The scenarios can be categorised into the following broad descriptors: > Slow building - risk factors are slow to change but which gain momentum (need to be careful not to ignore the scope for non-linear growth) > De-anchoring - scenarios in which barriers (e.g. regulatory safeguards) are suddenly removed, leading to sharp, sudden changes in the risk factors > Point-in-time - scenarios where the probability over the short-term is low, but it is almost certain to occur at some point Even if an organisation chooses to use sophisticated statistical models, they aren’t always capable of fully capturing such scenarios, so there is always a need for forward-looking expert judgement to develop them. Climate Pathways In constructing scenarios, it is important to factor in alternative scenario pathways that allow for the potential impact of the transition to a low-carbon economy and which utilise published definitions and associated assumptions. As an introduction to climate pathways it is important to understand that climate-related scenarios have long been used by scientists and policy analysts to assess future vulnerability to climate change. Producing these scenarios requires estimates of future population levels, economic activity, the structure of governance, social values, and patterns of technological change. Economic and energy modelling are also often used to analyse and quantify the effects of such drivers in climate change. A number of published scenarios are available that outline various plausible pathways to particular target outcomes (e.g., specific temperature increases or CO2 concentration levels). These scenarios have varying assumptions about the likely timing of policy changes, technology adoption, changes in energy mix, and other factors to achieve a climate-friendly economy that may be useful to a company in conducting its own scenario analysis. The Network for Greening the Financial System (NGFS) has been developing an analytical framework for assessing climate-related risks in order to size the impact of climate-related risks on the economy and the financial stability.24 The NGFS has concluded that there are two important dimensions to consider when assessing the impact of physical risks and transition risks on the economy and the financial system: > The total level of mitigation or, in other words, how much action is taken to reduce greenhouse gas emissions (leading to a particular climate outcome); and > Whether the transition occurs in an orderly or disorderly way, i.e. how smoothly and foreseeably the actions are taken. However, they often have limitations for assessing the business implications of climate change at a local or industry sector level. Regulatory scenario frameworks and climate pathways Regulators have built on the reference scenarios currently being developed by the NGFS to provide a coherent set of climate pathways and key macroeconomic variables. The PRA’s discussion paper, “The 2021 biennial exploratory scenario on the financial risks from climate change” published in December 2019, provides some good guidance on the approaches required over a 30year future time horizon. It provides details of discrete climate scenarios aligned to the Paris agreement and variables for consideration. Physical risk examples cited include regional sea level increases, changes in storm patterns, and transition variables include a pathway for the carbon price. 24
NGFS A call for action Climate change as a source of financial risk, April 2019
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