Understand how risk is categorized for climate-related financial disclosure
The Task Force on Climate-Related Financial Disclosures (TCFD) separate climate-related risk into two distinct categories:
(1) risks related to the physical impacts of climate change
(2) risks related to the transition to a lower-carbon economy
These two categories form the foundation of the TCFD framework, and underpin it’s development and implementation. The EarthScan Disclosure module currently covers physical risk.
What is Physical Risk?
Physical risk describes the potential for negative consequences, such as loss and damage, from climate change impacts and climate-related hazards.
Climate change is driving a variety of different physical impacts to human and ecological systems across the planet. Extreme weather events present short-term “shocks'' to human and ecological systems, albeit with potentially long-term ramifications. Climate change is also driving more gradual, long-term changes that are stresses on human and ecological systems, such as increasing global temperatures, shifting climate zones and rising sea-level.
The TCFD recommendations distinguish between two types of physical risk, acute and chronic.
Acute Risk: physical risks that are event-driven, such as an individual heatwave, or flood. Acute physical risks are location-specific.
Chronic Risk: risks resulting in systematic shifts in climate patterns, such as sea level rise, hence more repeated coastal flooding or highly recurring heatwaves
What are the financial implications of physical risk?
The physical impacts of climate change can affect the financial performance of organizations in a number of ways, including:
- direct damage to assets
- indirect impacts from supply chain disruption, changes in water availability, sourcing, and quality
- increased costs to organizations’ premises, operations, supply chain and transport needs as a result of extreme temperature changes
- Impacts on employee health and safety.
What is Transition Risk?
Transition risk describes the potential negative consequences associated with transition to a low carbon economy. This includes risk from policy, legal, technology and market changes to address mitigation (and adaptation) requirements related to climate change. These are outlined in the table below.
Depending on the nature, speed, and focus of these changes, transition risks pose varying levels of financial and reputational risk to organizations. These risks are highly sector-specific and relate to politically determined mitigation targets.