Climate change is already showing its effects on businesses. Climate-related risks could have a real financial impact on corporations, investors, and insurers. With growing regulatory and public pressure, more companies are integrating climate-related risks and opportunities in their risk assessments and strategy. Still, it seems difficult for many to grasp it and to implement a relatively new way of thinking to assess climate-related risks and opportunities and formulate an effective response.
Over the past decades, climate change has grown into one of the biggest challenges facing our world. Because of the severity of the problems, climate change is not easy to grasp. What’s even harder is for corporations to adopt a new way of thinking in order to assess and eventually mitigate climate-related risks.
Remote climate-related risks are quickly becoming serious financial impacts
Severe weather events are already damaging critical infrastructure and disrupting supply chains, while the transition to a lower-carbon economy is bringing new regulations and changes to market dynamics. Several carbon-intensive companies are already facing lawsuits over their contributions to climate change. Together these developments threaten to bring serious financial risks to companies and their investors, lenders, and insurers. Climate change shows its effects on businesses. As an example, the company Pacific Gas & Electric (PG&E) found out the hard way. It became the largest utility in the U.S. to declare bankruptcy triggered by $30 billion in liabilities from wildfires. California faces an increasing threat of wildfire disasters, which forced PG&E, as well as other companies in the state, to consider how to prepare for more frequent and impactful climate-related events.
Investor pressure forces climate action
Meanwhile, the Paris Agreement, imminent regulation, and shareholder activism have led to a growing group of investor commitments to climate action. As an example, the investor support for the Follow This climate resolution, asking Shell to shift investments to renewables and to align reduction targets with the Paris Agreement, more than doubled since 2020. The investor led initiative Climate Action 100+, with $54 trillion in assets under management, is pushing companies to take action on climate change. In addition, the CEO Larry Fink of the world’s largest investment management firm, BlackRock, stated in his annual letter to chief executives in 2020 that “"climate risk is an investment risk” and that “as markets started to price climate risk into the value of securities, it would spark a fundamental reallocation of capital”. There is a need for companies to respond to these investor needs and understand the financial impacts from climate change that they may face.
Reporting on climate-related risks becoming mandatory soon
The increasing expectations from investors and other stakeholders require more transparency and disclosure of information into how corporations not only identify and manage climate-related risks and opportunities. In 2015, the Financial Stability Board formed the Task Force on Climate-related Financial Disclosures (TCFD). Currently, about 2,000 companies with a combined market capitalization of $19.8 trillion and financial institutions managing $175 trillion in assets are supporting the TCFD’s recommendations on climate-related disclosures. In addition, the G7 nations recently agreed to make climate reporting mandatory, based on the TCFD recommendations. And also the EU, the IFRS Foundation and the US are preparing for mandatory disclosure of climate-related risks and opportunities.
A four-step approach to understand and address climate-related risks and opportunities
The above developments demonstrate that the world has changed. While climate change has been a recognized risk with large potential implications, climate risk has long remained at the bottom of the corporate agenda. Until now. For most companies, assessing, disclosing and responding to climate-related risks and opportunities is a new challenge. So how to approach this? KPMG has developed a four-step approach to understand and address climate-related risks and opportunities:
- Identify financially material climate-related risks along the company’s value chain. At the same time, by assessing these risks, organizations can capture key opportunities, like efficiency, innovation, access to new markets, and resource diversification.
- Develop climate scenarios to understand how the identified risks and opportunities may impact the business. Scenario analysis is a key aspect of the TCFD framework, aiming to assess the resilience of the company’s business under different potential future levels of temperature rise.
- Quantify the risks and opportunities under each scenario to determine the potential financial impact on the business and be able to define responsive actions to mitigate or adapt to the effects.
- Integrate climate-related risks into risk management processes and implement strategic takeaways to benefit from innovations and new technologies, new products and services, and retain talents.