What is climate risk and why does it matter for companies?

A practical climate risk definition is the possibility that climate change or the transition towards a lower-emissions economy may have negative consequences for a company.

These consequences can take very different forms. A weather event may interrupt production for several days. Unusual temperatures may increase a facility's energy consumption. A new emissions policy may change the cost structure of certain activities. Technological developments may reduce the competitiveness of carbon-intensive products.

The effects therefore depend on the company's specific exposure, which means that climate risk needs to be assessed against the characteristics of the individual organisation.

A manufacturing company operating several facilities will have different exposures from a service company. Even two facilities belonging to the same group may face very different levels of risk depending on their location, water availability, energy dependence or supply chain structure.

When assessing climate change risks, a general classification is therefore only the starting point. The actual level of exposure depends on where the company operates, which resources it relies on and how dependent its processes are on infrastructure, suppliers and external conditions.

Climate risk and environmental risk: what is the difference?

Environmental risk is a broader concept. It may include environmental factors that could affect a company as well as risks generated by its own activities, such as soil contamination, water management, pollutant emissions or biodiversity loss.

Climate risks represent a more specific category and relate to the effects of climate change and to the measures introduced to address it.

An environmental risk analysis may therefore include climate risk, but the two assessments do not necessarily cover the same issues. When analysing climate and environmental risks together, it is useful to clearly define which factors fall within the scope of the assessment.

Defining this scope is particularly important for companies operating multiple sites or in sectors with a strong dependence on natural resources, energy and infrastructure. Environmental management systems such as ISO 14001 can also provide a structured framework for assigning responsibilities, managing controls and monitoring relevant environmental factors.

Physical and transition climate risks: the two main categories

Climate risk analysis generally starts by distinguishing between physical and transition climate risks, the two main categories used to assess corporate exposure to climate change. The same distinction is used by IFRS S2 for the assessment of climate-related risks and opportunities.

Understanding physical and transition climate risk helps separate impacts directly related to climatic conditions from those resulting from regulatory, technological and economic changes.

Physical climate risks

Physical risks from climate change arise from the effects of changing climatic conditions on company activities and assets.

They can be acute, when associated with individual extreme events, or chronic, when caused by gradual changes in climatic conditions.

A flood that temporarily makes a production facility unusable is an acute risk. A progressive increase in average temperatures or a structural reduction in water availability are examples of chronic risks.

The financial relevance of these risks depends on the company's actual exposure. The same event can have very different consequences depending on the asset involved: limited for a commercial office, for example, but significantly greater for a production facility containing machinery that is difficult or expensive to replace.

Transition climate risks

Transition climate risks arise from the changes associated with moving towards lower-emissions production, energy and consumption models.

Factors to consider may include new emissions requirements, carbon pricing mechanisms, the development of alternative technologies and changes in market demand.

For an industrial company, for example, an increase in the cost of emissions may change the economic viability of a production process. Understanding the company's corporate carbon footprint can help identify the most significant emission sources and determine which activities may be more exposed to changes in carbon-related costs.

Energy consumption can also become a significant factor. Energy prices, source availability and energy policies may affect the cost of energy-intensive processes, making structured energy management and reliable energy data particularly relevant.

For a component manufacturer, the development of a new technology may rapidly change demand for certain product lines.

The consequences may also extend to financial performance. Changes in operating costs, impairment of certain assets or additional capital expenditure may create financial risks arising from climate change.

Assessing these effects is an important part of broader climate risk management, particularly when transition factors can affect investment decisions, margins or the expected value of long-lived assets.

The analysis should therefore assess the concrete effect that each change may have on costs, revenues, investments and business continuity.

How to conduct a climate risk analysis

An effective climate risk assessment follows a structured process. The aim is to create a comparable set of climate risks, with enough detail to allow the company to determine priorities.

1. Identify exposed activities, assets and locations

The first step is to define what needs to be assessed.

For an industrial group, this may mean starting with production facilities, warehouses, key suppliers and strategic assets. For each element, the company should determine which climate-related factors could affect its ability to operate.

Geographical location plays a central role in the assessment of physical risks. Two facilities performing exactly the same function may have completely different exposures if one is located in a flood-prone area and another in a region affected by water stress.

For transition risks, factors such as energy intensity, generated emissions, technologies used and dependence on specific markets become particularly relevant.

Exposure may also extend beyond the company's direct operational boundaries. If a critical material or component is sourced from a small number of suppliers concentrated in the same geographic area, a climate event may disrupt production even when the company's own facilities remain unaffected. A structured supplier assessment can therefore help identify dependencies and areas of the supply chain that require closer attention.

This first stage helps avoid overly generic assessments and focuses the analysis on activities that are actually relevant to the business.

2. Assess hazard, exposure, vulnerability and impact

Once the risks have been identified, the company needs to determine their relative significance.

A climate risk and vulnerability assessment starts by considering three key elements: the climate hazard, the exposure of the activity or asset and its vulnerability. This is also reflected in the IPCC's approach to climate risk, where risk results from the dynamic interaction between hazard, exposure and vulnerability.

Based on these elements, the company can then estimate the likelihood and severity of potential consequences and assign priorities to different risks.

Consider, for example, a production facility located in an area potentially exposed to flooding. The presence of the hazard alone is not enough to determine the level of risk.

The company should assess how exposed the site actually is, how vulnerable it is to the event and what effect an interruption would have on operations. A site equipped with protection measures, alternative production capacity and appropriate insurance coverage will have a different risk profile from a facility without adaptation measures.

Impact can be expressed using quantitative criteria when sufficient data are available, or through qualitative scales defined by the company.

The methodology should remain consistent across different risks so that results can be meaningfully compared.

3. Consider different climate scenarios

Climate risk changes over time. An assessment based exclusively on current conditions may underestimate future exposure.

The analysis should therefore consider different time horizons and scenarios.

For physical risks, this helps assess how the frequency and intensity of factors such as extreme temperatures, heavy precipitation or water scarcity may change.

For transition risks, scenario analysis can be used to consider possible developments in energy prices, climate policies, technologies and market demand.

For companies subject to European sustainability reporting requirements, ESRS E1 links climate risk assessment to the exposure of assets and activities over the short, medium and long term and includes specific requirements related to climate scenario analysis. These requirements form part of the broader CSRD sustainability reporting framework applicable to companies within its scope.

Outside the European regulatory framework, scenario analysis remains relevant as a risk management tool and is also reflected in international disclosure standards such as IFRS S2.

The objective is not to predict exactly what will happen. Climate scenario analysis helps test how resilient the company's strategy, operations and assets would be under different possible developments in climate conditions and the transition.

4. Prioritise each climate risk

Once the assessment is complete, risks can be represented through a matrix combining likelihood and impact.

This makes it easier to distinguish between risks that require immediate intervention and those that can be monitored.

A simple matrix may, for example, assign likelihood and impact a score from 1 to 5. The resulting score creates a comparable measure across different risks.

The score should not replace the underlying analysis. Two risks with the same score may require very different responses depending on the company's ability to intervene, the time needed to implement measures and the investment required.

Final prioritisation should therefore also consider existing controls and the level of residual risk after those measures have been applied.

How to manage climate risk

Once the assessment is complete, the next step is to convert priorities into concrete climate risk management actions.

To manage climate risk effectively, the company should determine the appropriate response for each material risk: reduce exposure or vulnerability, limit the consequences, transfer part of the risk or accept and monitor it.

For physical risks, measures may include adapting facilities, installing protection systems, identifying alternative suppliers or developing business continuity plans. Transition risks may instead require energy-efficiency projects, technological changes, emissions reductions or a review of products and investments.

For companies setting emissions reduction objectives, frameworks such as the Science Based Targets initiative (SBTi) can provide a reference for setting measurable corporate climate targets and connecting them with decarbonisation plans.

To make risk management operational, each action should be assigned to an owner and linked to a deadline and a progress indicator. This makes it possible to verify whether planned measures are actually being implemented and whether they are producing a measurable reduction in exposure.

Companies also need to manage the financial risks arising from climate change where climate-related factors can affect capital expenditure, operating costs, asset values or continuity of supply.

Climate risk information should therefore feed into the business processes where it can influence actual decisions. A new facility, for example, can be assessed by considering the future exposure of its location to extreme temperatures or water scarcity. Similarly, the selection of a strategic supplier may include an assessment of its ability to maintain operations in the event of climate-related disruption.

The assessment should also be updated after measures have been implemented. This allows the company to determine residual risk, meaning the level of exposure that remains after the adopted measures have been taken into account.

If, for example, a facility with a high flood risk is protected through specific infrastructure and a business continuity plan, its level of risk may decrease significantly. The updated assessment should reflect that change.

External factors can also evolve over time. New climate data, regulatory developments or changes in the supply chain may increase or reduce the relevance of previously assessed risks.

It is therefore useful to maintain a structure connecting initial risk, mitigation or adaptation measures, responsible owners, implementation progress and residual risk. For organisations operating multiple sites or business units, centralised management makes it easier to compare risks and update assessments consistently over time.

Making climate risk analysis useful for business decisions

The value of climate risk analysis ultimately depends on its ability to support concrete decisions.

Even a highly detailed assessment has limited value if it remains disconnected from the processes through which the company decides where to invest, which suppliers to select, which assets to protect or which actions to prioritise.

A useful system should make it possible to update risks over time, compare different sites or activities and measure whether the adopted actions are effective. Effective climate transition and climate risk management can then become part of the same processes already used to manage investments, business continuity and resource allocation.

The quality of the analysis depends largely on how precisely climate information is connected to the company's operational reality. A risk becomes manageable when it is clear which activity it affects, what consequence it may generate, which action has been defined and who is responsible for it.

For companies managing multiple sites, suppliers or processes, ESG software can support this work by centralising assessments, responsibilities, documentation and actions while keeping the overall climate risk picture updated over time.