Understanding & managing climate change risks

Climate change and extreme weather present increasing risks such as hurricanes, wildfires, floods, and drought, which is a major financial worry for businesses and investors as well as a critical consideration for ESG (Environmental, Social, Governance) strategies and funds.

For the last 10 years, climate action failure and extreme weather have dominated global risk concerns, according to the World Economic Forum's Global Risks Report. Natural resource crises, biodiversity loss, involuntary migration, and livelihood crises are all potential dangers of these two threats.

S&P Global’s Trucost released research detailing how unchecked global warming will affect properties and assets, like mines, utilities, and processing plants, owned by the world’s largest corporations. 60% of companies in the benchmark S&P Index own physical assets across 68 countries (with a market capitalization of $18 trillion) that are exposed to at least one type of climate change physical risk, according to the report.

Climate change is the largest threat to physical assets owned by firms in all sectors of the stock market, therefore understanding climate risks and how ESG can help manage them is critical.

What is climate change?

Climate change is a significant aspect of ESG considerations for businesses, one that's becoming increasingly important as governments and organizations around the world work to address environmental risks. But what is climate change?

The Intergovernmental Panel on Climate Change has reached a unanimous conclusion that human activities, such as burning fossil fuels and deforestation, are causing the Earth's temperature to rise, consequently warming the globe. Greenhouse gas emissions have increased by more than 30% since the industrial revolution and the planet’s surface temperatures are approximately 1.0°C (1.8°F) warmer than the pre-industrial period.

Even a minor increase in global temperatures can have disastrous implications. Floods, storms, fires, droughts, desertification, sea-level rise, ocean acidification, lower air quality, rain pattern variations, and biodiversity loss are all being exacerbated by climate change and have a significant impact on economies and human society.

Climate change, according to the World Health Organization, is already causing 150,000 deaths each year, and the World Bank forecasts that climate change could create 143 million climate migrants over the next 30 years. Climate change is also predicted to have a significant impact on economic output. According to the Swiss Re Institute, if global temperatures rise by 3.2°C, climate change could wipe out up to 18% of global GDP by 2050.

ESG & climate risk management

Climate risk is linked to the environmental component of ESG. The environmental aspect focuses on a company's environmental impact, disclosures, and attempts to cut carbon emissions which are issues that pose significant risks for stakeholders and stockholders alike.

Potential infrastructure and property losses due to climate change are already affecting organizations' long-term sustainability. Many investors examine a company's preparation assessment and capacity to forecast and respond to a variety of climate threats when evaluating its ESG profile.

As companies embark on risk assessments, there are three primary types of risk to consider:

Transition risk
Transition risk refers to the climate policies and laws shifting the global economy away from fossil fuels. Policy and regulatory risks, technological risks, market risks, reputational hazards, and legal risks are all part of transition risk. These risks are intertwined, and they're often on investors' minds as they try to negotiate a more aggressive low-carbon agenda that might have capital and operational implications for their assets.

Litigation risk
Companies that generate and emit more CO₂ than others are more liable to class-action lawsuits and other legal issues that hold them responsible for contributing to global warming. Over the past few decades, environmental groups and citizens around the world have filed more than 1,800 climate suits seeking to force governments and companies to take action against climate change. Regardless of their success outcomes, these lawsuits can lead to direct costs and reputational damages.

Physical risk
Extreme weather and record temperatures are now recognized as events that can be predicted and factored into financial planning. Droughts, floods, excessive precipitation, and wildfires are all examples of acute threats. Rising temperatures, the spread of tropical pests, illnesses in temperate zones, and an accelerated loss of biodiversity are all examples of chronic concerns. Investors are exposed to both idiosyncratic and systemic risks as a result of acute and chronic threats.

Beyond these three primary risks, businesses should also consider the costs incurred as a result of the political instability and conflicts that climate change may engender. Supply chains are also impacted by extreme weather occurrences when workers are unable to physically come to work and product supply chains are disrupted.

Transitioning to a sustainable future

Fortune 500 firms, in particular, may have a big impact on lowering emissions and hence play a substantial role in tackling climate change provided they have an established ESG focus. There are a variety of initiatives that financial institutions, governments, and companies can undertake to help speed the transition to a sustainable future. Companies can:

• Set a baseline by assessing their ESG performance across the entire value chain, including business operations and product lifecycles.
• Use forward-looking scenarios that consider their exposure to climate change risks and their impact, beginning with transition and physical risks.
• Assess how well you’re aligned with global sustainability goals like the Paris Agreement or the UN Sustainable Development Goals (SDGs).
• Identify how you’re creating a positive impact now and where you can improve.
• Set ESG goals and targets that demonstrate a commitment to managing sustainability risks and identifying opportunities.
• Report your ESG performance to relevant stakeholders through sustainability-focused communications, such as a corporate sustainability report.

As associated calamities and economic losses increase and regulators increasingly identify climate change as a systemic financial risk, these risks have become impossible to ignore. Many businesses have begun to engage in carbon offsetting initiatives such as reforestation, landfill methane capture, wastewater treatment facilities, and investments in energy efficiency technology.

However, calls for businesses to prioritize emissions reductions as a dedicated endeavor and achieve net zero emissions are expected to expand in the coming years. In turn, the creation of ESG-specific data and analytics will become a vital component of any climate risk assessment and effective ESG strategy. As risk mitigation and ESG disclosures become mandatory, the quality of ESG data will become critical and necessary.

ESG materiality assessments

With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.

An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks. Download our guide to creating and extracting the maximum strategic value from an ESG materiality assessment.

Download guide

Helee Lev

Helee joined our team in 2012, overseeing strategic account management, new business, and industry alliances. In 2015, she participated in raising $5M of venture capital funding. She leads sales, business development, and Conservice ESG's strategic consulting group.

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