Climate-Related Financial Risk

At-a-glance

  • There are several types of climate-related risks. They can be broadly categorized into transition risk and physical risk.
  • To be prepared for future climate scenarios and respond to stakeholder pressure, companies need to strategically identify the climate-related risks and opportunities unique to their business.
  • Many companies report on the risks and opportunities associated with climate change through corporate sustainability reports, financial filings, and voluntary reporting frameworks.
  • To promote greater rigor and consistency in climate-related disclosures, the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) developed a voluntary reporting framework that provided recommendations for how companies could disclose climate-related risks and opportunities across four areas: governance, risk management, strategy, and metrics and targets.
  • An increasing number of companies are using the voluntary framework released by the TCFD to analyze how climate change presents strategic risks and opportunities to their operations.
  • As demand for more nuanced climate-related financial information has risen, C2ES has hosted workshops and released publications to further support corporate disclosure efforts.

The risks of climate change to ecosystems and vulnerable communities are well-known. However, companies are increasingly recognizing and starting to analyze how climate change could affect their operations. Over the last five years, reporting the risks and opportunities of climate change through corporate climate disclosures has grown in relevance and importance. C2ES has hosted workshops and released publications to further support corporate climate disclosure efforts.

What is Climate Risk?

Climate-related risk encompasses several different types of risk. Transition risks involve changes in law, policy, technology and markets related to the transition to a lower-carbon energy supply. Those risks include regulatory risk, such as climate laws and policies that affect how companies operate, and liability risk, such as litigation that targets companies for contributing to climate change and affects a company’s reputation. Physical risks from climate change include damage to fixed assets, like buildings and property, or supply chain disruptions. They can result from extreme weather events or changes in water availability.

Climate change can also present opportunities, including expanded markets for existing products and services, new markets for new products, and cost reductions.

To be prepared for future climate scenarios and respond to stakeholder pressure, companies need to strategically identify the climate-related risks and opportunities unique to their business. Companies recognizing these risks and opportunities report on them in their corporate sustainability reports, voluntary reporting frameworks, and in financial filings.

However, there is no single framework, regulation, or set of guidelines for companies to report these risks and opportunities to investors and the public. In fact, nearly 400 mandatory and voluntary frameworks for climate and sustainability disclosure exist. Those with some of the highest corporate participation include the CDP, the Global Reporting Initiative, and the PRI.

In addition to voluntary reporting frameworks, publicly traded companies must also provide periodic filings to the U.S. Securities and Exchange Commission (SEC).  These financial filings only require “material” risks to be included. Materiality is typically defined as information that could affect the decision making of an informed investor. However, many stakeholders are challenging the traditional definition of materiality in the climate context, since most investors take a relatively short-term view of the market. More stakeholders are now considering the long-term financial viability of companies through the multi-decadal lens of climate change. Moreover, there has been increased pressure to include the disclosure of material climate change-related information in financial filings.

Task Force on Climate-related Financial Disclosures

To promote greater rigor and consistency in climate-related disclosures, the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) developed a voluntary reporting framework that provided recommendations for how companies could disclose climate-related risks and opportunities across four areas: governance, risk management, strategy, and metrics and targets. Since the recommendations were released in 2017, a growing number of diverse companies have been working to align public reporting on climate-related risks and opportunities with the recommendations. The recommendations also came at a time when a greater number of companies were seeking to better understand their potential climate-related risks and opportunities as some risks started to emerge and materialize.

The recommendations include implementing guidance for companies on how to translate climate risks and opportunities into traditional financial terms, like revenues, expenditures, assets, and liabilities, and how to integrate climate risks into existing business continuity and risk management systems. A key recommendation is that more companies conduct a scenario analysis examining what climate change will mean for their facilities, operations, supply and distribution chains, as well as demand for their products and services over a range of plausible scenarios.

C2ES supports the TCFD’s recommendations and seeks to enable better and more consistent climate-related financial reporting in the private sector. C2ES convened several workshops and webinars with companies leading up to the TCFD’s recommendations. In September 2017 we issued a report, Beyond the Horizon: Corporate Reporting on Climate Change, in which we identified areas where additional support was needed for companies implementing the TCFD’s recommendations. One such area included helping companies use scenario analysis to assess climate-related risks and opportunities. Based on these issues, C2ES released a brief in August 2018, Best Practices and Challenges: Using Scenarios to Assess and Report Climate-Related Financial Risk.

Companies continued to discover new challenges and lessons as they began implementing the TCFD recommendations. They needed support translating information gleaned from climate scenario analysis into information that can be used for corporate decision-making. They also needed support assessing and disclosing the risks and opportunities related to the physical impacts of climate change, including how to demonstrate the financial value of resilience. In response, C2ES hosted two workshops in 2019 that focused on these implementation challenges. In April 2020, C2ES released a brief, Implementing TCFD: Strategies for Enhancing Disclosure, that describes the themes, lessons, and best practices from the  workshops.

Through our ongoing work on the TCFD, C2ES is focused on how companies disclose their climate risks, and how to support best practices in disclosure, as research and policy action continues to evolve and emerge. C2ES is also focused on how the federal government is now seeking to best assess and quantify climate risk in its own operations, and at an industry and sector level across the U.S. economy.

Recently, key independent U.S. financial regulatory agencies such as the Federal Reserve, the SEC, and the Commodity Futures Trading Commission have all begun to develop new oversight capabilities regarding climate change. For instance, the Federal Reserve has announced the creation of two new internal climate risk committees, one dedicated to macroprudential oversight issues, the other focused on climate-related risks to individual banks.

The SEC is also actively seeking input on how to support corporate disclosure of climate risk among the public companies it regulates (C2ES has provided comments to the SEC). Further, in the first meeting of the Financial Stability Oversight Council under the Biden Administration, the treasury secretary stated that climate change will now be a main priority in the groups work on systemic risk oversight in the U.S. financial system.