A plethora of companies in the region, and particularly their board members and the C-suite, are considering what they need to do to address the environmental aspect of ESG.
The environmental, social, and governance (ESG) framework comprises of three pillars.
The environmental pillar includes business and human interactions with the environment. The social aspect focuses on interactions with stakeholders to end poverty and promotes dignity, equality, and a healthy work environment.
Governance relates to how businesses are administered, including risk, oversight and ethics.
Most companies have a history of contributions through their corporate social responsibility (CSR) initiatives (S) and have been slowly enhancing their corporate governance (G) (Also read: The G is not silent in ESG).
The environmental aspect (E), is the elephant in the boardroom.
People stuck in traffic often complain about being late without considering their own vehicles as responsible for this traffic.
Similarly, companies need to approach the E from two distinct perspectives: how the environment is impacting their organisation, as well as how their own organisation is impacting the environment.
The UAE is taking the lead, with COP28 set to be hosted by the UAE next year. We have witnessed the UAE government encouraging large government entities to put in place strategies around ESG, and drafting legislation that would support the elimination of single use plastics and the establishment of more renewable energy projects.
One of the most significant, and perhaps most misunderstood, risks that organisations face today is climate change. The potential impact of climate change on organisations is not just physical–it will manifest in the long-term.
Mitigating climate risk
In December 2015, nearly 200 countries agreed to reduce their greenhouse gas (GHG) emissions, accelerating the transition to a low-carbon economy (LCE). This implies the movement away from fossil fuel energy and related physical assets.
In fact, climate-related risks and the expected transition to an LCE affect most industries and economic sectors.
For many investors, climate change also poses significant financial challenges and opportunities.
The expected transition to a LCE is estimated to require around $1 trillion of yearly investment opportunities.
A 2015 study estimated the value at risk resulting from climate change to the total global stock of manageable assets as ranging from $4.2 trillion to $43 trillion from now until the end of the century.
New research published in 2021 in the scientific journal ‘Nature’ has also found that almost half of the world’s fossil fuel assets could become worthless by 2036 under a net-zero transition.
Nevertheless, mitigating climate change produces opportunities for organisations. These include: resource efficiency and cost savings, the adoption of low-emission energy sources, the development of new products and services, access to new markets, and building resilience along the supply chain.
Opportunities will also vary depending on the region, market and industry in which the organisation operates.
How the environment impacts the organisation
When organisations examine the impact of climate change, they need to look at both transitional and physical risks (acute and chronic).
Physical climate risks will result if no action was taken on their behalf. However, if organisations do act on climate change, they may witness the transitional impact of moving away from fossil fuels and a carbon-based economy.
Transitional risks involve converting to an LCE. This may entail extensive policy, legal, technology and market changes to address the mitigation requirements of climate change.
Depending on the nature, speed and focus of these changes, transitional risks may pose varying levels of financial and reputational threats to the organisation.
Acute physical risks can be event driven (floods, wildfires, cyclones or droughts). Chronic physical risks, on the other hand, are long-term and include changes in weather patterns, heat waves and rising sea levels.
Physical risks may have financial implications for organisations, such as direct damage to assets and indirect effects from supply chain disruption.
The organisation’s financial performance may also be affected by changes in water availability, sourcing and quality and food security.
Other factors may also include extreme temperature changes affecting the organisation’s premises, operations, supply chain, transport needs and employee safety.
Finally, eminent regulations, shifting customer preferences and the organisation’s own GHG emissions, air and water pollution and waste generation can all be linked to its financial performance.
How the organisation impacts the environment
After examining the impact of the environment on their organisation, board members need to evaluate their own impact on the environment.
This can be broken down into two aspects: the impact resulting in climate change and the impact resulting in resource depletion.
The impact leading to climate change can be mitigated by reducing GHS emissions and achieving carbon neutrality through net-zero targets.
The impact of resource depletion is addressed by improving the circularity of the business and promoting the circular economy (CE).
Net-zero and the circular economy
Net-zero refers to the balance between the amount of GHG produced versus the amount removed from the atmosphere. It is achieved when the amount added is no more than the amount taken away.
A target of completely negating the amount of GHG produced by human activity is achieved by reducing emissions and implementing methods of absorbing carbon dioxide from the atmosphere. The UAE has adopted a net-zero target for the country by 2050 and KSA by 2060.
The CE is a model of production and consumption which involves sharing, leasing, reusing, repairing, refurbishing and recycling existing material and products.
A CE aims to tackle global challenges using three principals: eliminating waste and pollution, circulating products and material and the regeneration of nature. The CE is defined in contradiction to the traditional linear economy of take, make, use and dispose.
The UAE has released its own CE policy 2021-2031. The policy aims to outline some of the ways in which the UAE can transition towards a more effective CE where the country’s natural, physical, human and financial resources are used in the most efficient and sustainable way.
Transitioning to a CE will require collaboration between national and local governments, the private sector and the general public.
The policy is also a call to action for all stakeholders in various sectors to consider how they can think and act in a more circular way to help the country transition to a successful, sustainable and happy CE.
While each company’s ESG journey is specific to its industry, maturity and unique business and operating models, ESG targets can only be successfully met when all three pillars are robust. Let’s get the elephant out of the boardroom!
Siddharth Behal, Partner, Governance, Risk & Compliance at KPMG Lower Gulf.
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