Climate resilience is the ‘resilience of a company’s strategy and business model to climate-related changes, developments and uncertainties.’ This language is worth reflecting on, as it brings the concept of resilience science into mainstream business thinking.
In June, the International Sustainability Standards Board (ISSB) issued its inaugural standards — IFRS S1 and IFRS S2. The Standards create a common language for companies to report on how sustainability and climate-related risks and opportunities affect their prospects. They reflect what investors want, and will form the basis of mandatory climate-related reporting requirements in many advanced jurisdictions (aside from the United States).
This article explores the most interesting part of IFRS S2: the climate-resilience assessment. Building on the TCFD — which IFRS S2 has now supplanted — climate resilience is defined as the “resilience of a company’s strategy and business model to climate-related changes, developments and uncertainties” [emphasis added]. This language is worth reflecting on, as it brings the concept of resilience science into mainstream business thinking.
Tipping points and ignorance
Invented by Canadian ecologist C.S. “Buzz” Holling in 1973, resilience science explains how human-natural systems (the interconnected relationship between humans and the environment) do not exist in a fixed state — but are instead characterized by constant change and tipping points.
This is not how businesspeople usually think. Instead, they assume that a complex system — like an organisation — is stable, isolated, measurable and linear. Take COVID: Most of us thought things would be disrupted for a time before ‘bouncing back’ to normal. The mistake is right there in the language. Post pandemic, we didn’t go back. The way we live and work changed.
The What, Why and How of Product-Level Impact Measurement and Carbon Labeling
Join us at SB'23 San Diego as Allbirds, Logitech, Oatly and the Cradle to Cradle Product Innovation Institute share insights on their journeys toward product-level impact measurement and reporting — including the methodologies and processes they have put behind their carbon labels to ensure high quality, accuracy and verifiability.
A better understanding of the world acknowledges that systems go through adaptive cycles of growth, decay, restructuring and renewal. As business leaders, we must acknowledge our lack of certainty and control. We should reimagine our actions, plans and strategies as experiments that, as in science, must be constantly re-evaluated.
That’s why IFRS S2 is not the dry reporting standard it appears at first view, but something quite visionary — it embraces uncertainty and consents to our ignorance. It asks us to see through the ‘illusion’ of the pristine, perfectly self-contained balance sheet — where the ledger is always squared, and all things are known.
Focus on the process
To explain the “changes, developments and uncertainties” that arise from the physical and transition risks and opportunities of climate change, a company is required to use scenario analysis. This is not meant to predict what might happen in the future — but to offer up ‘what if’ scenarios to help your business better think through its options and plan accordingly.
IFRS S2 says you must disclose the “inputs and key assumptions” used in your scenarios — not just the result. In other words, your explanation of the process is essential. This is because investors want to test the quality of your thinking, rather than simply reading a claim that your business is resilient.
The method of scenario analysis you employ is up to you, and should be “commensurate with your circumstances.” For most businesses, an expensive, quantitative-modelling exercise is not required or even the best option. The authors of IFRS S2 recognize the burden that companies face in complying with a science-based approach to climate change.
As a result, they have sought to navigate a practical approach that requires the use of “all reasonable and supportable information” (the floor of the effort required) available at the reporting date without “undue cost or effort” (the ceiling). The concept is explained by ISSB Vice Chair Sue Lloyd in this webinar. The IPCC, IEA and PRI all provide publicly available scenarios which provide the basis for a useful, cost-effective and strategic approach.
Finally, your company is not required to perform a scenario analysis as part of the reporting effort each year. The minimum requirement for updating your scenarios is whenever you review your corporate strategy as part of the strategic planning cycle. That said, each year you must revisit the assumptions that underpinned your analysis and consider whether any changes affect the assessment of your company’s climate resilience. The IFRS refers to this annual update as a “resilience assessment.”
Scenario analysis done well will ultimately help you fine-tune your overall strategy and business model — enhancing your business’s prospects and resilience against the vagaries of an uncertain future.
In recent years, investor portfolios have grown too big to avoid systemic risks such as climate change. Recognizing their vulnerability to black swans, institutional investors have pushed investee companies to prioritize resilience over short-term cost optimisation; the IFRS Standards reflect the trend. As Taleb says, the defining characteristic of change is that it cannot be predicted: “This is the central illusion in life — that randomness is a risk — that it is a bad thing.”