ESG Series: Climate Risk Management

Climate risk is a transversal risk that can impact all traditional categories of risk that we are familiar with. It can and should be incorporated into Enterprise Risk Management (ERM). This includes risk governance, strategy, assessment, review, monitoring and reporting.

We must consider climate risk at nearly every stage from product conception and approval to drivers of physical and transition risk then transmission channels through various types of risk into financial risk.

This brings us to the concept of Life Cycle Assessment (LCA) which is an evaluation of every stage of a product’s lifecycle as described in ISO 14040; Goal and scope; inventory analysis (inputs, outputs, and energy use); impact assessment of products; and interpretation (conclusions and recommendations).

Physical and Transition risk, previously discussed, can impact traditional risk categories in the following ways:

Operational Risk

·         Physical risk from extreme weather events can result in property damage, business interruption, supply chain issues, and worker productivity.

·         Transition risk from policy changes can lead to stranded assets (e.g. facility closures) and people risk from staff inadequately trained in new technologies or processes.

Credit Risk

·         Physical risk from property damage or business interruption can lead to loss in revenues and profits which can impact a company’s ability to service its debts and fulfil obligations.

·         Transition risk causing asset stranding can severely damage a company’s balance sheet position (e.g. asset write-off) thereby causing an overweight in respective liabilities and increasing probability of default.

Liquidity Risk

·         Both physical and transition risks can result in sharp repricing of products and market re-evaluations of a company as a going concern. Liquidity impacts result from funding shortages and banks can be particularly prone to this risk with the potential for bank runs on any banks perceived to be in trouble as a result.

Market Risk

·         Physical and transition risks can cause severe fluctuations in prices of commodities, shares, bonds etc.  through abrupt repricing or gradual change. This in turn can impact portfolio values and investments.

Underwriting/Insurance Risk

·         Perhaps not a traditional risk category but an important one to note. Physical risk can lead to higher insurance premiums or even uninsurable areas/assets. Transition risk can lead to less insurance availability for industries and activities that are being phased out.

Whilst the above are company (and asset) level risk considerations, it is important to also assess the impact the wider macro environment through systemic risk factors.

Ghassan Zeidan, Founder & CEO of Paragon Consulting Partners

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Risk Management, Internal Audit and ESG Consulting Firm (paragonconsulting.partners)