Date posted: 14/10/2021

What are climate-related risks and why should you know about them?

Physical and transition risk explained, and what this means for accountants

In brief

  • Businesses need to disclose the impacts of material climate-related risks
  • Managing the financial implications of climate change requires first identifying relevant climate-related risks
  • Accountants have a pivotal role to play in translating these risks into potential operating impacts for decision-making

It’s been four years since the Task-Force on Climate-Related Financial Disclosures (TCFD) released their recommendations. Since then, there have been growing calls from investors for climate-related disclosures by business and legal opinions outlining how directors duties include consideration of climate risks. In New Zealand, climate-related disclosures are likely to become mandatory for 225 businesses and there are calls for mandatory financial disclosure on climate risk in Australia.

So, what do we mean by climate-related risks?

The TCFD recommendations have played a vital role in framing our current understanding of climate-related risks for the purposes of financial disclosures.

Per the TCFD recommendations, there are two types of climate-related risks to be considered by organisations:

  1. transition risks – those related to the transition to a lower-carbon economy which could entail policy, legal, technology and market changes (for example, like the policy changes recommended by the Climate Change Commission in New Zealand), and
  2. physical risks – those related to the physical impacts of climate change, such as extreme weather events, chronic heat waves, sea-level rise, erosion, and biodiversity loss. 

Why is this distinction helpful?

Clearly understanding the way in which climate change can affect business is vital for proactive strategy and risk management. Governance-level decisions are only as good as the information underpinning them and finding a way to appropriately classify and quantify the different climate change impacts helps to focus and support the mitigation efforts taken. 

The initial focus for many organisations is to measure their greenhouse gas (GHG) emissions and seek to minimize those. This falls under transition risk and typically relates to associated policy changes with respect to forward looking emissions reduction targets. However, this focus may overlook other material climate-related risks for example those associated with customer or investor expectations and in particular the opportunities which technological changes may offer.  

The physical risks tend to be the least well understood, with undue focus on the chronic physical risk of sea-level rise. However, society is already being confronted on a daily basis with news of floods, fires, droughts and record temperatures. These are not just societal issues but also represent risks to business operations, for example damage to premises, harm to employees and disruption to supply chains as well as the long-term implications to business models.

For example, many may recall the footage of the derailed goods train in the Townsville floods of 2019 – whilst flooding may not have been high on their risk register prior to that, it certainly is now. Or, how about the New Zealand Government’s commitment to increase the number of electric vehicles in use – a transition risk that is only really being considered now. 

But what does this mean for accountants?

Climate-related risks do not fall evenly and as each business identifies those most likely to affect them, we’ll gain a broader understanding enabling more targeted and effective responses.  

The key step here is being able to identify which climate-related risks are likely to have the biggest impact on the specific business, considering its location, operations and supply chain and acting accordingly. Appropriate and meaningful risk management depends on this identification and quantification process, and that’s where accountants can assist.

While those in risk management functions may be tasked with identifying and categorising possible risks, accountants have a pivotal role to play in translating these into potential operating and financial impacts – positive and negative – for an individual business, industry sector and the overall economy. In doing so, accountants also support those charged with governance in making decisions about the order in which to address risks or realise opportunities. 

In playing this role, accountants can facilitate the development of long term operational resilience, and at the same time, support efforts to mitigate the effects of climate change. In order to do this, accountants need to increase their knowledge of climate-related risks across the sectors and locations they work in. This article has only provided a very high level overview of the different forms of climate risk.  The TCFD have a knowledge hub with many publications and guides released on climate-related risks and some free online e-learning modules to help accountants better under climate risk.

TCFD Knowledge Hub

Find the resources you need to understand and implement the TCFD recommendations.

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Webinar on climate risks

Access the webinar for accountants on the importance of climate-related risks for business.

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