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Transforming businesses through climate strategy

April 18, 2024

As responsible investors, we research a wide array of environmental, social, and governance (ESG) factors to evaluate companies in terms of their strategy, management of risks, and performance relative to peers.  We not only use this information to better inform our own investment decisions, but also to provide our investee companies with market insights and tailored advice for their climate strategy.  We often engage with the same companies on climate, transition, water, and biodiversity several times a year, sharing research performed by our team as well as through our participation in financial sector initiatives like Climate Engagement Canada (CEC), Climate Action 100+ (CA100+), Nature Action 100 (NA100), and Valuing Water Finance Initiative (VWFI). In 2023, we were involved with 1,698 company engagements on ESG matters across a wide array of companies, including longstanding leaders in sustainability and those just beginning to adopt best practices.

While climate risks and opportunities differ widely among companies, we have found that the best-managed companies share common behaviours when it comes to developing their climate strategy. This article serves to summarize key behaviours and supporting disclosures that investors look for in a company’s climate strategy.

While climate risks and opportunities differ widely among companies, we have found that the best-managed companies share common behaviours when it comes to developing their climate strategy. This article serves to summarize key behaviours and supporting disclosures that investors look for in a company’s climate strategy. 

#1 They get started

A journey of 1,000 miles begins with a first step. While some companies are still waiting for climate disclosure to become mandatory1, voluntary adoption of frameworks like the Task Force on Climate-related Financial Disclosures (TCFD)2is a clear demonstration of leading management practices.
Early adopters of TCFD now have a strong advantage as climate disclosure becomes mandatory in North America and abroad. TCFD was instrumental in informing the EU’s Non-Financial Reporting Directive in 2019 and both the Securities Exchange Commission’s climate disclosure rule and Canadian Securities Administrator’s National Instrument 51-107. And according to TCFD’s final report, close to 60% of global GDP has proposed or finalized TCFD-aligned disclosure requirements3. Even as North American disclosure rules are being finalized, approximately 1,300 Canadian and 3,200 US companies that do business in Europe are already subject to European CSRD’s disclosure requirements for 20254. IFRS’s S2 Climate-related Disclosures5 now builds on TCFD’s legacy6.

In our engagements with companies who have voluntarily adopted climate disclosures, they have demonstrated that they are also better equipped to support their business partners’ climate ambitions. Because supply chain emissions often dwarf a company’s own emissions7, companies are increasingly looking beyond their “bricks and mortar” to deliver results though supplier agreements, lease renewals, and other incentives. Private markets and small and medium sized enterprises should take note: Even when a company is exempt from mandatory disclosure, having a climate commitment and voluntarily disclosure of emissions is rapidly becoming a requirement by their business partners.

#2 They make it relevant

At its core, a climate strategy is simply strategy.  For a climate strategy to be successful it can’t be viewed as standalone from business operations – it must be part of the company’s overall vision, strategy, and purpose.  A strong climate strategy therefore begins by focusing on the most business-relevant topics.

We recommend companies leverage IFRS’s SASB Standards as a starting point to identify broad themes and focus resources on the most relevant issues to their business and communicate these risks to investors through a materiality matrix.  Greenhouse gas emissions may be the source of greatest risk for many companies, while others may have significant dependencies on biodiversity, fresh water, or other climate-related concerns. Some companies may have several significant risk exposures, and each should be supported by a mitigation strategy.  At BMO GAM, we consider investors best informed when an issuer considers a double materiality lens.

#3 They look to the future

Conventional ESG reporting focuses heavily on disclosure of the company’s current state of operations and progress in ESG.  While this approach may be sufficient for broad ESG disclosures, it often fails to include sufficient forward-looking information about the company’s climate strategy.  As we shift our focus to the future, it is no wonder then that investors are looking for a new approach to climate-disclosures: transition plans.  

A transition plan shifts a company’s frame of reference for disclosure from disclosing improvements to today’s operations to disclosing plans and progress towards a future business model.  It should allow investors to assess the resilience of the business to new environmental and social realities, its plan to navigate the current transitioning economy, and how it will ultimately emerge as a leading 21st century company. 

Companies with net-zero commitments have been transforming their ambitions into actions, demonstrating how their vision for a low-carbon company will be achieved through various initiatives and stages of their transition plan.  In addition, companies focussed on net-zero shift their frame of reference from making incremental improvements to today’s operations towards achieving a fundamentally transformed business model.  This also helps companies avoid inefficient allocation of capital towards what may be “dead ends”, and also helps them to accurately disclose asset retirement obligations to investors.

A common example of inefficient capital allocation would be a coal-fired power plant investing in energy efficiency improvements with diminishing returns instead of making a more transformational fuel switch. But the idea of transformational change itself is not new and existed throughout the industrial revolution. When the automotive pioneer Henry Ford said, “If I had asked people what they wanted, they would have said faster horses.” he understood that incrementalism often stood in the way of innovation. Today, the company that bears his name is again looking to the future and investing a staggering $50 billion to retool factories and accelerate electric vehicle production8.

#4 They invest

Transitioning to net-zero 2050 requires investments in both human and financial capital. 

Having the right leadership and people is key. Asset managers like BMO GAM increasingly look to corporate boards and directors to have climate expertise, and climate governance is one of the key pillars we engage companies on through Climate Engagement Canada.  Boards’ expertise in “Environmental Health, Safety, and Compliance” supports the company in terms of environmental compliance and litigation risks, but navigating climate transition risks requires new skillsets.  With a clear understanding that climate risk is financial risk, boards are seeking additional training on climate to ensure they are maintaining their fiduciary obligations.

We look for companies with strong climate governance and boards that empower the company to attract, develop, and retain experts needed to execute on a climate strategy. Companies like Teck have created new senior roles focused exclusively on decarbonization and have successfully integrated land restoration into their performance goals, while others like AtkinsRéalis have created new services like “Decarbonomics” to support their clients in the transition.

And of course, decarbonization targets need to be supported with capital investment, shifting both capital expenditures and operating expenditures from “business as usual” towards forward-looking strategies.   As investors, we look for capital commitments towards cleantech solutions, development of green revenue streams, and towards research and development (R&D) in areas where solutions are not yet commercialized.  While various labels are given for these investments, a common approach companies take is to set targets for “climate solutions”, “green” revenue, or climate-aligned capital expenditures. 

Revenue targets seek to increase the proportion of revenue from green products or services over time and are backed by business initiatives to expand into new markets or segments.   

Capital targets relate more closely to capital planning and operations and are typically broken down into three time horizons: Short-term, medium-term, and long-term targets (including net zero).  Short-term capital targets typically focus on economically achievable solutions; a medium-term target involves solutions that do not yet meet conditions for investment; and a long-term target of net zero through which the remaining emissions, after all practical solutions have been deployed, are addressed through external instruments such as offsets.

Short-term activities are regularly supported with clear capital commitments in financial disclosures.  Medium-term targets may be established based on expectations for emerging technologies to become cost-effective to deploy but may also include other strategies to reach the target.  Investors can look beyond direct forecasted capital commitments to R&D expenditures, partnerships, and/or recent acquisitions of solutions providers as supporting evidence of progress towards these goals.  And finally, while the long-term target is often lacking in cost-expectations, disclosure of the “emissions gap” between achievable technological solutions and net zero is welcome, key information for the investor. Companies often address this gap through a commitment to negate remaining impacts using external instruments such as nature-based offsets. 

For investors, understanding the unknowns and uncertainties is just as important as disclosing what is known. While many companies were once reluctant to quantify the gap between their climate ambition and actions, sharing this information through financial filings is becoming commonplace. According to PwC’s 2023 analysis of annual report disclosures, climate change was referenced as a risk factor by all S&P100 companies and 55% discussed climate in their MD&A9.
Janet Yellen, the U.S. Secretary of the Treasury, has called the transition to a low-carbon economy “the most dramatic and predictable economic shift in human history.”10 Companies recognize this transition is underway, and are aligning their business strategy to capture opportunities. Companies with net-zero commitments need to support their goals with strong, forward-looking plans and investments in their business. Investors can look to companies with net zero commitments, green revenue targets, and transition plans supported with a clear investment strategy as leading the way.

Disclaimer:

Commissions, management fees and expenses (if applicable) may be associated with investments in mutual funds and exchange traded funds (ETFs). Trailing commissions may be associated with investments in mutual funds. Please read the fund facts, ETF Facts or prospectus of the relevant mutual fund or ETF before investing. Mutual funds and ETFs are not guaranteed, their values change frequently and past performance may not be repeated.

 

For a summary of the risks of an investment in BMO Mutual Funds or BMO ETFs, please see the specific risks set out in the prospectus of the relevant mutual fund or ETF.  BMO ETFs trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.

 

BMO Mutual Funds are offered by BMO Investments Inc., a financial services firm and separate entity from Bank of Montreal. BMO ETFs are managed and administered by BMO Asset Management Inc., an investment fund manager and portfolio manager and separate legal entity from Bank of Montreal.

 

BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate. Certain of the products and services offered under the brand name, BMO Global Asset Management, are designed specifically for various categories of investors in Canada and may not be available to all investors. Products and services are only offered to investors in Canada in accordance with applicable laws and regulatory requirements.

 

®/™Registered trademarks/trademark of Bank of Montreal, used under licence.

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