Risk Management

Yes we can: treasury’s response to climate change

Published: Nov 2019

Few could have escaped the mounting need to take action to halt and possibly reverse the damaging effects of climate change. Can corporate treasurers really do anything to help?

Siberian tiger running and jumping in water

Climate change is the biggest threat the modern world faces. Experts and critics may argue about the causes (and some deny it), but the increasingly extreme weather systems seen around the world and the rise of the oceans are bad news for us all.

Individuals, businesses and governments have myriad of other issues to tackle, but the bottom line is that if climatic conditions deteriorate much further, those issues may not matter. An existential crisis? Maybe, for future generations.

Doubt it?

Changes in global temperature are nothing new. In the last 650,000 years there have been seven cycles of glacial advance and retreat. The start of the modern climate era was signalled by the end of last ice age, about 7,000 years ago.

Most of these climate changes are attributed to small variations in Earth’s orbit, subtly altering the amount of solar energy received by Earth. However, according to the Intergovernmental Panel on Climate Change (IPCC) Fifth Assessment Report, the current warming trend has a “greater than 95% probability” of being man-made.

Information gathered by NASA indicates that Earth’s average surface temperature has risen by 0.9°C since the late 19th century. The majority of this increase occurred in the past 35 years, with the five warmest years on record taking place since 2010.

What will be the legacy of the current inhabitants of this planet, then? Swedish teenager Greta Thunberg is doing a remarkable job in raising awareness of the risks posed by climate change. If someone so young can stand on the world stage and hold politicians to account for their paucity of action, then surely worldly-wise professionals, including treasurers, can take a stand too.

Of course, few can garner the kind of public profile achieved by Thunberg, but all can take action of some kind. And it needs everyone’s input. Globally, US$90trn will be needed by 2030 to achieve sustainable development and climate objectives, according to figures from the City of London Corporation’s Green Finance Initiative.

The precision of the figures is uncertain, but the scale of the potential problem for humanity is not. This is why the Paris Climate Agreement and the UN 2030 Agenda both ask for commitment from financial institutions and businesses to align their financial flows with a pathway towards low-carbon and climate-resilient development.

Fringe benefits

The motivation to make a difference should be self-evident. Some companies make a much larger contribution to global warming than others, and it is reasonable to recognise that responses can be relative.

But we live in challenging times and bludgeoning people with the cold, hard facts of climate change, when it is perceived that there are more immediate issues to tackle (poverty, inequality, financial crises et al), is not always the most persuasive method. Sometimes a ‘what’s in it for me’ approach is necessary (as if survival of the human race was not sufficiently persuasive).

According to DARA (an independent non-profit organisation working for populations affected by armed conflict and natural disasters) and the Climate Vulnerable Forum (a global partnership of leaders of countries most vulnerable to climate change), climate change is already costing US$1.2trn a year, with five million deaths each year related to weather impacts and a carbon-intensive economy. Without strong action, the UK government ‘Stern Review on the Economics of Climate Change’ predicts that costs could be equivalent to at least 5% of GDP each year globally, or up to 20% of GDP regionally.

On a more positive note, and at a corporate level, if tackling climate change is viewed in terms of sustainability and environmental, social and governance (ESG) policy, then there is some evidence that putting it high on the agenda improves financial performance.

In 2018, Switzerland-based academic publisher, MDPI, produced a paper, ‘The Impact of Sustainability Practices on Corporate Financial Performance: Literature Trends and Future Research Potential’, presenting an analysis of the impact of corporate sustainability on corporate financial performance. Using content analysis techniques to examine current research, it concluded that from a total of 132 papers from “top-tier” journals, 78% reported a positive relationship between corporate sustainability and financial performance.

There is some evidence too for treasurers and CFOs that sustainable finance is prudent from a purely financial perspective. Within the investor market there appears to be a continuing and significant growth in mandates, to the extent that demand outstrips supply of ‘green’ assets – lending or bonds. This can lead to a pricing advantage for issuers.

If businesses get this right, then climate change is not just a risk but also an opportunity to drive value and grow the business.

David Nayler, Financial Institutions Industry Practice Leader, UK & Ireland, Marsh

Awareness

To what extent are treasurers professionally aware that they can do something about climate change? Not enough, says Anne van Riel, Head of Sustainable Finance, Americas at ING Capital. “Typically, treasurers are not very aware of the company’s sustainability initiatives unless it concerns the budget,” she notes. “Many do not know that their company is externally rated on its ESG performance either.”

It’s not that treasurers are not aware per se of the problem that is climate change. When van Riel and her team meet treasurers to discuss sustainable finance opportunities she says they appreciate the bigger picture. But with many sustainability investments, the impact is long-term and quantifying that can be difficult. It needs someone to relay outside experience to bring it into perspective.

“As we provide the viewpoint of investors and other stakeholders, they are better able to justify internal initiatives,” explains van Riel. The impact is akin to the whole being greater than the sum of its parts. “When sustainability teams have a closer relationship with treasurers and their goals are better aligned, the company can make a bigger positive contribution towards climate change goals.” Amplify this the world over and many small but co-ordinated activities suddenly have a vastly more powerful resonance.

It is not hyperbole to suggest that treasurers knowing they can make a difference will play an important part in the success of every global movement such as the Paris Climate Agreement and the UN 2030 Agenda.

Treasury action stations

The most important role the treasurer can play is that of internal alignment and acceleration of certain investments or initiatives. “One client told us they had several initiatives internally to improve energy efficiency of their operating facilities, but by making the greenhouse gas reduction KPI transparent and linked to their financing, they would likely execute on it faster,” says van Riel.

This is not the only way in which treasurers can make a difference; other approaches are emerging as the understanding grows. Indeed, another important development is that of the increased focus of credit rating agencies on this topic. Van Riel notes that both S&P and Moody’s are starting to show how ESG factors are affecting the credit rating. “That will automatically bring the ESG focus on the agenda of the treasurer and incentivise them to engage internally on initiatives.”

It’s important for treasurers to work with other functions in their organisations in the response to climate change. An organisation is most successful if its sustainability initiatives have strong senior management support and are carried out by the entire organisation, van Riel believes. “To make sure ESG factors are identified and positive actions are undertaken, coordination and cooperation between all different functions is key.”

In this context, it is difficult for treasurers to make the right sourcing decisions in isolation from operations or design. “I think they increasingly understand the role they play to ensure the company has access to liquidity and is able to raise funds from a wide range of investors. Communicating ESG strategies is increasingly important in that respect.”

It does make a difference. By having a good ESG score (as defined on a broad level by the ISMA’s Green Bond Principles, and on a sector-by-sector basis by the likes of the major ratings agencies, the banking sector’s own experts and third parties such as Sustainalytics) it allows investors to come on board who otherwise would not invest. Diversification of funding is in itself a prudent risk management tactic; an ESG/sustainability led approach opens up the market.

If there was any doubt about this, consider, for example, that Swiss Re, one of the world’s largest institutional investors, announced last year that it was moving its entire US$130bn investment portfolio to ESG indices.

Legal & General Investment Management (LGIM) is also taking a strong stance. “The investment risks surrounding climate change have become so urgent that, for the first time, we are going beyond solely engaging with companies in order to hold them to account on the issue,” Meryam Omi, LGIM Head of Sustainability told Treasury Today Group.

“All companies, whether they emit carbon or not, need financing. They require banks, pension funds and insurance companies to buy their shares and debt. How they invest or allocate capital holds the key to financing a 2°C world rather than a 3-4°C world, because what gets financed today is the world we will build for the future.” (She is referencing the impact of average temperatures rising above pre-industrial levels.)

Companies that fail to embrace the transition to a low-carbon economy by demonstrating adequate strategy, governance and transparency will be excluded from LGIM’s new Future World Fund, says Omi. “In all other funds where we cannot divest, we will vote against the chair of the board to ensure we are using one voice across all of our holdings. This is the first time we have pledged to do so on a global scale for the issue of climate change.”

Off the rails?

Not all experts agree with the doomsday scenario. World Meteorological Organisation (WMO) Secretary-General, Petteri Taalas, offers a moderating take on the subject. He told Talouselämä magazine in Finland this year that he disagrees with “climate extremists” who call for radical action to prevent a purported apocalypse. He believes that we should “consider critically, and with reservations, the thoughts of experts” before becoming overly anxious or adopting a radical stance.

“While climate scepticism has become less of an issue, now we are being challenged from the other side,” he said. “Climate experts have been attacked by (radical climate alarmists) and they claim that we should be much more radical. They are doomsters and extremists. They make threats.”

For Taalas, “it is not going to be the end of the world. The world is just becoming more challenging. In parts of the globe, living conditions are becoming worse, but people have survived in harsh conditions.”

Bank action

Banks have a major role to play here and they need to commit fully to the cause. ING has launched an approach that will begin steering its €600bn lending portfolio towards alignment with the Paris Agreement’s re-asserted target of preventing global average temperatures from rising 2°C (it was actually ratified by 192 countries as part of the 1997 Kyoto Agreement).

Known in-house as the ‘Terra’ approach, this bank is using open source technology, developed with the 2˚ Investing Initiative, a global think tank on developing climate and long-term risk metrics and related policy options in financial markets.

Terra is a scientific approach to measuring the technology shift needed across certain sectors to keep well below the 2°C target. It works on the basis that real progress on decarbonisation is dependent not on emissions targets per se but on major changes to domestic energy, industrial and innovation policies, and that these efforts should be supported at source.

In the automotive sector, for example, lowering emissions must be complemented by changed manufacturing models (the efficacy, in this respect, of electric motive power, where it needs charging from national grids, is debatable but progress will be made). Terra effectively quantifies the gap between current and future practices, defining what needs to shift, by how much and when. With other banks having been invited to join the programme, funding development along these lines will gain momentum.

A number of banks, united under the Banking Commission of the United Nations Environmental Programme Finance Initiative (UNEPFI), have also launched a positive impact manifesto. This is a commitment from members – notably also including some investors – “to think more holistically about their role in the economy, society and the broader environment”.

Hoping for the best, preparing for the worst

“The business impacts of climate change risks should be assessed and modelled in similar ways to any other business risk,” advises David Nayler, Financial Institutions Industry Practice Leader, UK & Ireland, Marsh. This happens through the process of identification, assessment, mitigation and monitoring.

He suggests four key questions to ask to begin testing whether an organisation is prepared:

  • Is our strategy climate ready? What effects might different climate futures have on our ability to execute our current purpose and strategy? How will the products and services we currently offer, and the markets we operate in, need to change?

  • Can our existing risk management, resilience and corporate governance controls cope? How will changes in climate alter the balance of investments the company might need to make in its risk management and resilience?

  • Will our key assets be protected? Which assets might be affected the most? Does climate change alter the balance of investment in asset management; will it drive the need for divestment, early decommissioning or changes in maintenance regimes?

  • Will we still be able to rely on our current supply chain? Who are your most critical suppliers, and how vulnerable are they to the effects of climate change?

“In our experience, this approach, coupled with scenario analysis, is the most common across a range of industries,” notes Nayler. However, he believes that much of the scenario work is still in its infancy and sees the work on developing relevant scenarios as “ever-evolving”.

This means that the use of the output in the strategic decisions at executive level can sometimes be limited, he maintains. “This is partly because climate change as a risk can impact many parts of the organisation; perhaps the only comparator being people or conduct risk as a risk that straddles the whole organisation and involves the risk, financial, investor relations, reputational concerns and executive functions.”

Adapt and survive

In many ways the climate change issues are not new issues per se, comments Nayler, but there is an increase in frequency, severity and locations, and the resultant financial and reputational impacts. Engaging with the best futurists, and understanding the current realistic thinking, is, he says, important.

“Businesses need to adapt their risk frameworks and response options to consider the longer-term ‘creep’ issues as well as the short-term shocks, to horizon-spot for the next regulatory issue, clash or change of view, and to engage with the changing consumer views,” he explains. “If businesses get this right, then climate change is not just a risk but also an opportunity to drive value and grow the business, while creating a positive environmental impact.”

Of course, continues Nayler, it’s important to remember that the available models reflect the current climate. “While the scientific community agrees that climate change is happening, opinions can differ on the consequences and speed of change. This means, currently there is no ‘easy solution’.”

All our content is free,
just register below

Already have an account? Sign in

Please only use letters.
Please only use letters.
Please only use letters.
Please complete this field.
Please select an answer.