Five Challenges to Meeting Net-Zero Commitments and How Stock Exchanges Can Help

Despite many pessimistic headlines, there is good news in the movement to halt the climate crisis. Net-zero commitments today cover 92% of global GDP and 88% of emissions worldwide. For stock exchanges, issuers and investors, this represents a tremendous commitment to transformation as well as an opportunity to capitalise.

But there are numerous challenges to meeting these net-zero commitments. At CDP, we are focused on helping organisations take the right next steps to resilience in a low-carbon future. By creating robust climate transition plans, companies can mitigate risks and seize opportunities – especially if stock exchanges help them by driving transparency and efficiency in transition finance.

Here are five of our most pressing challenges to delivering on net-zero pledges – and how these challenges can be addressed.

1) Defining non-financial information into financial materiality

Our transformation to low carbon requires us to have a consensus on how we assess transition, at both an entity level and an economy level. In 2021, CDP pioneered the definition of a climate transition plan for corporates and established the assessment criteria for its credibility. The concept aligns with our existing understanding of business governance, strategy, risk management and target-setting.

Today, there are well researched and established concepts that have been developed on transition plans, through legislation such as the Transition Plan Taskforce (TPT), and through best practice guidance such as that of the Glasgow Financial Alliance for Net Zero (GFANZ), while others have put forth proposed guidelines such as those by the Monetary Authority of Singapore for financial institutions.

In the past year alone, we have seen disclosure on climate transition plans become a requirement by several standards including the IFRS climate disclosure framework and the European Sustainability Reporting Standards (ESRS). All of these frameworks have helped to clarify the boundaries of transition planning.

2) Lack of data based on current guidance

Based on our definition of credible climate transition plans, CDP established assessment criteria across 21 indicators. The assessment is developed to present where in the journey a company is in establishing a credible plan.

Last year, over 23,000 companies shared climate data through CDP, the largest environmental disclosure platform in the world. Approximately 6,000 of them (or 26%) reported developing a credible transition plan aligned with a 1.5 degrees Celsius world. But, when we applied our assessment criteria, it showed that just 140 of these 6,000 companies met our evaluation for credibility and completeness. So, the data is there and it is growing in size and robustness – and, importantly, it tells us that 140 companies are leading the way on climate transition planning for a net-zero future.

3) Lack of capacity to generate the data

Corporate responses also show us a range of preparedness in planning, and gaps are already visible within the strategy development. Some 32% of disclosing companies are identifying climate risks and opportunities to their business. But a far smaller number are able to translate these identified risks to target-setting. Fewer still are able to assign financial materiality to these opportunities.

Clearly, it is crucial that climate transition planning is normalised among economic entities. This is where stock exchanges can play a vital role. They are a hub for developing the engagement and uptake of new concepts among companies and financial institutions. Several stock exchanges today have set their own net-zero targets. This means they can lead by example in communicating their transition plans with stakeholders.

Already, some stock exchanges have begun publicly reporting on their transition plans annually. This is certainly encouraging. But engagement with issuers and market participants must accelerate across all stock exchanges in order to normalise the undertaking of transition planning.

One way to kickstart this would be to take a roadmap approach to meeting common denominators that the market needs to achieve across all issuers, within specific time frames. Those 140 companies that met CDP’s evaluation for credibility and completeness of transition plans already feature in many major global exchanges. A knowledge exchange from these leaders in their respective regions or globally by sector could also be a starting point for broader acceptance on transition planning.

4) Deriving meaningful understanding from transition planning

Companies have upskilled in identifying climate risks and opportunities, but this hasn’t necessarily translated to financial planning.

Take, for example, a large global cement company with a well-thought-through climate transition plan, headquartered in an emerging economy. Cement is a high climate impact sector. The company has a net-zero target that covers 92% of its Scope 3 emissions. It has developed its transition plan in line with identified short-, medium- and long-term targets, and has received board approval to execute on this plan.

At all times, these transition targets are assessed against financial risk impact as defined under the company’s enterprise risk management guidelines. For example, any transition risk that affects or has the potential to affect 4-6% of global EBITDA is termed as high impact risk. These risks are further identified across business units in relation to the company’s global EBITDA.

Let’s take the case of climate regulation. Assessing the impact of current carbon regulation in their countries of operation, the company developed a roadmap listing carbon reduction initiatives per site of operation. They presently report that if implemented successfully, the financial impact can be significantly reduced by 20%. Besides transition risk, they have initiated similar financial materiality exercises for physical climate risk to their business.

This would be an excellent company for stock exchanges to partner with – to engage with other companies and brainstorm ideas on their approach to transition, plus how they’re implementing their plans across developed and emerging economies.

5) Financial innovation needed to meet the scope of climate transition 

The stock market is key to climate progress, as it is a hub for solutions and change. As markets advance and new solutions come up, the stock market represents both the creator and channel for the proliferation of transition finance as the green economy grows.

Stock exchanges set the pace and tone for financial innovation – and transition finance is not an exception. They play an integral role in driving transparency and efficiency in transition finance as a whole. The International Capital Markets Association (ICMA) has come out with initial guidance on transition finance principles, and several others are also in development.

Transition finance has the potential to match the demands of a net-zero economy. Transition is not just about changing select processes or structures. It is about building a roadmap to meeting the commitments we have made.

Success in meeting our net-zero commitments will always be a common endeavor. We can only succeed if we consciously apply our creativity to imagining a financial world that is inclusive of the planet and its people.