The 26th UN Climate Change Conference of the Parties, or COP26, was described by US Climate Czar John Kerry as our last best chance to save the world before the climate crisis overwhelms our critical systems.
Businesses are already facing climate change disruption, risks, increasing costs, and tighter regulations. The scientific consensus is that impacts will get worse over time without action. What is less certain is the outcome of COP26, scheduled to happen over two weeks from 31 October to 12 November.
The much-anticipated event is a global political stage where all things climate change — such as wildfires, record heat deaths, flooding, and melting polar ice — will be brought front and centre, amplified by global news channels and social media. There will be major social and economic consequences whether it's the success or failure of the global political elite to respond to these problems.
Even if there is a failure to reach new global agreements, many nation-states will use COP26 as a platform to announce their aspirations, strategies, and priorities — making national pledges; launching action plans, new policies, and regulations; and responding to their local stakeholders. These have been a feature of all previous COPs.
Predicting the outcome of international political conventions is notoriously difficult. COP26 could be a watershed moment in climate change, or it could be a monumental fudge. However, regardless of any final agreements, COP26 will change things for business in a number of ways. For one, we know that COP26 will undoubtedly direct attention towards the greenhouse gas (GHG) emissions and climate strategies of individual businesses. Similar to previous COPs, this could result in new regulations or greater scrutiny by concerned stakeholders.
Understanding these changes and preparing for them are critical to future business strategies and the sustainability of business models. Rather than predicting these outcomes, this article attempts to shine a spotlight on the bits in COP26 that finance professionals should be looking out for.
Global and local regulatory changes
Drawing on the latest IPCC reports, the carbon budget — the global amount of GHG allowed to be emitted in any year — is likely to be reduced significantly. How that shrinking budget is allocated between nations or industrial sectors is likely to change, with more losers than winners. One possible outcome could be all parties at COP26 agreeing to a shift from voluntary national commitments to reduce GHG to a more mandatory, binding regime with enforceable sanctions. Individual countries, like the UK has already done, could choose to embed these voluntary commitments in their national laws or regulations.
There may be the introduction of global carbon taxes, trade restrictions, and new ways to price carbon into goods and services. There could be extensions of GHG-emission trading schemes, similar to that recently announced by the EU, with emission rights being auctioned rather than allocated freely.
Any global or local regulatory changes will have significant consequences for business in general and to specific sectors. The impact of any of these changes will fall more heavily on businesses that already emit large amounts of GHG emissions or are seen not to have made significant efforts to reduce their carbon footprint. A carbon footprint is the life cycle greenhouse emissions as result of a specific activity, product, business, or individual. Major reductions in allowable emissions may result in businesses becoming carbon insolvent, as their business relies on emitting levels of greenhouse gases that exceed allowable limits. Allowable GHG emissions become the limiting factor for some businesses, which will be unable to operate, unless they alter their business models.
Finance professionals should look out for these announcements in relation to where their businesses are located, their supply chain, where they get their finance, and where they sell their products. A change in a single country can have major ramifications in all the value chains that pass through it.
It is likely that the debate around COP26 will result in calls for enhanced GHG disclosures. The buzz around COP26 may lead stakeholders to question individual businesses on their GHG performance, strategy, and plans. Under this spotlight, not knowing or providing partial or questionable evidence is a major reputational risk for organisations, and it could impact future sales or returns.
It is also worth checking announcements from standard-setters or professional accounting associations in relation to GHG accounting, most of whom have pledged support to become net-zero or carbon-neutral.
All major professional accounting bodies and firms will be present at COP26, promoting their services and plans and potentially launching new initiatives or reporting on progress on current pledges. We know that the IFRS Foundation has announced it will name its new International Sustainability Standards Board (ISSB) at COP26, which will be tasked with further developing new climate disclosure requirements. What can be predicted is that in the future businesses will have to disclose more, not less, information on their GHG emissions. And our experience suggests that any requirements for large corporations to disclose more will be passed on to smaller businesses through the supply chain.
Pressure has already been building for businesses to provide more comprehensive accounts of their contribution to the climate problem. It is becoming difficult to hold the line that a business can be net-zero or carbon-neutral while ignoring the GHG emissions of their supply chain or emissions from the use of their products or services. Many leading businesses are developing systems that gather information on the GHG emissions of the goods and services they purchase and incorporating GHG emissions into tendering or procurement processes.
All businesses are strongly advised to take stock of their climate risk, assess full carbon footprints, and develop appropriate plans in readiness of this new scrutiny. Of course, many businesses are already aware of this, and they are likely to fair much better than those that are operating without full knowledge of their contribution to climate change. On the positive side, these enhanced internal processes will help businesses make better informed decisions. Basing decisions on incomplete GHG emissions can lead to decision-makers selecting options that they mistakenly believe will reduce GHG emissions, when in fact they increase global GHG.
Last month, the UK Advertising Standards Authority published new regulations on climate-related claims and have upheld complaints on misleading statements. Other regulators are looking to issue guidance on defining ambiguous terms such as low carbon, carbon-neutral, and net zero. Finance professionals need to investigate the risks of any possible changes in the regulations they are subject to.
Existing "low carbon" solutions may become banned or considered socially unacceptable. Many net-zero business strategies rely on offsetting, purchasing carbon credits from schemes that look to remove CO2 from the atmosphere at least equal to their annual emissions. Most of these schemes rely on nature-based solutions, such as reforestation; rewilding projects; protecting valuable ecosystems such as mangrove forests and peatbogs; seagrass cultivation; and urban forests. Sadly, previous abuses of these schemes has led to a lack of trust in the efficacy of some schemes, and it is likely that COP26 will increase the level of scrutiny, leading to the need for better assurance and certification. There remains a risk that businesses inadvertently purchasing problematic offsets could suffer serious reputational damage if they cannot demonstrate sufficient due diligence in how they choose to offset their emissions.
Balance sheet implications
Another related consideration, the concept of stranded assets is likely to have significant impact on some sectors. A stranded asset is an investment or resource that cannot now be commercially exploited because of GHG regulations. In 2018 it was estimated there were over $1 trillion of stranded assets in the oil and gas sector. Climate change will also impair the value of other asset classes, requiring write-off or devaluation. The value of land, properties, or sites at risk of sea-level rise will need to be prudently revalued, and provisions will need to be made for losses and increased insurance charges. Even though your business may not own any stranded assets, you may have stranded liabilities in these affected businesses; for example, if you have sold goods or services to them, lent them money, or collaborated with them. Any reduction in global carbon budgets will create even more classes of stranded assets and stranded liabilities.
Capital market reactions
The capital markets will react to the mood music of COP26 as news leaks out of the late-night discussions or on the rumours of agreements. The financial markets may go through structural adjustments following any global agreements. National currencies could be affected by lower national GHG budgets, with greater volatility in high-GHG-emitting countries or in nations whose consumption patterns are responsible for rising GHG emissions. Interest rates and cost of capital for businesses could increase if any of these agreements impact the potential returns of a sector. These returns can be influenced by predicted price increases of GHG-intensive products or products considered obsolete due to their climate risks.
Share prices in high-GHG emitters could be marked down as institutional investors rebalance their portfolios to reflect climate risks and new climate scenarios or carry through with previously announced disinvestment strategies to comply with new disclosure requirements such as the Task Force on Climate-Related Financial Disclosures (TCFD). Any announcement of cheaper or subsidised transitional financial instruments, such as new issues of climate bonds, already sitting at $1.4 trillion, will disrupt the financial markets.
COP26 will also be a global shop window for new thinking, technologies, and products in relation to reducing GHG. No business wants to emit carbon, since there is no value in doing so. It is a waste product with many negative social and environmental impacts. In many cases GHG emissions are avoidable or at least reducible.
Every day new zero-carbon solutions are being developed, which are, or will be, cost-effective. Commercially wind-generated electricity is now cheaper than using fossil fuels. Hydrogen technology is pushing ahead and has the advantage of being able to use the same storage and transmission infrastructure as natural gas. Electricity works the same regardless of how it is generated, but renewable generation comes without such a damaging environmental footprint.
The COP26 green zone will be full of zero-carbon solutions that could be effectively applied in many businesses. The green zone is the publicly accessible part of COP26 and is a low-carbon festival, which includes free events, exhibitions, workshops and talks from businesses, civil society, and academics and artists from across the world. These events includes the latest technology, innovative thinking, and thought leadership in how to future-proof your business. Opportunities to partner with other businesses or charities may emerge that could reduce the risks of carbon insolvency, or we could see creative ways to respond to the need to reduce global emissions.
Watch, listen, and act
Tighter restrictions on GHG emissions are inevitable; if not at COP26, they will be developed in the near future. The science is clear, and action will be needed. Not doing anything is a risky strategy and likely to be costly. Adapting your business is shifting from a voluntary choice to a non-optional imperative. Social expectations of business in relation to climate change are likely to change drastically. Use COP26 as an opportunity to learn what the future may hold for your business and to be prepared for the changes that are coming.
— Ian Thomson, ACMA, CGMA, is professor of accounting and sustainability and director of the Lloyds Banking Group Centre for Responsible Business at the University of Birmingham in the UK. To comment on this article or to suggest an idea for another article, contact Alexis See Tho, an FM magazine associate editor, at Alexis.SeeTho@aicpa-cima.com.