Climate risk: Taking the road to opportunity, not risk

Those were the words of UN chief António Guterres at the COP27 climate summit. Climate risk management goes beyond simple compliance with Task Force on Climate-Related Disclosures (TCFD) recommendations, but instead should be considered an existential crisis for every corner of the economy. If we fail to address it, it’s going to change everything – and not for the better.

Just look at the impact of rising energy and food costs that we are experiencing today – the disruption and impact on people and businesses. That’s just a taste of what climate change could mean. What happens when certain parts of the Earth become uninhabitable due to heat or flooding, displacing billions of people, disrupting supply chains and turning whole cities into stranded assets?

Would you rather be on the receiving end of those crises, or an innovator, offering transition-ready solutions and capitalising on emerging opportunities?

The time for tinkering is over. Act now and you can help mitigate the risks and realise the value that being a climate leader can bring to your business.

So, where do you start?

Here’s our four-step approach to tackling climate risk.

Just like taking your car (EV, of course) to the garage, it starts with a diagnosis of the problem and understand your current position.

Identifying how far you are from compliance will help you understand the size of the challenge. How far away are you from meeting TCFD requirements in the mid-term and International Sustainability Standards Board (ISSB) standards in the longer-term?

This isn’t a tick-box exercise though. There are 33 TCFD recommendations and, sure, you can go through and tick each box to comply, just like your MOT. But that’s missing the strategic intent of TCFD – and its leaving value on the table. If you’d like your new EV to stay on the road in the long term, then you’d better go for the full service.

The real impact, and the real value to your business, comes when you act on the issues TCFD has brought into sharp focus. And I’m not talking about setting a Net Zero target and then reporting on it. I’m talking about driving change, through targeted action which addresses the specific issues your business is facing – and seizing those opportunities!

To do that, you need to identify blockers. Ask yourself the following questions:

• Do we have the right incentives in place? How are we encouraging changes in behaviour through our remuneration policy?

• Are our staff fully aligned with your climate strategy? Is it real for them? Are we telling them a compelling story that they can get behind?

• Do we have robust governance that provides the agility to respond at every level, and which takes correct action we go off track?

• Does our investment process take into account all the climate risks? (That goes beyond reducing carbon emissions, by the way. For example, did you check for flood risk on that new asset?)

I recently ran a readiness assessment which concluded that the organisation in question needed to rethink its entire business plan to address climate risk. “Hold on,” said the CEO. “Our Head of Sustainability asked for funding for a few initiatives. That’s what I signed up for. What’s this about rethinking my whole approach?”

When you’re building your climate strategy, you need to go into it with your eyes open. That requires you to ask two key questions:

• Will we still be producing the same widget, the same way, in a climate-changed world?

• Will we still be selling to the same customers, in the same places?

Understanding the full risks and opportunities that underpin your strategy takes effective scenario planning – mapping out all the possible outcomes and understanding the common sensitivities. It’s something that many businesses are currently struggling with (see the other articles in this series for more on that).

Of course, the extent of scenario planning you need to conduct, and the impact on your climate and business strategy, will vary depending on the nature of your business. Online retailer? You might just be looking at diversifying your product base. Oil and Gas? Settle in, this may take a while.

You may be thinking, “just a second, there’s still strong demand for my products and services today, why would I change everything?” But do you really want to be designing your diversification strategy once the market has already started moving? How are you protecting your business from the risk of lower demand? Customers are going to start voting with their feet, if they’re not already. Make sure you’re the one they’re walking towards, not the one they’re leaving behind.

Your answers to these questions need to be incorporated into your strategic response. And it can’t be the usual five-year plan. That won’t enable you to make sensible decisions about engines that run for 20 years or factories with a 35-year lifespan. Remember, the impact may not occur in the next 5 years, but the market might start to price it in even sooner than that. Did someone say “ISSB”?

Once you’ve diagnosed the issues and opportunities, and formulated your strategy, it’s time to take action and transform your business.

We ran a scenario analysis for a company that was sceptical about climate risk. What we found was that its risk register, strategic planning and financial reporting were all running in isolation. We also discovered that a small increase in the cost of capital could blow out its margins. That organisation has now completely changed its mindset and is investing significant time and money into tackling climate change as a matter of urgency, through an integrated response across strategy, risk and finance.

That change of mindset is vital to driving the necessary transformation – both to manage the risks and seize the opportunities.

It also takes data to fuel the transition-engine. You need to put in place the right controls to provide reliable data on the changing risks and opportunity profile, and then you need to monitor that data continuously. That enables you to react fast and reset your course when necessary. Collecting this data can be a huge task in itself. A good starting point is to identify where you’re already gathering it across your business.

If you get steps 1, 2 and 3 right then the results will speak for themselves, and your climate risk reporting should fall into place. You’ll find a lot more insight on regulatory requirements and compliance in the other articles in this series. But here are some key points on climate risk reporting to consider:

• What you claim in the front half of your financial report must be reflected in the back half. That means you need your business to be connected. Don’t treat climate risk strategy and reporting in isolation.

• When it comes to emissions, extend your focus beyond your own scope 1 emissions. You need to look at scope 2 and 3 emissions as well, plus your trajectory. That requires more effective scenario analysis to catch those indirect effects.

• Your non-financial data now needs the same level of data quality as financial data. At most organisations, the sustainability team is responsible for climate risk reporting. But do they have the same rigour over data quality as your finance team? And do you have the level of assurance you need in your climate data?

We’ve talked a lot about the importance of data to making the right decisions and driving your climate strategy forwards. But make sure you avoid analysis paralysis. Set a course and let’s get under way.

You can start by putting in governance measures and incentives. You can define your priorities and begin identifying and taking some tangible actions. In that way you can eat the elephant, one bite at a time.