6 December 2022

What is climate-related material risk?

Dr. Helen Beddow

By Dr. Helen Beddow

What is climate-related material risk?

Climate-related Financial Disclosures are key to helping global economies meet Net Zero targets and build capacity to cope with the impacts of climate change. Recent discussion from the G20's Taskforce on Climate-Related Financial Disclosures (TCFD) focussed on the urgently needed progress on company climate disclosures. To meet TCFD guidelines, companies must report on their material risks that are related to climate change. This means companies need to understand what constitutes climate-related “material risk”. How do companies discover the material risks facing their assets?

What is material risk?

Material risk is a common concept in multiple industries, such as insurance, finance and banking. Labeling a risk as “material” means that if that risk becomes a reality, it is likely to cause significant harm to an object, event or person. Material risk weighs how much impact a particular risk would have, so companies can identify and prioritize areas that cannot be ignored. Where a company has material risks to its assets or operations, it must take action to avoid potentially catastrophic financial consequences.

Material risk and climate-related financial disclosures

The Task Force on Climate-related Financial Disclosures (TCFD) guidelines recommend that companies complete a materiality assessment as part of their climate risk disclosure. However, as the TCFD does not give any definition of materiality, the onus is on each organization to pinpoint when climate-related risk becomes a material risk.

The definition of material risk has been debated widely, materiality can vary hugely across industries and organizations. Why? It’s context-dependent. What one company qualifies as significant or material consequences, might look entirely different to another. Although the TCFD has refrained from providing a definition, there is guidance provided by other sources that could be used as a guide to materiality:

According to the Climate Disclosure Standards Board (CDSB), environmental information is thought to be material if:

  • ‘The environmental impacts or results it describes are, due to their size and nature, expected to have a significant positive or negative effect on the organization’s current, past or future financial condition and operational results and its ability to execute its strategy; or’

  • ‘Omitting, misstating or misinterpreting it could influence decisions that users of mainstream reports make about the organization.’

Companies might also choose to turn to the Sustainability Accounting Standards Board (SASB), which define materiality as:

  • ‘A topic is financially material if omitting, misstating, or obscuring it could reasonably be expected to influence investment or lending decisions that users make on the basis of their assessments of short-, medium-, and long-term financial performance and enterprise value.’

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How we approach materiality in EarthScan

EarthScan™, Cervest’s climate intelligence product, gives each asset and portfolio a Cervest Rating, a globally standardized risk rating between A (very low climate-related risk) to F (extremely high climate-related risk). To provide an indication of material risk, EarthScan identifies all assets with a Cervest Rating of C or below as assets that could be under ‘material risk’ and includes these automatically in any climate risk report. As materiality is open to interpretation and varies between organizations, the Cervest Rating C threshold provides a starting point for organizations to place climate-related material risks in the context of their organization.

To help you discover and analyze your physical risk, EarthScan offers insights into multiple climate hazards including flooding (coastal and riverine), drought, extreme temperatures and wildfire. EarthScan then rates each asset across multiple time horizons and emission scenarios simultaneously. Using the Combined Physical Risk Rating, you can quickly screen assets and portfolios, identify the greatest climate-related risks and opportunities, then drill-down into the specific metrics and risk categories driving the overall risk rating.

Not only do Cervest Ratings support companies to identify their material risk and enhance ESG reporting, but it also enables them to make climate-informed decisions. Understanding which assets or locations have the most material risk enables organizations to build climate risk into due diligence processes and identify climate-related opportunities.

If you are planning to disclose your climate-related risk in the UK, please download this ebook for more information about the guidelines and how to ensure full compliance.

If you are looking to voluntarily disclose your climate-related risks to get ahead of increased regulations, download our voluntary reporting guide here.

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