Climate change poses significant risks and opportunities for businesses across all sectors and regions. To address these challenges and enhance their environmental, social and governance (ESG) performance, companies need to integrate climate risk management into their strategies, operations and reporting. In this article, you will learn how to do that by following six steps:
The first step is to identify and assess the physical and transition risks that climate change poses to your business. Physical risks are related to the impacts of extreme weather events, such as floods, droughts, heat waves and storms, on your assets, operations, supply chains and markets. Transition risks are related to the policy, legal, technological and market changes that result from the shift to a low-carbon economy, such as carbon taxes, regulations, consumer preferences and innovation. You can use tools such as scenario analysis, risk mapping and materiality assessment to evaluate the likelihood and severity of these risks for your business.
Climate change is a key ESG issue that is likely to impact most businesses across geographies. According to the TCFD framework, there are two branches of risks 1. Transition risk: risks to the business that emerge from changes in regulatory policies or technology 2. Physical risk: environmental events like floods, storms, droughts Regulators are increasingly treating climate change as a systemic risk and advising Boards and C-suite to implement have a Climate strategy to make sure their businesses are resilient and can weather these changes. The TCFD framework is quite helpful in this regard, and could potentially identify both risks and opportunities for businesses.
Consider an insurance company employing scenario analysis to evaluate physical risks, anticipating potential claims due to increased extreme weather events like cyclones. In response, adjustments to coverage policy premiums or investments in risk mitigation strategies, such as promoting resilient construction methods, may be made. Transition risks are associated with the regulatory landscape. If a government introduces carbon taxes, the insurance company might need to adapt pricing models. Understanding consumer preferences for sustainable practices could lead to developing new insurance products incentivising eco-friendly behaviour.
A novel approach in assessing climate exposure involves integrating climate risk data with business intelligence systems. By overlaying climate projections and risk assessments onto existing business models and market analyses, companies can gain a more nuanced understanding of how climate change may impact different facets of their operations. This integration allows for more informed decision making, enabling companies to anticipate and mitigate potential disruptions from climate change more effectively.
From my experience in the petrochemical sector and banking sector in Saudi Arabia, there are two ways on how to assess climate risk. In both cases the focus was on climate transition risk. In petrochemical, exposure assessment is done by surveying the nature of the physical assets (small in number) the company owns by age and technological disruptability with exact details. Transition risk is seen as under the company's control. Banks on the other view use a 1000-foot view to analyze a broad portfolio that includes wide range of sectors and clients (large number) using proxy data for portfolio emissions assessment. The risk in this case is heavily reliant on the energy transition progress of the whole economy.
To integrate climate risk management into ESG performance: -Risk Assessment: Conduct thorough assessments to identify climate-related risks impacting the business. -Strategy Integration: Incorporate climate risk considerations into overall business & ESG strategies. -Policy Development: Develop policies focused on reducing carbon footprint & enhancing sustainability. -Stakeholder Engagement: Engage stakeholders in understanding & managing climate risks. Reporting and Disclosure: Regularly report on climate risk management efforts & progress. -Continuous Improvement: Constantly review &update practices to adapt to evolving climate challenges and regulations. -Investment Decisions: Factor climate risks into investment & operational decisions.
The second step is to define your goals and targets for climate risk management and ESG performance. These should be aligned with your vision, mission and values, as well as with the expectations and requirements of your stakeholders, such as investors, customers, regulators and employees. You should also consider the best practices and standards in your industry and the global frameworks and initiatives that support climate action, such as the Paris Agreement, the Sustainable Development Goals, the Task Force on Climate-related Financial Disclosures (TCFD) and the Science Based Targets initiative (SBTi).
In my experience, companies tend to benchmark against peers ambition as well as the ambition of the country of operation including their NDCs and long term climate commitments. Another factor that is considered is the technological readiness of the industry, especially in hard-to-abate sectors. De-risking technological barriers through collaborations, even sometimes with competitors, is key in those sectors to provide the institutional comfort to set an ambitious target.
While setting the goals the 4 pillars and 11 recommendations prescribed by TCFD plays a very important role. Goals can broadly be defined under 1) Scope 1 & 2 emissions 2) Scope 3 emissions 3) Emission intensity 4) Risk Assessment of Portfolio The goals need to be in synch with organisation’s aspirations and Net Zero ambitions sone in accordance to SBTi or any other standard framework.
When defining climate risk management goals, businesses can adopt an aspirational approach, setting targets that comply with current standards as well as anticipate future regulations and market shifts. This forward thinking strategy involves setting 'beyond compliance' goals, which can position a company as a leader in climate resilience. By aiming higher than current requirements, businesses can drive innovation, create more sustainable practices, and establish themselves as pioneers in climate change mitigation and adaptation.
In the second step, establish climate risk management and ESG performance goals aligned with your vision, mission, values, and stakeholder expectations, including those of investors, customers, regulators, and employees. Incorporate industry best practices and standards, and adhere to global frameworks such as the Paris Agreement, Sustainable Development Goals, Task Force on Climate-related Financial Disclosures (TCFD), and Science-Based Targets initiative (SBTi).
The third step is to develop your strategy and action plan for climate risk management and ESG performance. This should include the measures and initiatives that you will implement to mitigate your exposure to climate risks, adapt to the changing conditions and seize the opportunities that arise from the transition to a low-carbon economy. For example, you can reduce your greenhouse gas emissions, increase your energy efficiency, switch to renewable sources, invest in low-carbon technologies, diversify your products and services, enhance your resilience and adaptation capacity, engage with your suppliers and customers, and collaborate with your peers and partners.
One crucial aspect of this strategy is to also do scenario analysis according to scenarios from IPCC, IEA, etc. By doing so, one would build the firm's resilience to different situations and plan for potential business impacts. I feel it would also broaden one's scope and allow one to make more calculated decisions.
Strategy development can proceed through identifying: 1) the broad functional areas (E.g., operations, workforce, technology, supply chain) relevant to the organization, 2) near and long-term goals under each functional area & quantitative/semi-qualitative indicators of measuring goals progress (Step 2 also ensures alignment to the organization's materiality assessment), 3) enablers & potential blocks for each goal, 4) regulatory alignments. Importantly, steps 1-4 should be reviewed with relevant stakeholders and enterprise-risk-management personnel.
Crafting a climate-related strategy and action plan for risk management and improving ESG performance presents a significant challenge. Many companies remain skeptical, viewing it as non-essential since it doesn't directly generate profits or new revenue streams. However, adopting such strategies can unveil numerous unforeseen opportunities for pioneering companies. It positions ESG top performers to not only mitigate climate risks effectively but also to capitalize on new possibilities. These include entering unexplored markets, tapping into new market segments, and establishing innovative business ventures. This forward-thinking approach not only demonstrates a commitment to sustainability but also opens doors to potential growth areas.
The fourth step is to monitor your progress and performance on climate risk management and ESG metrics. You should establish a system and a process to collect, analyze and report the data and information that reflect your achievements and challenges. You should also use indicators and benchmarks that are relevant, reliable, comparable and consistent, and that follow the principles and guidelines of the TCFD, the SBTi, the Global Reporting Initiative (GRI) and other frameworks and standards. You should also seek external assurance and verification of your data and reports to enhance your credibility and transparency.
The fifth step is to communicate your results and impact on climate risk management and ESG performance to your internal and external stakeholders. You should use clear, concise and compelling language and formats to convey your goals, strategy, actions, outcomes and challenges. You should also tailor your messages and channels to the needs and interests of your different audiences, such as investors, customers, regulators, employees and media. You should also highlight your contributions to the global and local climate goals and agendas, and showcase your best practices and innovations.
Effective communication of ESG results is crucial. Often, stakeholders may not completely grasp the extent of a company's efforts towards sustainability, potentially leading to underappreciation of its green initiatives. However, if a company employs more impactful and clear communication strategies to convey their ESG achievements, it can significantly enhance its reputation. Articulating the outcomes and benefits of these efforts in a way that resonates with stakeholders not only fosters greater appreciation but also reinforces the company’s commitment to sustainability. This improved understanding among stakeholders can lead to increased support, trust, and a stronger overall reputation for the company in the market.
The sixth and final step is to review and improve your climate risk management and ESG performance on a regular basis. You should evaluate the effectiveness and efficiency of your measures and initiatives, and identify the gaps and areas for improvement. You should also monitor the changes and trends in the climate context and the stakeholder expectations, and adjust your goals, strategy and actions accordingly. You should also seek feedback and input from your stakeholders, and learn from your peers and partners, to enhance your performance and impact.
Climate Risk would fall under Climate Reporting, which is more closely aligned with Financial rather than non-financial reporting. However, using an Integrated approach has many benefits and improves efficiency. Climate Risk Management (as any risk management approach) is rather an iterative process. Driven by the speed of changes, the iterations and strategy adjustments may warrant more frequent reviews and improvements. Keeping track of Transition and Physical risks is at upmost importance in this process and demands due attention and time for the Climate Risk Management to be effective.
For sustainability teams, partner closely with your enterprise risk management teams for climate risk work. This ensures that the work is truly understood and integrated into company-wide risk efforts, has the appropriate level of visibility from leadership, and is not viewed as 'separate from' but rather part of ERM efforts.
Educating employees about climate risks and sustainability practices is essential for embedding climate risk management into corporate culture. In various organisations, I've initiated training programs that focus on understanding climate risks and implementing sustainable practices at work. This empowers employees to contribute to the company's climate risk management and ESG goals. Strengthening supply chain resilience against climate risks is crucial. In my consultancy work, I've helped companies map their supply chains to identify climate vulnerabilities and develop strategies to mitigate these risks, such as diversifying suppliers or sourcing from regions less affected by climate change.
The main idea is to make sure all types of risks, including those linked to sustainability, are taken into account throughout the organization at all levels. To achieve this objective, it is essential to identify the risks and establish metrics and mechanisms that enable the assessment of the material impact of these risks (the "inside-out" perspective) and financial materiality (the "outside-in" perspective). I believe there is no one solution for materiality assessment. It's up to each company to decide the best way to do it based on its own situation and the industry it's in.