COP26 – Is your company ready for the low-carbon economy?

Whilst the outcomes of COP26 are expected to provide clarity on how companies can adapt towards a low-carbon future, they may also have significant implications for global capital markets.

Recent signals suggest a shift in sentiment towards greener ambitions. According to the Global Sustainable Investment Alliance, sustainable investment topped $35.3 trillion in five major markets in 2020, equating to 160 percent growth over eight years.

In the lead up to COP26, many investors have also joined initiatives under the umbrella of the Glasgow Financial Alliance for Net Zero (GFANZ) resulting in a global coalition of financial institutions committed to accelerating decarbonisation of the economy.

Another popular sentiment core to climate change mitigation is the adoption of low-carbon technologies. With a view to upscale their uptake, it has been suggested that pricing carbon at higher levels – via mechanisms such as emissions trading systems, carbon tax, social costs of carbon and/or through carbon shadow pricing – could improve the financial competitiveness of new technology.

An agreement on carbon taxes would slow growth rates for carbon-intensive sectors and constrict access to capital, particularly for companies that aren’t on a trajectory in alignment with the Paris Agreement. Despite this, the road ahead largely hinges on meaningful climate pledges emerging from COP26.

As the global investment community looks to evaluate the carbon profile of new investments, here are five questions companies should be asking themselves:

What scope of greenhouse gas (GHG) emissions are financially material to your sector?

Financial materiality of GHG emissions (the level of financial risk a company may face as a result of emissions-limiting regulations) can have a knock-on financial effect to a company’s bottom line. Companies are exposed to GHG emissions either directly through combustion (Scope 1), indirectly through purchasing electricity from fossil fuel powered grids (Scope 2) or in their supply chain (Scope 3).

The outcomes of COP26 are expected to provide clarity on how companies can adapt towards a low-carbon future.

In many cases, Scope 3 emissions represent the largest portion of GHGs generated by corporations; when disclosed, it’s often limited to two of 15 categories recognised by the GHG protocol: business travel and purchased goods/services. Although company control of Scope 3 emissions may be limited, they nevertheless represent a source of business risk.

What does your emission reduction target involve?

Emission reduction targets can be absolute or relative, cover varying scopes of emissions, different types of emissions, and have various or multiple timeframes.

A current area of debate is strategies that rely heavily on carbon offsets. The market for carbon offsets could be worth $100 billion by 2030, however less than 5 percent of offsets actually remove carbon dioxide from the atmosphere, igniting controversy due to the threat that low-cost offsets will be used to evade the hard work of eliminating emissions.

Companies looking to add credibility to their reduction target should consider alignment and commitment with the Science-Based Targets initiative (SBTi), which doesn’t approve of carbon offsets, requires Scope 3 disclosure if this accounts for more than 40 percent of emissions, and stipulates interim targets are set within a minimum of five years and a maximum of ten.

How well does your company compare to its competitors?

A challenge faced by investors is the comparison of company emissions data against peers. The commonly used metric, annual t-CO2eqv (tons of carbon dioxide equivalent), is inherently backward looking and is difficult to predict trends continuity.

One group establishing itself as the go-to benchmarking tool is the Transition Pathway Initiative – an investor-led initiative which analyses companies’ quality of management of GHG emissions and their alignment with the Paris Agreement. This initiative has been touted as playing a key role in the post-COP26 financial infrastructure to support disclosure, responsibility and action on climate pledges.

The fossil fuel production plans of governments are dangerously out of sync with the internationally agreed temperature limits of the Paris Agreement.

What other climate-change material factors are you disclosing?

Disclosure on emissions does not provide an insight into how a company is managing climate change adaptation. As the world continues to warm, the global asset pool will be more exposed to floods, droughts and severe storms. This may lead to supply chain interruptions and challenges, increased health and safety risks, damage to property, increased operating costs and increased insurance premiums.

Climate change is also accelerating the depletion of natural capital and ecosystems. Lately, there have been increasing efforts to support the definition and quantification of natural capital in the financial process. One example of this is the Task Force for Nature Related Financial Disclosures.

How long has your company been disclosing and has management made other commitments to future disclosure?

A lack of disclosure or willingness to disclose may be an indicator of management challenges, particularly for carbon-intensive industries. Companies should be ready to provide explanations to why data is not available, as investors make a judgement around the level of risk this may pose.

According to a report by the UN Principles for Responsible Investment, ESG disclosures in the Middle East market are still in their infancy, with many companies still tackling the requirements of ESG. Investor demand is driving increased disclosure; however these are predominately international investors, and substantial improvements to ESG reporting need to materialise in line with security exchanges’ disclosure requirements.

Katherine Bruce, senior consultant – Corporate Sustainability at WSP Middle East.