Climate risk

Definition

Climate risk refers to the potential for financial loss, damage, or disruption caused by climate-related events, such as extreme weather, rising sea levels, and shifts in climate patterns. It is a key concern for investors and corporations as it can significantly affect operational performance and long-term sustainability, influencing environmental, social, and governance factors in decision-making processes.

5 Must Know Facts For Your Next Test

1. Climate risk is increasingly being integrated into corporate governance frameworks as companies recognize its impact on long-term viability and shareholder value.
2. Investors are demanding greater transparency from companies regarding how they assess and manage climate risks, leading to the development of various reporting standards.
3. Regulatory bodies around the world are beginning to mandate disclosures related to climate risks, compelling companies to evaluate their exposure and develop strategies to mitigate them.
4. Climate risk can be categorized into two main types: physical risks (direct damage from climate events) and transition risks (financial risks related to the move toward a sustainable economy).
5. Ignoring climate risk can result in significant financial repercussions for businesses, including decreased asset values, increased operational costs, and reputational damage.

Review Questions

• How does climate risk influence corporate governance practices?
  • Climate risk significantly influences corporate governance as companies are pressured to integrate climate considerations into their strategic decision-making processes. Boards are increasingly tasked with overseeing climate risk management and ensuring that it is aligned with overall business strategy. This shift encourages organizations to enhance transparency and accountability regarding their environmental impact and sustainability initiatives.
• In what ways are investors responding to climate risk in their investment strategies?
  • Investors are responding to climate risk by prioritizing environmental, social, and governance (ESG) factors in their investment decisions. They are actively seeking out companies that demonstrate effective climate risk management practices and are increasingly divesting from those that fail to address these issues. Furthermore, many investors are advocating for enhanced disclosure of climate-related risks to better assess potential impacts on portfolio performance.
• Evaluate the implications of not addressing climate risk for businesses in the long run.
  • Failing to address climate risk can have severe implications for businesses in the long run, including financial losses from extreme weather events that damage infrastructure or disrupt supply chains. It can also lead to increased regulatory scrutiny as governments implement stricter environmental policies. Furthermore, companies that do not adapt may face reputational harm among consumers and investors who prioritize sustainability, ultimately jeopardizing their market position and long-term viability.

Related terms

physical risk: Physical risk involves direct damage to assets due to climate-related events, including floods, hurricanes, and wildfires, impacting infrastructure and supply chains.

transition risk: Transition risk refers to the financial risks associated with the shift to a low-carbon economy, including regulatory changes and market shifts that can affect businesses and investments.

carbon footprint:

A carbon footprint measures the total greenhouse gas emissions caused directly and indirectly by an individual, organization, event, or product, reflecting its impact on climate change.