Corporates increasingly concerned about climate risks

Co-author: Jinlong Kang

Climate risks are an essential element of Environmental Social Governance (ESG) frameworks for both companies and their stakeholders, including regulators, investors, NGOs, researchers, and academia. The TCFD classifies climate risks into two main categories: physical risks and transition risks, with six sub-categories (see Table 1).

Organizations can assess climate risks using various methods, such as stress testing, sentiment analysis, climate risk heatmaps, materiality assessment, and stakeholder consultations. To make the outcomes comparable, we apply the general risk characteristics defined by the TCFD. The TCFD framework outlines two key aspects: likelihood (the probability of occurrence) and impact (the severity of economic consequences). Using this approach enhances climate risk management, benchmarking, and transparency.

Regardless of the assessment method, a company’s rating of a risk’s likelihood and impact reflects their perception of that risk. Essentially, it shows how the risk is regarded, understood, or interpreted. We calculate “Climate Risk Importance” as the product of likelihood and impact, as explained in the Data & Methodology section.

Climate change presents significant risks, costs, and opportunities for companies, stakeholders, and society. Different actors prioritize and manage these risks based on their own assessments and environmental goals. This leads to varying perceptions and strategies for addressing climate risks, influenced by factors like regulatory guidelines, financial obligations, and sector-specific concerns.

Stakeholders integrate climate risks into their strategies in various ways. Companies use climate risk frameworks to disclose their climate-related risks and to incorporate these into their business strategy. Financiers consider natural disaster risks that could affect their clients’ ability to repay loans, while investors align portfolios with ESG standards, such as the EU Taxonomy and Sustainable Finance Disclosures Regulation.

Both companies and other stakeholders can benefit from understanding how companies perceive climate risks. Companies can validate their climate risk management by comparing with peers or authoritative assessments. Other stakeholders can verify if a company’s climate risk perception aligns with scientific data, regulatory expectations, or company targets.

For instance, regulators can issue evidence-based climate risk assessments across sectors and regions. By reviewing companies’ climate risk disclosures, regulators and stakeholders can determine if perceptions align with authoritative sources.

In this report, we quantify companies’ perception of the six types of climate risks outlined in Table 1. We have employed the Climate Risk Assessment Matrix and the Climate Risk Importance Index to examine global companies’ climate risk perceptions using their responses from the CDP database. This framework allows for the assessment and comparison of climate risk perceptions across companies and sectors, and over time, contributes to improved climate risk management.

Our paper examines the current and recent historical perceptions (2020-2023) of physical and transition climate risks among CDP signatories. We align our risk management concepts with the six types of climate-related risks defined by the TCFD. The TCFD’s 2023 status report shows the most-frequently reported climate risks for companies. Our study goes one step further by highlighting which climate risks are perceived as most important and how their impact and likelihood are rated globally, as well as across time periods and sectors.

The CDP is an international non-profit organization that operates the global environmental disclosure system. Over the last two decades, more than 23,000 companies have reported to CDP on sustainability topics such as climate change and water security, representing two-thirds of global market value.

Table 2 provides an example of CDP survey results, illustrating how companies assess the likelihood and impact of various climate risks. Companies identify material climate risks and rate their impact and likelihood on predefined scales (five levels for impact and eight levels for likelihood). For instance, a company might rate “policy and legal” risks as “very likely” with a “medium-low” impact (see figure 2).

We reviewed the full CDP survey results from 2020 to 2023, including 13,415 firm-year observations from 5,395 companies across 13 industrial sectors,[1] classified according to the CDP’s Activity Classification System (CDP-ACS). We consider these results representative for two reasons. First, given the market share of CDP respondents, these companies provide a snapshot of major market players’ climate risk perceptions. Second, CDP respondents, as voluntary disclosers, are assumed to perform better or at least similarly in terms of climate risk management. Even if the assumption does not hold, our results statistically represent the global CDP respondents. However, we do not claim to represent all companies worldwide due to the selection bias inherent in the CDP – which invites major players – and the self-selection bias inherent in voluntary disclosure.

We use the Risk Assessment Matrix to assess climate risk perception, with likelihood and impact as its two axes (see figure 1). This is a tool widely used by scientists (e.g., IPCC), risk managers and policy makers (e.g., European Commission) to judge the probability and severity of risks, providing a clear basis for rating their importance.

[1] The 13 industrial sectors cover: apparel; biotech, healthcare and pharma; food, beverage, and agriculture; fossil fuels; hospitality; infrastructure; international bodies; manufacturing; materials; power generation; retail; services; transportation services. However, sectors with fewer than three observations (n<3) are excluded from the analysis.

Figure 2 shows how we normalize the CDP scales for likelihood and impact. In the CDP questionnaire, companies rate the likelihood of identified climate risks on an eight-level scale and the impact on a five-level scale. We encode the likelihood responses from 0 to 7 and the impact responses from 0 to 4. For example, a “high” impact is encoded as 4. We then normalize these values to a 0-1 scale, where a “high” impact becomes 1 and a “medium” becomes 0.5.

[2] FAO, EAF Toolbox (2012) - The ecosystem approach to fisheries.

Figure 3 shows the Climate Risk Assessment Matrix, based on 13,415 firm-year observations of all sectors aggregated over 2020 to 2023. This matrix reflects the average level of companies’ climate risk perceptions. The dashed lines indicate the average likelihood and impact of all six types of climate risks for comparison. Climate risks in the upper right corner are perceived to have higher importance, combining both impact and likelihood.

Overall, companies think that the chances of climate risks affecting them are between “about as likely as not” and “likely.” Similarly, when it comes to the effects of these climate risks, companies believe the impact will be between “medium” and “medium-high.” Therefore, companies on average consider both the likelihood and impact of climate risks to be more than just moderate, but not at the highest level of concern.

Market and technology transition risks are top concerns

Companies generally consider transition risks as the most important., meaning they rate transitions risks with high likelihood and impact. The potential impacts of market and technology transitions are considered significantly above all other climate risks, while policy and legal risks are perceived as the most likely. The risk of reputational damage is of relatively low importance – despite it being considered of higher impact than climate change risks, it is considered as the least likely risk to materialize.

Physical climate risks are perceived of low importance. Most companies rate these as less likely to happen and/or less disruptive. Despite the numerous challenges posed by climate change to firms’ bottom line, companies are more concerned about climate transition risks that directly impact their short-term competitiveness , such as technology and market transitions.

This result contrasts with experts’ assessments, such as those from the IPCC, who caution against the direct and disruptive impacts that physical risks may have on operations, infrastructure, short-term profit and sustainability goals. Furthermore, a report from the S&P Global Sustainable1 indicates that 85% of the world’s largest companies depend significantly on nature for their operations and that 46% of companies have at least one asset located in a “key biodiversity area”. Climate and nature are two sides of the same coin and, as experts conclude, we either solve both or neither. There are multiple inter-dependencies between climate and nature. The rising global temperature has been linked to ecosystem disruption, such as habitat loss, water scarcity, species extinction and ocean acidification, for example.

Our findings also contrast with a study on perceived risks by the World Economic Forum (2004), where the respondents included corporates, but also experts from across academia, business, government and civil society. One-third of respondents identified “extreme weather” the most likely risk to present a material crisis in the year 2024.

Climate risk perception is changing fast

From 2020 to 2023, the perceived importance of all climate risks increased. This includes both transition risks (like market, technology, policy and legal, and reputation risks) and physical risks (like acute and chronic physical risks). The perceived importance of transition risks has increased more significantly compared to physical risks, which have only seen a slight increase in importance (see figure 4). Despite these trends, companies still rate the average impact and likelihood of all risks as below “medium-high” and “very likely.”

Companies reported higher perceived impacts across all types of risks, in the period from 2020 to 2023. However, the perceived likelihood of these risks varied. The perceived likelihood of market, policy and legal, and technology risks increased significantly, while reputation risks were considered less likely to happen.

For physical risks, the perceived likelihood of acute physical risks increased slightly, whereas the perceived likelihood of chronic physical risks remained virtually unchanged. These findings are inconsistent with the rising climate risks reported by scientific authorities such as the Intergovernmental Panel on Climate Change (IPCC) and the World Economic Forum,[3] which highlight the increasing impact of physical climate risks on food security.

Some potential interpretations for the higher importance of transition risks, compared to physical risks, include the possibility that companies are focusing more on risks that are more tangible, well-known, or manageable. Since transition risks resemble traditional financial risks, they are more familiar and thus easier for companies to address. On the other hand, companies might feel more confident to mitigate climate and environmental risks, and thus they perceive such risks with a lower “net risk” i.e., less likely and impactful to materialize in a disruptive way for their operations.

[3] World Economic Forum, Global Risks Report (2024)

Varied perceptions of climate risks across sectors

Corporate perceptions of climate risks vary across sectors. Figure 5 summarizes the results for 2023, based on responses from all 4,505 CDP respondents across 12 sectors. In the total sample, only 3.3% of firms (n=150) identified all six types of climate risks as material. Meanwhile, a large majority, 95% of firms (n=4,270), discard at least one transition risk. Similarly, 78% discard at least one physical risk (n=3,537).

Most sectors perceive transition risks as more important than physical climate risks. Physical risks receive special attention (rated above average in the importance index) in only five sectors: food, beverage, and agriculture; hospitality; infrastructure; power generation; and transportation services. The infrastructure and transportation sectors view climate risks as the most important, rating all types of climate risks above average except for reputation risk, since companies in these sectors are directly impacted by chronic and acute climate events. Companies in the services sector perceive all types of climate risks below average, suggesting they consider themselves resilient to transitions. This makes sense since they are typically at the end of supply chains and might not be as directly affected by climate risks.

Most sectors view market, policy and legal, and technology transition risks as more important than average. All sectors, except the materials sector, rate reputational risk below average. The hospitality and power generation sectors place more importance on chronic physical risks compared to acute physical risks. Presumably because their business operations depend on physical assets that are impacted by slower, long-term climate changes, such as natural environments and power grids.

Agriculture sectors perceive physical climate risks as most important

We use the food, beverage, and agriculture sector as an example to demonstrate the in-depth industry analysis possible with our approach. Utilizing the CDP dataset, we analyzed all responses from 249 food, beverage, and agriculture companies across 41 countries in 2023.

Figure 6 shows the Climate Risk Assessment matrices of selected food, beverage, and agriculture sub-sectors. Interestingly, only the food and beverage processing sub-sector shows a similar pattern to the global results as seen in figure 3, where market and technology risks are perceived as the most important, while reputation risk remains the least important. The farming sub-sectors have their own unique perception of climate risks, which deviates significantly from the global results.

The crop farming sub-sector rates the impact of four types of climate risks highly: technology transition risk, acute physical risk, chronic physical risk, and policy and legal transition risk.

Similarly, the fish and animal farming sub-sector rates both acute and chronic physical risks as highly important and likely to occur. For this sub-sector, physical risks are perceived to have a higher impact than transition risks, although the likelihood of technology transition risks materializing is seen as “virtually certain,” indicating that disruptive changes in production and environmental technology are anticipated for the sector.

We confirm our expectation that farming sectors, which depend more directly on natural ecosystems, perceive physical risks as more important. Accordingly, more downstream industries, such as food and beverage processing, perceive climate risks as less important than farming sectors. However, they still rate these risks higher than the average.

Peer analysis reveals nuances within the food and agriculture sector

Roughly half of the Food and Agriculture (F&A) companies surveyed attach above-average importance to chronic and acute physical risks, as well as regulatory and technology risks. Figure 7 shows the corporate climate risk importance index, categorized by detailed industries within the food, beverage, and agriculture sector.

In the F&A sample (n=249), only 2.4% of firms (n=6) have identified all six types of climate risks as material. In contrast, 96% of firms (n=240) discard at least one transition risk. Additionally, 67% (n=168) rate at least one physical risk as “unidentified”.

When companies report some climate risks as “unidentified,” it does not necessarily mean they are overlooking potential climate risks. It might also imply that companies have assessed that certain climate risks are not material or relevant to their specific industry.

We examined how companies perceive six types of climate risks (two physical and four transition risks) over the period from 2020 to 2023, using responses from the CDP climate change survey. Most sectors, except for the food and agriculture sector, view transition risks, such as market and technology risks, as more significant than physical risks. The perceived importance of physical risks has remained low and stable over the past four years.

Our goal is to understand how companies perceive climate risks to provide valuable insights for various stakeholders, including companies, financiers, regulators, and supply chain actors. By understanding, stakeholders can identify trends and gaps in risk management practices, helping to develop robust climate risk management strategies.

Stakeholders can use the outcome of the survey to benchmark climate risk perceptions against objective assessments, industry peers, ESG standards, or regulatory directives. Regulators can verify if companies’ perceptions align with regulatory assessments and develop appropriate guidelines. Financiers and NGOs can evaluate if companies’ perceptions meet the expectations for sustainable financing. Companies can compare their climate risk perceptions with those of their peers to enhance their climate risk management systems.

Our findings and framework offer guidance for companies and stakeholders, helping them to reassess and manage climate risks efficiently.