Evolving From Regulatory Conformance to Driving Organizational Performance: The Transition to a Climate-Resilient Economy
Climate disclosure requirements have solidified climate risk as a material financial risk, squarely placing active oversight of climate issues as part of a board member’s fiduciary duty. The US Securities and Exchange Commission’s proposed climate disclosure rule, the two recent California Senate bills (SB 253 and SB 261) and the EU Corporate Sustainability Reporting Directive (CSRD) all reinforce this. While the goal of the Taskforce on Climate-related Financial Disclosures, the creator of the “founding” framework for climate-related financial risks, was to provide reliable information for financial markets to accurately assess and price these risks, CSRD has made it compulsory to analyze and disclose the financial impact of these risks.
Boards approaching climate risk and opportunities with a strategic mindset will acknowledge the importance of going beyond compliance and integrating the analysis into financial and strategic decision-making. This recognition is crucial to driving organizational performance amid the evolving business landscape.
Steps to Achieve Organizational Performance
1. Articulate the financial impact of climate-related risks and opportunities. The board plays a crucial role in advising and challenging management to manage and quantify climate risks and identify and capture opportunities.
Climate risks include both physical and transition risks. Physical risks, arising from acute extreme weather events and chronic longer-term shifts in climate, can cause disruption and pose threats to business operations. Transition risks arise during the shift to a low-carbon economy, for example, changes in consumer behavior, regulation, emissions pricing, cost of raw materials and capital, and cost to transition to lower emissions technologies). Board oversight of both categories of risk is critical as they have the potential to impact and transform businesses significantly with potentially far-reaching consequences.
Quantifying climate risk means assessing the transition and physical risk impacts on your business in terms of the impact on asset value, revenue, cash flow projections, and overall entity value, under various climate scenarios. Additionally, analysis should encompass assessing potential strategic actions to enhance company resilience, preserve value, and capture the opportunities of the transition. While this analysis is valuable to stress test the business, it also enables the business to integrate climate risks and opportunities in financial planning and inform strategic decisions.
2. Ensure the full board has the skills and knowledge it needs to perform its duties. A global survey conducted by the Nasdaq Center for Board Excellence and WTW between February and April 2023 provided insights into modern boardroom dynamics. It found that roughly half of respondents (48%) reported that their boards lack the skills and expertise needed to provide effective oversight of the climate risks facing their companies, and a third of respondents revealed that their boards did not dedicate sufficient time and resources to climate-risk governance.
Climate governance should be owned by the full board to retain responsibility for approving climate strategy and commitments. However, aspects of climate governance should be incorporated into existing committee remits as another lens to their regular activities and approvals. For example, the audit committee may be responsible for the impact of climate risk on financials, the compensation committee can drive accountability for climate strategy by incorporating shorter-term targets into incentive plans, and the nominations committee can ensure board effectiveness in climate-related capabilities. When a company has a specific environmental, social, and governance or sustainability committee, this committee’s responsibilities typically support the activities of the existing committee remits with regular touch points. This committee may be delegated responsibility for more detailed analysis or strategic development (e.g., climate modelling, which feeds into the audit and risk committees’ discussions).
Full board ownership, with clear subcommittee remits over climate-related matters, ensures that climate risk is not dealt with in silos but fully integrated into strategy and “business as usual.”
3. Establish a clear business case for climate action that aligns with value creation and purpose. As with any strategic imperative, the board has a responsibility to develop and to be able to clearly articulate a compelling business case that aligns with purpose and fiduciary duty.
This is an important first step toward meaningful climate action, but it can only be achieved through a robust understanding, quantification, and strategic integration of risks, opportunities, and financial impacts. Strategic changes to manage risks and capture opportunities might include divestment from and portfolio optimization of high transition-risk segments to investment in low transition-risk segments, moving operations from areas prone to flooding, planning adaptation measures for natural hazards, or innovating climate solutions. Such strategic decisions may result in a trade-off in short-term profits for longer-term risk mitigation and value creation. Therefore, it’s critical to develop a business case that has buy-in from the board and the business to guide strategic decision-making and support dialogue with stakeholders.
Evolving from regulatory conformance to driving organizational performance involves articulating the financial impact of climate-related risks and opportunities, ensuring the full board has the skills and knowledge it needs to perform its duties, and establishing a clear business case for climate action that aligns with value creation and purpose.
WTW is a NACD partner, providing directors with critical and timely information, and perspectives. WTW is a financial supporter of the NACD.
Holly Teal is the North America Climate Practice leader at WTW.
Ken Kuk is a senior director of the Executive Compensation and Board Advisory at WTW.
Hannah Summers is a director of the Executive Compensation and Board Advisory and the Climate Practice at WTW.