Preparing for Climate Risk
Preparing for Climate Risk
by: Amanda Mast | December 15, 2022
Business leaders, investors, and policymakers are increasingly aware of how climate-related risks impact companies’ financial performance and operational resilience. According to the National Oceanic and Atmospheric Administration (NOAA), there have been 15 separate, billion-dollar weather and climate disasters during the first nine months of 2022. [i] Acknowledging the risks posed by climate change and investor requests for better information, the U.S. Securities and Exchange Commission (SEC) proposed rule amendments in March. These changes would require companies to share additional climate-related information—including climate risks and efforts to manage these risks. [ii]
How can business leaders prepare for a world with rapidly evolving climate risk? The SEC’s proposed rule amendments build upon the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD). [iii] This blog outlines how companies can leverage the TCFD recommendations and shares quick tips on what to consider when approaching climate risk for the first time.
The Task Force on Climate-related Financial Disclosures
TCFD is the dominant framework for managing climate risk. Established by the Financial Stability Board in 2015, TCFD set out to identify climate-related information that firms should gather and disclose to investors and other stakeholders. [iv] The TCFD released final recommendations in 2017, updating guidance in 2021. [v] These recommendations ask companies to consider climate risks under different scenarios, including transition risks—those associated with a transition to a low-carbon economy, such as a price on carbon—and physical risks, like extreme weather. [vi] This information is useful to investors looking to more accurately price climate risk, and to companies as they assess and manage these same risks.
Figure 1. The TCFD recommendations highlight various categories of climate-related risks that companies can assess. [vii]
Firms see the value and are getting on board. The rapid adoption of the TCFD recommendations shows their value to companies and investors. In the TCFD’s 2022 Status Report, 80 percent of the large companies included in the review disclosed TCFD-aligned information. CDP, the non-profit responsible for the global environmental disclosure platform, incorporated the TCFD framework into their climate change questionnaire, further amplifying the recommendations. [viii] In 2022, over 18,000 companies representing more than half of global market capitalization disclosed to CDP—responding to requests from investors, customers, and other stakeholders. [ix]
Regulators reinforce TCFD recommendations. Over 120 regulators and governments have expressed support for the TCFD, with numerous governmental entities encouraging aligned disclosures, including Brazil, Canada, New Zealand, and the UK. [x] The United States is also counted in this group, as the SEC based the proposed rule amendments, in part, on the TCFD recommendations. [x]
Scenario Analysis Basics
Tools enable planning despite uncertainty. To help companies develop meaningful risk assessments, the TCFD recommends an analytical tool called scenario analysis. [xi] During a scenario analysis, companies consider a range of plausible futures, from an emissions trajectory that limits warming to 2°C or lower to a business-as-usual emissions trajectory that causes significant change to global temperatures. [xi] These scenarios are not meant to be forecasts but hypothetical paths of development that can allow a firm to build resilience across a range of possible future states. [xi] Institutions have published robust scenarios that companies can leverage in this exercise, ranging from “physical climate scenarios” to “transition scenarios.” [xii]
Figure 3. High-level framework for the scenario analysis of physical and transition risks by the U.S. Commodity Futures Trading Commission. [xiii]
The physical impact of climate change. Physical scenarios focus on climate drivers, including GHG emissions, that allow models to explore the resulting changes in the climate system. [xiv] The Intergovernmental Panel on Climate Change (IPCC) is well-known for these scenarios, including the five Shared Socio-economic Pathways (SSPs) outlined in the Sixth Assessment Report (AR6). The AR6 highlights a range of changes to the physical climate across scenarios. For example, an extreme heat event that historically occurred once every 50 years will likely occur more than 30 times in that same period under a high global warming scenario. [xiv] Companies can use scenarios to assess how their assets and operations may be affected and inform adaptation plans to stay competitive.
Transition impacts of climate change. Other scenarios allow companies to explore potential transition risks, like the scenarios of the International Energy Agency (IEA). The IEA’s Net-Zero Emissions by 2050 Scenario (NZE) outlines one possible pathway for the energy sector to reach net-zero emissions. [xvi] The IEA’s Stated Policies Scenario and Announced Pledges Scenario take policies and commitments, among other conditions, and model the resulting changes to the energy sector and global emissions. [xvi] Assessing resiliency under these scenarios can help firms understand their exposure to the impacts of the energy transition.
Figure 5. The International Energy Agency’s three scenarios show a range of possible changes in the global energy system. The IEA also shows how two of these scenarios compare to select IPCC scenarios. [xvi]
How to Get Started
Better planning based on better data. Armed with an understanding of risks under future scenarios, companies can prepare despite significant uncertainty. They can not only consider current climate risks but also anticipate how they may change. Developing robust climate assessments now can allow companies to anticipate regulation, meet investor disclosure requests, and improve the resilience of business operations against both the physical and transition risks of climate change.
Leveraging TCFD in preparation for regulation. When aligning to the TCFD framework, ClimeCo recommends that companies reflect internally first:
- What are your primary goals? The TCFD recommendations can help companies prepare for upcoming regulations like the SEC’s proposed rule amendments. It can also help companies meet investors’ requests for TCFD alignment, improve their CDP Climate score, and better understand and manage business risk.
- What is your existing governance and strategy related to climate change? By understanding and enhancing internal structures and priorities, companies can mitigate risk and capture economic opportunities related to the energy transition.
- How do physical and transition risks currently impact the business? Understanding the most significant risks can allow a company to allocate resources efficiently for future risk management.
- Who are the essential stakeholders? A shared understanding of climate change and the proper internal buy-in, whether from facilities, procurement, or investor relations teams, can help ensure the success of climate assessment initiatives.
[i] NCEI. Billion-Dollar Weather and Climate Disasters. 2022. https://www.ncei.noaa.gov/access/billions/time-series
[ii] SEC. Fact Sheet Enhancement and Standardization of Climate-Related Disclosures. 2022. https://www.sec.gov/files/33-11042-fact-sheet.pdf
[iii] SEC. The Enhancement and Standardization of Climate-Related Disclosures for Investors. 2022. https://www.sec.gov/rules/proposed/2022/33-11042.pdf
[iv] TCFD. About. 2022. https://www.fsb-tcfd.org/about/
[v] TCFD. Implementing the Recommendations of the Task Force on Climate-related Financial Disclosures. 2021. https://assets.bbhub.io/company/sites/60/2021/07/2021-TCFD-Implementing_Guidance.pdf
[vi] TCFD. Final Report: Recommendations of the Task Force on Climate-related Financial Disclosures. 2017.
[vii] TCFD. The Use of Scenario Analysis in Disclosure of Climate-related Risks and Opportunities. https://www.tcfdhub.org/scenario-analysis/
[viii] CDP. How CDP is aligned to the TCFD. 2022. https://www.cdp.net/en/guidance/how-cdp-is-aligned-to-the-tcfd
[ix] CDP. How companies can take action. 2022. https://www.cdp.net/en/companies
[x] TCFD. 2022 Status Report. 2022. https://assets.bbhub.io/company/sites/60/2022/10/2022-TCFD-Status-Report.pdf
[xi] TCFD. 2022 Status Report. 2022. https://assets.bbhub.io/company/sites/60/2022/10/2022-TCFD-Status-Report.pdf
[xii] TCFD. 2022 Status Report. 2022. https://assets.bbhub.io/company/sites/60/2022/10/2022-TCFD-Status-Report.pdf
[xiii] TCFD. Technical Supplement: The Use of Scenario Analysis in Disclosure of Climate-Related Risks and Opportunities. 2017. https://assets.bbhub.io/company/sites/60/2021/03/FINAL-TCFD-Technical-Supplement-062917.pdf
[xiv] TCFD. Technical Supplement: The Use of Scenario Analysis in Disclosure of Climate-Related Risks and Opportunities. 2017. https://assets.bbhub.io/company/sites/60/2021/03/FINAL-TCFD-Technical-Supplement-062917.pdf
[xv] TCFD. Technical Supplement: The Use of Scenario Analysis in Disclosure of Climate-Related Risks and Opportunities. 2017. https://assets.bbhub.io/company/sites/60/2021/03/FINAL-TCFD-Technical-Supplement-062917.pdf
[xvi] TCFD. Technical Supplement: The Use of Scenario Analysis in Disclosure of Climate-Related Risks and Opportunities. 2017. https://assets.bbhub.io/company/sites/60/2021/03/FINAL-TCFD-Technical-Supplement-062917.pdf
[xvii] U.S. Commodity Futures Trading Commission. 2020. Managing Climate Risk in the U.S. Financial System. https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf
[xviii] IPCC. Summary for Policymakers. In: Climate Change 2021: The Physical Science Basis. 2021. https://www.ipcc.ch/report/ar6/wg1/downloads/report/IPCC_AR6_WGI_SPM.pdf
[xix] IPCC, 2021: Summary for Policymakers. In: Climate Change 2021: The Physical Science Basis. https://www.ipcc.ch/report/ar6/wg1/downloads/report/IPCC_AR6_WGI_SPM.pdf
[xx] IPCC. Climate Change 2021: The Physical Science Basis. 2021. https://report.ipcc.ch/ar6/wg1/IPCC_AR6_WGI_FullReport.pdf
[xxi] IPCC, 2021: Summary for Policymakers. In: Climate Change 2021: The Physical Science Basis. https://www.ipcc.ch/report/ar6/wg1/downloads/report/IPCC_AR6_WGI_SPM.pdf
[xxii] IEA. Global Energy and Climate Model. 2022. https://www.iea.org/reports/global-energy-and-climate-model/understanding-gec-model-scenarios
[xxiii] IEA. Global Energy and Climate Model. 2022. https://www.iea.org/reports/global-energy-and-climate-model/understanding-gec-model-scenarios
[xxiv] IEA. Global Energy and Climate Model. 2022. https://www.iea.org/reports/global-energy-and-climate-model/understanding-gec-model-scenarios
About the Author
Amanda Mast joined ClimeCo in 2022 as a Manager of Climate Advisory on the Sustainability, Policy, and Advisory Team, and is based in Washington D.C. Before ClimeCo, she worked on Apple’s Environment, Policy, & Social Initiatives team and with The Coca-Cola Company, supporting global initiatives for environmental sustainability. Amanda leads climate strategy and risk management projects, corporate sustainability, and ESG disclosure.