Awareness in the business community is growing on the need to integrate climate-related risks into risk management processes. But before starting this journey, companies need to understand how to identify climate-related risks and opportunities.
Climate-related risks are often underestimated by companies because of their complexity and long-term effects. However, today, many companies are already facing the impact of climate-related risks. For most companies, identifying, managing, and disclosing the topic of climate-related risks and seizing the opportunities of climate change are new challenges, and therefore they don’t know exactly where to start.
Companies should realize what they are up against, and need to understand their key risks, as well as the interconnectedness of these risks, to be able to come up with mitigation and adaptation measures. At the same time, by assessing these risks, organizations can capture key opportunities, like efficiency, innovation, access to new markets, and resource diversification.
We have defined four steps to help companies with identifying their climate-related risks and opportunities , which will be explained in this blog.
Firstly, it is crucial to start defining the scope of the identification assessment of climate-related risks and opportunities. Climate-related risks can be divided into risks related to the physical impacts of climate change (e.g. extreme weather events and rise of sea level) and risks related to the transition to a lower-carbon economy (e.g. changing market demand and carbon pricing). Which type of risks does your company want to focus on: physical and/or transition risks?
We see two main approaches companies take to scope their climate-related risk identification . There is the ‘holistic scope’ including multiple risk types that will impact their entire value chain (i.e. suppliers, operations, customers, regardless of their locations). Then there is the ‘focused scope’, in which companies decide to focus only on a specific type of risk (e.g. flood risk) or a certain part of their business (e.g. one product category or geographic location).
The second step in identifying climate-related risks is to understand the different risks and opportunities associated with climate change within the defined scope. Whichever approach you choose, it is key to start thinking about vulnerabilities (being unable to cope with and adapt for adverse effects of climate change) and exposure (the monetary value of various types of property, infrastructure, or lives that may be subject to undesirable outcomes) and ask the following type of questions:
What could be the financial impact if consumers change their behavior towards low carbon products? For example, physical risks such as rising sea levels and increasing extreme weather events may have financial implications for companies, such as direct damage to assets and indirect impacts from supply chain disruption. But while some risks can be daunting, climate change can also lead to business opportunities if companies can address, mitigate and adapt fast – such as energy efficiency, cost savings, resilience, and competitive advantages.
A robust understanding of potential climate-related risks and opportunities can be best obtained through desk research, expert views and benchmarking, as well as through holistically incorporating the views of internal and external stakeholders. You can think of different departments within your company, such as Strategy, Risk, Legal, Finance and Operations departments. This step leads to a longlist with identified potential risks and opportunities within the defined scope.
Next, every organization needs to understand from a high-level perspective what the implications of these identified risks could be for the business. The business impact varies significantly depending on the industry and economic (sub)sector, geographic location of the organization’s value chain, the organization’s assets and organization’s customers, and other key stakeholders. Business implications could be direct (e.g. expenditure, revenue, assets, liabilities) and indirect (e.g. delay in delivery, drop in demand, disruption of supply chain, compliance breaches, reputational damage). For example, for a global food manufacturing company, an increase in temperature could negatively impact the crop yield (leading to increased costs of raw materials) and could impact operations and cooling facilities (leading to an increased cost of cooling capacity). Within the defined scope, it is crucial to determine how each risk and opportunity may or may not materialize under different scenarios. Will they impact your company directly, or indirectly?
Once your organization has made a long list of risks and opportunities, it is important to understand how these risks and opportunities are interconnected . For decades, organizations have used a two-dimensional approach to predict risk, grading individual risks according to their likelihood and severity. But this method is increasingly incapable of foreseeing and preventing crises that arise from complex chain reactions and tipping points. A Dynamic Risk Assessment (DRA), by contrast, investigates the structure of the whole risk system to understand the connections between risks and the speed at which risk impacts could occur. For example, rising global temperatures are leading to global sea level rise by causing the melting of glaciers and the land-based ice sheets in polar regions, as well as the thermal expansion of ocean water. Subsequently, an increased risk of sea level rise can amplify risks on flooding along coastlines and estuaries, during high tides and storms.
By analyzing the interconnectivity of risks and understanding its business impact, the key constructs of risks will be more clear and can be used as input in the organization’s risk management framework and for the scenario analysis .
KPMG supports clients in understanding the nature and scale of climate-related risks and opportunities, developing robust and insightful climate scenarios, and implementing strategies to mitigate climate-related risks and seize climate-related opportunities. We also help clients understand and implement TCFD recommendations and the increasing number of climate-related regulations. Let our experts guide you while preparing your business to thrive in a new, low-carbon world.