Companies around the world experience billions of dollars in financial losses tied to climate risk every year, from damaged property and rising insurance costs to supply chain disruptions and lower yielding assets. Climate risk disclosures have the potential to be one of the most powerful levers in mitigating these increasing losses, and bringing climate resilience and financial security to businesses and the economy as a whole. However, the way these disclosures are currently made leads to inaccurate and misleading reports, with non-actionable metrics that are impossible to compare between companies.
As climate risk threatens companies’ bottom lines, investors’ returns, and financial stability at large, fixing the broken climate risk disclosure system is critical to pushing private and government actors to urgently tackle climate change on a systemic level.
Climate risk is composed of two parts:
Most businesses are only tracking, measuring and making tangible headway on the second type of risk. While on paper these climate risk disclosures seem solid, they’re only really tackling half the problem. The rest — the part where we have actually have to deal with the ramifications of climate change, and work to adapt — is almost entirely a facade.
According to the 2021 EY Global Climate Risk Disclosure Barometer released last month, “Many organizations are reporting on metrics that don’t correlate directly to risks. For example, disclosing Scope 1 and 2 emissions (important for transition risk) has no bearing on exposure to physical risks, such as a factory or data center being at increased risk of fire or flood.”
We’re setting ourselves up for mediocrity and a failure to mitigate against the impacts of climate change. Meanwhile, almost 60% of the companies in the S&P 500 have at least one asset at high risk of physical climate change impacts, according to S&P Global Trucost data.
The reason is simple: Until very recently, there was no half-decent way to measure physical risk. Current climate risk disclosure platforms attempt to address physical risk measurements by having companies disclose their processes, corporate structures and the like. But the reality is that this is essentially useless. If there’s no way for companies to measure and predict risk, then there’s no way to know how to properly mitigate it either.
This gap in the system poses a threat to investors who get little visibility into the immediate physical climate risks facing the companies they invest in. It also limits companies’ ability to efficiently bolster resilience and secure success and profitability over the coming years.
“Most of the models today work in a reactive way,” Bhavesh Shah, former chief procurement officer at Firmenich S.A., told us. “They look at things like Twitter feeds to gather info. Let’s take, for example, the Rhine River level in Germany. BASF, the largest chemical company in Germany, uses the Rhine River for transportation, so if there is an issue there, you’re going to have an impact on your chemical cost and logistics. That’s reactive.
“What we need is predictive, looking at the climate risk for the coming weeks, months, and years so we can understand our true risk, what it means for our businesses, how that risk will evolve over time, and how we can best mitigate it,” Shah added.
Tim Coates, co-founder and chief customer officer at Oxbury Bank Plc, described how the U.K. was already seeing the impact of climate change, and how the market was unable to account for it. “We are getting stormier, wetter weather, and our infrastructure in the U.K. is not necessarily built to take that level of water coming out of the sky in such a short period of time,” he said. “So there will be flooding, which creates loss. If you're in the insurance industry, obviously, you know that's a big problem. There is already market failure there, whereby there are certain British flood plains and profiles where the property cannot get adequately insured.”
True physical climate risk disclosures — measuring the risks of heatwaves, floods, drought, wildfire and the like — will help economies reach a more climate-resilient equilibrium faster and more efficiently, and will set businesses up to win.
We’ve seen progress in recent years. Policymakers have begun responding to the billions of dollars in annual financial losses tied to climate change; the U.K, Japan and New Zealand have all issued laws requiring businesses to assess and report the climate-related risks they face. Last year, the United States joined them: President Biden directed federal agencies to address the economic risks stemming from climate change for the first time in American history.
In addition, EY notes that more than 1,100 companies across 42 countries were in line with the most common climate risk framework, the Task Force on Climate-Related Financial Disclosures (TCFD), and “the research found that companies have continued to make progress in addressing the quality and coverage of climate-related financial disclosures.”
But if these disclosures are flawed, how can we expect any tangible climate action from these companies?
The world is approaching an inflection point on corporate climate risk disclosure, possibly one of the most impactful moments in the history of the battle against climate change. But we need a far more rigorous, data-driven and predictive system for climate risk disclosures, if we actually want to drive behavioral change and make progress not only on reducing emissions, but also adapting to the impacts of climate change that are already here and affecting business today.
We have the chance to get climate risk right. But we need to act now.
Himanshu Gupta is founder and chief executive officer of Climate.ai.
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