Finance Monthly - August 2023

one that becomes obvious later in the process – is to integrate this information into core strategic and financial planning, in order to ensure the future profitability, and perhaps viability, of a business model. ESG performance is now monitored in boardrooms. A growing number of firms are tying the remuneration of executives to sustainability criteria. There are persistent market signals which suggest such metrics will increasingly dictate firms’ access to and cost of capital. This isn’t just virtue signalling – investors realise the need to price sustainabilityrelated risks in the face of systemic global changes, or else suffer damage to their own returns. Corporate balance sheets do not sufficiently value externalities, including the dependence of business value creation on the environment and natural resources. Business growth plans typically fail to account for the escalating costs of climate change, biodiversity loss, and societal trends. Sustainability and finance remain decoupled, and a company’s ESG goals, which aim to reduce impacts, are often at odds with its financial targets which expect growth. It is also vital that companies plan for an uncertain future. It is a relative certainty that physical risks posed by climate change, including more frequent and severe extreme weather, will cause greater disruption to businesses in the future. However, the rate of societal transformation to a green economy is contingent on numerous uncertain near- and long-term factors: who wins the next US election; the state of global geopolitics; and stabilisation of an inflating economy. The potential transition risks resulting from these economic shifts require companies to plan differently. It is necessary to measure a business as it is today, but also essential that companies do not bet on one future but plan for multiple scenarios. This will ensure that targets are grounded in a realistic view of the future, and that a company’s dependence on factors outside its control are quantified. Quantifying the ROI of sustainable action To implement a cost-effective and impactful sustainability strategy, businesses need to accurately assess the return on investment from not only an environmental or social but also a financial perspective. Understanding the price of removing one unit of emissions (or other impact), or “marginal abatement cost”, of individual initiatives ensures those which are most cost effective, and lead to the greatest emissions reductions, can be prioritised. Quantifying in financial terms how initiatives will reduce or mitigate a company’s exposure to physical or transition risks can further build a case for investment across the company. For instance, quantifying how the decarbonisation initiatives put forward by a company will reduce its exposure to increased carbon pricing risk in the future. This level of information is increasingly being called for by investors, asset managers and other stakeholders, keen to understand the wider financial implications of a company’s net zero plan. For decarbonisation initiatives, this is all relatively straightforward as there is a common, widelyunderstand metric for calculating impact: tonnes of carbon dioxide equivalent. With corporate sustainability disclosure expanding to encompass social and governance dimensions, a new challenge is being posed: how to quantify and compare social or governance impacts without a common, standardised metric? Some individual KPIs are readily quantifiable, such as ensuring no child labour within a supply chain, but others focusing on positive social considerations and human rights issues require greater examination and agreement of how best to meaningfully assess and quantify impact. Investors realise the need to price sustainabilityrelated risks in the face of systemic global changes, or else suffer damage to their own returns. Finance Monthly. Business 51

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