The answer to this question is simple. Wherever standards require us to present material risks, we should describe gross risks, i.e., before taking any control or mitigation measures. The net value of risk applies to situations where such measures have already been implemented. As a result, the risk may cease to be significant, or it may remain significant but its effects will be absorbable by the organization. The matter becomes a little more complicated when we add the time factor.
For example, during our materiality assessment, we determined that one of our assets (the building where production takes place) is exposed to physical risks related to climate change—during heat waves, the temperature inside will be too high for employees to work there. We will even be able to estimate the anticipated financial impact of this risk (a production stoppage lasting a certain number of days will result in lost revenue and possibly even penalties from customers who are not served on time). We will not leave this matter unattended and will, of course, plan to install an appropriate air conditioning system in this building, which will involve certain costs and take some time to install. The effects of the production interruption caused by the heat wave before the air conditioning system is installed determine the gross risk level. The analogous effects after the installation of the air conditioning system are the net risk level (if it is a truly robust system, capable of coping with any heat wave, then perhaps they will be zero).
If we identified the risk in 2024 and are preparing a report for that year, we should disclose the risk at the gross level. Of course, in the relevant disclosures, we will also write about the investment plan under which we will install an air conditioning system. Even if we completed all the work during the same year, we must also disclose the gross risk and the measures taken to mitigate it. And what happens in the next report? If we have already dealt with the risk of production interruptions caused by heat waves in 2024, we will not disclose this risk at all in the report for 2025. Heat waves will continue to occur, but our production facility is equipped in such a way that there will be no production interruptions, so we will not consider this risk to be significant. In the future, as the climate crisis deepens, or as a result of applying other climate change scenarios in our analyses, the situation may change and the risk may reappear (at a significant level), but that's another story...
When discussing gross and net risk, it is worth mentioning one of the many errors in the Polish version of the ESRS standards. In ESRS E1 on climate change, paragraph 20 explicitly refers to „gross physical risks” and „gross transition risks” in the English version, while the Polish version refers to „serious physical risks” and „serious transition risks.” „Gross” means „gross,” not „serious.” Unfortunately, work on the report based on the Polish ESRS still requires constant checking of the English original.
In today's newsletter, we discussed gross and net risk. Significant inflows must also be reported in gross terms—but that's a topic for one of our future newsletters 😊
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