Taking climate into account: Knowing and showing management of climate risk

This is the third in a series of four articles from CDP‘s CEO Paul Simpson addressing what CFOs will need to know after Mark Carney and Michael Bloomberg’s climate Task Force reports to the G20 in July.

Last year was the hottest on record. Even though climate change is generally seen as a long-term issue, it is already radically re-shaping many businesses, especially when it comes to risk management. For example, climate-related events such as Hurricane Sandy and the recent Californian drought have reshaped sectors like insurance and farming in the affected areas, causing massive financial losses. Increasingly, all organisations are expected to consider the complex set of climate risks and opportunities that might affect their business from a ROI, brand reputation and regulatory perspective.

As discussed in the first article of this series, one of the most important developments for CFOs in this area may prove to be the Task Force on Climate-related Financial Disclosures (TCFD), led by Mark Carney and Michael Bloomberg, which this July will set out a suggested framework for companies to report how they are managing climate risk. This article elaborates on the third of the TCFD’s four key areas: risk management.

Businesses are now expected to disclose climate risk management 

Under “risk management”, the TCFD suggests that companies disclose: “How the organisation identifies, assesses and manages climate-related risks”.

In practice, the TCFD elaborate that this means that in the coming years CFOs and their companies will be expected to publicly describe:

  • The organisation’s processes for identifying and assessing climate-related risks;
  • The organisation’s processes for managing climate-related risks;
  • How processes for identifying, assessing and managing climate-related risks are integrated into the organisation’s overall risk management.

The good news for risk management teams is that the tools and processes required to help CFOs are already widely available. Two good examples are internal carbon prices and science-based targets.

Internal carbon prices

Putting a price on carbon is an essential part of any strategy to combat climate change, mitigate risks and capitalise on opportunities. Already, nearly 60 states and regions are participating or preparing for a carbon price. According to the World Bank, if the likes of China, South Africa and Chile implement it, 25% of all emissions could be covered by carbon prices next year.

It is little surprise then that corporate use of an internal price on carbon nearly tripled in 2015-16 to 437 companies, and more than 500 additional companies plan to implement in budgeting and strategic planning by the end of 2017. A recent CDP report backed by industry heavyweights – including leaders from Bank of America, Barclays, Engie and Iberdrola – further builds on the TCFD’s recommendations by providing a metric for companies and investors to integrate carbon pricing into their climate-related financial disclosure and stress test their portfolios against a 2 degree scenario.

Science-based targets

Science-based targets (SBTs) are an equally powerful mechanism for helping clients manage climate risk. Science-based target setting results in meaningful reduction programmes that align with the Paris Agreement. For example, a company may have adopted a target to “halve its greenhouse gas emissions by 2020″ but may not have considered whether this target actually aligns with the scientific requirements needed by their company and sector to ensure that global warming remains below 2°C and ideally below 1.5°C. SBTs aim to ensure targets are not arbitrary but effective. They also enable companies to better understand where they are vis-a-vis their competitors and how they are progressing against the targets set.

Over 265 companies have already committed to adopt science-based emissions reduction targets, including household names like Kellogg’s and Tesco. Companies that have already set SBTs report benefits including increased innovation, reduced regulatory uncertainty, strengthened investor confidence and credibility and improved profitability and competitiveness.

Climate is already a fundamental part of the risk management process for many companies and it will soon be seen as a major oversight to exclude such considerations from the process. Companies that fail to include climate risk in their planning are likely to find themselves under pressure from shareholders, investors and consumers once the TCFD recommendations are handed to the G20 this summer.

Paul Simpson is the CEO at CDP.

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