Mandatory climate reporting

Climate scenario analysis – a guide for finance professionals

Mandatory climate-related financial reporting in line with Australian regulations requires the assessment of risks and opportunities under two scenarios for temperature increases. For many finance professionals, such work is unfamiliar. Recently, Chartered Accountants Australia and New Zealand and ERM Energetics collaborated to develop an information guide to climate scenario analysis.

While introductory, the guide is designed to help finance professionals learn about climate scenarios in preparation for the incoming mandatory climate-related financial disclosure regime in which disclosures must be made against two scenarios of temperature increases above pre-industrial levels namely 1.5^oC of warming by 2050 as a low global warming scenario and 2.5^oC or higher by 2050, to provide a high warming scenario. The scenarios are selected to enable reporting entities to assess their climate resilience. We note that the Australian mandatory reporting regime differs from other jurisdictions in the stipulation of both the number of scenarios, and the future global temperatures to be investigated. If you report under CSRD, SEC or other ISSB aligned frameworks please assess the scenario requirements of your specific regulations.

The guide addresses what scenario analysis is, the value of a scenario analysis and how to get started. 

To follow are some insights taken from the guide, although you can access it in full through this link.

What is climate scenario analysis and why is it useful?

The future climate of the world depends on how quickly the world decarbonises. This depends on a range of factors including technology, policy, atmospheric forcings and feedback loops; all of which are uncertain. Climate scenario analysis is a tool to help deal with this uncertainty by providing analysis of a range of future states.

Climate scenario analysis explores the impacts of material risks on a business’s portfolio under different climate futures. A scenario is a narrative describing a potential future, where key uncertainties are assumed to have eventuated in certain ways.

Climate scenario analysis is part of the climate risk management framework of a business. It is a valuable tool to support the building of resilience in the business model and assess the implications of climate related risks and opportunities. Scenario analysis can uncover novel risks and bring to light timelines for essential decision making. It is also a useful tool for stakeholders to determine how the business is responding to climate related risks and opportunities.

A risk assessment is often the first step for a business when considering climate related risks and opportunities. We recommend developing a risk assessment prior to embarking on scenario analysis. This allows a targeted analysis of existing risks to determine material risks and opportunities for the scenario analysis. The risk assessment can also aid in the understanding of control measures under different scenarios as well as providing owners for risks and their mitigation.

Information related to this risk assessment is required to be disclosed as part of the risk management pillar in the Australian mandatory reporting requirements.

Climate scenario analysis requires a holistic approach

Scenarios are holistic narratives of a consistent future. The narrative for each scenario aligns to define a possible future state. The Taskforce for Climate-related Financial Disclosure (TCFD) has five guiding characteristics for scenario analysis narratives. These are:

• Plausibility: a narrative must be credible
• Distinctive: each narrative should focus on a different combination of key factors
• Consistent: a narrative must have strong internal logic
• Relevant: a narrative should contribute specific insights
• Challenging: a narrative should explore alternatives to business-as-usual assumptions.

We recommend that you use these points to guide the development of your scenarios as they have been tried and tested through the TCFD program over time and have proven to deliver scenarios that have value when used to stress text a company’s strategy. What risks are considered under scenario analysis?

How do I get started?

As noted previously, we recommend completing a risk assessment as a pre-step to embarking on climate scenario analysis. This will allow a streamlined process when conducting scenario analysis.

Selecting the scenarios is the first step in climate scenario analysis. The risk assessment can be used to inform the scenarios by ensuring that each scenario is plausible, distinctive, consistent, relevant and challenging.

The second step is to use the narrative of each scenario and the risk assessment to conduct a qualitative assessment, identifying material risks and opportunities to the business. Steps one and two may be combined in an iterative process to ensure that the scenarios are of the most value to the business.

The third step is to use the qualitative assessment to develop a quantitative assessment. This requires deriving evidence-based assumptions to project the financial implications of these risks and opportunities to the business under each scenario. The financial implications might include the impact on an entity’s cash flows, its access to finance or cost of capital over the short, medium or long term, or future value at risk.

Climate scenario analysis takes time and will require engagement across the business to ensure thorough identification of risks and data for quantification. A deep understanding of the business and its business model, its operations, supply chain, consumers, value chain, legislative environment, economic environment is necessary to identify material risks. The process is bespoke and uniquely identifies the risks and opportunities to a business under each particular scenario. Engaging all the appropriate individuals in the business at the beginning of the process will save time and result in the most useful analysis.

Ongoing updates to scenario analysis and increasing complexity of analysis can provide additional value to building a resilient business. Revisiting the scenarios and updating the scenario narratives will become increasingly important in managing climate risks.

ERM Energetics can help

ERM Energetics has been advising large Australian businesses on both the risks and opportunities associated with the transition to a decarbonised economy and the physical changes we will see as the impacts of a warming climate are increasing felt. As recognised by the Chartered Accountants Australia and New Zealand, climate scenario analysis is an area within which ERM Energetics has both extensive experience and deep technical knowledge.