Having experienced one of the longest and deepest global recessions on record, and concerned about the global impact of the eurozone debt crisis, the business world is now taking risk management more seriously than it did before.
Despite this, the idea of climate risk is still struggling to gain traction with businesses. Even with increasing regulatory and investor interest in climate change disclosures, climate change risk awareness and reporting amongst the business community is often sketchy. Compounding the problem is the lack of a standardized approach to climate change risk disclosure, which has resulted in a proliferation of disclosure and assurance regimes, leaving businesses, regulators, and investors with limited scope for comparing and assessing performance, or identifying best practice.
It’s not all bad: effective climate reporting is on the up amongst the biggest companies, while report-preparers are beginning to gravitate towards some of the more respectable reporting frameworks, such as those developed by the Climate Disclosure Standards Board (CDSB), the Intergovernmental Panel on Climate Change (IPCC), the World Resources Institute and the World Business Council for Sustainable Development (WRI-WBCSD), the Global Reporting Initiative (GRI) and the International Standards Organisation (ISO) .
Nonetheless, the business community still has a long way to go before climate risk is treated as seriously as other risks. Ultimately, businesses should be treating robust climate change disclosures as the norm.
While every large company – and plenty of small ones – engages in some form of climate reporting, as with everything in business, some do it better than others. CorporateRegister.com runs a global corporate responsibility reporting awards programme, with one category being for carbon disclosures (including risks). The March 2011 winner in this category, and by a long way, was Vodafone’s CSR report, followed by the General Electric and Brazilian bank Banco Bradesco. Bayer, Coca-Cola, and Shell also appeared in the top-10. The SME reporting winners were Australian renewables outfit Pacific Hydro.
Describing the winning report, one of the voters said: ‘Vodafone has a good, strategic approach to climate change, with a dual-target approach to reducing their emissions in both developed and emerging markets, and addressing carbon disclosure in their supply chain.’
One thing that makes the differentiation between different company disclosures possible is the wide variety of disclosure frameworks in use. Today’s leading framework for climate-related disclosures is provided by the CDSB. The framework includes climate risk reporting – defined as a ‘qualitative assessment of the [organisation’s] exposure to current and anticipated (long-term and short-term) significant risks associated with climate change’.
The CDSB framework may be popular, but it exists alongside plenty of other frameworks with varying levels of take-up. These frameworks cover different products, projects, countries, regions, sectors, and all manner of other classifications; some are mandatory, such as the EU’s Emissions Trading Scheme (ETS), some are not.
Beyond the CDSB framework only a few others reach beyond limited silos of use. These include the 2006 IPCC Guidelines for National Greenhouse Gas Inventories, the WRI-WBCSD GHG protocol, ISO 14064 GHG Inventories and Verification, the Global Reporting Initiative’s (GRI) G3 GHG indicators, and the Kyoto Protocol’s Joint Implementation (JI) and Clean Development Mechanism (CDM).
In the absence of a single unifying framework for climate disclosures, the Carbon Disclosure Project (CDP) has become a useful tool for finding out exactly what reporting does take place amongst the mix of frameworks. The large number of companies that respond to the questionnaire is a useful way of consolidating what is reported and by whom.
Why account for climate change risk?
Risks to businesses from climate change are just as serious for businesses as other risks, if not more so. The environment and the earth’s natural resources are the bedrock of the global economy; if these resources were to become scarce, or if the consequences of climate change were to become extreme, then business operations would be irrecoverably altered. The typical short-term business risks pale in comparison to those posed by climate change.
Climate risks present short-, medium-, and long-term problems, bringing with them physical, policy, and market impacts. Climate change risks can be financial, regulatory, physical, or reputational. In a 2009 paper for ACCA by Acclimatise and IBM (‘Adaptation’), the most common climate risks were identified.
Climate change means changing markets, with different customer expectations and needs. It means an increase in corporate liabilities and the danger of non-compliance with new industry and environmental regulations. Climate change means weather disruptions that could lead to equipment downtime and increased maintenance costs. It means a reduction in the quantity and quality of water and mineral resources, in turn leading to increased pressure on contacts, procurement processes, and supply chain. Climate change could cause sudden changes to values of assets and expected returns, creating problems with credit ratings and the cost of borrowing.
More specifically, future risks are likely to include: extreme variations in rainfall and temperature; heat waves or sea level changes affecting transport infrastructure; risks to third-parties or suppliers, such as data- or call-centres being located on flood plains or suffering from energy shortages; the vulnerability of coastal assets to storm surges or seal level changes; changing seasonal demands from customers; and possible confrontations with local communities over resource access.
On top of this is the fact that not providing climate disclosures is something of a risk in itself. Investors and regulators punish those that fail to provide the right information; investors in particular are increasingly on the lookout for climate disclosures that might help make investment decisions. This is typified by Ceres, a sustainable-investor group launched in the wake of the Exxon Valdez spill in 1989. Their Investor Network on Climate Risk, which works to improve corporate climate change strategies, currently represents over $9.5tn of assets.
Over-reporting of climate risks isn’t necessarily a problem, but under-reporting them can be. If the information on climate risk is missing, investors could possibly be put off. In the same way that a business wouldn’t avoid reporting its financial risks, it shouldn’t avoid reporting its climate risks too.
Despite this pressure there is a danger that assessing climate change risk can be seen as a purely PR or regulatory box-ticking exercise. Those businesses that approach climate change risk from this superficial angle risk missing out on the wider benefits of taking climate change risk seriously.
A business that takes a truly comprehensive approach to climate change risk will glean insights into previously unseen trends amongst inputs and outputs that can challenge assumptions and affect strategic decision-making; it will find efficiencies and inefficiencies that were previously hidden; and it will be able to adapt to future market demands before its competitors.
One of the most comprehensive approaches in this vein is taken by German pharmaceutical giant Bayer. Bayer sits towards the top of the CDP’s Leadership Index and is leading the way in the reporting of new disclosures like Scope-3 emissions. In its report to the CDP, Bayer states that: ‘climate change [is] one of today’s megatrends. The identification of opportunities arising from this trend is an integral part of Bayer’s strategy process.’
Efforts to reduce climate risks and impacts have seen Bayer substitute as much business travel as possible with phone-calls or video-conferencing, while, for cost and environmental reasons, there’s a much greater focus on energy efficiency in both external and internal logistics: bulk material is transported by greener and cheaper pipeline, water, or rail where possible.
There’s a focus on the wider supply chain too, upstream and downstream, with Bayer recognising that climate impacts on customers and suppliers will affect them too.
As well as providing opportunities for efficiencies, climate risk has allowed Bayer to diversify into new product areas with new subgroups being created to serve the mitigation and adaptation requirements that have arisen in the marketplace.
While Bayer seems to perform well, the lack of a uniform disclosure framework means we can’t reliably assess their relative performance. The lack of a framework makes benchmarking and performance analysis almost impossible; it also results in a lot of extra work, as businesses try to meet requirements that differ from jurisdiction to jurisdiction.
No benchmarking makes the reports that are produced very limited in their use for investors. Benchmarking is the logic that lies behind any reporting standard: the ability to compare like-with-like; being able to see how well different companies perform relative to one another. Without the ability to compare one set of data with another, both sets become meaningless. Without benchmarking, investors have no idea if they’re comparing apples with apples, apples with oranges, or apples with something that isn’t even fruit.
In 2009, ACCA embarked on a major project with the GRI to look at how well major companies did deal with climate change disclosures. Our survey looked at the world’s largest businesses from fifteen ‘high-impact’ sectors – including air travel, mining, metals, and energy – that had produced annual sustainability reports from 2003-2008. In all, this gave us a sample of 36 of the world’s biggest companies with big impacts on the environment.
The effectiveness and comprehensiveness of the businesses’ climate change disclosures were assessed against 45 criteria, split into six groups: policy; governance and strategy; risk; GHG emissions; mitigation and adaptation; and credibility. A total of 45 points were available per business, per year.
Interestingly, the number of businesses in the sample that used the GRI’s reporting guidelines expanded from only eight in 2003 to 24 in 2008. Of the five top-scoring companies, four based their reports on GRI guidelines.
Overall, the performance was decidedly patchy. While the combined performance improved year-on-year from 2003, scores ranged from 0 per cent for some companies in some years, to a top score of 56 per cent (Xstrata’s 2007 report). And, despite the improvement to 2008, the average score in 2008 was only 28 per cent. Worse, 28 companies never scored above 40 per cent in any year, and only two companies ever scored over 45 per cent.
Looking specifically at the performance of businesses in the ‘risk’ category, the results suggest that businesses find climate change risk ones of the toughest areas to report on. ‘Risk’ performance did improve, but from an average low of nine per cent in 2003 to only 18 per cent in 2008. ‘Mitigation’ and ‘policy’ saw, by contrast, much higher scores.
It was the general mining companies that performed best in the ‘risk’ category, with Xstrata, BHP Billiton, and Anglo-American all appearing in the top-five performers (Xstrata top-scored again with a five-year average of 39 per cent). By 2007-8, the general mining companies were all recording scores of over 50 per cent for climate risk disclosures. This perhaps isn’t surprising: mining companies tend to operate in place most susceptible to the physical impacts of climate change.
Other industries were well behind though. Five companies did not disclose anything on climate risks in any reports, while another 12 companies scored under 10 per cent on average.
Given the overall lack of systematic or integrated approaches to climate change risk reporting, it is worthwhile to take a look at the kind of risk disclosure that helped Xstrata top-score. From their 2008 report:
“It is anticipated that weather patterns will be affected by climate change, which may pose a risk to Xstrata operations. For example, a study completed in 2007 indicated that climate change could increase the frequency, length and severity of droughts, resulting in potential water shortages with a consequent impact on our operations in arid areas. Raglan, our site in the Canadian Arctic, will be affected by rising temperatures because it relies on permafrost for tailings storage…The transport networks we use will come under increasing pressure if extreme weather events become more common and sea levels rise.”
The low level of overall engagement indicates an almost complete lack of systematic identification or monitoring of risks. Unlike Xstrata and the aforementioned Bayer, many companies only consider on-site climate risks at most. Risks attached to distant data-stores or suppliers go unaccounted for but could have potentially disastrous impacts.
The uneven approach to climate change disclosures, particularly risk reporting, is borne out by other pieces of ACCA research, which have found poor awareness, let alone poor reporting.
A similar study to the one above, but this time covering the BRIC nations (Brazil, Russia, India, China) and South Africa found that 85 per cent of surveyed businesses disclosed a policy or mitigation statement on climate change but almost nobody reported on things like the effect of physical climate change risks on supply chains or customers, or provided information on how climate risks are assessed and managed.
Interviews conducted for an ACCA-sponsored study of the EU ETS (published in 2010) found that while report-preparers were very much in favour of some sort of formal guidance for how to account for emissions allowances, few (if any) had had any direct engagement with the bodies (International Accounting Standards Board and the US Financial Accounting Standards Board) that are preparing an exposure draft on the subject this year.
Reporting everything else
One possible reason for the limited view of climate change is the narrow interpretation that many businesses make of their impact on the environment. As noted above, businesses tend to focus on risks and impacts under their direct control – Scope-1 and Scope-2 emissions.
Over the past decade or so, there’s been a lot of work by a lot of organisations to develop credible methodologies for measuring impacts and exposure for Scope-1 and Scope-2 emissions. What there hasn’t been though is a similar focus on Scope-3 emissions: everything else.
Scope-3 emissions are those generated up and down the whole supply chain of a business. It looks at business travel, distribution and logistics, waste disposal, and even the usage and disposal of a business’ products. Unsurprisingly, Scope-3 emissions can make up the bulk of the emissions for which a business is responsible, perhaps up to 75 per cent.
While the idea of reporting on non-direct emissions may seem time consuming and pointless to some businesses, it’s actually by looking at these types of emissions that businesses can identify common climate change risks. Focusing on the whole of the supply chain, rather than just its own operations, forces a business to be aware of the sustainability of its resources at one end of the supply chain and the reputational and environmental impact of its products at the other. As noted elsewhere in this article, it’s offsite risks that can cause big problems, but these are the risks most often ignored.
Taking a holistic approach to emissions reporting will help integrate climate change risk considerations into everything a business does. A business’ awareness of its business relationships, sales, and marketing doesn’t stop at the factory gates; neither should a business’ awareness of climate impacts and risks.
In 2009, 409 of the Global500 companies (82 per cent) responded to the CDP’s request for GHG emission information. A little under half of these companies reported on any Scope-3 emissions. Of these, 98 reported on only one class of Scope-3 emission; only 6 of the 500 reported on all 5 classes of Scope-3 emissions.
This lack of engagement is hardly surprising. Awareness of and research into Scope-3 is currently low: there are not many frameworks for reporting these kinds of emissions and comparatively little research has been published. Basic questions, such as what to report and how to report it, have yet to be answered.
This is changing though. Formal Scope-3 guidance from the WRI-WBCSD is expected by 2012; ACCA has recently published our own overview of Scope-3. Shortly after we published this, the UK government launched a consultation into carbon reporting that could end up covering Scope-3.
The wider business community is undeniably weak at assessing its own exposure to climate change risk. The lack of a uniform framework for assessing and reporting this risk is understandably not very helpful, hindering any attempts at benchmarking.
Despite the challenges, businesses need to update their game. Climate change and other sustainability issues will have a serious impact on the very foundations of businesses: the availability of inputs; reputation; efficiency; and customer and investor demand. A better understanding of the risks and opportunities associated with GHG emissions and climate change would bring real benefits to business by enabling the development of strategies that can create value for organisations and their stakeholders.
Ideally added pressure from governments and investors would hurry the process along.
But with attempts at forging international governmental agreements on climate change repeatedly ending in failure, a policy vacuum is developing at the centre of the sustainability agenda. There is certainly an opportunity for the business community here.
Businesses would gain much from shaping this agenda, but until the business community grasps the risks that it will be exposed to by climate change this kind of leadership is unlikely.
Things are moving in the right direction and climate change risk is an area attracting an increasing amount of attention. However, at the current rate of change it’s going to be a long-time before the robust reporting of climate change is risk is anything but the exception.