Many firms have made commitments to reach net zero greenhouse gas (GHG) emissions amid growing stakeholder expectations that they develop, disclose and execute credible transition plans. Firms are at different stages on this journey[i].
Executing the transition plan will require firms to transform their organisation, across their business strategy, products and services, investment, lending, and/or underwriting decisions, risk management and operations. Due to the scale of change required, we believe a key factor in whether a firm succeeds or fails on its transition plan will be its governance and culture.
In the attached report, we identify four key governance and culture challenges related to the transition and some good practices and questions for the Board to help address them. Unsurprisingly, there is no silver bullet. Boards will need to undertake and oversee a combination of actions to address the challenges.
To inform our work in relation to the role of management, governance structures, remuneration and training, we analysed the disclosures of FTSE 100 financial services companies aligned to the Task Force on Climate-related Financial Disclosures (TCFD) [ii], as governance of climate risks and opportunities is one of the key pillars of TCFD disclosures.
This blog provides an overview of the governance and culture challenges set out in the report, as well as highlights from our analysis of TCFD disclosures.
Overview of governance and culture challenges
1. Who is responsible?
While net zero commitments may have emerged initially from corporate responsibility or strategy teams, multiple individuals and Committees are likely to have responsibilities in relation to the transition plan’s design and execution.
Firms will need to identify an executive with overall accountability for the design and execution of the transition plan. As a major change programme, accountable Senior Management Functions will likely be required for each in-scope regulated entity. However, firms will also need to ensure that each senior executive plays their role in the delivery of the transition plan through clear and measurable objectives and incentives; the transition plan cannot be delivered through the efforts of a single executive or function.
Sustainability will also need to be embedded in established business mechanisms, such as budgeting and business planning, forecasting, and risk appetite, leading to a dynamic and iterative interplay between divisional and business unit executives and the central accountable executive.
In terms of the Board, Board Committees and Executive Committees, mandates, roles, terms of references and reporting packs will need to be updated to reflect responsibilities and enable oversight of progress in relation to the transition plan.
2. Aligning priorities
Transitioning to net zero will require a shift to a fundamentally different and more sustainable economy. This will mean difficult decisions and significant changes across lending, investment and/or underwriting, particularly for more carbon intensive sectors. Not all clients will have the same climate ambitions and may be unwilling to have changes made to their products and services.
This is likely to lead to at least some individuals within the business not buying-in to the transition plan. They may have concerns about whether actions are in the best interests of their customers, or they might be reluctant to restrict their activities or say no to certain clients or opportunities.
To address this, there should be a clear sense of purpose and alignment between the transition plan, climate strategy, business strategy, risk appetite, risk management, culture, and values.
Boards and CEOs will need to drive buy-in across the firm, backed up by aligned remuneration and incentives, where emissions are considered a key part of decision-making. They should drive discussion on the tough decisions that need to be made, as well as identify and emphasise the opportunities the business should focus on. While the CEO may have identified another Executive Committee member to hold accountability for the transition plan, the tone set by the CEO will be critical in driving the desired culture and behaviours within the organisation.
While the governance structure will vary by firm, it should be effective in cascading the transition strategy horizontally and vertically.
3. Making it real
Executing the transition plan will affect nearly every role within the firm. If staff do not understand the transition plan and how it will affect their role, and are not seeing day-to-day changes, then change is not happening.
Even where some changes are taking place e.g., to lending, investment or underwriting decisions, there is a danger that a “tick box” mentality develops. If the biggest deals or investments with the largest emitting clients are still taking place without challenge or discussion, then the change is not real.
Some firms may need to transform their cultures, drawing on previous experiences of large-scale culture programmes. Every employee needs to understand that every action they take to reduce emissions helps.
Firms should encourage diversity of opinion and staff to speak up without fear of repercussion, for example, to identify greenwashing and misconduct, as well as strengths and weaknesses in the transition strategy and plan.
Firms should identify training needs and experience gaps across the firm and put a plan in place to address them. Staff taking decisions relating to customers will need to understand the transition plan with sufficient granularity to be able to navigate judgmental areas and mitigate the risk of greenwashing. Incorporating sustainability into documented customer journeys will be a valuable exercise to identify barriers to the transition previously not understood.
Management information (MI) will also be important to aid decision-making. The Board and senior management should receive regular updates on progress against the transition plan, including plan assumptions and uncertainties, as well as feedback on how culture change is embedding. Where remuneration is aligned to sustainability goals, the Remuneration Committee should receive sufficient information to demonstrate individual contributions.
4. Group versus subsidiary
Different countries have different levels of decarbonisation ambition, and some countries will find it much more difficult to achieve a just transition. Group and subsidiaries will have different priorities and their stakeholders and clients will have different climate ambitions.
Consequently, individual subsidiaries within the same group may be moving at varying speeds or in varying directions on their transition plans. Complex groups will also need to navigate divisional governance alongside entity and group governance given that divisions may face different challenges as part of the transition.
Communication between group and subsidiaries will be important, and group and subsidiary can leverage existing channels and processes to reconcile their differences. Subsidiary Boards will need to be involved in decisions on disclosures of external commitments.
Subsidiaries may be reliant on group shared services to deliver their transition plan, for example, because supply chain decarbonisation may be run from the Group. Strong engagement will be required to ensure that the shared service centre understands, for example, the need for data and reporting, operational changes, or new investment management approaches. Intra-group service level agreements will also need to be updated.
Key findings from our analysis of TCFD disclosures of FTSE 100 financial services companies
- Climate risk: at the executive level, the Chief Risk Officer (CRO) was most commonly cited as the individual responsible for overseeing climate risk management. Excluding where it was not disclosed or not clear, 70% had the CRO or the Chief Risk and Compliance Officer (CR&CO) solely responsible or jointly responsible with another role. Consideration of climate risk was typically integrated into broader Risk Committees.
- Transition plan: the individual(s) responsible for overseeing delivery of the climate ambition or transition to net zero at the executive level, below the CEO, was typically not disclosed or not clear (this disclosure is not a TCFD expectation). Where disclosed (three firms), the individuals had specific sustainability or climate roles (e.g., Chief Sustainability Officer).
- Climate/Sustainability Committees: at the Board level, 11% of firms disclosed that they had a standalone Sustainability Committee, while 17% of firms disclosed that they had a non-traditional Board Committee which included sustainability in its scope[iii]. At the executive level, most firms (83%) disclosed that they had a standalone ESG/Sustainability Committee and/or Climate/Environment Committee. It was most common for Executive Committees to cover broader ESG/sustainability matters, than solely climate/environment.
- Remuneration: two thirds of firms disclosed that they included climate or sustainability considerations in the executive scorecard, with some firms also starting to look at the executive long-term incentive plan (LTIP) (50%) and wider staff incentives (22%).
- Training: most firms (78%) disclosed that they had provided training in relation to climate and sustainability to the Board and 56% disclosed that they had also provided training more broadly across the firm, typically to specific teams (e.g., risk or relationship managers) or staff-wide.
If firms are to meet their net zero commitments and develop, disclose and execute credible transition plans, they will need to enhance their governance and culture through a combination of actions.
They should focus on allocating responsibilities, aligning priorities, making the transition real to staff, and ensuring Group-wide coordination.
Please see the attached report for further information on the four key governance and culture challenges related to the transition and some good practices and questions for the Board to help address them.
[i] For example, the Financial Conduct Authority found in their October 2021 Climate Change Adaption Report that while 75% of asset managers they surveyed had made a net zero commitment, only 38% had set any underlying targets.
[ii] We reviewed the TCFD disclosures of 18 financial services firms in the FTSE 100. These were: 3i Group Plc; Admiral Group Plc; Aviva plc; Barclays plc; Experian Plc; Hargreaves Lansdown plc; HSBC Holdings plc; Intermediate Capital Group plc; Legal & General Group; Lloyds Banking Group plc; the London Stock Exchange Group; M&G plc; NatWest Group; Phoenix Group Holdings plc; Prudential plc; Schroders plc; Standard Chartered plc; and St James's Place plc. The TCFD disclosures were contained in either the Annual Report, Climate/ESG/Sustainability reports, or standalone TCFD reports. The reports were published in 2022, reflecting on 2021.
[iii] By non-traditional Board Committee, we are referring to a Committee other than e.g., the Audit Committee, Nominations Committee, Remuneration Committee, or Risk Committee. These Committees were: Responsible Business Committee; Customer, Conduct and Reputation Committee; and Culture and Sustainability Committee.