Climate change is one of the most significant and uncomprehended risks that organisations face today. The continued emission of greenhouse gases (GHG) is the leading cause of global warming, which further exacerbates climate-related issues. Beside intensifying physical and transition risks, climate change also leads to detrimental financial and socio-economic consequences. Businesses across the globe are increasingly under pressure to address climate change through adaptation and resilience. Moreover, stakeholders have increased demand for transparency from organisations on their governance structures, climate adaptation strategies, and risk management practices. As a result, organisations are also increasing transparency in financial disclosures, making financial markets and economies more efficient, stable, and resilient. The Task Force on Climate-Related Financial Disclosures (TCFD) is helping companies to access climate-related risks and opportunities and disseminate sustainability-related information in their reporting [1].
Overview of TCFD Reporting and Its Importance
Climate-related financial disclosures have become a critical component of corporate reporting to assure transparency in financial as well as sustainability disclosures. The Task Force on Climate-related Financial Disclosures (TCFD) established by The Financial Stability Board (FSB) provides a robust framework for investors, lenders, and insurance underwriters to properly evaluate and disclose climate-related risks and opportunities. By integrating TCFD recommendations into existing financial reporting frameworks, companies can enhance transparency, improve resilience, and meet investor expectations. However, integrating TCFD recommendations into existing financial reporting can be a complex task, especially for companies with established systems and communication channels. Nevertheless, the Task Force utilised member expertise, stakeholder engagement, and existing climate-related disclosure regulations to create a unified and user-friendly framework for disclosing climate-related financial information [2].
Key Aspects of TCFD Recommendations
The recommendations put forth by the TCFD apply to financial as well as non-financial sector entities, such as banks, asset management institutions, energy companies, and FMCG organisations. The Task Force has formulated four highly adaptable recommendations concerning climate-related financial disclosures, which are relevant to organisations operating in different industries and sectors [2]:
These Recommendations are:
Adoptable by all types of organisations
Included in the financial filings
Intended to elicit forward-looking information that is useful for decision-making
Emphasis on risks and opportunities associated with the transition to a low-carbon economy
Core Elements of TCFD Recommendations
The TCFD recommendations focus on four core areas: governance, strategy, risk management, and metrics and targets. These areas provide a framework for companies to disclose their climate-related risks and opportunities in a clear, consistent, and comparable way [3]:
Governance: This refers to how an organisation's board and management oversee and assess climate-related risks and opportunities, ensuring climate risks are properly integrated into business decision-making process.
Strategy: This involves identifying the actual and potential impacts of climate-related risks and opportunities on the organisation's business, strategy, and financial planning.
Risk Management: Companies are required to describe the processes they use to identify, assess, and manage climate-related risks, integrating them into overall risk management.
Metrics and Targets: Organisations must disclose the metrics and targets they use to assess and manage relevant climate-related risks and opportunities, providing transparency on performance and progress.
Key Principles of Integrating Climate-Related Risks
Integrating climate change risks into the existing risk management framework is probably the best way to ensure that the impact of climate change is properly considered in the decision-making process. The Task Force has highlighted key principles to assist companies in effectively integrating climate-related risks into their current risk management processes. These principles ensure that climate-related risks are identified and managed cohesively and strategically. Additionally, the Task Force believes that these principles can also be valuable for the continuous management of climate-related risks and are briefly explained below [3], [4]:
Interconnections: Effective integration requires cross-departmental collaboration within the organisation. Since climate risk impacts every unit within the organisation, the principle of interconnections implies that all the relevant functions, divisions, and experts should be engaged in the effective integration of climate-related risks into the company’s existing risk management processes.
Temporal Orientation: Climate change risks, whether physical (e.g., extreme weather events) or transition-related (e.g., regulatory changes), must be analysed across short-, medium-, and long-term horizons. This broad temporal approach ensures that strategic business plans are made beyond traditional time frames, which considers the full spectrum of risks that may evolve over decades.
Proportionality: The extent to which climate risks are integrated should be proportionate to the company's exposure and materiality of these risks. Companies must balance climate risk management with other operational risks, ensuring that the approach fits the strategic significance of the identified risks.
Consistency: A standardised and consistent methodology for assessing and managing climate risks is vital for organisations. Consistency ensures that the company can track, evaluate, and compare climate-related developments over time by improving the clarity and reliability of risk assessments.
Key Steps For Integrating Climate-Related Risks Into Enterprise Risk Management
The Task Force provides a structured framework (concrete steps) for incorporating climate-related risks into existing risk management practices. The TCFD suggests a step-by-step, incremental method, which companies have successfully used to embed enterprise risk management (ERM) into their operations. These steps draw on the guidance developed by the Committee of Sponsoring Organisations of the Treadway Commission (COSO) and the World Business Council for Sustainable Development (WBCSD) in their published guidance document. The guidance here outlines a series of initial, high-level steps designed to assist companies in recognising key factors for successful integration. The process aims to help organisations embed climate considerations into their overall risk management strategies by focussing on practical steps and essential elements as described below [4], [5], [6]:
Step 1 - Understand Climate Change Concepts (Foundational Principle)
For companies where climate-related risks have not been part of the traditional risk management process, it is crucial to develop a foundational understanding of climate change concepts and their potential impact across the organisation. This can be achieved by clearly defining key climate-related terms and identifying the major hazards and impacts related to climate change. Through this approach, the organisation’s management and risk professionals will be able to draw connections between the broad consequences of climate change as well as any specific consequences for the company. The IPCC’s Fifth Assessment Report provides the following sample of climate change potential hazards, key risks, and key vulnerabilities [4], [5], [7]:
1. Rising Sea Levels & Coastal Flooding
Key Vulnerabilities: Coastal regions are highly vulnerable due to the dense population, significant economic activities, and critical infrastructure situated in low-lying areas.
Key Risks: Sea-level rise and coastal flooding pose threats to human lives and livelihoods, disrupt essential resources like food and water, and damage infrastructure.
2. Extreme Heat
Key Vulnerabilities: Urban areas, especially with ageing populations, young children, and individuals with chronic health conditions, are particularly susceptible to rising temperatures.
Key Risks: Extreme heat leads to increased mortality rates and worsens health outcomes, especially during prolonged heat waves.
3. Drought
Key Vulnerabilities: Areas already facing water scarcity are highly vulnerable, particularly where increasing water supply is difficult.
Key Risks: Severe water shortages can lead to widespread economic impacts, threatening agriculture and livelihoods, and worsening living conditions.
Step 2 - Identify Processes And Functions (Key Principle)
To effectively integrate climate-related risks into business operations, organisations should recognize how risk management processes and strategic planning are interconnected together. Moreover, companies should also identify who are the key stakeholders responsible for those processes and elements. A good starting point is to review governance structures, strategic planning elements, and risk management processes. By understanding these elements together, companies can evaluate the role of various department functions in managing climate-related risks that support long-term strategic goals. The risk recognition process widely consists of three phases as follows [4], [8]:
Identify new, emerging, and dynamic risks that may affect a company’s short-, medium-, and long-term objectives.
Assess risks to understand the intensity of their impact on business objectives.
Prioritise risks to facilitate decision-making on risk responses.
To do ongoing identification, assessment, and management of risks, COSO has identified the strategic planning activities for various departments and functions as follows [8]:
Board / Management: Sets strategy and defines short-, medium-, and long-term goals and plans.
Finance / Risk Management: Creates financial and capital allocation plans.
Operations / Business Areas: Creates operational plans to support strategies within financial constraints.
Step 3 - Update Risk Taxonomy (Key Principle)
Using a standardised risk taxonomy, which categorises risks consistently, allows companies to better identify, evaluate, and manage their risks. When incorporating climate-related risks, businesses must decide if these risks will be treated as standalone or as cross-cutting influences that impact existing risks. This decision shapes how these risks are integrated into the company’s established risk taxonomy. Categories like financial, operational, and strategic risks are commonly used, though many companies have additional specified risk categories [4].
The Task Force on Climate-related Financial Disclosures (TCFD) recommends treating climate-related risks as drivers of existing risks. Companies can begin by aligning climate risks with their current risk categories. For example, climate-related events, such as rising temperatures or increased natural disasters, might raise costs related to raw materials; this presents a financial risk for many organisations. Once these risks are categorised; companies should regularly update their risk inventory to reflect these integrations. The inventory should outline each risk, its potential impact, and strategies to manage it. An example of Risk Categories, Risk Types, and Climate-Related Risks as indicated by COSO is elaborated below [8]:
1. Category: Financial
Type (Sub-Category): Credit Risk, Liquidity Risk, Tax Strategy
Climate-Related Risks:
Climate change can negatively impact a company's creditworthiness as lenders become cautious about escalating climate-related business risks, leading to higher interest rates. Additionally, costs may rise due to carbon taxes or environmental fees introduced by governments to reduce carbon emissions.
2. Category: Operational
Type (Sub-Category): Supply Chain, Raw Material Availability, Business Continuity Planning
Climate-Related Risks:
Supply chains face disruptions from extreme weather or drought in supplier regions, affecting raw material availability. Companies may also experience increased costs due to compliance with sustainable practices like eco-friendly forestry. Weather pattern changes and natural disasters can further impact business continuity and daily operations.
3. Category: Strategic
Type (Sub-Category): Competition, Changing Customer Preferences
Climate-Related Risks:
Consumer preferences are shifting towards low-emission products. Companies that fail to align their products with sustainable practices risk losing market share to competitors that better address the demand for eco-friendly solutions.
Step 4 - Adapting Risk Management Processes for Climate-Related Risks (Key Principle)
To effectively manage climate-related risks, companies should review and adjust their existing risk management processes. The Task Force on Climate-related Financial Disclosures (TCFD) outlines key considerations for the risk management process; including risk appetite, risk identification and assessment, and risk management tools [4].
Risk Management Tools
When evaluating the need for new risk management tools or adapting existing ones, companies should consider the unique characteristics of climate-related risks. Scenario analysis, a valuable tool recommended by TCFD, can help identify and assess potential implications of various climate-related scenarios. By understanding how climate-related risks and opportunities might impact the company over time, businesses can make informed decisions and develop strategies to mitigate risks and capitalise on opportunities [9].
Scenario Analysis: It involves the process of identifying and evaluating potential consequences of various possible future situations under uncertain conditions. By applying scenario analysis, businesses aim to achieve insight into how risks and opportunities related to climate change that could plausibly affect a company over time.
Conclusion
Successfully integrating climate-related risks into existing risk management processes requires a company-wide understanding of climate change concepts and risks. Existing processes must be adapted to account for the unique characteristics of these risks. The key principles outlined in this guide form the foundation for effective climate risk integration. Identifying, assessing, and managing climate-related risks necessitates involvement from various departments and functions within a company due to the wide-ranging implications of climate change. The process of adapting existing risk management processes can also form the basis of broader improvements in overall risk management practices.
How SmartResilience Can Help?
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Our comprehensive services include:
Physical Risk Assessments: SmartResilience conducts in-depth physical risk assessments, to identify vulnerabilities to extreme weather events and other climate-related hazards. These assessments directly address the CSRD's mandate for climate risk disclosure and potential impacts.
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Partnering for a Sustainable Future:
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References
[1] TCFD, “Task Force on Climate-Related Financial Disclosures (TCFD) | Home Page,” Task Force on Climate-Related Financial Disclosures (TCFD). [Online]. Available: https://www.fsb-tcfd.org/
[2] TCFD, “Recommendations of the Task Force on Climate-related Financial Disclosures,” Task Force on Climate-related Financial Disclosures, Switzerland, Final Report, Jun. 2017. [Online]. Available: https://assets.bbhub.io/company/sites/60/2021/10/FINAL-2017-TCFD-Report.pdf
[3] TCFD, “Implementing the Recommendations of the Task Force on Climate-related Financial Disclosures,” Task Force on Climate-related Financial Disclosures (TCFD), Dec. 2021. [Online]. Available: https://assets.bbhub.io/company/sites/60/2021/07/2021-TCFD-Implementing_Guidance.pdf
[4] TCFD, “Guidance on Risk Management Integration and Disclosure - Task Force on Climate-related Financial Disclosures,” Task Force on Climate-related Financial Disclosures (TCFD), Oct. 2020. [Online]. Available: https://assets.bbhub.io/company/sites/60/2020/09/2020-TCFD_Guidance-Risk-Management-Integration-and-Disclosure.pdf
[5] R. J. Anderson and Mark L. Frigo, “Creating and Protecting Value: Understanding and Implementing Enterprise Risk Management (Though Leadership Paper).” Committee of Sponsoring Organizations of the Treadway Commission (COSO), Jan. 2020. [Online]. Available: https://www.coso.org/_files/ugd/3059fc_a74bf1bf5d30448cafd74bcf22ebba76.pdf
[6] COSO, “Enterprise Risk Management Integrating with Strategy and Performance.” Committee of Sponsoring Organizations of the Treadway Commission (COSO), Jun. 2017. [Online]. Available: https://www.coso.org/_files/ugd/3059fc_61ea5985b03c4293960642fdce408eaa.pdf
[7] M. Oppenheimer et al., “Emergent risks and key vulnerabilities,” in Climate Change 2014 Impacts, Adaptation and Vulnerability: Part A: Global and Sectoral Aspects, vol. 1, Cambridge: Cambridge University Press, 2015, pp. 1039–1100. doi: 10.1017/CBO9781107415379.024.
[8] COSO and WBCSD, “Applying Enterprise Risk Management to Environmental, Social and Governance-related Risks.” Committee of Sponsoring Organizations of the Treadway Commission (COSO), Oct. 22, 2018. Accessed: Sep. 20, 2024. [Online]. Available: https://www.wbcsd.org/resources/applying-enterprise-risk-management-to-environmental-social-and-governance-related-risks/
[9] TCFD, “The Use of Scenario Analysis in Disclosure of Climate-Related Risks and Opportunities,” Task Force on Climate-related Financial Disclosures, Technical Supplement, Oct. 2020. [Online]. Available: https://assets.bbhub.io/company/sites/60/2020/10/FINAL-TCFD-Technical-Supplement-062917.pdf
