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Physical Risks and Adaptation: An Analysis of Regulatory Requirements
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Physical Risks Associated with Climate Change, and, more generally, the issue of adapting to climate change, are gaining prominence in the economic and financial world. The distinction between physical risks and transition risks is now well established, and the fight against climate change is being waged on two fronts: reducing greenhouse gas emissions and building resilience to climate impacts. The level of maturity among economic actors in this second area (climate resilience) lags significantly behind that in the first area (emissions mitigation). However, renewed interest has been evident in recent months.
This trend can be explained by the increasing number of visible impacts of climate change on economic activities, but not solely by that. Regulatory and voluntary reporting frameworks, which are becoming increasingly stringent with regard to physical risks, are a major factor in the interest organizations are showing in this topic. These frameworks therefore appear to be essential for engaging economic actors in efforts to build resilience and adapt to climate change.
Several regulatory and voluntary frameworks exist, but are their requirements regarding physical risks aligned? And do they adequately address the challenges of resilience and adaptation to climate change?
In this article, we present a comparative analysis of the compliance criteria related to resilience and adaptation in the four main reporting frameworks for organizations: the Task Force on Climate-Related Financial Disclosures (TCFD)[1], the Carbon Disclosure Project (CDP)[2], the European Taxonomy[3] and the Corporate Sustainability Reporting Directive (CSRD)[4].
Published before any regulations were in place, The TCFD report published in 2017 was the first set of guidelines for companies wishing to communicate how they are addressing the physical risks associated with climate change. This report was subsequently refined and supplemented by other publications and the CDP drew on the work of the TCFD to supplement his initial list of questions—which focused on the transition—with questions about physical risks. In 2020, the European Taxonomy Regulation established, for the first time through regulation, how European companies should address climate change adaptation[5]. The CSRD is a European directive that replaces the NFRD, which will take effect gradually starting on January 2024. This directive applies to European companies and builds upon the Taxonomy, supplementing it to make the disclosure of information related to climate change—and in particular, adaptation to physical risks—mandatory. The CSRD is based on standards known as “ESRS” standards (European Sustainability Reporting Standards), which are prepared by theEFRAG (Advisory Group on Financial Reporting in Europe.
At Carbone 4, we believe that an ambitious approach to climate change adaptation must meet the following criteria.
We conducted a detailed review of the main physical risk reporting frameworks. This assessment allowed us to highlight the key differences between these frameworks and to facilitate an understanding of the specific characteristics of each.
We identify two categories of criteria for compliance with reporting frameworks:
The following table summarizes, for each of the frameworks examined, whether or not each compliance criterion in the first category is present. Some frameworks do not mention these criteria (we indicate this as “no”), some mention them very clearly (“yes”), and others imply them but are not explicit on the subject (“ambiguous”).
The following table summarizes, for each of the frameworks examined, whether or not each compliance criterion in the second category is present. The legend has the same meaning as in the previous table.
A review of the reporting frameworks, including the references cited in the methodological guides, reveals that the vast majority of the analysis criteria are included.
Still, a few differences stand out:
Reporting frameworks related to physical risks and adaptation are not easy to grasp. A certain level of prior expertise is necessary to fully understand the reporting requirements and what they entail in terms of analysis.
That said, after a detailed analysis of the texts, it appears that The requirements of the reporting frameworks are generally aligned and tailored to ensure a proper understanding of climate risks. This regulatory environment is therefore favorable to engage economic stakeholders in efforts to adapt to climate change.
It might be helpful to assist stakeholders in fully understanding these frameworks; we hope this explanatory note will help them do so!
The tables from the benchmark study of the main frameworks for analyzing physical risks are presented below, along with additional information and details that were not included in the main body of the article.
5.
This applies to: publicly traded companies; companies that meet two of the following three criteria: (1) more than 250 employees, (2) annual revenue exceeding €40 million, (3) total assets exceeding €20 million; international and non-EU companies with more than €150 million in revenue within the European Union and at least one subsidiary in the EU
6.
including those that have no accounting counterpart, such as the existence of roads in working condition or sufficient rainfall.
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