Financial materiality - Detecting climate-related risks, dependencies and opportunities

In preparation for the the European directive CSRDwe are producing a series of articles on Dual Materiality. We continue with an article dedicated to Financial Materiality, and the risks, dependencies and opportunities that the company must identify as material.

While all aspects of the ESG acronym (environment, social, governance) must be taken into consideration when identifying material themes for the company, today we're zooming in on the theme of climate, to illustrate our article.

To understand the origins of Dual Materialityplease consult our previous article.

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What is Financial Materiality?

Financial materiality, in the context of ESG reporting, represents the sustainability topics (or ESG themes) that are important for the company's value in the short, medium and long term.

This perspective (compared with Impact Materiality, which we'll develop in a later article) encompasses all the risks and opportunities linked to sustainable development that are likely to positively or negatively affect the company's development, performance and position in the short, medium or long term, and thus create or erode its corporate value.

It can also be called "impact inwards".

The main recipients of this information are investors, lenders and other creditors.

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What are the risks of climate change for business?

The risks of climate change to a company's financial performance can be classified as physical risks or transition risks.

Transition risks

Transition risks are corporate risks arising from the transition to a low-carbon, climate-resilient economy. They include:

> Political risks

For example, due to energy efficiency requirements, carbon pricing mechanisms that increase the price of fossil fuels, or policies to encourage sustainable land use.

> Legal risks

For example, the risk of litigation for failing to avoid or minimize negative climate impacts, or for failing to adapt to climate change, or climate regulation may mean that some of its products and services are no longer relevant.

> Technological risks

For example, if a technology with a less damaging impact on the climate replaces a technology that is more damaging to the climate.

> Market risks

For example, if consumers and businesses choose products and services that are less damaging to the climate.

> Reputation risks

For example, the difficulty of attracting and retaining customers, employees, business partners and investors if a company has a reputation for harming the climate.

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Physical risks

Physical risks are risks to the company arising from the physical effects of climate change. They include :

> Acute physical risks

They arise from specific events, particularly meteorological ones such as storms, floods, fires or heat waves, which can damage production facilities and disrupt value chains.

> Chronic physical hazards

They result from longer-term climate changes, such as temperature changes, sea-level rise, reduced water availability, loss of biodiversity and changes in land and soil productivity.

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Dependence on natural capital

Many companies are dependent on natural capital. If natural capital itself is threatened by climate change, the company will be exposed to climate-related risks, including physical risks.

Companies must therefore carefully examine their dependence on natural capital when identifying and reporting on their climate-related risks.

For example, an agricultural production business may depend on various natural assets such as water, biodiversity and land and soil productivity, all of which are vulnerable to climate change.

Such a company is therefore expected to explain these dependencies when reporting on its climate-related risks.

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Climate-related opportunities

Climate-related risks can often be converted into opportunities by companies offering products and services that contribute to mitigating or adapting to climate change.

Adapting to climate change means anticipating the negative effects of climate change and taking appropriate measures to prevent or minimize the damage they may cause.

It includes business opportunities such as :

• > New technologies enabling more efficient use of limited water resources, or the construction of new flood defenses, for example.

• > Climate change mitigation, which refers to efforts to reduce or prevent GHG emissions.

• > Renewable energies or the development of more energy-efficient buildings and transport systems are examples of business opportunities associated with mitigation.

• > The taxonomy of sustainable economic activities, proposed by the Commission as part of the action plan on financing sustainable growth, aims to identify and classify climate-related opportunities.