After the most crucial climate-related risks and opportunities to a company have been identified, the next step towards TCFD compliance consists of estimating how these will impact the company across different plausible futures. This requires impacts to be quantified and subsequently projected into the future using climate scenarios. Scenario analysis helps to identify and assess potential risks associated with climate change, allowing companies to prioritize and address the most critical risks. Translating physical and transition impacts into financial terms enables companies to support evidence-based decision-making on the business strategy and investments, as well as to develop adaptation and mitigation strategies.

Safeguarding your business for tomorrow with climate-related scenario analysis

While climate change is apparent, the ways in which it will specifically impact a company are not. Differentiating factors are the geographic locations of a company’s operations, produced products, and services offered, among others. At the same time, the austerity and timing of policy responses to any of these factors will vary between countries, creating an immense level of uncertainty. For this reason, one of the core recommendations of the TCFD framework is to describe the resilience of a company’s strategy, in light of different climate scenarios.

Additional reasons for conducting scenario analysis on climate impacts are:

• Data-driven understanding of risks incorporated into the risk appetite
• Guidance on viability of (long-term) investments, especially into physical assets
• Identified leverage points on which to focus mitigation actions

Properties of climate-related scenario analysis

Climate scenarios are pathways to different plausible futures. They consider the physical climate, such as rainfall, heatwaves, and sea level rise, and socio-economic factors such as population growth, inflation, energy prices, policy responses– as well as the interactions between these. These scenarios typically range up to 2100, meaning that analyses over the short-, medium- and long-term are possible.

It is important to realize that climate scenarios are hypothetical constructs and thus their explanatory power does not necessarily lie in forecasting absolute values, but they are meant to understand companies’ sensitivity to climate impacts across scenarios. Climate-scenarios are provided through for instance the Network of Central Banks and Supervisors for Greening the Financial System (NGFS). Two common scenarios are Orderly Transition, where climate policies are introduced early and become more stringent in order to align with 1.5 degrees, and Hot House World, in which companies continue operating business as usual under the current regulations and policies that we have today.

Using different climate scenarios, and quantifying the outcomes, supports companies to inform the business strategy and planned investments through improved risk management, mitigation, and adaptation strategies. By doing so it reassures business partners, creditors, and investors that the company is resilient to climate impacts across different scenarios.

Unilever is a consumer goods company, already performing two climate scenario assessments: one is the proactive pathway and the other is the reactive pathway, both are 1.5°C pathways. While the proactive pathway takes into account dramatic changes due to aggressive and persistent regulations as well as the use of available technologies, the reactive pathway relies, among other things, on technologies that are not yet mature. Unilever has evaluated climate scenarios based on three time horizons (2030, 2039, and 2050). Based on this, the company claims to have performed a high-level quantitative assessment. One risk highlighted is the impact of rising energy prices on suppliers and manufacturers. The potential financial impact on profits in 2030, if no action is taken, is around €0.6 billion, and in 2050 the projections rise to €3.4 billion.

In addition, Unilever does not stop there and quantifies an opportunity for growth in the plant-based foods category. In 2030, €0.5 billion can be capitalized and in 2050, it will be €6.4 billion. The company also provides some key assumptions, showing a good level of transparency. However, Unilever points out that there may be a financial impact on profit if no action is taken, although the company does not directly state what remedial action will be taken.

Insurance company Allianz performed sensitivity and scenario analyses with time horizons up to 2050 and including scenarios ranging from 1.5°C to 4°C. The company has conducted a carbon stress test, modelling carbon risks for listed equity portfolio with a bottom-up approach. For that assessment, Allianz used for instance today’s carbon prices and standards for energy efficiency as well as future predictions. This way the company was able to determine the carbon price sensitivity. Nevertheless, the company is not disclosing the actual financial impact and therefore lacks transparency.

Tips for conducting climate scenario analysis
 

1) Select at least two climate scenarios

The TCFD framework requires performing two climate scenario assessments, one of which has to be a 2ºC-or-lower scenario. Each carries a vastly different set of assumptions, which reveals more about a company’s unobserved gaps.

2) Scenario narratives specific to your company

Identifying how each climate scenario affects the provides an understanding of how a company’s financials are affected. These scenario narratives serve as the basis for creating logically sound quantitative models.

3) Clear and modifiable assumptions in the financial model

Creating the link between climate scenarios and the financial impact on a company is most helpful to guide decision-making.

The TCFD framework provides recommendations for companies to identify, assess and manage climate-related risks and opportunities. This information is crucial for investors with a long-term time horizon to determine how well companies are preparing for the inevitable impacts of climate change. Companies that can demonstrate their effective management of climate risks specific to their business and industry, as well as their plans to capture and capitalize on climate-related opportunities, will retain investors’ confidence that they will remain a successful business in the future.

Learn more about Finch & Beak’s suggested TCFD Roadmap outlining the different steps in the TCFD journey and for more practical tips on how to overcome the barriers to implementing TCFD, download the document at the top of this article.

Finch & Beak provides broad TCFD support

At Finch & Beak, our purpose is to accelerate sustainability within the business of our clients. Together with our fellow companies from SLR Consulting, we offer a wide range of TCFD support services:

• TCFD Readiness Assessments
• Risk & Opportunity Assessments including physical risk analysis of sites
• Scenario Analysis using detailed location-specific climate variables and value-at-risk data from CLIMSystems
• Full TCFD Support

If your organization requires support with implementing the TCFD framework, reach out to Johana Schlotter, at johana@finchandbeak.comor call +31 6 28 02 18 80 to discuss how Finch & Beak can assist you.

^{Photo by Fran on Unsplash}