1. Committing to a Science Based Target (SBT) means my business is insulated from Climate Risk
We often hear from clients that they have pledged to reduce their carbon emissions and therefore climate change does not pose a risk to their business. Whilst committing to an SBT is an indicator of responsible business, it does not protect a business from other impacts of climate change. These risks include both physical impacts (e.g. flooding, storms, drought and wildfire), and transition impacts (e.g. technology-driven market shifts, supply chain disruption and changes in resource costs). A carbon reduction target will likely be part of an appropriate mitigation to your transition risk exposure, but the Taskforce on Climate-related Financial Disclosures (TCFD) recommends companies consider a wide range of physical, market, reputational and legal risks in their approaches to climate risk identification, assessment and management.
2. We have an A in our CDP, so we’re on top of climate risk
The Carbon Disclosure Project (CDP) assesses disclosures on climate change and decarbonisation but does not assure the quality of the disclosure or underlying analysis. Plenty of companies who disclose to CDP, even those with ‘A’ scores, may not be appropriately assessing climate risks and opportunities internally or using the most robust analytical approaches. Stakeholder expectations are also shifting on how climate risk assessments are reflected in the assumptions underpinning company financial disclosures. Here are a few questions you can use to understand the quality and completeness of your climate risk disclosures:
a. Has the financial impact of all climate risks and opportunities been quantified in a consistent way under different future scenarios?
b. Have climate risks and opportunities been clearly linked to the company strategy, informing an assessment of your organisation’s strategic resilience to climate change?
c. Are climate related assumptions disclosed and applied consistently across the front half and back half of your annual reporting?
3. Climate risk analysis doesn’t provide a return on investment, therefore we are not interested in it
The purpose of climate risk scenario analysis is to assess an organisations’ full exposure to the impacts of climate change, including both risks and opportunities over different timescales. Limiting climate change to 1.5 degrees will require deep economic transformation across sectors, whilst failing to limit climate change will result in significant damages from climate impacts globally. Given the scale of the changes expected, early and effective scenario analysis can deliver significant ROI through both revealing opportunities for value creation and mitigating the risk of value destruction.
4. I’m not impacted by climate change because I’m not in the fossil fuel sector
Whilst some companies will be more exposed than others to climate change, climate risk is a systemic risk, meaning it can impact all sectors of the economy. These impacts arise because direct impacts, such as government policies or infrastructure damage, then have indirect consequences across the economy. Globalised operations and supply chains can increase exposure to these indirect, systemic impacts. Given the complexity involved, scenario analysis is the best-practice methodology recommended by the TCFD for companies seeking to understand the risks or opportunities ahead of their TCFD disclosure. We recommend using a quantitative climate risk model, capable of capturing indirect macroeconomic impacts, as the best way to monitor and manage these systemic risks.
5. Climate change is a long-term issue, we must focus on quarterly and annual priorities.
Climate change is happening here and now. Damage and disruption from hurricanes, wildfires and floods cost the world $210 billion in 2020 and these costs have increased every decade since 1970, according to Munich Re. These impacts are damaging infrastructure and assets and affecting insurance premiums today. Investor sentiment, a key driver for quarterly and annual earnings targets, is also increasingly shifting towards advocating for ambitious action on climate risk. Recent developments such as BlackRock’s communication to CEOs, S&Ps credit downgrade of several oil and gas companies and rapid growth in ESG investment or divestment has highlighted that climate is a near team financial and strategic risk for many companies. This combination of near- and long-term impacts means that your journey towards climate risk management should start now, with an assessment of what the most material climate impacts could be for your organisation. Given the speed of change in market expectations, having board-level governance of climate risk is also key to ensuring the risk assessment process remains live and continues to inform decision making and strategy development.