From Transition to Transformation
By Gerri Ward, Principal Consultant
At time of going to press, about 35 Climate Statements have been uploaded to the New Zealand Companies Office Climate-related Disclosures Register. By the end of their respective reporting periods in this financial year, a total of about 200 reporting climate-reporting entities (‘CREs’) will have uploaded their reports; as is mandated by the Financial Sector (Climate-related Disclosures and Other Matters) Amendment Act 2021.
The purpose of these statements is to provide the reader (the “primary user”) with comparable and meaningful evidence to help them to understand how climate change is currently impacting the entity, and how it may do so in the future. Full disclosure includes the scenario analysis the CRE has undertaken, the climate-related risks and opportunities the CRE has identified, the anticipated impacts and financial impacts of these, and how the CRE will position itself as the global and domestic economy transitions towards a low-emissions, climate-resilient future.
Key to the approach is a scenario analysis requirement. The outputs of scenario analysis will identify the climate-related risks and opportunities which the governing bodies of CREs must then factor into their risk management and strategy disclosures. That is what is expected to drive both adaptation and mitigation by the CREs.
It is important to note here that the XRB have been explicit in their advice that the standards are not there to directly cause that mitigation and adaptation to occur in the first year: a CRE’s reporting cannot fall short of meeting the standards because it hasn’t mitigated or abated their emissions as a result of measuring and reporting against them. The reporting requirements are essentially a regime to ensure that the effects of climate change are routinely considered in business, investment, lending and insurance underwriting decisions, and to help climate reporting entities better demonstrate responsibility and foresight in their consideration of climate issues, so that they may be clearer and more comparable.
So, the expectation (for now) is disclosure; not necessarily action against those disclosures – particularly in this first reporting period when the XRB has, understandably, given CREs the time and flexibility to adjust to these very complex standards. The step up into the second year of reporting, when the first reporting year’s loopholes are closed, will be marked.
Early insights into the first disclosures have been fascinating. In this excellent summary from KPMG for Chapter Zero, five early themes have emerged in the uploaded climate statements:
The Standards are time intensive. Organisations are grappling with many other pressures, and integrating complex climate considerations into their business requires resourcing they don’t necessarily have available.
Focusing on disclosure requirements can detract from the real progress made on climate change. Those in sustainability roles have indicated that they are spending more time on reporting and collating information than on making real change in their business.
Organisations are capturing and providing a lot of information, but that doesn’t automatically equate to insight for themselves – or for the market.
While these first disclosures are published as a result of world-leading (at the time) legislation on mandatory climate reporting, the market seems underwhelmed with the impact.
Missed opportunities; organisations don’t appear to be leveraging the strategic opportunities that this effort presents. Instead, what we have seen is that a ‘reporting first’ approach has been taken, focused on compliance. Organisations seem to underestimate the extent and potential speed of change as well as the investment needed to support strategic resilience. This is at the core of what the standards set out to achieve.
To some extent, this is to be expected – the standards are new and evolving and the regulator (the FMA) has explicitly stated they’ll take a “broadly educative and constructive approach to compliance”. As the regime becomes more established, the FMA will take a more proactive approach examining climate statements and reviewing the records of the CREs to ensure compliance.
On the other hand, from a practitioner's perspective within these CREs, there is a sense of frustration that the time, money, and resource spent on disclosure could better have been put directly to the doing; rather than the measuring and complying. The Interim Results Survey of Climate Reporting Entities and Primary Users by the University of Otago for the XRB, found that the most common challenges with climate-related disclosures currently are lack of reliable data and cost of producing such disclosures. But the Otago study found a resoundingly positive response to whether the disclosures did actually lead to increased disclosure capability and strategic decision-making: one survey respondent said: “We really want to be able to use the insights collected from this exercise and this disclosure and funnel those towards informing our approach going forward.” Our observation is that even if demonstrable 'climate activities' are yet to be activated, the raising of climate as a topic at Board and Management level, and legitimate inclusion in risk registers, strategic discussions and governance processes is not to be dismissed. This has required – and seen - a level of capability building along the way in roles that would not have touched this agenda before.
So, once you have measured, reported, set targets, identified risks and opportunities, overlaid them with your enterprise risk strategy, upskilled your Board, assured your GHGs, and mapped your risks against your global warming scenario pathways, what do you do? The biggest uplift for reporting entities from this financial reporting period to the next is going to be the transition pathway that does the actual decarbonisation. So, what does this even mean?
To make a complicated regime and lexicon even more complex, we've found it doesn't help that "transition" essentially reflects two distinct aspects of climate disclosure reporting - firstly, it's the term given to risks your entity faces in the transition to a low-emissions economy (so: policy, regulations, and emission pricing; for instance), and it's also used to refer to the actions you'll take as a result of having gone through this entire disclosure journey, or what is called "transition planning". We would submit that perhaps the latter should be better referred to as “transformation planning”, as that’s essentially what will be required of your business strategy and operating model. Minimally, it should describe the “transition aspects of your strategy”, as per the XRB standards.
A transition plan is defined in NZ CS 1 of the standards as “an aspect of an entity’s overall strategy that describes an entity’s targets, including any interim targets, and actions for its transition towards a low-emissions, climate resilient future”. Transition planning is about the repositioning and transformation of an entity’s business model and strategy in response to climate-related risks and opportunities. The XRB describes it as “exploring the options available, charting a pathway informed by the different risks and opportunities identified, and taking tangible actions to maintain an entity's ability to operate, generate sustainable revenue, protect its assets, and finance itself in a rapidly changing world.”
The best explanation we’ve seen to date comes from the UK’s Transition Plan Taskforce Recommendations, which very aptly describes the three inter-related channels in designing a transition plan: decarbonising the entity, responding to the entity’s climate-related risks and opportunities, and contributing to an economy-wide transition:
Source: Transition Plan Taskforce Recommendations
This third, essential, element recognising the contribution to an economy-wide transition, reminds us of the fundamental objective of our – and any – climate reporting regime. To ultimately cause a profound shift in financial flows towards a low-emissions, climate-resilient economy. To do this will take meaningful action from all of those reporting entities to make up the parts of the whole which will represent such a shift.
The UK guidance emphasises that “good practice transition plans should reflect the urgency to act” and consequently discloses whether and how an entity has “identified, assessed, and taken into account the impacts and dependencies of the transition plan on the entity’s stakeholders, society, the economy, and the natural environment, throughout its value chain, that may give rise to sustainability-related risks and opportunities.”
We thought it might be useful to take the first Climate Statements published so far and draw out some examples of the transition actions that reporting entities have outlined, in order to have some demonstrable transition actions to refer to when you’re considering this evolution from disclosure to strategic approach. (Note, this is not an exhaustive list, and is meant only to be an example of the types of actions described in this first year. Note also that the Aotearoa New Zealand Climate Standards allow for a first-year adoption provision whereby the transition plan aspects of the CRE’s strategy may be exempted in the first reporting period). Indeed, according to The Lever Room’s excellent recent research 78% of the first tranche of companies who’ve uploaded their disclosure reports have taken this exemption. From the second reporting period on, the standards require the CRE to disclose the transition plan aspects of its strategy, including how its business model and strategy might change to address its climate-related risks and opportunities; and the extent to which transition plan aspects of its strategy are aligned with its internal capital deployment and funding decision-making processes.
To simplify what we’ve extracted, we think it fair to attest that what is referred to as the transition plan aspects of a reporting entity’s strategy for the second reporting year will effectively total the actions listed in their Emissions Reduction Plan, as a result of identifying how to mitigate their emissions, plus the mitigants as identified in the risk identification process. Some entities have, however, clearly stated what their transition plans will include once they are legislatively required to disclose them. This is generally reflective of the maturity of the existing risk framework and how aligned already climate risk is with existing risk management processes. AIA NZ, for example, already assimilates climate-related risks into their risk management framework, and manages them as a transverse risk within their risk management framework.
By sector, some of these example actions include:
As mentioned above, the uplift from the first to second year of climate-related disclosures will be steep. There is certainly a sense that we’re all learning by doing in this new, uncharted territory (as also evidenced within our 2024 Sustainability Professionals Research). But from the next reporting period on, the loophole created by the adoption provisions will close, and reporting entities, and those in their supply chains, will need to understand and be able to demonstrate concrete and specific planned actions towards decarbonisation and adaptation. This will include the measures the entities are taking to reduce their emissions, how they will meet any targets it has set, how it is shifting its business model and strategy, and how it has engaged stakeholders to ensure a just transition. Not only will this help to protect and enhance an entity’s long-term value, but it will also – collectively – add up to an integrated shift in the flow of capital towards a more resilient, low-emissions economy. This is where transition, truly becomes transformation.