Companies are under mounting pressure to achieve net-zero carbon emissions. Angus Chan, Vice-President, Head of ESG Solutions for Greater China, Alliance Advisors, gives some guidance on how the net-zero transition can be achieved.
Escalating and ubiquitous expectations on climate change are now calling for hard action – gone are the days of boilerplate statements and gentle nudging. Thanks to the interdependence between climate change and net zero, a surging number of institutional investors are directing portfolio companies to move towards net-zero emissions by 2050, together with medium-term targets for an unambiguous carbon emissions reduction trajectory.
The Net Zero Asset Managers initiative (NZAM), one of several different coalitions associated with net zero, is an international group of asset managers committed to supporting the goal of net-zero greenhouse gas (GHG) emissions by 2050 or sooner, a target which is in line with global efforts to limit warming to 1.5°C above pre-industrial levels. NZAM has 236 signatories, representing over US$57.5 trillion in assets under management.
Additionally, there has been a surge in the number of companies setting and committing to science-based targets. As of 31 December 2021, there were more than 2,200 companies with US$38 trillion in market capitalisation working on decarbonisation with the Science Based Targets initiative (SBTi).
Sustainable mutual funds and ESG-focused exchange-traded funds rose globally by 53% last year, to US$2.7 trillion, with a net US$596 billion flowing into the strategy, according to Morningstar Inc. Riding on the accelerating influx of ESG funds, institutional investors are stepping up their engagement with companies to ask about their strategies and actions on a spectrum of ESG topics such as net-zero targets, board oversight of ESG issues and natural capital.
Net zero 101
The transition to net-zero carbon emissions will not be an easy one, nor can it be achieved overnight. On the other hand, there is now widely available guidance companies can draw on when choosing their own pathways to net zero. SBTi, for example, has published its Corporate Net-Zero Standard, which provides systematic guidance to companies in setting net-zero targets. The guidance sets out the following key steps:
- select a base year
- develop a full GHG inventory, including Scope 1, 2 and 3 GHG emissions
- set target boundaries
- choose a target year
- calculate near-term and long-term science-based targets, and
- establish a robust review mechanism.
Garnering data and calculating Scope 3 emissions, referred to in the second item in the list above, will be challenging for many companies as data availability is often low and extensive communication with relevant internal departments and external stakeholders along the value chain will be needed. Moreover, constructing a Scope 3 emissions inventory is only part of the net-zero journey. Heading towards near-term targets and the net-zero target, engaging with relevant internal departments, assigning internal targets to departments or business divisions and managing renewable energy procurement are also of prime importance.
Key internal departments that influence internal carbon emissions and emissions from external suppliers should be identified and prioritised. Generally, suppliers and service providers such as goods suppliers and logistics vendors usually contribute a significant portion of Scope 3 emissions, while the primary contact point is likely to be the procurement department, rather than the internal sustainability department. Dedicated and ongoing engagement is needed since decarbonising along the value chain outside a company’s primary nexus of control is more daunting than slashing carbon emissions in a company’s own operations.
A carbon reduction target is similar to a revenue target. Determining what portion of the target should be owned by each department can be challenging and could ultimately become an obstacle to progress, leading to slippage. Moreover, if yearly internal departmental targets have not been well defined, continuous progress monitoring cannot be exercised effectively.
Utilising renewable energy constitutes a pivotal action for achieving net zero. There are, as a minimum, eight options for switching to renewable energy, including procurement from onsite installations owned by a supplier, green electricity products from an energy supplier and so forth. Given that the renewable energy market is evolving, setting procurement criteria with timely updates and monitoring the market price fluctuation drive effective progress in this regard. In addition, hydrogen may well play a critical part in decarbonisation, but the technology to harness its potential seems far away. Nevertheless, a small number of companies are studying the uses of hydrogen as an alternative fuel and estimating how far it will help them reduce their GHG emissions.
A roadmap lasting more than one or two decades will always involve an element of uncertainty, so reviewing the roadmap and the action plan continuously and systematically will be critical to add robustness to the system. This could facilitate responses to external stakeholders such as institutional investors and minimise reputational harm.
The ESG universe is continually expanding. Companies should identify the latest institutional investor ESG priorities, and reshape their strategies and approach to shareholder engagement to meet these expectations.
Angus Chan, Vice-President, Head of ESG Solutions for Greater China
SIDEBAR: Online resources
Net Zero Asset Managers initiative (NZAM) – www.netzeroassetmanagers.org
NZAM is an association of asset managers in support of the goal of net-zero greenhouse gas emissions by 2050 or sooner.
Science Based Targets initiative (SBTi) – https://sciencebasedtargets.org
SBTi provides guidance to companies and financial institutions on science-based target-setting in line with the latest climate science.
BlackRock Investment Stewardship (BIS) – www.blackrock.com
BIS publications offer a useful primer on the institutional investor approach to sustainability issues. Its Our Approach to Engagement on Natural Capital was published in February 2022.
RE100 – www.there100.org
RE100 is a global corporate renewable energy initiative committed to 100% renewable electricity.
The Task Force on Nature-related Financial Disclosures (TNFD) – https://tnfd.global
TNFD offers guidance on incorporating nature-related risk and opportunity analysis into corporate and financial decision-making. Its Nature-related Risk & Opportunity Management and Disclosure Framework (beta version) was released in March 2022.
SIDEBAR: Natural capital – the basics
Achieving net-zero carbon emissions is part of a larger issue that should also be high on company agendas – managing corporate impacts and dependencies on natural capital assets. Just as with greenhouse gas emissions, companies’ natural capital management is increasingly under scrutiny by stakeholders. This February, for example, BlackRock Investment Stewardship (BIS) published its engagement priorities encompassing five topics, one of which is climate and natural capital.
BIS focuses on three major areas of concern – biodiversity, deforestation and water – and makes the point that management of these areas will inevitably have increasing impact on the long-term financial returns of companies. ‘Given the growing pressures on the natural ecosystems from which many companies derive economic benefits, business will increasingly face financial risks and opportunities associated with their impacts and dependencies on natural capital. As a result, we view the careful management of natural capital as a core component of a resilient long-term corporate strategy for companies that rely on the benefits that nature provides,’ BIS states in its Our Approach to Engagement on Natural Capital publication.
Natural capital management is also directly related to decarbonisation – forestry, for example, absorbs carbon dioxide from the atmosphere – and it is therefore relevant to companies’ climate action initiatives.
In March 2022, The Task Force on Nature-related Financial Disclosures published the beta version of its Nature-related Risk & Opportunity Management and Disclosure Framework for consultation, which provides an outline of the fundamental concepts and definitions relevant to natural capital management. It also provides disclosure recommendations and guidance on performing nature-related risk and opportunity assessments. By developing an integrated nature-related risk and opportunity assessment process called LEAP (Locate, Evaluate, Assess, Prepare), it provides guidance on how companies can develop and implement their own strategies in natural capital management.