From risk to opportunity: Harnessing climate transition insights for business success

Muhammed Anwar director, (centre) Climate Transition Analytics, Climate Practice, WTW; Holly Teal (left) climate practice leader – North America, WTW; and Hannah Summers director, Climate Practice & Executive Compensation and board advisory, WTW explain a credible transition plan is not only necessary for compliance with evolving climate disclosure regulations but also increasingly integral to boosting investor confidence.

The climate transition plans of organisations will be central to delivering an orderly shift to a low-greenhouse gas (GHG) and climate-resilient global economy. While there is growing regulatory momentum across the world for businesses to disclose their roadmaps to net zero, transition planning can also represent a strategic opportunity.

Transition-related risks, and opportunities, are arising from the societal and economic progress towards a low-carbon and more climate-friendly future. These risks speak to the business uncertainties around net-zero transition, such as policy, legal and market changes which could see some companies face significant moves in asset values and cashflows and/or higher costs of doing business.

You can manage the impact of climate change on the business, such as losses to physical assets as a result of more intense weather, in a number of ways. These include buying insurance, considering alternative risk transfer options, selling or sunsetting emitting assets or moving assets. You’ll both reduce your contribution and increase your resilience to a warming world by moving to a business model that generates a lower carbon footprint and lower greenhouse gas emissions.

Deciding the right strategy for your organisation could require you switch to a more system-wide dynamic approach to understanding your transition risks, one that enables you to better understand the connections between risks, their cause and effects.

Quantifying the climate risks that could erode the value of your business is the first step towards developing transition plans that manage and mitigate these exposures and maximise the opportunities. By using modelling and analytical tools to quantify climate risks and integrating this into business and financial planning, you can:

Embed transition planning into business strategy by defining the most efficient moves to get the business towards net zero (whether this is divesting from at-risk assets, optimising business portfolios, or investing in new business lines or growth strategies, for example).

Deliver the returns the business and investors expect while managing climate risks.

Meet your evolving climate reporting obligations, in particular requirements to quantify climate risks and disclose transition plans.

Growing momentum around transition plan disclosure

There is increasing regulatory impetus for climate risk quantification and robust transition plans. 2023 saw the International Sustainability Standards Board (ISSB) finalise its International Financial Reporting Standards (IFRS) with the publication of Standard 1 Sustainability-related disclosure standard and Standard 2 Climate-related disclosure standards (IFRS S1 and S2), with IFRS S2 including provisions around disclosing transition plans.

In addition, the Corporate Sustainability Reporting Directive (CSRD) will mean all listed and large companies in the EU will need to disclose a transition plan aligned to 1.5 degrees Celsius global warming scenario in their annual reports on a comply or explain basis.

In the U.S., meanwhile, he Securities Exchange Commission (SEC) climate rule will require organisations to disclose transition plans if they have adopted one as part of their climate-related risk management strategy.

Organisations like the Transition Plan Taskforce (TPT) provide clear guidance on how to develop a transition plan effectively. The TPT’s disclosure recommendations are designed to build on the wider climate-related disclosure requirements incorporated in both the TCFD and the IFRS S1 and S2 standards to ensure interoperability. As a result in the UK, for example, the regulator is consulting on the introduction of the IFRS S1 and S2 and TPT-aligned transition plan reporting requirements at the same time.

Going beyond carbon to quantify transition risk

One of the first considerations in developing your transition plan is the metrics your organisation should use to baseline its position and define its roadmap to net zero. Here, emissions-based metrics have the advantage of appearing relatively objective and straightforward for external stakeholders to verify.

However, there remains little consensus in this area, including how GHG emissions are unlikely to represent a comprehensive indicator of an organisation’s exposure to transition risk, in part because emissions suffer from systematic reporting biases, tend to be backward-looking, and may not accurately capture how a firm’s profitability is likely to be affected by an increase in the cost of emissions (including that brought about by the imposition of a carbon tax).

How to financially quantify transition risks

The goal of quantifying transition risk is to put meaningful numbers against your exposures and the options for mitigating transition risks, as well as revealing the opportunities. Transition risk quantification, then, is ultimately about making financially-sound decisions for the long-term success of the business.

One approach here is to apply analytical techniques to quantify transition risk as a financial risk that can be modelled as an impact on cash flows, based on an understanding of how market transition may affect operating costs, capital expenditures and revenues Using this methodology enables the business to define transition risk as the difference in your future value between a business-as-usual scenario and a given number of transition scenarios. WTW expresses this as Climate Transition Value at Risk (CTVaR). You can then feed these outputs into transition plan disclosures and, more crucially, into strategic decision-making to support resilience and growth.

Connecting quantified transition risk to transition planning

Credible transition plans map out the actions you will take in the short and medium term to capture opportunities, minimise future risks and protect and enhance long-term value for your stakeholders, as well as society, the economy and natural environment.

As the Transition Plan Taskforce (TPT) reinforces in its Disclosure Framework, transition plans should also be characterised by accountability. This means ensuring your organisation’s planned actions are underpinned by robust governance and quantified using time-bound metrics and targets (including financial). Again, analytics and modelling can help you assess possible changes to the business model and value chain to achieve your climate ambitions through a financial impact lens.

If you embed these analytics, complete with financial metrics, into risk quantification and strategic action, disclosing resulting business strategies in transition plans could serve to increase investor confidence. This could be seen in contrast with the disclosure of strategies that only serve to reduce a firms own emissions, which alone may not necessarily demonstrate value creation under the current market and regulatory landscape.

Embedding transition planning in business strategy

Using climate transition analytics to inform transition/business strategy might involve three key steps:

Step one – Identify transition risks, integrating with market intelligence to outline the likely structural changes for your sector and region, feeding into qualitative assessments of risks/ opportunities and integrating these into your enterprise risk management framework.

Step two – Financially quantify risk and opportunities using detailed financial modelling that quantifies the impact of a climate transition and different strategic decisions on your company’s financial outlook.

Step three – Inform strategy and transition planning by integrating analytical insights on quantified climate risk into business strategy and financial planning.

Transition planning is business strategy. Ultimately, the essence of transition planning is to identify what needs to change (and how) in the short and medium term for your organisation to deliver its climate ambition and strategic objectives in the long term.