Winning Green

Companies worldwide are facing significant adjust­ments and restruc­turing of their business models to meet the growing climate challenges. Capital markets play an important role in setting the pace here, along with govern­ments and society.

As an exempli­fication of just how large the pressure from the capital sector has become, take this recent instance from January 2022: around 70 large capital investors, insurers and pension funds joined forces as the “Net-Zero Insurance Alliance”, a coalition including Allianz, Munich Re, Zurich and Swiss Re, among others. The Alliance members, who manage 10.4 billion USD in total, are united by the goal of holding companies and govern­ments accountable with objective commit­ments to climate protection. It calls for up to 65 percent reduction in CO2  emissions by 2030. 

A simulation by the German Federal Bank (Bundesbank Monthly Report, 24 January 2022) high­lights how severely the challenges of climate protection affect listed companies in particular. 5,300 companies in 75 countries were studied. Among these companies, 81 % would face a loss in market value of not more than 4 % due to the burden of emissions. However, 7 % of the companies – which amounts to no less than 350 companies in total – could expect losses of more than half of the company’s value.

These environ­mental policy-related challenges add up to a completely trans­formed raw material cycle, which currently threatens to have a long-term impact on the energy-intensive primary industry sector in parti­cular. Natural gas prices have increased fivefold over the year, the oil price has doubled and the European COprice has risen four­fold. European govern­ments are no longer able to keep their promise of reimburse­ments to corporate or private consumers to compensate for a rise in the (politically induced) energy prices. 

The causes behind the price develop­ments on the energy markets include geo­political crises, the hesitant re­generation of the global economy after the corona­virus pandemic and stricter European climate protection regula­tions, as well as the accelerated with­drawal from nuclear energy and coal. Since 2014, invest­ments in the discovery of new oil deposits have decreased 50 % worldwide. This is politically intended, in order to meet the climate protection targets of the Paris Agreement. To reach climate neutrality by 2045, the annual climate protection target would have to be tripled in Germany alone.

The role of the courts
Courts are now also under increasing social and political pressure. A judgement by the District Court of The Hague in May 2021 could be an indication of what is to come: the Dutch court ordered the Royal Dutch Shell oil company to cut global emissions by net 45 % by 2030. The company, which announced it would lodge an appeal, was not only ordered to reduce its own emissions, but also to account for the emissions of its customers as a result of using its products.  

Implications for companies

For companies, this represents a serious upheaval. So far, most companies have addressed their own emissions (Scope 1 and 2). A comprehensive obligation to factor in emissions on the customer’s side as well (Scope 3) would have momentous consequences for corporate environmental management systems. As a further consequence, companies will be increasingly held solely legally accountable for the greenhouse gas effect. This does not correspond to the ideal of consumer sovereignty, but more importantly, it presents companies with an additional risk in terms of potential claims for damages in the rapidly growing area of climate litigation.

The extent to which the courts and politicians place companies under pressure is clearly demonstrated by the decision of the Federal Constitu­tional Court to tighten the Climate Protection Act in March 2021. The EU presented further extensive guide­lines in July 2021 (The “Fit for 55” package). Clearly, in addition to control by means of the price – as in emissions trading – legislators are tackling the regu­lation of specific sectors in increasing depth.

On 31 December 2021 a delegated act was adopted as an extension of the green “taxonomy”. With this taxonomy, the EU has created a frame­work for private investors to contribute to the achieve­ment of climate neutrality. According to OECD estimates, global invest­ments of 630 billion USD per year would be needed to meet the climate protection targets of the Paris Agreement (OECD 2017: Investing in Climate, Investing in Growth, OECD Publishing, Paris )– amounts that are unlikely to be covered entirely by the public coffers. The taxonomy is meant to provide private investors with guidance for their invest­ments and make it easier for them to distinguish between “green” assets and “brown” assets, i.e. activities that are harm­ful to the climate. 

Divided opinions in society

The taxonomy is well-meaning, and yet the supplemental provision on the issues of natural gas and nuclear energy, which has recently become public, has once again high­lighted the potential for social conflict that comes with the energy transition.

30 % of the German population surveyed in an opinion poll by IPSOS favoured a complete rejection of the entire set of taxonomy proposals, while 25 % were on the supporting side, at least for natural gas. Whereas nuclear energy doesn’t stand a chance any more in most countries, precisely because of the cost, in Germany the discussion on natural gas shows how difficult it is going to be to balance the demands from environ­mental policy and energy policy with measures to ensure security of supply when facing an accelerated coal phase­out. It will take years for renewable energies and storage solutions to be completely substi­tutable for conventional energies in the process of electricity generation. Also, the infra­structure for hydrogen that is needed to de­carbonise the industry and create the required storage systems, is still in its infancy.

What needs to be done?

Companies are affected by environment and climate protection measures in a number of ways: they must convince their own customers of their sustainable competi­tive­ness, remain attractive as an employer on a competi­tive market for talent and, at the same time, juggle conflicting demands from society with economic opportunities. The situation is becoming more and more complex due to the shifting nature of communi­cations. Any organisation that has faced public condemnation for alleged environ­mental offences under­stands the potential for scandali­sation in social media.

As a consequence, what companies need, in addition to any necessary restruc­turing towards more climate-friendly processes, is a clearly defined strategy for dealing with expecta­tions from stake­holders in the market, employees, society and govern­ments, while demonstrating their own contributions in a credible way. What is needed is a transparent, annually verifiable action plan that goes way beyond any previous declara­tions of intent that companies may have been accustomed to in their environ­mental reporting to date. The pressure for such measures – from the capital markets, govern­ments and society, and increasingly also from the courts – has become much too strong. To put the objective of “Winning Green” into action, congruent communi­cations – that unite different disciplines and stake­holder interests – are needed to ensure corporate success in the long term. The example of the taxonomy clearly shows the difficulties confronting companies today with regard to the issues of ESG and climate protection. After all, the taxonomy was meant to put an end to the debate about what is green. Now, it threatens to open up old wounds again.    

This article – written by Volker Heck – was featured in the German online journal RestructuringBusiness in March 2022 and appears on our website with the kind permission of the publisher. Download pdf (in German).