Chris McCann, WhichPLM Expert and Director of Resilient.World, is a well-known figure in compliance and sustainability. Here, he discusses the links between the worlds of Finance and Fashion when it comes to sustainability. Circular Fashion, believes Chris, is well within our reach.
Fast fashion, and sustainability.
The two are rarely viewed as anything other than mutually exclusive – opposite ends of a spectrum, the one being the antithesis of the other, ‘Tree Huggers’ vs. ‘Wolf of Wall Street’. It’s a binary argument, often characterised by deliberately reductive statements from both camps – buyers who state “we’re not a charity”, and activists who refuse to acknowledge that their current standard of living, undreamt of throughout history, is the result of that system against which they rail.
And so we’re left at something of an impasse.
It’s an impasse that will likely be broken in the very near future, however, although this will require intelligent redesign of current operating models. Progressive business is beginning to step back and review its value chain, from acquisition of raw material through to product end-of-life, and adjust accordingly. Business transformation principles applied to a circular economy strategy (stabilisation, extended lifecycle, and on to closed loop), likely enabled by digital technologies, advanced manufacturing techniques and reshoring, are beginning to create a sustainable proposition attractive to the new, climate-sensitive investor community: Circular Fashion. True, although there are switching costs involved these are unlikely to be anywhere near as heavy as those experienced by other sectors such as oil and gas, or automotive.
Circular Fashion is well within our reach. The real issue, as always in these matters, is the lack of critical thinking applied by some brands, the avoidance of risk modelling and the desire to maintain an attitude of ‘business as usual’. However, there are powerful drivers for change that are increasingly evident and come from arguably the most persuasive of sectors: the finance and investment community. Fashion brands would do well to pay attention to recent developments here, understand that these are not ‘charitable initiatives’, and consider the implications for their business. Ponder the following:
A New Financial System
Mark Carney, current Governor of the Bank of England, noted recently that “a new, sustainable financial system is under construction. It is funding the initiatives and innovations of the private sector and amplifying the effectiveness of governments’ climate policies…”. He stated:
“…the demand for TCFD (Task Force on Climate-related Financial Disclosures) disclosure is now enormous. Current supporters control balance sheets totalling $120 trillion, and include the world’s top banks, asset managers, pension funds, insurers, credit- rating agencies, accounting firms, and shareholder advisory services. As a result, companies are much more highly motivated to disclose and manage climate-related risks. Moreover, climate change claimed its first Standard & Poor’s 500 bankruptcy last year, and climate-related shareholder resolutions spiked to 90. Investment managers controlling more than 45% of global assets under management now back shareholder actions on carbon disclosure, and companies representing over 90% of all shareholder advisory services now support the TCFD. And disclosure is on the rise: four-fifths of the top 1,100 G20 companies now disclose climate-related financial risks as some TCFD recommendations advise. Three-quarters of those who use this information have seen an improvement in the quality of climate disclosure. The next step is to make disclosure mandatory, as the United Kingdom and European Union have already signalled.”
An early example of such signalling came with the introduction of the EU Non-Financial Reporting Directive (NFR), which came into effect in 2018 and requires large companies and financial corporations to disclose information necessary for understanding their impacts on society and environment, as well as sustainability-related financial risks. The Directive requires companies to provide information on their business model, policies and due diligence processes, principal risks, and key performance indicators relating, at a minimum, to environmental matters, employee and social matters, respect for human rights, and anti-corruption and bribery matters.
Managing Financial Risk
The NFR is only the tip of a phenomenon that has grown and continues to grow to significant proportions in the finance community, expressed politically by parliaments in the United Kingdom and many other countries driven to declare a “climate emergency.” Record temperatures across Europe and North America, the worst wildfires ever in the Amazon basin, severe tropical storms in Asia, and sea levels that are rising faster than previously thought are focussing the minds of investors and legislators alike.
One likely catalyst to the introduction of the NFR was the announcement in 2017 of a record $140 billion in insured losses, eclipsed by an additional uninsured $200 billion. In some of the countries most exposed to climate change—Bangladesh, Egypt, India, Indonesia, Nigeria, the Philippines, and Vietnam—insurance penetration was less than 1%. The risks posed by climate change to supply chains, exacerbated in production countries where financial protection is often so low, should give brands pause for thought. In particular, brands should take heed of Carney’s observation, that climate change and financial risk management are now inextricably linked:
“The Bank of England is overhauling its supervisory approach…[and] will be the first regulator to stress-test its financial system under various climate pathways, including the catastrophic business-as- usual scenario and the ideal – but still challenging – transition to net zero by 2050 consistent with the UK-legislated objective. This stress test will bring cutting-edge risk management techniques into the mainstream, and it will make the heart of the global financial system more responsive to changes to both the climate and to government climate policies.”
Massive Reallocation of Capital
The financial risk considered is not short term. In 2018 the Intergovernmental Panel on Climate Change reported that the world has only 12 years left to stop runaway climate change – that is two average business cycles. The International Energy Agency estimates that a low-carbon transition could require $3.5 trillion in energy sector investment every year for decades—twice the current rate. Under the Agency’s scenario, in order for carbon to stabilize by 2050 nearly 95% of the electricity supply must be low carbon and 70% of new cars electric, and the carbon dioxide intensity of the building sector must fall by 80%. For the entrepreneurial minded, then, while it is true that to keep global warming below 1.5 ̊C will require massive reallocation of capital, this challenge presents unprecedented opportunity.
Financial Risk vs. CSR
There are those who would say that such a transition is unthinkable, and will not happen. Consider, however, the announcement by BP’s CEO Bernard Looney in February 2020 when he stated that BP is aiming to become “a net zero company by 2050 or sooner,” adding that it also wanted to “help the world get to net zero.” BP aims include: Cutting the carbon intensity of products it sells by 50% by 2050 or earlier; installing methane measurement at its major oil and gas processing sites by the year 2023 and halving the methane intensity of operations; and upping the proportion of its investment in non-oil and gas businesses. In this, BP appear to be in step with the finance community. Carney, once again:
“The Bank of England’s latest survey finds that almost three-quarters of banks are starting to treat the risks from climate change like other financial risks – rather than viewing them simply as a corporate social responsibility…”
Corporate Social Responsibility, or CSR, has proven to be an inadequate vehicle for change. The Alliance for Corporate Transparency, in its report ‘An analysis of the sustainability reports of 1,000 companies pursuant to the EU NFR Directive’, found that ‘Companies are reporting policy, not outcomes’, and that while 82% of companies have policies only 35% have targets, and even fewer – 28% – report on their outcome. It is clear, however, that through the lens of financial risk this focus on policy and not outcome will no longer suffice. Indeed, strenuous efforts are being made by analysts to understand and close the gap between policy and outcomes.
Squaring the Circle
Prudent brands that understand and react to the finance community’s direction of travel will place them ahead of the curve, and for the apparel sector it is Circular Fashion that squares the circle. I’ll leave you with a final thought from Carney:
“Changes in climate policies, new technologies, and growing physical risks will prompt reassessment of the value of virtually every financial asset. Firms that align their business models with the transition to a net-zero world will reap handsome rewards. Those that fail to adapt will cease to exist. The longer meaningful adjustment is delayed, the greater the disruption will be….”