From budget to Climate Transition Plan

As business models shift towards more balanced value generation, ESG (Environmental, Social and Governance) factors continue to receive increasing attention as part of sustainability-focused strategies. To measure environmental impacts, or climate in particular, carbon footprint has emerged as one of more popular non-financial metrics. & Inclusion embedded across all.

As business models shift towards more balanced value generation, ESG (Environmental, Social and Governance) factors continue to receive increasing attention as part of sustainability-focused strategies. To measure environmental impacts, or climate in particular, carbon footprint has emerged as one of more popular non-financial metrics. With scientifical support and application of GHG (Greenhouse Gas Protocol) and good progress towards standardisation, in example due to work done by organisations such as PCAF (Partnership for Carbon Accounting Financials) or SBTi (Science-Based Targets initiative), number of organisations having Climate Transition Plan (CTP) is rapidly increasing across various industries. Main objective of a company’s CTP is to provide a clear path towards a stated climate objective, which in many cases is to become climate neutral or even climate positive by a certain date. Large number of companies chose to align their CTPs to the main goal of the Paris Agreement, which means reducing carbon footprint by half by 2030 and reaching ‘net-zero’ by 2050.

During AICPA&CIMA ENGAGE CFO Strategy & Innovation Summit 2023 in Warsaw we had a pleasure of sharing our experience from transforming the financial planning activities of NatWest Group to integrate the climate aspect. We spoke about how to approach a transformation of a key annual planning process, the budget, so that it starts to inform and guide company’s journey towards climate neutrality.

It is worth noting that for a banking organisation, the main source of carbon footprint is through assets on the balance sheet – loans provided to customers from various industries or securities the bank holds on the books. This means that bulk of CO2 emissions would be scope 3 emissions for which decarbonisation actions are less straightforward than in case of scope 1 & 2 that organisation has more control over.

Here are some of the key highlights we shared:

• ESG as part of business Purpose

Purpose statement in itself is key for every organisation and acts as a compass that can navigate direction of travel, however, you still need a roadmap. So, if we follow Task-force on Climate-related Financial Disclosures (TCFD) framework, but apply it to broader ESG considerations, to truly embed ESG it needs to go into your strategy, the way you identify and manage risks and opportunities through execution of the strategy, it needs to find a way into your organisational governance and decision making processes and finally the targets you set and how you measure progress against delivering on them need to follow through. ESG is a very broad framework, so one of the things we found out is that it’s good to agree key areas of focus at the very top of the organisation and then for these priorities to be cascaded throughout your different franchises, business lines, product lines etc. And they will contribute in different ways but will eventually find ways to contribute meaningfully. Our experience from NatWest is with these key areas of focus having been built around Climate, Learning and Enterprise, with Diversity, Equity & Inclusion embedded across all.

• What has been our journey so far towards creating a CTP-aligned budget

In 2022 we built so-called CTP 1.0 and the emissions reduction targets were calculated in our Transition Planning Tool (a model developed in cooperation with external consultants). We can talk about two processes, CTP1.0 and the core budget process, that were running next to each other in parallel and then were reconciled to each other. The end state though was that CO2 reduction targets were quantified, targets were set and potential gaps were acknowledged. CTP 1.0 was very much in the project mode with little involvement of Financial Planning & Analytics teams who own the core budget process, but also ran in a tactical way without systems that could support it as they support the core budgeting process.

Of the back of the CTP 1.0 there were clearly some learnings and actions that we could leverage from. It became apparent that CTP 2.0, an improved 2023 version of prior year process, should be much more joined up with the core budgeting process, so that they can feel more like a single activity. We have set up a number of working groups to:

• Systemize the modelling of financial metrics required to inform the CO2 emissions modelling
• Improve connectivity with other Finance teams who needed to get involved
• Understand any gaps and map out the plan to bridge them through clearly agreed roles and responsibilities
• Deliver necessary trainings to our staff to help them understand how our activity with customers from various sectors is impacting climate
• Assign sector leads to support business across key sectors including the financial modelling of climate levers – actions that can be undertaken to decarbonize our balance sheet

                It is worth mentioning that whereas significant improvements have been made in 2023 in line with the plan we had outlined in 2022, there is more to be done in 2024 to optimize and influence some inefficiencies, as well as make further progress with embedding CTP even more into our regular, business-as-usual (BAU) activities.

• Net-Zero planning horizon

For the organisation we’re part of, becoming net-zero is a 2050 target, however, before we get there, our target is to cut our carbon footprint by half by 2030 compared to 2019 baseline. Whether we talk about 2030 or 2050 targets, we touch an important point in terms of evolution of traditional budgeting that is required to support climate transition, which is a much different planning time horizon. With all the dynamics and uncertainties in the short term, organisations already need to be flexible and adaptable, but now more than ever they also need to stay focused on the long term. That is a huge challenge, because there are many turns and bumps on the way.

• Ownership of the climate transition plan and budget sits with the business, but what is the role Finance can play?

With budget being a financial reflection of the strategic business plan, it is fair to say that final ownership sits with the business. However, it would not work well without heavy engagement of the CFO and their Finance team at each step of the process. The way we organised this in our organisation is that Financial Planning & Analytics (FP&A) teams, responsible for modelling of the traditional, financial metrics of the budget, work closely with the Climate Finance team who own the financed emissions calculation models. Then we have Strategic Finance Partners who work with Business Heads to ensure full integration of the plans and reflect via agreed business initiatives. Whilst there are different levels of engagement and different teams play varied roles, it is important to note that direction, guidance, structure, requirements, trainings and templates were so far coming from the centralized Climate Finance team.

The role of Finance function is instrumental with key priorities built around:

• Embedding climate targets into decision making and performance management
• Building capability to track and hold business to account against CTP commitments
• Development of frameworks and analysis to allow climate decisioning to be increasingly embedded in wider budget decisions. This is where FP&A teams provide data, insights required to develop, and lead on integration into Franchise/Segment/Business/Product reporting
• Proactive engagement to shape direction of wider impact (economic capital, funding, income, costs) but also non-financial (environmental)

End state ambition that we’re quickly moving towards is for the activities performed by the Climate Finance team to be moved into mainstream of the budgeting process and done in a BAU mode by the FP&A teams.

• Key components of the budget to support CTP

• Starting point – it’s important to get solid understanding of your current carbon footprint and where it comes from, then you can set your carbon budget and start breaking it down. As mentioned earlier, for banks in general there will be some scope 1 and 2 emissions but given banks don’t own too much of fixed assets and don’t produce goods, we’re finding out that pretty much all of their carbon footprint comes via scope 3 emissions. And within a wide pool of scope 3, most important for a bank (or any other financial institution in that matter) will be category 15 called Investments, which drive so-called financed emissions.
• Then we get to climate levers – initiatives you can undertake or investments you can make to transition:
  • In order to decarbonise their balance sheets, banks need to make their investment portfolios greener. Similar with banks engaging into underwriting or intermediation of bond issuances - emissions associated with this activity are called facilitated emissions. So green and transition lending, or green and transition bonds facilitation would be climate levers a bank can pull to decarbonise. The sector is seeing massive business opportunity in this area already, as well as in the upcoming decades. Equivalent of a climate lever for a non-banking company would be investment into projects that reduce carbon footprint through switching to cleaner technologies such as renewable energy or improving energy efficiency to reduce usage of the portion coming from non-renewables.
  • Another important step that can be taken is to stop some activities that drive negative climate impacts, such as to stop providing a harmful product or disengage from a harmful business segment. Example for a bank could be to stop lending to a coal producer. Example for energy producer would be to exit their coal segment and re-pivot towards renewables. For a car manufacturer that is re-pivoting to electric vs ICE (Internal Combustion Engine).
  • You can also look at your supply chain and switch to using materials produced in a more sustainable, greener way.
  • Last, but not least, you can use carbon offsets. As long as they’re high quality, they can solve the residual part of the equation.
• All of these come with a cost, if not through P&L, there could be social costs to bear by communities that are impacted, so such decisions need to be looked at broadly and taken with diligence.

• Key challenges whilst incorporating CTP into the budget

Incorporating a comprehensive climate transition plan into the core budget process presents a multifaceted challenge that stems from several interrelated factors.

• One significant hurdle lies in the difficulty of harmonizing the timelines of the climate transition plan with the existing budgeting schedule. The clash of two distinct timetables, each with its own set of priorities and urgencies, adds a layer of complexity to the process, making seamless integration more challenging task.
• Moreover, the incorporation of a climate transition plan introduces additional stakeholders and parties involved, each with unique perspectives and considerations, necessitating a more inclusive and collaborative approach to decision-making.
• The inherent complexity of the business further complicates matters, as the market dynamics, capital, funding, costs and revenue must be carefully considered in tandem with the environmental objectives. This complexity often results in the need for additional layers of budgeting, making the overall process more intricate and demanding.
• The iterative nature of the budget process compounds the challenge, requiring continuous adjustments and refinements to align with evolving environmental goals and regulatory landscapes.
• Moreover, given that the requirements of the climate transition plan may be novel for majority of employees, there is a crucial need for enhancing the knowledge and awareness levels across the organization.
• Clear delineation of roles and responsibilities becomes imperative in navigating this intricate landscape, ensuring that each team member understands their contribution to the broader climate objectives.

Finally, the decision-making process must be adapted to accommodate the dynamic nature of climate-related considerations, fostering a culture of responsiveness and adaptability within the organization. Addressing these challenges requires a concerted effort, strategic planning, and a commitment to integrating sustainability seamlessly into the core budgeting processes. This is a journey though and does not happen overnight.  

• Examples of metrics and KPIs that can support CTP tracking

KPIs and metrics would require being tailored to the type of activity and a sector or industry the company operates within. For banks specifically we can name the following:

• Own operational carbon footprint.
• Banks need to analyse their balance sheets and associated estimated carbon footprint, based on absolute emissions and emissions intensities (such as CO2 per £1m of exposure). That includes tracking of current emissions and forecasting future emissions vs a set baseline. It’s worth noting that the baseline might require restatement as data availability and quality improve.
• Extra attention should be provided to exposures to heightened climate-related risk sectors.
• Progress against sectoral decarbonisation pathways.
• Estimated assessment of impact from climate levers or other climate-centric initiatives such as commitments to provide certain amount of funding & financing aligned to sustainability-focused projects (determined by the use of proceeds aligned to certain principles such as Green Bond Principles, Green Loan Principles, EU Taxonomy).
• Use of proceeds from a bank’s own green bond issuance.
• Estimates of facilitated emissions from corporate bond underwriting.

• Some practical advice on how to approach the transformation of budget into CTP

We have given various pieces of advice of the back of our personal experience and learning from colleagues we work with:

• Begin here and now, don’t wait for a perfect moment with less volatile external environment, better economics or better and more reliable data. This moment may never come, but even if it comes, your ‘transition train’ might have already left by then.
• Get on the journey and be ready to constantly learn to maximise value generation.
• Appreciate you will likely not get it right first time and the road will be bumpy, but if you do not start it now you will not be able to assess how long your journey is going to be.
• Be mindful that CTP is timebound, so the later you start, the less time you leave your organisation to react and set an action plan aligned to the objectives of the Paris Agreement.
• Based on our experience some of the actions need to be really kicked out soon to allow to hit 2030 target.
• To get stakeholder buy-in, you will need to be clear on CTP linkage with purpose and strategy.
• Embed CTP through organisational governance to make sure climate considerations are part of decision making processes, especially for those key, strategic choices.
• Be clear when you talk about risks of doing or not doing things, but also make sure you have identified and flashed out opportunities clearly, because there is a business case for sustainability too.