Scenario Analysis, Time Horizons, Financial Impacts, and More
By Tory Grieves, VP of Analytics for The Climate Service, Zoey Kriete, Senior Project Director and Alua Suleimenova, Associate Consultant, Sustainability, Energy and Climate Change at WSP.
Today, after months of work, sustainability teams worldwide are taking a moment to celebrate their 2020 CDP submissions. After disclosure comes the hard work of performing retrospective analysis to assess disclosure strategies. This article analyzes this year’s CDP reporting season for trends and tips companies can employ to set themselves up for success in 2021 and beyond.
What is CDP?
CDP is an international nonprofit working to transform the way organizations respond to climate change, water security, deforestation, and sustainable supply chain management issues. Backed by institutional investors with hundreds of trillions of dollars in assets, CDP holds the largest collection of voluntarily reported climate change, water, forest, and supply chain data in the world, based on information requests sent to thousands of participating organizations each year. CDP’s climate change program is the oldest of its initiatives. In 2019, more than 8,000 companies, including the Fortune 500 companies, disclosed to CDP through its climate change questionnaire alone.
The Climate Service partners with leading consultants like WSP to translate and embed the climate risk insights delivered through our TCFD-aligned software—Climanomics®—into comprehensive answers to the CDP and other reporting frameworks. Our focus on delivering decision-useful and financially-quantified climate risk information affords a valuable perspective on the questions presented in the CDP questionnaires.
CDP and TCFD Alignment
Recognizing the need to better understand and disclose climate risks, industry reporting initiatives are not only requesting climate risk and resilience-related information from companies but are also working towards aligning numerous corporate reporting frameworks. The CDP climate and water risk questionnaires are an example. Aligned with the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD), these surveys incorporate sections on climate-related risks and opportunities, scenario analysis, and climate resilience of corporate business strategy.
The benefits of such alignment are manifold. The closer reporting frameworks are calibrated, the less burden of duplicate work there is for participating companies, and the easier it is for stakeholders to compare the sustainability performance of multiple companies to make investment decisions. There are also significant internal communications benefits, as TCFD reporting, in particular, involves virtually every department across a company. As companies collect and prepare data for reporting, they engage multiple teams within the corporate structure and help raise awareness of the climate, water, and sustainability-related efforts that are spearheaded in their company.
New this Year
While the CDP reporting process provides a great deal of stability from year to year, the organization works to raise the bar. With the refinement of CDP questionnaires and the development of new sector-specific surveys targeting specific industries, the process of making it to the CDP’s A-list and earning a position on the leadership index gets more challenging, and this is where comprehensive climate risk reporting becomes truly invaluable.
Defining Time Horizons for Reporting
An important component of the CDP Climate Change and Water Security disclosure is defining short-, medium, and long-term time horizons that companies use to analyze and evaluate their climate-related risks and opportunities. To illustrate how the exposure of corporate assets to climate-related risks and opportunities changes over time, the Climanomics® platform analyzes risk over decadal periods covering the time horizon of 2010-2100.
Customers typically analyze the 2020’s-2030's decadal periods to understand the short-term picture of climate risk currently held in their portfolios or operations, and those that will likely be incurred over the next ten years. For a medium-term perspective, we recommend the 2050’s decade; by mid-century, physical hazards like coastal flooding tend to accelerate rapidly, often overtaking transition risks under the higher-emissions RCP8.5 scenario. However, under the RCP4.5 (or a scenario more in line with the Paris Agreement), we often see certain transition risks, such as carbon pricing, surpassing physical risks for assets by mid-century. For a longer-range view, we recommend an analysis that focuses on the 2090’s decadal period, as this provides the most comprehensive view of risk anticipated throughout the operational life or holding period of major assets.
The Question of Scenario Analysis
High-quality scenario analysis helps firms move beyond short-termism and instead, bridge to longer-term, strategic thinking. Yet conducting scenario analysis is often cited as one of the most challenging aspects of climate risk reporting.
Currently, the Climanomics® software includes RCP8.5 and RCP4.5 emissions scenarios. Both scenarios were employed in the Fifth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC) in 2014 as a basis for the report’s findings. RCP8.5 is referred to as the high-emissions scenario, with an expected 3.2-5.4℃ of warming by the end of the century, and RCP4.5 is a scenario that results in a moderate increase in emissions, yielding between 1.7-3.2℃ of warming by 2100. TCS plans to add additional scenarios to the platform in the coming months.
One approach to scenario analysis employed by some of TCS’ customers is to identify the assets that emerge as high risk under both RCP8.5 and RCP4.5 scenarios across various time periods; these assets are then prioritized for resilience investments or other risk mitigation efforts.
Identifying Climate-Related Risks
CDP Climate Change and Water Security Questionnaires request from companies a full disclosure of climate-related risks and opportunities that have been identified in their climate risk assessments. To examine their climate change exposure, we recommend companies examine both physical and transition risks they may face in the future by conducting scenario analysis with different GHG emissions projections.
If a company is interested in understanding the magnitude of its financial risk in the context of climate change and act upon that understanding through strategic or financial planning, we recommend companies conduct a quantitative screening of all the assets within their portfolio with a focus on financial materiality. Only through more granular, scenario-based, asset-level analysis can a given organization or investor uncover insights upon which risk management, resilience, and other strategic decisions can be based. Through this approach, many users of our Climanomics® platform find that most of their climate risk resides in a small number of their assets due to the vulnerability of their location, asset type, or lack of adaptive capacity and inherent resilience to withstand future climate impacts. This information affords important intelligence in terms of identifying risks and exploring opportunities to, for example, achieve a high return on resilience investments, such as seawalls, water efficiency technology, and stormwater best management practices (BMPs).
Pinpointing “Substantive” Financial or Strategic Impacts
TCS’ Climanomics® software empowers customers to understand what climate-related risk factors are driving financial risk due to climate hazards, understand which locations hold higher risk, and uncover when risks are likely to become financially material—at both the asset and portfolio levels and under high and low GHG emissions scenarios.
As CDP is becoming more aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), companies start evaluating their exposure to climate-related risks and opportunities under different climate scenarios representing several plausible future outcomes. Per the TCFD framework, the physical risks we analyze using the Climanomics® platform include extreme heat, wildfire, drought, water stress, convective storm damage, tropical cyclones, coastal and fluvial flooding. Transition risk analysis in the platform includes carbon pricing (using prices derived from the Shared Socioeconomic Pathway, or SSP, models), reputational risk, litigation risk, market risk, and technology risk.
CDP questionnaires also ask companies to identify climate-related opportunities with the potential to have substantive financial or strategic impacts. TCS’ Climanomics® software includes opportunities outlined in the TCFD framework: Resource Efficiency, Energy Source, Products and Services, Markets, and Resilience. Each category reflects ways in which companies and investors can reduce operating costs, enhance brand value, capture additional revenue, and better position themselves for a changing and uncertain future.
Climate Risk Impacts on Strategic and Financial Planning
Climate-related risk and opportunity factors influence a wide variety of corporate strategic and financial considerations. CDP questions related to the strategic implications of climate risk form the foundation of a company’s strategic plan to adapt to the changing climate.
We have seen customers use climate risk data for strategic and financial planning in many ways—and use cases are rapidly evolving as the understanding of climate risk deepens across industries. For example, real estate investors are actively employing this risk analysis during due diligence to assess the viability of acquisitions and inform the price they are willing to pay for a given property. Corporations are using climate risk analysis in enterprise risk management and longer-term strategic planning including where to invest in new facilities, where to establish new offices, and to scout new markets for their goods and services. We also routinely see clients using Climanomics® platform data to understand potential changes in insurance coverage and availability.
The global presence and uncertainty of climate change and its cascading impacts across different economy segments make risk analysis extremely challenging. For this reason, strategic focus on decision-relevant insights is of paramount importance. Of course, decision-relevancy will change dramatically depending on the business and industry. For real estate investors, the most useful information is often potential impacts on asset value over time. A manufacturer of consumer products may focus on extreme weather shocks to production volume or days of business interruption. An airline may be most interested in impacts on revenue due to shifts in where people do or do not go on vacation because of the increasing impacts of climate change on customers’ preferences and decision-making.
As companies begin to emerge from the fog of COVID-19 and double down on the work of risk assessment and resiliency, now is the time to perform a valuable gap analysis. Such an analysis can help companies determine programmatic opportunities and make strategic adjustments for more optimal outcomes. When it comes to CDP reporting, improvements in climate risk analysis can present one of the biggest opportunities for enhanced disclosure as well as, overall better business outcomes.