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Develop a robust transition plan
IFRS S2 distinguishes climate-related risks the following ways:
- Physical risks
- Event-driven or acute risks
- Longer-term shifts or chronic risks
- Transition risks (those associated with moving to a lower-carbon economy)
Transition risks may expose a company to various degrees of financial and reputational risk depending on the nature, speed and focus of the risks associated with moving to a lower-carbon economy. In a world focused on reducing carbon emissions, as governments increasingly commit to transitioning towards lower-carbon economies, companies are recognizing the importance of developing transition plans as a key part of their overall strategy. IFRS S2 incorporates many specific disclosure requirements regarding transition plans, with the overall goal of enabling primary users to understand the impact of climate-related risks and opportunities on a company's strategy and decision-making. This could prove useful, for example, when a company needs to explain whether a climate-related risk it has identified is physical or transitional in nature. In addition, companies will also have to disclose the amount and percentage of their assets or business activities that are vulnerable to transition risks specifically. For companies that have already developed a transition plan, IFRS S2 requires them to disclose key information about:
- Critical assumptions and/or dependencies that they identified when developing their transition plan; and
- How they are resourcing, or plan to resource, the activities outlined in their transition plans.
It’s important to remember that a transition plan is different from a long-term goal; it needs to be sufficiently detailed so as to clearly illustrate the company’s overall strategy for how it plans to transition towards a lower-carbon economy, as well as setting out specific targets and actions about how it plans to transition, i.e., reducing its greenhouse gas emissions.
The use of scenario analysis to enhance resilience
Given the requirements of IFRS S2, investors will have access to a much broader spectrum of information about a company and its climate related risks and opportunities that will help them to understand and adjust to uncertainty related to climate change. Specifically, IFRS 2 requires companies to explain the resilience of their strategy and business model to both physical and transition risks and opportunities. To achieve this, IFRS S2 mandates that companies conduct climate-related scenario analysis to evaluate their climate resilience. This analysis should use a suitable method, appropriate for their circumstances considering their exposure to climate-related risks and opportunities, as well as the skills, capabilities and resources that are available at the time of reporting. Companies will have to determine their approach to climate-related scenario analysis based on all reasonable and supportable information that is available without undue cost or effort and take into account both the choice of inputs and the analytical decisions made when conducting the analysis.