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Alphabet soup: deciphering physical climate risk disclosure

Published on
May 9, 2023
Alphabet soup: deciphering physical climate risk disclosure
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TCFD, ISSB, SEC, EFRAG. For companies navigating their climate risk environment, the initialisations can seem like a bewildering foreign language. What you have to assess, report and disclose, and when, differs depending on your jurisdiction, your size, your industry. So what’s the best approach?

Assets: Whatever guidance or draft disclosure rule you’re applying, chances are that it’s going to suggest you disclose the number and percentage of your assets that may be subject to damage, failure or disruption as a result of acute or chronic physical risk. You should also find about the physical risk to assets owned or leased by companies you invest in and then benchmark this against other companies.

Value chains: Incoming climate disclosure standards will want companies to disclose material risk in their value chains. If you think that’s a big undertaking for counting Scope 3 emissions, just imagine how complicated it will get for assessing the physical risk from eight or more chronic and acute hazards, applying climate change modelling in different countries and considering the range of ways the weather and the environment can disrupt supplies, demand, workforces, critical services. In its recent consultation paper for Enhancement of Climate-related Disclosures, the Hong Kong Stock Exchange defined “value chain” as “The full range of activities, resources and relationships related to an issuer’s business model and the external environment in which it operates.” Which is about as broad as you might choose to make it.

Scenarios and time-frames: The thing about climate change is, we’ve never been through it before. We can’t use the past as a rule for the future. That’s why most disclosure regimes, taking their queue from the TCFD, recommend using scenario analysis to explore how change could unfold. For physical risk, this means exploring just how bad things might get, with a warming scenario like the IPCC’s RCP8.5, applying models that stress test for each hazard. It also means modelling out to the end of the century, because in the risk business, the sting is in the tail, and what looks likely beyond 2050, is still possible earlier.

Quant what you can, qual what you must: Metrics and targets are as important for physical risk as for emissions reporting. You might know an asset or business activity is at risk from one or more climate change extreme weather hazards, but what you need is a metric that will turn that risk into impacts on your balance sheet, your output, your operating reserves. In short, you need to know the “Material financial effects” of hazard damage. So much so simple, XDI can do that, but what about the risk you know is there that doesn’t confidently downscale into firm-level numbers? Like the physical tipping-points being reached? Or economic tipping points? Or the effects of compound, cascading and systemic risk?  

XDI blogged about the TCFD guidelines three years ago, and since that time:

Several disclosure regimes have come into force and many more guides and recommendations have been published. But the advice we gave then still holds now: start by understanding your assets, their exposure and their vulnerabilities, consider your upstream and downstream dependencies, use climate modelling that tests your tail risk, use metrics that translate climate change extremes into financial terms. Above all, undertake your climate risk analysis in good faith. If you’re just ticking boxes, and missing material risk, chances are the climate will have surprises in store for you.

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