Investors can congratulate themselves on influencing the world’s businesses to act on climate change. In a survey last year by Oliver Wyman and the Climate Group, corporate sustainability leaders said that investors were by far their greatest source of pressure to undertake a climate transition – with least pressure coming from policymakers.
Investors might feel less proud, however, about what they are influencing those companies to do.
The demand for metrics and disclosures to feed the ESG ratings industry is driving an extraordinary activity of detailed quantification, which is absorbing money, talent and management attention at an unprecedented scale. And it is distracting from the big transition challenges for which we still don’t have answers.
When Refinitiv assigns ESG scores by modelling 630 company-level measures, it’s no wonder that sustainability teams find that the task of reporting is overwhelming the task of transition, or that PwC says it needs to hire 100,000 people focused on climate (and diversity) reporting.
Of course, we need metrics – but we are disappearing down a rabbit hole of complexity.
The Paris Agreement needs the 2020s to be our “decade of delivery” – but on our present path it will be the “decade of disclosure”. To meet our Paris goals, we need to halve the world’s carbon emissions by 2030. Today we are already more than halfway to that date, and the world’s emissions are still on the rise. We can’t afford to spend the decade putting in the accounting system.
Worse, the accounting system that businesses are being driven to build is untested and ill-suited to the task. We are collectively betting it will work, but there are good reasons why it may not. This is a climate risk that is rarely recognised.
The curse of large numbers
The challenge is in the combination of an enormously complex, interconnected and evolving economic system, with a multitude of actors at all levels each with their own motivations.
“We face the strains and limitations necessarily imposed by such considerations as the collection and dissemination of information, the remoteness of decision-makers, aggregation, problems of motivation, and above all ‘the curse of large numbers’ – the sheer magnitude of the work of calculating, allocating, evaluating, checking, financing.”
This assessment describes today’s carbon accounting challenge well – although in fact it was written in the 1970s to describe the centrally planned economy of the Soviet Union. The similarities should sound an alarm.
The practical issues we are facing with carbon accounting are sadly familiar from the Soviet economic system. If we set targets at an aggregated level, companies will find unintended ways to meet them that don’t serve the end goal.
A 1950s Soviet cartoon showed a factory foreman delighted to have fulfilled his annual plan by creating one giant nail. Today, companies find it similarly tempting to meet their climate goals by selling assets to someone else rather than by actually reducing emissions.
If instead we set targets at a micro level, we risk misdirecting the effort through another effect familiar to Soviet managers: “The problem is that the centre is trying to set up an incentive system designed to achieve more efficiency – but, because it does not and cannot know the specific circumstances, its instructions can frequently contradict what those on the spot know to be the sensible thing to do.”
Today, headquarters must be careful quite what they prescribe to their operating units, and the same with businesses to their supply chains and banks to their corporate clients.
Exiting the rabbit hole
So what should a responsible investor do instead?
Wherever investors go with ESG, the carbon accounting I have described will mostly happen anyway. Regulators have picked up that agenda, with the European Union’s Corporate Sustainability Reporting Directive and other measures elsewhere.
Rather than encourage businesses to go deeper down the accounting and reporting rabbit hole, investors can use their influence positively to engage with businesses on what we actually need them to do.
As you move up from the carbon-accounting detail, the first stage is to focus on companies’ transition plans.
What is the role they want to play in a decarbonising or net-zero world? What is their strategy for the coming transition, in terms of risk (how it will affect their business), opportunity (how they can create new value if they play in the right places) and impact (how they can drive the transition forward)?
How are they anticipating, or even facilitating, other organisations’ moves so that the whole ecosystem evolves in step? Who is going to pay for the investments needed, and why?
The degree of change we need won’t come just from setting targets in a carbon accounting system and expecting business units to adapt to them. It needs strategy, planning and investment. This is why the Glasgow Financial Alliance for Net Zero is driving real-economy businesses as well as financial services organisations to create net-zero transition plans.
Moving up further, beyond that process-led approach, we need to try a top-down, 80/20 mindset to complement the bottom-up detail of carbon accounting.
Looking at the world’s emissions this way, there are a handful of substantial problems to solve, mostly through technology:
● Clean power generation;
● Electrification;
● Energy we can’t electrify (how to avoid fossil-fuel emissions using hydrogen, carbon capture, advanced nuclear);
● Industrial processes (how to avoid emissions from making steel, cement and plastics);
● Agriculture (how to avoid fossil-fuel-based fertilisers, drive yields through genetic modification and gene editing, substitute animal agriculture and free up land).
If businesses see investors focusing on where they are at on these big issues – how they may be affected, and how they are contributing to the solution – that would help concentrate business leaders’ minds where we really need them.
Simon Glynn is founder of the charity Zero Ideas, challenging business thinking on climate change.
