Climate change poses myriad risks to businesses, impacting operations, markets and supply chains. While short-term risks include exposure to extreme weather events and shifts in consumer preferences, long-term risks are characterised by regulatory uncertainties and investors’ growing concerns about climate risks.

These risks, which are both physical and transitional, carry tangible financial implications, and boards must take proactive measures to safeguard shareholder value.

Physical risks involve damage to assets from extreme weather events and broader climate trends, such as global warming and rising sea levels. These risks can affect companies’ operations, supply chains and markets, leading to increased costs and disruptions.

Transition risks arise from changes in technology, market sentiment, consumer preferences, and regulations during the transition to a low-carbon economy. These risks can impair asset values, decrease profitability, and result in stranded assets.

Board education and awareness

The board’s key roles include promoting long-term value and defending the company’s reputation. An integrated approach to climate risk starts at the top, and boards need to ensure that management understands how climate change is reshaping the company’s risk landscape and that this is reflected in corporate strategy.

Corporate governance structures play a pivotal role in addressing climate risks and integrating sustainability into business strategies. Investors are placing greater emphasis on board competency in addressing climate-related risks and opportunities. Shareholder resolutions are urging companies to appoint board members with environmental or climate expertise. To enhance the focus on sustainability issues, some companies (for example, Shell, Nestlé and Unilever) have established sustainability committees within their boards.

In addition to taking proactive governance measures, boards must also navigate the increasingly stringent regulatory requirements related to climate risk reporting and disclosure. Implementing emerging disclosure frameworks, such as the Task Force on Climate-related Financial Disclosures (TCFD), enables companies to communicate climate-related risks effectively and is a particularly useful reference for boards.

The TCFD (2017) recommends that voluntary climate-related financial disclosures should focus on governance, strategy, metrics and targets, and risk management. Compliance with these reporting standards is crucial for maintaining trust and credibility in the market.

With mounting concerns about climate risks among investors and regulators, and growing demands for disclosure of climate risks, boards that fail to effectively oversee climate risks may be vulnerable to shareholder action and litigation.

Integrated risk management and strategic alignment

To navigate environmental risks, companies should adopt an integrated approach to risk management while aligning strategies with sustainability objectives. As a basic starting point, companies must understand their exposure to physical and transition risks. However, they must also understand the exposure originating from their supply chain (counterparties, suppliers, customers and partners).

Embedding climate risk in strategy is essential for long-term value creation and competitiveness. Boards could explore the following options:

• Integrate sustainable practices into operations, product management, product and service portfolios, financing and marketing practices.

• Incorporate climate risk considerations into strategic planning processes to safeguard against potential disruptions and capitalise on emerging opportunities.

• Integrate climate risk considerations into capital budgeting processes to enable companies to make informed decisions that mitigate risk and enhance long-term value creation.

• Strengthen supply chain resilience by identifying vulnerabilities due to climate risks in order to maintain operational continuity.

• Assess the exposure of each business unit to transition risks, and develop strategies to mitigate their potential impacts.

• Embed sustainability principles into business models. Leveraging sustainable innovation, such as renewable energy solutions or eco-friendly packaging, enables companies to meet evolving consumer preferences and regulatory requirements while driving business growth and enhancing brand reputation.

• Mergers and acquisitions (M&As) are a powerful tool that companies can use to improve their sustainability performance and generate new business opportunities. However, to maximise the chances of success, it is important to carefully consider the sustainability factors involved in each transaction.

• Integrate strategy and finance tools. Instruments such as green bonds, sustainability-linked loans, or sustainable supply chain financing help to align incentives with sustainability goals and drive meaningful change.

Navigating the transition

Understanding and managing climate risks is critical for businesses to maintain resilience and long-term sustainability. Despite the acknowledgement of climate-related risks across sectors, there is significant uncertainty around many aspects of climate change. It is vital to maintain organisational resilience in order to navigate the evolving environmental landscape, which is characterised by regulatory changes and market uncertainties.

Agility enables swift responses to emerging challenges and opportunities. Companies should stay abreast of changing environmental policies, tax implications and compliance requirements. It is important to be flexible in adjusting operational strategies to ensure alignment with changing regulatory landscapes.

The board of directors plays a pivotal role in steering a company through the complexities of climate change. By integrating climate considerations into governance structures and fostering a culture of environmental awareness, the board can enhance resilience, drive innovation and, ultimately, create sustainable value for all stakeholders.

Companies that adopt an integrated approach to risk management and achieve strategic alignment with sustainability objectives will be better positioned to navigate the evolving environmental landscape successfully and thrive amid change.

Nuno Fernandes is professor of finance and governance at IESE Business School and managing partner of Odgers Berndtson Board Solutions.