Physical climate risk describes the physical exposure of an enterprise’s assets or operations to acute (e.g., severe weather events) and chronic (e.g., sea level rise) climate-induced hazards (from The Boundaries of Corporate Physical Climate Risk: Definitions and Frameworks). Physical climate risk is distinct from climate transition risk, which refers to the exposure of a business to transformations in the regulatory or economic landscape resulting from climate change.
Understanding risk is central to companies’, ability to plan and shareholders’ ability to evaluate their investment choices. Physical climate risks are sufficiently important to a company’s performance that some public and private governance regimes now require large companies throughout the world to disclose their physical climate risks in public reports. Although the U.S. Securities and Exchange Commission has put its requirement for publicly traded companies to disclose material physical climate risks in annual reports (otherwise known as 10-K forms) on hold, remaining reporting regimes like the California’s Climate-Related Financial Risk Act, the European Union’s Sustainability Reporting Directive, and the Taskforce for Climate-Related Financial Disclosure (TCFD) remain. However, as Caroline Cox and Chick Hallinan explain in The Boundaries of Corporate Physical Climate Risk, it is not always clear how physical risks are determined, what counts as a physical climate risk, or at what point climate hazards become material risks under these regimes.
One challenge for understanding physical risk is the opaqueness of the growing climate analytics market. In many cases, the climate data services firms use proprietary data to model the risks for a company. Although common modeling methodologies exist in the field, the services offered can differ depending on the analytics firm and the company’s needs. For example, companies may seek information on risks to individual assets, their supply chains, and workforce, and the results can be as simple as a numerical score for identified hazards or estimates of quantified financial loss.
Challenges also exist in understanding what companies must disclose as a physical climate risk. Private governance has led in this area, with the TCFD’s voluntary climate-related financial risk disclosure standards serving as the basis for public governance regimes like the SEC’s proposed disclosure requirement. Questions of materiality, however, may lead to different disclosures under different regimes. In the U.S., a matter is material if there is “a substantial likelihood that the . . . fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” In contrast, the EU uses a double materiality standard, wherein companies must disclose both the risks they face due to climate change as well as the risks they pose to climate change mitigation and sustainability initiatives. These standards also leave insufficiently answered how much of its value chain a company must assess for physical climate risks.
Physical climate risk assessment remains highly uncertain, but ever more important. Accurately measuring one’s exposure to climate risks is fundamental to short- and long-term decision making. See The Boundaries of Corporate Physical Climate Risk: Definitions and Frameworks for a more in depth discussion of the current state of, consensus on, and questions about what should be included in physical risk analyses for private actors.
