By: Emma Cutler, Senior Analyst, Verdantix
News of climate change- and El Nino-driven drought slowing traffic in the Panama Canal hit headlines last week. Where the news will likely never appear, however, is firms’ own reporting, even for those that experience significant losses, at least not as a climate-related loss. Though the World Meteorological Organization cites economic damage from droughts as up more than 60% on its 20-year average, companies are today blind to the risk ahead from climate change and failing to account for the climate impacts behind them. For many, it’s simply because they don’t understand it.
Companies face a growing array of climate risks more immediate and severe than previously believed, from extreme weather events disrupting supply chains to rising climate litigation and regulations against carbon-intensive industries. Despite growing corporate concern about climate change, firms do not have access to the information and skills needed to understand and act on climate risk.
Firms underestimate climate risks
Climate change impacts are already noticeable throughout the global economy. Storms, heatwaves, wildfires, floods and droughts disrupt supply chains, affect labour and resource availability, damage infrastructure and increase operating costs. These acute hazards combined with chronic changes such as sea level rise are making some assets in high risk locations uninsurable. Research from Morningstar Sustainalytics found that with 2°C of warming, the average ratio of losses attributable to physical climate risk to operating cash flow could be nearly 4% for some industries.
Despite these material financial risks, Verdantix research found that 40% of corporate risk managers expect minimal or no risk to physical operations from climate change before 2030. The reasons for this disconnect come, at least partially, from a lack of information and skills. Climate expertise is concentrated in academic settings, rather than industry, and existing climate research, models and scenarios do not adequately capture risks to businesses. In a summer 2023 survey of corporate leaders, Verdantix found that lack of data availability is a significant obstacle to climate risk analysis and management for 36% of respondents, while approximately one quarter struggle to integrate insights into decision-making processes.
Many firms do not disclose financial impacts of climate change
Fewer than 30% of firms publicly disclose climate impacts on revenues, expenditures, assets, liabilities, capital and financing. Similarly, the Verdantix Climate Benchmark reveals that across 12 of the largest software companies in the world, disclosures regarding the impact of climate-related risks and opportunities, on average, address only 40% of TCFD recommendations. In the insurance industry, average disclosures of climate impacts meet only 30% of TCFD recommendations.
However, some firms do not have the luxury of ignoring credible climate risks, and – tellingly – these risks are moving much faster making it increasingly more challenging to understand, prepare for, and invest to manage them. Industries with direct exposure to climate change – such as utilities, energy and materials – are more likely to disclose financial impacts. Insurers and big banks, whose liability is distributed and societal, are more likely to be subject to regulation and may face even stricter requirements in the future.
Under-estimating climate risks creates new threats to business
Failing to disclose climate impacts exposes firms to litigation risks. Even in the absence of climate-specific regulation, corporates who do not disclose material impacts of climate change face allegations of securities fraud. These lawsuits have direct financial impacts and can harm reputation, creating a cascade of climate risks.
Mispricing presents an additional threat of under-estimating risk. When financial impacts of climate change are not accounted for, assets may be overvalued creating price bubbles. As climate impacts progress and extreme events become more frequent and intense, overpriced assets will be devalued with potentially devastating financial outcomes for public and private sector actors.
New approaches for corporate climate risk assessment are needed
Translating academic knowledge, data and climate scenarios to support industry-relevant research is critical. The IPCC emphasizes an optimistic future in which warming is limited to 1.5°C. However, businesses also need information about the economic impacts and adaptation options of worst-case outcomes including a 4°C scenario, which the French government included in its own analysis. To improve access to and the ability to use relevant climate data, companies should grow their in-house climate skills, while also engaging with climate change consultants, advisory services and digital solutions. Understanding the financial impacts of climate change is critical for corporate climate risk management and the future of health of businesses.