As California moves forward with its landmark Climate-Related Financial Risk Act (SB 261), the foundation of compliance starts with Section (a) — Definitions. This section establishes the parameters for who needs to report, what must be reported, and how the concept of climate-related financial risk is understood. Understanding these definitions is essential for companies preparing their first disclosure under the Act, which is due on January 1, 2026.
At its core, SB 261 applies to any “covered entity,” meaning a corporation, partnership, limited liability company, or other business entity with annual revenues exceeding $500 million that conducts business in California. Notably, insurers are excluded since they fall under a separate climate disclosure law, SB 253. This revenue threshold includes a wide range of enterprises, such as manufacturing and logistics companies, financial institutions, and technology firms with operations or sales in the state.
The law defines “climate-related financial risk” as any significant danger that could harm short-term or long-term financial results due to physical and transition risks linked with climate change. This wording broadens the usual understanding of economic risk to include climate-driven factors that might affect profitability, asset value, and long-term sustainability.
Within this broader definition, the Act differentiates between two main categories of risk:
Physical risks involve the direct impacts of a changing climate on assets and operations, including sudden events like storms, floods, heat waves, and wildfires, as well as ongoing changes such as sea-level rise, long-term temperature increases, and drought. These hazards can interrupt supply chains, damage property, and lower asset values.
Transition risks arise from the systemic economic shift toward a low-carbon future. These include policy and regulatory changes, market realignments, technological disruptions, and reputational impacts that can affect the cost of capital, demand for products, or overall market positioning.
By formalizing these definitions, Section (a) anchors the rest of SB 261 in a clear and forward-looking framework. It ensures that companies look beyond traditional financial metrics to consider how climate change, through physical events and economic transitions, could impact their bottom line.
For organizations operating in California, understanding these definitions is not only a legal requirement but also a strategic necessity. Companies that identify and assess their climate-related financial risks today will be better equipped to comply, adapt, and compete in a quickly changing business environment.
Ready to get started? To learn how ClimaTwin can help you assess the physical and financial impacts of future weather and climate extremes on your infrastructure assets, capital programs, and investment portfolio, please visit www.climatwin.com today.
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