The summer of 2023 was the hottest on record in Europe, with extreme weather phenomena such as excessive rains, floods, and wildfires serving as strong evidence of climate change's expanding impact. Businesses are becoming aware of how climate change directly impacts their operations.
What does that mean? Companies are under growing pressure to manage climate risks and implement adaptation measures where necessary. The climate risk assessment is intended to provide a tool for this purpose. It uses scenario analyses to help estimate the financial impact of climate change - and thus identify the need for action in risk management at an early stage.
Legislators have also recognized this problem and are following suit: the Corporate Sustainability Reporting Directive (CSRD) – but in particular the EU Taxonomy Regulation, outlines specific requirements for these assessments.
Let's find out what climate risk assessment means, what it entails, and how it can be carried out. Plus, learn about 3 important tips to make your climate risk assessment a complete success.
What is a climate risk assessment about?
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 examination of physical climate risks has been incorporated into numerous legislative requirements and recommendations for business reporting in recent times. In 2017, the Financial Stability Board of the G20 established the Task Force on Climate-related Financial Disclosure (TCFD), which released guidelines for disclosing corporate climate risks. A climate risk assessment is mandated under the CSRD as well as the EU Taxonomy Regulation. Businesses must also report on their adaptation plans, targets, and strategies in accordance with the EU's sustainability reporting standards (ESRS).
The EU Taxonomy Regulation requires companies to report on their contribution to environmental goals 1 and 2 – climate change adaptation and mitigation. To this end, companies must conduct a robust assessment of climate risks. Therefore, the aim of such an assessment in the EU Taxonomy is to identify appropriate adaptation solutions that can reduce the physical climate risks that are material to economic activity.
| Is your company subject to EU Taxonomy reporting and therefore required to conduct a climate risk assessment? Check your status here. |
|---|
Where is a robust climate risk assessment required in the EU Taxonomy?
Appendix A of the EU Taxonomy Regulation specifies that companies must provide a comprehensive climate risk assessment.
The demonstration of a robust climate risk assessment is part of the EU Taxonomy’s
► technical screening criteria (TSC) regarding the substantial contribution to climate change adaptation.
► DNSH requirements to climate change adaptation for climate change mitigation (already) and (likely in the future for) all other environmental objectives (biodiversity, pollution, etc.)
Reminder: What are TSC and DNSH criteria in the EU Taxonomy? According to EU Taxonomy requirements, all identified business activities of a company must be checked for their taxonomy eligibility and taxonomy alignment. To consider an economic activity not only eligible but also aligned, a company must confirm that it complies with the Technical Screening Criteria (TSC). This means an economic activity must make a significant contribution to at least one of the six environmental objectives, do no significant harm (DNSH) to any of the remaining environmental objectives, and meet the minimum safeguards based on certain global human rights standards and frameworks. |
|---|
Which EU Taxonomy climate risk categories exist?
When assessing climate risks, companies need to consider three main categories:
Physical risks
These risks arise from the direct effects of climate change on the environment and are divided into two types:
Acute physical risks
These are short-term, event-driven risks caused by extreme weather events such as hurricanes, floods, wildfires, and heat waves. These events can disrupt business operations, damage infrastructure, and affect supply chains.Chronic physical risks
These involve long-term changes in climate patterns, like rising average temperatures, sea levels, shifting precipitation patterns, and ocean acidification. These changes can gradually impact areas such as agricultural productivity, water resources, and energy consumption, posing ongoing challenges to businesses
Transition risks
Transition risks are associated with the shift towards a low-carbon economy. They arise from changes in policies, technologies, market dynamics, and societal preferences aimed at reducing greenhouse gas emissions. Key transition risks include:
Regulatory risks
These involve changes in laws and regulations, such as carbon pricing, stricter emissions standards, or other climate-related policies that can impact operational costs or require changes in business practices.Technological risks
As new technologies for renewable energy and energy efficiency emerge, companies may face challenges if their current technologies or processes become obsolete or uncompetitive.Market risks
These risks stem from shifts in market demand, such as increased consumer preference for sustainable products or services, which could affect the viability of existing products or business models.Reputational risks
Companies that fail to adequately address climate risks may suffer damage to their reputation, which can result in loss of customer trust, investor support, or difficulties in attracting talent.
Liability risks
These risks involve potential legal actions against a company for contributing to climate change or failing to adequately manage and disclose climate-related risks.
Two main types of liability risks are
environmental damage claims related to pollution, environmental degradation, and damage to health, and
claims for failure to adapt where companies have not taken adequate measures to mitigate or adapt to climate change.
How is a climate risk assessment conducted?
A climate risk assessment in line with EU Taxonomy requirements begins with evaluating the expected lifespan of economic activities to determine whether future Intergovernmental Panel on Climate Change (IPCC) climate scenarios should be used. Then, your company needs to identify systems relevant to these activities, such as production sites, procurement, and transportation, and compile site-specific climate risks. Only climate-related hazards directly relevant to the business are assessed, focusing on those that could impact operations.
For physical risks, both current trends and future projections are considered. Data from past events and regional climate assessments are used to gauge potential impacts, including direct and indirect effects. The assessment includes understanding interdependencies and the sensitivity of system elements, using tools like climate impact chains to visualize complex risk pathways.
Based on the assessment, your company needs to identify and evaluate adaptation solutions, ranging from compiling possible actions for low risks to implementing detailed plans for high risks. Reporting on the assessment process, results, and adaptation measures is required for EU Taxonomy compliance, with regular updates recommended to keep pace with evolving climate data and new investments.
| Interested in learning more? We are currently developing a detailed 7-step guide to conducting a climate risk assessment, which will be published here shortly. Stay tuned! |
|---|
3 tips to make your climate risk assessment a success
Use a collaborative approach to your risk assessment
In addition to site-specific hazards, such as extreme weather events, the company should also analyze site-specific sensitivities and adaptive capacity. This includes, for example, the age structure of the workforce and the cooling and shading capabilities of the site. This requires local knowledge from various experts, which is best gathered and evaluated in workshops. As the aim of climate risk analysis is not only to identify and prioritize risks and prepare adaptation measures but also to raise awareness of the risks, collaborative processes, local expertise, and ownership are key components of successful risk analysis.
Consider reciprocal and cascading effects
Analyzing the impact of climate events raises awareness of the dangers of cascading effects, such as the multiple consequences of a power outage or the need for well-established communication channels in the event of an extreme event. Your company should, therefore, also take interactions and cascading effects into account in its analyses. Work with local administration and infrastructure operators in advance of crisis events to identify synergies for adaptations and prevent maladaptations. Maladaptations are measures that compromise other social goals, such as climate or biodiversity protection or future adaptation.
Document every step in detail
According to the legal requirements, all decisions must be documented in an audit-proof manner. These concerns, among other things, include the arguments for prioritizing risks, for example, in the context of filtering climate-related hazards in step 3 above. For example, make sure to document and justify precisely why an excluded hazard has no negative consequences for a production facility to ensure compliance.
Ready to get started with your climate risk assessment? Envoria simplifies the complex process of climate risk assessment, ensuring your company meets the stringent requirements of the EU Taxonomy – soon even with its own software module exclusively for climate risk assessment! With Envoria, you can…
Contact us today to see how Envoria can support you with your climate risk assessment and more! |
|---|