According to the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD), there are two categories of risks related to climate: physical risks and transitional risks. In previous articles, we have explored various types of physical risks such as wildfires, floods, and heatwaves. Today, we will present transitional risks and how a business can manage them to adapt timely and appropriately to climate change.
Transitional risks are associated with the societal shift towards a low-carbon economy, which may involve extensive changes in policies, legal frameworks, and technological trends, as well as market dynamics.
Transition risks are classified into the following four categories:
Depending on the nature, speed, and focus of changes in policies, legal frameworks, and technological trends, transition risks can pose various levels of economic risks and reputation risks for businesses.
1. Political and Legal Risks
The risks associated with policies pertain to potential challenges and uncertainties stemming from shifts in government policies and regulations, which could affect businesses, industries, or entire economies. Legal transition risks encompass the repercussions resulting from alterations in the legal framework, such as the introduction of new laws or amendments to existing laws' enforcement practices, potentially imposing obligations on businesses.
2. Technological Risks
Transitional technological risks encompass the potential adverse impacts on businesses arising from disruptions to current technologies, slow adaptation to emerging technologies, and insufficient support for nascent technologies. These challenges hinder the ability to adapt and sustain competitiveness.
3. Market Risks
Transitional risks in the market denote potential challenges confronting businesses as a result of shifts in market conditions, customer preferences, or industry dynamics. These changes can significantly impact competitiveness and financial performance.
4. Reputation Risks
Reputation transitional risks involve threats to a business's credibility and reliability arising from shifts in societal perceptions and stakeholder expectations. These changes can lead to decreased trust and diminished business value.
Businesses urgently require a strategic framework to promptly tackle the most critical transitional risks.
Businesses need to be able to anticipate transitional risks that may threaten them in the future, either in the medium or long term. Furthermore, it is essential to develop a strategic framework for promptly addressing the most severe risks among them.
Among the indicators that predict transitional risks are carbon prices, energy consumption, and intensity. Consultants and businesses can use these indicators modeled until 2100 under different scenarios from various sources. Each source has its advantages and disadvantages; for example, some provide their data for free, while others do not. At the same time, some sources provide an abundance of scenarios, while others provide only two scenarios. The business or a consulting firm can acquire these predictive data and, in conjunction with other socioeconomic data and the business's characteristics, forecast and quantify the transitional risks pertinent to them.
Below, we present modeled data for the carbon price produced by the International Institute for Applied Systems Analysis based on the Shared Socioeconomic Pathways.
Figure 1 Carbon price projection to 2100 based on different SSP scenarios and models.
Source. Applied Systems Analysis 2018.
At E-On Integration, we've created the RiskClima platform specifically tailored for managing both natural and transitional risks associated with climate change. For transitional risks, RiskClima seamlessly integrates data from external sources with internal business data, leveraging advanced big data analysis and artificial intelligence techniques. This synergy enables the generation of comprehensive reports essential for effectively managing and addressing climate risks within businesses.