There is reason to be hopeful of a significant scaling up of sustainability-related information flows over the years ahead, with the development, adoption and harmonisation of a number of sustainability disclosure frameworks. This includes, not least, the emerging ISSB standards on climate and sustainability, while the EU sustainability disclosure regime also continues to advance, and in the USA the SEC has released for consultation a proposed climate disclosure rule. A number of national jurisdictions (France, Japan, New Zealand and the UK) have already introduced mandatory TCFD disclosure requirements, with the entire G7 expected to follow their lead in the coming years.

At the same time, the physical climate change impacts continue to rise up the agenda. The IPPC paints a sombre picture of accelerating global heating, while the WEF has identified global climate action failure and extreme weather as the two most severe global risks over the next decade. In June this year, UN climate talks in Bonn ended in acrimony, with clashes over climate finance flows driven by the concerns of vulnerable countries facing severe physical climate risks.

So, how is physical climate featuring in these fast-evolving sustainability disclosure frameworks? Is it still the poor cousin to carbon-related disclosures, or is it beginning to catch up? Cadlas takes a closer look

The story so far

There has been some progress over recent years, driven largely by the continued evolution of TCFD recommendations. While physical climate has always been part of the TCFD framework, its prominence was limited at first. However, things quickly advanced in the years following the TCFD’s launch in 2017. This included the emergence of physical climate analytics service providers, and a number of initiatives by organisations including the EBRD and the Global Centre on Adaptation, and UNEP-FI.

As climate risk become mainstreamed into financial supervision, physical climate assumed a central role alongside carbon transition. This was evident in the comprehensive climate-related requirements of prominent supervisors such as the Bank of England, Banque de France and the European Central Bank, as well as influential international bodies such as the NGFS and the Basel Committee on Banking Supervision.

An important step forward occurred in 2021, when the TCFD updated its guidance on metrics and targets. This has influenced the inclusion of physical climate in other disclosure frameworks such as the ISSB, EFRAG and SEC, and climate disclosure regimes in the UK and elsewhere that follow TCFD recommendations.

Key common features

So how is physical climate is being treated in the main sustainability disclosure frameworks?

One general theme is that they all call for physical climate to be mainstreamed across climate-related disclosures, typically following the TCFD structure of governance, strategy, risk management and metrics & targets. In practice though, physical climate is often overshadowed by carbon transition and suffers from a lack of guidance on precisely how it should be assessed and disclosed. In line with the direction set by the TCFD, three broad categories of disclosures, which are either directly or indirectly related to physical climate, are emerging as broadly common across all the main frameworks.

Exposure to physical climate risks: this refers to extent to which business operations (assets, revenues, turnover or other activities) are exposed to material physical climate risks. However, there is significant room for interpretation in the scope, boundaries and granularity of physical climate risk assessments, the climate models, scenarios and timescales used, the definitions of physical climate hazards used, and the criteria used to assess the materiality of physical climate risks.

Alignment with climate resilience opportunities: while the cross-industry TCFD metrics refer to climate-related opportunities in general, this clearly includes opportunities associated with climate resilience (or adaptation), for instance an agricultural company’s revenues from the sale of drought-resilient seeds. This calls for clear and widely understood definitions of climate resilience opportunities. Relevant taxonomies such as the EU Taxonomy may help to provide this necessary clarity, although it may take time for the necessary market familiarity with its adaptation requirements to evolve.

Capital deployment associated with physical climate: again, the cross-industry TCFD metrics refer to capital deployment towards climate-related risks and opportunities in general, and once more this also clearly covers physical climate. This could include, for example, capital deployed for making infrastructure more resilient, or towards investment in efficient irrigation or weather monitoring technologies. Such disclosures may provide incentives for organisations to report private adaptation finance flows, thereby filling a significant information gap in the climate finance landscape.

Application across different sustainability disclosure regimes

While the overall direction of travel may be broadly consistent, there are some differences in the approaches being taken by the various emerging sustainability disclosure regimes.

The draft ISSB climate standard is closely aligned with the updated TCFD requirements and mirrors its cross-industry metrics on physical climate risk exposure, alignment with (physical) climate opportunities and capital deployment for (physical) climate-related risks and opportunities. At the industry-specific level, the draft ISSB climate standard refers directly to the SASB industry standards, although only some of these cover exposure to physical climate risk (e.g. agricultural products).

Within the evolving EU sustainability disclosure regime, the existing non-binding guidelines on climate-related reporting follow a roughly similar pattern to the TCFD, calling for information on exposed to physical climate risk, and on the percentage of turnover and of investment or expenditures that qualify as climate resilience opportunities by meeting the criteria for Substantial Contribution (to adaptation) under the EU Taxonomy. However, these will soon be superseded by EFRAG’s draft climate change standard, currently under development. This sets out a more granular approach that, in addition to the above points, also covers policies, targets, plans and resources related to climate (including, presumably, physical climate). This standard will naturally reflect the EU’s commitment to double materiality (i.e. sustainability matters that are both financially material to businesses and material to the market, the environment, and people), although precisely how this concept applies to physical climate requires further consideration and discussion.

Looking forward

It is no longer true to say that physical climate is being left out of climate and sustainability disclosure frameworks, nor that physical climate requirements are completely unambitious – in fact, if the requirements of the above disclosure frameworks on physical climate were to be followed to the letter, then this would be considerably challenging for most organisations, under current conditions. However, there remain important areas whether further advances are still needed:

• More consistent and granular requirements and guidance on physical climate risk assessments, including scope, boundaries and the definition of physical climate hazards, the climate models, scenarios, timescales and materiality criteria used.
• Clear differentiation between carbon transition and physical climate in disclosures of climate-related opportunities, and better application of taxonomies and definitions for climate resilience opportunities.
• Clear differentiation between carbon transition and physical climate in disclosures on climate-related capital deployment, and clear linkages made between capital deployment for climate resilience and adaptation finance tracking.

The absence of any mention of impact metrics in any these frameworks also needs to be addressed. These are needed for expressing how physical climate risks are managed and how climate resilience is advanced, and are also necessary for making adaptation taxonomies fully operational.

Finally, the extent to which any of these disclosure frameworks meaningfully address physical climate will ultimately depend upon the way in which they are applied, monitored and enforced by regulatory or supervisory authorities. If they choose to pay due attention to physical climate in sustainability disclosures, then this could play an important role in helping markets adjust to the reality of a changing climate, and to contribute towards building more climate-resilient economies.