The mainstreaming of climate as a systemic risk with potentially enormous financial consequences has led to investors scrutinizing climate risks. The result is that companies will increasingly position climate and sustainability under the chief financial officer’s oversight. For CFOs, there are four key areas of focus to be able to oversee the climate response in their organization:
1. Know your emissions
Emissions arise from all aspects of an organization’s business model. Both absolute emissions reduction and carbon intensity provide a benchmark for targeted actions for decarbonization. Assumptions about emissions affect accounting estimates and asset values.
Establishing a reliable carbon footprint for an organization, or for a product, can be a complex task but is critical. A carbon footprint (or greenhouse gas (GHG) emissions inventory) measures the energy consumption of an organization’s activities and the GHG emissions associated with the business model. A huge challenge for companies and investors is understanding the absolute emissions arising from its business model including across its value chain (i.e. beyond its direct emissions and electricity indirect emissions).
Setting key performance indicators (KPIs) that improve performance and linking these to incentives is also critical. For example, an airline might be reducing its emissions per passenger mile travelled, but its overall emissions might be increasing because of increased number of passengers. CFOs need to ensure that GHG management plans are in place so they can prioritize carbon reduction projects, quantify them, and place numbers on cost savings, carbon savings, and implementation costs.
2. Integrate climate information into strategy and risk management
Incorporating climate risks and opportunities in strategy and risk analysis is the foundation for decision-making that leads to decarbonization.
A comprehensive understanding of climate risk assessments and scenario modelling supports robust analysis of risks and opportunities in relation to different transition pathways. Scenario analysis is a critical element in bridging strategy and risk management and provides useful insights into how resilient strategies and business models are in the context of physical and transition climate risks.
Risk assessments help to quantify climate impacts and their potential financial impact in relation to revenues, expenditures, assets and liabilities under various climate scenarios. The adaptive capacity of the business model in different scenarios is highlighted by the extent to which weather events and increasing carbon costs impact expected cash flows and asset valuations. In turn, information on climate risks needs to be embedded in strategic decision-making processes such as capital investment.
3. Understand your decarbonization options
Decarbonizing a business requires knowledge of climate financing and new ways of doing business.
In terms of business models, it is important to be familiar with various options for permanent carbon reduction and removal, and their associated cost and benefits. Investments in low-carbon and novel solutions can often appear economically unviable because of high up-front capital costs, so measuring economic returns and other potential benefits over a longer period becomes important. Investments in research and development and innovation can be directed at enabling greater resource and energy efficiency, migration to circular business models, avoiding the use or production of virgin materials (e.g. using bio-based raw materials like mycelium leather), and the diversification into other energy forms.
Climate finance is the key to unlocking resource mobilization and capex decisions to finance low-carbon investments and products such as electric fleets or renewable energy generation. Mobilizing equity or debt finance to support new technologies and processes is usually critical to changing business models and supply chains.
4. Tell the story
Communicating how a company is becoming compatible with a net-zero economy is going to be part of a CFO’s conversation with boards, investors and other key stakeholders. This involves being able to explain the business risk and opportunities from emissions, targets and KPIs being used to track progress, where capital investment is prioritized to support the transition of the business model, and the financial impact of climate change.
The current valuation challenge exists because companies are generally not incorporating material climate-related matters in financial reporting under existing financial reporting standards. As the transition risk escalates with new taxes and regulations and changing consumer behaviour, climate change will likely have a material effect on financial performance and position, particularly for high emissions industry sectors. The CFO is the person to explain how the strategy and risk management on climate change relates to the accounting estimates and judgements used in the preparation of financial statements and reports.
For climate to move beyond a marketing exercise to one that provides the information that boards and investors need to enable economies to decarbonize, CFOs need to be part of the equation and be empowered by their chief executive officers.
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