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Making sense of climate-related scenario analysis

Author: ICAEW Insights

Published: 09 Jun 2021

In line with its existing work on climate change, the FRC is running a Scenario Analysis Research Project and is seeking input from FTSE 350 companies.

The FRC has commissioned a project to explore the use of scenario analysis by FTSE 350 companies in the context of climate change. It’s all about learning more about the processes through which companies develop their scenario analyses, how these processes shape outcomes, and how those outcomes influence companies’ planning and decision-making. As with other FRC commissioned research the overriding purpose is to inform future regulatory strategy and its delivery.

The project will investigate both climate and non-climate applications of scenario analysis and is being carried out by Alliance Manchester Business School (AMBS), University of Manchester. Dr Robert Charnock is driving the research team while Professor Paolo Quattrone of AMBS is the Principal Investigator.

Charnock has worked in this space for 12 years, during which time he has focused largely on: how the financial sector should respond to climate change, what the potential impacts of climate change could be on finance, and all the accompanying strategic investment considerations. He has a special interest in the tools available to companies and financial institutions in gaining an understanding of climate change risks.

The project comes at a time when there is already a lot going on around climate disclosures, not least the requirement by the Financial Conduct Authority (FCA) in the UK since January 2021 for premium listed companies to improve their disclosures about the impact of climate change on their business, consistent with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD).

Charnock points out that a significant head of steam around these issues has built up since 2015. “The momentum has shifted away from asking if we're going to tackle climate change, to asking how we're going to do it, and when,” he says. “The main question right now is: what are those policies going to look like? For companies and financial institutions, this brings a new priority to their strategic outlook.”

He explains that a key theme in this space has been to look at whether finance and business were systematically overlooking climate change and to nail down which techniques are available to bring those long-term issues into short-term planning. Of course, a core part of TCFD’s recommendations is also scenario analysis.

“Scenario analysis has been thrust into the limelight by TCFD and the questions we are asking now are: what should that look like and what would be the impact of associated mandatory disclosures?” says Charnock.

“The FRC’s interest in researching this area builds on the 2020 FRC climate thematic report on how companies report on climate change, how it's impacting their business decision-making, and how mature companies are investing around climate change.”

Now the FRC is seeking to understand how far FTSE 350 companies have come in terms of climate reporting using scenario analysis – or, indeed, the use of scenario analysis generally.

“The FRC wants to know more about the processes that guide scenario analysis, how these influence the outcomes, and also how those outcomes from the scenario analysis feed into decision-making within companies,” says Charnock.

There are three core components to the research. The first is a study of FTSE 350 company reports for 2020/2021, and in particular the extent of the use of scenario analysis disclosures. There will also be a questionnaire sent out across the FTSE 350, and a series of deep dive interviews and focus groups.

“Our AMBS research team want to understand what current practice looks like, identify some of the key issues in this space, where those issues arise and what the potential solutions might look like,” says Charnock.

He is mindful that different sectors may well be taking different approaches, and that the financial sector might have gone further in its climate scenario analysis in place already, but also that scenario analysis has a wider application than climate disclosures.

“We think we might find quite mature approaches to scenario analysis for other business purposes that are not yet being applied to climate change,” he says, “so that's something we're really interested in looking at as a core part of the project.”

Given that, one way or another, certain companies are going to be expected to report on their strategy to do with climate change – whether that's how they'll respond to policy, new policies on climate change or by responding to the physical risks of climate change as well and how it affects their operations – why not get involved. If you work in this field for a FTSE 350 company, please help inform the debate by completing the questionnaire

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