Businesses can reduce their vulnerability to uncertain climate-related risks by embedding flexibility into their strategy, which also enables them to take advantage of opportunities as they arise. Best practice is to build adaptive capacity following the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD), which involves testing the business under a range of scenarios.

4 min read | Last updated 5 March 2021

Systemic environmental, political and socioeconomic changes will unroll as the climate changes and as we fight climate change. How will this affect business? It boils down to two fundamental types of climate-related risk – physical risks and transitional risks.

Some changes will open up opportunities, such as resource efficiencies, new energy sources, new products and services, new markets and more resilience to further change. An analysis of G500 business disclosures found that reported climate-related opportunities exceeded climate-related risks, with 225 companies reporting climate-related opportunities worth US$2.1 trillion. Meanwhile, 215 companies reported climate-related risks costing US$970 billion, of which US$250 billion was for impairment relating to stranded assets (CDP, 2019 (pdf)).

Physical RisksPotential Business Impacts
Extreme heat; droughts and water scarcity; sea level rise; storm surges; changing rainfall patterns; increased frequency and intensity of weather extremes; increased weather variability; wildfires; cyclones; flooding; loss of biodiversity; changes in pest and disease distribution; rising average temperatures; melting sea ice; thawing permafrost (Oxfam et al, 2012(pdf))Risks to worker health and safety; supply chain and network disruptions; decreased crop yields; increased cost of water; conflicts over water use; soil salinity; fluctuating cost and availability of raw materials; fluctuating commodity prices; altered seasonal cycles; damage to / destruction of infrastructure; increase in peak energy demands; increase in insurance claims and prices; uninsurable assets; demand for new products; loss of natural assets and their ecosystem services
Transitional Risks Potential Business Impacts
Fossil fuel policy change, technological change, market change; civil unrest; geopolitical change; greater stakeholder scrutinyCarbon taxes; carbon pricing; energy efficiency standards; stranded assets; shift in consumer preferences; human rights abuses in the supply chain; corruption; demand for data; access to finance; legal action; liability; shareholder resolutions; assurance of non financial performance; non financial reporting standards and regulations

Vulnerability to change depends on two things: exposure to change and sensitivity to change. Vulnerability can be ameliorated through building the capacity to incrementally adapt as change occurs.

Best practice for building the business capacity to adapt to climate-related change is to follow the recommendations of the Taskforce on Climate-related Financial Disclosure. Corporate disclosure based on TCFD recommendations will be made mandatory for New Zealand listed entities from 2023, ie in FY22 reports.

The TCFD highlights five industry groupings that it believes will be most financially impacted by a transition to a low-carbon economy due to their material GHG emissions, energy use and water dependencies associated with their operations or products – these are the financial, energy, transportation, materials and buildings and agriculture, food and forest groups. The most financially-vulnerable industries are oil and gas, real estate management and development, agriculture and paper and forest products.

The chart below gives an overview of the areas of potential financial impact.

The chart below shows New Zealand industries that contributed more than NZ$12 billion to GDP in 2018. Half of these – real estate services, construction, financial / insurance services, transport and agriculture – have been highlighted by the TCFD (above) as particularly susceptible to the financial impacts of climate change.

Source: Stats NZ

The TCFD framework aims to address investor concerns about business readiness for an uncertain future through financial risk analysis and disclosure. As of December 2020, more than 1,600 organisations around the world had stated their support for the framework.

The TCFD’s six step process is described in the diagram below (TCFD, 2017 (pdf)).

Technical Supplement – The Use of Scenario Analysis in Disclosure of Climate-Related Risks and Opportunities, TCFD, June 2017 (pdf)
Step 1: Ensure Governance is in Place

The Aotearoa Circle has prepared a climate risk tool kit for New Zealand directors (Chapman Tripp, 2020 (pdf)).

Step 2: Assess Materiality of Climate-Related Risks

Climate change will affect every business uniquely through risks and opportunities that could have a material financial impact on revenues, expenditures, assets and liabilities, capital and financing.

Step 3: Identify and Define Range of Scenarios

This is new to many businesses. Scenarios are non-predictive, non probabilistic stories about plausible futures that a business can use to stress-test its business strategy, thereby indicating where adaptation planning is required.

A scenario should:

  • be custom-built for the business
  • be scaled to local levels of granularity as far as possible
  • integrate climate, socioeconomic and policy assumptions
  • refer to a future year, eg 2050 or 2100
  • refer to a global warming temperature, eg 2C or 4C

TCFD recommends using two opposing global warming scenarios, such as:

  • BAU – a high physical risk, low transition risk scenario, eg 4C global warming
  • Low carbon future – a low physical risk, high transition risk scenario, eg 2C global warming with aggressive mitigation

Discover more about climate change scenarios here.

Step 4: Evaluate Business Impacts

Examine the impact that each scenario would have on business strategy assumptions, such as input costs, operating costs, revenues, the supply chain, business interruption and timings. Where is the business most sensitive to change?

Step 5: Identify Potential Responses

How could the business respond to improve its resilience to these impacts? Where has it the most sensitivity? What changes could be made to strategy, the business model, assets or capabilities?

Step 6: Document and Disclose

Prepare an annual disclosure describing the findings and responses achieved through steps 1 to 5. TCFD recommends an 11-part disclosure under four headings: governance, strategy, risk management, and metrics and targets (see below).

Source: TCFD, 2020 (pdf)

Disclosure is the sixth and final step in the TCFD’s recommended climate change adaptation process – which means that a substantive TCFD disclosure can only be the result of several years of work in building adaptive capacity through risk assessment, scenario analysis, impact evaluation and adaptation planning. Among businesses that have made a TCFD statement, 93% have not yet explained the resilience of their business strategy under different climate-related scenarios (Strategy: recommended disclosure (c)) (TCFD, 2020 (pdf)).

Discover more: TCFD Workshops: Practical steps for implementation, McGuinness Institute, 2019