Our industry is engaged in an important dialogue to improve sustainability through ESG transparency and industry collaboration. This article is a contribution to this larger conversation and does not necessarily reflect GRESB’s position.
Climate change poses a significant threat to businesses across the globe. Organizations are preparing to adapt and mitigate risks in a changing climate, from extreme weather events to shifting regulatory landscapes. That is where climate risk assessments come into play. These assessments are not merely fulfilling reporting and regulatory requirements, but they are necessary for any organization looking to thrive in an uncertain future, comply with emerging regulations, meet stakeholder expectations, and build climate resilience into corporate governance. Fortunately, not every organization has to start from zero regarding climate risk assessments.
The climate challenge
The urgency of addressing climate change is apparent. The world is experiencing more frequent and more severe weather events, disruptions in supply chains, and growing pressure from stakeholders — including investors, customers, and regulators — to adopt sustainable practices. To meet these challenges, organizations must conduct climate risk assessments to identify potential future impacts, evaluate their vulnerability, and develop enhanced management methods to meet the risk appetite of the organization.
What is a climate risk assessment?
A climate risk assessment comprehensively evaluates how climate change may affect an organization. It involves identifying and understanding the various climate-related risks an organization faces, such as physical risks (e.g., flooding and extreme heat), transition risks (e.g., policy changes and market shifts), and reputational risks associated with sustainability and climate action. The risk assessment process prioritizes critical issues and supports strategic investment to create a more resilient organization.
Mounting regulatory & stakeholder pressure
Around the world, regulators increasingly demand organizations to disclose their climate risks. For instance, the Task Force on Climate-related Financial Disclosures (TCFD) framework recommends that companies provide information on the fiscal impact of climate risks. Ignoring these requirements can lead to legal, economic, and reputational consequences. For example:
- Legal consequences: In 2019, ExxonMobil faced lawsuits related to its climate risk disclosures when the New York Attorney General’s office accused the company of misleading investors about the potential financial risks of climate change.[1]
- Economic consequences: The coal industry has been significantly impacted by asset stranding due to the declining demand for coal and regulatory pressure to reduce carbon emissions.
- Loss of stakeholder trust: Volkswagen lost stakeholder trust when it was revealed in 2015 that the company had manipulated emissions tests on its vehicles. This scandal led to lawsuits, fines, and a significant loss of brand reputation.[2]
You have likely heard of the European Union Corporate Sustainability Reporting Directive (CSRD), EU Taxonomy, the Sustainable Finance Disclosure Regulation (SFDR), the U.S. Securities and Exchange Commission (SEC) rule, and the California Accountability Package, all of which indicate the trajectory of emerging regulations requiring climate risk transparency. Amid mounting regulations and heightened investor expectations surrounding climate risk (as seen by the International Financial Reporting Standards and the International Sustainability Standards Board), organizations must grapple with the absence of a universally-standardized methodology for assessing and integrating these risks into Enterprise Risk Management (ERM) systems.
Stakeholder expectations
Investors, customers, employees, and the broader public expect organizations to take climate risk seriously. Transparency and a proactive approach to risk management can enhance an organization’s reputation and stakeholder trust, and can thus increase an organization’s access to capital. Climate risks are a business continuity issue with substantive financial implications. For example:
- Acute physical risks, such as increased frequency and severity of extreme weather events, can disrupt supply chains, damage infrastructure, and lead to business interruptions, resulting in production delays and revenue losses.
- Chronic physical risks, such as droughts, can disrupt the availability of raw materials, leading to supply shortages and increased procurement costs.
- Transition risks, such as regulatory changes and carbon pricing mechanisms, can increase operational costs, compliance expenses, and the need for technology upgrades or investments in emission reduction measures.
Your investors know your organization is exposed to these risks and want to see how you plan to address and mitigate them.
Your organization is already mitigating risk
Business continuity
Climate risks can disrupt operations, damage assets, and increase costs. Organizations must proactively identify and address these risks to ensure business continuity and financial resilience. Organizations conducting climate risk assessments often discover that they have existing mitigating activities that naturally reduce their exposure to climate-related risks. These activities may include sustainable practices, renewable energy adoption, and sustainable supply chain management.
However, during the assessment process, it often becomes evident that these existing measures may not be aligned with the organization’s risk appetite, which could be more conservative or ambitious depending on its strategic goals. Organizations must enhance and tailor their existing climate mitigation strategies to bridge this gap to align with their desired risk appetite, which may involve investments in additional sustainability initiatives, technology upgrades, or even reevaluating their business model to ensure they can effectively navigate the evolving landscape of climate-related challenges while staying within their predefined risk tolerance thresholds.
Leveraging existing expertise
An organization’s strength lies in the expertise within its operations. These experts play a crucial role in climate risk mitigation and adaptation as they understand operational intricacies, allowing them to navigate the delicate balance between agility and limitations in management abilities. Expert insights enable an organization to identify areas to enhance sustainability efforts and proactively respond to climate-related challenges. Recognizing the nuances of operations, key stakeholders help develop strategies that mitigate risks and align with broader organizational goals and priorities. Their knowledge and experience are invaluable in ensuring an organization remains resilient and adaptive in the face of evolving climate risks. Examples of common stakeholders are:
- Investor relations
- Human resources & workplace
- Enterprise risk management
- Procurement & supply chain
- Brand/regional-level managers
- Finance
- Legal
- Sustainability
- Manufacturing
- Operations & facilities
- Real estate
Once these stakeholders are brought into the process, an organization can launch into establishing climate risk and opportunity key performance indicators, map KPIs to existing risk registers, evaluate risk appetite, integrate into enterprise-wide risk governance, and operationalize resilience.
Data is your ally
Leveraging climate data sets is a transformative approach that can shift climate risk analysis from theoretical to actionable. These data sets provide a wealth of real-world information on historical climate patterns, extreme weather events, and environmental trends. By incorporating these data into risk assessments, organizations gain a more concrete understanding of the specific climate-related challenges they may face, enabling them to make informed decisions. This empirical approach allows for the quantification of risks, making it easier to hedge your bets on potential impacts and plan for effective adaptation and mitigation strategies.
Climate datasets bring visibility to what was once an abstract concept and enhance an organization’s ability to manage and respond to climate risks proactively. Linking your data to climate exposure, clearly defining criteria that mirror your organization’s risk appetite and tolerance, aligning with strategic objectives, and leveraging sustainability metrics will result in an output that builds the business case for investment in resilience.
The quality of climate risk analyses depends on the quality and scope of the input data. The accuracy and comprehensiveness of data directly influences the precision of risk assessments and the ability to make informed decisions. With reliable and comprehensive data, it becomes easier to anticipate the full extent of climate-related threats and opportunities.
Conclusion
Climate risk assessments are not a luxury; they are necessary for organizations navigating an increasingly volatile and climate-impacted world. The costs of inaction far outweigh the investments in understanding and managing these risks. By leveraging existing expertise, data, and implementing a proactive approach, organizations can position themselves for sustainable resilience and long-term success. Rest assured your organization will not be starting from zero.
This article was written by Kaylee Shalett, Global Technical Director, Climate Risk & Reporting, at Arcadis.
References
[1] MyJoyOnline (October, 2023). Exxon accused of misleading investors on climate change.
[2] Atiyeh C. (December, 2019). Everything You Need to Know About the VM Diesel Emissions Scandal.