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Climate risk and how to approach it

Portrait photo of David Carlin, programme lead for the UN Environment Programme Finance Initiative's Task Force on Climate-Related Financial Disclosures

SG Voice spoke to David Carlin, programme lead for the UN Environment Programme Finance Initiative’s Task Force on Climate-Related Financial Disclosures, about how small and medium-sized enterprises (SMEs) can start approaching climate risk.

  • Climate change poses both physical and transition (or policy) risks to organisations worldwide.
  • Businesses need to understand, measure and address these risks to develop effective growth and development strategies.
  • Regulatory regimes are becoming more stringent as central banks and investors want comprehensive assessments of climate risks.

What are climate risks?

With the planet on track for a temperature rise of 2.4-2.6°C by the end of this century, well above the 1.5°C limit imposed by the Paris Agreement, companies worldwide are inevitably subject to climate-related risks. These are divided into physical and transition risks.

Physical climate risks arise from things such as damage to property, land and infrastructure or disruption to supply chains and food systems. Transition risks are associated with the economy evolving towards low-carbon models, and include changes in policies, technologies and consumer trends, as well as costs related to compliance and regulatory requirements.

According to David Carlin, programme lead for the UN Environment Programme Finance Initiative’s Task Force on Climate-Related Financial Disclosures, both are cross-cutting risks. As such, they can impact other types of risks encountered by companies – such as those related to credit, markets and operations.

“A changing climate and the low-carbon transition are two unavoidable elements of the future world. For individual firms, understanding how climate change may impact their business can enable them to be more prepared, resilient, and successful in the face of these changes. For supervisors and policymakers, understanding the systematic impacts of climate change can help to preserve stability and functioning markets,” Carlin says.

Climate risk assessment for small and medium-sized enterprises

All organisations should calculate how climate risks can impact their operations as a baseline for developing effective strategies. Businesses can begin looking at climate risk for a number of reasons, which can range from increasing investor or client demand, reputational purposes or a sustainability mission – or a combination of the three. Small and medium-sized enterprises (SMEs), however, often worry about a lack of available and accurate data or dedicated resources. 

Carlin points out that there are a number of open-source resources that can help SMEs understand the types of climate scenarios that they should consider. A starting point is the work of the Network for Greening the Financial System, which has developed a series of reference scenarios and a related explanatory guide. Other valuable resources include the World Bank and the World Business Council for Sustainable Development

“After exploring the scenarios, SMEs can then identify areas of potential risk in their operations or exposure. This can be done by creating a heatmap that considers different physical and transition hazards and how different elements of the business may be affected by them,” he adds.

“Further quantification can be done by tracking emissions from the firm’s activities (for transition risk) and exploring the resiliency of real assets (for physical risk). Firms that want to be best prepared can develop a transition plan and a resiliency plan to ensure continuity in the face of the low-carbon transition and physical climate change.”

Climate risk disclosure regulations

An increasing number of regulatory bodies are looking to set mandatory disclosures. For example, the Biden Administration has proposed a new rule, whereby federal contractors would be required to publicly disclose their greenhouse gas emissions and exposure to climate-related financial risks.

Also in the US, the Federal Reserve launched a climate risk pilot for six major banks in October 2022. Meanwhile, the International Sustainability Standards Board plans to impose climate-related scenario analysis for companies to comply with its upcoming Sustainability Disclosure Standards. 

Carlin comments: “These requirements have certainly improved the quality and comparability of the disclosures made… Policy risk is typically seen as a component of transition risk, and I would argue that the commitments that nations are making to decarbonisation and climate readiness are raising the stakes for the companies that operate within their borders to take climate seriously.”

Transition requires comprehensive understanding of climate risks

There is a long way to go before climate risk is fully embedded in financial assessments worldwide. According to Carlin, we need market-based solutions that accelerate the transition to a sustainable, resilient, low-carbon future.

This will require scaling up investment in new technologies and the deployment of existing technologies that reduce emissions and promote adaptation.

The transition will also require the creation of the right financial incentives to avoid the lock-in of assets that are incompatible with that future. It will be crucial to deploy clean energy technologies across the world, with a focus on electrification, sustainable agriculture, and low-carbon buildings. This will need to be complemented by climate-resilient infrastructure that will not fail and disrupt supply chains in the face of worsening climate change. 

“In taking these bold steps, we also need to consider the impacts of our decisions on natural systems and local communities, ensuring a nature-positive and just transition,” Carlin concluded.

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