Some of the UK’s largest businesses and financial institutions must now report publicly on the risks and opportunities they face as a result of climate change.
However, the exact timing and severity of climate change impacts are difficult to estimate, which leads many organisations to postpone (or even ignore), carrying out an assessment of the possible negative and positive impacts on their business model and operations. Many organisations also mistakenly believe that climate impacts will not be felt for many years and are therefore not necessarily relevant to any business decisions they make today.
However, this is simply ‘kicking the can down the road’. Businesses face a number of current, emerging and future potential threats and challenges from climate change. These range from reductions in the availability of raw materials (and price rises caused by their scarcity); new duties to adopt best available techniques and new technology to help protect the environment; and the introduction of new laws by national governments requiring businesses to do much more to reduce their carbon emissions. However, all businesses of every size and sector can begin to plan for these impacts today.
The potential impacts of climate change on organisations range from the physical, such as flooding and storm damage affecting business sites and operations, to those affecting the health, safety and wellbeing of workers – such as exposure to rising temperatures. As a result, businesses need to plan and prepare for these and other impacts.
However, the expected transition to a low-carbon economy will also create significant opportunities for organisations focused on climate change mitigation and adaptation solutions. For example, new ‘green jobs’ will be created and companies that are able to decarbonise their business will make cost savings.
The fiscal impact of climate change on businesses is something that has now come to the forefront and led to the Task Force on Climate-related Financial Disclosures (TCFD) being set up. The TCFD is an industry-led, international group which both helps investors understand their financial exposure to climate risk and helps businesses around the world to disclose this information in a consistent and transparent way. The TCFD was launched at the 2015 Paris Climate Change summit (COP21) by the Financial Stability Board and Mark Carney, the UN Special Envoy on Climate Action and Finance and UK Finance Adviser for COP26.
In 2017, the TFCD issued recommendations for how businesses around the world can effectively disclose reliable financial information on the risks and opportunities climate change poses to their organisation. In essence, the first aim is to encourage businesses to consider the risks and opportunities they may face from climate change and decide what they need to do to ensure they are well-placed to harness opportunities from the world’s planned transition to a low-carbon economy.
It also aims to encourage businesses to set out their emission reduction plans and sustainability credentials, and communicate how they are managing the risks and opportunities from climate change to potential and existing investors and other stakeholders.
The second aim is to provide investors, lenders and insurers with a better understanding of how organisations and assets will be affected by climate change. The general idea is to help the financial markets channel investment, credit and insurance underwriting into projects and activities that will support the transition to a low-carbon economy and remain resilient to climate change.
It also aims to help investors, lenders and insurers identify and support companies that will endure and flourish as the impacts of climate change are felt and steps are taken to reduce global carbon emissions, It will also identify those businesses that will struggle as a result of climate change and the move to a low-carbon economy.
New reporting duties
In October 2021, the UK announced it would become the first G20 country to make it mandatory for certain large UK businesses to report on the climate-related risks and opportunities they face, in line with the TFCD recommendations.
As a result, from 6 April 2022, over 1,300 of the largest UK-registered organisations and financial institutions will have to disclose climate-related financial information on a mandatory basis under new legislation. This includes many of the UK’s largest traded organisations, banks and insurers, as well as private organisations with more than 500 employees and £500 million in turnover.
The affected businesses will have to assess and disclose the potential impacts, risks and opportunities they face from climate change and the UK’s transition to net zero in their annual reports. The UK government has now published guidance to help in-scope companies and limited liability partnerships understand how to meet these new mandatory climate-related financial disclosure requirements.
In essence, the affected organisations will have to consider how climate change is likely to affect their business and report on the likely impacts across four key reporting areas: governance, strategy, risk management, and metrics and targets:
- Governance: Organisations should disclose their governance around climate-related risks and opportunities
- Strategy: Organisations should disclose the actual and potential material impacts of climate-related risks and opportunities on their businesses, strategy and financial planning
- Risk Management: Organisations should disclose how they identify, assess and manage climate-related risks
- Metrics and Targets: Organisations should disclose the metrics and targets used to assess and manage relevant material climate-related risks and opportunities.
The TFCD has divided climate-related risks into two major categories:
- Risks related to the transition to a lower-carbon economy; and
- Risks related to the physical impacts of climate change
1. Risks related to the transition to a lower-carbon economy
Transitioning to a lower-carbon economy will require extensive policy, legal, technology and market changes to address climate change mitigation and adaptation requirements. Depending on the nature, speed and focus of these changes, transition risks may pose varying levels of financial and reputational risk to organisations – for example, through additional taxation or technological requirements in energy and carbon management.
Policy actions around climate change continue to evolve from country-to-country driven in the main by commitments at international level to reduce greenhouse gas (GHG) emissions and mitigate the impact of climate change. These policy actions fall into two categories.
- Those that attempt to constrain actions that contribute to the adverse effects of climate change (known as migration). Examples include implementing carbon-pricing mechanisms to reduce GHG emissions (such as the EU Emissions Trading Scheme); moving towards energy sources and uses that involve lower GHG emissions or use energy only from renewable sources; adopting energy-efficient technical and managerial solutions (such as an Energy Management System); and encouraging greater energy and water efficiency measures.
- Those that seek to promote adaptation to climate change. Examples include policies aimed at installing protective and/or resilient technologies and materials in properties that are prone to flooding; reducing paved areas to deal with rainwater and heat; installing better flood defences, such as sea and river walls; and increasing drainage capacity.
Businesses should therefore assess not only the potential direct effects of policy actions on their operations but also the potential second and third order effects on their supply and distribution chains.
Climate change litigation and reputational risk
Another important risk to businesses in relation to climate change is litigation. There has been a year-on-year increase in climate-related litigation and claims being brought by property owners, staff exposed to health and safety-related climate change risks, insurers, shareholders and others.
The arguments (and claims) behind these legal actions include the alleged failure of businesses to mitigate the impacts of climate change on staff, customers and the organisation as a whole (including the supply chain); failure to adapt to climate change; and inadequate disclosure to investors of the financial risks the business (and in turn its investors) face from climate change.
Climate change also poses a reputational risk to a business if customers and communities believe an organisation is not properly supporting (and actively making) the transition to a low-carbon economy.
For example, in a landmark 2021 case, a court in the Netherlands ruled that the oil company Shell must reduce its carbon dioxide emissions by 45 per cent compared to 2019 levels. This is the first time a company has been legally obliged to align its policies with the Paris climate accords, according to Friends of the Earth. The environmental group brought the case to court in 2019, alongside six other bodies and more than 17,000 Dutch citizens.
Meanwhile, the environmental charity ClientEarth is bringing a separate civil court case against Shell in the UK. ClientEarth argues Shell’s board of directors has failed to properly manage the climate risks faced by the oil and gas company, which is a breach of its legal duties. It also claims that Shell has failed to adopt and implement a climate strategy that truly aligns with the Paris Agreement’s goal to keep global temperature rises to below 1.5°C by 2050. ClientEarth claims Shell is breaching its duties under sections 172 and 174 of the UK Companies Act, which legally requires it to act in a way that promotes the company’s success, and to exercise reasonable care, skill and diligence.
Technology and market risk and opportunities
In future, many businesses will need to make technological improvements or innovations to support the transition to a lower carbon economy, and the investment required for these will have a significant impact on their capital and operating expenses.
For example, the development and use of emerging technologies – such as renewable energy, battery storage, energy efficiency and carbon capture and storage – will affect the competitiveness of certain organisations. Also, due to climate change, production and distribution costs are likely to increase, and ultimately the demand for a company’s products and services from end users may change. However, the timing of technology development and deployment is uncertain and this makes it difficult to assess the impact on business – for example, whether a company will have to make substantial investments in technology to support the move to a lower-carbon economy.
2. Physical risks of climate change
The physical risks resulting from climate change can be short-term and event-driven (‘acute’) or longer-term shifts (‘chronic’) in climate patterns.
Acute physical risks are classed as those that are event-driven, including the increased severity of extreme weather events, such as cyclones, hurricanes and floods. Chronic risk means longer-term shifts in climate patterns – such as sustained higher temperatures – that may cause sea level rise or chronic heatwaves. Physical risks can have financial implications for organisations, such as direct damage to assets and indirect impacts from supply chain disruption.
Efforts to mitigate and adapt to climate change will also create financial and business opportunities for many organisations.
For example, there may be cost savings from adopting resource efficiency measures and using low-emission energy sources; financial opportunities from developing and selling new low-carbon products and services; and access to new markets that are keen to purchase low-carbon products and services from businesses that are supporting the transition to a low-carbon economy.
Climate-related opportunities will vary depending on the region, market and industry in which an organisation operates. The TCFD identified several areas of opportunity, including:
a. Resource efficiency
Organisations that have successfully reduced operating costs by improving efficiency across their production and distribution processes, buildings, machinery/appliances and transport/mobility (in particular in relation to energy efficiency), are more competitive. Global rises in energy costs mean businesses that take appropriate steps to become more energy efficient are in a better position to weather the impact of rising energy costs.
b. Products and services
Organisations that innovate and develop new low-emission products and services may improve their competitive position and take advantage of shifting consumer and producer preferences.
Examples include consumer goods and services that are marketed and labelled in a way that places much greater emphasis on the product’s reduced carbon footprint (for example, travel, food, beverages and consumer staples, printing, fashion and recycling services).
Organisations that seek opportunities in new markets or types of asset may be able to diversify their activities and better position themselves for the transition to a lower-carbon economy.
In particular, there may be opportunities for businesses to access new markets by collaborating with other stakeholders who are already shifting their products, services and business models to align with and support a lower-carbon economy.
Climate resilience involves organisations taking appropriate steps and allocating adequate resources to plan for and adapt to climate change. The aim is to ensure the business is able to both better manage the associated risks and seize climate-related business opportunities. Climate resilience may be especially relevant for organisations with long-lived fixed assets or extensive supply or distribution networks, those that depend critically on utility and infrastructure networks or natural resources in their value chain.
The UK government has announced plans to make TCFD-aligned disclosures mandatory across the UK economy by 2025. It has published a roadmap setting out how an increasing number of organisations will have a legal duty to disclose comprehensive and high-quality information on the climate-related risks and opportunities they are facing and how they are managing them. This will mean that a wider group of UK organisations and sectors will have to assess and disclose what the climate change will mean for them.
As many more organisations complete consistent, reliable disclosures related to climate-based risks and opportunities, the financial markets will be better equipped to evaluate, price and manage those risks and opportunities.
Dr Keith Whitehead CEnv is Senior environmental consultant at the British Safety Council
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