Climate Change in the Boardroom: What Do Boards Need to Understand about Climate Transition Plans?

Expectations of companies’ approaches to climate change are increasing and allocators of capital have articulated a need to understand how investee companies’ strategies will remain resilient in a net zero by 2050 world. Climate transition plans have emerged as a key component of climate change strategy and investors have expressed a clear desire for disclosure of these plans.

However, corporate directors do not feel that their boards are prepared to provide oversight of climate change and adoption and disclosure of climate transition plans remains relatively low.

Of the over 18,600 organizations that disclosed climate change information through the CDP’s Climate Change questionnaire in 2022, approximately 22% disclosed that they had already developed a 1.5°C-aligned climate transition plan.

PWC’s 2023 Annual Corporate Directors Survey revealed three notable findings:

1. About half of corporate directors surveyed felt that their boards were prepared to oversee mandatory ESG disclosures.
2. 40% reported that their board does not understand carbon emissions very well or at all.
3. 37% said their board does not understand climate risk very well or at all.

These data highlight important climate knowledge gaps among the corporate director community. As a first step to closing these gaps, this article provides corporate directors with key information on climate transition plans, including their relevance for corporate directors and what a corporate director should start thinking about today to prepare for evolving climate change expectations.

What are Climate Transition Plans?

As time progresses, organizations are expected to demonstrate progress towards the key climate milestone years of 2030 and 2050. Companies are increasingly expected to demonstrate that their business strategies can remain resilient in a net zero by 2050 world. Those that have set climate-related targets, including net-zero GHG emissions reduction targets, will next need to demonstrate that they have a clear and credible plan to achieve these targets despite the persistent uncertainties surrounding available and evolving technologies, data quality and the regulatory environment.

In this context, climate transition plans have emerged as a critical component of a company’s strategy to address climate change risks and opportunities. A transition plan outlines how an organization plans to adapt its strategy and remain resilient as a business through the transition to a lower carbon economy.

Figure 1 is included in the Task Force on Climate-related Financial Disclosures (TCFD) Guidance on Metrics, Targets and Transition Plans and provides a clear depiction of the relationship between corporate strategy, climate change strategy and the climate transition plan.

Figure 1: Relationship between business strategy, climate strategy and transition plan

The IFRS Sustainability Disclosure Standards developed by the International Sustainability Standards Board (ISSB) define a climate transition plan as follows:

 

“A climate-related transition plan is an aspect of an entity’s overall strategy that lays out the entity’s targets, actions or resources for its transition towards a lower-carbon economy, including actions such as reducing its greenhouse gas emissions.”

Why Are They Important?

Climate change has been identified as a systemic risk to the global economy and allocators of capital have been focused on understanding and assessing the exposure of their portfolios to climate-related risks and opportunities. Investors are integrating climate change factors into their investment decision making processes and stewardship activities, setting portfolio-level climate change targets, and developing their own climate transition plans to demonstrate how they expect to manage the transition to a lower carbon economy. Investors need information from investee companies to support this work and to develop credible climate transition plans and assess portfolio alignment to net zero by 2050.

In response to investor demand for better climate-related information from companies, there are several ongoing voluntary and mandatory ESG initiatives underway that include a focus on development and disclosure of climate transition plans.

Several leading global investor coalitions, including the Glasgow Financial Alliance for Net Zero (GFANZ), the Institutional Investors Group on Climate Change (IIGCC) and Climate Action 100+
(CA 100+), have identified climate transition plans as an important priority. These coalitions’ investor members are pursuing their own climate-related targets and ambitions and need to understand how companies plan to manage the transition and deliver on their strategies in a changing world.

Disclosure on climate transition plans is referenced in the ISSB’s IFRS S2 Climate-related Disclosures, the U.S Securities and Exchange Commission’s proposed rule on The Enhancement and Standardization of Climate-related Disclosures for Investors and the European Financial Reporting Advisory Group (EFRAG)’s European Sustainability Reporting Standards (ESRS).

The U.K. government has signaled that it intends to strengthen disclosure requirements related to climate transition plans. The FCA’s Primary Market Bulletin 45 commits the body to consult on guidance that will set out expectations for listed companies’ transition plans and the provisional agreement reached by EU lawmakers on the proposed Corporate Sustainability Due Diligence Directive would require that certain companies adopt and disclose a transition plan to demonstrate that their business model and strategy are compatible with the transition to a lower carbon economy.

As we have seen with other ESG-related regulation in the European Union, new mandatory ESG regulation targeting large, listed companies in one jurisdiction often impacts other companies that are not directly subject to the regulation by raising best practice expectations for all companies and potentially creating knock-on impacts for other companies that are included in the regulated company’s value chain. As a tangible example, the EU’s Corporate Sustainability Reporting Directive is expected to impact over 10,000 companies outside of the EU, including approximately 1,300 Canadian companies.

Why Should Directors Care?

Rising stakeholder and investor expectations have amplified the need for climate change oversight and disclosure, and these issues are now firmly in the boardroom.

Developing a robust, achievable, and credible climate transition plan can be challenging. As a result, many examples of best practice guidance have emerged to identify the key components of a credible, comprehensive and consistent transition plan. While there are variations in the best practices identified, there is one component that is surfaced consistently across best practice guidance: governance and accountability.

Companies are expected to ensure that appropriate governance structures are developed to provide effective oversight of the climate transition plan – including board level oversight. Table 1 provides an overview of leading best practice guidance for the development of climate transition plans and a summary of the governance components that are included.

There is a recognition that climate transition planning is inextricably linked to corporate strategy. Ensuring that a company’s strategy remains resilient under a range of potential future scenarios and that the company is well-positioned to generate long-term value is consistent with directors’ oversight responsibilities.

As highlighted above, directors feel that their boards lack an understanding of important climate-related concepts that will surface during the development of climate transition plans, such as GHG emissions and climate risk. There is a clear gap to be bridged between market expectations for climate transition plans, notably regarding board oversight of the plan, and the board knowledge required to provide effective oversight.

What Should Directors Do to Prepare?

Formal climate transition planning and the development of robust and credible climate transition plans is still in relatively early stages in the North American market; a practice typically adopted by the largest publicly traded companies that seek to be market leaders on climate change. Evolving disclosure expectations and the regulatory focus in the European market are expected to increase focus on this topic in North America over time. The development of a robust and credible climate transition plan will take time and require deep cross-functional engagement and collaboration at all levels of the organization. Proactively starting to build a strong knowledge base on climate change oversight and transition planning today is prudent for all organizations.

Directors should ultimately seek to ensure that they can engage thoughtfully with management on the company’s climate transition plan and decide regarding whether the plan is robust, credible, and aligned with best practice. For directors to position themselves to provide this oversight, consider the following three practical tips:

1. Build foundational knowledge through board-level climate change education. Ensure that the board has a shared understanding of climate science, key climate-related terms, the company’s material climate-related risks and opportunities over the short, medium, and long term and how these factors could impact the company’s ability to achieve strategic objectives, and the role of the board in providing climate change oversight. The ICD offers the Board Oversight of Climate Change course designed to build directors’ climate competency.
   
   
2. Understand climate transition plan best practice and market expectations, including climate change disclosure expectations. Ensure that the board has a baseline understanding of what constitutes a robust and credible climate transition plan, including an understanding of investor expectations for climate change and climate transition plans. The resources outlined in Table 1 provide a strong starting point for further reading on best practice and investor expectations. Additionally, disclosure expectations can often be the driver behind the mainstreaming of a practice. The ESG disclosure landscape is undergoing a significant period of transformation as frameworks are consolidating and jurisdictions move from voluntary ESG disclosure to mandatory ESG disclosure requirements. Understanding how disclosure expectations may evolve in the jurisdictions in which the company operates will help inform potential timelines for transition plan development and implementation and what information will be required for disclosure to stakeholders.
   
   
3. Align on company specific ESG and climate change ambitions. Alignment throughout the organization on the company’s ambitions as it relates to ESG and climate change will help the board provide effective oversight of climate change, including climate transition plans. Having a clear view of the level of ambition on climate change that the company seeks to achieve and maintain and what practices are required to secure that specific leadership position within the market can help guide oversight and strategic decision making: how far does the company want to go and how fast does it want to get there?

These three tips will support directors and their board with building a foundational understanding of the board’s role in overseeing climate change and position directors well to engage thoughtfully with management on climate transition plans. Stakeholder pressure in this area is expected to increase, so being proactive today and starting to build a strong knowledge base on climate change oversight and transition planning is prudent for all organizations.