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The Importance of Climate Scenario Analysis in 2022

Extreme weather events are becoming the new normal. From year-long fire seasons to atmospheric rivers that bring unthinkable amounts of rain, we’re all experiencing the effects of climate change. In fact, we’ve seen the number of climate-related disasters increase by 83% in the past 20 years, and the damages have cost the world $2.5 trillion in the last decade alone.

Business is no stranger to these impacts, and with a pandemic layered in, companies are feeling the consequences on multiple fronts. Just as the pandemic is forcing businesses to change their ways, so too is the climate—78% of S&P Global 1200 companies will face moderate to severe physical climate risk by 2050, let alone financial and reputational risk.

The key takeaway from both COVID and climate is a lesson in resiliency. The more you can understand and mitigate risks of future shocks, the better you’ll fare in the long run, and climate scenario analysis is one of the best tools out there to help you do this.

Climate scenario analysis is nothing new, so what’s different about this year? Read on to learn why climate risk analysis is a must for 2022 and how to get started.

Increasing Investor Pressure & External Reporting

Today’s investors want to know how companies are evaluating their climate risk. As such, climate scenario analysis has gone from a nice-to-have to a core component of most ESG reporting frameworks (TCFD, SASB, CDP, etc.). If you’re a publicly traded company or sell to a major retailer, you can most certainly expect disclosure requests from your investors, if you haven’t gotten them already.

If you’re just beginning your ESG reporting journey, TCFD is the newest and most heavily requested framework by investors. Climate scenario analysis is one of the TCFD’s key disclosure recommendations:

  • Governance: Governance around climate-related risks and opportunities
  • Strategy: Impact of climate risks and opportunities on strategy and financial planning
  • Risk Management: How climate-related risks are identified, assessed, and managed
  • Metrics and Targets: Metrics used to assess and manage risks and opportunities
  • Scenario Analysis: Resilience of business strategy considering various climate scenarios

Other reporting bodies are following suit. For instance, CDP markedly increased the depth and scope of the climate scenario analysis section in its 2022 questionnaire. By 2023, this will be table stakes.

Bottom line - companies that build programs in line with these recommendations will show their external stakeholders, partners, and suppliers that they mean business and are taking the issue seriously.

Getting Ahead of SEC Disclosure Regulation

Last year, the Securities and Exchange Commission (SEC) started working on a new rule requiring publicly traded companies to provide investors with detailed disclosure on how climate change could impact their business. It’s expected that the SEC will propose ruling for mandatory climate risk disclosure in the coming months, with policy going into effect in late 2022 or 2023.

Climate scenario analysis will help companies stress test potential disruptors and determine what climate-related risks they need to disclose.

What About Privately Held Companies?

If you’re a private company, climate-scenario analysis is still a powerful tool to help you understand your risks and plan against future uncertainties. Plus, pressure on private portfolio companies is increasing rapidly as investors look beyond public markets.

Just as COVID has shown us the importance of resilient and agile supply chains, companies that proactively manage climate-related risks will beat out the competition when the next crisis inevitably strikes. To shelter your business from physical risks of climate change, how much redundancy do you need in your supply chain? Your operations? These are all questions that climate scenario analysis can help you answer.

In fact, it won’t be too long from now that climate risk analysis becomes a de facto component of sound business resiliency strategy.

Where To Start

Now that you understand the why, let’s move on to the how. Climate scenario analysis can be broken down into four key steps.

1) Determine Who You Should Involve

Conducting a meaningful climate scenario analysis will require cross-departmental participation from various subject-matter experts within your organization. A representative list may include leaders from the following departments:

  • Investor relations
  • Sourcing and supply chain
  • Operations and facilities
  • Risk management (general counsel, ERM, audit, environmental affairs)
  • Business strategy
  • Sales and marketing
  • Finance
  • ESG/sustainability
2) Create a List of Top Risks

Once you’ve got the right people at the table, determine your most material ESG risks. Are these physical, financial, brand or transition risks? If you’re not sure what risks are most material to your business, you may need to start with a baseline sustainability assessment. This will help you take a comprehensive look at where you stand on today’s ESG issues.

Here are a few common risks we help our clients evaluate through climate scenario analysis:

  • Policy and legal risks (carbon pricing, new efficiency standards, etc.)
  • Technology risks (emerging technology that may pose risks to competitiveness)
  • Physical risks (extreme weather events that may pose risks to assets or interrupt operations)
3) Identify Appropriate Scenarios & Evaluate Impacts

There are a number of scenario models to choose from depending on the risks you want to evaluate. For example, the International Energy Agency’s climate scenarios can help you model transition risks associated with future energy makeup. For modeling physical risks, IPCC’s Representative Concentration Pathway (RCP) provides robust temperature-based scenarios. Here’s what that might look like in practice:

  • Your business has facilities in a flood plain or near the coast.
  • You use the RCP scenario analysis to see how your buildings would be impacted if the temperature rose by 1.5°, 2°, and 3°C.
  • With 1.5° of temperature rise, you might be impacted by a moderate flooding event, but with 3° of temperature rise, your facilities will be underwater by 2040.

Check out the TCFD’s Technical Supplement for a list of climate scenario frameworks and models.

4) Integrate Results into Business Processes

Once you’ve evaluated the physical, financial, and brand-related impacts of your scenarios, it’s absolutely critical that you integrate the results into your planning, budgeting, and business processes. Equally important is developing governance structures and control mechanisms to ensure your company manages these risks.

For instance, say you determine that you need to improve your facilities and move equipment above the projected flood line. You should factor this into your annual budgeting cycle.

Next Steps

To develop a resilient business strategy in an uncertain world, you must deeply understand your risks and vulnerabilities.

Climate risk analysis will help you craft a strategy that is responsive not only to physical and financial risks, but also risks to the brand in a changing culture. And that’s just good business!

If you’re not sure where to start or need help filling out your CDP, SASB, TCFD, or other investor questionnaires, our team would be happy to walk you through the process. Get in touch with us for more information.