Earth’s climate is changing. On average, temperatures have risen by 1.1 degrees Celsius over the past 150 years, and it’s not stopping there. In many parts of the world, average temperatures are expected to rise to 1.5 degrees Celsius above pre-industrial levels by 2050.
Though these numbers might sound small, this is an enormous change. And it’s happening fast. In fact, scientists report that the current rate of warming is at a magnitude not seen in the past 65 million years.
As a result, we are already seeing a wide range of extreme weather events and climate risks. Some are happening slowly, such as rising sea levels. Others are happening rapidly, such as the onset of tropical storms, wildfires, flooding, and heat waves.
In this article, we explore the different types of climate risk, and what this might mean for your business in terms of potential costs – and possible benefits – as well as a regulatory changes, and provide an overview of how you can begin to manage your organization’s climate risks.
Let’s get started.
what is climate risk?
In simple terms, climate risk is the potential for climate change to create negative impacts on people and the environment.
It is felt by everyone including both individuals and organizations, however the impacts of climate change are not spread evenly around the planet. Research has shown that there are a staggering 3.6 billion people already living in areas that are highly vulnerable to climate change.
For organizations, climate change threatens to impact every sector, across every part of the world, with varying degrees of risk.
According to the Intergovernmental Panel on Climate Change (IPCC), climate risk involves three factors:
- Hazards – the potential causes of harm
- Exposure – the extent to which people will experience harm
- Vulnerability – how strongly people will be affected by harm
“In the near term,” the IPCC states, “every region in the world is projected to face further increases in climate hazards” and, “the risks and related losses from climate change will escalate with every increment of global warming.”
In other words, the risks of climate change are real and their effects are already being felt around the world.
different types of climate risk
When people speak about climate risk, they often divide this into two main categories as per the Task Force on Climate-related Financial Disclosures’ 2017 Recommendations Report. Let’s take a look at these two categories which comprise: physical risks and transition risks.
1. physical climate risk
Physical climate risk is related to the physical impacts of climate change.
It includes acute risks, which are event-driven such as tropical storms, flooding, droughts, and heat waves. These type of events happen quickly and although their impact may be short lived, they can be highly destructive.
Chronic risks, on the other hand, are longer-term changes in the climate. These often evolve gradually over time, although their impacts are usually irreversible. This could include risks such as rising sea levels, changes in precipitation over time, sustained humidity changes, or water scarcity.
The impact of these physical risks can be felt by every industry sector, in every country, around the world. These changes also carry inherent financial risks, which could be experienced by your organization in various ways.
2. transition climate risk
Put simply, a transition climate risk is one that’s related to the transition to a lower-carbon economy. Effectively, as the world seeks to reduce greenhouse gas emissions and move to a low carbon economy, there will inevitably be change. Depending on how fast this occurs, it can create different levels of reputational and financial risk for your organization.
To understand these transition risks, we can look at four main categories: policy and legal risks, technology risks, market risks, and reputational risks.
Policy and legal risks stem from the fact that you need to keep up with the latest legal requirements. Many countries are implementing legislation to report and reduce greenhouse gas emissions or stimulate adaptation strategies. This means you could face litigation if you fail to mitigate the risks of climate change, adapt to it, or make adequate disclosures around financial risk.
Technology risks refer to the ways that evolving technologies create winners and losers in the transition to a lower-carbon economy. New technologies are created and older technologies are replaced, which can have a significant impact on your organization. It may be that there are costs associated with transitioning to lower-emitting technologies or that investment in newer technologies fails to reap rewards. In either case, resources will be required to adapt.
Market risks relate to the changes in supply and demand for certain products or services as economies transition to lower-emissions choices. For example, some raw materials may become more expensive as demand increases. Not only that, but as consumer behavior and purchasing preferences alter, your organization may need to change course.
Finally, reputational risks stem from the fact that a shift to a lower-carbon economy can lead to changing consumer or community perceptions of an organization’s action or inaction. This might see your organization face negative stakeholder feedback or specific consumer concerns, as well as potential stigmatization of entire industries, sectors or business practices.
As you can see, climate change poses many risks for organizations. In the next section, we dive deeper into why your organization should be paying attention to what lies on the horizon.
why your organization should care about climate risk
There are many reasons to address climate risk. First, it’s safe to expect that every sector will be impacted at some point, and second, there will be winners and losers so the actions you take now can set a trajectory for the future.
As with any change, the risks involved could result in costs. But they could also result in opportunities. Here we explore a few of the potential outcomes from the various risks we have described.
counting the costs
If climate-related risks are actualized, you can expect to pay a price. There are potential financial impacts to climate risk, and some of these could be significant.
Below are some of the effects that could result from physical risks:
- Loss of existing assets damaged due to acute events
- Decreased revenue due to reduced production capacity during supply chain interruptions, or due to damaged facilities
- Decreased revenue or higher costs due to the impact on your workforce such as absenteeism or poor health
- Increased operating costs resulting from higher prices for raw materials, water scarcity, or increased electricity costs
- Increased capital costs as you seek to replace or repair damaged facilities
- Decreased sales because customers are affected, or there are interruptions to downstream activities
- Increased insurance premiums or reduced insurance availability for facilities located in “high-risk” areas
And here are some examples of financial impacts and knock-on effects that could arise from transition risks:
- Policy and legal risks:
- Loss of existing assets because of policy changes
- Decreased sales and reduced demand for your products or services resulting from fines or judgments
- Higher operating costs resulting from increased compliance costs, or increased insurance premiums
- Technology risks: Loss of existing assets because of obsolete or new technology
- Increased capital investment required to switch to new technology or fund research and development into alternative technologies
- Reduced demand for your products or services because of more favorable technologies
- Market risks: Reduced demand for your products or services thanks to changes in consumer preferences
- Decreased revenues stemming from decreased sales
- Increased production costs caused by higher costs for raw materials, water, electricity, or waste treatment
- Repricing of assets because of changes to fossil fuel reserves, land valuations, or securities valuations
Reputation risks:
- Decreased revenue caused by reduced consumer demand
- Decreased production capacity because of supply chain interruptions, poor employee retention, or delayed planning approvals
- Less capital available due to changing preferences of investors or lenders
reaping the benefits
On the other hand, there can be benefits for those organizations that try to get ahead of climate risks. Although climate change is going to continue due to simple inertia, there is still an opportunity to slow it down. Adaptation is also crucial at this juncture for those that want to succeed.
According to the EPA, “Climate-related opportunities will vary depending on the region, market, and industry” but they can include:
- resource efficiency and cost savings
- the adoption of low-emission energy sources
- the development of new products and services
- access to new markets
- maximizing new policies that subsidize efficiencies and clean energy
- building resilience along the supply chain
By taking proactive action now to mitigate climate risk, you can sidestep some problems and even increase your profitability. As we explore in our blog post here, there are, in fact, a variety of compelling reasons to prioritize ESG risk management, not least that it can improve your ability to secure capital and retain investors.
understanding your disclosure requirements
If the push and pull of costs and benefits isn’t enough to provide impetus for change, recent (and impending) regulatory requirements ought to be.
Countries and regulatory bodies around the world are introducing new or tighter requirements that compel many corporations to report on metrics related to their climate-related activities. From a financial-disclosure perspective, this is to protect investors and reduce incidents of corporate greenwashing.
Those who are taking action include:
- Australia – In June 2023, the Australian Treasury released a Climate-Related Financial Disclosure Consultation Paper. The paper outlines the requirements that certain Australian companies may have to follow related to climate disclosures – as soon as 2024.
- Canada – In 2021, the Canadian Securities Administrators (CSA), which regulates securities and publicly-traded companies in Canada, proposed aclimate-related disclosure requirement for financial institutions and ESG-related requirements for large and listed entities.
- European Union – In January 2023, the European Union’s (EU) new Corporate Sustainability Reporting Directive (CSRD) entered into force. The first companies that will be required to report using the new rules will have to do so in the 2024 fiscal year, with their reports published in 2025. These companies will be required to report using the European Sustainability Reporting Standards (ESRS).
- India – The Business Responsibility and Sustainability Report (BRSR) came into effect in 2023 and is the first framework in India that requires eligible Indian companies to report metrics on sustainability-related factors. Beginning in the 2022-2023 fiscal year, all eligible Indian companies must prepare a BRSR-compliant report.
- USA – In March 2022, the US Securities and Exchange Commission (SEC) announced proposed rule changes requiring registered companies to include specific climate-related disclosures in their registration statements and periodic reports. Once finalized, these disclosures will cover information about climate-related risks, along with key climate-related metrics to be included in their audited financial statements. This will include greenhouse gas emissions disclosures.
For a deeper dive, check out our blog post: ESG Regulations Around the World in 2024.
how to manage climate risk
If all that has got you thinking, it’s good to know that there are many ways to manage your climate risk. The following key steps can help you begin the process.
step one: discover
This will involve different activities based on the nature of your organization, but commonly includes conducting a gap analysis, engaging stakeholders to understand what metrics to report against, and creating a roadmap in alignment with any local reporting requirements.
step two: assess
Typically this will include scenario analysis to identify possible physical and transition risks, as well as opportunities. It’s important to look at location-specific information like historical weather data. From there, you can undertake a climate risk assessment to establish the potential impact of these risks, along with goals, metrics, and reporting targets to help mitigate impacts.
step three:report
Next, comes time for reporting. This involves developing and preparing regular reports to evaluate progress towards your goals including submitting any reports required by legislation or by your investors. It can be helpful to use a tool like the AMCS Sustainability Platform to collect data, turn insights into action, and automate reporting.
step four: manage
Finally, the management phase involves implementing your roadmap, monitoring and re-evaluating risks, and continually improving your processes and programs.
take action today
Climate risk isn’t going away any time soon. Instead, it’s only becoming more significant. Now is the time to take action and get ahead.
To see how AMCS can streamline your climate risk data collection, management, and reporting, speak with one of our experts today.