Climate change is increasingly recognised as a driver of economic and financial risk, with implications that extend beyond environmental considerations. Its effects influence operational conditions, supply chains, resource availability, and market dynamics across industries.

These shifts can impact organisational performance, cost structures, and long-term financial stability. Understanding how climate-related developments affect individual businesses is essential for evaluating exposure, anticipating potential disruptions, and assessing overall resilience.

Climate-related financial risk refers to the potential for climate change and associated societal and economic responses to affect an organisation’s financial position, performance, and strategic outlook.

Type of risks

Climate-related risks can affect organisations both through direct physical impacts on assets and operations and through economic, regulatory, and technological changes associated with the transition to a lower-carbon economy. These impacts are typically categorised into physical risks and transition risks, each with distinct characteristics and implications for financial outcomes.

Physical risks

Physical risks arise from the direct effects of climate change on natural and built environments. Acute physical risks are associated with extreme weather events such as storms, floods, wildfires, and heatwaves, which can disrupt operations, damage assets, and impair supply chains, creating higher costs and lost revenue.

Chronic physical risks result from longer-term changes in climate patterns, including rising average temperatures, sea-level rise, water scarcity, and ecosystem degradation. These gradual shifts can reduce asset productivity, increase operating costs, and alter the geographic viability of business activities.

Physical risks can also affect insurers, lenders, and investors through higher claims, credit losses, and declining asset values. Such risks are expected to increase globally over the coming decades, with developing countries particularly vulnerable due to limited adaptive capacity.

Transition risks

Transition risks emerge from the societal, economic, and regulatory adjustments required to move toward a lower-carbon economy. Policy measures, including carbon pricing, emissions regulations, and energy efficiency standards, can alter cost structures and affect profitability across sectors.

Technological changes may render existing assets or processes obsolete, particularly in carbon-intensive industries, while shifts in market preferences and investor expectations can influence demand for products, increase compliance or investment costs, and reduce the value of existing assets.

Legal and liability risks may also arise from climate-related litigation or failure to adapt business practices. Transition risks are likely to intensify over the next two decades as decarbonisation efforts accelerate and can materialise unevenly, creating financial stress and competitive reallocation within markets.

Both physical and transition risks will continue to evolve, with transition risks predominating in the short to medium term as mitigation efforts increase, and physical risks expected to dominate after 2050 if global temperatures continue to rise.

Transparent and consistent disclosure of these risks enables stakeholders to evaluate how climate considerations are integrated into financial planning, risk management, and long-term resilience strategies.

Transmission channels

These risks propagate through multiple financial transmission channels, affecting cash flows, operating expenses, asset valuations, and access to capital, thereby influencing profitability, balance sheet strength, and long-term resilience.

The primary financial transmission channels can be grouped into revenues, costs, assets, and financing. Together, these channels provide a structured framework for tracing how climate-related risks move from abstract hazards into measurable financial impacts, supporting more informed decision-making and strategic planning.

• Revenue channels are affected when physical disruptions or shifting market preferences reduce sales or market share.
• Cost channels emerge through increased operating expenses, including repair and maintenance, higher energy or input costs, and investments required to comply with regulations or adopt low-carbon technologies.
• Asset channels reflect changes in the value of tangible and intangible assets, such as stranded high-emission facilities, impaired infrastructure, or reduced property valuations in vulnerable regions.
• Financing channels capture the effects on capital access and cost, as lenders and investors may adjust risk pricing, tighten credit, or demand higher returns in response to elevated exposure.