Scenario analysis is a tool used to assess the potential impacts of different climate-related scenarios on an organization's financial performance. By exploring various scenarios, companies can assess how their business may be affected and make informed decisions to adapt and mitigate risks or capitalize on emerging opportunities for investment.
The TCFD recommends scenario analysis as a way for organizations to better understand and manage their exposure to climate-related risks and opportunities.
The TCFD recommends that organizations conduct scenario analysis on both physical and transition risks, and that they use a range of scenarios to capture the uncertainty and complexity of the climate-related landscape. Typically, it involves developing a range of plausible scenarios based on different climate-related assumptions and then analyzing how these could impact an organization's:
The TCFD also recommends that organizations disclose information based on their scenario analysis findings. This should include any assumptions and inputs used, the results of the analysis, and how the organization is using the results to inform its strategic decision-making.
Undertaking a climate scenario analysis involves a structured and rigorous process, which typically includes the following steps:
Determine the focus of the scenario analysis and the relevant time frame. This may include physical and transition risks, and different time frames, such as short, medium, and long-term.
Develop a range of plausible scenarios based on different assumptions about climate-related risks and opportunities. This may involve reviewing existing scenarios developed by third-party organizations or developing custom scenarios tailored to the organization's specific context.
Identify the key drivers of risk and opportunity for each scenario. This may include factors such as policy and regulatory changes, technological developments, consumer behavior, and the physical impacts of climate change.
Analyze how each scenario could impact the organization's financial performance, including revenue, costs, assets, liabilities, and cash flow. This may involve using financial modeling and other analytical tools to quantify the potential impacts.
Assess the organization's resilience to each scenario, including its ability to adapt to changes in the business environment and to manage risks and capitalize on opportunities.
Develop strategies to mitigate risk and capitalize on opportunities identified in the scenario analysis. This may involve identifying areas of the business that need to be strengthened, such as supply chain resilience, and opportunities to invest in low-carbon technologies or markets.
Disclose the results of the scenario analysis, including the key assumptions and inputs used, the results of the analysis, and how the organization is using the results to inform its strategic decision-making.
Overall, conducting a scenario analysis requires input and engagement from across the organization, including senior management, risk management team, and finance. The TCFD provides further guidance on how organizations can undertake scenario analysis and disclose the results of their analysis in their climate-related financial disclosures.