Awareness in the business community is growing on the need to integrate climate-related risks into risk management processes. But before starting this journey, companies need to understand how to identify climate-related risks and opportunities.
Climate-related risks are often underestimated by companies because of their complexity and long-term effects. However, today, many companies are already facing the impact of climate-related risks. For most companies, identifying, managing, and disclosing the topic of climate-related risks and seizing the opportunities of climate change are new challenges, and therefore they don’t know exactly where to start.
Companies should realize what they are up against, and need to understand their key risks, as well as the interconnectedness of these risks, to be able to come up with mitigation and adaptation measures. At the same time, by assessing these risks, organizations can capture key opportunities, like efficiency, innovation, access to new markets, and resource diversification.
We have defined four steps to help companies with identifying their climate-related risks and opportunities , which will be explained in this blog.
Step 1: Defining the scope
Firstly, it is crucial to start defining the scope of the identification assessment of climate-related risks and opportunities. Climate-related risks can be divided into risks related to the physical impacts of climate change (e.g. extreme weather events and rise of sea level) and risks related to the transition to a lower-carbon economy (e.g. changing market demand and carbon pricing). Which type of risks does your company want to focus on: physical and/or transition risks?
We see two main approaches companies take to scope their climate-related risk identification . There is the ‘holistic scope’ including multiple risk types that will impact their entire value chain (i.e. suppliers, operations, customers, regardless of their locations). Then there is the ‘focused scope’, in which companies decide to focus only on a specific type of risk (e.g. flood risk) or a certain part of their business (e.g. one product category or geographic location).
Step 2: Understanding potential risks and opportunities
The second step in identifying climate-related risks is to understand the different risks and opportunities associated with climate change within the defined scope. Whichever approach you choose, it is key to start thinking about vulnerabilities (being unable to cope with and adapt for adverse effects of climate change) and exposure (the monetary value of various types of property, infrastructure, or lives that may be subject to undesirable outcomes) and ask the following type of questions:
- Where in the supply chain do you recognize vulnerabilities or have climate-related risks already manifested?
- Which of your products or services have already been impacted by extreme weather events?
- What could be the financial impact of carbon taxation being implemented in countries where your business operates?
What could be the financial impact if consumers change their behavior towards low carbon products? For example, physical risks such as rising sea levels and increasing extreme weather events may have financial implications for companies, such as direct damage to assets and indirect impacts from supply chain disruption. But while some risks can be daunting, climate change can also lead to business opportunities if companies can address, mitigate and adapt fast – such as energy efficiency, cost savings, resilience, and competitive advantages.
A robust understanding of potential climate-related risks and opportunities can be best obtained through desk research, expert views and benchmarking, as well as through holistically incorporating the views of internal and external stakeholders. You can think of different departments within your company, such as Strategy, Risk, Legal, Finance and Operations departments. This step leads to a longlist with identified potential risks and opportunities within the defined scope.
Step 3: Understanding the business impact
Next, every organization needs to understand from a high-level perspective what the implications of these identified risks could be for the business. The business impact varies significantly depending on the industry and economic (sub)sector, geographic location of the organization’s value chain, the organization’s assets and organization’s customers, and other key stakeholders. Business implications could be direct (e.g. expenditure, revenue, assets, liabilities) and indirect (e.g. delay in delivery, drop in demand, disruption of supply chain, compliance breaches, reputational damage). For example, for a global food manufacturing company, an increase in temperature could negatively impact the crop yield (leading to increased costs of raw materials) and could impact operations and cooling facilities (leading to an increased cost of cooling capacity). Within the defined scope, it is crucial to determine how each risk and opportunity may or may not materialize under different scenarios. Will they impact your company directly, or indirectly?
