Climate Risk: Definition, Types & Business Impact

What is Climate Risk?

Climate risk refers to the potential negative impact of climate change on businesses, economies, and societies. It encompasses both physical risks, such as extreme weather events, and transition risks, related to regulatory, technological, and market shifts toward a low-carbon economy.

Types of Climate Risks in ESG

1. Physical Risks Physical climate risks arise from climate-related events that can disrupt operations, supply chains, and infrastructure. These are categorized into:

• Acute Risks – Short-term events like hurricanes, floods, heatwaves, and wildfires.
• Chronic Risks – Long-term shifts such as rising sea levels, prolonged droughts, and temperature increases.

2. Transition Risks Transition risks stem from policy, market, and technological changes in response to climate change. These include:

• Regulatory Risks – Stricter carbon emission laws, carbon pricing, and disclosure requirements (e.g., CSRD, TCFD).
• Market Risks – Changing consumer preferences favoring sustainable products and services.
• Technology Risks – Disruptive innovations (e.g., renewable energy, electric vehicles) making carbon-intensive industries obsolete.
• Legal & Reputational Risks – Litigation over environmental damage and increasing investor scrutiny on corporate climate action.

Why Climate Risk Matters in ESG

• Financial Impact – Climate risks can disrupt supply chains, reduce asset values, and increase insurance costs.
• Regulatory Compliance – Governments worldwide are enforcing climate-related disclosure requirements, such as TCFD (Task Force on Climate-Related Financial Disclosures) and CSRD (Corporate Sustainability Reporting Directive).
• Investor Expectations – ESG investors consider climate risk when making financial decisions, pushing companies to adopt climate resilience strategies.
• Operational Resilience – Businesses must prepare for climate-related disruptions to infrastructure, logistics, and workforce stability.

Assessing & Managing Climate Risk

To mitigate climate risks, companies conduct climate risk assessments and integrate resilience strategies:

1. Climate Scenario Analysis – Evaluating risks under different global warming scenarios (e.g., 1.5°C vs. 3°C temperature rise).
2. Carbon Footprint Reduction – Implementing decarbonization strategies such as energy efficiency, renewable energy, and carbon offsets.
3. Supply Chain Adaptation – Diversifying suppliers and securing climate-resilient infrastructure.
4. Climate-Related Financial Disclosures – Aligning reporting with TCFD, ISSB, or CSRD guidelines to improve transparency and risk preparedness.

Climate Risk in ESG Reporting Standards

• Task Force on Climate-Related Financial Disclosures (TCFD) – Recommends climate risk disclosure across governance, strategy, risk management, and metrics.
• Corporate Sustainability Reporting Directive (CSRD) – Requires double materiality assessments, covering both financial and environmental climate risks.
• Sustainability Accounting Standards Board (SASB) – Provides industry-specific climate risk guidance.
• Global Reporting Initiative (GRI) – Covers corporate climate impact and sustainability disclosures.

The Future of Climate Risk in ESG

With growing climate regulations, investor scrutiny, and environmental shifts, businesses must proactively manage climate risks to stay competitive. Climate-resilient strategies will be essential for long-term financial stability and sustainability.