What Is Climate Risk?
Climate risk describes the potential environmental, financial, and social consequences of climate change on businesses and the wider global economy. These hazards encompass both the direct physical effects of a changing climate and the transition risks that come with shifting to a low-carbon world. Recognizing and mitigating climate risk is crucial for organizations to develop effective strategies that build resilience and combat the impacts of climate change.
The Types of Climate Risks
Climate risks are broadly divided into two main categories: physical risks and transition risks.
Physical risks
Physical climate risks are the potential adverse outcomes and disruptions caused by changing climate conditions. Climate change can also put existing infrastructure, supply chains, and people under strain, with hazards either driven by severe climate events or continuous climate changes:
- Acute risks: Extreme weather events such as earthquakes, hurricanes, heatwaves, and floods.
- Chronic risks: Long-term changes in climate patterns that occur over time, such as rising sea levels, sustained high temperatures, and air pollution.
Transition risks
Transition risks arise from the economic and social changes that occur as a result of transitioning to a low-carbon economy. With decarbonization critical to long-term climate stability, industries and economies that still rely heavily on fossil fuels may face significant transition risks on the path to net zero.
- Policy and legal risks: These stem from government regulations and legislation designed to limit GHG emissions or accelerate the low-carbon transition, such as carbon taxes.
- Technology risks: New low-carbon technologies displace existing products, services, or business models, making carbon-intensive assets obsolete and creating pressure to invest in cleaner alternatives.
- Market risks: Shifting consumer preferences can affect supply and demand and increase production costs.
- Reputational risks: Perceived inaction on climate change can create negative public sentiment, leading to reputational damage and reduced revenue.
Climate Risk as a Strategic Business Priority
Climate risk touches every dimension of how organizations operate, affecting capital allocation, operational growth, and even the communities they serve. The first step to responding is recognizing that climate exposure has real and measurable business consequences. A few reasons why addressing climate risks should be a priority include:
- Aligning with regulatory compliance: ESG standards and regulations, such as the IFRS S2, ESRS E1, and California SB 253, outline and mandate stringent disclosure requirements for climate-related risks and opportunities.
- Meeting growing investor expectations: Climate change is seen as a systemic financial threat, with 68% of the world’s largest private market allocators expecting fund managers to integrate and assess climate risk into their investment processes.
- Withstanding socio-economic disruption: Climate change can lead to profound economic and geopolitical instability that ripples across global supply chains and financial markets. Proactively managing climate risks can help businesses remain agile and competitive.
- Building resilient business models: Organizations that deploy climate adaptation strategies are empowered to respond quickly to the physical risks of climate change, safeguarding operational growth and ensuring sustainable business continuity in times of uncertainty.
- Unlocking innovation opportunities: Addressing climate risk facilitates sustainable innovation, creating new pathways for market and revenue expansion.
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The Financial Impacts of Climate Risks
Behind every climate risk lies a financial consequence. Physical disruptions, policy shifts, and changing market dynamics all have tangible consequences on revenues, costs, and valuations.
Operational financial impacts
Extreme weather events and natural disasters can destroy infrastructure, disrupt supply chains, and affect livelihoods, leading to increased cost pressures and the potential withdrawal of insurance coverage in high-risk areas.
Market and valuation impacts
Climate considerations are now influencing asset valuations, and investors are increasingly embedding climate expectations into their decisions. Regulatory disclosures and climate hazards can affect access to capital and portfolio losses due to increased market volatility and financing costs.
Financial system impacts
Climate shocks and transition pressures erode the stability of banking systems and credit markets by weakening borrowers’ financial health, damaging firm assets, and disrupting cash flows.
Reputational impacts
Inadequate climate disclosure or perceived inaction to address climate risk can undermine trust with investors, stakeholders, and customers, restricting future capital and market opportunities.
What Is a Climate Materiality Assessment?
A climate materiality assessment is a structured process for identifying the climate-related risks and opportunities most significant to an organization and its operations through the lens of geography, sector, and business considerations. It serves as a valuable precursor to in-depth scenario analysis and disclosure preparation, allowing reporting companies to focus efforts on strengthening risk management where it matters most.
Before conducting a climate materiality assessment, here are a few tips that can simplify the process:
- Pinpoint material risks: While the European Commission references 28 distinct climate hazards, not all are relevant to an organization. Map material risks based on sector exposure, operational geography, and financial impact. Aggregating risks into broad categories, such as physical and transition risks, is a practical starting point.
- Reduce complexity with technology: Climate risk assessment tools help reduce the time, costs, and resources it takes to execute early-stage materiality work. AI-powered models have also gained traction for their ability to automate and streamline climate reporting processes, as they enable first-time reporters to prioritize material climate hazards efficiently while reducing manual complexity.
- Reference industry frameworks and benchmarks: Standards-setting boards such as the have publicly available reports that provide valuable context while ensuring regulatory alignment. Sector-specific guidance and benchmarking against industry peers are also helpful ways to identify priority areas and accelerate the assessment process.
- Engage stakeholders early: Climate risks impact multiple functions; engaging stakeholders across an enterprise not only builds cross-functional alignment and collaboration, but also uncovers risk blind spots, interdependencies, and ensures that risk assessments are grounded in real business impact.
What Is Scenario Analysis?
Scenario analysis is a strategic planning method that assesses and predicts the possible outcomes of certain events. Through a climate risk lens, it is used to evaluate how different climate conditions may affect an organization’s operations, finances, and assets.
Scenario analysis builds on the foundation of a climate materiality assessment, applying rigorous data modeling to quantify the potential impacts of climate risk. In practice, this means measuring the following three components of risk:
- Likelihood: The probability that a given climate hazard will materialize, often measured using hazard indicators.
- Impacts: The adverse consequences if a hazard materializes, typically measured in financial terms and operational data.
- Vulnerability: The degree of resilience or susceptibility of the organization when exposed to a given risk. This is evaluated qualitatively and can inform risk management activities.
Organizations are also required to define “time horizons”—short-, medium-, and long-term goals that align with their business lifecycles, industry needs, and growth ambitions. These timeframes are crucial to ensure that risk management strategies keep pace with how different climate risks are likely to unfold, embedding future-ready planning and decision-making in a holistic way.
Regulatory requirements for scenario analysis
Scenario analysis is increasingly mandatory for many climate-related disclosures. IFRS S2 and California’s SB 261, for example, encourage reporters to use a minimum of two contrasting scenarios in their analysis—typically one representing a high-emissions future (>3°C warming) and one representing a low-emissions pathway (<2°C).
This dual-scenario approach captures a broad range of potential outcomes and ensures disclosures address both physical and transition risks.
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Best Practices for Identifying Material Climate Risk
Getting a climate materiality assessment right from the beginning requires the right scope, the right data, and a clear framework for turning findings into actionable decisions. Here are a few tips to start:
- Map your value chain: Transition and physical risks extend beyond the assets under your organization’s direct control. Upstream suppliers, logistics hubs, and key customer locations can all carry material climate exposure—and in many cases, the most significant vulnerabilities sit outside the four walls of the business. Understanding the full picture of your value chain can help you identify your greatest exposures.
- Ground risks in geographic data: Location data is the foundation of most physical risk models. Compiling operational addresses or locations allows you to quantify your vulnerability to specific climate hazards in the area, such as flood risks or heat stress.
- Connect financial data to risk exposure: Effective scenario analysis links asset locations to financial metrics to assess the financial impact of each exposure.
- Align to recognized frameworks: Structuring your climate materiality assessment around TCFD, IFRS S2, or applicable climate disclosures ensures alignment with investor expectations and regulatory requirements, and provides a clear roadmap for improving reporting maturity over time.
Common Challenges with Measuring Climate Risks
Companies are increasingly expected to understand how to measure and report their climate risks. But even with the tools and guidelines available, they still run into roadblocks. Six common challenges include:
- Getting good data is harder than you think: To properly assess climate risk, companies need detailed data, but obtaining granular sustainability information can be challenging. For businesses operating globally or across many layers of suppliers, this data is often scattered, inconsistent, or missing altogether, creating significant data gaps that hamper visibility and the accuracy of risk assessments.
- Limited data visibility beyond internal operations: A climate risk assessment is only as useful as what it covers. Ideally, companies should look not just at their own operations, but also at their suppliers’ upstream and downstream activities and how these are exposed to material risks. But getting that data from third parties who may not track it themselves can be slow, expensive, and frustrating, especially for first-time reporters.
- Climate risk plays out over decades: Most businesses plan for one to five years ahead. Climate risks, on the other hand, can take decades to fully materialize. This creates a real tension: how do you make decisions today about risks that might only hit in 2040 or 2050? Translating long-term resilience planning into practical, decision-useful strategies that can be acted on today and in the future is a difficult balancing act.
- Poor clarity in a fragmented landscape: The list of climate disclosure standards continues to grow each year. However, with this proliferation comes new challenges: Different requirements and limited interoperability between frameworks add to reporting burdens, as companies need to navigate complex requirements while ensuring their disclosures remain aligned with a shifting landscape.
- Lacking the right in-house expertise: Conducting a holistic climate risk assessment requires technical knowledge that spans climate science, financial modeling, and regulatory understanding. Most organizations lack the internal capacity and expertise to bring these capabilities together effectively. For many, climate disclosure may even be the first time they’ve been asked to pinpoint exactly how, when, and where climate change might impact their operations and value chain.
- Knowing what to do with the results: Even when a company completes its climate risk analysis, turning those findings into actionable risk management strategies is key to meaningful climate action. Interpreting these outputs and what they mean for operational strategies, risk management, and public disclosures requires buy-in and cross-functional collaboration across the entire enterprise.
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Tips for Getting Started with Measuring Climate Risks
Getting started with climate risk measurement can feel overwhelming. But breaking it down into clear steps makes it much more manageable.
- Understand your regulatory obligations first. Before diving into data collection or analysis, know what’s actually required of you. The regulatory landscape is evolving quickly, with rules such as IFRS S1 and IFRS S2, the EU’s ESRS, and California’s climate disclosure laws (SB 253 and SB 261) all introducing new requirements. Knowing which your business is in scope for will help focus efforts in the right direction. Novata’s Regulatory Navigator is a useful tool for mapping your obligations.
- Start with a climate materiality assessment. Rather than trying to assess every possible climate risk at once, a materiality assessment helps you identify which risks actually matter to your business. This prioritization saves time and resources. Learn how to shortlist climate risks in this guide.
- Gather the data you already have. You likely have more useful information than you think, such as energy bills, utility records, and supplier data. Start pulling together what exists instead of having to build everything from scratch.
- Commission scenario analysis early. Scenario analysis exercises typically require weeks or months to gather and assess data and interpret findings, making it critical to begin well in advance of any reporting deadlines. Read this practical step-by-step guide to help you get started.
- Plan for iterative improvement. Climate risk reporting is not a one-and-done exercise. Your first attempt doesn’t have to be perfect. What matters is building a solid foundation you can refine with each reporting year as your data, tools, and understanding improve.
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Identifying where to start can be the hardest part. Novata’s specialized climate risk and disclosures support combines data collection, scenario analysis, and reporting alignment into a streamlined climate risk and reporting process. Confidently assess risks and prepare accurate disclosures for leading frameworks and standards like TCFD and IFRS S2, while gaining expert guidance to strengthen disclosure preparation efforts with Novata’s Advisory.
FAQs
Is climate risk disclosure mandatory for my organization?
It depends on where you operate and the size of your organization. Use Novata’s Regulatory Navigator to check what applies to you.
What climate data do I need to get started?
Less than you might think. Registration of addresses or map coordinates is usually enough to get started with most physical risk models, while data used to assess financial impact can range from revenue generated in a given location to greenhouse gas emissions or headcount. Energy bills, utility records, and operational location data are also good starting points.
How long does a climate risk assessment take?
They typically vary by scope and complexity. Scenario analysis exercises alone typically require weeks or months to gather and assess data and interpret findings—and that’s before factoring in the time needed for materiality assessments. Starting early, well ahead of any reporting deadlines, is strongly advised.
What types of climate risk analysis can I do on the Novata platform?
Novata enables both transition risk and physical risk analysis.
Teams can assess risks across business units or portfolio companies, link climate scenarios to operational and financial outcomes, and prioritize mitigation actions using structured insights.
How does Novata connect climate risk to financial decision-making?
Novata connects climate risk analysis to financial planning by linking risks to key business metrics and material outcomes. This helps teams understand the risks that exist, and how they can affect revenue, costs, assets, and cash flows, which creates insights that support budgeting, capital allocation, and investor communications.
Can Novata help with climate risk reporting to investors and regulators?
Yes, Novata supports climate risk reporting aligned with TCFD, IFRS S2, and other climate disclosure expectations.
For teams that need deeper support, Novata Advisory provides climate risk expertise, including TCFD and IFRS S2 readiness, climate risk assessments, scenario analysis, and disclosure support.
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