Tuesday 23 Jul 2024
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This article first appeared in Forum, The Edge Malaysia Weekly on March 27, 2023 - April 2, 2023

A crisis can bring out the best in critical thinking — a prized attribute  of leadership — especially in a volatile, uncertain, complex and ambiguous environment. Now, more than ever, facing the climate crisis head on, we are relying on the directors of company boards to have essential leadership skills such as critical thinking, strategic thinking and managing market and regulatory ambiguity.

Human civilization has thrived over millennia within a very narrow climatic envelope. Now, as informed by science, we know we are facing an existential crisis which will change many of the ways in which we allocate capital and profit, and how we live.

As the impacts of the climate crisis are now mainstreamed, legal opinion states that “directors risk acting in breach of their duties if they do not inform themselves of climate risks”. It also asserts that “the law will not punish directors who make an educated assessment of future risks and opportunities, but it will not tolerate those who make uneducated guesses”.

Further, “it may be misleading for a financial institution to claim that it is a ‘leader in climate change’ where it manages (and discloses) only the emissions footprint of its office operations, but fails to account for the carbon intensity of its loan book or integrate stranded assets and other climate risks into its credit risk assessments” and this has also been confirmed by the United Nations’ panel of experts on greenwashing, which opined in November 2022 that “actors cannot claim to be ‘net zero’ while continuing to build or invest in new fossil fuel supply or any kind of environmentally destructive activities. They can’t also participate or have their partners participate in lobbying activities against climate change or just report on one part of their business’ assets while hiding the rest”.

Now is the time to invite a variety of informed views, assessed by a board of cognitive diversity, to carefully consider risks which are not only measured based on financial information, about which a prudent investor ought reasonably to be informed, but to also consider the recently and rapidly evolving concepts of materiality.

Double materiality is “a recognition that a company’s impact on the world beyond finance can be material”. This would include environmental and social impacts, which affect the sustainability of the business.

Dynamic materiality, meanwhile, recognises that “what appears financially immaterial today can quickly prove to be business-critical tomorrow”.

For example, much of the conversation around decarbonising relies on net zero targets popularised in December 2015, when all countries pledged to limit the impact of anthropogenic greenhouse gas emissions around mid-century.

It was then clarified in 2018 by the UN’s Intergovernmental Panel on Climate Change that global carbon dioxide (CO2) emissions must fall by 45% by 2030 and be net zero by 2050, to avoid the devastating consequences of warming by more than 1.5°C (compared with pre-industrial levels).

However, the UN’s World Meteorological Organization issued a warning in May 2022, which was reinforced in January 2023, that — despite the cooling effect of the La Niña phenomenon, which unusually, is now in its third year — average global temperature in 2022 was already about 1.15°C above pre-industrial (1850-1900) levels and there was a 50% chance of the “annual average global temperature temporarily reaching 1.5°C above the pre-industrial level for at least one of the next five years”.

Existential risks arising from the climate crisis are therefore a perfect example of dynamic materiality, which many businesses are patently not ready for, if they have not fully understood the massive momentum in recent years by allocators of capital agitating for increased reporting and disclosure, or if they have not anticipated the inevitable policy response of governments and trading partners when they scramble to mitigate emissions and adapt to a warmer world.

As long-term stewards of the business, directors (collectively and individually) are responsible for future-proofing the business, acting on behalf of the shareholders and accountable to multiple other stakeholders. Scenarios, which we must remember are not forecasts, are one of the tools available to directors.

It would seem logical and reasonable that one ministry or council or regulator or other relevant entity should be tasked with convening multiple informed and experienced stakeholders to collectively derive a set of climate scenarios, which can then be adopted and adapted by all industries, businesses and communities in the country, instead of a parallel allocation of duplicate resources towards developing multiple sets of scenarios.

These scenarios, which are currently dangerously under-explored, should reflect the catastrophic climate change scenarios, described as “climate endgame”, including societal collapse, conflict, political instability and systemic financial risks.

For example, the World Bank says as at August 2018, only one in 10 refugees is hosted by high-income countries. This part of the world, disproportionately affected by the climate emergency, with a significant number of stateless persons, will be under increased strain.

Directors and boards across the country play an essential role in overseeing and contributing towards the smooth and just transition which is required, which all of society demands. Their inputs and decisions include the rapid decarbonising of the grid and the economy, as well as opportunities to create value with the wide spectrum of adaptation measures which are inevitable in a warmer world.

The joint foreword of the guide to climate scenario analysis issued by the network of central banks in June 2020 famously described the crisis as being “uncertain yet at the same time totally foreseeable”. With so much uncertainty, directors need to articulate, in military parlance, the commander’s intent or the desired end state, described with sufficient clarity that subordinates can execute a mission successfully amid highly volatile and complex circumstances.

Climate Governance Malaysia has been working hard behind the scenes to launch a Community of Practice of Directors, who, in their individual capacities, will commit their mental capabilities including critical thinking skills, to brainstorm, critique and refine solutions which could translate into easily actionable hyper-localised initiatives to decarbonise the economy and increase our collective climate resilience.

There are many who are voluntarily stepping up to be counted as contributors towards smoothing this massive transition. Whether successful or not, we will owe them a debt of deep gratitude.

Sunita Rajakumar is the chairman of Climate Governance Malaysia. This column is part of a series coordinated by Climate Governance Malaysia, the national chapter of the World Economic Forum’s Climate Governance Initiative (CGI). The CGI is an effort to support boards of directors in discharging their duty of care as long-term stewards of the companies they oversee, specifically to ensure that climate risks and opportunities are adequately addressed.

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