How many risks do successful executives and directors ignore? If you answered zero, you’re correct!
From rising insurance premiums to central bank policy shifts, the financial impact of a changing climate is reshaping the global economy. Executives and directors overlook these risks at their peril.
Let’s take two recent examples. First is the U.S. central bank’s decision to withdraw from a global consortium dedicated to risk management and the second is the catastrophic L.A. area wildfires. Central banks and the insurance industry are both designed to stabilize financial systems, and both are sending up warning signals.
The Federal Reserve’s recent withdrawal from the Network for Greening the Financial System (NGFS) starkly contrasts with the proactive climate risk management strategies of the Bank of England, the European Central Bank, and other global central banks. As Stuart P.M. Mackintosh noted, the Fed’s decision to turn its back on climate risk analysis undermines its data-driven approach and increases the likelihood of systemic failures (“The Fed Is Running Scared of Trump,” Project Syndicate, January 24, 2025)
The insurance industry, meanwhile, is staggering under the weight of rising costs from climate-induced disasters. Between 2018 and 2022, homeowners in high-risk areas saw insurance premiums skyrocket by 82%, driven by escalating risks from wildfires, hurricanes, and flooding. The Guardian recently reported that some major insurers have begun withdrawing coverage from disaster-prone regions like California and Florida, leaving property owners and financial systems exposed to significant losses (“US Homeowners Insurance Costs Skyrocket as Climate Crisis Intensifies,” The Guardian, January 22, 2025).
The interplay between these two sectors is clear: while central banks can stress-test financial systems and enforce climate disclosure standards, insurers serve as early warning systems, reflecting the immediate costs of climate impacts. For business leaders, this interconnected landscape underscores the urgent need to understand and address climate risks, both physical and transitional, to safeguard their organizations’ future.
I’ll explain the difference between physical and transitional risks, but first let’s speak to the elephant in the room.
How Politics Can Blind Businesses to Risks
Business risks don’t disappear just because they’re inconvenient to acknowledge or politically unpopular. Climate risks and their financial impacts are realities that demand attention, regardless of personal or political viewpoints. Elected officials may be insulated from the immediate fallout of inaction, but business leaders don’t have that safety net.
Ignoring climate risks is like ignoring a warning light on your vehicle’s dashboard—it may be tempting, but it doesn’t prevent a breakdown. No matter your political leanings or the policies of the day, the financial risks tied to climate are too significant to ignore.
Understanding Climate Risks: Physical vs. Transitional
Climate risks come in two forms: physical risks and transitional risks. Understanding both is essential for business leaders because they directly affect operations, finances, and long-term strategy.
Physical Risks
Physical risks are the direct effects of climate change on the environment. These include:
- Extreme weather events like hurricanes, wildfires, and floods.
- Gradual changes such as rising sea levels, prolonged droughts, or shifting weather patterns.
For businesses, physical risks can mean damaged buildings, disrupted supply chains, or lost productivity. For example, a logistics company might struggle with increased transportation costs due to extreme weather, or a factory in a flood-prone area might face frequent shutdowns.
In extreme cases these physical risks to the business turn into real and deadly risks to the employees. During 2024’s hurricane Helene 11 workers lost their lives AT WORK because their factory was in the path of a flood.
Transitional Risks
Transitional risks are the challenges businesses face as the world shifts to a low-carbon economy. These include:
- Policy changes like carbon taxes or stricter environmental regulations.
- Market shifts as consumers demand more sustainable products and services.
- Technological disruptions from the development of cleaner, more efficient alternatives.
For businesses, transitional risks might mean higher compliance costs, the need to adapt operations, or even the risk of losing customers to more eco-friendly competitors. Financial systems are also affected, as investors increasingly favor companies with strong environmental strategies, potentially limiting access to capital for those who fall behind.
Why It Matters
Physical and transitional risks are interconnected. Whether you live in an area with a direct and visible price on carbon, your business pays for the carbon it uses, vehicle fuel, natural gas, business travel. Reducing your carbon usage reduces your input costs. A company might face physical risks from wildfires today and transitional risks from stricter emission regulations tomorrow. Both types of risks can significantly impact a company’s bottom line if left unmanaged.
From Recognition to Action
Still not interested? One, how did you make it this far, and two, let me really drive the point home. Let’s talk about Fiduciary Duty and how it applies to climate risks. Fiduciary duties obligate directors and executives to act in the best interest of the corporation and its shareholders, ensuring prudent management of risks. Climate risks—both physical and transitional—fall squarely within these duties. Failure to identify, address, and disclose these risks exposes businesses to financial, legal, and reputational damage. Under the duty of care, directors must stay informed about material issues, including climate-related threats, while the duty of loyalty compels them to act in ways that prioritize long-term corporate health over personal or political interests. Properly disclosing climate risks aligns with these fiduciary responsibilities, providing transparency to stakeholders and enabling informed decision-making that safeguards corporate value.
Steps for CFOs and Boards to Identify, Manage, and Report Climate-Related Risks
To effectively address climate risks, CFOs and boards must transition from recognition to action. Here are actionable steps:
- Assess the Risks
- Identify both physical and transitional risks specific to your business.
- Conduct scenario analyses to understand potential impacts on operations and finances.
- Integrate Risks into Strategy
- Include climate risks in enterprise risk management frameworks.
- Align sustainability goals with overall business strategy to ensure resilience.
- Engage Stakeholders
- Communicate with shareholders, employees, and partners about your organization’s approach to climate risks.
- Collaborate with industry groups and regulators to stay informed about best practices.
- Implement Governance Structures:
- Assign responsibility for climate risk oversight to a board committee or executive team.
- Establish clear accountability for monitoring and reporting progress.
- Disclose Transparently:
- Prepare climate-related disclosures following global standards like IFRS, TCFD, or if you prefer your guidance American-Flavoured, the AICPA’s guidance.
- Share actionable insights with stakeholders to demonstrate commitment and build trust.
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SCOP3™ : Empowering Climate Risk Management and Disclosure
SCOP3™ simplifies this complex process, giving CFOs and boards the tools they need to manage and report climate risks effectively:
- Streamlined Risk Analysis: SCOP3™ uses AI-driven insights to identify and quantify physical and transitional risks, offering a clear picture of potential impacts on your business.
- Integration with Financial Systems: By linking climate data to financial reporting tools, SCOP3™ enables seamless integration of climate risks into budgeting, forecasting, and strategic planning.
- Robust Reporting Tools: SCOP3™ supports compliance with global disclosure frameworks.
- Assurance: Created by an ISO 14065:2020 accredited GHG verifier (auditor), your report and our system is ready for auditors to do their work.
With SCOP3™, CFOs and boards can go beyond compliance to create a proactive climate strategy that mitigates risks, seizes opportunities, and drives sustainable growth. This isn’t just about avoiding problems—it’s about leading the way in a rapidly changing business environment.