According to the World Economic Forum’s 2022 Global Risks Report, climate change risks are now classified as worlds’ biggest threats.

The Urgency of Climate Change Risks

Failure to take climate action and extreme weather events top the list of threats for the next 5-10 years. These risks lead to additional environmental issues such as biodiversity loss, resource scarcity, and environmental degradation. In 2022, environmental risks dominated the top five global risks for the first time.

Financial Impact on Global Companies

Climate-related risks significantly impact a company’s revenues, costs, operations, and strategy. A 2019 report found that over 200 of the largest global companies faced nearly $1 trillion in climate impacts over five years.

Climate Change – An Investment Concern for SMEs

Climate change is not just an environmental issue but also a critical investment issue for small and medium-sized enterprises (SMEs). The SEC’s 2021 examination priorities reflect a growing focus on climate-related risks as investors increasingly consider these risks in their decisions. SMEs face new and growing risks such as natural hazards, technological risks, real estate loss, and rising energy and raw material costs due to climate change. Furthermore, concerns regarding costs for maintenance and infrastructure reconstruction must also be addressed.

Financial Risk Mitigation for SMEs

By proactively managing their environmental impact, SMEs can mitigate these risks and safeguard their financial stability.

Regulatory Compliance

Governments are increasingly implementing policies and regulations aimed at reducing GHG emissions, such as carbon taxes, emissions trading systems, and stringent reporting requirements. SMEs need to comply with these regulations to avoid penalties and remain competitive in their markets.

Investor Expectations

Increasingly investors are considering climate risks and prioritizing sustainability. SMEs that fail to address their environmental impact will find it harder to attract investment, while those that demonstrate robust environmental management practices are likely to gain traction.

Market Competitiveness

Millennials’ and Gen Zs’ attitudes and demand for environmentally friendly products and services is growing steadily. SMEs that want to appeal to these increasingly dominant demographics must commit to reducing their GHG emissions and developing sustainable products. These are tactics that can lead to increased market share and customer loyalty with these consumers.

Operational Efficiency

Monitoring and reducing GHG emissions can lead to increased energy efficiency and lower operational costs. By optimizing energy use and reducing waste, SMEs can achieve cost savings and improve their bottom line, which in turn also increases their appeal to potential investors.

Corporate Reputation

Companies that manage their environmental impacts proactively are seen as responsible and forward-thinking. This enhances their brand reputation, builds trust with internal and external stakeholders, and leads directly to better financial outcomes:

1. Sales increase due to increased customer satisfaction and loyalty
2. Employee retention increases in response to employees’ higher job satisfaction, leading to increases in operational efficiency, and savings on recruitment costs.

Businesses’ Perspective on Climate Change

Michael E. Porter and Forest L. Reinhardt from Harvard Business School emphasize that treating climate change as a business problem, rather than just a corporate social responsibility issue, is essential. Companies that fail to adapt will face severe consequences. By monitoring and reducing GHG emissions, businesses can increase energy efficiency, which lowers costs and enhances profitability.

Starting Sustainable Business Practices

In the context of managing climate-related risks and optimizing operational efficiency, it’s clear that integrating sustainable practices, such as utilizing carbon credits (more on this below) is vital for SMEs. According to Michael E. Porter and Forest L. Reinhardt from Harvard Business School: “Companies that persist in treating climate change solely as a corporate social responsibility issue, rather than a business problem, will risk the greatest consequences”.

Achieving Net-Zero: Key Steps

Unlocking the aforementioned benefits, reducing financial risks, meeting regulatory compliance, and meeting investor expectations all hinge on a company’s ability to, not only manage its carbon footprint, but also bring it to net-zero. This requires the company to:

• Have awareness for, and keep tabs on, its greenhouse gas (GHG) emissions.
• Create and enact a plan for reducing these emissions through improvements to operational efficiency, technology, and practices.
• For those GHGs that cannot be reduced or removed thanks to improved efficiencies and changed business practices, companies must engage in carbon emission trading, where they buy and sell carbon credits to account for whatever emissions remain.

But before we can consider these trades, it’s important to understand the global frameworks that have been developed and approved to help businesses do their greenhouse gas emission accounting correctly.

Introducing the GHG Protocol Standard for SMEs

The GHG Protocol Standard, published by the World Resources Institute (WRI) and the World Business Council for Sustainable Development (WBCSD), is a crucial framework for SMEs aiming to manage and reduce their greenhouse gas emissions. It is the most comprehensive, policy-neutral evaluation tool for quantifying GHG. This globally recognized standard helps define, measure and report emissions across three scopes:

• Scope 1 – Direct emissions
• Scope 2 – Indirect emissions from purchased energy.
• Scope 3 – Other indirect emissions within the value chain.

The GHG Protocol Corporate Standard requires businesses to report their scope 1 and 2 emissions, whereas scope 3 is voluntary, however companies that report all three scopes stand to gain the most definitive and sustainable advantages. Let’s dive in and understand these three scopes a little better…

Scope 1: Direct Emissions

Scope 1 emissions are those directly produced by the company’s activities. These include:

• Stationary Combustion: Emissions from fuel used for heating and other stationary sources.
• Mobile Combustion: Emissions from company-owned vehicles.
• Fugitive Emissions: Greenhouse gas leaks from equipment like air conditioning units.
• Process Emissions: Emissions released during manufacturing and industrial processes.

Scope 2: Indirect Emissions-Owned

Scope 2 emissions are indirect emissions from the consumption of energy that the company purchases from utility providers, such as electricity.

Scope 3: Indirect Emissions-Not Owned

Scope 3 emissions are all other indirect emissions occurring in the company’s value chain. These emissions come from sources not owned or directly controlled by the company, such as:

• Purchased goods and services
• Financial investments
• Storage by other companies
• Transportation and distribution of manufactured goods
• Use and disposal of sold products
• Activities of the company’s franchisees
• Leasing of assets
• Business travel and staff commuting
• Waste management and processing
• Capital goods like machinery, vehicles, buildings, and offices

Aggregate and Report Emissions

Once the company is aware of its emissions across all three scopes, these should be aggregated into the company’s total emissions value, which may then be reported using standardized formats, such as the GHG Protocol reporting template.

Using the GHG Protocol Standard helps companies not only to create effective strategies for managing and reducing emissions, but also to achieve related business goals:

• Identifying GHG Reduction Opportunities: Find ways to lower emissions.
• Managing Emission Risks: Assess and handle risks related to GHG emissions.
• Public Reporting: Participate in voluntary programs for monitoring and reducing GHGs.
• Regulatory Compliance: Meet mandatory GHG emissions reporting requirements.

The GHG Protocol Standard can be viewed as the roadmap by which a company may align its sustainability efforts to global best practices. It’s a research backed pathway towards better environmental and business performance.

Financial metrics

While measuring a company’s environmental impact is a painstaking process, it’s ultimately an exercise in accounting. As can be expected, this accounting becomes more complex when a number of companies are working together to complete a project, since it becomes increasingly difficult and messy to figure out how to allocate the projects’ environmental impact among the participating companies. This is where financed emissions come into play.

Understanding Financed Emissions

Financed emissions involve aggregating GHG emissions at the portfolio level, linked to the underlying entities or projects. These emissions are allocated proportionally based on the financial stake in the underlying entity or project.

The Role of Carbon Credits

Once a company has a clear insight into its overall carbon footprint, it can start formulating a plan on how to reduce it. This typically includes steps towards optimizing energy consumption and reducing waste, however in most cases there’s a certain portion of the company’s environmental impact that can’t be “optimized” away. It’s precisely for handling the zero-ing out the carbon accounting of this remainder that Carbon Credits were invented.

Carbon credits are certificates denoting audited equivalents for the removal of one metric ton of carbon dioxide, or its equivalent in GHGs, from the atmosphere, and can be bought and sold on specialized markets.

Companies can purchase these credits to cover whatever emission deficit they have remaining after eliminating as much as their footprint as possible through process, energy and waste optimizations.

By effectively managing their GHG emissions and utilizing carbon credits, companies can reduce their environmental impact, comply with regulations, and meet investor expectations.

The Practicality Aspects of Carbon Accounting

In terms of practicality, the effort required to estimate GHG emissions/financed emissions at the group level is highly dependent on the level of accuracy desired – Tracking such emissions from the bottom up for each relationship can become impractical and exceed the estimated value of the entire effort. Approximation methods exist, but these are subject to critiquing over their accuracy and value.

Conclusion

Ultimately an organization’s commitment to becoming net-zero comes down to the degree to which every individual in the organization feels committed to this goal. The existing frameworks provide best practice guidelines for organizations’ for strategy, reporting, and implementations, but the degree to which execution is motivated by mere compliance or by deeply held beliefs are what will dictate the outcome. The overarching principle should be to focus on the forest – becoming net-zero, rather than the trees – overthinking the accounting.

Image Credit

Thomas Richter on Unsplash