Entity-level climate scenario development

One of the wicked problems in climate risk disclosures whether to comply with TCFD, ISSB, ESRS or for strategic reasons, is quantification of climate transition risks. While the financial sector and some companies themselves have developed methodologies for transition risk quantification, these methodologies have often not been publicly disclosed, are not based on any peer-reviewed methodology and are not standardized across the economy or industry or sector. Bringing some standardization to transition risk quantification will be imperative to make risk disclosures comparable and meaningful. In our new paper, myself, David Carlin, Edward Byers and Keywan Riahi propose fundamental principles that are based in the science of climate scenarios, and should be followed when doing company level climate transition risk quantifications. These principles include;  1. Climate risks are more than just carbon emissions and won’t be mitigated by emissions reduction only. 2. At least two scenarios should be used for one risk disclosure statement. Risk has to be measured against a ‘business-as-usual’ scenario. 3. There should be transparency around which transition risks are assessed quantitatively and qualitatively, and which are excluded. 4. Lack of extreme events coverage should be acknowledged in the disclosures. 5. Risk model assumptions should not differ from underlying climate scenario assumptions. It would be important to build fora to standardize risk quantification and expand on this set of principles and methodologies. If you want to contribute to this important exercise please don’t hesitate to reach out. You can read the complete paper at https://lnkd.in/dHWsAyER

One of the biggest criticisms we hear about climate scenario analysis is that it is not decision-useful. The scenarios used often miss key factors, understate tail risk and ignore tipping points, creating long-term uncertainty that is too large to make any meaningful decisions.   The BoE has today published a bulletin exploring how financial institutions can use scenario analysis to quantify climate change risks. The bulletin is clear on this point, noting that standard climate scenarios “generally do not provide the level of detail end users need to undertake asset-level financial risk analysis”; however it offers that the solution lies with the end-users of scenarios, and encourages firms to extend scenarios to improve spatial granularity and resolution for physical risks, derive and interpret relevant related variables, determine the extent to which long-term risks are likely to be “priced in” to asset prices over time and understand the interconnectedness of different sectors in the economy.   The key requirement of this solution is data. For one of the BoE’s examples, residential mortgages, this means: Data on individual assets (for example, using Energy Performance Certificates (EPC) ratings to assess the impacts of an aggregate energy price shock on individual households). Data on macroeconomic variables (household disposable income, default rates, household debt-solvency ratios). Data on macroclimate variables (granular flood-risk data and other risks outside the UK).   Scenario analysis can be powerful, even when it has limitations. Any refinement to the scenario and reduction to the limitations only makes it more powerful, and it is fair to conclude that investing in improved data capture and sourcing will be a key step for many firms. In any case, to be decision-useful is sometimes about helping users keep in mind the limitations in models alongside the results, adhering to the "all models are wrong, some are useful" maxim. https://lnkd.in/evbyk3PU

🌍 When it comes to understanding and preparing for future climate scenarios, two essential frameworks stand out: RCPs (Representative Concentration Pathways) and SSPs (Shared Socioeconomic Pathways). These tools work together to provide a more complete picture of our potential futures. 🔹 What are RCPs? RCPs focus on greenhouse gas (GHG) concentration pathways, showing different levels of radiative forcing by 2100: -RCP2.6: Aggressive mitigation to limit warming below 2°C. -RCP4.5 & RCP6.0: Stabilization scenarios with moderate emissions. -RCP8.5: High emissions, often called "business-as-usual." RCPs are essential for modeling physical climate impacts like temperature rise, sea-level change, and extreme weather. 🔹 What are SSPs? SSPs provide socioeconomic pathways based on narratives about global development: -SSP1: Sustainability-focused, green growth. -SSP2: Business-as-usual progress. -SSP3: Regional rivalries and fragmented development. -SSP4: Inequality with uneven adaptation. -SSP5: Fossil-fueled growth with high emissions. SSPs address the human side of climate challenges, including population growth, urbanization, and policy decisions. 🔗 How They Work Together RCPs and SSPs can be combined to create integrated scenarios, helping us understand the interplay between climate and socioeconomic factors. For example: SSP1-RCP2.6: A sustainable future with strong mitigation efforts. SSP5-RCP8.5: A high-emission future driven by fossil fuels. These combinations help organizations model risks, plan for adaptation, and align strategies with realistic climate trajectories. 💡 What does this mean for you? Think of RCPs and SSPs as the maps and compass for navigating the uncertain terrain of climate change. Whether you’re shaping policies, developing sustainable business models, or planning for long-term infrastructure resilience, these frameworks can: 🌱 Guide Adaptation: Prepare for physical risks like extreme weather or rising sea levels with data-driven insights. 📊 Inform Strategy: Align your organizational goals with realistic climate trajectories and socioeconomic contexts. 🌍 Empower Decisions: Understand how today’s choices can shape tomorrow’s opportunities and challenges. ✨ How are you leveraging scenario analysis in your work? Share your experiences or questions in the comments—let’s learn from each other! #ClimateAction #SustainabilityStrategy #ClimateRiskManagement #ClimateChange #ESG #Sustainability #Adaptation #Mitigation #RCP #SSP #ScenarioPlanning #Resilience #SustainableDevelopment #FutureProofing #RiskManagement #GreenBusiness #ClimateLeadership #EnvironmentalPlanning