Explainer | How climate scenario analysis helps firms assess the impact of global warming on their assets
- Such analysis ‘allows companies to better prepare and allocate resources to plan for a range of future scenarios’, EY analyst says
- Regulators in Hong Kong have been urging firms to become familiar with the TCFD and ISSB reporting standards before they become mandatory by 2025
Climate scenario analysis is an important tool for companies to understand the risks rising temperatures pose to their assets, and is being demanded by both regulators and investors as the impact of climate change is felt across the globe, according to analysts.
Financial markets have identified that climate-related risks and opportunities will have a material impact on enterprise values in the long run, and companies will need to consider this potential impact while framing their corporate strategies and growth outlooks, said Ee Sin Tan, EY’s climate change and sustainability services partner in Hong Kong.
“Climate scenario analysis is an integral tool to help a company understand the risks and opportunities it may encounter under different plausible futures” as a result of climate change, Tan said.
“This allows companies to better prepare and allocate resources to plan for a range of future scenarios, increasing their resilience against future shocks and disruptions brought by changing weather patterns and a low-carbon economy.”
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What is climate scenario analysis and why is it important?
Climate scenario analysis is a process where both companies and investors can test business strategies and portfolio outcomes against different levels of implied temperature rises, according to Scott Bennett, head of quantitative investment solutions in the Asia-Pacific region at Northern Trust Asset Management.
“A key benefit of climate scenario analysis is that it provides companies and investors with a forward-looking assessment of both the risks and opportunities that companies and portfolios face,” Bennett said.
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Climate scenario analysis is proliferating as more investors are demanding it, and is increasingly being built into major reporting standards, Marina Petroleka, managing director and global head of environmental, social and governance (ESG) research at Sustainable Fitch, said during a webinar this month.
“What that means is that more and more investors will be presented, are presented and will continue to be presented with climate scenario analysis as the basis for transition or net-zero plans of corporations … and the result of stress tests for financial institutions,” Petroleka said.
The Task Force on Climate-Related Financial Disclosures (TCFD), set up by the Basel-based Financial Stability Board in 2015 to develop guidelines for voluntary climate-related financial disclosures across industries, has highlighted the importance of scenario analysis in developing a climate strategy and assessing climate risks.
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As an example, Hong Kong and China Gas (Towngas) has adopted climate scenario analysis to evaluate the impact of physical risks, transition risks and opportunities across its core energy-related businesses in Hong Kong and on the Chinese mainland under various climate scenarios.
“Under extreme weather scenarios, with an average temperature rise of about 4.3 degrees Celsius, there could be increased occurrences of severe typhoons in the year 2100, and lead to a possible interruption of the gas supply in Hong Kong for up to four days,” according to Towngas’ head of corporate ESG, Isaac Yeung.
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“With climate modelling in place and the execution of the low-carbon fuel transition, we can plan ahead and develop mitigation plans in the coming years.”
What is the time frame for mandatory reporting in Hong Kong?
Regulators in Hong Kong have been urging firms to become familiar with the TCFD and ISSB reporting standards before they become mandatory by 2025.
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HKEX has also proposed the introduction of new climate-related disclosures aligned with the ISSB climate standards being released on Monday.
Most of the new disclosure requirements by HKEX will become effective in the financial year starting January 1, with a two-year interim period before full compliance is required, said EY’s Tan.
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“To effectively utilise scenario analysis, a mindset shift is needed to embrace forward-looking estimations and transparent disclosures on potential impacts, instead of focusing on historical performance,” Tan said.
How can climate scenario analysis be improved?
Regulators can help firms with scenario analysis by recommending a common set of assumptions, or predefined scenarios, for companies to assess potential risks and opportunities, Tan said.
The TCFD, as well as bodies such as the World Business Council for Sustainable Development, have also provided guidelines on how to develop scenarios and integrate them into climate reporting, William Attwell, director of climate research at Sustainable Fitch, said in a webinar this month.
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The TCFD recommends that organisations describe the resilience of their strategy, taking into consideration different climate-related scenarios, including a rise of 2 degrees Celsius or lower. This would provide a way for organisations to consider how the future might look if certain trends continue or conditions are met, according to its website.
