It’s all in the planning: three key challenges to consider when designing a transition plan

Deloitte’s series of blogs on transition plans is intended to set out a path for financial services firms to navigate the recommended guidance as well as to present a framework for them to design, implement and report on their own transition plans effectively. Our approach draws on guidance, recommendations, and standards from the Glasgow Financial Alliance for Net Zero (GFANZ), the Transition Plan Taskforce (TPT) (final recommendations expected in October 2023), the Taskforce on Climate-related Financial Disclosures (TCFD), and the International Sustainability Standards Board (ISSB), within three phases - Aim, Plan and Report - while introducing two additional phases for operational design and delivery - Structure and Deliver.

This blog sets out what we consider to be the second stage of the process in Plan, outlining the decarbonisation strategies, skills, resources, and incremental steps needed to achieve the targets established in the Aim phase.

It’s all in the planning: three key challenges to consider when designing a transition plan.

At a glance:

• This blog is the latest in our series of blogs on transition plans. Our series presents our framework to support financial services firms as they design, implement and report on their transition plans.
• This blog addresses the ‘Plan’ phase of our framework. It outlines the decarbonisation strategies, skills, resources, and incremental steps needed for a firm to achieve its decarbonisation targets.
• We identify three priority actions for firms:

1. Identify decarbonisation potential across the business and portfolios – firms need to assess which practical levers they have that will most likely enable them to reach their greenhouse gas (GHG) emissions targets in the most effective way.
2. Set out the engagement programme - a programme of sustained engagement with portfolio clients and companies is central to how firms pull on their strategic levers. Firms are making progress on developing scoring tools to inform engagement, but they also need to think about how engagement can be optimised to drive decarbonisation outcomes.
3. Lay out implementation steps and assess financial implications - many firms have lengthy to-do lists sitting behind their strategy documents, but firms now need to ensure that they have assessed the financial implications of these actions.

• To meet regulatory and industry expectations and recommendations, as well as their own commitments, it is crucial that firms have a detailed plan to show what levers they will use to deliver their transition plan, how they will engage with stakeholders and across the value chain, and assess the financial implications of their plan.

Relevant to: CEOs, Chief Sustainability Officers, CFOs, CROs, CCOs, and those working on sustainability in Risk, Compliance, and Finance across banking, insurance, and investment management.

Decarbonisation targets are at the core of any effective transition plan. Once firms have established targets, they need a detailed plan to achieve them.

Firms are making progress. The CDP, a global charity focused on environmental disclosures, found that more than 4000 out of 18,600 companies they looked at disclosed that they had a climate transition plan. However, a lot more work needs to be done, as they determined that only 0.4% of companies disclosed a credible climate transition plan, when measured against their 21 transition planning indicators.

Firms can draw on the guidance and recommendations set out by the GFANZ and in the proposed TPT framework, to set out a clear strategy and milestones for reaching net zero emissions.

Our series of blogs on transition plans is intended to set out a path for financial services firms to navigate the recommended guidance as well as to present a framework for them to design, implement and report on their own transition plans effectively. Our approach draws on guidance, recommendations, and standards from GFANZ, the TPT, TCFD, and the ISSB, within three phases - Aim, Plan and Report - while introducing two additional phases for operational design and delivery - Structure and Deliver.

This blog sets out what we consider to be the second stage of the process in Plan, outlining the decarbonisation strategies, skills, resources, and incremental steps needed to achieve the targets established in the Aim phase.

Previous blogs in the series:

• Setting the direction for your transition plan – this blog introduced our five-phased approach to transition planning.
• Taking aim at transition planning? Start with strong foundations – this blog focused on the Aim phase and set out the importance of establishing a baseline for emissions, utilising sector-specific pathways to set targets, and incorporating transition plans within the broader business strategy.

1. Identify decarbonisation potential across your business and portfolios

Firms need to look at their own business models and assess which practical levers they have that will most likely enable them to reach their GHG emissions targets in the most effective way, while also taking into account business and customer needs. The focus should be on relevant actions, resources, and projects that the firm is able to use to enable entity-led decarbonisation and influence economy-wide decarbonisation.

GFANZ recommends that firms have strategies across four levers to finance and enable: (i) the development and scaling of climate solutions; (ii) entities that are already aligned to a 1.5 degree Celsius pathway; (iii) entities that are committed to aligning to a 1.5 degree Celsius pathway under robust transition plans; and (iv) the managed phase-out of high-emitting assets.

Other levers that firms might want to use beyond direct engagement include offering incentives attached to decarbonisation, adjusting risk models and processes to include transition targets, and using net zero as a category in procurement and third-party contract evaluation.

There are other tools available, such as carbon in-setting and carbon off-setting. However, firms’ primary focus should be on decarbonisation and reducing real economy emissions within the value chain, with the use of carbon credits for residual emissions. Firms should ensure that any reliance on voluntary carbon markets and/or carbon investments is based on scientific evaluation and credible emissions-based metrics to show a positive contribution to net zero.

2. Set out the engagement programme

A programme of sustained engagement with portfolio clients and companies is central to how firms pull on their strategic levers. This is critical for each of GFANZ’s four financing strategies, where engagement helps to avoid divestment pitfalls and keep clients on target.

Firms are making progress on developing scoring tools to inform engagement on transition planning where BAU company emission trajectories are reconciled with company targets and reference industry pathways. Firms can now also consider alignment feasibility by analysing transition plan disclosures where available. Where not available, firms can use TCFD disclosures and climate strategy documents supplemented by direct engagement to assess alignment feasibility.

Currently, coverage by sector or proportion of portfolio emissions is limited. Scoring methodologies will inevitably be refined as corporate disclosures mature, but that should not stop firms seeking to improve portfolio coverage using current methodologies.

Few firms have moved past scoring to think about how engagement can be optimised to drive decarbonisation outcomes. There are several questions firms can consider. What are sensible engagement objectives and milestones? What are the most effective engagement mechanisms? When should engagement escalate to divestment? How can engagement outcomes be tracked and governed transparently? The resources firms dedicate to answering these questions will determine how successful their engagement programme is and if they gain or lose competitive advantage.

The TPT recommends engagement with peers and policy makers as a key aspect of transition planning, but this engagement also often lacks an optimisation approach, with many firms weighed down by industry memberships and government consultations. These types of engagements should be purposeful and streamlined, conducted in line with the overarching engagement strategy.

3. Lay out implementation steps and assess financial implications

TPT recommends that firms lay out the steps they will take over the short, medium and long term to achieve their targets and the financial implications of taking the steps. Many firms now have lengthy to-do lists sitting behind their strategy documents, but few have assessed the financial implications of these actions.

TCFD guidance, which is referenced in FCA TCFD-aligned disclosure rules applicable to listed issuers, asset managers, and asset owners, is that the transition plan should describe its supporting financial plans, budgets, and related financial targets. However, the CDP found that on average only 3% of organisations it looked at disclosed sufficiently on financial planning, according to its own framework.

One reason why few firms have conducted this analysis is because many of their ‘next steps’ relate to completing strategy work. Firms are still expanding coverage of emission baselining and target setting across sectors, as well as developing their engagement strategies.

Consequently, often the only financial planning that has been completed is budget allocation for consulting services. In addition, firms have often provided high-level projections of growth for products and services in new ‘green’ sectors, but without analysing the reduction in income from legacy ‘brown’ sectors.

TPT implementation guidance sets out further detail on financial planning which firms can leverage. It recommends that entities assess and disclose how they expect their financial position, performance, and cash flows to change over time given the actions they are planning to take to meet their climate objectives and priorities, and how these actions will be resourced. We would expect this to reflect, for example, current and committed capital allocation plans, internal investment needs for MI system development and training, changes in revenues, changes in profit margins, and operational expenditures.

As part of this, firms will need to undertake sensitivity analysis to understand the dependency of the plan on the specific assumptions that underpin it. This might include scaling new technology, supply chain action, policy change, and shifts in demand. This analysis will allow firms to assess and monitor the feasibility of their plans.

The Finance team will be integral to this work and will need to ensure consistency with general purpose financial reporting.

Conclusion

To meet regulatory and industry expectations and recommendations, as well as their own commitments, firms need to go beyond setting an emissions baseline and targets and have a detailed plan to show what levers they will use to deliver their transition plan, how they will engage with stakeholders and across the value chain, and assess the financial implications of their plan.

Working with clients and contractors will be key to delivery, especially for scope 3 emissions, and firms should use sector-specific pathways to help identify opportunities to influence stakeholders. We will get further clarification and guidance on how regulators in the UK expect firms to develop sector-specific pathways when the TPT publishes its consultation in Q3 2023.