Net zero in the boardroom: getting oversight right in a changing energy landscape

 
Achieving net zero and other emissions reduction targets¹ requires charting a course through technological and regulatory uncertainty, requiring a multi-faceted understanding of the science of carbon emissions, operational considerations, financial impacts, regulatory and disclosure requirements, and stakeholder priorities. The breadth of these issues makes it difficult for anyone to become fluent across all of them. Yet given the implications of climate change on their organizations, many directors and senior executives are quickly expanding their competencies to meet the challenge.

The changing regulatory landscape

The transition to a low carbon economy is quickly changing the regulatory landscape in which companies operate. Various jurisdictions around the world have started to adopt net zero legislation and set national emissions reduction targets. In July 2021, the European Climate Law was entered into force, setting new binding EU-wide targets to reduce GHG emissions 55% below 1990 levels by 2030, and to achieve net zero emissions by 2050. Canada’s net zero Emissions Accountability Act enshrines the government’s commitment to achieve net zero by 2050 and provides a framework of accountability and transparency to deliver on that pledge. Certain U.S. states have passed similar legislation. For example, Massachusetts passed a new climate law last year with binding emission reduction targets of 50% below 1990 levels by 2030 and 75% below 1990 levels by 2040, as well as net zero emissions by 2050. These commitments are increasingly driving the development of specific policies and regulations intended to regulate and incentivize domestic GHG reductions—including carbon pricing regimes that will become significantly more stringent in the coming years.

Securities regulators are also developing rules for the disclosure by public companies of climate change risks and opportunities. The U.S. Securities and Exchange Commission (SEC) and the Canadian Securities Administrators (CSA) have each proposed rules that, if adopted, would require reporting companies to report climate-related information in their public filings. Both proposals are modelled in part on the recommendations of the Taskforce on Climate-Related Financial Disclosures (TCFD). Climate change disclosure is increasingly a focus of other regulators as well, including the Canadian Office of the Superintendent of Financial Institutions (OSFI), which recently closed consultation on draft guidelines that would provide federally regulated financial institutions with a framework for managing climate-related risk and require them to make climate-related financial disclosures.

These are only some examples, and more regulation is expected. Yet there remains significant uncertainty around the timing and details of future rules, particularly as the current markets are pressured by energy security and scarcity issues. Climate change also remains a political issue in many jurisdictions, and proposed carbon price increases will be put to the ballot box in coming years.

Governance for the energy transition

Boards are confronting this rapid change and uncertainty as they guide their organizations through the energy transition. To do so effectively, the following considerations will be key:

Ensuring training and support. Boards must evaluate their composition to determine whether they have the appropriate skills and expertise internally to be properly informed and to oversee the organization’s climate strategy. In many cases, boards may need to invest in education and provide regular, dedicated agenda time for these complex issues. They may also need external expert advice not only for education and strategic advice, but also to help evaluate the efficacy of management’s specific proposals, action plans and progress.

Engaging with stakeholders. In Canada, directors and officers are obliged to make decisions in the “best interests of the Corporation” taking into account the interests of different stakeholders. Not surprisingly, stakeholder sentiment on climate change issues remains dynamic, with different stakeholders expressing different and at times competing priorities. Management and boards should try to anticipate emerging issues and trends and be in “listening mode” to understand the views of different constituencies and build strong relationships over time. Board engagement with stakeholders on these topics should happen early and regularly, not just when problems emerge and engagement is forced. It is important that the board, not just management, can demonstrate that it is actively engaged and understands stakeholders’ viewpoints and concerns, accommodating where possible and explaining where there are diverging approaches.

Implementing governance structures. Given the complexity and long timelines of many decarbonization commitments, it will also be important to establish well-functioning governance structures to oversee the implementation of climate transition plans. There is no one-size-fits-all governance structure that will work for every organization. Rather, each organization should tailor its reporting structure and division of responsibilities to the nature of its business and board composition. Each board should consider the best use of its own and management’s resources and competencies to address the development and oversight for their organization’s climate plan. In some cases, the board may define executive functions and determine whether separate committees are responsible for certain aspects and report to the board for debate and decision-making. In others, the board may determine objectives and then delegate certain aspects to committees for ongoing responsibility. Many organizations now have sustainability committees, at the management level, the board level, or both.

Defining roles and responsibilities. Under any approach, the responsibilities and reporting structures need to be embedded and defined in the board and committee charters and properly prioritized and integrated across the organization, not siloed to separate functions. The full board is ultimately responsible to develop and evaluate their net zero strategy, then determine the governance structure and provide oversight to ensure progress for the strategy. Once the management and board structures are defined, it is important that the management and committees are aligned and coordinated in their functions and reporting to the board, and that adaptations are made as needed over time.

Integrating climate change considerations throughout the organization. To effectively implement a climate transition plan, an organization must embrace the plan as central to its business. Boards will play a key role in kickstarting and overseeing this integration. Board members must be actively engaged with their company’s climate transition plan, recognizing that these plans will require significant innovation and coordination across multiple functional units and skill sets. This is especially important when implementing an organization’s climate transition plan, as discussed further below.

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Setting credible targets

There has been significant pressure in recent years for organizations to announce net zero and other emissions reduction targets. The UNFCCC’s Race to Zero initiative now reports over 7,000 companies with a net zero pledge².  According to the online net zero tracker, of the world’s 2,000 largest publicly-traded companies by revenue, 790 have announced a net zero or similar commitments³. However, net zero is no longer just the purview of the world’s largest public companies and institutional investors; mid-market and small cap companies, including private companies, are increasingly turning their minds to target setting.

That said, while many companies have now announced targets, far fewer have disclosed a plan for how they intend to meet those targets⁴. And those plans that have been published vary considerably in their operational scope, emissions coverage, and implementation timelines. Amid increasing litigation and shareholder activism⁵, organizations will be expected to develop more concrete plans for how targets are going to be met, and stakeholders will likely continue to increase the pressure for accountability for those targets and action plans.

Given this state of play, it will be important for boards to focus not only on setting targets, but also on ensuring the organization has in a plan in place that is supported by adequate resources to achieve those targets—even if that plan may evolve and become more detailed over time. A well-considered implementation plan will help ensure targets are credible not only to investors and external stakeholders, but also within the organization to the employees that are tasked with achieving those targets. Boards must therefore ensure management has the time and resources to “do their homework” and gather and assess the data and information to set meaningful short-, medium- and long-term targets that can be implemented, monitored, measured, and verified.

At the same time, given the imperative of mitigating climate change, organizations cannot afford to wait for perfection before acting. The objectives of a climate transition plan may need to change over time in response to scientific, technological, regulatory, and economic developments. And it may take time to resolve data collection challenges. For example, while many organizations have an accurate picture of their Scope 1 emissions, they may face challenges in obtaining Scope 2 or 3 emissions data, given that this information often requires input from third parties or public resources⁶. In these cases, it may be necessary to recognize the limitations of the data, make reasonable assumptions and ensure those limitations and assumptions are transparently stated alongside an organization’s targets or performance metrics. As organizations make more detailed disclosure (whether voluntary or mandatory) regarding their targets and progress, boards will need to ensure organizations have established proper disclosure practices under a consistent and recognized framework, with tailored qualifiers and cautionary statements.

Integrating climate transition plans throughout the organization

As companies move beyond target setting toward implementation and accountability, they will increasingly face investor and stakeholder pressure—and risk shareholder proposals and litigation—if their climate transition goals are not being met. This is a serious consideration for boards given that many climate transition plans are, in effect, plans for major organizational change as companies modify, to varying degrees, how they do business. A company facing such a significant transition must fully embrace its climate strategy as an organization-wide priority. With a broadly integrated mindset, the climate strategy should be a driving force for decision-making throughout the existing operations and business, in financial decisions, in growth strategies and M&A transactions, in the advancement of new projects and technologies, and in evaluating partners and others in the supply chain. For carbon-intensive businesses, innovation and investment will be required at many levels of the organization over a long-time horizon, and the board must ensure that the investments and timelines for new staff, R&D, technology and operational changes, and resources and budgets are aligned.

In addition, many commentators are suggesting that organizations should reflect their success in achieving climate goals in their compensation criteria. Organizations adopting this approach may need to consider how to select climate-focused performance indicators and scorecards that can be measured and assessed on a consistent basis in annual compensation decisions over time. They may also need to rebalance other performance indicators. Boards should adopt the same rigour in assessing these criteria as they do with other metrics, and should consider how these criteria and compensation philosophies will be disclosed in proxy materials.

In exercising their duties, boards will need to expand their expertise and think holistically about their organization’s needs while staying flexible in light of the changing dynamics of addressing climate change. With the world working in concert to take on this common and global challenge, companies will want to be agile and responsive to change on the road to net zero in order to remain competitive.