UK climate-related financial disclosure: What is a climate scenario?

Businesses are well-versed in the certainty of uncertainty. One of the ways they seek to gain a better grasp of what the future may hold is through scenario analysis, which are common and powerful tools that allow companies to examine an array of outcomes across multiple plausible futures.

Scenario analysis is especially useful when it comes to understanding the impact of climate change. The UK government has made considering multiple emissions scenarios a mandatory part of the country’s climate-related financial disclosure requirements, which went live in April 2022.

This blog explains what climate scenarios are, who develops them, how they are used, and how to select the right scenarios to accurately assess the impact of climate change over different time periods. For a more in depth overview of how your business can assess its climate risk and comply with new UK climate-related financial disclosure regulations, download our ebook.

Climate scenarios are analytical tools used to explore the potential impacts of climate change under different socioeconomic conditions, as well as to understand how human development and associated emission pathways affect the natural world. They help business leaders to make informed decisions by considering multiple different future climate possibilities and impacts, and allow them to better create strategies to mitigate damage to their assets and adapt.

The Task Force on Climate-Related Financial Disclosures (TCFD), an international body set up following COP21, recommends that organizations “describe the resilience of the organization’s strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario.”

The TCFD’s recommendations form the basis of the UK’s disclosure requirements, which advise companies to “select scenarios which are most relevant to its business” and that scenarios may include “a 1.5°C scenario or a ‘business as usual’ scenario where temperatures are likely to continue on their current trajectory to reach over 2°C.” Businesses are asked to explain why they selected the scenarios they use in their disclosures, with typical answers including industry recommendations or the choice to use science-backed scenarios such as those used by the IPCC.

The UK guidance suggests that climate scenario analysis produces qualitative, rather than quantitative information. Businesses can use scenario analysis to ask the question “what if…?” and explore how climate impacts might affect the resilience of the organization’s business model and strategy if it were to operate in that given scenario. Where companies are implementing adaptation measures, climate scenarios allow stakeholders to understand the varying extent of the measures required to build resilience to climate shocks and stresses in different climate futures.

A recent report from the Financial Conduct Authority (FCA) highlights the most common third-party scenarios currently employed by businesses, with most opting to use scenarios developed by well-known science or industry experts, such as the Scenario Model Intercomparison Project (ScenarioMIP), used by the IPCC.

However, the report also found that many firms choose to use either their own or third-party bespoke scenarios, instead of those that are publicly available. The range of scenarios chosen for disclosure does present some issues around comparability and transparency and prevents a universal benchmark of climate risk across industries and sectors.

Climate scenarios fall into two main categories. One set of scenarios, such as the scenarios developed by ScenarioMIP, take an earth system modeling approach covering the full spectrum of climate-related outcomes. Earth systems scenarios are used to best understand the physical risk posed by extreme weather events such as flooding or heat waves, and slow-onset hazards like rising sea levels. These are widely used by major institutions like the Intergovernmental Panel on Climate Change (IPCC).

The second set of scenarios, such as those developed by the International Energy Agency (IEA) and the Network for Greening the Financial System (NGSF), use a simpler climate model but incorporate models of how energy markets function into their scenarios. These scenarios are designed to explore future transition risks - the disruption caused by political, social, and economic shifts arising from decarbonization.

Within each set of scenarios there are a range of future scenarios to choose from. For an organization to form a good idea of the range of uncertainties within their climate risk, companies select three scenarios - a best-case scenario, worst-case scenario and a middle of the road scenario. Following information from the IPCC, these scenarios are:

• Business as usual

• Emissions peak in 2040

• Paris-aligned

Business as usual

This represents the worst-case scenario, where we take no further policy action and emissions continue to rise throughout the 21st century.

Emissions peak in 2040

This is the intermediate scenario, where net greenhouse emissions start to fall after 2040.

Paris-aligned

This scenario reflects emission reductions in line with the UNFCCC Paris Agreement. Global temperatures would not rise beyond 2°C by 2100, limiting the worst repercussions of climate change.

While they are essential to understanding long-term risk, the TCFD acknowledges that climate scenarios do not always provide the ideal level of transparency, and that many companies lack the necessary data to understand the impact of different scenarios over multiple regions.

EarthScan™, Cervest’s flagship product, presents a solution to this problem by allowing anyone to analyze climate-related physical risks at the asset level across a range of climate scenarios. Powered by Climate Intelligence (CI) — asset-level intelligence on climate risk to inform decision-making — it fuses the latest climate data and machine learning techniques to generate automated, science-backed climate risk insights that can upgrade your climate-related financial disclosure.

To learn more about navigating the UK’s climate-related financial disclosure regulations, and how Climate Intelligence insights can enhance your report, download our ebook.