Executive Summary – Physical Climate Risk Moves to Center Stage
California’s climate disclosure laws are redefining how large businesses think about climate change by shifting attention beyond emissions data toward the real-world ways physical climate impacts can disrupt operations, assets, supply chains, and financial performance. Through SB 261 and the California Air Resources Board’s (CARB) draft regulations, companies doing business in the state are being asked to understand and explain how floods, heatwaves, wildfires, storms, and sea-level rise translate into climate-related financial risk and strategic decisions, even as legal challenges to the laws proceed.
California Climate Policy – From Emissions to Business Impacts
California is not simply asking companies how much carbon they emit; it is asking how physical climate risks will affect their businesses. Through its landmark climate disclosure laws and CARB’s draft regulations, the state is pushing large companies to confront how climate impacts will affect their operations, assets, supply chains, workforces, and long-term financial performance across their portfolios.
Draft CARB Regulations – Turning Climate Laws into Business Requirements
On December 9, 2025, CARB released draft regulations to implement California’s two major climate disclosure laws, SB 253 and SB 261. While SB 253 has drawn attention for greenhouse gas emissions reporting, SB 261 is where the core conversation about physical climate risk, business resilience, and financial exposure is taking shape, and the draft regulations indicate that California intends this framework to be durable, operational, and integrated into corporate decision-making.
SB 261 Overview – Climate-Related Financial Risk at Scale
SB 261, the Climate-Related Financial Risk Act, applies to U.S.-based companies with more than $500 million in annual revenue that do business in California. These covered entities must, by January 1, 2026, and every two years thereafter, publish a report that describes their climate-related financial risks and the measures they are taking to mitigate and adapt to those risks, which effectively requires executives to connect physical climate hazards to revenue volatility, asset impairment, operational disruption, and long-term strategy.
Legal Context – Injunction Pauses Enforcement but Not Direction of Travel
Although the Ninth Circuit Court of Appeals has temporarily enjoined enforcement of SB 261 pending litigation over its constitutionality, CARB has signaled that the underlying policy direction remains in place. In a December 1 enforcement advisory, CARB confirmed that it would not enforce the January 1, 2026, reporting deadline during the injunction. Yet, the agency is maintaining momentum and continuing to build the climate-related financial risk framework that will ultimately require companies to treat physical climate risk as a core business issue.
Regulatory Momentum – Voluntary Reporting and Guidance Encourage Preparation
Even under the injunction, CARB has opened a public docket where companies may voluntarily submit SB 261 climate-related financial risk reports and has published a compliance checklist and a detailed frequently asked questions document. This combination of voluntary reporting channels and practical guidance signals that organizations should begin treating physical climate risk assessment and disclosure as a core part of corporate risk management, governance, and investor communication rather than a distant compliance task.
Scope and Applicability – Definitions of Doing Business in California
The draft regulations provide essential clarity on which companies must address climate-related financial risk under SB 261. CARB proposes definitions of doing business in California and revenue that determine whether an entity falls within scope, including companies organized or commercially domiciled in the state and those with California sales above a specified threshold, while expressly excluding wholesale electricity sales from the calculation, which directly shapes the set of firms expected to analyze and disclose their exposure to physical climate impacts.
Corporate Structure – Parent and Subsidiary Relationships and Risk Coverage
CARB’s alignment of the definitions of parent and subsidiary with those used in its Cap-and-Invest Program has significant implications for complex corporate groups. By clarifying how corporate associations are treated, the draft regulations make it clear that large organizations operating through multiple legal entities must consider physical climate risk at the group level and cannot avoid climate risk obligations simply by dispersing operations among subsidiaries.
Business Exposure – Physical Climate Hazards as Financial Risk Drivers
These definitional choices are more than technical legal details; they define the universe of companies that will be expected to examine how climate-driven events could damage facilities, disrupt logistics, threaten workers, undermine customer demand, or erode asset values. For a corporation with a geographically diverse footprint, physical climate risk may include coastal flooding at ports and distribution centers, chronic heat stress affecting worker safety and productivity, drought or storm events disrupting supply chains, or wildfire smoke hindering operations and demand in key markets, all of which must now be considered through a financial risk lens.
Governance Implications – From Sustainability Topic to Board-Level Risk
Under SB 261, climate risk is no longer an issue confined to sustainability or corporate social responsibility teams. Physical climate hazards and their financial implications must be translated into the language of boards, lenders, insurers, and investors, including the potential for increased credit risk, insurance gaps, stranded or impaired assets, changes in enterprise value, and higher capital costs due to climate-related volatility and disruption.
Program Funding – CARB Signals Long-Term Commitment to Climate Risk Oversight
The draft regulations also describe how CARB will fund the administration of SB 253 and SB 261, which underscores the long-term nature of the initiatives. The laws authorize CARB to collect annual fees from covered entities. The draft proposes a flat fee approach in which each entity subject to a law pays the same amount, with program costs estimated at approximately fourteen million dollars by fiscal year 2026–27 and supported by up to forty-two permanent staff across four new sections devoted to climate disclosure and enforcement.
Financial Architecture – Loans and Dedicated Funds Institutionalize Climate Risk
Initial implementation costs are being financed through a loan from the state’s Greenhouse Gas Reduction Fund, which will be repaid with fee revenues allocated to the Climate Accountability and Emissions Disclosure Fund for SB 253 and the Climate-Related Financial Risk Disclosure Fund for SB 261. This financial structure indicates that California’s climate risk framework is not temporary but is instead being institutionalized as part of the state’s broader climate and financial governance architecture.
Exemptions – Narrowing Applicability While Preserving Scale
CARB’s proposals also identify entities that would be exempt from SB 253 and SB 261, including federal, state, and local government entities and companies majority-owned by those governments, tax-exempt non-profit and charitable organizations, entities whose only presence in California consists of teleworking employees, and entities whose only business within the state consists of wholesale electricity transactions. These exemptions narrow the field but still leave thousands of private sector entities with a requirement or strong expectation to systematically address physical climate risk.
Strategic Implications – Physical Climate Risk as a Core Planning Input
For affected companies, the practical implications of SB 261 are significant because the law compels firms to consider how climate change could affect cash flows, capital expenditures, insurance coverage, and access to financing. A manufacturing company may need to analyze how more frequent flooding could shut down critical plants or suppliers, a retailer with a large California footprint may need to evaluate how extreme heat and wildfire smoke influence store traffic and workforce availability, and a financial institution may need to assess how climate-related damages to collateral or insured assets could translate into credit and underwriting losses.
Integration with Emissions Data – Connecting GHG Reporting to Physical Risk
Even companies that are primarily focused on emissions reporting under SB 253 should recognize the growing convergence between greenhouse gas disclosure and physical climate risk analysis. While SB 253 emphasizes Scope 1, Scope 2, and later Scope 3 emissions, the strategic value for corporate leaders is most significant when emissions data are combined with forward-looking analysis of climate hazards and financial exposure, creating a more complete view of how climate change could reshape business performance and enterprise value over time.
Competitive Advantage – Climate Risk Disclosure as a Business Differentiator
In the coming months, CARB will hold a public hearing on the proposed regulations and accept written comments, allowing companies, trade associations, and other stakeholders to influence issues such as timing, fee design, and interpretive guidance. Regardless of how those details evolve, California is clearly building an integrated framework that links climate science, physical climate risk, and financial disclosure, and companies that move early to develop robust climate risk assessments may gain advantages in risk management, investor trust, and regulatory readiness.
Action Steps – Turning Compliance Work into Strategic Climate Insight
Businesses that begin now by mapping physical climate risks across their portfolios, integrating climate scenarios into enterprise risk management, and aligning internal reporting and governance with SB 261 expectations will be better positioned than those that wait for legal uncertainty to resolve. For many firms, the greatest value will not come from merely satisfying a California disclosure requirement, but from using this work to understand where climate change could most disrupt operations and finances and then using that insight to guide investment, adaptation, and long-term corporate strategy.
Frequently Asked Questions (FAQs)
- What is SB 261 in California? SB 261 is California’s Climate-Related Financial Risk Act. It requires large U.S.-based companies that do business in California and meet a revenue threshold to publish climate-related financial risk reports that describe material climate risks, including physical climate risk, and the measures the company is taking to reduce and adapt to those risks.
- How does SB 261 focus on physical climate risk rather than just emissions? SB 261 requires companies to explain how climate change can affect their financial performance, not just how much they emit. This includes physical climate risks such as flooding, extreme heat, drought, wildfires, and storms, and how those events can disrupt operations, damage assets, affect supply chains and workers, and change revenue and cost profiles.
- Which companies are covered by SB 261? SB 261 applies to U.S.-based entities with more than five hundred million dollars in annual revenue that are considered to be doing business in California under CARB’s proposed definitions, which include being organized or commercially domiciled in the state or surpassing a threshold level of California sales.
- Is SB 261 currently being enforced? Enforcement of SB 261 has been temporarily paused by a court injunction pending litigation. Still, CARB has continued to develop the implementing framework, issued guidance, and opened a voluntary reporting docket, signaling that companies should still prepare for climate-related financial risk disclosure.
- Why should companies start preparing for SB 261 now? Companies that begin early can integrate physical climate risk into enterprise risk management, identify vulnerabilities before they become acute, engage more effectively with investors and lenders, and use climate risk insights to inform capital allocation and long-term strategy. Early preparation also reduces the risk of rushed or incomplete reporting once enforcement resumes or related requirements emerge in other jurisdictions.
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