7 minute read 31 Oct 2021
A girl standing with tree.

Will future business success be measured in °C?

By Nicole Richter

Leiterin Climate Change and Sustainability Services & Co-Leiterin EYCarbon, Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft | Deutschland

Ist passionierte Verfechterin nachhaltigen Unternehmertums. Setzt sich für Transparenz im Berichtswesen ein.

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Head of Sustainability, Leader EYCarbon and Sector Leader Energy & Resources | Switzerland

Accompanies the transformation of the energy world, both large and small. Meets current challenges with a positive attitude and focus on solutions.

7 minute read 31 Oct 2021

Companies are expected to make a contribution toward achieving climate targets. The motto is “Do good and talk about it.” But how does that work?

In brief
  • Lawmakers, customers and investors are calling for companies to make a significant contribution to climate protection
  • Transparency on green reporting is becoming a must
  • The lack of uniform standards makes it difficult to compare and assess climate efforts

Climate change is the major challenge of our time. With the Paris Agreement, the international community has acknowledged the human impact on the global climate and the associated risks for the planet. The 2°C upper limit was defined based on scientific findings with the aim of reducing the negative effects of global warming to a sustainable level. However, if the world community wants to prevent irreversible changes, it must limit global warming to 1.5°C to avoid critical tipping points.

For the Paris Agreement to be successful, developed countries must join forces with the growing emerging economies. We need a spirit of joint responsibility for reducing emissions and to support those countries hardest hit by climate change. By ratifying the Paris Agreement, Switzerland has undertaken to halve its greenhouse gas emissions compared with the level of 1990 by 2030. The Swiss Federal Council is targeting a significantly greater reduction of emissions in the longer term. We have the potential: with renewable energy, carbon-neutral transport, less waste and more efficiency, Switzerland can reduce its greenhouse gas emission production to a fraction of the current levels.

The expected negative impact of climate change on the environment and society and the related tightening of regulations are putting investors under increasing pressure. As physical and transitional risks from climate change (e.g., extreme weather events or increasing prices) grow in significance, carbon emissions are being accorded a new materiality when it comes to assessing investment portfolios and financial forecasts. Therefore, the new measurability of the financial impact of carbon emissions on business models is becoming an indicator for business success.

Reporting on sustainability topics such as environmental issues, occupational health and safety, human rights and social responsibility is already routine for a lot of businesses. However, compared to financial ratios, these disclosures account for just a minuscule part of the reporting, around 10%. Another problem is the lack of granular data. Many companies limit themselves to describing the impact of climate change on their production, locations or employees. This leaves important questions unresolved: How do the company’s products and production processes impact society and the environment? What does the company contribute to climate protection? Furthermore, a maze of different standards make a direct comparison difficult. Investors wondering whether car manufacturer A or B is more climate-friendly will not find many answers in the reports.

The growing materiality of carbon emissions brings new challenges

At present, the quality of carbon ratios and the approaches used for deriving them are comparable to a limited extent only. A good example is the carbon footprint of products, for which there is no standard definition at either the national or international level. The calculations are often based on different system limits, assumptions and primary data.

In addition to conventional carbon accounting issues, double materiality is increasingly at the forefront of discussion. Under this concept, a company’s impact on society and the environment is considered in addition to a purely economic perspective. Failure to consider environmental and social risks arising from climate change entails the risk that the decarbonization of the business model will have a negative impact on other stakeholders and thus lower sustainability.

This leads to another aspect of the disclosure of climate-related information: demonstrating the ability to align the business model with a net zero economy in the medium term. It’s not just about reporting carbon emission figures. Rather, companies are under pressure to openly provide information about how they are adjusting to and managing climate change-related risks and opportunities. In addition to setting ambitious and science-based climate targets, scenario analyses serve to support strategic decisions within the company.

Disclosure 2.0 – beyond checking the box

Due to the new materiality of carbon, there are new challenges with regard to collecting data on carbon emissions. Previously a standard check-the-box reporting exercise, the carbon intensity of a product can now have a strong impact on a company’s procurement process. It is therefore important to enhance the comparability and robustness of climate information as well as improve data quality.

This also applies to climate change-related cost and profit projections in scenario analyses and financial estimates of risks and opportunities. Investors use this information to allow them to assess the extent to which companies are able to align their business models with a net zero economy in the medium term, that is, to examine whether companies are futureproof and how high the risk of a failed investment is.

In light of the many different reporting methods, calls from international investors and companies for greater transparency and a regulatory framework for carbon reporting are getting louder.

Given the lack of consensus over what reporting information is required and the need for comparability across and within jurisdictions, there has been a growing momentum towards a global harmonization of sustainability-related financial reporting standards. The number of environmental, social and corporate governance (ESG) regulations and standards globally has nearly doubled in the last five years.

International investors and companies are calling for a globally consistent standard for sustainability reporting.

Calls for uniform reporting standards

In April 2021, the EU adopted a proposal that will replace the reporting requirements under the Non-Financial Reporting Directive (NFRD), which currently require large public-interest companies with more than 500 employees to disclose environmental, social and employee-related matters, such as anti-bribery, corruption and human rights performance. The proposed Corporate Sustainability Reporting Directive (CSRD) will extend the scope to include large companies and all companies listed on EU-regulated markets (except listed micro-enterprises).

Things are on the move in Switzerland too. The rejection of the Swiss Responsible Business Initiative (“Konzernverantwortungsinitiative”) leaves the path free for a counterproposal supported by the government to implement enhanced requirements for non-financial transparency and a due diligence review. The indirect counterproposal will implement non-financial disclosure requirements for certain public interest entities (PIEs), largely in line with EU Directive 2014/95/EU on the disclosure of non-financial information (NFRD). Given the complexity of modern value chains, companies will need to start early on assessing their risk potential and preparing for transparent reporting and effective risk management.

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For companies, this means that they must change their accounting. Non-financial information will take up half of reports in the future. Climate targets, specific climate protection measures, progress and setbacks will need to be described in terms that are transparent, plausible and comparable. Past achievements are not the only things that count. As with balance sheets, which have gradually started to incorporate forward-looking statements, climate reporting will also include forecasts. Can we achieve our carbon milestones? What risks do we see? These are questions that companies will need to answer in the future.

Fast forward to 2030 and let us visualize what this could mean for non-financial reporting:

  • Double materiality: The jurisdiction of countries and companies that fail to uphold the provisions of the Paris Agreement will increase. Today, attribution science can already determine the percentage of damage caused by natural disasters that is man-made. This will inevitably lead to double materiality reporting.
  • Integrated sustainability analysis: The pressure on water reserves and biodiversity from climate change will strengthen the understanding of shared risks. Today we’re talking about carbon emissions, tomorrow it will be water pricing and loss of biodiversity. Some companies have already begun to apply the approach of a fair share of a global resource budget to environmental dimensions other than the science-based targets. This is partly possible for planetary boundaries or science-based targets for nature, for example. After 2021, the Carbon Disclosure Project intends to combine its various surveys into a single questionnaire that will also include new questions on biodiversity.

Will we measure business success in °C in the future?

The indirect counterproposal to the Swiss Responsible Business Initiative will lead to new requirements for non-financial reporting and due diligence reviews for affected companies. Since the statutory requirements are expected to become effective by 2022, all affected companies must act to identify the need for and take action promptly. This includes describing the business model and disclosing non-financial figures in a sustainability report. It goes beyond mere carbon emission targets, covering social topics such as working conditions, respect for human rights and anti-corruption activities. “Carbon+x” is the future – only those who consider sustainability in all dimensions will be able to position themselves well in the market and create added value for internal and external stakeholders.

Summary

Lawmakers, customers and particularly investors are demanding that companies actively contribute to climate protection. They should set realistic climate targets, report transparently on activities and progress, and prepare forecasts. Companies that do not know and minimize their climate risks will have a tough time on the capital market in the future. First steps toward uniform standards will ensure transparency and comparability.

About this article

By Nicole Richter

Leiterin Climate Change and Sustainability Services & Co-Leiterin EYCarbon, Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft | Deutschland

Ist passionierte Verfechterin nachhaltigen Unternehmertums. Setzt sich für Transparenz im Berichtswesen ein.

Local contact

Head of Sustainability, Leader EYCarbon and Sector Leader Energy & Resources | Switzerland

Accompanies the transformation of the energy world, both large and small. Meets current challenges with a positive attitude and focus on solutions.