Risk Management

Best Practices: The Role Of Climate Risk In Enterprise

Risk Management

By Katelyn Johnson
With Bill Pennington August 2023

verdantix.com
Risk Management

Best Practices: The Role Of Climate Risk In Enterprise

Risk Management
By Katelyn Johnson
With Bill Pennington August 2023

In late 2021 the Institute of Risk Management provided a framework for considering climate change risks, in which
it stated: “There is widespread consensus that addressing climate-related risks is a critical component of ERM
[enterprise risk management] in supporting an organisation in understanding its future risk profile”. The institute also
acknowledged the need to have an “early warning system in place” to improve firms’ resilience. Nevertheless, many
firms struggle to account for or incorporate climate-related risks into ERM frameworks. These risks are unique to
each firm; they are also hard to quantify and their interrelation with traditional and emerging risks can be unclear.
Accounting for climate-related risks requires specific data, analyses and capabilities that many firms lack, generating
numerous challenges for their risk management processes. Moreover, compliance-based attitudes towards climate
risks inhibit firms from fully capturing their climate risk landscape. Resilience-focused firms should therefore consider
embedding climate risks into their ERM frameworks.

Table of contents
Climate risk: a new juggernaut for enterprise risk management 3
Climate risks are already having costly impacts on organizations
Risk managers will struggle with challenges unique to climate risks
Today’s views on climate risk are poorly connected to organizations’ ERM
Integrate climate risk into your ERM strategy to futureproof your organization
Utilize technology to support your climate risk management process

Table of figures
Figure 1. Definition of climate risk-related terms 3
Figure 2. Ripple of climate risks 4
Figure 3. Climate risk quantification: an iceberg of uncertainty 7

Organizations mentioned
AlertFind, Aon, Arkema, AuditBoard, European Central Bank, European Risk Management Council, Everbridge,
Global Association of Risk Professionals (GARP), Google, Harvard Business Review, Institute of Management Accountants,
Institute of Risk Management, Intergovernmental Panel on Climate Change (IPCC), International Sustainability Standards
Board (ISSB), Latham & Watkins, Nature, Origami Risk, Reuters, Science Advances, Strategy&,
Sustainability Accounting Standards Board (SASB), Swiss Re, Task Force on Climate-related Financial Disclosures (TCFD),
UN Environment Programme (UNEP), U.S. Chemical Safety and Hazard Investigation Board (CSB),
US Senate Committee on the Budget, World Economic Forum, World Meteorological Organization.

Best Practices: The Role Of Climate Risk In Enterprise Risk Management

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Figure 1
Definition of climate risk-related terms

Term Definition

Climate risk The potential adverse impacts of climate change and human responses to climate change,
climate risk can be broken down into physical and transition risks. The impact and extent of these
risks hinges on the dynamic relationship between hazard exposure, sensitivity to impact, and
adaptive capacity.

Physical risk The potential for physical damage or financial losses due to the impacts of climate change, from
both sudden and slow onset events.

Acute physical risk Risks resulting from short-term events, and increased severity of short-term events, such as
hurricanes, winter storms, wildfires, floods, heatwaves, etc.

Extreme weather events Weather events (such as hurricanes, floods and heatwaves) that are unusual, severe or
uncharacteristic for a particular area. Events can be considered extreme based on statistical
probabilities relative to the historical record, or on their impact.

Chronic physical risk Risks resulting from long-term changes in the climate, for example, sea-level rise, ocean
acidification, desertification and rising global mean temperature.

Extreme climate events Climate events (long-term events such as persistent droughts) that are unusual, severe or
uncharacteristic for a particular area.

Transition risk Risks resulting from the transition to a low-carbon economy, including, but not limited to: regulatory
and policy changes, technological developments, societal shifts, and climate-related liability.

Climate resilience The ability to prepare for, recover from and adapt to the impacts of climate change.

Climate-related disclosure Publicly reported information, aligned to varying degrees with the recommendations of the
Task Force on Climate-related Financial Disclosures (TCFD) and the International Sustainability
Standards Board (ISSB), documenting firms’ climate-related risks and emissions.

Source: Verdantix analysis

Best Practices: The Role Of Climate Risk In Enterprise Risk Management

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Figure 2
Ripple of climate risks

STRATEGY IMPACTS
• Litigation due to inaccurate
climate disclosures
• Tarnished reputation
• Stakeholder trust falls

FINANCIAL IMPACTS
• Decreased revenue
• Failure to meet
contractual sales OPERATIONAL IMPACTS
• Increased insurance
• Unsafe working conditions
costs or uninsurable assets
• Production shutdowns
• Increased supply costs

EXTREME EVENTS
• Physical assets damaged
• Supply chains disrupted
• Local infrastructure failures

Source: Verdantix analysis

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Climate risk: a new juggernaut for enterprise risk management
Enterprise risk management (ERM) has, to date, focused on traditional categories such as compliance and legal,
financial, strategic, operational and reputational risks; climate risks, however, are increasingly becoming an issue
for firms (see Figure 1). The World Economic Forum’s ‘Global Risks Report 2023’ predicts that the two greatest global
risks over the next decade will be a failure to mitigate and a failure to adapt to climate change. A 2020 report from
the Global Association of Risk Professionals (GARP) indicated that over 80% of risk professionals and organizations
planned to expand their focus on sustainability and climate risk issues over the next two to five years. Nevertheless,
in 2023, many firms still lack an understanding of how climate risks will impact them – and such risks remain on the
fringe of risk management processes, leaving organizations vulnerable in the face of evolving climate regulations
and increasing climate costs.

Climate risks are already having costly impacts on organizations

Firms need to prepare for the impacts of physical and transition risks to build resiliency. This poses
a challenge for organizations, as climate risks are vast and hard to quantify, owing to data and modelling limitations.
Their impacts, however, are far-reaching, affecting all levels of an organization, as well as aspects external to the
organization, such as supply chains (see Figure 2). A 2021 Swiss Re report found that global GDP will fall by
$23 trillion by 2050, under the current climate trajectory. As mandates around climate-related disclosures are not
yet finalized in many markets, firms may view climate-related risks as a problem of the future. However, regardless of
mandates, firms all over the world are experiencing and will continue to experience the direct and indirect impacts
of climate-related risks, as:

• Rising temperatures and extreme weather result in financial and operational losses.
A Science Advances study indicated that from 1992 to 2013, extreme heat, driven by anthropogenic climate
change, cost the world between $5 trillion and $29.3 trillion. As global temperatures climb higher, the
Intergovernmental Panel on Climate Change (IPCC) expects extreme weather and climate events, such as
heatwaves and floods, to become more frequent and severe. These events lead to operational disruptions
across all industries, affecting worker safety and productivity, impacting critical infrastructure and driving up
operating costs. Firms will need to spend extra capital to make their organizations resilient to these stressors
and ensure safe working conditions.

• Reduced access to insurance forces firms to change strategy.

The impacts of physical and transition risks may force firms to reevaluate the geographies they
operate in and the products they produce, as insurance access dwindles in high-risk areas and industries.
Skyrocketing damages have led to insurance firms exiting property and casualty insurance markets in
California and Florida, and this trend could have a knock-on impact on organizations operating in those
areas. Further, to meet climate targets, several insurance and reinsurance firms – such as Allianz, Hannover Re,
Munich Re, SCOR and Swiss Re – have announced that they will severely limit new policies for oil and gas
projects. Insurance access woes are not limited to fossil-fuel-intensive industries; even the renewable sector
is being impacted, as extreme weather events drive costs higher and make some projects uninsurable.
As climate change propels developments in the insurance space, firms are at risk of owning stranded,
uninsurable assets.

• Climate change threatens utility reliability, leading to operational setbacks.

Power grids have been under stress from extreme heat and drought, and aging and fragmented grids are

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 more vulnerable to the increasing occurrences of extreme weather events (see the Verdantix blog Wiring
For Change: Adapting The US Power Grid To Climate Risk And Uncertainty). While firms have little control
over externally operated infrastructure, grid failures can drive up operating costs or shut down operations
completely. In 2022, factories in Sichuan had to shut down for six days to reduce the strain on the power grid.

• Previously abundant resources become scarce.

According to the World Meteorological Organization’s ‘State of Global Water Resources 2021’ report, water
scarcity is expected to impact over two-thirds of the world’s population by 2050. Recently, Phoenix restricted
new home construction due to water shortages, unless developers sourced water elsewhere. As water
resources dry up, increased regulation and the availability of water will become a material climate risk
for firms. Businesses will need to shift their accounting and management practices for resources that are
impacted by climate change, to be resilient.

• Supply chain risks grow in prominence.

The COVID-19 pandemic disrupted supply chains worldwide, and climate change is likely to do the same,
with a Harvard Business Review study showing that only 11% of suppliers are adequately prepared for extreme
weather events. A 2023 study in Nature Climate Change suggested that the impacts of extreme weather
events and climate-related risks on global ports and maritime supply chains put an estimated $122 billion in
economic activity at risk on a yearly basis. Climate-related supply disruptions drive up prices and can force
firms to stop or delay production. In response to these stressors, Reuters reports that firms are buying into risky
commodities markets, to protect themselves against supply chain disruptions and meet climate targets.

• Climate-related litigation rises.

The UN Environment Programme’s ‘Global Climate Litigation Report: 2023 Status Review’ shows
2,180 climate-related cases filed as of December 2022. This is almost 2.5 times the number of cases in 2017,
with 70% of cases residing in US jurisdictions, followed by Australia, the UK and the EU. Governments and
organizations are facing climate-related lawsuits relating to issues such as ‘climate rights’ – where inadequate
climate action has threatened access to a clean environment, water or similar; greenwashing or inaccurate
climate disclosures; and failure to adapt to climate change. Future trends in climate litigation may include
cases from populations displaced by climate change; cases brought against organizations for failing to
prepare and manage the impacts of extreme weather events; and cases assigning responsibility for climate
change through attribution studies.

Risk managers will struggle with challenges unique to climate risks

Verdantix has found that most firms have not fully considered physical climate risk as a threat to their business.
However, organizations are mistaken to assume immunity from physical climate risks simply because they are not
located in an area frequented by extreme events or because they do not have fixed-location assets. Evgueni Ivantsov,
Chairman of the European Risk Management Council, stated: “The CRO [chief risk officer] faces the challenging task
of managing a wide spectrum of traditional and emerging risks [such as climate change risk] that interplay with each
other, creating a unique and dynamic risk landscape.” Climate risks can be difficult to assess for risk managers, as:

• Expansive timeframes present unique challenges.

Climate risks are both acute and chronic (see Figure 1). Firms must account for risks that occur in the
short term (defined here as less than two years), as well as the changes expected over the coming decades.
Furthermore, these short-term risks (such as extreme weather events) can interact with long-term changes,
causing additional challenges. For example, storm surges from hurricanes and subsequent flooding will be
worse, due to long-term sea-level rise, as seen during 2017’s Hurricane Harvey. Firms need to realize that the
risk-preparedness of the past may not protect them from the increasing severity, frequency and duration of
the extreme events brought on by climate change. Arkema’s Crosby Plant faced the harsh realities of this
when it experienced a plant explosion in the wake of flooding from Hurricane Harvey. While Arkema did

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Figure 3
Climate risk quantification: an iceberg of uncertainty

In quantifying climate risks and assessing local impacts, risk practitioners

Local must make sure to account for the uncertainties and assumptions that are
impacts ‘baked into’ their analyses.

Latent assumptions and uncertainties

Policy developments Technology developments
To quantify the local impact of climate risks, changes in social and economic
Social factors Economic factors factors, as well as developments in policy and technology, must be considered.

Compound Extreme Most acute physical risks that cause material impacts are extreme weather events
or compound events; these are difficult to model.
events events

Global average temperatures are not indicative of the warming experienced in

Downscaling
a particular area. To understand how changes in global average temperature
methods
affect a region, downscaling methods must be used, which introduce uncertainties.

Global climate models perform well at predicting long-term (decades to centuries)

Global climate global averages, such as rising temperatures. They are less skilled at simulating
models short-term, local-scale weather patterns, which tend to be the most relevant for
assessing a firm’s climate risk.

Source: Verdantix analysis

Title
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 have flood preparations in place, the U.S. Chemical Safety and Hazard Investigation Board (CSB) found
that industry safety guidance was insufficient to prevent the explosion during an event of Harvey’s scale.

• Risks do not occur in isolation, creating more severe, hard to predict, impacts.
Climate risks often arise in conjunction with other adverse events and interact with other social and
economic risks (see the Verdantix blog Feeling The Heat From Compound And Interconnected Risks),
generating more extreme impacts than if the risks occurred alone or if the original events were not extreme
themselves. While climate change is causing extreme weather events to become more frequent, these events
tend to have multiple influencing factors, making them difficult to predict via models. Further, climate change
may create events for which there is no past analogue, forcing risk practitioners to plan for events they have
not yet experienced.

• Quantification of climate risks is problematic.

Climate and economic systems are inherently complex; interactions between the two are more so.
Predicting the impact of climate on a particular asset requires granularity that current tools lack. Global
climate models are much better at predicting long-term, global averages, such as increasing temperatures
under various global warming scenarios, than smaller-scale, acute climate risks, such as hurricanes.
Models with a typical resolution of 100x100 km (about the size of Connecticut or the greater Paris region)
are too coarse to assess physical risks on an asset at a particular location. However, the use of finer-scale
regional models or downscaling methods can introduce uncertainties that propagate through the risk
management process, and need to be understood (see Figure 3). As Pitman and others report, “Material
extremes will almost always be weather-scale phenomena which are least skilfully simulated by existing
global climate models”.

• Scenario analysis may underestimate risks, given risk managers’ top-down approach.
While scenario analysis can help firms explore climate risk, organizations should understand the inputs,
assumptions and limitations of the scenarios used. It is difficult to predict the human factor, for example –
how policy, technology and societal factors will evolve with time and how evolution in one area affects
another. Top-down approaches to scenario analysis – where outputs of global climate models are used to
assess the likelihood of smaller-scale extreme events (such as hurricanes and floods) or compound events
(for example, a hurricane followed by a heatwave) at a city level – may produce misleading results.
Compliance-driven approaches, which focus solely on financial outcomes and regulatory requirements, are
short-sighted and may also fail to capture all climate-related risks. The failure to thoroughly explore climate
scenarios and the downplaying of uncertainties associated with such analyses threaten firm resilience.

Today’s views on climate risk are poorly connected to organizations’ ERM

The Verdantix 2023 global corporate net zero and climate risk survey showed that less than half of CROs are
involved in their firms’ net zero and climate risk strategies (see Verdantix Global Corporate Survey 2023: Net Zero
Budgets, Priorities And Tech Preferences). Furthermore, a study released by the Institute of Management Accountants
indicated that only 7% of firms place climate risk in a separate risk category, while 15% consider climate risks along
with other ESG risks. More surprisingly, over 30% said that climate risks were excluded from their firms’ ERM processes.
There are a multitude of barriers preventing organizations from integrating climate-related risks into their ERM
processes. Notably:

• Climate risks do not fit neatly into any one risk category – and therefore need their own.
ERM often classifies business risks across categories such as compliance and legal, strategic, operational,
reputational and financial risks. However, physical and transition climate risks contribute to all of these
categories. For example, physical climate risks can have massive operational and financial implications.
Advances in climate attribution, meanwhile, will expose those firms that have contributed to anthropogenic
climate change to rising legal challenges. ESG and sustainability disclosures also generate compliance and

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 legal risks, particularly as regulators audit these disclosures for accuracy (see Verdantix Strategic Focus: The
Future Of ESG and GRC).

• Evolving climate regulations and reporting frameworks are difficult to keep up with.
Risk managers should be aware that there are a multitude of frameworks and reporting standards, which
hampers the comparison of climate-related disclosures and targets between organizations. Work began in
late 2021 to synthesize these standards, with the International Sustainability Standards Board (ISSB) building
on the existing Sustainability Accounting Standards Board (SASB) and Task Force on Climate-related Financial
Disclosures (TCFD) frameworks to create consolidated reporting standards that include Scope 3 emissions.
The ISSB released these consolidated standards on June 26, 2023.

• Lack of necessary data makes risk assessments hard.

Firms often lack the necessary quantitative and qualitative data – and the expertise – to carry out climate
risk assessments themselves. Existing data that risk managers can use to properly assess climate risk are
often spread throughout – and outside – a firm, with different owners and curatorial processes. It can take
significant time and resources to collate this information into a central location and to transform it into a
useful format, with some firms outsourcing this, due to the technical skill involved (see Verdantix Green
Quadrant: Climate Change Consulting 2023). Finally, firms need to assign ownership of the data for quality
control and governance purposes. Without this, they will struggle to measure progress over time.

• Firms are commonly locked in a compliance mindset.

Many firms still view climate risks in terms of carbon accounting and emissions reductions and neglect
the bigger picture of climate-related risks. This leads to organizations viewing climate-related risks through
the lens of compliance, rather than incorporating them into broader risk management practices. In testimony
to the US Senate Committee on the Budget in March 2023, Aon president Eric Andersen said: “Just as the
US economy was overexposed to mortgage risk in 2008, the economy today is overexposed to climate risk.”
Firms stuck in a compliance mindset may not interrogate their climate risk assessments adequately, and could
therefore leave themselves unshielded from impacts outside their direct control.

• Businesses lack the necessary climate expertise.

Businesses face the additional challenge of not having sufficient in-house climate expertise, with demand
for this exceeding the talent supply (see Verdantix Strategic Focus: Mind The Climate Skills Gap). In fact, there
are almost as many open positions in the climate space as there are people working in the entire field in most
markets right now. Those with climate expertise typically lack corporate experience, so even when talent is
identified, further training is required. The lack of supply and direct corporate experience can impede a firm’s
ability to adequately quantify and incorporate climate risks into existing ERM frameworks.

Integrate climate risk into your ERM strategy to futureproof your organization
ERM must evolve with today’s changing risk landscape to be effective. Not only do climate issues create new risks,
but their impacts can amplify other, existing risks. The far-reaching nature of climate-related risks requires new ways
of thinking, so as not to underestimate a firm’s exposure. To adequately prepare for climate-related risks, as well as
seize the opportunities of a green transition, organizations must take steps to integrate climate risk into their ERM
frameworks. The Global Co-Chair of the Latham & Watkins ESG practice, Paul A. Davies, advises: “Integration of
climate risk into a company’s ERM process should become the norm, and this should not be limited to physical risks,
but also transition risk.” To accomplish this, firms must:

• Move beyond the compliance mindset to get ahead – and ERM can help.
A compliance mindset is detrimental to organizations, as it fails to set them apart from competitors in the
short term and raises their risk exposure in the long term. Organizations also place their funding in jeopardy,
as consumers, lenders and stakeholders push for climate accountability irrespective of regulations. Providers

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 of Directors’ and Officers’ liability insurance are also starting to consider firms’ climate performance in their
underwriting processes, as businesses that fail to address their climate-related risks pose larger litigation
threats. Addressing climate risks through a risk management process will build long-term resilience in an
organization, while also identifying future opportunities for growth.

• Obtain stakeholder buy-in and support from the top.

Many of the mandatory climate reporting frameworks are based around the recommendations of the TCFD.
These span corporate governance and strategy, and require metrics and targets, which makes them ideal
for integration into an ERM framework. Internal and external stakeholder mapping provides a clear view
of stakeholder expectations with regard to a firm’s climate risks and opportunities. Stakeholder mapping
also clarifies the benefits of addressing material climate risks, such as maintaining stakeholder trust and
futureproofing a firm’s overall strategy. Support for increased disclosures needs clear direction from the top
of a firm and should be ingrained into the organizational culture, to increase the buy-in of climate risk in the
ERM process. As Google’s Chief Sustainability Officer Kate Brandt notes: “Ambitious climate goals are not
achievable if sustainability is siloed into a single department.”

• Understand their planning starting points and be prepared to iterate.

The absence of suitable data and expertise needed for effective reporting is the main hurdle to
integrating climate risks into ERM frameworks. Existing ESG, risk, location-specific climate, and financial
data are often spread amongst teams and require cross-functional collaboration for collation. Further, as
climate disclosure frameworks did not gain speed until the late 2010s, there is often a lack of experience
with climate risk management and reporting at all levels of a firm. Conducting gap analysis against climate
disclosure frameworks, and benchmarking against industry peers, will help identify what data, training and
capabilities already exist in a firm, and can highlight opportunities for improvement. Risk managers should
keep up to date with emerging regulatory developments to futureproof their climate change strategies.

• Identify where climate risk fits into their ERM frameworks.

As climate risks do not fit neatly into existing risk structures and ways of thinking, leaders should set
up a separate climate risk space within their ERM frameworks, to define clear ownership of the risks.
Stakeholders from multiple teams should work together to develop an organizational climate change
‘risk radar’. Cross-functional collaboration from multiple experts will help break down silos and pinpoint key
climate-related risks and opportunities. From here, leaders should establish clear governance structures,
identifying ownership of climate risks and outlining the steps towards integration into ERM frameworks.
Risk managers and climate leaders can work with their CIO offices to develop data management processes
that enable the tracking of year-on-year progress on climate-related goals. This will reduce risk and help
connect climate risks to strategic decisions.

• Design risk review timelines with climate risks in mind.

Firms must prepare for climate risks on the short-, medium- and long-term time horizons, which may fall
outside the timelines of their current ERM frameworks. Furthermore, the increased frequency of short-term
risks may require much more frequent reviews of risks than are currently carried out. These timelines also
do not align well with organizations’ typical three- to five-year planning cycles, and according to a 2018
Strategy& study, exceed the five-year median tenure of a CEO. To be resilient, firms must find a way to keep
climate risk at the forefront of planning, regardless of internal dynamics and leadership movement.

• Set up a process around transparency.

Risk professionals need to set up a process around transparency as this relates to their climate risk

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 quantification and disclosure. Aligning climate transition plans with corporate strategy may prevent firms
from being fully transparent about their schemes, in case they lose their competitive advantage. The
relationship between transparency and trust is not always straightforward; it has been shown that in some
cases, full transparency may lower trust. However, many climate-related disclosures provide guidance on
transparency in a way that protects strategy. The provision of some level of transparency will boost external
stakeholder confidence and safeguard against greenwashing claims. Clear guidelines around transparency
will also help prevent bottlenecks when integrating climate risk into the wider ERM framework.

Utilize technology to support your climate risk management process

Identifying climate-related risks, while also accounting for the deep uncertainties that exist in the process, and
using that information to drive risk management, is a monumental task. It requires new ways of working across
teams and probably some form of outside expertise and new technologies. While the size of the task may deter
firms from acting, the cost of inaction exceeds the costs of a green transition. The European Central Bank concludes,
“If climate risks are not reduced, the costs to companies arising from extreme weather events could rise substantially,
and greatly increase their probability of default.” Thankfully, many tech and consultancy firms are developing
solutions to help firms understand and manage their climate-related risks. As they embark on their climate journeys,
firms should consider:

• Seeking external expertise to help manage climate risks.

Firms should seek consultancies that have industry-specific expertise and which employ a range of
experts – such as actuaries, climate scientists, geospatial analysts, engineers and planning professionals –
to produce bespoke and scientifically rigorous climate risk assessments that will stand up to the changing
regulatory landscape. Firms should seek to fully understand the limitations associated with their assessments
and be conscious of how these limitations affect the provided recommendations. Further information on
climate change consultancies and climate change scenario analysis can be found in the following Verdantix
reports: Verdantix Green Quadrant: Climate Change Consulting 2023 and Verdantix Best Practices: Climate
Scenario Analysis.

• Employing new technology to protect assets and workers from physical climate risks.
Firms can take advantage of new technology to immediately build resilience in their organizations. Investing
in critical event management (CEM) software, such as that offered by AlertFind or Everbridge, can help
firms plan for and actively manage responses to extreme weather events, mitigating losses. Heat stress, for
example, is increasingly becoming an issue for workers around the world, even in geographies where this was
not previously a problem. EHS management systems, as well as wearable devices, can provide employees
and employers with training and tools to identify and warn of unsafe working conditions.

• Utilizing integrated platforms to help manage interconnected risks.

The wide reach of climate-related risks necessitates the use of risk management platforms that enable
cross-functional collaboration to manage and audit risks. Developing a common risk language amongst
teams, and establishing a centralized location for tracking risks, will go a long way towards integrating
climate-related risks into ERM frameworks. Platforms such as AuditBoard and Origami Risk help firms integrate
risk data across teams, enabling better strategic decisions for managing risk.

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