Climate risks & opportunities explained.
As experts warn about rising temperatures, investors seek to understand how climate change could affect the companies in their portfolios. In response, the Task Force on Climate-Related Financial Disclosures (TCFD) established a framework for companies to disclose their climate-related risks and opportunities. What we discover from this process will teach us how to create better, more climate-resilient business models.
“The risk climate change poses to businesses and financial markets is real and already present. It is more important than ever that businesses lead in understanding and responding to these risks—and seizing the opportunities—to build a stronger, more resilient, and sustainable global economy.”
Michael R. Bloomberg, Chairman of TCFD
What are the risks?
Climate-related risks can be split into two categories: risks associated with the transition to a lower-carbon economy (Transition Risks) and risks associated with the physical impacts of climate change (Physical Risks).
Transition Risks
Transitioning to a low-carbon economy will require significant changes to policy, law, technology, and markets. Companies that are slow to adapt to these changes run the risk of financial and reputational damage.
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Policy actions around climate change continue to evolve. Their objectives generally fall into two categories—policy actions that attempt to constrain actions that contribute to the adverse effects of climate change or, policy actions that seek to promote adaptation to climate change.
Some examples include implementing carbon-pricing mechanisms to reduce GHG emissions, shifting energy use toward lower emission sources, adopting energy-efficiency solutions, encouraging greater water efficiency measures, and promoting more sustainable land-use practices. The risk associated with and the financial impact of policy changes depends on the nature and timing of the policy change.
Another important risk is litigation or legal risk. Recent years have seen an increase in climate-related litigation claims being brought before the courts by property owners, municipalities, states, insurers, shareholders, and public interest organisations. Reasons for such litigation include the failure of organisations to mitigate the impacts of climate change, failure to adapt to climate change and the insufficiency of disclosure around material financial risks. As the value of loss and damage arising from climate change grows, litigation risk is also likely to increase.
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Technological improvements or innovations that support the transition to a low-carbon, energy-efficient economic system can have a significant impact on organisations. For example, the development and use of emerging technologies such as renewable energy, battery storage, energy efficiency, and carbon capture and storage will affect the competitiveness of certain organisations, their production and distribution costs, and ultimately the demand for their products and services from end users. To the extent that new technology displaces old systems and disrupts some parts of the existing economic system, winners and losers will emerge from this “creative destruction” process. The timing of technology development and deployment, however, is a key uncertainty in assessing technology risk.
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While the ways in which markets could be affected by climate change are varied and complex, one of the major ways is through shifts in supply and demand for certain commodities, products, and services as climate-related risks and opportunities are increasingly taken into account.
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Climate change has been identified as a potential source of reputational risk tied to changing customer or community perceptions of an organisation’s contribution to or detraction from the transition to a lower-carbon economy.
Physical Risks
Physical risks may have financial implications for organisations, such as direct damage to assets and indirect impacts from supply chain disruption. Organisations’ financial performance may also be affected by changes in water availability, sourcing, and quality, food security, and extreme temperature changes affecting organisations’ premises, operations, supply chain, transport needs, and employee safety.
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Acute physical risks refer to those that are event-driven, including increased severity of extreme weather events, such as cyclones, hurricanes, or floods.
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Chronic physical risks refer to longer-term shifts in climate patterns (e.g. sustained higher temperatures) that may cause sea level rise or chronic heat waves.
What are the opportunities?
Climate change mitigation and adaptation efforts can provide opportunities for businesses, such as resource efficiency and cost savings, the adoption of low-emission energy sources, the development of new products and services, access to new markets, and supply chain resilience.
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A business can reduce its operating costs by improving efficiency across its production, distribution, buildings, machinery and transport. Particularly in relation to energy efficiency, but also including broader materials, water, and waste management. Such actions can result in direct cost savings to organisations’ operations over the medium to long term and contribute to the global efforts to curb emissions.
Innovation in technology is assisting this transition. Such innovation includes developing efficient heating solutions and circular economy solutions, making advances in LED lighting technology and industrial motor technology, retrofitting buildings, employing geothermal power, offering water usage and treatment solutions, and developing electric vehicles.
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In recent years, investments in renewable energy capacity have exceeded investments in fossil fuel generation. The trend toward decentralised clean energy sources, rapidly declining costs, improved storage capabilities, and subsequent global adoption of these technologies are significant. Organisations that shift their energy usage toward low emission energy sources could potentially save on annual energy costs.
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Organisations that innovate and develop new low-emission products and services may improve their competitive position and capitalise on shifting consumer and producer preferences. Some examples include consumer goods and services that place greater emphasis on a product’s carbon footprint in its marketing and labelling (e.g., travel, food, beverage and consumer staples, mobility, printing, fashion, and recycling services) and producer goods that emphasise reducing emissions (e.g., adoption of energy-efficiency measures along the supply chain).
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Organisations that pro-actively seek opportunities in new markets or types of assets may be able to diversify their activities and better position themselves for the transition to a lower-carbon economy. In particular, opportunities exist for organisations to access new markets through collaboration with governments, development banks, small-scale local entrepreneurs, and community groups in developed and developing countries as they work to shift to a lower-carbon economy.
New opportunities can also be captured through underwriting or financing green bonds and infrastructure (e.g., low-emission energy production, energy efficiency, grid connectivity, or transport networks).
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The concept of climate resilience involves organisations developing the adaptive capacity to respond to climate change to better manage risks and seize opportunities, including the ability to respond to transition risks and physical risks. Opportunities related to resilience may be especially relevant for organisations with long-lived fixed assets or extensive supply or distribution networks; those that depend critically on utility and infrastructure networks or natural resources in their value chain; and those that may require longer-term financing and investment.
The shift towards a low-carbon economy is underway.
Our job is to help you understand the climate-related risks and opportunities you face, and how they can drive your business forward. For more information, take a look at our Climate Transition service or contact us.