Comment: Does every company need a climate transition plan? The simple answer is ‘no’

Climate Transition Plans (CTPs) have gained significant momentum with funders and regulators in the last 18 months (indicatively, see the number of climate resolutions at the 2023 US AGM season). They have also spurred a heated debate about whether CPT advocates are becoming too prescriptive or interventionist in companies’ climate strategies.

While, unfortunately, this debate has been contaminated by politicisation and emotion (even across Europe), it has nevertheless raised genuine strategic questions about the role of the corporation in climate change. Should companies formally commit to saving the planet and society, and, if so, at what expense to their balance sheet and profitability? How far is too far? What are realistic boundaries to corporate responsibility?

To address these questions, we interviewed 23 senior executives in industry, financial services, investment firms, and strategic advisers. We learned a lot. Based on these interviews we would like to suggest an approach to CTPs that is both practical and responsible.

A company’s top priority is to remain a going concern and so its climate strategy must support the overall corporate strategy and protect its vital resources, not detract from them. Any moral obligation that the company has assumed by virtue of its consciously defined purpose, or jurisdictional requirements owing to the national climate commitments of its countries of operations, should be placed in the context of the company’s long-term going concern considerations.

These basics are firmly established in common law. The UK TPT guidance, which has emerged as a global CTP reference framework, carefully uses the operative word around CTPs being “informed by” (inter-)national agreements and commitments, instead of “driven by them”.

Moreover, a company should define long term based its natural capex and product life cycles, and longest-term contractual liabilities. Taking a long-term view on company success, then, doesn’t automatically equate with incorporating the ultimate economic effects of climate change into the company’s business plan.

Let us be clear. Not every company needs a CTP. There is little commercial value, and most likely a fair amount financial resources, time and executive attention wasted in developing a CTP for the sake of communication optics; neither the company nor its stakeholders will become any wiser from it.

On the other hand, where climate has emerged as a principal commercial risk or opportunity for a company, it would be both commercially (and probably legally) imprudent for the company to not proceed with a CTP and not to seek meaningful stakeholder feedback on it.

Naturally, if regulation or the company’s funders demand it then the course of action is clear.

It all comes down to materiality, which should be conducted as a matter of natural course of business. Based on our interviews we would like to suggest a three-step process for how a company should decide whether it needs a CTP.

Internal materiality assessment

Most corporate materiality climate assessments are conducted by analysing external stakeholders’ views on the company’s climate sensitivities and priorities. There is indeed strategic value in soliciting dispassionate and impartial feedback from these groups. However, it is quite unlikely that external parties will be more informed or insightful than internal ones on the company’s strategy or prospects.

“There is little commercial value, and most likely a fair amount financial resources, time, and executive attention wasted in developing a CTP for the sake of communication optics”

Thus, we recommend that the company start with an internal materiality assessment. This helps to focus the leadership’s attention on systemic climate parameters that: (a) have the largest impact on the main stages of the company’s value chain (both in terms of magnitude and scope); and (b) speak best to a purposeful company’s core values.

To be effective, an internal materiality assessment needs to be commercial, technical, and quantitative. The assessment should be designed in a way to provide decision-ready input to a company’s strategy. It should also provide a reference point for weighing business trade-offs (ie, short vs. long term, cost vs. benefit, etc). These requirements have the following three implications:

First, a company needs to conduct a top-down and bottom-up corporate climate risk mapping exercise to synthesise a unified picture. This mapping should span across sourcing, production, sales, operations and, increasingly, the workforce’s capabilities and convictions.

Accordingly, the company should run a simple, business-driven, forward scenario analysis translating climate narratives into commercial impact. This will produce balance sheet, cashflow, profitability and solvency sensitivities for a defined set of company-relevant climate parameters.

The desired outputs should include an “impact times probability” assessment on core risk thresholds, pricing structure trajectories and tangible business decision variables such as a green capex ratio for the industry and credit limits and capital charges for banks.

The company should also conduct a similar sensitivity analysis for climate-related new market entry or market-creating opportunities (ie, cost vs. profitability, timing and likelihood assessment).

Second, while divisional heads own the company’s business strategy, execution lies with middle management. A good materiality assessment, then, captures unique company and business data points that sit across the hierarchy, not just at the top. This helps to garner collective corporate intelligence effectively and makes climate materiality assessment rooted in the idiosyncrasies of the business.

Third, risk, finance and key business functions need to quantify materiality and derive a confidence level for their assessment. For that, they need pricing input on core climate parameters from the market and relevant commercial data points.

For instance, on carbon they need to price their emissions by taking the carbon curve from a liquid carbon exchange. For access to clean water, they can use the cost of water purification borne by water companies. On biodiversity, they can rely on rehabilitation costs from the extractive industry. For physical risks, they can look at insurance damages from peers or proximate locations, or at adverse stock price action following a significant climate event. On degree of confidence, they can look at the reliability of their assumptions, and degree of crude approximations and “known unknown” factors they can’t price.

The level of analytical resources and the stage of the company’s corporate maturity will naturally impact the quality of the results of this exercise. However, there is no way of circumventing the need for rigorous risk assessment, whatever the capabilities available.

It is at this step in which the company determines whether it needs to produce a CTP or not. If the answer is “Yes”, it proceeds through the next two steps. If the answer is “No” it explains this to the board to ratify this decision or to challenge the conclusion.

Stakeholder engagement

Following an internal analysis, the company should then produce a sophisticated climate-engagement stakeholder map. This will help to get an external viewpoint into the company’s materiality and add insights into the company’s internal analysis.

A sophisticated stakeholder climate engagement map weighs the company’s stakeholders meaningfully on a multidimensional basis. Popular parameters like the stakeholders’ power and influence (by kind, magnitude, and scope) should be deemed a starting point. Additional critical factors include the stakeholders’ quality of insights into the company’s value chain and strategic dependencies, and their climate sophistication across different aspects (including liability risk, given the rise of climate litigation).

“Genuine and dynamic stakeholder climate engagement brings out key climate materiality factors, as well as providing insights into their permeability and urgency”

Finally, the persistence and significance that stakeholders assign to climate engagement should also be factored in. For instance, a majority but passive shareholder would weigh up less than a substantial active manager shareholder with a clear climate mission, or a climate activist investor on a high-profile engagement campaign (eg, Engine No. 1’s 2021 proxy campaign on ExxonMobil).

It is also important to deep dive into stakeholders to pin down the core decision makers and their key decision drivers. This helps to understand their views on climate trends, trajectories and system interdependencies more deeply, and to respond more accurately.

Stakeholder engagement should be conducted dynamically in the context of nurturing a deep commercial relationship. In other words, this should be an ongoing process and not simply an annual or bi-annual exercise. This helps to capture new information, thinking and latest developments. This is why it should be deemed a commercial exercise, not a compliance or central function exercise.

Genuine and dynamic stakeholder climate engagement brings out key climate materiality factors, as well as providing insights into their permeability and urgency. Conversely, superficial engagement gives the company a false sense of security on its strategic climate dependencies and their commercial impact.

Get the board on board

The combination of an internal assessment and stakeholder engagement synthesises a complete and reliable materiality assessment which is used to prepare a draft CTP. A complete materiality assessment effectively solves for the key aspects of a CTP: setting time-bound targets, fully revising the business plan, including resourcing, the products and services portfolio, budget and capex, and business and climate metrics, and putting the necessary governance process in place to monitor progress.

This draft is then carefully reviewed by the executive committee which provides feedback and again determines whether to go ahead with a published CTP. Management’s final recommendation and draft (if the decision is to proceed) is then shared with the board for their feedback.

The board makes the ultimate decision about whether the company should publish a CTP. Legal counsel and consulting advice to both management and the board can be helpful. At the same time, it is vital to appreciate that legal and advisory resources are aids; they are not forms of outsourcing the discharge of fiduciary or senior management responsibilities on climate matters.

“Legal and advisory resources are aids; they are not forms of outsourcing the discharge of fiduciary or senior management responsibilities on climate matters.”

The quality of the board’s input to a CTP and decision on whether to proceed with a public one or not is a function of the climate competence of the board. This competence is based on having a cognitively diverse board with relevant senior operating experience and critically resident climate skills on its audit, risk and increasingly talent committees.

Board committees should coordinate closely on their annual schedules of work on climate matters. This ensures that independent non-executive directors ask the right questions and stress-test the executive’s assumptions and rigour of analysis in their draft CTP.

Finally, boards are naturally concerned about any corporate liability from having a CTP, particularly in the context of publishing climate targets and time-bound action plans. Legally speaking, both are akin to forward statements of commercial intent on climate management.

At the same time, demonstrating that the company is following a robust process on CTP determination should help to demonstrate due skill, care and diligence and should protect the company both commercially and legally.

Companies are commercial entities, not organisations for addressing the problem of climate change. That said, climate change can have a profound effect on a company’s ability to create value over the long term.

For some companies, a transition plan can be very useful to ensure it is able to do so. Whether a company should have a published CTP is a board-level decision. We have suggested a process to enable the board to make that determination.

Robert G Eccles is a visiting professor of management practice at Saïd Business School, Oxford University, and the founding chairman of the Sustainability Accounting Standards Board.

Tina Mavraki is a portfolio non-executive director and strategic adviser to policy makers and corporates on sustainability and climate transition. She has a 25year C-level career in finance and physical supply chains globally.