How to Build Climate Resilience
The business case for building resilience to the changing climate can be made primarily in terms of avoiding unexpected costs, managing risks and making the most of opportunities, although the focus is on the former. Organizations will ultimately need to improve their control environment by designing improved risk mitigation plans.
The reasons for this include the fact that weather events can be very costly with regard to lives, money, security, internal morale and reputation. Good risk management practices should allow for early recognition of threats so as to empower the organization to classify and highlight the risks. The organization can then deal with the threats in an effective and timely way.
Risk management often achieves this through the promotion and facilitation of improved communication between employees, management board and stakeholders concerning how the threats are being managed.
While no one has yet discovered how to play God, there is a range of both preventive and reactive risk management controls and solutions that can be developed to reduce the impact on business. These are often referred to as pre- and post- loss mitigation strategies, such as business continuity plans and insurance, which seek to protect income affected by unfavourable weather conditions.
When building operational resilience, developing pre- and post- loss event operational controls is important in the context of reducing the severity or financial impact of physical risks due to climate change.
It is important to first understand the context of what is meant by resilience and then to consider what controls can be designed to help organizations improve their resilience to climate change physical risks. Resilience can be grouped into different areas of focus: operational resilience, financial resilience and strategic resilience.
Operational resilience
The primary objective of operational resilience is the ability of the organization to continue to deliver critical operations, i.e., products and services, throughout a disruption. Operational resilience is really linked to the ability of an organization to prevent, adapt, respond to, recover and learn from operational disruptions.
Regulators’ expectations also extend to the fact that building operational resilience is necessary to protect the wider society and consumers. Financial regulators for example state that “Operational resilience is also about changing your organization’s mindset. Instead of thinking about operational disruption as something that could happen, firms should assume it will happen. This shift in attitude should propel your organization to make operational resilience a priority and will help to drive cultural change within the industry.”
The key components or control mechanisms include:
- Business Continuity and Crisis management
- Supply Chain Risk management
Financial resilience
Financial resilience is the ability of an organization to withstand events that affect its capital structure, liquidity, revenue and assets.
Organizations can design pre- and post- loss controls that they can use through risk financing mechanisms. This will be either pre-financing losses from climate events or through insurance and hedging strategies. Both arrangements will seek to reduce the volatility of earnings that can in turn help to provide other financial benefits and targets, such as:
- Stronger credit ratings
- Lower cost of debt
- Improved access to funding.
Furthermore, eliminating or reducing the uncertainty generated by different non-core risks allows management to concentrate on executing core business strategies. The physical risk from Climate change is mainly linked to the uncertainty in cash flow and earnings caused by volumetric risk (which is variability in supply and/or demand caused primarily by variability in the climate conditions).
As awareness of climate risk increases among shareholders, Chief Executives are no longer able to use the climate as an excuse for lower profits. As a result, a growing number of companies are developing risk financing solutions to hedge specific exposures. Some of the risk financing mechanisms available for companies include the use of captive insurance companies and of innovative solutions such as parametric or index solutions.
The key components or control mechanisms include:
- Risk Financing
- Strategic Insurance Risk Gap Analysis
- Financial Planning and Capital Management
Strategic resilience
Strategic resilience considers the implications of the strategic and organizational choices a firm must make, and the potential implications for long-term stability.
One of the most important techniques is to develop an emerging risk management framework using tools and techniques such as horizon scanning. Emerging risks are those that you can see approaching but are not yet sufficiently clear to enable a formal impact and likelihood risk assessment. However, the key is to understand emerging risks as best as possible. Consider monitoring them to ensure they don’t arise unexpectedly and consider any possible cost-effective actions that can be taken now to prepare for when the risks materialize.
The key components or control mechanisms include:
- Emerging Risk Management Framework
- Strategic Planning
Developing a climate resilience framework
The below climate resilience framework can be used to improve resilience across operational, financial and strategic dimensions.
The framework helps to explain the main controls that organizations should seek to develop and the associated tools and techniques. Some of the traditional controls for building operational risk will be covered in this chapter, such as the use of business continuity planning and insurance.
A number of tools are available within the Risk Manager’s ‘toolkit’, to enable them to assess and control risks facing an organization.
One of the most important tools for building climate resilience is stress and scenario testing However, it is important to note the importance of stress testing and scenario analysis to climate resilience both in understanding the nature of potential events and the steps needed to build operational, financial or strategic resilience. The techniques vary slightly but the principles apply equally across all three. Operational resilience relies on stress testing to challenge the impact tolerance assessments. Financial resilience relies on it to test sensitivities to key financial shocks. Strategic resilience utilizes the technique to ‘war game’ future scenarios.
It is particularly useful in assessing not only root causes, but also possible outcomes, and provides a basis for debate regarding key controls which could be implemented. Bow-tie analysis for example is also a simple and effective tool for communicating risk assessment results to employees at all levels.
The main objective of the tool is to help evaluate whether the existing controls are effective in meeting the organization’s target risk appetite for the specific climate scenario.
Design risk mitigation strategies
Developing risk mitigation plans and improving the control environment is critical and organizations need to align them with stakeholder expectations and then align them with their strategic objectives, core operations and processes.
Organizations need to evaluate and develop risk mitigation plans that:
- Reduce the impact and/or likelihood of the climate scenario of concern
- Ensure the benefit of the cost of implementation of the control improvement is greater than the cost.
The risk mitigation plans should be formalized as part of ongoing climate change plans in line with risk appetite strategy.
Conclusion
Organizations are increasingly hard-pressed to remain agile in today’s environment and need to understand both their current and possible future risk exposures, including the influence of climate change. It is essential to anticipate key events from emerging trends, constantly adapt to change, and rapidly bounce back from adversity.
It is important to first understand the context of what is meant by resilience and to consider what existing or new risk mitigation plans can be designed to help organizations improve their resilience to climate change management processes and how these can be used to help organizations.
As companies deal with physical changes and a transition to a more sustainable business, they need to align the impacts of climate change to balance sheet solutions that can reduce volatility. Climate change requires a forward-looking approach and the assessment of the ‘more intangible’ transition risks.
Risk management ultimately needs to be more fully integrated into the DNA of the business elevated as a critical process that supports both strategy and financial planning.
