Carbon pricing is on the up but more companies need to get on board. Almost 1,400 companies are now factoring an internal carbon price into their business plans, representing an eight-fold increase in the last four years.
Regulation is a key driver of this, with CDP’s research clearly demonstrating a correlation between companies being regulated within an EU Emissions Trading System and the growth of internal carbon pricing. But regulation isn’t the only driver.
Climate risk: A growing concern for investors
From major institutional investors to the biggest players in the asset management world, concern around climate risk is increasing. In 2016 the BlackRock Investment Institute said ‘climate factors have been under-appreciated and underpriced’, while a recent model developed by Schroders – the Carbon Value at Risk framework – shows that ‘almost half of listed global companies would face a rise or fall of more than 20 percent in earnings if carbon prices rose to $100 a [metric ton].’
All in all, climate risk does and will continue to have financial implications so investors want to know that companies are managing this risk and are aware of any potential opportunities. From an investor perspective, this also ties into a renewed emphasis on good governance. When internal carbon pricing is done well it tells investors that a company is maturing in its approach to climate-risk management, which can be used by investors as a proxy for good governance.
The carbon-pricing trend is growing
The trend toward setting an internal carbon price is only going to grow with imminent regulation coming down the line in countries such as China, and investors calling for more disclosure and transparency from companies.
On top of this, the recommendations of Bank of England governor Mark Carney’s Task Force on Climate-related Financial Disclosures (TCFD) explicitly list internal carbon pricing as a key metric for organizations ‘to assess climate-related risks and opportunities in line with their strategy and risk-management process’.
The TCFD also calls for companies to provide details of their methodologies and application of this metric. The implementation of these recommendations will drive further adoption of carbon-pricing tools by companies and investors alike over the coming years.
A best practice approach
Companies have a variety of reasons for setting an internal carbon price, whether to reveal hidden carbon risks and opportunities, or as a deliberate tool to transition a company to a low-carbon business model, or both.
In terms of actually putting a carbon-pricing system in place, the first step is to identify exactly what you are looking to achieve. As the use of carbon pricing grows and develops, investors will ask for more consistent disclosure around intentions for implementing – and approaches to embedding – carbon pricing within a business’s decision-making process.
A four-dimensional framework has been developed to support the implementation of internal carbon pricing. It outlines that a best practice approach would, in time, develop a carbon price at a level capable of changing decisions, cover all greenhouse gas emissions hotspots in the value chain, have a material impact on business decisions and be evaluated regularly to bring the business strategy in line with a low-carbon economy. The fourth dimension in this model – time – is important, allowing the company to develop its approach in stages to achieve the characteristics set out above.
Once implemented, it is important to monitor and report on the impact these measures have had. The questions to ask companies using this tool to assess and manage carbon-related risks are: did it reveal material risks within your business? Has it influenced business strategy or affected investment decisions? Equally, if the internal carbon price has not impacted the business in any way, it is important to explain why.
Get ahead of the game
Carbon pricing has the potential to serve as a globally understood metric for climate risk, which is an ever-growing area of public, regulatory and investor scrutiny. Getting the frameworks in place early will demonstrate a company’s good corporate governance to investors, while readying the business strategy for the inevitable next steps in the transition to the low-carbon economy. Companies should be taking the opportunity to get ahead of the game.
Nicolette Bartlett is director of carbon pricing at CDP
