Sustainability : the fundamental challenge

How the agreement of the COP 21 will foster the transition towards new business models.

A tipping point

We are at a tipping point on sustainability. Climate change is the most complex and challenging of the sustainability issues and will be highly disruptive for corporates. Not only does the world need to curb global warming and GHG emissions, but it needs it to be done in a record time. The target set by the United Nations to stay below a 2°C warming limit will require a 50% to 70% reduction in GHG emissions by 2050 – a very ambitious target.
 
The COP21 negotiations ended with an agreement approved by 194 countries setting post 2020 climate actions covering over 90% of the world GHG emissions. The awareness among both public and private sectors across the world has now reached an unprecedented level. A vast majority of countries have announced detailed plans to curb the GHG emissions via new regulations as well as the set-up of emission trading schemes and carbon markets. Beyond global warming, the resource scarcity is likely to challenge current economic models in the coming decades.
 
“Our planet and our society are at risk”, as stated by Paul Polman, CEO of Unilever. “Business has a historic opportunity and responsibility to lead the world down to a more just, rich and sustainable path. We cannot choose between economic growth and sustainability – we must have both”. Large corporates are becoming increasingly concerned about their environmental and social impact and are dedicating resources to improve their footprint. More than 90% of CEOs believe that sustainability is important for the future success of their company (UN Global Compact – Accenture study 2013). In 2014, three-quarters of S&P 500-listed firms published corporate sustainability reports – dramatically up from 20% in 2011. The interconnection between economy, society and environment is more than ever a focal point to safeguard firms’ long-term strategic interests.

The resource scarcity is likely to challenge current economic models in the coming decades.



Increasing pressure for corporates

Sustainability is entering into a new era which is driven by a considerable pressure from society and a much greater public awareness of environmental issues. Corporates are under the pressure from all stakeholders: regulators, customers, shareholders, employees and rating agencies. New laws and environmental standards are being passed in an attempt to foster the transition to a low carbon economy. Regulators around the world, including the European Central Bank, Central Bank of the Republic of China and the Bank of England, are looking into climate change as an emerging risk for the financial system.
 
Shareholders are increasingly engaged and questioning the governance as well as the CSR policies implemented by listed corporates. In the wake of COP21, a new trend has been set by the world largest European and US pension funds and insurance companies towards decarbonisation of their portfolios: Allianz, Axa, Calpers, Norges Bank, AP funds are leading the pack and divesting from coal-fired plants and other so-called “stranded assets”. What will be the impact on the future stock price of these corporates? To what extent will it jeopardize funding sources? Over the past two years, the FTSE has developed a model able to rate listed companies based on their “green” business. Numerous stock indices have begun to integrate a sustainable component (Environmental, Social and Governance criteria), including the emergence of sustainable indices such as FTSE4Good and MSCI. When will these indices become benchmarks for asset owners? The latest pressure comes from leading rating agencies, namely Moody’s and Standard & Poors. They recently announced they will introduce extra-financial criteria in their methodology to assess corporates’ business models and credit rating and more particularly the risks linked to climate change. This underlines the belief that sustainability issues directly translate into both business risks and opportunities.  


Capturing business opportunities 

Tackling global warming will require a profound shift in business models for some industry sectors, starting with the power sector. The IEA estimates that the world capacity of renewable energy should be multiplied by three. The transition to a low carbon economy will profoundly transform the power sector in the coming decades. We can expect new rising stars in renewable energy as well as the so-called “smart grid” and energy storage universe.
 
The IEA also predicts that energy efficiency should be multiplied by eight before 2030. Ahead of real estate and transportation, the industrial sector is by far the largest energy consumer, representing over 50% of the world energy consumption. We expect corporates to formulate strong energy efficiency plans, capturing the opportunity to cut operating costs and lower their exposure to volatile energy prices, in particular, but not exclusively, in the most energy intensive sectors such as the metals and mining industry. Sustainability is also about capturing business opportunities, client franchise and enhanced branding. The most environmentally friendly supply chain often provides an enhanced value proposition for the customers, meeting the increasing demand for equitable products, organic products, transparency and safety. It could also soon become a necessity to attract, recruit and retain “millennial” staff. The most sustainable firms, such as Kering or Unilever, have already fully recognised that transforming their supply chain is the ideal way to differentiate themselves and set a competitive advantage.

Secure competitive funding sources

 
In this changing and challenging world, corporates are facing sustainability issues which may soon become highly disruptive. Securing stable and competitive financing solutions is vital for those sectors where the transition to a new business model is required.
 
Corporates would certainly benefit from the high quality of their sustainability policy. Neglecting this aspect could be detrimental to secure private funding resource. The difference may well be set by shareholders and bondholders in the light of the sustainability strategy of the corporate