The effects of climate change are no longer distant forecasts – they are an immediate reality. As climate risks grow, companies are now facing mounting pressure to not only acknowledge these risks but to actively manage and mitigate them.
One of the key tools for navigating this new landscape is the climate risk assessment. In a climate risk assessment, your company must identify and assess the materiality of climate-related risks and opportunities, including physical and transition risks and the company's resilience to such risks.
The regulatory environment has evolved as well to reflect the urgency of addressing climate risks. The Corporate Sustainability Reporting Directive (CSRD) and the EU Taxonomy Regulation, have made climate risk assessments a mandatory requirement.
In this article, we will guide you through the 7 essential steps to conduct a climate risk assessment, helping your company not only comply with these regulations but also build resilience in a rapidly changing world.
Back to basics first? Read this article to find out everything you need to know about climate risk assessments: Understanding the climate risk assessment for EU Taxonomy compliance |
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Step 1: Determining the expected lifespan for each economic activity
The requirements for climate risk assessments from the Climate Delegated Act distinguish between activities with an expected lifespan of
(1) less than ten years
and
(2) at least ten years.
You might or might not need to employ future IPCC climate scenarios, depending on this timetable. A lifespan of less than ten years can be anticipated only in cases where there are specific reasons not to. For example, if it seems expected that demand for a particular product will fall dramatically, it is reasonable to assume that it will be phased out of the market in the future years.
Step 2: Determining investigation objects for economic activities
The systems that execute the taxonomy-relevant economic activities are the investigation objects for your climate risk assessment. For instance, production sites and the related procurement and transportation between sites are typically included in the manufacturing industry.
Identifying and compiling site-specific climate risks for every manufacturing site that produces turnover, OpEx, or CapEx is necessary. Compared to industrial sites, the identification of investigation objects in transportation and procurement is more complicated. Consequently, it is adequate to look into transportation and procurement only in regions with a significant chance of material risks.
Step 3: Determining climate-related hazards
Appendix A of the EU Taxonomy provides a comprehensive list of hazards associated with climate change. You only need to evaluate the materiality of risks for climate-related hazards directly relevant to your business. Thus, it saves an immense amount of time and effort to eliminate hazards at the outset of the assessment without impacting the specific investigation objects.
You may exclude those climate-related hazards that
(1) do not occur at the location of the investigation object, for example, coastal erosion for inland locations
and/or
(2) cannot cause negative impacts on the performance of the economic activity. For example, a cement company will not have to worry about the climate-related hazard of changing wind patterns because this can cause no significant adverse effect at the production site.
Step 4: Conducting the climate risk assessment
Climate risk assessment estimates the materiality of physical climate risks for each part of the investigation object. Every climate-related hazard that has the potential to impair economic activity performance poses a risk.
Step 4.1: Understanding the impact relationships
Understanding how climate-related hazards impact businesses involves recognizing both direct and indirect effects. While some impacts, like damage to buildings from floods or storms, are straightforward, others can occur in a sequence or compound each other, leading to more complex outcomes. For instance, a storm might damage energy infrastructure, causing power outages that disrupt production if backup power is insufficient. Combined hazards, such as drought, storms, and pest infestations, can also interact to create new risks, like increased tree falls.
To effectively assess these relationships, companies should leverage existing knowledge of past events, focusing on substantial impacts. Guiding questions can help uncover these relationships:
Has your company or similar businesses been affected by climate-related hazards in the past decade or two?
How did these impacts occur (directly, successively, or through combined hazards)?
What might have happened if the hazards were stronger or simultaneous?
Visualizing these indirect impacts through tools like climate impact chains can aid in understanding and communicating complex impact pathways within the company. Impact chains illustrate how hazards (e.g., heatwaves) can lead to risks (e.g., operational interruptions) and can be used to identify key leverage points for adaptation strategies. While these visualizations don’t need to rely on complex models, they should be seen as evolving documents that help capture important risk factors like exposure and sensitivity.
| Tipp: Further guidance on creating impact chains is available in ISO 14091. |
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Step 4.2: Gathering information on climate-related hazards
Gathering information on climate-related hazards is crucial for assessing risks. These hazards include natural or human-induced events like extreme weather or sea-level rise that may cause damage. For a comprehensive risk assessment, it's important to gather data on both current and future climate hazards, especially for activities expected to last more than ten years.
Current climate hazards (less than 10 years)
To assess current climate-related hazards, consider trends in the region of interest over the past two decades. Observing past changes can help predict potential future disruptions if no action is taken. For example, if extreme weather has frequently disrupted operations recently, such events will likely increase in the coming decade. National meteorological services and existing regional climate risk assessments can provide valuable information on these trends. Additionally, the Climate Delegated Act recommends using climate projections at the smallest appropriate scale, though for periods of less than ten years, only climate forecasts based on weather models are available.
Future climate hazards (more than 10 years)
For future hazards, assessments should be based on state-of-the-art climate projections, considering a range of future scenarios, including the IPCC's RCP scenarios.
Quick check: What are RCP scenarios? Scenarios are essentially models that describe possible future developments, based on a set of consistent assumptions about key factors and their interactions (IPCC AR6). In climate research, two types of scenarios are particularly important: climate scenarios and socio-economic scenarios. The Representative Concentration Pathways (RCP) mentioned in the EU Taxonomy are climate scenarios introduced in the IPCC’s Fifth Assessment Report (AR5). These scenarios illustrate different levels of greenhouse gas concentrations and their effects on the Earth's energy balance, known as "radiative forcings." Each RCP scenario—2.6, 4.5, 6.0, and 8.5 –represents varying assumptions about future emissions and their impact on global climate. On the other hand, socio-economic scenarios explore potential future societal and economic trends. They consider factors like demographic shifts, economic resources, and land use, which can influence a region's vulnerability or capacity to adapt to climate change. These socio-economic projections have been integrated into the latest set of Shared Socioeconomic Pathways (SSP), introduced in the IPCC’s Sixth Assessment Report (AR6) in 2021/2022, offering a more comprehensive view of how human and environmental factors may shape the future. |
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Local and regional climate assessments can provide detailed information using high-resolution data. However, each hazard and investigation object must be individually evaluated for its specific climate risks.
| Tipp: Annex A.1 of this document provides additional guidance on general trends and developments. |
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Step 4.3: Gathering information on the sensitivity of system elements
Sensitivity refers to how much a system is affected by climate-related hazards. In a climate risk assessment aligned with taxonomy requirements, it's important to focus on negative impacts. For a thorough assessment, evaluate the sensitivity of each system element identified during the preparation phase by considering:
Past impacts on system elements due to similar hazards
Potential impacts on system elements if hazards occurred, based on experiences from similar objects
Information from comparable sites and companies can provide valuable insights into the potential losses and damage.
Step 4.4: Assessing the overall physical climate risk
To assess overall physical climate risks, evaluate the potential for adverse impacts from climate-related hazards on each system element of your investigation object. This involves a qualitative approach, using a climate risk matrix to categorize risks as low, medium, or high. The process should involve relevant experts, not just the person in charge.
Start by assessing current climate risks over the next 10 years, which is essential for short-term adaptation solutions. For activities lasting over ten years, also assess future risks under different climate scenarios to guide long-term adaptation. Consider changes in hazards and uncertainties in the data. Companies with a low-risk tolerance may classify uncertain risks as high, signaling the need for action. However, a detailed risk scale should be used cautiously to avoid pseudo-accuracy.
Assessments typically focus on system elements rather than broader economic activities, as adaptation solutions are more effectively tailored to specific elements.
Step 5: Identifying and assessing adaptation solutions
One requirement for EU Taxonomy compliance is the identification and evaluation of adaptation solutions that help mitigate the identified climate risks.
This involves assessing your company's current and future adaptive capacity – the ability to manage potential damage, seize opportunities, or respond to climate impacts. Key factors include resource availability (e.g., financial, human, and technical) and organizational processes.
The adaptation solutions should be adapted to the severity of the climate risk.
For low risks: Compile a list of appropriate and effective possible adaptation solutions, including an assessment (e.g. qualitative cost-benefit ratio)
For medium risks: Decide on a case-by-case basis whether to actually implement adaptation solutions and create plans as necessary.
For high risks: Develop and implement a detailed adaptation plan (mandatory) within five years for existing assets and before commissioning new assets.
Step 6: Reporting
Reporting on the climate risk analysis is also part of the requirements for EU Taxonomy compliance. Reporting should include:
Preparatory steps: initial steps taken in the assessment process
Assessment details: performed evaluations and analyses
Assessment results: results and justifications of the findings.
This comprehensive documentation not only supports external audits but also helps internally update assessments and verify the rationale and decisions made.
Step 7: Validity check
The EU Taxonomy doesn’t specify update frequencies for climate risk and vulnerability assessments. Technically, it’s recommended to update assessments every three years for current risks and every five years for future risks due to evolving climate science. Significant investments may also prompt ad hoc updates.
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