A new era for climate risk analysis
A raft of new pledges at COP28 ended the climate summit in Dubai on a positive note in contrast to previous years. However, despite pledges to triple renewables and cut methane emissions, the consequences of global warming remain a huge risk. For companies, the direct impact of climate change on business activities is increasingly evident. In 2022 alone, the reinsurer Munich Re estimated the total global economic loss from natural disasters was US$270bn.
As a result, investors, consumers and regulators are demanding more corporate commitment to climate protection. Notably, there is the requirement for more companies to move away from the voluntary reporting standards of the Task Force on Climate-related Financial Disclosures (TCFD) to mandatory reporting requirements.
This approach was underlined during COP28 where announcements by the Financial Stability Board (FSB) and the International Financial Reporting Standards (IFRS) confirmed that focus and responsibility for climate reporting will move away from TCFD and the FSB to the International Sustainability Standards Board (ISSB) from 2024. The move coincides with the global adoption of IFRS S1 and S2. While IFRS sustainability standards are currently voluntary, major jurisdictions are actively considering making them a requirement. .
Transitioning to mandatory reporting on climate risk
As the first comprehensive standards for climate risk data disclosure published in 2017, the TCFD recommendations were a game changer. Seen as the definitive framework for identifying climate-related opportunities and risks, financial impacts and consistent sustainability reporting, 97% of the 100 largest companies worldwide support the TCFD, disclose data in accordance with the TCDF recommendations, or do both.
Indeed, these now well understood TCFD principles are rooted in IFRS S1 and S2 and so play a central role in transitioning from voluntary to mandatory climate risk disclosures as more countries consider adopting IFRS sustainability standards as a requirement. In particular, the TCFD recommendations underpin new EU regulations such as the Corporate Sustainability Reporting Directive (CSRD) and the EU taxonomy. As a result, companies already using the TCFD recommendations or disclosing data internationally – outside the EU – should not expect any significant hurdles as the standards build on each other.
What will change, however, is the depth and analysis of climate risks analysis that mandatory reporting will require in future.
ESRS and EU taxonomy: analysis of physical climate risks
The requirements of the CSRD are underpinned by the European Sustainability Reporting Standards (ESRS). The ESRS make the disclosure of climate risks in the management report mandatory for all companies that have identified climate change as a material issue. According to the ESRS E-1 transitory risks and opportunities must be disclosed in addition to physical risks in a so-called worst-case scenario and a 1.5 degree scenario. A financial assessment of risks and opportunities will also be part of reporting requirements.
With the Taxonomy Regulation, the EU wants to promote investments in sustainable economic activities that are taxonomy-compliant. Taxonomy compliance means that economic activities significantly contribute to at least one of six environmental goals. At the same time, economic activity that conforms to the taxonomy must meet the “do no significant harm” criterion, which means It must not contradict any of the other five environmental goals.
Companies subject to the taxonomy regulation must disclose for the past financial year what sales they generated with taxonomy-compliant corporate activities or what investment and operating expenses flow into activities that are considered sustainable. The second environmental goal – adaptation to climate change – will be checked as part of a climate risk analysis. The EU taxonomy only requires the analysis of physical climate risks in a high-emission scenario. It classifies the physical hazards into the categories of temperature, wind, water and solid mass, such as coastal erosion or land degradation. The EU taxonomy and CSRD are based on similar requirements so that both regulations can be analysed in a combined climate risk process.
Orientation, approaches and next steps for companies
The arrival of mandatory reporting on climate risk means it is now crucial for companies to take a comprehensive look at the standards to define a suitable process that meets all reporting regulations. Using high-emission to net-zero scenario analyses process to assess financial impacts, climate risk analyses can identify the need for action in risk management at an early stage. Within the process, different physical and transitory risks and opportunities arising from climate change should be considered.
The first step is to identify suitable analysis objects critical to business success. Depending on the requirements of the reporting standards for physical risks, these can include office buildings, production facilities, data centres or a vehicle fleet. Transitory risks will include market or product segments or demand development. It is essential to take your business operations, including the upstream and downstream value chain, into account.
As a second step, the analysis objects are checked for their vulnerability to climate risks in different climate scenarios. This requires quantitative data based on the latest scientific findings. Here, reports from the United Nations Intergovernmental Panel on Climate Change (IPCC), which regularly assess scientific, technical, and socio-economic information concerning climate change, provide solid foundations for sourcing quantitative data.
As we move to a new era of mandatory reporting, reviewing climate adaptation plans and improving the depth and analysis of climate risk reporting is now critical. It’s an approach that allows companies to not only position themselves as more climate risk resilient, but communicate the process transparently to relevant stakeholders.