16 March 2023

What is physical climate risk reporting and how to get it right


By Cervest

What is physical climate risk reporting and how to get it right

The financial cost of climate change – to individuals, communities and businesses – is becoming clearer as its impacts increase in severity and frequency. Assets worth trillions are at risk around the world. To build economic resilience, a number of governments are implementing mandatory climate risk reporting, pushing businesses to identify and act on their climate vulnerabilities. Many other businesses are voluntarily reporting their physical climate risk as part of ESG and sustainability reporting, or to inform long-term adaptation strategies.

What is climate risk reporting?

Climate risk reporting is the process of identifying, quantifying and disclosing climate risks affecting a business. It considers both the risks posed by physical impacts of climate change (‘physical risk’) and the risks created by the transition to a low carbon economy (‘transition risk’).

A variety of frameworks are used for climate risk reporting. Most current disclosure mandates including those in the UK align with guidelines established by the Task Force on Climate-Related Financial Disclosures (TCFD). The TCFD recommendations are structured around four areas of organizational operation: governance, strategy, risk management, and metrics and targets.

Other frameworks also exist. The CDP (formerly the Carbon Disclosure Project), the Global Reporting Initiative (GRI) and the International Sustainability Standards Board (ISSB) all offer TCFD-aligned reporting structures, while industry bodies such as the UK Green Building Council have developed their own sector-focused frameworks.

It is important to note that the TCFD has been called a “framework without a framework” due to the ambiguous nature of some of the requirements. It is therefore essential that companies looking to fully comply with the regulations find a reporting solution that has fully analyzed the framework and provides clear guidance for accurate and complete disclosure.

Why is physical climate risk reporting essential?

Access to climate risk reporting is essential at every economic level, from markets to individual shareholders. Financial markets rely on good quality disclosures to inform asset pricing and capital allocation. Regulators and insurance underwriters need disclosure data to accurately price the risk and opportunities related to climate change. Governments rely on it to develop policy and long-term adaptation strategy, as well as to meet commitments to drive down emissions.

For businesses, it’s vital on a number of fronts: to comply with, or stay ahead of, regulatory requirements; to build trust with partners, stakeholders and customers, and to create a competitive advantage. This competitive advantage plays out in two important ways. The first is taking forward-thinking decisions that build business resilience. The second is identifying and seizing adaptation and purchase opportunities ahead of competitors.

For stakeholders and investors, visibility of physical climate risk plays a major role in decision-making. A survey by Deloitte found that “institutional investors overwhelmingly (86%) cited climate change as the most significant ESG factor influencing investment decisions”. Investors want to ensure that businesses they invest in or lend to are resilient to the physical impacts of climate change, as well as to any transition risks. Clear, credible climate risk reporting also plays an important role in attracting and retaining talent: according to a recent study, top employers, as measured by employee satisfaction and attractiveness to talent, have significantly higher ESG scores than their peers.

Building business resilience is undoubtedly one of the most significant benefits of physical climate risk reporting. Enterprises are already facing physical climate risks and experiencing significant losses. In 2021 alone, weather and climate-related events cost USD329 billion – 45% higher than the 21st century average. In a ‘business as usual’ emissions scenario, the value of assets facing climate risk could be as high as USD24.2 trillion. According to S&P Global, “80 percent of the world’s largest companies are reporting exposure to physical or market transition risks associated with climate change.”

There are opportunities to be discovered too. “Embedding climate risk and opportunities into corporate strategic thinking can have the potential to increase innovation, anticipate and stay ahead of policy changes, and improve operational efficiency and resources management,” says EY. For anyone who owns, operates or relies on physical assets, there are clear competitive benefits to risk visibility. The process of identifying and quantifying risks can indicate which assets should be relocated, and where conditions might be more favorable. It can identify assets with high risk and enable prioritization for adaptation.

Other business activities beyond climate risk disclosure might also require or benefit from physical climate risk insights. M&A reports, asset-level supply chain planning, pre-transaction due diligence, business continuity planning, as well as annual and ESG reports are all enhanced by meaningful physical climate risk analysis.

TCFD-aligned climate risk reporting

The TCFD was established in 2015 by the Financial Stability Board (FSB) to improve and increase reporting of climate-related financial information. Its role is to “develop recommendations on the types of information that companies should disclose to support investors, lenders, and insurance underwriters in appropriately assessing and pricing a specific set of risks—risks related to climate change.” In 2017, it released its recommendations – a framework of 11 overarching recommendations for disclosure over 4 thematic areas - governance; strategy; risk management; and metrics and targets – designed to create a full, standardized picture of climate risk.

Download our infographic to discover exactly how we can help your company comply with TCFD recommendations, including strategies a), b) and c), risk management a) and b), and metrics a).

TCFD-aligned reporting regulations already affect businesses in the UK, EU, France and New Zealand, with Switzerland and G7 nations soon to follow suit. Japan, Singapore, Hong Kong and New Zealand are planning the rollout of reporting regulations, while Brazil, Mexico, Canada and South Africa are currently developing their TCFD-aligned reporting strategies.

Key upcoming milestones for mandatory physical climate risk reporting include:

  • UK Climate Disclosure Law, enacted April 2022; first reports due April 2023. It requires public and private companies of a certain size to disclose their climate-related risks roughly in line with the recommendations of the TCFD.

  • EU Taxonomy, enacted December 2021; mandatory reporting requirements phased in for certain EU companies beginning in January 2023. The taxonomy serves as a classification system for economic activities with detailed criteria to cut through the greenwashing and distinguish between what is sustainable business and what is not.

  • ISSB climate disclosure standards, final rules expected in June 2023. The new voluntary standards will inform future regulations and serve as the global baseline for disclosures that enable investors to assess and compare business resilience to climate change.

  • SEC Rules, final rules expected in the second half of 2023. The U.S. rules will enhance climate-related disclosures from public companies in order to provide investors with consistent, comparable, and decision-useful information.

What does the TCFD framework require you to disclose?

Under the TCFD framework, companies must disclose both transitional and physical climate-related risks, producing information about how they monitor and manage the potential impacts of our changing environment. They must outline financially material business risks and opportunities across different time periods, and assess their resilience against multiple climate scenarios.

To do this, businesses need to consider their physical risks at the individual asset-level: a hotel in Paris will face very different climate hazards, and frequency and severity of impacts, to an equivalent property in Istanbul. As well as owned assets, they must also consider the physical risk to the third-party assets their business depends on – those in their supply chain, for example.

Physical climate risk describes the potential for physical damage and financial losses as a result of increasing exposure to climate hazards – like floods, extreme heat, drought or wildfires – resulting from climate change. The TCFD’s inclusion of physical risk is self-explanatory in a world already experiencing continuous unprecedented climate impacts. S&P Global reports that 60% of its S&P 500 Index-listed companies, with a market capitalization of USD18 trillion, hold assets with high exposure to climate-related physical risk. Cervest’s survey puts that figure even higher: 88% of respondents said one of their corporate physical assets, such as an office, warehouse, or other building, had already been affected by extreme weather.

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What are the barriers to effective physical climate risk reporting?

Four months after the UK’s mandatory reporting requirements were introduced, the Financial Conduct Authority (FCA) found that although 81% of companies indicated that they had adequately disclosed their climate risk, huge gaps in detail, consistency and completeness remained.

Good physical climate risk assessment requires expert analysis and interpretation of detailed data to determine complex and interrelated potential outcomes. As Nature puts it, it “requires…knowledge of the climate change hazards across multiple space and timescales (e.g., likelihood of changes to extreme rain over North America over the next decade), knowledge of the exposures (e.g., location of assets and value chains), and knowledge of the vulnerabilities (e.g., response of communities to drought or response of supply chain to changes in carbon taxes).”

In other words, it requires highly complex and credible climate intelligence about specific assets, as well as across portfolios and business operations. This represents a major challenge for enterprises and governments – particularly those with significant physical asset inventories or supply chains. In addition to the lack of time and in-house expertise reported by many companies, there are two major barriers to good climate risk reporting:

Lack of accessible and accurate data

Climate data, in its raw form, is almost impossible for non-scientists to interpret. Analyzing it is an incredibly complex task, which must consider not only isolated hazards such as heat waves or drought, but also how they interrelate. As Cervest’s Dr. Helen Beddow says, “Our climate is an interconnected system and climate hazards interact with each other. Any analysis examining the risk posed to a single building must also consider the climate as a whole. This is not an easy ask for any company that doesn’t have physical climate risk expertise in-house.”

Difficulty conducting scenario analyses

The FCA report highlighted scenario analysis as a gap in many climate risk reports it assessed. Scenario analysis asks businesses to analyze how a range of different climate scenarios (and associated emissions pathways) might affect their assets and operations across a range of timeframes. Properly conducted, scenario analysis helps decision makers devise better adaptation strategies in full view of multiple different future climate possibilities. However, ”climate-related scenarios are generally developed for macroscopic assessments,” points out Dr Helen Beddow – and are not straightforward to apply at asset- or business-level. Yet these scenarios are critical for developing a full understanding of physical climate risk and effective strategies to build resilience in a climate future that evolves daily.

How climate intelligence saves time and supports robust climate risk reporting

To reckon with climate risk, says McKinsey, “policy makers and business leaders will need to put in place the right tools, analytics, processes, and governance to properly assess climate risk.” Climate intelligence (CI) is the solution: it provides accessible, highly credible climate risk analysis, syncs with existing operational processes, and drives informed governance – as well as being report-ready. IDC’s market perspective on CI calls it “a strategic priority for organizations worldwide.”

Climate intelligence is business intelligence for managing climate risk. Fusing cutting-edge earth science with machine learning techniques, CI lets decision makers see, understand, quantify and disclose the current and emerging hazards facing their business, asset by asset and across the board.

This asset-level view made possible by CI is transformative for risk reporting. “To comply with TCFD-aligned frameworks, which require companies to disclose transition and physical climate-related risks, companies must be able to report the impacts of climate change at the asset level. This is because, for many companies, physical climate risk is closely tied to assets they own or rely on,” says Dr Helen Beddow.

Report-ready insights at your fingertips with EarthScan

EarthScan™, from Cervest provides on-demand climate intelligence and science-backed insights to make the physical climate risk reporting process simpler and more comprehensive. Offering report-ready CI insights and analyses, EarthScan generates downloadable physical climate risk insights that can be added into your report to upgrade your climate-related financial disclosure.

  • It aligns with TCFD-reporting recommendations across several important areas:

  • Asset-level analysis enables detailed quantification and reporting of physical risk

  • Risk takes into consideration both individual climate hazards, such as heat stress, flooding, wildfire, drought and precipitation, and combined physical risk into consideration

  • Built-in climate emissions scenario analysis, with three scenarios (Paris-aligned, 2040 Peak and Business As Usual) to explore and add to reporting

  • Variable time horizons make it possible to baseline risk back to 1970 and explore changes up to 2100 in five-year time steps

  • Generation of analysis, insights, charts and executive summaries to enhance your reports

Enterprises can also integrate these science-backed insights and intelligence into other business-critical documents such as annual, M&A or ESG reports. Crucially, EarthScan’s climate intelligence can be meaningfully applied beyond the reporting process, informing business continuity planning, long-term business development, supply chain planning and developing adaptation strategies.

EarthScan’s climate intelligence offers compounding returns on investment, from minimizing climate-related business disruption to early identification of emerging opportunities. Smart decision-makers know there’s no time to lose: nearly three quarters of business leaders surveyed by BCI believe that by addressing the risks associated with climate change now, their organization will be more resilient.

With the costs of inaction becoming starker with each passing day, now is the time to sign up to start your climate intelligence journey.

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