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Task Force on Climate-Related Financial Disclosures Guidance on Scenario Analysis for Non-Financial Companies

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Task Force on Climate-Related Financial Disclosures Guidance on Scenario Analysis for Non-Financial Companies Task Force on Climate-related Financial Disclosures Guidance on Scenario Analysis for Non-Financial Companies October 2020 The Task Force on Climate-related Financial Disclosures Executive Summary Climate change is spawning a host of long-term and short-term “ No matter how well we prepare ourselves, effects that affect businesses broadly and fundamentally. The World Economic Forum ranks climate risks among the top five when the imagined future becomes the very business risks, saying “climate change is striking harder and more real present, it never fails to surprise.” rapidly than many expected.” – Alan AtKisson, Believing Cassandra Companies will be affected by climate change across multiple dimensions (strategic, operational, reputational, and financial), along the entire value chain, across regions, and over long periods • Scenario analysis allows for the continual exploration of of time. But assessing and planning for these risks — and alternative strategies, even if current strategies seem to be opportunities — is challenging given the associated uncertainties. working. Scenario analysis can identify key drivers of change and pathways of development that a company can monitor to Scenario analysis helps companies in making strategic and risk understand which futures are emerging and allow for “midcourse management decisions under complex and uncertain conditions corrections.” This is a cornerstone of resilient strategies. such as climate change. It allows a company to understand the risks and uncertainties it may face under different hypothetical • Scenario analysis is used beyond climate issues. Scenario futures and how those conditions may affect its performance, analysis is applicable to a wide range of issues facing companies thus contributing to the development of greater strategy resilience under conditions of uncertainty (e.g., the COVID-19 pandemic). and flexibility. Scenario analyses should be an integral part of a company’s decision-making process. • Scenario analysis is not new. It is a long-established planning tool with a rich and extensive literature and practice. Scenario analysis has limitations. Scenarios, for example, rely on a snapshot of external drivers that allow a company to explore only • Scenario analysis informs strategic management in a a limited range of uncertainties. Acquiring climate data at the right structured, systematic, and analytical way. It provides new scale and granularity to craft a scenario also can be challenging. perspectives and unique insights, clarifies the predictable and uncertain elements in different futures, and reorients decision- Disclosure regarding strategy and scenarios is important. makers’ mental models. The Task Force on Climate-related Financial Disclosures (TCFD) recommends disclosure of “the actual and potential impacts • Scenario analysis contributes to strategy resilience. It broadens of climate-related risks and opportunities on the organization’s strategic thinking, and identifies options to address different businesses, strategy, and financial planning where such information climate-related circumstances. It “road-tests” different strategy is material” including “the resilience of the organization’s strategy, options, and provides a lens through which to assess a company’s taking into consideration different climate-related scenarios.” strategic position. 1 The Task Force on Climate-related Financial Disclosures • Adjustments to a company’s strategy and financial plans • Before embarking on scenario analysis, a company should think represent a key disclosure element. Investors (e.g., current through its implementation of the full TCFD recommendation and potential shareholders, debt holders, banks, and insurers) framework (Governance, Risk Management, Strategy, and Metrics and other stakeholders want to understand how a company is and Targets). Scenario analysis is not standalone but is supportive positioning itself strategically, operationally, and financially in of overall strategy, governance, and risks management. light of potential climate-related impacts. • Nothing in this guidance should be read as altering or adding • Companies should disclose sufficient information for investors to the TCFD’s 2017 recommendations. It provides suggestions and other stakeholders to (1) determine the potential impacts on for, and considerations about, process-oriented methods to assist the company of climate-related risks and opportunities, and how in undertaking scenario analysis to assist with implementing the the company plans to address them in its strategy and financial TCFD Strategy recommendation. plans; (2) understand the soundness of a company’s scenario analysis; and (3) judge the resilience of the company’s strategy • The target audience of this guidance is large- and midsized to the material climate-related risks and opportunities that may non-financial companies in the early stages of implementing emerge under different climate futures. climate-related scenario analysis. However, small companies will also find useful information and considerations to help them Getting started using scenario analysis is not difficult. A typical undertake scenario analysis. scenario analysis process often takes only a handful of full-time staff and less than a year (often three to nine months) depending on the size • Senior executives and those tasked with sponsoring scenario of the company and the scope of the decisions under consideration. analysis in their companies will benefit from the highlights and key messages in the guidance. Those executives include corporate • This guidance can help you to get started. It provides a leaders in strategic planning, sustainability, corporate reporting, practical, process-oriented way for businesses to use climate- and risk management functions. related scenario analysis. It extends and deepens the TCFD’s 2017 Technical Supplement on The Use of Scenario Analysis in Disclosure • Those tasked with implementing a scenario program in their of Climate-related Risks and Opportunities. This guidance, however, companies may benefit from the more detailed content in the is not a checklist of everything a company should do to meet the guidance and its appendices. TCFD’s Strategy c) recommended disclosure. Rather, it is meant to illuminate common practices, considerations, and questions that a company needs to think about, taking into consideration its particular circumstances. 2 Contents Executive Summary 1 A. Introduction 4 B. Getting Organized 8 1. Inform, Educate, and Engage 9 2. Build the Case for Scenarios 9 3. Clear Governance and Executive-Level Leadership 10 4. Establish a Strong, Dedicated Scenario Team 11 5. Internal and External Resource Requirements 12 C. The Scenario Process 14 1. The ABCs of Scenarios 15 2. The Scenario Development Process 20 D. Strategic Management Using Scenarios 32 1. Strategic Management and Strategy Resilience 34 2. Applying Scenarios to Strategy Formulation 37 3. Managing Strategy Resilience 40 E. Disclosure: Demonstrating Strategy Resilience 42 1. What Information Do Investors and Other Stakeholders Desire? 44 2. What Information Should Be Disclosed Around Strategy and Scenarios? 46 3. Other Disclosure Considerations 51 Conclusion 54 Appendix 1: An Overview of Public Scenarios and Models 56 Appendix 2: Scenario Construction 69 Appendix 3: Summary of Selected Scenario Tools and Information 84 Appendix 4: Interviewed Organizations 107 Glossary and Abbreviations 109 References 115 Acknowledgments 132 A. Introduction The Task Force on Climate-related Financial Disclosures A. Introduction This section explains why this work has been carried out and the broader context that makes this contribution timely. Key Messages • Companies use scenario analysis increasingly as a tool in their climate-related risk management and strategy formulation processes, but they face challenges. • In response to these challenges, the TCFD developed this guidance to assist non-financial companies wishing to implement climate-related scenarios as part of those risk management and strategy formulation processes. • This guidance is aimed at non-financial companies at the early stages of using scenario analysis Executive Summary to assess climate-related risks and opportunities. Scenario analysis is useful for assessing the business implications of climate change. Table of Contents • Scenario analysis helps in making strategic and risk management decisions under complex A. and uncertain future conditions such as climate change. Introduction • Scenario analysis allows a company to understand how it might perform under different hypothetical climate futures. B. Getting Organized • Scenario analysis contributes to greater strategy resilience and flexibility by: - testing a strategy and strategy options against a set of scenarios; C. The Scenario Process - identifying possible future threats or opportunities; - identifying trigger points to set contingency plans in motion; and D. Strategic Management - serving as a basis for continuous monitoring and strategy adjustment. Using Scenarios E. Disclosure: Demonstrating In July 2017, the TCFD issued a set of 1. Strategic thinking, planning, and risk Strategy Resilience recommendations for disclosing clear, effective, management are fundamental aspects and consistent information about the business of a business. Conclusion risks and opportunities presented by climate change. Those recommendations form an 2. Climate change presents a number of strategic risks, opportunities, and uncertainties.
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