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SEC Climate Rule: Scenario Analysis - Part 5
This post is the fifth in a series to do with scenario analysis and the proposed SEC Climate-disclosure rule. The background to the series is explained in the first post: SEC Climate Rule: Scenario Analysis - Part 1. In this post we look at guidance provided by the Task Force on Climate-Related Financial Disclosures (TCFD), including suggestions for scenario analysis.
The TCFD says the following about scenario analysis (emphases mine).
One of the Task Force’s key recommended disclosures focuses on the resilience of an organization’s strategy, taking into consideration different climate-related scenarios, including a 2° Celsius or lower scenario . . . The Task Force recognizes the use of scenarios in assessing climate-related issues and their potential financial implications is relatively recent and practices will evolve over time, but believes such analysis is important for improving the disclosure of decision-useful, climate-related financial information.
Scenario analysis is a process for identifying and assessing the potential implications of climate-related risks and opportunities. Scenarios are hypothetical constructs and not designed to designed to deliver precise outcomes or forecasts. Instead, scenarios provide a way for organizations to consider how the future might look if certain trends continue or certain conditions are met. In the case of climate change, for example, scenarios allow an organization to explore and develop an understanding of how various combinations of climate-related risks, both transition and physical risks, may affect its businesses, strategies, and financial performance over time.
(Task Force on Climate-Related Financial Disclosures, 2017)
The highlighted statements are discussed below.
The “2° Celsius or lower scenario” is too restricted. We are already very close to 1.5°C, and there is every indication that we will reach 2°C within a few years. The scenarios need to consider higher temperatures.
The statement that the use of scenario analysis is “relatively recent” is somewhat misleading. As discussed in Appendix D — The Process Safety Analogy — the process industries (chemicals, oil refining, offshore oil and gas) have been using a form of scenario analysis for over three decades. In particular, the technique of Process Hazards Analysis develops and analyzes many potential incident scenarios.
Scenario analysis should not focus on “climate-related financial information”. Instead, the analysis should consider scientific, engineering and ecological issues. Out of those discussions will result useful guidance to do with financial performance.
Scenarios are not a linear extension of present trends; they are based on imagination, systems thinking and story-telling.
The phrase “various combinations” points to the fact that scenario analysis is also systems analysis. Climate change is not a stand-alone topic. It is intimately related to many other factors, including resource depletion, loss of biodiversity, economic constraints and population growth.
The TCFD identifies three key elements of an effective scenario analysis.
The findings within the analysis should be internally consistent.
The analyses should be logical.
The assumptions and constraints built into the analysis should be clearly identified.
The SEC rule is lengthy (490 pages) and can be difficult to follow. The various TCFD documents are almost as long. Meeting the rule’s requirements can become a paper exercise. It is important never to forget that it is to do with real world issues. The following picture from the Daily Telegraph shows how heat has distorted some of the rail track in recent days. The heat waves in Europe are not only unprecedented, they are a harbinger of what is to come.
Earlier posts in this series are:
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