 separate billion-dollar (or more) weather and climate disaster events in 2019, at a total cost of $45 billion. For CFOs, such events indicate the high potential impact that climate change may have on future operations and financial returns—whether in the form of physical risks (rising temperatures, lower crop yields, etc.), as a result of the transition to a low-carbon environment (for example, investments in updated equipment), or of having to accommodate a shift in consumer preference.
In this issue of CFO Insights, we’ll explore the multitude of forces pressuring companies to act now on climate change and examine some of the ways CFOs can fortify their companies against the expected economic damage it could generate.
A gathering storm
CFOs' growing focus on mitigating climate change–related risks is not just a reflection of their concerns about how changing precipitation patterns could affect sectors such as agriculture and insurance. Beyond the dramatic, most publicized scenarios—damaged farmland, disrupted supply chains, mass migrations—sits a mounting body of data suggesting that nearly all sectors could feel the effects. CDP Global, a United Kingdom–based organization, last year reported that a group of the world’s biggest companies, representing nearly $17 trillion in market capitalization, have valued their business' climate risks at almost $1 trillion. Around $500 billion of costs were rated as likely to virtually certain, with higher operating costs linked to legal and policy changes making up a significant risk.5
Such numbers may speak for themselves—but perhaps not as loudly as conditions might warrant. A growing breed of investors is advocating for a large-scale reallocation of capital toward sustainability-sensitive investments. The types of external forces of change that are bearing down on CFOs include the following:
- Investment firms integrating climate change into their decisions. In January, BlackRock chairman and CEO Larry Fink wrote a letter to his portfolio CEOs declaring that "climate change has become a defining factor in companies’ long-term prospects" and stating that "we are on the edge of a fundamental reshaping of finance."6 The world’s largest investment management firm vowed "to place sustainability at the center of our investment approach"—signaling that boards of its portfolio companies can expect to be questioned. In addition, State Street Global Advisors issued a letter vowing to "take appropriate voting action" against board members at big companies in Australia, France, Germany, Japan, the United Kingdom, and the United States, who lagged in terms of various environmental, social, and governance (ESG) metrics and had no clear plans to improve.7 Elsewhere, one of the United Kingdom’s biggest fund managers, Legal & General Investment Management (LGIM), has also been outspoken on climate change. Its Future World funds are governed by a Climate Impact Pledge, enabling it to exclude companies over weak climate disclosures and other related issues.8 Investor-led initiatives include Climate Action 100+ and the Portfolio Decarbonization Coalition, which is focused on driving reductions in greenhouse gas emissions.
- The push to disclose climate-related financial risks. As long ago as 2015, The Financial Stability Board formed the Task Force on Climate-related Financial Disclosures (TCFD). The organization has since released recommendations to standardize how companies assess and disclose their climate-related risks.9 Meanwhile, the Sustainability Accounting Standards Board (SASB), a San Francisco–based nonprofit organization, has developed a set of 77 industry-specific sustainability accounting standards to help public corporations disclose material ESG information to investors for decision-making. Additionally, the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), a Paris-based consortium of about 50 central banks and other institutions, recently issued its recommendations for managing climate-related risks to foster a greener financial system. In January, Federal Reserve Chairman Jerome Powell said that the Federal Reserve would "probably at some point" sign on as a member.10 Another notable initiative includes the Frankfurt-based Value Balancing Alliance, which seeks to develop a globally recognized standard for valuing the social and environmental externalities of corporate value chains. It has gathered significant political momentum, is backed by the Organisation for Economic Co-operation and Development (OECD) and the European Commission, and is supported by the Big Four professional services organizations. Such support makes it highly probable that the alliance’s suggested approaches will form the basis of forthcoming regulation regarding the integration of externalities into corporate accounting and steering.
- Prince Charles and the Sustainable Markets Initiative. At the World Economic Forum in January 2020, longtime sustainability advocate Prince Charles characterized global warming and climate change as "the greatest threats that humanity has ever faced." At Davos, he also launched the Sustainable Markets Initiative, aimed at bringing together leading international figures to find ways to "decarbonize" the global economy.11
- Growing stakeholder engagement. In this age of accountability, it’s not sufficient for companies to only enrich shareholders, as was acknowledged by the Business Roundtable’s recently revised Statement on the Purpose of a Corporation, which was signed by more than 180 CEOs.12 Concerned consumers now view a company’s awareness—and measurement—of key issues, such as diversity and climate change, as integral to exhibiting corporate citizenship.
What all of this adds up to is an increasing intensity—some of it beneath the surface—that could come to a boil if triggered by certain events. In the face of more disruptive weather disasters, climate risk is swiftly rising to the top of many companies’ agendas.
An imperative to act
It is fair to say that many CFOs are already feeling the pressure. Large proportions among both European CFOs of big companies (59 percent) and North American CFOs (47 percent) report feeling at least moderate pressure emanating from their employees. And the number of CFOs who said that shareholders/investors are applying that same level of pressure amounted to 52 percent of European CFOs and 37 percent of those based in North America.
There were stark differences in some stakeholder categories. For instance, 19 percent of North American CFOs said they were feeling no pressure from board members or management, while just 7 percent of their European counterparts claimed the same absence. While about two-thirds (67 percent) of European CFOs felt at least moderate pressure from clients and customers, not even one-half (43 percent) of North American finance leaders felt at least moderate pressure from that direction. A significant disparity was also present between the two CFO groups regarding regulators and government: 51 percent of large-company European CFOs sensed at least moderate pressure coming from those stakeholders, while just 29 percent of their North American counterparts felt the same.
It's worth noting that European regulators and policy makers have been framing climate risk in terms of potential economic advantage for much longer than their US counterparts have—and setting ambitious targets for slashing carbon emissions. Guided by the European Union since 2017, more than 60 countries and cities have adopted net-zero carbon emission targets, with the United Kingdom and France having enshrined those targets into national law.[i] In the Autumn 2019 European CFO Survey, 38 percent of European CFOs said they have already reduced carbon emissions in the upstream supply chain or in logistics. Among North American CFOs, that figure was 24 percent, according to CFO Signals.
Those are not the only actions CFOs have taken. In fact, more than 90 percent of North American finance chiefs said their company has taken at least one action in response to climate change, with an average of 3.7 actions. Specifically, three actions drew more than one-half of the North American responses: increased efficiency of energy use (80 percent); inclusion of climate risk monitoring and management in corporate governance processes (53 percent); and use of energy-efficient or climate-friendly machinery, technologies, and equipment (52 percent).
By contrast, only 43 percent of European respondents said they had included climate risk in their corporate governance processes. On the other hand, 80 percent reported increasing the efficiency of energy use, while more than one-half (55 percent) said they had taken the step of using energy-efficient or climate-friendly machinery, technologies, and equipment. A slightly lower proportion (53 percent) reported shifting operational energy usage toward renewable energy sources. Almost half (48 percent) said they were developing new climate-friendly products or services. Whether companies are doing so, it turns out, may be connected to where the pressure on them to act originates. For instance, 42 percent of all European companies that felt more than moderate pressure from their clients are developing new products, according to the Autumn 2019 European CFO Survey. Only 21 percent of those who did not feel client pressure reported taking that action.
Rising to meet climate opportunities and challenges
There are additional steps CFOs should consider to position themselves to seize growth opportunities driven by climate change. For example:
- Look beyond the short-term. While improved energy efficiency and reductions in carbon emissions are laudable and cost-efficient, CFOs should also consider evaluating the longer-term structural risks. In the not-too-distant future, changes in the climate could start to affect supply chains or the availability and quality of raw materials. By taking a broader strategic view and incorporating climate change into their forecasts, finance executives can improve the company’s long-term viability.
- Make climate change a board priority. CFOs need to ensure that directors understand that climate change could have a material impact on the business. Mitigating that risk may mean integrating climate change strategy into the board’s mandate, as well as building competence and assigned oversight within the board. Oversight needs to be consolidated, elevating it to become part of the board's responsibilities.
- Maintain a robust R&D budget. Meeting the challenges of climate change can drive innovation in new products and services, as well as in business processes. In past years, companies seeking to hedge against the high cost of oil have generated solutions such as software that can route trucks with greater efficiency. The process of decarbonizing the global economy—the Paris Climate Agreement sets ambitious targets for limiting global warming—will not only result from incremental improvements in fuel or energy efficiency. It will require breakthroughs in areas such as battery technology.
- Adopt environmental accounting and reporting tools. By integrating a sustainability-reporting tool into their company’s ERP, CFOs can better measure—and manage—their company’s environmental performance against its established targets. Automating the process of collecting environmental data, including greenhouse gas emissions, can also equip finance leaders to optimize trade-offs between climate-related risks and opportunities. It can also expedite the process of reporting the company’s environmental impact, reducing regulatory risks.
- Incorporate climate change throughout the business. CFOs should consider promoting robust climate-change disclosure so that investors can get an accurate reading on the company’s progress toward its related goals. They may also support changes in areas, such as executive compensation, where a link to climate-change mitigation would likely be effective.
CFOs can help drive a refreshed investor or stakeholder narrative, one that draws together risk assessment, governance, and strategic thinking and ensures that this is coherently represented within the financial statements. As financial statements both look forward in their narrative while reporting a recently historical financial position, clearly representing the organization’s position and actions on this complex topic can be a significant challenge that CFOs are well placed to help address.
Modern finance executives are keenly alert to the need for a company to preserve its reputation—many have witnessed the market’s capacity for punishing companies that are deemed as having behaved less than respectably (whether toward the environment or their own employees). Climate change response could be next reputation-basher. Calculating the dollars at stake should make it clear that the relationship between climate change and finance has left the realm of the theoretical. While images of depleted oceans and expanding deserts can seem distant and fuzzy, the risks related to climate change are becoming clearer and clearer.
Endnote
1 Deloitte LLP, "CFO Signals: Q4 2019: Downturn concerns dampen 2020 revenue, earnings, investment, and hiring expectations," 2019
2 Deloitte, "Into the woods," European CFO Survey Autumn 2019, 2019.
3 North American respondents represented 147 companies, 88 percent of which posted more than $1 billion in annual revenue; among European respondents, the survey consisted of 218 respondents whose companies generated annual revenue of more than €1 billion.
4 NOAA National Centers for Environmental Information (NCEI), "Billion-Dollar Weather and Climate Disasters: Time Series," updated January 8, 2020.
5 CDP press release, "World’s biggest companies face $1 trillion in climate change risks,", June 4, 2019.
6 BlackRock, "A Fundamental Reshaping of Finance," January 14, 2020.
7 Cyrus Taraporevala, "CEO Letter to Board Members Concerning 2020 Proxy Voting Agenda," Harvard Law School Forum on Corporate Governance, February 3 2020.
8 Legal & General Investment Management, "Climate Impact Pledge: Tackling the climate emergency," 2019.
9 Network for Greening the Financial System, "A call for action: Climate change as a source of financial risk," April 2019.
10 Katia Dmitrieva, "Powell Says Fed Is Likely to Join Group of Green Central Banks," Bloomberg Green, January 29, 2020.
11 Reuters, "UK's Prince Charles says climate change is humanity's greatest threat," January 22, 2020.
12 Business Roundtable press release, "Business Roundtable Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All Americans'", August 19, 2019.
13 Ibid.
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