Climate-Related Risk Taxonomy

From Open Risk Manual

Definition

A Climate-Related Risk Taxonomy is a Risk Taxonomy that focuses on identifying and defining risk categories associated with climate / environmental factors (Also climate-related hazards). This entry aims to summarize and integrate any formally proposed and published taxonomies

EU Sustainable Finance Taxonomy

For the purposes of the EU Sustainable Finance Taxonomy the TEG has developed a classification of climate-related hazards[1]. This climate-related hazard classification comprises four major hazard groups, with hazards related to

  • water
  • temperature
  • wind, and
  • mass-movements.


All groups include acute (extreme) and chronic (slow-onset) hazards, as adaptation must account for both rapid as well as gradual changes in the weather and climate to take the appropriate adaptation measures and avoid maladaptation

Temperature-related Wind-related Water-related Solid mass-related
Changing temperature (air, freshwater, marine water) Changing wind patterns Changing precipitation patterns and types (rain, hail, snow/ice) Coastal erosion
Heat stress Precipitation and/or hydrological variability Soil degradation
Temperature

variability

Ocean acidification Soil erosion
Permafrost thawing Saline intrusion Solifluction
Sea level rise
Water stress
Heat wave Cyclone, hurricane, typhoon Drought Avalanche
Cold wave/frost Storm (including blizzards, dust and sandstorms) Heavy precipitation (rain, hail, snow/ice) Landslide
Wildfire Tornado Flood (coastal, fluvial, pluvial, ground water) Subsidence
Glacial lake outburst

TCDF Taxonomy

The TCDF Report[2] divided climate-related risks into two major categories:

  • risks related to the physical impacts of climate change and
  • risks related to the transition to a lower-carbon economy

Physical Risk

Physical risks may have financial implications for organizations, such as direct damage to assets and indirect impacts from supply chain disruption. Organizations’ financial performance may also be affected by changes in

  • water availability, sourcing, and quality;
  • food security; and
  • extreme temperature changes affecting organizations’ premises, operations, supply chain, transport needs, and employee safety.


Physical risks emanating from climate change can be event-driven (acute) such as increased severity of extreme weather events (e.g., cyclones, droughts, floods, and fires). They can also relate to longer-term shifts (chronic) in precipitation and temperature and increased variability in weather patterns (e.g., sea level rise).

Acute Physical Risks

Acute physical risks refer to those that are event-driven, including increased severity of extreme weather events, such as

  • cyclones, hurricanes, or floods
  • droughts
  • fires

Chronic Physical Risk

Chronic physical risks refer to longer-term shifts in climate patterns (e.g., sustained higher temperatures) that may cause sea level rise or chronic heat waves.

Transition Risk

Transitioning to a lower-carbon economy may entail extensive policy, legal, technology, and market changes to address mitigation and adaptation requirements related to climate change. Depending on the nature, speed, and focus of these changes, transition risks may pose varying levels of financial and reputational risk to organizations

Transition Risks can be segment as follows:

  • policy and legal actions
  • technology changes
  • market responses, and
  • reputational considerations.

Policy and Legal Actions

The Political Risk associated with and financial impact of climate-related policy changes depends on the nature and timing of the policy change.

Legal Risk (in climate-related risk context) is climate-related litigation claims being brought before the courts by property owners, municipalities, states, insurers, shareholders, and public interest organizations. Reasons for such litigation include the failure of organizations to mitigate impacts of climate change, failure to adapt to climate change, and the insufficiency of disclosure around material financial risks

Technology Changes

To the extent that new technology displaces old systems and disrupts some parts of the existing economic system, winners and losers will emerge from this “creative destruction” process. The timing of technology development and deployment is a key uncertainty in assessing technology risk.

Market Responses

Shifts in supply and demand for certain commodities, products, and services as climate-related risks and opportunities are increasingly taken into account.

Reputational Considerations

Climate change has been identified as a potential source of reputational risk tied to changing customer or community perceptions of an organization’s contribution to or detraction from the transition to a lower-carbon economy.


References

  1. Technical Expert Group on Sustainable Finance Taxonomy, Technical Report, June 2019
  2. TCFD Report, Recommendations of the Task Force on Climate-related Financial Disclosures, 2017

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