Climate governance

• Companies need support to improve the integration of climate change considerations into business strategy
• Basic Materials, Financials, and Energy sectors lead the way on high quality climate governance
• Thorough climate governance can generate strategically valuable insights for management and identify key risks and opportunities

Climate change has far-reaching consequences for communities globally, as well as the financial industry. Coalitions such as the Glasgow Financial Alliance for Net Zero (GFANZ), which has representation from leading financial institutions, highlights the trend towards integrating climate change considerations into capital allocation. With scientists warning that with the current trajectory of warming we will fall short of the 1.5-degree target, immediate action is needed.

An encouraging step in the right direction was announced at COP27 this month when the UK Government’s Transition Plan Taskforce issued new guidance for companies seeking to publish transition plans. This will provide companies additional tools to produce robust transition plans, ahead of mandatory disclosure for UK-registered companies from next year onwards. It signals increased efforts to aid companies through the transition.

Public companies on the London Stock Exchange are already developing plans to manage climate change and integrating these considerations into their business models. To support them, we launched our Climate Transition Offering which is designed to help companies understand current progress on climate reporting and transition planning, discover best practice and areas for improvement, and mobilise credible transition plans. As more investors focus on building climate resilient portfolios, they are choosing to allocate capital to companies with clear frameworks for managing climate-related risk and opportunities.

Within this offering, our Climate Governance Score is a key pillar of our support for companies, and acts as an assessment of how well climate change has been integrated into business strategy. It is also a practical measure of how far a company has progressed towards the core elements of climate reporting defined by the Task Force on Climate-Related Disclosures (TCFD). It can act as an educational resource to help companies assess their performance, compare against industry peers, and identify areas for improvement.

The underlying methodology for the Climate Governance Score is that of the Transition Pathway Initiative’s (TPI) Management Quality Score. TPI is a global initiative led by asset owners and supported by asset managers which aims to empower asset owners to support action on climate change and the low-carbon transition. To date, 131 investors globally have pledged their support and commitment to using the TPI tool, jointly representing over $50tn combined Assets under Management.

It has been a year since we first provided these scores privately to companies. The following article reflects on the progress made to integrate climate change into more businesses and highlights trends across the market.

Across the industry, there is still work to be done in the way companies report on climate risk and opportunity, but overall, we are seeing an increase in the level of companies that are integrating climate change into operational decision making. Examples include having a nominated board member with responsibility for the company’s climate change policy, reporting scope 3 emissions, or having a process to manage climate-related risks. The latest TPI data reveals that this level of preparedness, which is classified as level 3, is the most common across the assessment scale which ranges from unaware (level 0) to strategic assessment (level 4).

At industry level, there are clear leaders when it comes to climate preparedness. There were companies in basic materials, financials, and energy sectors that reached the highest level of climate governance, meeting all criteria set out by the TPI. It is encouraging to see that sectors that are traditionally high emitting sectors are assessing the risk and opportunities associated with climate change and transitioning their businesses accordingly.

And yet for some sectors, namely consumer staples, financials, industrials, and real estate, there are still some companies that fail to even recognise climate change as a business issue. This points to the fact that whilst companies have regulatory obligations to comply with TCFD, some are not implementing those insights into their decision making or prioritising climate as they plan for the future.

There are some sectors where this trend is particularly apparent. Companies in the real-estate sector for example have the lowest scores when compared to other industries. On average, companies in this sector would be considered as having some awareness of climate change considerations. This means they have made some commitments to acting on climate change, which may be integrated into strategy in the future.

This is at odds with the reality that the physical climate impacts, such as flooding or the displacement of people, present significant risks for the industry . Conversely, implementing changes such as low-carbon heating and energy efficient homes could create real value for businesses in the sector. More industry specific awareness is needed to ensure that these risks and opportunities are identified and implemented into decision making.

The scores also indicate that there can be significant variation in climate preparedness between companies in the same sectors. Some companies have limited awareness of climate change considerations and others are fully integrating it into business strategy and planning. This disparity is most pronounced in the energy sector but exists across sectors.

According to the latest data, there are now less companies that do not acknowledge climate change as a significant business issue, meaning that there has been an improvement overall in climate governance. However, whilst more companies are starting to demonstrate awareness of climate, a smaller percentage of the companies overall are making a strategic assessment. When considering the two highest levels combined, which comprises companies integrating climate change considerations into operational decision making or making a strategic assessment, there is a small increase in companies that achieve these levels.

Perhaps unsurprisingly, companies with larger market caps score the highest. The general trend is that scores improve relative to the market cap band. There are several reasons we may see this trend. Larger companies typically have more resources internally or budget to outsource climate disclosure and strategy, whilst smaller companies may not have established sustainability teams, large investor relations teams, or the capacity and expertise to integrate climate change into business strategies. Additionally, larger companies may partake in more investor engagement or face additional scrutiny, which in turn leads to more focus on building a climate change strategy. It is important to develop deeper climate governance irrespective of company size as climate risk and opportunity is inherent economy wide.

The UK has some of the most progressed legislation on climate reporting in the world. The UK government has begun future proofing its financial markets by mandating ‘gold standard’ climate reporting and transition planning that meets the needs of long-term oriented investors. It was a first mover when it came to legislating TCFD compliance to ensure companies are adequately assessing the risks and opportunities of climate change and disclosing this information to support investors decision making. The UK government’s legislation covers all UK registered companies and LLPs, both public and private, if they have over 500 employees. In addition, the Financial Conduct Authority issued rules that mean that companies listed (including GDRs) on the Main Market of the London Stock Exchange must include a statement in their annual financial reports explaining whether their disclosures are aligned to the eleven TCFD recommendations. This regulation is on a comply or explain basis, meaning that if they are not aligned, companies will need to explain why, along with steps they are taking to comply with these disclosures in the future.