This is particularly relevant for those companies whose activities are heavily reliant on fossil fuels and which need to decarbonize to lower their future risks.
In May 2020, Robeco played a role in getting a former wind power executive appointed to the board of the Italian energy company Enel. He is expected to contribute to moving Enel away from its exposure to fossil fuels and towards renewables in an effort to make the company carbon neutral by 2050.
“There is a need for board directors to build up their climate expertise,” says Carola van Lamoen, Head of Active Ownership at Robeco. “This can be done through training provided by company experts, accessing external advice or appointing board directors with expertise in areas that are key for the company to succeed in a low-carbon economy.”
“We are not looking for academics or scientists to sit on boards. On the contrary, we believe that industry knowledge and expertise is critical to understanding what an industry might look like in a low-carbon economy, and how the business models will need to change in order to adapt to new emerging needs.”
“Board self-assessment will be an important tool for them to identify potential gaps in skills or expertise among their members and update the profiles needed. So far, our engagement efforts have revealed that only a small minority of boards are assessing their composition from a climate-related expertise perspective.”
Van Lamoen says investors have a role to play here, by using their voting power and engagement influence to propose board members who can actively help to steer the transition. Some jurisdictions may facilitate this more than others, and the Italian voto di lista system has proven particularly useful as it safeguards the right of minority shareholders to nominate a percentage of the board at the company’s AGM.
“As co-lead of the engagement under the Climate Action 100+ initiative, Robeco worked with the Italian asset managers association Assogestioni to use this system to try influence the board at Enel,” she says.
“The nominee has substantial expertise on the energy transition. This is the first time a board nomination has been used in this way, and is an innovative approach to influencing a company’s governance on climate issues.”
Directors now have guidelines on what such a role entails following the publication of climate governance principles in a joint project between the World Economic Forum and auditors Pricewaterhouse Coopers in 2018. These aim to help boards and senior management to think about the quality of climate governance at their organizations and to look for areas in which they can develop it further.
Virtually all economic sectors are exposed to climate-related risks in some form or other, although those directly involved with fossil fuels are most at risk of disruption, Van Lamoen says. The source of this disruption could vary from regulation, which is already being tightened to lower carbon emissions to meet national commitments, to the Paris Agreement, which seeks to limit global warming to well-below 2°c above pre-industrial levels by the end of the century.
“This calls for diligent oversight by company boards as well as investor awareness of what companies need to do to ensure the long-term resilience of their business strategies,” she says. “In 2017 the Task Force for Climate-Related Financial Disclosures (TCFD) issued recommendations for companies and investors to help understand the financial implications of climate change better.”
“Although a lot of progress has been made among corporates to implement these recommendations, most of them are still struggling to genuinely identify and assess the potential financial impacts of the climate-related risks that are relevant to their business, and embed them into their risk management and strategic plans in an effective manner.”
“Corporate boards and senior management face the challenge of gaining a deeper understanding of how the energy transition and the physical consequences of climate change could have adverse impacts or create business opportunities.”
The wider issue of devoting sufficient resources in order to avoid these impacts – or indeed to find opportunities – have yet to be fully embraced by business, governments or monetary authorities, says engagement specialist Cristina Cedillo Torres.
“Climate change is a long-term trend with impacts that are hard to predict,” she says. “These impacts are likely to take place over the mid and long-term, exceeding the usual business cycles. Based on current scenarios, catastrophic impacts of climate change will be felt by the end of the century, but potentially as early as the middle of this century, which is already within 30 years.”
“This is well beyond the traditional horizons of most people today, imposing a cost on future generations that the current generation has no direct incentive to fix. This is what Mark Carney, former Chairman of the Financial Stability Board, famously labeled the ‘tragedy of the horizon’.”
“That means thinking beyond normal business cycles, political cycles and the horizon of technocratic authorities, like central banks, which are bound by their mandates. The horizon for monetary policy extends out to two to three years.”
“For financial stability, it is a bit longer, but typically only to the outer boundaries of the credit cycle – about a decade. In other words, by the time climate change becomes a defining issue for financial stability, it may already be too late.”