Climate change has become a present reality with considerable implications for the business sector. Climate-related risks can affect a company's long-term financial performance and addressing these hazards is becoming more important for investors. The need for companies to understand, monitor, manage, and mitigate their climate-related risks has never been more present.
Understanding climate risk
Climate risk reporting entails revealing the potential financial consequences of climate change on a company's operations and strategy. These dangers are classified into two types:
Physical risk – direct material and tangible impact on the company value, operations/services due to the increasing and extreme climate changes. Typical examples are the disruption in supply chains, damage to property, and reduced productivity – all caused by severe natural disasters.
Transition risk – financial or reputational losses, resulting in an adjustment to a low-carbon and more sustainable economy. Examples include the adoption of strict legislation/regulations for environmentally and socially responsible activities, requiring more investments and restructuring in existing businesses; implementation of energy efficiency standards triggering sizeable adaptation costs; change in market sentiments towards non-ESG-compliant / negatively impactful businesses, leading to loss of market share and higher risk premiums in the cost of capital.
In addition, companies should also consider the systemic risk that climate change poses to the global economy, and factor in potential adverse events, such as disruptions to international trade and supply chains, market volatility, and economic instability.
Regulatory landscape: TCFD, SFDR, and CSRD
Several regulations and frameworks guide companies in climate risk reporting.
Task Force on Climate-related Financial Disclosures (TCFD) – provides a framework for companies to disclose climate-related financial risks and opportunities. By integrating climate risks into financial planning and risk management, businesses can reduce their exposure to climate hazards.
Sustainable Finance Disclosure Regulation (SFDR): requires financial market participants and financial advisors to disclose how they integrate sustainability risks into their investment decisions and advice.
Corporate Sustainability Reporting Directive (CSRD): expands the scope of companies subject to disclosure of sustainability and requires big companies to report on the environmental and societal impact of corporate activities and provisions for audit of reported information.
Why climate risk reporting matters
Kofi Annan, former Secretary General of the United Nations, once said: “On climate change, we often don't fully appreciate its significance. We think it is a problem waiting to happen."
Climate change failure and extreme weather are the two largest hazards to Earth over the next 5 to 10 years, according to the World Economic Forum's Global Risks Report 2022. These two elements are major contributors to other environmental concerns such as biodiversity loss, natural resource scarcity, and human environmental damage. Environmental risks topped the top five global risks for the first time in 2022.
A 2019 report by CDP found that over 200 of the biggest global companies report almost 1 trillion US dollars at risk from climate impacts, with many likely to hit within the next five years. Companies that properly manage and disclose their climate risks are more likely to be resilient in the face of climate change, thereby providing investors with stable long-term returns.
Investors need relevant, accurate, comparable, and decision-useful information to inform their decision-making. Big corporates are incorporating ESG considerations in their supply chain management. Understanding a company's climate-related risks, and how risks are managed is critical for attracting funding and gaining vendor contacts. For startups and scaleups, climate risk reporting can help attract investments and win vendor contracts by demonstrating a robust approach to risk mitigation and commitment to sustainability.
Practical advice for effective climate risk reporting
Materiality and risk assessment: Identify and assess the physical and transition risks that climate change poses to your business.
Integration into decision-making: Incorporate climate risks into business strategy, risk management, and financial planning processes.
Incorporate climate hazards into risk management processes: Climate hazards should be included in the entire risk management processes of the firm. This entails recognizing and evaluating climate-related hazards, as well as incorporating them into company strategy and decision-making.
Use scenario analysis: Scenario analysis can assist businesses in understanding how different climate-related scenarios may affect their operations. This can help firms plan strategically and prepare for a variety of probable future scenarios.
Set and disclose climate-related targets: Companies should set targets related to their climate risks and opportunities and disclose their progress towards these targets. This can demonstrate a commitment to managing climate risks and capitalizing on opportunities.
Engage with stakeholders: Effective climate risk mitigation and reporting involves engaging with a range of stakeholders, including investors, customers, employees, and regulators. This can help ensure that the company's disclosures are relevant and actionable.
In conclusion, climate risk reporting is a critical tool for managing the financial implications of climate change. By assessing the material factors for the company, integrating climate risks into risk management processes, using scenario analysis, setting and disclosing climate-related targets, and engaging with stakeholders, companies can enhance their resilience and capitalize on the opportunities of the transition to a low-carbon economy.
You can’t control what you don’t measure. Start with your ESG assessment now.