Climate change risks and how to mitigate them

Climate change risks are a growing concern for companies, including financial institutions, as they can be caused by physical effects, weather changes, or emissions reduction efforts. Integrating sustainability and climate risks into business strategies is crucial for a sustainable economy. Jean-Philippe Peters, Partner at Deloitte Luxembourg and Maria Josefin Johansson Juup, Senior Manager at Deloitte Luxembourg provide us with insights, as well as 5 useful tips for companies developing a climate risk management framework.

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1. What are the climate change risks and the consequences thereof that companies face?

Climate change poses a rising concern for all companies, including financial institutions. The World Economic Forum’s Global Risks Report 2024, which tracks the risk perceptions of leaders globally, found that climate and environmental related risks were considered as a top risk, and that extreme weather is expected to become a material global threat in both the short term (2 years) and the long term.

Climate risk can be caused by the physical effects and changing weather patterns resulting from climate change (physical risks) or by efforts to reduce and eliminate the greenhouse gas emissions that cause it (transition risks).

Consequently, climate risk can take many different forms, impacting a company’s risk profile in both the short term (e.g., acute natural events like flooding that are increasingly likely to occur) and in the long term (e.g., the inability to adapt to changing client preferences in terms of sustainability).

It is thus very important for companies to incorporate sustainability and climate risks considerations into their business strategy, by identifying how various facets of climate risk may affect their operations and financial situation.

2. Should climate-related and environmental risks be integrated into risk management frameworks?

Yes, definitively. Aside from the supervisory expectations and requirements, companies and financial institutions should prepare themselves to withstand the impacts of climate change risks. Simultaneously, they should prioritize informing their employees, clients, and partners about the essential measures required to promote a sustainable and resilient economy. Additionally, they should also integrate these impacts into various aspects of their operations, such as provisioning, insurance policies, product offering, and pricing strategies.

Given the specific nature of climate risks, organizations typically achieve this through what is often referred to as “transmission channels,” representing causal chains linking climate risk drivers to other “classical” risk types, such as credit risk, operational risk, market risk, and others.

For instance, if a company relies on a sub-contractor located in a geographical area that is exposed to an increased risk of natural disasters, its exposure to the risk of operational discontinuity will increase over time if changing climate conditions continue to deteriorate.

3. Can financial solutions help mitigate these risks?

As part of its Action Plan on Financing Sustainable Growth, the European Union aims to reorient capital flows toward sustainable investment, in order to achieve sustainable and inclusive growth. As a consequence, financial institutions in general, and banks in particular, will be encouraged to design “sustainable-friendly” products to achieve this objective.

Companies (and individuals) will thus increasingly have access to specific financial solutions and products to anticipate and adapt to climate change. Hence reducing their potential vulnerabilities against climate risks while also actively contributing to the financing of projects and investments that support the green transition.

As a result, we expect an increased wave of financial innovation in this field in the coming years.

4. What are your expectations for the future regarding climate risk management practices and the associated challenges?

The future management of climate change risks introduces many subtle complexities, one of which revolves around the time component associated with climate risk.

In many industries, including banking for instance, business models are usually designed to span over 5-10 years. Profiling the impact of climate change and strategizing for a much longer timeframe, of 15-20 years, poses significant challenges due to high levels of associated uncertainty. Availability of data and predictability of climate scenarios make it difficult to integrate climate considerations in a “classical” business model, just like integration of new technologies and innovative solutions developed to mitigate and address climate change.

Yet, the area of scientific analysis of climate change is progressing extremely fast, with relevant methodologies and data constantly emerging for use in risk management frameworks. We therefore expect companies to gradually enhance their capacity to fully embed climate risks into their risk management practices.

At Deloitte, we are committed to facilitating solutions to these challenges. Three years ago, we established a collective platform - the MOMENTUM conference – which aims to stimulate active engagement and open dialogue among stakeholders focusing on climate change and environmental risks. By providing a forum, we can help all participants deepen their understanding and develop effective strategies to manage these issues.

5 useful tips for companies when developing climate risk management framework?

Integrate climate risks into company strategy: climate risks should be integrated into overall company strategy and should not be seen as a separate issue, but rather as something that can have implications for all aspects of the business.
Consider that climate risk is muti-faceted. One key characteristic of climate risk is the multiple forms it can take and the various time horizons it covers: ensure to adopt a comprehensive perspective.
Data is key. Internal climate-risk data is often scarce, requiring detailed evaluation of external sources to obtain the right data for your specific needs.
Stakeholder engagement. Engage with internal and external stakeholders throughout the process, including employees from various business functions (not only risk management), customers, and regulators.
See this as a journey. Climate is not a one-time activity but rather as something that should be reviewed and improved regularly as climate science and regulations evolve.

About the blog:

There is an urgent need for rapid transition to global sustainability. Business and industry have enormous social and environmental impacts. "Why does it matter?" is a bi-monthly blog that aims to elucidate this important topic through the eyes of our experts.

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