Understanding climate risk analysis: everything you need to know for EU Taxonomy compliance

Climate change is increasingly presenting companies with complex challenges. In addition to direct physical risks such as extreme weather events, climate-related transition risks arise from regulatory requirements, changing market conditions, and growing expectations from investors and stakeholders. A well-founded climate scenario analysis (climate risk analysis) is therefore essential for systematically assessing these risks and developing appropriate adaptation measures. At the same time, it serves as a key foundation for reporting under the Corporate Sustainability Reporting Directive (CSRD) and the EU Taxonomy.

What is a climate risk analysis?

A climate risk analysis identifies specific risks and opportunities resulting from climate change that are likely to impact a company’s financial situation in the medium to long term based on their probability and severity. Relevant risks and opportunities for the company and its value chain are evaluated based on climate scenarios.

According to the ESRS, physical risks must be assessed using a scenario with over 4°C of global warming, while transition risks and opportunities must be analyzed using a 1.5°C scenario.

With the help of the climate risk analysis, companies can prepare for significant climate-related risks and opportunities, deriving appropriate measures to enhance resilience. Many banks, investors, and insurances require a climate risk analysis.

Climate risk analysis within the Double Materiality Assessment

As part of the ESRS, companies must demonstrate in IRO-1 of Topic E1 "Climate Change" that they have conducted a climate risk analysis when identifying and assessing their IROs (Impacts, Risks, and Opportunities) within the Double Materiality Assessment (DMA). The ESRS specify the following two tables of physical climate hazards and climate-related transition events, whose impacts on the company must be analyzed. The precise term in the ESRS is "climate-related scenario analysis"

Physical climate risks

The ESRS distinguish between chronic (i.e., permanent) and acute (i.e., temporary or event-related) physical climate risks. The affected areas and severity of risks vary depending on the assumed extent of climate change. The ESRS specify that a "high emissions" scenario should be selected. As an example, they cite the RCP-8.5 scenario from the IPCC, which assumes global warming of over 4°C by 2100.

Physical climate risks are particularly relevant for industries with substantial tangible assets, their own production sites, and/or key geographical connections in the value chain.

Transition risks

When analyzing climate-related transition events, both risks and opportunities for the company can be derived. A scenario assuming no or only limited exceedance of the 1.5°C global warming target should be used, as it includes the most significant required changes.

Conducting the climate risk analysis

As part of the IRO assessment, it makes sense to analyze the vulnerability of company locations and key upstream and downstream value chains for each listed hazard or event. Locations with different vulnerability levels should be assessed separately.

The results of the climate risk analysis are not only relevant for risk management but also for sustainability reporting. A key regulatory framework in this context is the EU Taxonomy.

What is the EU Taxonomy regulation and its connection to the CSRD/ESRS?

The EU Taxonomy is a classification system for sustainable economic activities with Technical Screening Criteria (TSC). Companies already subject to the NFRD must comply with it today, and it will also apply to all CSRD-mandated companies.

The taxonomy is also integrated into the ESRS. Under Topic E1 "Climate Change," companies can create a "Transition plan for climate change mitigation" They must quantify the investments they made or planned in the reporting year to align their activities with the EU’s climate goals. In addition to the two climate-related objectives, the EU has established four other environmental goals under the Green Deal:

1. Climate change mitigation
2. Climate change adaptation
3. Sustainable use and protection of water and marine resources
4. Transition to a circular economy
5. Pollution prevention and control
6. Protection and restoration of biodiversity and ecosystems

The EU Taxonomy and its relevance for climate risks

Within the EU Taxonomy, the so-called climate risk and vulnerability assessment plays a crucial role, as many of the Technical Screening Criteria (TSC) explicitly focus on assessing and addressing climate risks. Among the six environmental objectives, two are directly climate-related:

Climate risk and vulnerability assessment under the EU Taxonomy

1. Climate change mitigation – Activities that contribute to reducing greenhouse gas emissions.
2. ‍Climate change adaptation – Activities that adapt to changing climate conditions and minimize climate-related risks.