The last few weeks have seen important moves in the financial community to improve and increase reporting in terms of climate issues. Whilst the work of the Task Force on Climate-related Financial Disclosures[i] is to be warmly welcomed in terms of helping to tackle climate risk, on its own, this will not lead to resilience in UK utilities.
Although achieving net zero is crucial for survival, it is clear that this is not the only risk we face.Across the economy, companies are experiencing significant disruption from Covid-19 as well as from deep technological, social and wider environmental change (including biodiversity). Along with the challenge of adapting to the climate change which is already 'hard wired' into our natural world and could be an even greater challenge.
Improving reporting in all these areas is important but will not be sufficient to increase resilience. And in essential services, investors are not the only ones with an interest.
Risk landscape for public utilities
For public utilities, being able to understand the changing social and environmental context is key to building resilience - and addressing associated policy and regulatory risk. As providers of essential services and critical national infrastructure, getting this right is vital.
For energy and communications companies, who hold the key to enabling decarbonisation and smart solutions across the rest of society, and for water companies, who with increasing risk of drought are on the front line of climate adaptation, this has a wider relevance.
Policy and regulatory risk in public utilities are nothing new.Over recent years, however, these have seen a trend increase.This is being driven by a number of factors including: the pace of change; the clustering and convergence of different issues – where dependencies and feedback loops can lead to escalation; 'perfect storms' – when shocks like Covid-19 can lead to unfavourable circumstances if the company doesn't have enough capacity to respond; and multiplier effects.
If policy and regulatory risk are not addressed in utilities, uncertainty increases.Uncertainty is almost impossible to measure, making planning and expectation management challenging.Left unchecked, policy and regulatory risks can lead to escalating calls for 'something to be done', the politicisation and polarisation of issues and potentially knee-jerk interventions.
Current approaches to risk in utilities
In February this year, Sustainability First examined current approaches to social and environmental risk in a sample of utility companies.In the companies that we studied, our research found that approaches to risk tended to be static and short-term, where environmental and social issues were treated as separate, ad-hoc and one-off externalities.
Many companies also took a reactive and compliance-based approach.Our research indicates that meeting legal and regulatory requirements is clearly crucial, but is unlikely to be sufficient, to address social and environmental risks.This is because policy and regulation in these areas tend to lag behind the science and technology - and public expectations.
Four shifts to help utility companies build resilience
To build resilience in this challenging environment, we consider that four shifts in the approach to social and environmental risk are needed in the utilities sectors.
- 1.A shift in time horizons to develop a more cumulative and long-term view of the strategic context.Environmental risks such as the climate crisis and biodiversity loss, and other high impact low probability risks, mean that the past may not necessarily be a good guide for what is to come. This makes a future-looking perspective vital. We need to steer not just 'by looking at the dials' but also looking out of the window.
- 2.A shift in scope to developing a more holistic and integrated view of risk. This is crucial to address the feedback loops that can exist between social and environmental issues. Bringing together social considerations such as fairness with the challenges of the climate emergency can also help us to better understand what a 'just' or fair transition to net zero might look like.
- 3.A shift in approach to become more proactive and focused on strategic and systemic risks.These may require a more joined up approach between utility companies, with utilities and local stakeholders, and between utility companies and government.
- 4.A shift in risk governance is necessary to enable a more open and learning environment where a focus on purpose, values and culture can help identify what 'the right thing' to do is – even if there isn't a complete evidence base or clear rules set.This is particularly important in a dynamic and fast moving environment.
What can utility companies do?
Sustainability First has just published a slide pack for utility company boards to help them achieve these shifts.This is designed to help utilities develop a more complete view of the social, environmental, technological, political and public health risks and opportunities that they face so that they can better understand their risk landscape.
The pack encourages companies to apply this broad risk universe and framework to better assess how their own risks may cluster and change.In doing so, it notes the 'dynamic risk factors' that can drive risks in utilities: climate and the environment (noting that the welcome focus on carbon mitigation now needs to be extended to include climate adaptation and biodiversity); the media (particularly social media); the consumer / citizen 'lived experience' (recognising the importance of wider and mutual / community and longer-term interests); and civil society action.
The slide deck sets out how these different risk factors can both amplify and reduce policy and regulatory risks and summarises some common mitigating actions.These can help companies chart how sustainability issues in utilities can become financially material to the business.
Given the fluid situation that utilities find themselves in, the pack also provides some possible 'big picture' political scenarios. These are intended to complement the extensive scenario work that companies already do in terms of resource planning. They are designed to help them assess how robust their strategies may be to different possible worlds.This can help assess how agile the organisation may be in this age of radical uncertainty[i] and to think through how their risk governance processes may need to change for resilience.
From risk to opportunity
For utility companies, getting a better grip on social and environmental risk is crucial to minimise policy and regulatory risk and help ensure resilience.This is of vital importance for the public interest but a difficult and complex area and challenging to get right.
But it's about more than this.Policy makers and regulators also need to consider their own approaches to social and environmental risk.Companies can't do this all solo or provide a blank cheque to address these issues.But getting on top of the risks under their own control, and being able to demonstrate this, is an essential step in having constructive conversations around shared and existential risks (that may involve asset stranding).
And, of course, the flip side of risk is opportunity.Sitting behind these challenges are potentially significant upsides.The companies that get good at this should be more trusted to help redesign the future policy and regulatory frameworks that will help unlock investment in a smart, fair and green recovery.And they should also be in the forefront of future value creation for their own businesses.Surely this is worth the hard work.Getting the reporting right on climate risk is essential, but it is just the beginning.
[i] Kay and King, Radical uncertainty: Decision making for an unknowable future, 2020
[ii] The Task Force on Climate Related Financial Disclosures (TCFD) was created to improve and increase reporting of climate-related financial information. See https://www.fsb-tcfd.org