The race to reach Net Zero is arguably one of the most pressing issues of the current period, if not in human history. Some companies are, therefore, beginning to set targets to reach Net Zero, and making disclosures regarding when and how they aim to achieve this. By Net Zero we mean the reduction of Scope 1, Scope 2, and Scope 3 emissions to zero, or at least to "near zero" (i.e., a reduction of at least 90%), with residual emissions eliminated via offsetting.
However, these targets and disclosures regarding such things as greenhouse gas emissions and residual offsetting may appear (at least at first glance) far removed from the world of finance, so why should investors care? As anyone familiar with the financial services industry is likely to be aware, the role of an investor is, effectively, to maximise returns for themselves or clients, while minimising their exposure to risks. The ability of a company to achieve Net Zero and adapt to a new low carbon economy represents such a risk, and - to put it bluntly - that is why investors should care.
While there are "outward" risks associated with emissions generated by companies (by which we mean the risk to the environment posed by these emissions) there are also "inward" risks (by which we mean risks to the profitability and valuation of a company) associated with emissions, and the ability of a company to adapt to the Net Zero transition. Outward risks associated with emissions are most likely to be relevant to investors that wish to minimise the environmental impacts associated with any holdings, such as asset managers that count wildlife charities as clients, for example. Inward risks associated with emissions (and especially the ability of a companies to reduce emissions and reach Net Zero), however, should arguably be considered by all prudent investors that wish to limit exposure to risks that may impact the value of their holdings.
Beyond the obvious inward risks linked to a changing climate and the need to reach Net Zero (e.g., the cash-flow and profitability of businesses will be severely impacted when assets belonging to these businesses have been destroyed by wildfires or flooding), the quality of commitments made by businesses to reach Net Zero, and the actions they subsequently undertake, also represent inward risks - they may impact the future cash-flow, profitability, and share prices of these businesses, and thus the return for an investor.
These inward risks are present given that, whether businesses are prepared or not, the pursuit of Net Zero and the transition to a new, low carbon global economy is in progress, and with this will come a number of challenges that businesses shall have to overcome. For example:
(i) Increased regulation - if Net Zero is to be achieved, it may require increasingly stringent regulations to be imposed on business to ensure reductions in emissions do occur. This may result in businesses being required to invest heavily in new equipment or methods that are necessary to ensure regulatory compliance. If a company has not already started taking measures to limit its emissions, it will be unable to spread the cost of this over a longer-time period.
(ii) Increased consumer expectations - as more consumers begin to care about the Net Zero commitments of businesses with which they spend their money, those businesses which have not made such commitments and/or established a clear transition plan may suffer from declining sales.
(iii) Difficulty in raising capital and obtaining insurance - going forward, companies that have not made clear commitments to achieving Net Zero and have not established clear transitions plans may find it increasingly difficult to raise capital due to expectations of lenders and other capital market participants. This may impact on the ability of companies to fund future capital expenditure projects and grow their businesses.
(iv) Backlash from "greenwashing" - if companies make public their commitments regarding Net Zero, but these are not based on scientific evidence or clear action plans, they may see a backlash from consumers and regulators, which may then result in loss of sales and potential fines.
Ultimately, for businesses that are not prepared to reach Net Zero and adapt to the wider transition to a low carbon economy, the difficulty of overcoming these challenges will be exacerbated, and with challenges comes risks - risks regarding the success of businesses, and thus risks associated with any investments made in these businesses.
Therefore, if investors wish to minimise their exposure to risks deriving from a company's lack of preparedness to adapt to a low carbon future, considering this preparedness is necessary. To do this, investors may wish to consider if a company has made a commitment to Net Zero, whether it has set science-based targets for 2050 (as well as any interim targets), the actions it has already taken to limit its Scope 1, 2, and 3 emissions of GHGs, any future actions it is planning on taking, its plans for the offsetting of any residual emissions, and its membership of relevant organisations such as the Science-Based Targets Initiative, RE100, and the Race to Zero.
We at Ethical Screening are able to provide this information, and would be delighted to work with any investors who wish to minimise the risks linked to Net-Zero preparedness as discussed above.
Click here to download our Net Zero Jargon Buster.