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Climate Risk Assessments

Meeting regulatory requirements and increasing operational resilience

The global average temperatures are steadily increasing and approaching the +1.5 °C threshold recommended by leading climate scientists to limit the direct impact of climate change. As temperatures rise, the Earth becomes more susceptible to extreme climate events, leading to more frequent, intense, and volatile occurrences, as well as long-term persistent changes to annual climates. For businesses and financial institutions, these physical climate hazards can result in increased exposure to property damage, business interruptions, higher operating costs, and elevated insurance premiums or reduced coverage availability if current economic practices remain unchanged. To combat human impact on climate change, there has been a global shift towards sustainability, with many countries pledging to achieve net zero emissions by 2050. Conducting scenario-based climate risk assessments allows companies to comprehensively understand the potential impact of direct climate hazards and the shift towards a net-zero economy in this evolving landscape.

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Figure 1. The step-by-step approach to climate risk assessments.

Conducting a climate risk assessment involves two main components, a qualitative assessment of their impacts on a company’s business operations and a quantitative impact assessment. The qualitative component sets the scope of the analysis and ensures qualitative identification of risks and opportunities. Reviewing industry and peer climate risk analyses and disclosures, and relevant literature helps companies evaluate potential material climate risks for the future.

The quantitative component involves assessing the company’s vulnerability and exposure to climate risks and assessing the monetary impact of these risks. This includes gathering data on key facilities, current GHG emissions, financial metrics, and the company’s growth aspirations. Reviewing past events and mitigation measures provides valuable insights into the company’s response to physical risks. By combining current data with growth projections, different ‘business cases’ are projected across short, medium, and long-term time horizons. These ‘business cases’ are then integrated into a scenario modelling framework using the latest scientific and macroeconomic scenarios (Figure 2) from the Intergovernmental Panel on Climate Change (IPCC), Network for Greening the Financial System (NGFS), and International Energy Agency (IEA). Physical and transition risks are analysed for each business case under different scenarios (e.g., low-emission +1.5 °C vs. high-emission +4 °C) and various risk indicators are correlated to assess exposures, operating expense risks, and other relevant metrics.

After understanding the physical and transition risks, companies can develop adaptation plans to mitigate these risks. This step increases resilience to climate change and the sustainability transition through effective adaptation measures, such as infrastructure upgrades, process changes, and new policies. Engaging with stakeholders, including investors, customers, and employees, ensures alignment with broader sustainability goals. Risks and adaptation plans can then be integrated into the company’s Enterprise Risk Management (ERM) process to continually track, monitor, and refine strategies based on evolving hazards and new insights.

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Figure 2. Contrasting climate scenarios and their temperature, CO2 emission, and carbon price evolution (Source: IPCC and NGFS [1, 2])

Lessons learned

Drawing from our extensive client experience across different stages of the sustainability journey, we identified varying levels of engagement and understanding. To provide guidance through your climate scenario analysis, we have distilled five key insights from our engagements.

Reporting Quality: Ranges from basic qualitative analyses to advanced regional, quantitative disclosures. Leading pioneers provide detailed figures on revenue or asset exposure to physical climate risks and outline mitigation strategies. They also extend assessments to supply and value chains, including potential employee impacts, setting a high standard for comprehensive climate risk reporting.

Preparedness and Business Resilience: Enhancing resilience and sustainability involves understanding and managing both physical and transition risks. Leaders are integrating climate management into existing processes like supply chain and enterprise risk management. Investing in efficient production processes reduces carbon costs and overall product costs, benefiting competitiveness and customer value. Comprehensive climate risk assessments should lead to actionable strategies, with the best results achived when all concerned parties are involved (e.g., risk, plant, and operation managers), making preparedness and business resilience the ultimate goals.

The Price of Inaction: Operating with non-sustainable practices in a net zero world will result in significantly higher costs compared to an SBTi-aligned path. This is driven by carbon taxes and incentives, meaning companies that take no action may face a significant additional operation expense. This highlights the need for proactive planning and awareness raising, as inaction ultimately costs more.

Timing is Crucial: Delaying transition efforts amid rising carbon prices makes future actions more challenging. Timely action is essential to avoid higher costs and locked-in inefficiencies as the competitive landscape becomes saturated with simultaneous efforts.

Stay Ahead: Continuously review and refine strategies, policies, and practices to stay ahead in the rapidly evolving landscape. Effective action relies on maintaining sufficient training and understanding necessary measures, ensuring your business remains competitive and resilient.

Outlook

Regulatory requirements in Switzerland and the EU mandate companies to assess their exposure to climate-related risks and opportunities, integrating both physical and transitional risks into strategic planning. Exploring climate scenarios enables companies to evaluate potential climate change impacts on their businesses. The process leads to the development of adaptation plans to mitigate identified risks and increase resilience to climate change and the sustainability transition.

Lessons learned from client engagements highlight the importance of reporting quality, preparedness, business resilience, the cost of inaction, the crucial timing of decarbonisation efforts, and the need to stay ahead in the rapidly evolving landscape. Understanding and managing both physical and transition risks enhance business resilience and sustainability, ensuring competitiveness and long-term viability in a changing climate and regulatory environment.

 

Thank you to the key contributors to this article: Abetare Zymeri and Ramona Achermann.

1. IPCC, “Climate Change 2022: Mitigation of Climate Change, Summary for Policymakers,” 2022. [Online]. Available: https://www.ipcc.ch/report/ar6/wg3/downloads/report/IPCC_AR6_WGIII_SPM.pdf


2. NGFS, “Scenarios Portal,” 2024. [Online]. Available: https://www.ngfs.net/ngfs-scenarios-portal/. [Accessed 2024].

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