Climate-related financial disclosures: reimagining the future
Right now, the focus on climate-related financial disclosures is largely from a compliance perspective. While it is indeed important to understand how to play by the reporting rules, disclosures are meant to be an accountability tool for taking meaningful climate action–not a mere box-ticking exercise.
So, what might the world look like when companies leverage the data and insights from their disclosure efforts to make decisions and inform action? We explore three changes that are already underway, and what this will mean for stakeholders across food and ag value chains.
Linking capital costs to production risk
Banks will need to account both for climate impacts enabled by their financing and the changing risk profiles of their loan books in light of physical and climate transition risks. In instances where banks don’t have a granular understanding of their portfolios, they will be required to use fairly blunt tools to make these assessments, and that will come at a high cost.
For example, earlier this year Rabobank downgraded the creditworthiness of its whole €10.3 billion dairy loan portfolio in the Netherlands due to the government’s policy plan to reduce nitrogen emissions in the agriculture sector. This downgrade was reflected in a €76m adjustment to Rabobank’s financial performance in 2022.
Of course not all of Rabobank’s dairy customers in the Netherlands have the same nitrogen risk profile. But without an understanding of practices and on-farm outcomes at the loan-level, the bank is left with no other option than to downgrade its entire portfolio.
Going forward, lenders and investors will look to develop a better asset- and customer-level understanding of their portfolios to avoid the costs of using blunt approaches. Just as segmentation and personalization has proliferated in the retail industry, we expect that financial instruments will increasingly rely on detailed customer information in B2B segments as well. And as in retail, much of this information will be collected and analyzed without active participation from the end customer (or in this case, farmer).
This data and information will be used to more granularly determine costs of capital for borrowers, inform creditworthiness, and even influence decisions of whether financing can be extended to customers or not. For example, it’s not unreasonable to think that banks might use remotely sensed data to determine sustainable stocking rates on specific land assets and then use this information in making approvals for working capital loans.
At the same time, there will also be new opportunities to design financial products and services that leverage this information. More granular data can open up new ways of securitizing and collateralizing capital, and even enable new investors to bring new pools of capital to market.
Structural reorganization to support changing corporate priorities
From a governance perspective, climate-related financial disclosure standards will require that core strategy and finance functions, at the highest levels of an organization, are informed by climate risks and opportunities. From an operational perspective, if companies plan to move from identifying climate risks to actually mitigating them, the way that organizations are set up will also need to change.
Although many organizations have made strides in establishing ESG and sustainability functions, in many cases they are not integrated with other departments such as strategy, finance, and operations, nor are they represented at the board level. Going forward, a key imperative will be aligning accountability and incentives so that businesses can deliver on board-level priorities to manage climate-related risks and opportunities.
One recent example that brings this to life is General Mills. In 2021, General Mills announced its Accelerate Growth Strategy which outlines “being a force for good” as one of the organization’s four key pillars for competitive advantage and success. Since then, there has been a massive overhaul in organizational structure to support execution of this strategy, including bringing Sustainability and Global Impact directly into Strategy and Growth, and establishing a cross-functional Global Impact Governance Committee at the board level (see below). According to CEO Jeff Harmening, this restructuring and breaking down of silos between functions has enabled General Mills to be more agile and has helped drive growth and financial performance.
Ultimately, these types of restructurings will influence how organizations operate internally and with their supply chains. For example, as growth, supply chain, and sustainability are more aligned internally, the way that procurement teams are incentivized and how they engage with their suppliers will change. Incentives will expand from typical metrics such as cost, quality, and reliability to include climate and sustainability performance.
For producers, these pressures could result in stricter requirements for market access–more stringent data and reporting or demonstration of sustainability credentials, for example. This could also open up new opportunities for incentives–for example, preferred contracting terms for suppliers who meet a certain profile.
New models for collaboration and risk sharing
When reporting is a key driver for sustainability efforts, there tends to be a lot of focus on individual attribution of programmatic efforts (i.e., in which a company gets to claim credit for a specific program or initiative). This results in redundancy and inefficiencies in achieving the actual outcomes (e.g., reduced emissions) that we are all working towards.
For example, there has been a lot of focus on scaling up regenerative agriculture as a way to mitigate climate impacts in agriculture. Just about every major food company (e.g., Danone, Nestle, Unilever, the list goes on…) has set up frameworks, pilot programs, and knowledge hubs to help farmers in their supply sheds adopt regenerative practices. But is having each of these companies fund and deliver their own programs with a subset of their supply chains really the best way to generate outcomes at scale? Probably not.
We’re starting to see a shift to more collaborative models that share the costs and risks to support transition efforts. The Sustainable Markets Initiative Agribusiness Task Force, for example, recently highlighted (i) cost-sharing mechanisms within supply chains and (ii) different sourcing models as two keys to scaling regenerative agriculture globally. In practice, this might look like banks and CPGs working together to design incentives for adoption of regenerative practices because ultimately, both parties would benefit from having more sustainable and resilient farms in their portfolios. Or, it might look like various CPGs working together to achieve specific outcomes (e.g., water, soil health, biodiversity, etc) at a regional and supply-shed level, so that they can spread risks and costs as farmers transition to new practices.
Collaborative initiatives like the Agribusiness Task Force and the Agricultural Sector Roadmap to 1.5°C, are promising signs that industry is moving beyond a reporting-first approach and progressing towards pathways to actually solving climate challenges in ag. But, there is still much work yet to be done.
Zooming out
It’s clear to us that requirements for climate-related financial reporting are driving big shifts in not only the landscape of reporting tools, but also access to finance, organizational structures, and cross-company collaborations along value chains.
While we’re somewhat skeptical on venture-scale exits for ag-specific tools, we’ll continue to monitor this space and see if our hypotheses hold up.
More broadly, though, we don't want the emphasis on reporting and disclosures in the investment community and in boardrooms to overshadow the real work of mitigating climate change. Reporting requirements can be a useful approach to focusing our attention, but ultimately they are only a means to an end.
We’re hopeful that climate-related financial disclosures will play a role in accelerating action, as our collective window of opportunity is rapidly shrinking. More importantly, though, we remain bullish that the world has the resources, talent, and technologies to do the actual work and deliver climate mitigation–and we’re excited to keep backing the bold entrepreneurs who are leading these efforts.
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