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Navigating climate scenario analysis

Undertaking scenario analysis is one of the key recommendations made by the Task Force on Climate-related Financial Disclosures (TCFD). This guide produced by IIGCC aims to help steer institutional investors through the process.

It sets out a five-step framework to help asset owners and managers use scenario analysis, in understand how climate changes drives financial impact across their portfolios.

Key points

This guide highlights ten key messages for investors on climate scenario analysis:

  1. Scenario analysis is already a well-established tool in investment risk analysis. Its application to climate change offers significant potential benefits for identifying both risks and opportunities, but there are challenges in implementation arising from the unique nature of the issue.
  2. The investment industry is still at a relatively early stage in developing methodologies – but there is rapid innovation taking place.
  3. In some areas, corporates are already ahead of investors in their analysis and reporting, but significant data gaps remain. Disclosure needs to improve throughout the value chain in order to provide a full picture of risk to stakeholders and regulators.
  4. No single methodology can fulfil the needs of all investors. Different tools and approaches will be relevant depending on the type of investor, what their objectives are and the level of the investment process at which the analysis takes place.
  5. Scenario analysis is best undertaken through a cross-functional approach involving experts in areas including risk management, investment and Environmental, Social and Governance (ESG). This gives the best chance of producing outputs which are actionable and investment-relevant.
  6. Understanding the assumptions behind scenarios and the methodologies used to apply them to investments is critical. These assumptions drive the results. Without knowing how they work, the outputs of analysis will be challenging to rely on for investment purposes.
  7. Investors need to consider how to balance comprehensiveness with simplicity. More complex models may be able to better capture the full range of climate change impacts, but simpler models can be more practical to apply and interpret.
  8. Many of the benefits of scenario analysis come through undertaking the process, rather than the end result. Experimenting with methodologies can be a valuable opportunity for investors to learn about the ways in which climate change drives financial impacts.
  9. Scenario analysis should be viewed as a dynamic process which is repeatable and can be embedded into mainstream risk management and investment functions.
  10. By providing a structured way to think about the climate transition, scenario analysis provides a starting point for investors to monitor the early warning signs about which scenario is most likely to materialise and to take action accordingly – improving the ability to be resilient to the changes ahead.