Our CEOs 4 Climate partner, South Pole, supports companies and governments to innovative solutions to both mitigate risks and achieve sustainability goals. In the article below, South Pole cites the importance for companies to implant the sustainability transformation in their growth strategy before the policy demands it.

At South Pole, we know that risks, challenges and opportunities can only be tackled head-on. This four-part blog series will explore how companies will be affected by and can engage with the European Green Deal, Europe’s most ambitious policy initiative since the introduction of the Euro currency. With the Green Deal, the European Union is producing a regulatory storm that will stretch far into the future, deep into today’s profit models, and way beyond Europe’s borders. This post argues that companies should integrate the Green Deal with their Climate Journey, pre-empt costs related to regulatory compliance and secure the competitive advantage of regulatory pre-alignment.

Europe’s new growth strategy is a game changer that will make or break the companies of today. This strategy – in the shape of the European Green Deal – has unleashed internal ‘soul searching’ across countries and economies: which business models will make the cut? As political discussions focus on how to meet the new greenhouse gas emission reduction target for 2030, strengthened from 40% to 55%, companies are advised to make sure they can align with this pathway to 2030 and beyond.

After all, to make Europe the first climate neutral, circular and competitive continent in the world by 2050 echoes a ‘do-or-die’ mentality that befits the scale of the climate crisis our society faces today. With the Green Deal, the European Union is producing a regulatory storm that will stretch far into the future, deep into today’s profit models, and way beyond Europe’s borders. It is more than a new set of rules; it is a paradigm shift to ensure European society can live within the planet’s boundaries.

Companies can and should prepare, not only by lobbying for (or against) new policies, but also through regulatory risk analysis and targeted pre-compliance action. After all, even if the details remain fuzzy, the direction of the shift is clear, both for the economy as a whole and each sector within.

The drivers of change abound

Building corporate climate resilience is as much about emergency response as it is about pre-compliance action. Companies are being put to the test as Covid-19 continues to affect supply chains across the globe. As numerous commentators have argued, it is also a clear signal of the type of disruption businesses can expect from climate change-induced calamity. Business can draw lessons and prepare measures to stem the fallout of climate risk on profit models. In fact, in a recent report published by South Pole called Crossing the Line to Zero, we saw that the Corona crisis is actually making organisations ‘Net Zero-ready’: they realize their vulnerability to external shocks and are thinking strategically about the next big emergency.

It is as my former colleague Charles Henderson wrote in his blog Why building corporate climate resilience has never been more important: “Shareholders, stakeholders, and the public will ask increasingly more difficult questions about the long-term security of their investments, pensions, and the businesses that hold together the fabric of society. Financial and planetary debt, and how they are governed, are at the top of this resilience agenda.”

Surfing these winds of change is not restricted to the physical risk that the climate crisis brings, however. Regulatory action around the world is rapidly raising the resilience agenda of business in the shape of ‘transition risk’. Aside from the growing chorus around non-financial reporting, epitomized in the TCFD framework and the EU’s Sustainable Taxonomy (a classification system for sustainable assets and activities), it is the Green Deal as a whole that may prove to be the real game-changer here.

We should all turn into green dealers

The Green Deal is a generational effort with few equals. In terms of scale, it aims to overhaul the economic system to an extent equal to the introduction of the Euro currency, the EU’s Common Agricultural Policy or the European Single Market. It propels decarbonization and economic growth to the middle of this century and beyond, while making sure that the impact is already felt today.

In fact, the Green Deal already informs and inspires economic recovery packages across Europe. Last week, EU leaders agreed a 30% climate spending target for the € 1.8 trillion budget and recovery package, which will be spent directly on the Green Deal objectives.The timing could not have been better. Although conceived before today’s recession, it arrives at a time of a deepening global climate crisis. It creates a practical hook for action; a map to guide decisions for the short, medium and long term.

The intended reach of the Green Deal is also significant: it seeks to drive investment decisions across the internal European market, the world’s largest single market area. In addition to setting ambitious targets for 2030 and 2050, the Green Deal hosts a plethora of binding and non-binding policy initiatives, as well as revamped governance processes, to help deliver this ambition. It also reverberates across the EU’s external borders. Embedded in the Deal are clear elements of what political scientists call external governance; the ability to influence other regulatory systems and markets.

Taken together, the scale, timing and reach of the Green Deal ensure that its impact will be felt across sectors and geographies. It will reward companies who leverage sustainability for competitiveness, while companies that are slow to adapt to the risks and do not seize the opportunities by aligning with the Green Deal could soon become irrelevant. Piece-meal action later on will undoubtedly drive up costs.

Incorporating the Green Deal is smart business

When it comes to climate change and its impact on market dynamics, the difference between surviving and thriving is that benefits can be reaped later by putting sustainability first. This can be felt across at least five business areas and is also clearly outlined in the way funding is targeted under the EU’s next multi-annual budget for 2021-2027:

  • Business model: Carbon-dependent business models are meant to become redundant. That is the entire purpose of the Green Deal; it is an economic growth strategy that is meant to realise a climate neutral, competitive and circular economy by 2050. Circular business models will benefit greatly, whereas carbon-intensive models will become more costly. Even the Just Transition Fund (€ 17.5 billion) to support coal regions excludes all financing for fossil fuel investments.
  • Bottom line: The cost of lagging behind increases exponentially. This is particularly visible in the EU’s Emissions Trading System (ETS) which forces companies in the sectors that are covered to buy emission allowances. As the cap decreases over time, allowances will become more expensive. This means that the lower your emissions are compared to the sectoral benchmark, the lower your costs. Note here that the cap is expected to tighten further under the Green Deal.
  • Incentives: Opportunities to use public funding to transform a business will go to the more ambitious. Companies stand a greater chance to access EU funding for R&D projects under the Horizon Europe fund ( €84.9 billion), technology demonstration projects under the EU Innovation Fund (€10 billion), or low-carbon cross-border infrastructure projects under the Connecting Europe Facility (€22.4 billion), than for projects that push business-as-usual.
  • Shareholders: New rules and frameworks will ‘green’ investment portfolios. The EU’s Sustainable Taxonomy, for example, identifies assets and economic activities that are classified as sustainable. It includes specific screening criteria for sectors such as manufacturing, agriculture, construction and real estate, power generation, transport and ICT. The Taxonomy is also tied to other regulatory initiatives such as the EU Green Bond Standard and corporate disclosures.
  • Global competition: The global competitive landscape will be disrupted. The expected carbon border tax adjustment measures have a clear impact. But the extra-territorial ripple effects of initiatives such as the Sustainable Taxonomy are also likely to be severe. The Regulation includes disclosure obligations to anyone offering financial products in the EU. Moreover, as the first of its kind, it will serve as an example for frameworks to be developed elsewhere.

In a nutshell, it is smart to embed the sustainability transformation into your business strategy before policy demands it. As previous South Pole authors have stressed, companies should reduce with ambition, engage their supply chain, and offset emissions where needed as we transition to net-zero in 2050. Sustainable and resilient business models thrive in times of crisis. Those companies that sync up to the Green Deal will have more sustainable and resilient business models.

Do not get left behind, sprint ahead

Global society finds itself on the brink of climatic and ecological collapse. The moral case for action based on science is clearer than ever. The European Green Deal contributes to the commercial incentive for climate action. We strongly recommend that companies take this opportunity head-on. To grasp the benefits, companies need to see how aligning with the Green Deal is a way to lock-in long-term competitiveness. This starts by asking yourself five questions:

  • Materiality: How important is this issue for my stakeholders – regulators, investors, consumers, citizens – and how do I measure this relative importance over time?
  • Compliance: What specific new regulatory obligations are coming my way and how do I measure the short, medium and long-term financial risks and opportunities?
  • Baseline: Is my business model aligned with the EU’s revamped 2030 target and the 2050 climate neutrality target and how do I assess this?
  • Optionality: How will different decarbonisation pathways affect my bottom line and what funding opportunities are there along the journey?
  • Strategy: How do I find out what I can do concretely to turn sustainability into a competitive advantage in line with market developments?

By answering these fundamental questions, a company can find its own unique path to a successful and beneficial integration of sustainability into its business model. The Green Deal then becomes a guiding framework for any business strategy, requiring a clear action plan for realisation.

In the second part of this blog series, we will assess the concrete impact of the Green Deal on voluntary and compliance carbon markets, before discussing how a company can pre-empt regulatory impact by conducting a thorough transition risk analysis and by engaging other stakeholders. Stay tuned!