Climate risks and the bottom line: who should lead a business’ response?

Author Dr Mary Stewart

Date September 2019

Increasingly, companies around the world are unpacking the implications of climate change for their business over the short, medium and long term. Frameworks such as the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) offer a structure for analysing and reporting these risks. However, there remains little advice on how best to manage the physical impacts of a changing climate. This is because everything that supports ‘business-as-usual’ will change as the climate changes. Organisations need the involvement and input of management teams across the business to develop a response – reassessing the business model, the strategic vision and the measures of business success.

As a company starts its journey to understand the impacts of a changing climate, we consider the complexities of the management challenge, the skills and insights needed, and where the responsibility for the business’ response might lie.

Understanding and managing the impacts of climate change on company performance

The changing climate is having two main physical impacts on business: the shock impact of more extreme weather events (which are increasing in frequency and strength) and the on-going stresses such as long-term higher temperatures and changes in rainfall patterns. While the impact of the former on a company’s profitability can be managed through insurance (for the time being), the impact of the latter is more insidious. It can result in a continual degradation of the conditions in which a company operates, ultimately resulting in a rethink its business model. An easy example to cite is rising sea levels. Companies and people will continue to operate until the point is reached that coastal inundation makes roads impassable and buildings inaccessible. Likewise countries are also facing similar issues. A number of Pacific Island nations are already experiencing sea level rises to the point that people are moving out of villages and off islands; the recent decision by Indonesia to move its capital from Jakarta to Kalimantan is another example[1].

Science tells us that all nations will experience these impacts and we can obtain a clear line of sight as to when regions are likely to be affected[2]. It is therefore better to plan and identify a specific tipping point at which a decision needs to be made to change something significantly, rather than continually responding to small but frequent changes with small measures. While the case for decisions in light of rising sea levels is relatively well articulated, similar decisions will need to be made for instances where rain doesn’t fall, or maximum temperatures become intolerable.

Managing stresses: the existential challenges

As the physical impacts of climate change build, business will need to adapt to this changed environment. The area within a company that is better placed to address these impacts is that which has oversight of the company business model, typically defined as profitability – however, it should be noted that in doing so the focus should not be on share price movements and financial reporting cycles. With the right analysis, those tasked with managing profitability into the long term will be best placed to assess how the company will be impacted by climate change – and how to respond to these changes.

As all organisations have different business and operating models, the way in which climate change will impact them will also differ. For example, a city council may view its performance in terms of improving livability, while a bank may measure its function by the sustainability of loans – that is, loans which the borrower can successfully pay back. Both examples, livability and the sustainability of loans, are measures of the success of the business model.

Future impairment of the measure of performance in the business model needs to be assessed according to variations in the climate. Given that the variations will occur across a range of uncertainty, this impairment function will result in a range of responses, not a single point. For this reason, it is necessary to include another group in the development of a company’s adaptive response – the risk managers.

Climate risk as part of risk management

Typically, risk is managed at the executive or board level. Depending on the business, it may even be a specific function within the organisation. The role of the risk managers is to assess the implications of the risks to the company arising as potential impairment to profitability.

When developing a position on how and when the impact is significant enough to change the operations of the company, it is critical that risk managers also consider how this change may open up opportunities: significant change can create notable threats to existing business models, but also substantial opportunities for those willing to move beyond business-as-usual.

A redistribution of responsibilities is needed

In summary, the certainty of climate risks and the broad impact on overall profitability means it is no longer sufficient to view climate change as a mitigation problem; companies need to understand their adaptation challenge and to drive programs through the structures typically used to manage risk and profitability. Companies that are truly focused on long-term financial sustainability and growth in a changing climate need to integrate assessment and response to climate risk at the board and executive level.

 

References:

[1] Walden, M: "Why is Indonesia looking to relocate its capital city and could it really pull it off?", ABC News, https://www.abc.net.au/news/2019-05-11/jakarta-indonesia-planning-to-move-its-capital/11090516, 11 May 2019

[2] Cleugh, H: “CSIRO saw this summer 30 years ago”, https://www.afr.com/opinion/if-this-summer-felt-different-that-is-because-it-was-20190227-h1brwl, Australian Financial Review, 28. February 2018.