Why climate-related risks and TCFD disclosures matter to businessOctober 28, 2022
Risks related to climate change are now ranked as top global risks. According to the World Economic Forum's Global Risks Report 2022, climate action failure and extreme weather are Earth’s two greatest risks over the next 5 to 10 years. These two factors are drivers for additional environmental risks such as biodiversity loss, natural resource scarcity, and human environmental damage. In fact, 2022 was the first year in which environmental risks dominated the top five global risks.
Climate-related risks are business risks that can have a significant impact on a company’s revenue, expenses, operations, and strategy. A 2019 report found that over 200 of the biggest global companies report almost US$1 trillion at risk from climate impacts, with many likely to hit within the next five years.
So what exactly are climate-related risks?
Climate-related risks consist of both physical risks resulting from the direct impacts of climate change (such as extreme weather events) and transition risks related to efforts to transition to a lower-carbon economy (such as carbon pricing). These risks can lead to significant business impacts.
1. Physical risks
Physical risks are those that pose a direct threat to human lives, infrastructure, and business activities. These can include acute risks, such as those caused by climate-related hazards like extreme storms, flooding, heatwaves, and droughts, as well as chronic risks, such as from rising sea levels, desertification, and increased average global temperatures.
2. Transition risks
Transition risks are risks to businesses resulting from global efforts to transition to a net zero economy. Transition risks can be divided into four main categories:
- Policy and legal risk – Carbon pricing, regulation of existing products and services, exposure to litigation
- Technology risk – Product obsolescence, unsuccessful investment in new technologies
- Market risk – Changing consumer behaviour, uncertainty in market signals, stranded assets
- Reputation risk – Shifts in consumer preferences, increased stakeholder concerns, sector stigmatisation
With risk comes opportunity
Efforts to mitigate and adapt to climate change will result in major disruptions to all sectors of the economy. However, these disruptions will offer not only new risks, but also new business opportunities. A 2019 report found that:
- Climate business opportunities are worth US$2.1 trillion, nearly all of which are highly likely or virtually certain.
- The potential value of sustainable business opportunities is almost seven times greater than the cost of realizing them (US$311 billion in costs, US$2.1 trillion in opportunities).
- Financial companies are forecasting US$1.2 trillion in potential revenue from low emissions products and services.
How do businesses assess climate-related risks?
Risks are influenced by three interacting variables: hazard, exposure, and vulnerability. Assessing each of these variables is key to assessing climate-related risks. The level of exposure and vulnerability ultimately determines the relative risk level for a given hazard.
A typical risk assessment would include input from the various business units and regional locations to ensure that all significant business risks are considered. A business would normally assess short-, mid-, and long-term risks to climate-related hazards, using several global warming scenario projections.
The level of detail of a risk assessment depends on available data and the individual requirements of a company to report on risks. At a minimum, a company should identify key climate-related risks and perform a materiality assessment to rank risks and highlight potential risk “hotspots”. The table below provides a simplified example of how to provide a high-level overview of climate-related risks for a given climate change scenario.
Benefits of assessing and disclosing climate-related risks
Climate-related risks are a type of business risk. Assessing and managing such risks allows companies to identify risk hotspots and better mitigate potential financial and strategic impacts related to climate change.
Potential benefits of assessing and disclosing climate-relate risks include:
- Increased understanding of climate-related risks and opportunities within the company, resulting in better risk management and more informed strategic planning.
- Opportunities to identify new business opportunities associated with a transition to a low-carbon economy, for example, new low-carbon products and services.
- Better access to capital by increasing investor and lender confidence that the company’s climate-related risks are appropriately assessed and managed.
As the call for corporate transparency grows, assessing and disclosing climate-related risks and potential financial impacts also has the advantage of satisfying stakeholder demand. To help standardise this disclosure process, an international framework was developed in 2017, known as the TCFD (Task Force for Climate-related Financial Disclosures) recommendations.
TCFD recommendations for reporting are contained within four pillars: Governance, Strategy, Risk management, and Metrics and targets.
Climate-related risks have become significant business risks. By measuring, managing, and disclosing such risks, your company will be in a better strategic position to mitigate and adapt to climate change and to meet the growing demand to disclose climate-related risks to your shareholders.
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