Climate risk is increasingly being considered as a key area of financial risk management and reporting for companies. Is this approach simply perpetuating the problem?

The problem starts with the statistic that climate-related risk is likely to affect the vast majority of businesses. According to the Sustainability Accounting Standards Board (SASB), 93 per cent of US public companies face some degree of climate risk. However, the reporting and transparency surrounding climate risk is also a problem – only 12 per cent of US companies disclose this risk, according to data from the SASB in December last year. The need for this to change was highlighted when US oil firm Exxon Mobil was investigated this year by the US Attorney General for not fully disclosing its climate change risks to investors.

Can we fight climate risk with financial reporting?

One initiative that is pushing for improved climate-related financial risk disclosure is the FSB Task Force on Climate-related Financial Disclosures (TCFD), which was set up in December 2015 by Michael Bloomberg. By developing voluntary standards for consistent financial disclosure, the TCFD aims to persuade corporates to report data consistently to investors, lenders, insurers, and other stakeholders.

The TCFD recently stated the view that “the issue is not within the financial system, but with companies not reporting on their risk exposure to climate risks”. According to this argument, climate change can be managed by business if they have access to more data, so they can hedge risks and provide transparency about those risks to investors and consumers.

Risk models won't reverse climate change

However, this is surely missing a broader, quite obvious, point, which is that companies should be tackling the root causes of climate change (consuming fossil fuels, depleting natural environments, polluting oceans and habitats, etc) rather than trying to build the effects of climate change into their risk models, with FX hedging strategies, cash forecasts and disaster scenario planning.

This is a point made well in an article by Christopher Wright, professor of Organisational Studies, University of Sydney, and Daniel Nyberg, professor of Management, Newcastle Business School, University of Newcastle. They argue that one of the key assumptions underlying corporate risk management is that “corporations are exposed to a variety of objective risks that can be managed through rational decision-making”. However, this approach to risk management (hedging and planning for financial fallouts caused by climate change events) fails to “fully account for the physical and political complexities of climate change”, according to Wright and Nyberg.

They suggest that historical risk models cannot account for new, extreme forms of weather event and also that there is little point in reducing carbon emissions if the company continues to invest in fossil-fuel based projects. So what's the answer? Companies need to be addressing the behaviours within their industry that cause climate-related risks, rather than seeking to just monitor and measure the risks and prepare to limit the financial or reputational damage that could ensue.

Latter-day wizardry

Wright and Nyberg write: “Like latter-day wizardry, corporate risk calculations suggest that markets and capital can, not only control the natural world, but somehow anticipate it.” They conclude by arguing that such risk calculations don't go far enough and that the 'business as usual' approach does not address the root causes of the climate risk, which are engrained in the business models and processes of many corporates. The authors conclude: “Ironically, the devastating environmental change that is supposedly being anticipated and managed by corporate risk management is locked in to an ever more terrifying degree.”

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CTMfile take: Wright and Nyberg have an interesting take on corporate risk management that contrasts with the emphasis on financial disclosure and transparency advocated by the TCFD. It's clear that simply disclosing climate-related financial risks is not enough.