Linking physical climate risk with mandatory business risk disclosure requirements

Abstract

Mandatory disclosure of physical climate risks to businesses is planned or being implemented in many countries. This raises the question, how viable is it to link increasing physical climate risk, expressed as extreme events, to an individual business. We demonstrate how the characteristics of increasing frequency, magnitude and duration of extreme events impact a hypothetical business supply chain using the analogy of a spider’s web, where an extreme event impacting a strand of the web (supply/market line) impacts the efficiency of the web (supply chain). We demonstrate that our hypothetical business, located in the centre of the web, can be unaffected by a very large number of extreme events, or be severely impacted by a small number of events, depending on exactly where the event occurs and the properties of the event. This implies that a business cannot assess physical climate risk based on a change in the frequency of events; the business needs to know the precise location of the events, as well as the magnitude and duration of each event. This information is not available and is unlikely to ever be available from climate model projections. Therefore, individual businesses required to disclose future physical climate risk are very unlikely to be able to provide useful quantitative assessments. We recommend that a business-specific storyline approach to future risk is used where multiple lines of evidence are woven into a risk assessment, including climate projections. Generic top–down prescriptions of future scenarios are very likely to lead to misrepresentation of risk and very poor outcomes for business, investors or financial regulators seeking to build resilience to future climate change.