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Setting a Net-Zero Target

Using scenario analysis for climate change

clock 5 minute read

Investors use scenario analysis to assess future risks and opportunities under conditions of uncertainty. Investors can use such analysis to understand how various combinations of climate-related risks may affect the performance of companies and portfolios over time.

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Using scenario analysis for climate change

The TCFD suggests five reasons for investors to use scenario analysis for climate change. Such analysis can:

  • Help investors consider possible outcomes that are highly uncertain, such as the physical response of the climate and ecosystems to higher levels of greenhouse gas emissions in the atmosphere, as well as outcomes that play out over the medium to longer term.
  • Broaden thinking across a range of plausible scenarios.
  • Help to frame and assess the potential range of plausible business, strategic and financial impacts from climate change and the associated actions that may need to be considered in strategic and financial plans.
  • Help with monitoring changes in the external environment and reassess and adjust their strategies and financial plans accordingly.
  • Assist investors in understanding the robustness of strategies at the companies they invest in.

Depth of scenarios

Because the effects of climate change vary greatly by sector, industry and organization, the TCFD recommends that all organizations consider applying a basic level of scenario analysis in their strategic planning and risk management processes.

  • A 1.5°C scenario, for example, lays out a pathway and emissions trajectory consistent with keeping the rise in average temperatures below the globally agreed threshold.
  • Physical-risk scenarios generally identify extreme weather threats of moderate or higher risk before 2030 and a larger number and range of physical threats between 2030 and 2050.

Some best practices in scenario analysis

The TCFD suggests that in analyzing scenarios, organizations should strive to achieve:

  • Transparency around parameters, assumptions, analytical approaches and time frames
  • Comparability of results across different scenarios and analytical approaches
  • Adequate documentation for the methodology, assumptions, data sources and analytics
  • Consistency of methodology year over year
  • Sound governance of analysis, validation, approval and application
  • Effective disclosure of scenario analysis that will inform and promote a constructive dialogue between investors and organizations on the range of potential impacts and resilience of the organization’s strategy under various climate-related scenarios

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Assessing climate risks in investors’ portfolios: a journey through climate stress-testing. A five-step approach to climate stress-testing published by the Principles for Responsible Investment (March 2020).

A comprehensive investor guide to scenario-based methods for climate risk assessment, in response to the TCFD. U.N. Environment Programme Finance Initiative (May 2019).

NGFS Climate Scenarios for central banks and supervisors. The Network for Greening the Financial System has published six transition- and physical-risk scenarios designed to provide a starting point for analyzing climate risks to the economy and financial system (June 2021).

The Use of Scenario Analysis in Disclosure of Climate-Related Risks and Opportunities. A guide from the TCFD that addresses why scenario analysis is useful, what a scenario is and how selected companies have used scenarios.