改变航向：投资者综合指南：响应TCFD利用情景分析评估气候风险（英文）-UNEP FIVIP专享VIP免费

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Changing Course | |

A comprehensive investor guide to

scenario-based methods for climate risk

assessment, in response to the TCFD

May 2019

Twenty institutional investors from eleven countries, convened by UNEP FI and supported

by Carbon Delta, have worked throughout 2018–2019 to analyse, evaluate, and test, state-

of-the-art methodologies to enable 1.5°C, 2°C, and 3°C scenario-based analysis of their

portfolios in line with the recommendations of the FSB’s Task Force on Climate-related

Financial Disclosures (TCFD). The outputs and conclusions of this Pilot are captured

in the following report and aim to enhance the understanding and ease adoption of the

TCFD recommendations by the wider investment industry.

UN Environment – Finance Initiative is a

partnership between UN Environment

and the global nancial sector created in

the wake of the 1992 Earth Summit with

a mission to promote sustainable nance.

More than 200 nancial institutions,

including banks, insurers, and investors,

work with UN Environment to under-

stand today’s environmental, social and

governance challenges, why they matter

to nance, and how to actively partici-

pate in addressing them.

www.unep.org

Vivid Economics is a strategic consul-

tancy providing our private and public

clients with deep sectoral and thematic

expertise at the nexus of nance,

commerce and the environment. For our

nancial sector clients, we provide policy

and market intelligence, scenario model-

ling, and risk and opportunity assessment

tools that support investment strategy,

risk management, investee engagement

and nancial disclosure.

www.vivideconomics.com

Carbon Delta is a climate change data

analytics rm that quanties investment

risks for more than 30,000 companies

along numerous climate change scenarios.

With our Climate Value-at-Risk (CVaR)

model we aim to em power nancial

institutions with the tools necessary to

protect assets from the worst effects

resulting from climate change and also

help identify new, innovative low carbon

investment opportunities.

www.carbon-delta.com

Changing Course | Contents |

CONTENTS

Perspectives from the pilot membership .....................................................................................................5

Foreword by Mark Carney .............................................................................................................................. 7

Foreword by Satya Tripathi .............................................................................................................................8

Acknowledgements ........................................................................................................................................... 9

Executive Summary ........................................................................................................................................10

1 Introduction ................................................................................................................................................16

2 Overview of methodologies ....................................................................................................................23

3 Building blocks of the Investor Pilot methodology ............................................................................38

4 Comparing Climate Value at Risk across 1.5°C, 2°C and 3°C Worlds ..........................................50

5 Operationalising the methodology: case studies ...............................................................................65

6 Future directions ......................................................................................................................................116

Appendix I ........................................................................................................................................................120

Appendix II ......................................................................................................................................................121

Appendix III .....................................................................................................................................................122

Acronyms .........................................................................................................................................................123

Glossary ............................................................................................................................................................ 124

References .......................................................................................................................................................125

/129

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1ChangingCourseAcomprehensiveinvestorguidetoscenario-basedmethodsforclimateriskassessment,inresponsetotheTCFDMay2019Twentyinstitutionalinvestorsfromelevencountries,convenedbyUNEPFIandsupportedbyCarbonDelta,haveworkedthroughout2018–2019toanalyse,evaluate,andtest,state-of-the-artmethodologiestoenable1.5°C,2°C,and3°Cscenario-basedanalysisoftheirportfoliosinlinewiththerecommendationsoftheFSB’sTaskForceonClimate-relatedFinancialDisclosures(TCFD).TheoutputsandconclusionsofthisPilotarecapturedinthefollowingreportandaimtoenhancetheunderstandingandeaseadoptionoftheTCFDrecommendationsbythewiderinvestmentindustry.UNEnvironment–FinanceInitiativeisapartnershipbetweenUNEnvironmentandtheglobalfinancialsectorcreatedinthewakeofthe1992EarthSummitwithamissiontopromotesustainablefinance.Morethan200financialinstitutions,includingbanks,insurers,andinvestors,workwithUNEnvironmenttounder-standtoday’senvironmental,socialandgovernancechallenges,whytheymattertofinance,andhowtoactivelypartici-pateinaddressingthem.www.unepfi.orgVividEconomicsisastrategicconsul-tancyprovidingourprivateandpublicclientswithdeepsectoralandthematicexpertiseatthenexusoffinance,commerceandtheenvironment.Forourfinancialsectorclients,weprovidepolicyandmarketintelligence,scenariomodel-ling,andriskandopportunityassessmenttoolsthatsupportinvestmentstrategy,riskmanagement,investeeengagementandfinancialdisclosure.www.vivideconomics.comCarbonDeltaisaclimatechangedataanalyticsfirmthatquantifiesinvestmentrisksformorethan30,000companiesalongnumerousclimatechangescenarios.WithourClimateValue-at-Risk(CVaR)modelweaimtoempowerfinancialinstitutionswiththetoolsnecessarytoprotectassetsfromtheworsteffectsresultingfromclimatechangeandalsohelpidentifynew,innovativelowcarboninvestmentopportunities.www.carbon-delta.com1ChangingCourseContentsCONTENTSPerspectivesfromthepilotmembership......................................................................................................5ForewordbyMarkCarney...............................................................................................................................7ForewordbySatyaTripathi..............................................................................................................................8Acknowledgements............................................................................................................................................9ExecutiveSummary.........................................................................................................................................101Introduction.................................................................................................................................................162Overviewofmethodologies.....................................................................................................................233BuildingblocksoftheInvestorPilotmethodology.............................................................................384ComparingClimateValueatRiskacross1.5°C,2°Cand3°CWorlds...........................................505Operationalisingthemethodology:casestudies................................................................................656Futuredirections.......................................................................................................................................116AppendixI.........................................................................................................................................................120AppendixII.......................................................................................................................................................121AppendixIII......................................................................................................................................................122Acronyms..........................................................................................................................................................123Glossary.............................................................................................................................................................124References........................................................................................................................................................1252ChangingCourseContentsLISTOFTABLESTable1:Keyinnovativeelements,gapsandnextstepsfortheCarbonDeltamethodology.....................................48Table2:ResultsfortheTop1,200companiesbyglobalmarketcap.............................................................................................51Table3:Sector-levelresultsforPolicyRiskillustratetherangeofclimate-relatedimpactsacrosstheportfolio..................................................................................................................................................52Table4:Sector-levelresultsforTechnologyOpportunitiesillustratetherangeofimpactsacrosstheportfolio.............................................................................................................................................................53Table5:PolicyRiskforaDelayedandNon-delayedscenario............................................................................................................53Table6:PhysicalRiskfortheaverageandaggressiveclimatemodelsandeachspecificweatherhazard.................................................................................................................................................................54Table7:PhysicalRiskfortheaveragescenariobysectorandweight...........................................................................................55Table8:Top10locationsexposedtophysicalrisksbasedonsectorandhazard..............................................................56Table9:ResultsfortheTop1,200companiesbyglobalmarketcap.............................................................................................58Table10:Sector-levelresultsforPolicyRiskillustratetherangeofclimate-relatedimpactsacrosstheportfolio.....................................................................................................................................................................58Table11:Sector-levelresultsforTechnologyOpportunitiesillustratetherangeofimpactsacrosstheportfolio.....................................................................................................................................................................59Table12:Policyriskforadelayedandnon-delayedscenario.................................................................................................................59Table13:PhysicalRiskfortheAverageandAggressiveclimatemodelsandeachspecificweatherhazard...................................................................................................................................................................60Table14:PhysicalRiskfortheaveragescenariobysectorandcontribution.............................................................................60Table15:Top10locationsexposedtoPhysicalRisksbasedonsectorandhazard.............................................................61Table16:ResultsforaCoalPortfolio.......................................................................................................................................................................63Table17:ResultsforaRenewableEnergyPortfolio......................................................................................................................................63Table18:CDPQcomparisonofsectorsthroughspecificvaluechains.........................................................................................72Table19:CDPQtotalVaRofcementandironandsteelsectors......................................................................................................73Table20:ManulifeCanadianequityportfolioresults....................................................................................................................................75Table21:ManulifeAsianequityportfolioresults..............................................................................................................................................75Table22:ManulifesectorweightsforCanadianandAsianequityportfolios.............................................................................76Table23:ManulifetotalportfolioVaRofthesehazardsforbothportfolios...............................................................................77Table24:Manulifeindustryrankingbyexposuretoextremeheatrisk.........................................................................................77Table25:Manulifeindustryrankingbyexposuretocoastalfloodingrisk.....................................................................................77Table26:Manulifeindustryrankingbyexposuretotropicalcyclonerisk.....................................................................................77Table27:RockefellerportfolioCVaRresultscomparison........................................................................................................................84Table28:InvestaNGAfactorsacrossAustraliancitieswhereportfolioissituated..............................................................95Table29:Investavariancebetweenenergyintensityandemissionsintensityacrossgeographicaldifferences..............................................................................................................................................................96Table30:KLPestimatedVaRforcumulativeholdingsinlistedbondsandstocks...............................................................100Table31:LaFrançaiseCVaRportfolioanalysis–summaryresults.................................................................................................106Table32:LaFrançaiseCVaRglobalreferenceindex–summaryresults...................................................................................107Table33:TDAMresultsundera2°Cscenario..............................................................................................................................................1123LISTOFFIGURESFigure1:Analyticalelementsofscenario-basedimpactassessments.............................................................................................11Figure2:TheTCFDrecommendationsarestructuredaroundfourbroadthemes...........................................................19Figure3:Analyticalelementsofscenario-basedimpactassessments.............................................................................................24Figure4:FrameworkforcategorisationofPhysicalRiskimpactassessmentmethodologies.......................................27Figure5:OverviewofPhysicalRiskassessmentmethodologies........................................................................................................28Figure6:FrameworkforcategorisationofTransitionRiskimpactassessmentmethodologies...................................33Figure7:OverviewofTransitionRiskassessmentmethodologies....................................................................................................34Figure8:ThefinaloutputsoftheCarbonDeltamethodologyarequantifiedcostsorrevenuesandtheCVaR..........................................................................................................................................................38Figure9:CarbonDeltaassessesclimateriskacrosstwomainpillars;transitioneffectsandphysicalimpacts.......................................................................................................................................................................39Figure10:CarbonDeltacalculatesclimatecostsandprofitsoverthenext15years,thenassumesalineardecline...............................................................................................................................46Figure11:SchematicdisplayofCarbonDelta’swarmingpotentialcalculation..........................................................................47Figure12:Anonymouscompanylocationsthatareexposedtosignificantlevelsofacutephysicalclimaterisks....................................................................................................................................................56Figure13:PortfolioTemperatureGaugeforMarketPortfolio................................................................................................................57Figure14:Anonymouscompanylocationsthatareexposedtosignificantlevelsofacutephysicalclimaterisks....................................................................................................................................................61Figure15:PortfolioTemperatureGaugeforTop1,200Companies...................................................................................................62Figure16:PortfolioTemperatureGaugeforCoalandRenewableEnergyPortfolios..........................................................64Figure17:Globalaveragesurfacetemperaturechangesrelativeto1986-2005.......................................................................68Figure18:Increaseindamagesas%ofassetvaluefromexpectedvalueto95thpercentileforcoastalflooding.................................................................................................................................................................69Figure19:AvivaanalysisofdifferencesbetweenAverageandAggressivescenariosacrossphysicalhazards..........................................................................................................................................................69Figure20:Warmingprojectionsto2100................................................................................................................................................................80Figure21:Nordeacostcurvesofthe2°CandDelayedscenarios.....................................................................................................81Figure22:NordeaVaRacrosssectors:notallcostsareequallyspreadacrosssectors,butrathercentered....................................................................................................................................................82Figure23:DNBportfolio,scenarioandresultsinformation.....................................................................................................................90Figure24:Investahistoricalemissionsperformanceandprojectedemissionstrajectoriesundervariousscenarios...................................................................................................................................................93Figure25:InvestacarbonemissionreductionsatAsset1andAsset2overtheperiodFY12-FY18........................94Figure26:Investavariancebetweenenergyintensity,emissionintensityandVaRacrossgeographies....................95Figure27:KLP’sapproachtoclimateriskassessmentisstructuredinaccordancewithTCFDrecommendations.................................................................................................................................................................98Figure28:KLP’sclimateriskscreeningprocesscoversallkeybusinessoperations................................................................99Figure29:KLPVaRcontributionperscenarioforcumulativeholdingsinlistedbondsandstocks........................100Figure30:KLPVaRcontributionbyscenarioforcumulativeequityholdingsandaspecialisedESGindexfund................................................................................................................................101Figure31:KLPtenindustrysectorswiththelargestnegativeVaRcontributionforcumulativeequityholdings..............................................................................................................................................................102Figure32:KLPunweightedVaRforthetenindustrysectorswiththemostpositiveaverageunweightedVaR.......................................................................................................................................................103ChangingCourseContents4ChangingCourseContentsFigure33:TDAMCVaR,warmingtrajectoryandweightsbysector–Globalequityportfolio................................113Figure34:TDAMCVaR,warmingtrajectoryandweightsbysector–Canadianequityportfolio..........................113Figure35:TDAMbreakdownofCVaR(Globalequityportfolio)bysectorandfactor..................................................114Figure36:TDAMcomparisonofclimaterisksignalswithinutilities–CarbonDeltavsSustainalytics..................115LISTOFBOXESBox1:Climate-relateddisclosureregulationintheEU:TheNon-FinancialReportingDirective(NFRD)...21Box2:Physicalimpactsonrealestateassets................................................................................................................................................42Box3:TransitionRiskimpactsonrealestateassets................................................................................................................................44Box4:NextstepsfortheCarbonDeltamethodology.......................................................................................................................49LISTOFCASESTUDIESStress-testingthemethodologyandresultsrecveivedCaseStudy1:Aviva:AggressivePhysicalRiskScenarios................................................................................................................................67CaseStudy2:CDPQ:Valuechainsandnon-substitutabilityofproducts.........................................................................................71CaseStudy3:Manulife:Thenon-linearityofclimateriskacrossgeographicallydistinctportfolios..............................74CaseStudy4:Nordea:Delayedpolicyresponse................................................................................................................................................79CaseStudy5:Rockefeller:Applyingscenarioanalysistoactivelymanagedstrategies...........................................................83IntegratingscenarioanalysisintointernalprocessesorexternalengagementCaseStudy6:AddendaCapital:Therealbenefitsofscenarioanalysisanddisclosurecomefromtheprocessitself..................................................................................................................................87CaseStudy7:DNB:Portfolioscenarioanalysisandcompanyengagement.................................................................................89CaseStudy8:Investa:Identifiedmetricsforfuturerealestateassessments..................................................................................92CaseStudy9:KLP:Anevolvingfocusonclimateriskmanagement....................................................................................................97CaseStudy10:LaFrançaise:ClimateVaRmetricsproviderelevantinvestmentsignals.......................................................105CaseStudy11:NorgesBankInvestmentManagement:Scenarioanalysisisausefultoolforassessingrisks..........................................................................................................................................................109CaseStudy12:TDAssetManagement:Comparingvariousclimateriskapproaches..........................................................1115ChangingCoursePerspectivesfromthePilotMembershipPERSPECTIVESFROMTHEPILOTMEMBERSHIPWehavehighexpectationsforclimate-relatedfinancialdisclosurefromtheentitiesweinvestin.ParticipatingintheUNEPFITCFDpilotprojectandpreparingourowndisclosurehasimprovedourunderstandingoftherisksandopportunitieswefaceasinvestorsandenabledustoidentifynextstepstocontinuetofurtherthisunderstand-ing.Ithasalsounderscoredtheeffortrequiredbyentitiesseekingtoprovidespecificandcompleteclimate-relateddisclosuretotheirstakeholders.ROGERBEAUCHEMINCEOAddendaCapitalAsaninstitutionalinvestorlocatedinanemergingmarketitwasaneyeopenertoseethelevelofexpertiseanddeepanalysisthatisdonebyourpeersworldwideinclimate-relatedrisks.Thisrepresents,bothachallengesinceweseethehugegapsthatneedtobeaddressed,andanopportunity,becausewenowknowbestpracticeandhaveidentifiedhowparticipationintheUNEPFIpilothasandcanfurtherhelpusbetterunderstandthesetopics.WeatAforeCitibanamexarejustintheprocessofincorpo-ratingESGanalysistoourinvestmentprocesses,andthetoolsandlearningsfromthisprocesswillbeafundamen-talresourcetoourongoingportfolioanalysisanddeci-sion-makingprocess.LUISSAYEGCEOAforeCitibanamexTheplanetdoesnothavetimeforexcuses.Investorshaveacentralroletoplayinmovingtheworldtoalowcarbonfuture;thiscollaborationshowshowwecanalltakebetterdecisions,forourcustomersandfortheenvi-ronment.Avivawillkeepcallingforproperdisclosurefromthecompaniesweinvestin,whileworkingwithregulatorsandpolicymakerstomakesurecapitalmarketsproperlytakeaccountoftheserisks.Thecostofdoingnothingisfargreaterthananycostsincurredbytakingaction.MAURICETULLOCHCEOAvivaplcClimatechangeisposingasignificantthreatacrossmanysectorsandregions,andbusinessesmustplayakeyroleinensuringtransparencyaroundclimate-relatedrisksandopportunities.Toaccelerateourclimateaction,wehaveadoptedscience-basedemissionsreductiontargetsvali-datedbyScienceBasedTargetinitiative(SBTi)andclimatechangescenarioanalysisbasedontheTCFDrecommenda-tions.Theseeffortsaimtofuture-proofourbusinessesbyidentifyingrisksformitigationandadaptationwithaviewtodeliveringlastingvalueforourbusiness,investors,stake-holdersandtheenvironmentatlarge.CDLispleasedtobepartoftheUNEPFIPilotandwillcontinuetoupholdourlong-establishedsustainabilitystrategyandpursuingbestpracticearoundcarbondisclosure.SHERMANKWEKCEOCDLGroupTheEarthis1°Cwarmertodaycomparedtopreindustriallevels,andwearealreadyseeingtheconsequences.Thepilotprojecthasbeenanimportantlearningexerciseforinternationalinvestors,establishingasystematicapproachtomeasuringandmitigatingclimatechangeimpactsatportfoliolevel.Whilefurtherworkremainstorefinethemethodology,itsignalstocompaniesthatignoringclimatechangeisnolongeranoption.Addressingtheserisksandopportunitieswillbecriticaltofulfillingourfiduciarydutytoourclientsmovingforward.OLAMELGÅRDCEODNBAssetManagementItisnotanoptiontoignoreclimateriskasitmaythreatenfinancialstabilityandreturnsoveralongperiodoftime.Yet,whatKLPhaslearnedaboutthecomplexityofassessingclimateriskinthepilotproject,suggestthatwealsohavealongwaytogobeforeclimaterisktothefinancialsectorismeasuredinamannerwhichisconsistentwiththeTCFD.Wethereforehopetocontinueourcollaborationwithpeers,academics,serviceprovidersandotherstakeholder,inordertoimprovetheclimaterisktransparencyinfinan-cialmarketsintheyearstocome.HÅVARDGULBRANDSENCEOKLPKapitalforvaltning6ChangingCoursePerspectivesfromthePilotMembershipAsaresponsibleinvestor,ourgoalistomakeinformedinvestmentdecisions.Thefurtherintegrationofclimate-re-latedriskmetricsintoourinvestmentprocessandreport-ingdocumentsisapositivestep.ThePilotgrouphasbeenausefulforumtochallengemethodologyandfindingsandtolearnfromgroupdiscussions.Thisreportwillspreadtheknowledgetoalargerpublicoflike-mindedinvestorsandstakeholders.LAURENTJACQUIER-LAFORGEManagingDirectorandCIOEquitiesLaFrançaiseAMAllfinancialinstitutionsneedtounderstandtherisksandopportunitiesthatstemfromclimatechangeandtheresultanttransitiontoalow-carboneconomy.Cognisantofthecomplexityofthischallenge,weseegreatvalueincollaboratingwithourpeersintheinvestmentcommunitytodevelopourcollectiveunderstandingoftheinvestmentimplicationsoffutureclimatescenarios.Welookforwardtobuildingontheseinitialeffortsandwillbeusingthefind-ingsasacrucialfirststepinstress-testingtheresilienceofourinvestmentsagainstoneofsociety’sgreatestchallenges.JOHNFOLEYCEOM&GPrudentialOneofthekeylessonsfromthepilotwasthepowerandnecessityofcollaborationtoenableinvestorstorespondtoclimatechange.Otherwise,itwouldtakemanyyearsforinvestorstoindividuallyexperimentwithscenarioanalysis,andforindustrybestpracticetoiterativelyevolvefromthat.TherecentIPCCreportunderlinedthattheplanetdoesn’thavetimeforthateither.CHRISTOPHERCONKEYCIO,PresidentandCEOManulifeInvestmentManagementAddressingclimatechangeishighontheagendaandNordeasupportstheTCFDrecommendationsandmanagementofclimate-relatedrisks.Webelievecollabo-rationwithotherinvestorsandstakeholderswillcontinuetobekeyinordertofurtherdevelopmethodologiestomanagethecomplexissueoffinancialimplicationsofclimatechange.WewillcontinuetopromotedisclosureaccordingtotheTCFDrecommendationsinourportfolioholdings.NILSBOLMSTRANDCEONordeaAssetManagementInorderforAssetOwnersandAssetManagerstoproducemeaningfulclimatechangedisclosures,theywillneedtocollaboratewithmanagementoftheirportfolioholdingstodothesame.ThisisacriticalinnovationoftheTCFDRecommendations,andultimatelytheonethatwilldriverobustandcomparablereportingonclimatechangerisksandopportunities.MEREDITHBLOCKSeniorVicePresidentRockefellerAssetManagementThequestionisnolongerwhysustainabilityshouldbeintegratedintodecisionmaking,buthowtofurtherexcelit.TheUNEPFITCFDpilotenabledcollaborationamongpeers,highlightingcriticalquestionsonhowtoimproveourwork.Thein-depthdiscussionswithintheteamhaveledtoabetterunderstandingonwhatneedstobedonetoenhancetheknowledgeonhowtointegrateclimate-re-latedrisksandopportunitiesduringdecisionmaking.JANERIKSAUGESTADCEOStorebrandAssetManagementClimatechangeiscertainlyarisktoportfolios,andclientsareincreasinglyrequestinginformationtobetterunder-standthatrisk.Thepilothasallowedustoexploreaddi-tionaltoolsthataimtoquantifytheimpactofclimateriskstoportfolios,providingusgreatercontextforensuringthatriskandreturnparametersarebalancedforanyinvest-ment.Movingforward,wehopethatthepilotservestoencouragecontinueddiscussionaroundthestrengthsandweaknessesofvariousclimate-basedscenarioanalysismethodologies.BRUCECOOPERCEOTDAssetManagement7ChangingCourseForewordFOREWORDIn2015,Ispokeofthe‘TragedyoftheHorizon’–thecatastrophicimpactsofclimatechangewillbefeltbeyondthetraditionalhorizonsofmostbanks,investorsandfinancialpolicymakers,whodonothavethedirectincentivestofixthem.Sincethen,importantprogresshasbeenmadefromtheParisAccordtoadvancesinmanagingtherisksaroundclimatechangeandoptimisingthereturnsinthetransitiontoalowcarboneconomy.Forthefirsttime,apathtobreakthisTragedyisbecomingpossible.Institutionalinvestors,asguardiansoflong-termsaving,havethehorizonstoappreciateclimaterisksandopportunitiesandmanyaredevelopingtheskillstomanagethem.Buttoappropriatelypriceclimateriskandtorewardinnovation,investorsneedtherightinformation.TheworkoftheTaskForceonClimate-RelatedFinancialDisclosures(TCFD)isvitaltoimprovingthereportingandunderstandingofclimate-relatedfinancialrisks.SincetheTCFD’srecommendationstotheG20LeadersSummittherehasbeenastepchangeinthedemandbyinvestorsforbetterclimatereporting.TCFDsupportersnowmanagealmostUSD110trilliononassets.MomentumbehindTCFD’svoluntarydisclosurerecommendationiscreatingavirtuouscirclebyencouraginglearningbydoing.Ascompaniesapplytherecommendationsandinvestorsdifferentiatebetweenfirmsusingbetterinformation,adoptionwillcontinuetospread,disclosurewillbecomemoredecision-useful,anditsimpactwillgrow.Translatingclimatemodelsintoeconomicandfinancialimpactsisdifficult,evenmoresoforinvestorswhodependontheinformationprovidedbyfirms.InitiativeslikeUNEnvironment’sFinanceInitiativeareinvaluableforsharingofgoodpractice—suchasinscenarioanalysis—sofirmscanmaketheirapproachmoregranularandsophisticated.Muchremainstobedone.Thisreportwillhelpusmaintainmomentumaswecontinuealongthevirtuouscirclewheremorecompaniesdisclosemoreinformation,investorsmakebetterinformeddecisions,andsustainableinvestmentgoesmainstream.MarkCarneyGovernoroftheBankofEngland8ChangingCourseForewordFOREWORDTheclimatechallengeoverthenexttwelveyearspresentsauniqueopportunityforcoordi-natedeffortsbytheprivatesectortoleadamoreconcertedandsystemicchangeinaccount-ingforenvironmentalexternalitiesandgreeningbusinessoperations.Companiesplayacrit-icalroleinshapingthestatusofnatureandindrivingresiliencefocusedactionincountries,whichaffectsthewell-beingof3.2billionpeople.SuccessfullymeetingtheParisAgreementandSustainableDevelopmenttargetsisonlypossiblebyleveragingprivatesectorfinanceandincreasinginvestmentsinactivitiesthatcandeliverthegreatestnumberofbenefitsforlivelihoods,climate,ecosystemsandbiodiversity.Bettermetricsandguidancestandardsareneededthatextendtomeasuringpublicbenefitsaskeyindicatorsofcorporateperformance.TheTCFDframeworkissuchadefinitiveguideforinvestors,aswellasallothercorpo-rateandfinancialactorsinmovingtowardsacircularityorientedlensthatcandelivermoreinformeddecision-makingandsupportthegrowthofclimate-friendlyinvestments.Mainstreamingsuchtriple-bottom-linemetricsiscriticalandUNEnvironmentisworkingwithkeyindustryleaderstofacilitateaccesstotheframeworkandtheguidanceitprovidesondisclosures.Asapartofthisprocess,UNEnvironmentwillcontinuetomobilizepart-ners,especiallyfromfinancialmarkets,todeliverpositivechangebyacceleratingthealign-mentoffinancialsystemswiththeParisAgreementandclimatechangegoals.SatyaTripathiUNAssistantSecretary-GeneralandSecretary,UNEnvironmentManagementGroup9ChangingCourseAcknowledgementsACKNOWLEDGEMENTSAcknowledgementsareinalphabeticalorder.PrimaryAuthors:JasonEisExecutiveDirectorVividEconomicsJustineSchaferEconomistVividEconomicsCaseStudyAuthors:Stress-testingthemethodologyandresultsreceivedAviva:BenCarr,AnalyticsandCapitalModellingDirectorFinnClawson,TeamLead.CDPQ:ThierryBorduas,Analyst,InvestmentStewardship,MichelLéveillée,Advisor,InvestmentStewardship,BertrandMillot,HeadofInvestmentStewardship.ManulifeInvestmentManagement:EmilyChew,GlobalHeadofESG,FredIsleib,DirectorofESGResearchandIntegration.Nordea:EmirBorovac,ESGAnalyst,KatarinaHammar,HeadofResponsibleInvestments.Rockefeller:MeredithBlock,SeniorVP.IntegratingscenarioanalysisintointernalprocessesorexternalengagamentAddenda:BrianMinns,Vice-President,SustainableInvesting,SamanthaCameron,JuniorAnalyst,SustainableInvesting.DNBAssetManagement:HenryRepard,ResponsibleInvestmentAnalyst,JanickeScheele,HeadofResponsibleInvestment,LauraNatumiMcTavish,ResponsibleInvestmentAnalyst.Investa:IanLieblich,SustainabilityCoordinator,NinaJames,GeneralManager,CorporateSustainability.KLP:LarsErikMangset,SeniorResponsibleInvestmentAdvisor.LaFrançaiseAssetManagement:RolandRott,HeadofESG,PerrineDutronc,ResponsibleInvestmentAdvisor.NBIM:AdrianaCarvallo-Aceves,Analyst,WilhelmMohn,HeadofSustainability.TDAssetManagement:AnthonyDaCosta,VicePresident&Director,InvestmentRisk,JulieSherratt,ManagingDirector,HeadofInvestmentRisk,VanessaAllen,Associate,InvestmentRiskContributingAuthors:AndrewCampbellBlack,BusinessDevelopmentManager,CarbonDelta.AnjaLudzuweit,DirectorofBusinessDevelopment,CarbonDelta.CarolineSundin,DataAnalyst,CarbonDelta.DavidLunsford,HeadofDevelopment&Co-Founder,CarbonDelta.KarishmaGulrajani,Economist,VividEconomics.Reviewers:AdrianaCarvallo-Aceves,Analyst,NBIM.AnnaMurray,VicePresidentSustainability&EHS,BentallKennedy,AnjaLudzuweit,DirectorofBusinessDevelopment,CarbonDelta.BertrandMillot,HeadofInvestmentStewardship,CDPQ.BrianMinns,Vice-President,SustainableInvesting,AddendaCapital.ChristopherWright,SustainabilityManagerRealEstate,NBIM.ElodieFeller,InvestmentLead,UNEPFI.HenryRepard,ResponsibleInvestmentAnalyst,DNBAssetManagement.JanickeScheele,HeadofResponsibleInvestment,DNBAssetManagement.Jean-FrancoisCoppenolle,SeniorManager,Aviva.JesicaAndrews,ConsultantClimateandInvestment,UNEPFI.JohnAdcock,HeadofRiskAnalytics,Aviva.KatarinaHammar,HeadofResponsibleInvestments,Nordea.LauraNatumiMcTavish,ResponsibleInvestmentAnalyst,DNBAssetManagement.MichelLéveillée,Conseiller,Investissementdurable,CDPQ.PerrineDutronc,ResponsibleInvestmentAdvisor,LaFrançaiseGroup.RolandRott,HeadofESG,LaFrançaiseAssetManagement.SunnivaBrattSlette,SustainabilityAnalyst,Storebrand.ThierryBorduas,Analyst,InvestmentStewardship,CDPQ.PhanosHadjikyriakou,SeniorProductManager,CarbonDelta.VanessaAllen,Associate,InvestmentRisk,TDAssetManagement.RemcoFischer,ClimateLead,UNEPFI.RussBowdrey,TCFDPhysicalRiskWorkstreamLead,Aviva.WilhelmMohn,HeadofSustainability,NBIM.ZeldaBentham,GroupHeadofSustainability,Aviva.ProjectLeads&Management:RemcoFischerClimateLeadUNEPFIJesicaAndrewsConsultant-ClimateandInvestmentUNEPFIElodieFellerInvestmentLeadUNEPFIPaulSmithConsultant-ClimateChangeUNEPFI10ChangingCourseExecutiveSummaryEXECUTIVESUMMARYCONTEXTClimatechange-ofabout1°Cofwarmingtodayrelativetopre-industrialtimes-isalreadyhavingdisruptiveeffectsoneconomiesacrosstheglobe,throughbothitsphysicalmanifestationsandthemitigationactionsaimedatavoidingthese.Onthephysicalside,extremeweathereventsareincreasinginfrequencyandintensity,resultinginsevererepercussionsforlivelihoods,communitiesaswellas,throughimpactsonoperations,supplychainsandcustomers,forcompanies.Withoutpolicyaction,theseeffectswillonlyintensifyastheglobalmeantemperaturecontinuestoincrease(IPCC,2018).Onthetran-sitionside,policyandtechnologyshiftshavebeguntoaffectthecompetitivepositionsofemissions-intensivecompaniesrelativetoprovidersoflow-carbonalternatives.TheParisAgreement—ratifiedby185Parties—aimstoensurethattheincreaseinaveragetemper-aturesabovepre-industriallevelsiskeptto‘wellbelow’2°Cby2100(UNFCCC,2015).Continuedphysicalclimatechangeandrapidpolicyactiontolimititpresentinvestorswithpotentiallyunprecedentedanduncertainfinancialimpactsthattheywillneedtomanage.TherecommendationsoftheTaskForceonClimate-RelatedFinancialDisclosures(TCFD)outlinetheneedforcorporateandfinancialinstitutionstoconductforward-lookingscenario-basedassessmentsoftheseclimate-relatedrisksandopportunities.Therecommendationtousescenario-basedanalysistoassessthelong-termeffectsofclimatechangeaimstoensurethatcorporateandfinancialinstitutionsincorporatetheseeffectsintostrategicdecisions.Forinvestors,asbothusersandissuersofclimate-re-lateddisclosures,engagementwithforward-lookingclimate-relatedriskanalysisisdoublyrelevant.Inholdinglargeportfolios,mostinstitutionalinvestorsfaceexposuretoriskacrosssectors,geographiesandfinancialinstruments,whileatthesametimefinancingthedevelop-mentoftherealeconomy.Thelongertimehorizonsoftheirassetandliabilitymanagement,aswellastheirexposuretoequityandunsecureddebt,furtherhighlighttheimportanceofconsideringclimatechangeinstrategicdecisions.However,thescopeofinvestors’exposuretoclimatechangecanbeparticularlydifficulttoassessgiventhesizeanddiversificationoftheirportfolios.ThisreportdetailstheresultsoftheUNEnvironmentProgrammeFinanceInitiative(UNEPFI)InvestorPilotonTCFDAdoption,acollaborativeefforttoexplore,enhanceandapplyamethodologyforassessingtheimpactofphysicalandtransi-tionrisksandopportunitiesontheportfoliosofinstitutionalinvestors.TheInvestorPilotGroupcomprises20institutionalinvestorsfromacrosstheglobe.ThisreportpresentsthemethodologyenhancedandusedbytheInvestorPilotGroupincollaborationwiththedataanalyticsfirmCarbonDelta.OutputsandevaluationsofthismethodologyareintendedasafirststeptowardsunderstandingthepotentialforincorporatingtheTCFDrecommen-dationsonscenario-basedriskassessmentininvestors’financialdisclosure.Inaddition,andinordertohighlighttherangeofmethodologiescurrentlyavailabletoconductthesetypesofassessments,thereportoffersa‘landscapereview’ofotherproviders’methodologiesforclimate-relatedscenarioanalysis.TheultimateobjectiveoftheInvestorPilotincludingthisreportistwo-fold:i)boostinvestorsavvinessandii)supportindustry-wideharmonisation.TheintentionoftheUNEPFIInvestorPilotisbothtocomprehensivelyguideindividualinvestorsonhowtodesignandstructuretheapplicationoruseofscenario-analysiswithintheirowninstitutionsaswellastoprovideabasisfromwhichtheinvestmentcommunitycanseektoachieveharmonisationandstandardisationofinvestordisclosuressothatovertimethesebecomecomparable.11ChangingCourseExecutiveSummaryStateofscenarioanalysismethodologiestodayTherearealargenumberofscenarioanalysismethodologiesandprovidersthatofferdiverseandcontinuallyimprovinganalyses.Theoverviewconductedforthisstudyfoundmanyavailablemethodologies,andavibrantmarketofserviceproviderstosupportTCFD-compliantscenarioanalysis.Manyproviderssharecommoncoremethodo-logicalelements,drawingonsimilardatasets,modellingcomponentsandmethodsforfinan-cialvaluation.However,significantdiversityexists,withprovidersofferingdifferent(andsometimescomplementary)methodologiesforassessingclimate-relatedfinancialrisksandopportunitiesacrossvariousassetclasses,scenariosandoutputformats.Asaresult,thereisalreadyalargesetofmethodologiestochoosefrom,dependingondesiredscope,depthandfocusofanalysis.TheanalyticalframeworkforassessingmethodologiesforscenarioanalysisisoutlinedinFigure1,andexaminesmethodologiesonthebasisofscenariosused(orconstructed),physicalandtransitionhazardsexamined,impactassessmentmethodologydeveloped,outputsproducedand,finally,theresolutionofanalysis—orcounterparties1oftheriskexamined.Figure1:Analyticalelementsofscenario-basedimpactassessmentsSource:VividEconomicsBuildingblocksoftheInvestorPilotmethodologyTheUNEPFIInvestorPilotexplored,enhancedandappliedtheCarbonDeltamethodology,throughoutthePilottoroad-testa‘ClimateValueatRisk’(CVaR)forlistedequities,corporatedebtandrealestateunderseveralfuturescenarios.Thismeasurebringstogetherassessmentofthephysicalandtransitionrisksofclimatechange.Onthephysicalside,themethodologyexaminestheimpactsofchronicchangesintheclimateandacuteweathereventsoncompanies’operationsusingbusinessinterruptionasa1.Thetermcounterpartyisusedthroughoutthisreporttorefertoentitiesthatinvestors,throughtheirportfolios,haveexposuretoandthataremoredirectlyaffectedbyclimate-relatedrisk.Theserangefromcountriestocompaniesandindividualfacilities/’projects’.Assuch,differentmethodologiesexaminedifferentcounterparties,butmaydosousingsimilarmethodologies.12ChangingCourseExecutiveSummaryproxy.Onthetransitionside,itexplorespolicyrisk—thecostforcompaniesfrommeetingcountries’emissionsreductionstargets;andgreenopportunities—theprofitsforlow-carbontechnologycompaniesearnfromprovidingthemeansbywhichtoreduceemissions.Thesephysicalandtransitionimpactsarethentranslatedintofinancialvaluesthroughfinancialmodelling.Themethodologyfurtherassessesportfoliosagainstinternationalclimatetargetstogiveatemperaturealignment:theimplieddegreeofwarmingofaportfolio.ComparingClimateValueatRiskacross1.5°C,2°Cand3°CWorldsApplyingthecurrentmethodology—andmindfulofthecurrentgapsandassump-tionswithinit—toa‘MarketPortfolio’thatincludes30,000equallyweightedcompanies,andhencerepresentstheinvestablemarketuniverse,yieldsnoteworthyinsights,including:◼Investorsfaceasmuchas13.16%ofriskfromtherequiredtransitiontoalow-carboneconomy:The1.5°Cscenario,inlinewiththelatestspecialreportbytheIntergovernmentalPanelonClimateChange(IPCC),exposescompaniestoasignif-icantleveloftransitionrisk,affectingasmuchas13.16%ofoverallportfoliovalue.Consideringthattotalassetsundermanagement(AUM)forthelargest500investmentmanagersintheworldtotalUSD81.2trillion,thiswouldrepresentavaluelossofUSD10.7trillion.◼Itisatthesectorlevelthatclimate-relatedrisks,includingrisksfromthetransi-tiontoalow-carboneconomy,becomeacutelyapparent.Utilities,transportation,agricultureaswellasmining&petroleumrefiningsectorsstandoutashavinghighpolicyrisk.Undera1.5°Cscenario,theutilitysectorismoststronglyexposedtopolicyrisk(-50.6%atrisk),however,thesectorcontributeslessthan10%overalltotheport-folio’sclimate-relatedrisks.Ontheotherhand,Manufacturinghasamuchlowerriskof-16.5%,butgetsthehighestportfoliocontributionof46.7%.Thishighlightsthesignificantvariationinclimaterisklevelsbetweensectors,whilealsohighlightinghowdiversificationcanhelptoreducetheserisks.◼‘Green’profitsina2°Cworldaresignificant–approximatelyUSD2.1trillion.Addressingclimatechangeandlimitingglobalwarmingrequireseconomicpoliciesthatsupportalowcarbonenergytransition.However,greenrevenuesgeneratedfromthesaleoflowcarbontechnologies,whichsupportthetransition,willhelpcompaniesoffsetcostsfromcomplyingwithgreenhousegas(GHG)reductionpolicies.Strongerclimatepolicythereforealsotranslatesintoanincreasedpotentialforcompaniestogenerate‘green’profits.Underthe2°Cscenario,thesumofallgreenprofitsgeneratedbythis30,000-companyuniverseequalsapproximatelyUSD2.1trillion.◼Lowcarbontechnologyopportunitieshelpoffsetrisk.Aggregatedtechnologyopportunitiesacrossaportfoliowillalleviatelossesgeneratedunderthe3°C,2°Cand1.5°Cpolicyscenarios.Theportfoliobenefitsby3.21%,6.94%,and10.74%underthesescenarios,respectively.◼Companiesfaceincreasedcost,andinvestorsincreasedrisk,ifgovernmentsactlate.Finally,ifgovernmentsdelayactiontoenactclimatepoliciesthatreduceGHGemissions,the30,000companiesintheuniversefaceafurthercostofUSD1.2trillionascomparedtoascenariowhereclimatepolicyisenactedsmoothlyandsteadilywithimmediateeffect.Furthermore,delayedactionnotonlyincreasespolicyrisk,butalsoresultsinmuchgreaterphysicalclimateriskduetheincreasedaccumulationofGHGconcentrationsinouratmosphere.13ChangingCourseExecutiveSummaryImplementationcasestudiesEachmemberoftheInvestorPilotGroupwasabletoanalyseatleastoneportfolioandtrialdifferentscenarios—theresultsofwhichsomeinvestorsexploreincasestudies,organisedaroundtwokeythemes:◼Thefirstsetofcasestudiesrepresentdeep-divesintoinvestors’resultsfromtheportfolioanalysis,focusingontheuniqueareasinvestorschosetoexplore.Theseincludetheexpansionofscenariostomoreaggressivephysicalriskanddelayedpolicyresponsescenarios(Aviva,Nordea),thenon-linearityofriskacrossdifferenttemper-aturepathways(ManulifeInvestmentManagement),andtheperformanceofactivelymanagedportfoliosrelativetorelevantindices(Rockefeller).AnothercasestudyfromCaissededépôtetplacementduQuébec(CDPQ)examinestheimportanceofconsider-ingvaluechainsandnon-substitutabilityofproductsinriskassessment.◼Thefocusofthesecondsetofcasestudiesliesonthepotentialintegrationofresultsininternalprocessesandexternalengagement.Casestudieswithinthisfocusareaexaminethebenefitsofengagingwithscenarioanalysis(Addenda),highlighttheinteractionsbetweentheCarbonDeltamethodologyandidentificationofmetricsforfuturerealestateassessment(Investa),exploreevolvinginternalriskmanagementprocessessurroundingclimate-relatedrisks(KLP),comparescenario-basedresultstoclimaterisksignalsprovidedbyenvironmental,socialandgovernance(ESG)dataproviders(TDAM),drawouttheimplicationsfordevelopmentofinternalscenarioanalysistoolsandriskmanagementpractices(NorgesBankInvestmentManagement(NBIM),LaFrançaise),andelaborateonhowinstitutionsintendtoconcretelyutilisetheresultsinengagementwithinvesteecompanies(DNB).MembersofthePilotGrouphighlightedseveralbenefitsofcollaborativelyengagingintheUNEPFIInvestorPilot:◼Consideringphysicalandtransitionrisktogethercanprovidevaluableinsightsintotheirinteractionsandresultinamorecomprehensiveandconsistentriskassessmentforinvestors.◼Thediversityofimpactsacrossdifferentscenariosofpolicyambitionandintensityofphysicalimpactsemphasisestheimportanceofconsideringarangeofscenarios.This,inturn,makesstandardisedissuanceofinvestordisclosuresthatarecomparablemorechallenging.◼TheCVaRmeasure—asonethatisan‘extension’ofacommonlyused,coreriskmetric—caneaseandfacilitateinternaldiscussionandharmonizationofdisclosurebyquantifyingriskthatmaypreviouslyonlyhavebeenassessedthroughratingsandgener-atingmoreinternalinterest.◼Someinvestors,infutureengagementwithinvesteecompaniesontheneedfordisclo-sureofmaterialclimate-relateddataandriskmanagement,intendtoutilisetheresultsoftheassessmentassupportingevidenceoftheneedforaction.However,investorsalsonotedthatscenarioanalysisshouldnotformthesolebasisforcorporateorinvestordecision-making.14ChangingCourseExecutiveSummaryFuturedirectionsBoththelandscapereviewofmethodologiesavailabletodayaswellasthemethodologyspecifictotheinvestorPilotdemonstratethemajorinnovationandmethodologicaladvancementsrecentlymadeinthisspaceaswellasanumberofkeyremaininggapsandareasofimprovement:◼Acrosstransitionandphysicalriskanalyses,methodologiescurrentlydonotcovertheentirevaluechainofthecounterpartiestheyexamineindepth;neitherdotheylinkmicroeconomicandmacroeconomicimpacts.Severalmethodologiesrestrictanalysistoacounterparty’soperationsandphysicalassetsratherthanalsoconsideringtheimpactsofclimatechangeonsupplychainsandmarkets,providingonlyalimitedviewofthescopeofimpact.Moreover,nomethodologiesintegratesuchmicroeconomicimpactswithimpactsonthemacroeconomicenvironment,whichcouldbesignificant,especiallyifthepolicytransitionoccursinadelayedandmoredisruptivemanner,orifclimatechangeisunabated.Companies’entirevaluechainsshouldbeconsidered,fromsupplychaintomarket,aswellasthebroadermacroeconomicenvironment.ThiswouldincludedistinguishingmoreclearlybetweenScope1,2and3emissions2inordertoholisticallycapturecompanies’carbonfootprints.◼Fewmethodologiesconsiderphysicalandtransitionriskinafullyintegratedmanner—asoutputsofthesamemodellingexercise—orexaminearangeoftemperaturepathways.Thetypeofriskassessedisoftenlinkedtoalimitedrangeoftemperaturescenarios.Forexample,physicalriskmethodologiesoftenfocusona4°C‘business-as-usual’scenario,whiletransitionriskscenariosoftenfocusona2°Cscenario.Inreality,bothwillhaveimportanttrade-offsandshouldbeconsideredtogether;however,thesignificantdiffer-encesinhowtheyaremodelledpresentongoingmethodologicalchallenges,resultinginalackofavailabilityofscenarioswhichincorporatethetrade-offs.Tosufficientlycapturetheinteractionsbetweenphysicalandtransitionrisk,analysesshould,wherepossibleandrelevant,extendbeyondthenext10–15years.◼Ingeneral,thereisscopeformorebottom-upanalysisthatconsiderstheuniquecharac-teristicsofthecounterpartystrategyformanagingclimate-relatedrisk.Fewmethodol-ogiesincorporatecompany-specificinformationonmitigativeactiontaken,keyperfor-manceindicators(KPIs)setorinsurancepurchased.Similarly,methodologiesshouldquantifynotjusttheexposureofcounterpartiestoclimatechangerisk,butalsotheirsensitivityandadaptivecapacity.◼Criticaltofurtherdevelopmentisovercominganumberofdatachallenges,especiallyinrelationtocorporatereportingoffactorsaffectingexposureattheassetlevel.Corporatedisclosurepracticetodatenotonlyfailstoroutinelyprovideriskassessmentsthatareforward-looking.Italsofailstoprovideinformationatthelevelofthephysicalassets—facilities,plants,infrastructures—ownedbythecompany.Riskexposure,however,willmanifestat‘assetlevel’moresothanatthelevelofthecompaniesaslegalentities.TheTCFDrecommendationscanformanimportantfirststeptowardsfuturedataavailabilitybyaskingbothcorporateandfinancialinstitutionstodisclosethistypeofinformation.2.TheGHGProtocol(https://ghgprotocol.org/)definesthree‘scopes’ofemissions:Scope1emissionsaredirectemissionsfromsourcesthatanorganisationcontrolsorowns.Scope2emissionsrefertoemissionsfrompurchasedelectricity,heatorsteam.Scope3emissionscompriseindirectemissionsfromanorganisation’sactivities,includingbothupstreamanddownstreamemissions.15ChangingCourseExecutiveSummaryIntheinterestofpursuingtheseimprovements,thereisaclearneedforbetterdisclosureofclimate-relateddatafrominvesteecompanies,particularlyincludingacompany’sindi-vidualsensitivityandadaptivecapacity.Themoregranularthedatadisclosedbyinvesteecompanies,themoreinformativescenario-basedanalysiscanbeforinvestors.Analysistodatehasreliedonsectoralindicatorsofresilience,suchasnaturalresourcedependenceandabatementpotential.However,thesecouldvarysignificantlyacrossasector,andmoredataonindividualcompanies’sensitivitiesandadaptivecapacitytophysicalandtransitionriskisneeded.Thisincludesdataonindividualfacilities,suchasproductionsitesandrealestate,whichshouldcoverlocation,aswellaskeyclimate-relatedcharacteristics,suchasfloodresil-ience,energyefficiencyorfacility-levelemissions.Todate,manyscenarioanalysisproviderseitherdonotusethistypeofdataorrelyonproprietarylocationdatabasestoconductfacili-ty-specificassessment.Ifscenarioanalysisistobecomemorecommonplace,particularlyforsmaller-scaleinvestors,dataonindividualfacilitiesneedstobecollectedandmadeavailablemorecomprehensively.Thereremainsanopenquestionaroundtheneedforstandardisationofscenarios,methodol-ogiesandoutputsofscenario-basedassessments.Financialregulatorscouldprovideasetofshocksorscenariostheywouldlikeinvestorstouseinscenario-basedanalysisoftheirportfo-lios.Alternativelyorinaddition,thoughtfully-designedtransparencyrequirementsofmodel-lingmethodologies—ratherthanfullstandardisation—couldfurtherenablecomparability,whilereducingtherisksofcorrelatedmodelerrorsandpreservingincentivestoimprovemethodologies.Inaddition,InvestorPilotGroupmembersagreedthatadditionalguidanceondisclosureofclimatescenarioanalysiswouldhelptheminterpretothers’results,beitinvesteecompaniesorotherinvestors.Outputstandardisationcouldalsohelptheinterpreta-tionofresultsbyallowinginvestorstoexaminethesamesetofimpactmeasuresthroughout.IndustrycollaborationplayedaninvaluableroleinthePilotproject,asinvestorspursuingtheirindividualinterestsculminatedinamoreholisticmethodology.Continuousengage-mentinthepilotmethodologyadvancedinvestorunderstandingofscenario-basedanalysisandallowedinvestorstocollaborativelysuggestmethodologicalimprovements.Forexample,overthecourseofthepilotproject,investorshighlightedtheneedforadditionalscenarios,whichresultedintheinclusionofamoreaggressivephysicalrisk,aswellasadelayedpolicyactionscenario.PilotGroupmembersfurtherpointedoutthatusingthesamemethodologyasotherinvestorsreassuredthemthatresultswouldbecomparableandinformativeintheindustry’sTCFDreporting.Collaborativeinvestoraction—incoordinationwithregulatoryadvancements,existingdisclosurestandards,andotherstakeholders—remainsakeyavenuetoachievefullerstandardisationandcomparabilityofinvestordisclosuresinthefuture.16ChangingCourseIntroduction1.INTRODUCTION1.1.EMERGINGUNDERSTANDINGOFLONG-TERMEXPOSUREClimatechangehasbecomeadefiningchallengeofthe21stcentury,andinter-nationalconsensusisgrowingthatitwillbe,atbest,costlyfortheeconomyand,atworst,disastrousforhumansociety.InitsspecialreportofOctober2018,theIntergovernmentalPanelonClimateChange(IPCC)projectsanincreasefromthepresent1°Cabovepre-industriallevelsto1.5°Cofaveragewarmingbetween2030and2052ifwarmingcontinuesatitscurrentrate.Warmingof1.5°Cwillalreadyposeunprecedentedyetpotentiallymanageableclimaticchallengestoecosystemsandsocieties.Itisfurtherincreasesfrom1.5°Cto2°C—earlyinthesecondhalfofthecentury—thatareexpectedtoleadtofullydisruptiveimpacts,includingsignificantsealevelrise,speciesextinction,increasedimpactsonhumanhealthfromheatstressandvector-bornediseases,andhigherrisksofdroughtsandflooding(IPCC,2018).Correspondingly,eveniftheParisAgreementisimple-mentedasenvisionedanditsobjectivesfullyrealised,3thefrequencyandseverityofextremeweatherwillcontinuetoincreaseandthechronic,‘slow-onset’manifestationsofphysicalclimatechange4(suchassea-levelriseortemperatureincrease)willcontinuetounfold.Atthesametime,correctivepolicyactionitself—aimedbothatdecarbonisingglobaleconomicactivityandadaptingsocietiestoachangingclimate—islikelytoimposesignificantuncer-taintyandcostsinkeyareasoftheeconomy,withthosecostslikelytoriseconsiderablyasactionisdelayed.Increasingly,theexpectationisthatbothphysicalandtransition-relatedeffectswillsignificantlyimpacteconomicoutcomes.Onthephysicalside,theincreasedfrequencyandintensityofextremeweathereventsandchronicchangesintheclimatearealreadyhavingsevererepercus-sionsforcompanies,beitthroughtheirownoperationsortheirsupplychains.Aswarmingcontinuesthesewillonlyintensify.Ifcompanies’operationsare,forexample,locatedinanareafrequentlyaffectedbyhurricanes,theymayhavetheirstaffevacuatedorfacilitiesdamagedduringanextremeweatherevent,leadingtobusinessinterruptionsandrepaircosts.Internationalsupplychainswillalsoexposecompaniestoclimate-relatedphysicalrisksacrossarangeoflocalenvironments,leadingtobusinessinterruptionsinonepartoftheworldduetoextremeweathereventsinanother.AprominentexampleofthewidespreaddisruptionextremeweathereventscausearetheThaifloodsof2011.5Localimpactswerefeltacrossseveralindustries:fromcarmanufacturerssuchasHonda,ToyotaandFordtoThailand’sriceexportindustry,oneofthelargestintheworld.Intotal,theWorldBankestimatesthedamagesandeconomiclossesassociatedwiththesefloods,includingoninternationalsupplychains,atUSD45billion(TheWorldBank,2012),with70%ofthislosscomingfromthemanufacturingindustry.OnlyapproximatelyUSD12billionofthislosswascoveredbytheinsuranceindustry(Lloyd’sofLondon,2012).Onthetransitionside,emergingclimatepolicyandlow-carbontechnologieshavealreadybeguntosignificantlyaffectcompanies’financialperformance.PolicyactionacrosstheworldispushingforareductioninGreenhouseGasemissions-intensiveactivities,particularlyinthepowerandtransportsectors.TheParisAgreementrequireseachPartytoprepare,maintainandcommunicateNationallyDeterminedContributions(NDCs)tothe3.TheAgreementaimstokeepglobalwarmingto2100wellbelow2°Cabovepre-industrialtemperatures.CurrentNationallyDeterminedContributions(NDCs)areonlyontrackfora3°Criseby2100(TheRoyalSociety,2018).4.Whiletheterm‘weather’describesshort-termvariationintheatmosphere,‘climate’referstoalocation’sweatheraveragedoveraperiodoftime.5.Itisdifficulttoattributeanyindividualweatherevent,includingthe2011floodsinThailand,toclimatechange(IPCC,2012).However,theimpactofanthropogenicclimatechangeontheincreasedincidenceofsucheventshasbeenwelldocumented.Forexample,a2018reportcombining17peer-reviewedanalysesofextremeweatheracrosssixcontinentsandtwooceansduring2017statedthat‘theU.S.NorthernPlainsandEastAfricadroughtsof2017,floodsinSouthAmerica,ChinaandBangladesh,andheatwavesinChinaandtheMediterraneanwereallmademorelikelybyhuman-causedclimatechange’(AmericanMeteorologicalSociety,2018).17ChangingCourseIntroductiontargetoflimitingglobalwarmingtowellbelow2°C.Theseshouldcomprisegreenhousegasemissionreductiontargetsthatconsidereachcountry’sindividualcircumstancesandcapabil-ities.Policyactiontofulfilthesetargetshasalreadybeguntoaffectcompanies,forinstance,asGermanyshiftsawayfromnuclearandcoaltowardsrenewables,thevalueofutilitycompanieshasfallensignificantly:RWEandE.ONrecordedmarketcapitalisationreduc-tionsof59%and65%,respectively,overtheperiodfrom2000to2015(Chazan&McGee,2016).Atthesametime,low-carbontechnologycompaniesrecordedsignificantgrowthoverrecentyears.In2017,renewablescomprised61%ofallnetpowergenerationcapacityaddedglobally,withsolaralonemakingup38%oftotalgrowth(UNEnvironment,2018b).Impactsonboththephysicalandtransitionsidesofclimatechangewillhavetobefactoredintofinancialdecision-makingtodayifa‘tragedyofthehorizon’istobeavoided.MarkCarney,ChairoftheG20’sFinancialStabilityBoardandGovernoroftheBankofEngland,hashighlightedthattimehorizonstypicallyappliedbybothregula-toryandeconomicactorsaretooshorttobeabletofullyconsiderclimateimpacts,whichunfoldoverthelongterm(BankofEngland,2015).Fundmanagersandfinancialanalystsgenerallyhavehorizonsthatdonotextendbeyondthenextfiveyearsand,asaresult,corpo-ratereportingrarelyincludesforward-lookingdisclosurebeyondthattimeframe.Whilefinancialstabilityconsiderationsoftechnocraticauthoritieslikecentralbanksdoextendoutclosertoadecade,thesehorizonsarestillinsufficientgiventhatthecostliestchangestotheclimatearelikelytooccurfurtherintothefuture.Aligningdecision-makinghorizonsoffinancialandothereconomicactorswiththelong-termnatureofclimatechangeiscriticaltorespondingtotheimpactsoftoday’seconomicactivitiesandtheeffectofclimatechangeonlong-termfinancialsystemstability.Goingfurther,theParisAgreementcallsforfinancialinstitutionstoplayanactiveroleinlimitingglobalwarmingtowellbelow2°C.Article2.1(c)oftheParisAgreementaimstostrengthentheworld’sresponsetoclimatechangeby‘makingfinanceflowsconsistentwithapathwaytowardslowgreenhousegasemissionsandclimate-resilientdevelopment’(UNFCCC,2015).Thiscallsonthefinancesectortoplayanactiveroleinthepursuitofinternationalclimatetargetsaboveandbeyondfocusingonlong-termfinancialstability.ThisAgreement[…]aimstostrengthentheglobalresponsetothethreatofclimatechange,inthecontextofsustainabledevelopmentandeffortstoeradicatepoverty,includingby[…]makingfinanceflowsconsistentwithapathwaytowardslowgreenhousegasemissionsandclimate-resilientdevelopment."ParisAgreement,Article2.1(c)(UNFCCC,2015)Asafirstresponsefromthefinancesectortothesechallenges,theTCFD,chairedbyUNspecialenvoyonclimatechangeMichaelBloomberg,publisheditsrecommenda-tionsfordisclosureofclimate-relatedrisksandopportunitiesinJune2017.Theindus-try-ledinitiativeaimstoincreasetransparencyaroundtheassessmentandmanagementofclimate-relatedrisksandopportunities.Ifunawareormisinformedoftherisksandopportu-nitiesaroundclimatechange,investorsandothersarelikelytocollectivelymispriceassetsandsystematicallymisallocatecapital,threateningfinancialstabilityandprofit.TheTCFDaimstoaddressthe‘tragedyofthehorizon’byencouraginginvestorstoconductforward-look-ing,scenario-basedassessmentsoftherisksandopportunitiessurroundingclimatechange.Momentumaroundtherecommendationshasgrownconsiderablysincetheinitialpublica-tion,withthenumberoforganisationssupportingtheinitiativesurpassing500inSeptember2018,includingfournationalgovernments(Canada,France,SwedenandtheUK).18ChangingCourseIntroductionThisreportdetailstheresultsoftheUNEPFIInvestorPilotonTCFDAdoption,acollaborativeeffortof20institutionalinvestorstodevelopmethodologiesforforward-looking,scenario-basedassessmentsoftheclimate-relatedrisksandoppor-tunitiesfacedbytheirportfolios.Themethodologyproducesanestimateofthefinancialvalueatriskfromclimatechangeor‘ClimateValueatRisk’(CVaR)underseveralfuturescenarios,incorporatingbothphysicalandtransition-relatedimpactsofclimatechange,forlistedequity,corporatedebtandrealestateassets.Itwasco-developedthroughanitera-tiveprocessbetweentheinvestors,theconsultingfirmCarbonDelta,andexternalexpertsconvenedbyUNEPFI.OutputsandevaluationsofthesemethodologiesareintendedasafirststeptowardsunderstandingthepotentialforenablinginvestorstoadopttheTCFDrecommendationsonscenario-basedriskassessmentinfinancialdisclosure.Thesemethod-ologies,whicharetailoredtothemainassetclassesinwhichinstitutionalinvestorstypicallyinvest,followthepublicationin2018ofequivalentmethodologiesdevelopedfortheloanbooksofbanks(themethodologiesforphysicalrisksandopportunitiescanbefoundhere;whilethosefortransition-relatedrisksandopportunitiescanbefoundhere).Theremainderofthisreportisstructuredasfollows:1.Sections1.2and1.3highlighttheobjectivesandinnovativeelementsoftheTCFDrecommendationsandoutlinethestateoftheirimplementationtodate.2.Section2summariseskeyexistingmethodologiesforscenarioconstructionandphysicalandtransitionriskassessments.3.Section3detailsthemethodologyforscenario-basedanalysisco-developedundertheInvestorPilot.4.Section4presentstheresultsofCarbonDelta’sanalysisofaglobalportfolioof1,200companiesusingtheInvestorPilotmethodology.5.Section5providesinvestorcasestudiesfromtheInvestorPilotGroup,elaboratingontheoperationalisingofthemethodologyandsummarisingthekeylessonslearntacrossthebroadermembership.6.Section6concludesthereportbyhighlightingpotentialfuturedirectionsofinvestorinteractionwithscenarioanalysisandtheTCFDrecommendations.1.2.CLIMATE-RELATEDRISKANDOPPORTUNITYASSESSMENTINTHEINVESTMENTINDUSTRYTheTCFD’scorerecommendationscentrearoundfourbroadthemes;Governance,Strategy,RiskManagementandMetricsandTargets.TheGovernancethemeencouragesorganizationstodisclosetheextenttowhichboardsandmanagementoverseeclimate-re-latedrisksandopportunities.TheStrategythemeaskscompaniestoassessthematerialityofclimatechangetotheirbusinessandtodisclosetheirexposuretoclimate-relatedrisksandopportunities,includingthroughforward-lookingscenario-basedanalysis.TheRiskManagementthemeaskscompaniestoreportonhowtheyintegratetheirprocessforidentifi-cation,assessmentandmanagementofclimaterisksandopportunitiesintotheirexistingriskmanagementframeworks.TheMetricsandTargetsthemeencouragesfinancialreportingtoincludeclimate-relatedmetricsandtosettargetsalignedwiththematerialrisksandoppor-tunitiesidentifiedthroughtheprocess.Thisshouldincludeacompany’sinducedScope1,2and3greenhousegasemissions(GHG).ThefourthemesaresummarisedinFigure2.19ChangingCourseIntroductionFigure2:TheTCFDrecommendationsarestructuredaroundfourbroadthemesSource:AdaptedfromTCFD,2017Therecommendationtousescenario-basedanalysisisparticularlyinnovativeandencouragesforward-looking,long-termassessmentofthefinancialimplicationsofclimatechange.Thetimingandmagnitudeoftheeffectsofclimatechangeoncompanies’businessmodels,strategiesandfinancialperformanceisuncertain,andthemostsignificanteffectsarelikelytoemergeoverthemedium-to-longterm.Toappropriatelyincorporatethesepotentialeffectsinstrategicdecisions,andtoovercomethe‘tragedyofthehorizon’,organisationsshouldconsiderthepotentialevolutionofclimate-relatedrisksandopportu-nitiesovertimeundervariousconditions,aswellastheirpotentialimplications.Onewaytoconductthistypeofassessmentisscenario-basedanalysisofarangeofplausiblefuturestates.Inparticular,theTCFDrecommendstheuseofa2°Corlowerscenariotostress-testfinancialperformanceagainstalow-carbontransitioninlinewiththeParisAgreement.TheUNEPFIBanking,InvestorandInsurancePilotsonTCFDAdoptionaimtoexpandthelistofscenariosexploredtoamoreambitious1.5°CscenarioandanNDCimplementation,3°Cscenario.Engagementwithclimate-relatedrisksandopportunitiesisdoublyrelevantforinsti-tutionalinvestorsandotherfinancialinstitutionssincetheyactasbothconsumersandissuersofclimate-relateddisclosures.Investorsmustassessandmanagematerialriskstotheirportfolio.Thisnecessitatesahighdegreeoffamiliaritywiththedriversoffinancialperformanceofindividualinvesteecompanies.Forthis,investorsrelyoninvesteesforinformationrelevanttotheassessmentofrisksandopportunitiesmaterialtotheirbusi-ness.Atthesametime,investorsmustissuetheirownfinancialdisclosureincorporatingthisinformation.ManyinvestorsinthePilotGrouparealreadyexperiencingincreasingdemandfromseveralstakeholdersincludingregulators,beneficiaries,clients,andthepublicatlargeforclimate-relateddisclosure,andcitethisasakeymotivationforworkingtogetheronUNEPFIandotherplatformsdedicatedtodevelopingtherequiredcapacityandtools.Asholdersoflargeportfolios,investorsareexposedtorisksacrosssectors,geog-raphiesandfinancialinstruments,andtheircollectiveactionscanhavesubstantialimplicationsforglobalfinancialstabilityandclimate-relevantfinancialflows.Institutionalinvestors,alongsidecommerciallendersandotherfinancialinstitutionsprovidethecapitalthatfuelsthedevelopmentoftherealeconomy.Forinvestors,climatechangeriskscanbeparticularlyimportantowingtothelongertimehorizonoftheirasset-liabilitymanage-ment,theirexposuretoequityandunsecureddebt,andtheiruniversalexposureacrosstheeconomy.Atthesametime,themagnitudeandconcentrationofinvestorexposuretoclimatechangecanbedifficulttoassessgiventhesizeanddiversificationoftheirportfolios.20ChangingCourseIntroductionAsaresult,theUNEPFIInvestorPilotonTCFDAdoptionhasaimedtoadvanceindustrycapacityonscenario-basedanalysisandseestheseassessmentsashavingfivekeycomponents:1.Choosing(ordesigning)arangeofscenarios.Scenariosshouldexploreseveralofthekeycategoriesofuncertaintyrelatedtoclimatechange,suchas—onthetransitionsideofclimatechange—policytimingandstringency,geographicaldispersion,relativetechnologycosts,and—onthephysicalsideofthechallenge—theevolutionofboththeseverityandfrequencyofextremeweathereventsaswellastheunfoldingofchronicdevelopmentssuchassea-levelrise.2.Selectingafinancialmodellingmethodology.Climateriskscanbeincorporatedintodifferentfinancialmodellingmethodologies,andwhichsetofmethodologiestousemustbedetermined.Inparticular,itisimportanttodecidewhethertousemacro-economicmethodologies(thatgofrommacroeconomicimpactstoassetclassimpacts)orbottom-upmethodologies(thatgofromasset-levelcash-flowimpactstoassetclassimpacts),orwhethertocombinethese.3.Measuringriskatthesector,country,andpotentiallyassetclasslevel.Afirststeptomeasuringthefinancialimpactsofpotentialfuturepathwaysistomeasureriskattheaggregatelevel,beitforsectorsorcountries.4.Measuringriskatthecompanylevel(attheleveloftheissuersofsecurities).Institutionalinvestorscanalsogooneleveldeepertoanalysetheexposureofindividualcompaniesintheirportfoliotoclimate-relatedrisksandopportunities.Thiswouldincludeselectingafinancialmodellingmethodologyforquantifythecompany-orsecurity-levelimpacts.5.Aggregatingriskstotheportfoliolevel.Finally,aggregatingriskstotheportfoliogivesinvestorsacomprehensiveoverviewoftheirexposuretoclimate-relatedrisksandoppor-tunitieswhichinturnenablesthemtoissuedisclosuresattheportfolioandinstitutionallevels.Thisimpliesthatthemethodologycoversallcomponentsoftheirportfolioonwhichclimatechangeislikelytohavematerialimpacts.Itshouldbenotedthat,whilescenarioanalysiscanbeausefultooltoexploreanddisclosethepotentialimpactsofanuncertainfuture,itdoesnotprovidepreciseforecastsandshouldnotformthesolebasisforcorporateorinvestordecision-mak-ing.Thepurposeofscenarioanalysisistoexploreseveralplausibleand‘best-available’‘what-if’scenarios,ratherthantopreciselyforecastthefuture.Duetothecomplexnatureofforecastingtherelationshipbetween(i)theeconomyandGHGemissions,(ii)atmosphericGHGconcentrationsandtheclimatesystem,and(iii)theclimatesystemandtheeconomy,everyscenario,asmuchaseveryscenarioanalysismethodology,reliesonmanyassumptions.Thismeansthatanynumberderivedfromsuchmethodologiesshouldbeusedwithcautionandfullyevaluatedinthecontextofthescenario’sandmodel’sunderlyingassumptions.Thisincludesvarious,necessarysimplifyingassumptionsrelatingto,amongotherthings,theavailabilityofabatementtechnologies,marketstructures,regionalgranularity,andmecha-nismsforpolicyimpacts,suchascarbonpricing.1.3.IMPLEMENTATIONOFTHETCFDRECOMMENDATIONSTODATEManynationalandlocalgovernmentshavetakenstepstomandateESGriskdisclosureforcorporationsandinvestors;however,thesedonotusuallyrequireforward-lookingdisclosureasrecommendedbytheTCFD.Investorsbenefitfromcorporatedisclosureonriskduetotheirexposuretocorporateperformancebutarealsothemselvesrequiredtoreportonrisksinmanyjurisdictions.Todate,regulationhasfocusedonassessmentofcurrent,short-termriskexposure,ratherthanforward-lookingassessmentsasrecommendedbytheTCFD.In2016thePRIidentifiesaround300policyinstrumentsinthelargest50economiesintheworld,focusingonESGdisclosureforandfrominvestors(PRI,2016).Thesearedividedintopensionfundregulations,stewardshipcodeswhichgoverntheinteractionsbetweeninvestorsandinvesteecompanies,andcorpo-ratedisclosureguidelines,whichhelpinvestorsaccessdataonESGrisksandopportunities.However,italsofoundthatmanyinvestorsarescepticaloftheeffectivenessofthesemeas-uresduetoweakpolicydesignandmonitoringaswellasinconsistenciesacrossgeographies.21ChangingCourseIntroductionSomeinitiatives,regulatorsandorganisations,suchastheEuropeanCommission,areconsideringalignmentwiththeTCFDrecommendations.January2019sawthepublicationoftheEuropeanCommission’sTechnicalExpertGrouponSustainableFinancereportwhichincludedasetofguidelinesaligningtheNon-FinancialReportingDirective(NFRD)withtheTCFDrecommendations,andexpandingonthem,asBox1illustrates(TechnicalExpertGrouponSustainableFinance,2019).TheNFRDappliestolargepublic-interestcompanieswithmorethan500employees,whichcoversapproximately7,400companiesandgroupsacrosstheEU,including,amongothers,listedcompanies,banksandinsurancecompanies.Banksandinsurancecompaniesshouldincludetheimpactoftheirinvestingandassetmanagementactivities.NotalltherevisionsproposedintheJanuary2019reportwouldbeexpectedofallcompanies—some,suchasscenarioanalysis,wouldbeexpectedonlyofthosewithsignificantexposure.UpdatedguidelinesfromtheEuropeanCommissionareexpectedinJune2019.Althoughnotaregulatingbody,butratheralargeinternationalinvestornetwork,thePRIhasalsoannouncedthatTCFD-basedreporting,butnotpublicdisclosure,istobecomemandatoryforsignatoriesstartingin2020(PRI,2019).ThePRIprovidesadirectoryofclimatescenariotoolsonitswebsite.Box1:Climate-relateddisclosureregulationintheEU:TheNon-FinancialReportingDirective(NFRD)RevisionstotheNon-BindingGuidelines(NBG)oftheNFRDtoincludemoreguidanceonclimate-relatedreportingarecurrentlyunderdevelopmentandsettobefinalisedinJune2019.TheEuropeanCommissionhassetupaTechnicalExpertGroup(TEG)onsustainablefinancetoassistitindevelopingfournewcomponentsofregulation:(i)ataxonomy,orEUclassificationsystem,todefinewhetheractivitiesareenvironmentallysustainable;(ii)anEUStandardforgreenbonds;(iii)benchmarksforlow-carbonstrategiesforinvestment;and(iv)guidanceonhowtoimprovecorporatedisclosureofclimate-relatedinformation.ThefinalworkstreamreleaseditsreportforpublicconsultationinJanuary2019,andwill,afteranotherroundofconsultation,formthefoundationoffutureclimate-relateddisclosureintheEU.ProposedrevisionstotheNFRDhavebeenexplicitlybasedontheTCFDrecommendations,butexpandontheminseveralkeyways:◼Explicitalignmentwithnationalandinternationalpolicycommitments.TheTEGrecom-mendsthedisclosureofKPIslinkedtonationalandinternationalclimatepolicy,explic-itlyreferringtotheParisAgreementandEUlong-termstrategicpolicy.TheJanuary2019reportalsocallsforambitiouscorporateactiontowardthesegoals:‘Moreprivatecapitalflowsneedtobeorientedtowardssustainableinvestmentstoclosetheyearly€180-billiongapofadditionalinvestmentsneededtomeettheEU’senergyandclimate2030targets.’Withthisaddition,theNFRDtakesamuchmoreexplicitstanceontheneedforcorporateassessmentanddisclosureofcontributionstothefulfilmentofclimatecommitmentsthanthattakenbytheTCFD.◼Incorporationofclimate-relatedissuesintobusinessmodelconsiderations.ParticularlygiventheEU’sclearclimatepolicypathwayandtherisingpricesofemissionspermitsundertheEUEmissionsTradingScheme(ETS),theTEGseesaneedforcompaniestodescribehowtheirbroaderbusinessmodelwilladapttothesechanges.Thisalsoincludesthepotentialinteractionsofthebusinessmodelwiththepotentialimpactsonclimatechangeofthecompany’sactivities,andwiththecompany’spotentialcontributiontopublicclimatepolicytargets.Accordingly,scenarioanalysisisthemostimportantgapinclimate-relatedreport-ingtodate.Bothcorporateandfinancialorganisationshaveprovidedlimitedinformationontheirresiliencetodifferentclimatescenariosintheirfinancialreporting,accordingtotheSeptember2018TCFDStatusReport(TCFD,2018).Notonlyarethecorresponding‘recommendeddisclosures’intheTCFDframeworkattheheartofitsinnovation(becausetheyrepresenttheclearestresponsetoMarkCarney’s‘tragedyofthehorizon’),accordingtotheTCFDtheyhavetodatescenarioanalysisoutputshavebeentheleastdisclosed.Thosethatdidreportontheresultsofscenario-basedanalysistendedtobeintheenergy,mate-rialsandbuildings,andinsurancesectors.Manyothersstatedthattheyintendtoconductscenarioanalysisinthenearfuture.22ChangingCourseIntroductionAsteptowardsencouragingmorescenario-basedanalysisamongfinancialinsti-tutionscouldbetheincorporationofclimatechangeintoregularstresstestsbyfinancialmarketregulators.FollowingtheDutchgovernment’sannouncementin2018ofa95%emissionsreductiontargetby2050(comparedto1990),theDutchcentralbankconductedanenergytransitionriskstresstestforthecountry’sfinancialsystem.Thisincludedfourtailriskscenarios(‘policyshock’,‘technologyshock’,‘doubleshock’and‘confidenceshock’6)andresultssuggestedthatadisruptiveenergytransitioncouldleadtosizeable,butmanageable,lossesforfinancialinstitutions(DeNederlandscheBank,2018).Inthesameyear,theEuropeanInsuranceandOccupationalPensionsAuthority(EIOPA)includedanaturalcatastrophescenarioinitsstress-testingoftheEuropeaninsurancesector(EIOPA,2018).Similarly,theBankofEnglandhasindicatedplanstoincludethepotentialimpactsofclimatechangeinitsstresstestsassoonastheendof2019(Binham&Crow,2018).Inthefirstinstance,theseanalysesservetohighlighttherelevanceofclimatechangetofinancialstability.Inthefuture,regulatorscouldmakeitmandatoryforfinancialinstitu-tionstostress-testtheirportfoliosagainstacommonsetofscenarios.InApril2019,theCentralBanksandSupervisorsNetworkforGreentheFinancialSystem(NGFS)releasedrecommendationsonhowcentralbanks,supervisorsandpolicymakerscanworktowardsensuringtheresilienceofthefinancialsystemtoclimate-relatedrisks(NGFS,2019).TheNGFSisagroupofcentralbanksandsuper-visorsfosteringthedevelopmentofenvironmentandclimateriskmanagementinthefinancialsector,andthemobilisationofmainstreamfinancetosupportalowcarbontran-sition.MembershavecollectivelypledgedsupportfortheTCFDrecommendationsandencouragedallcompaniesissuingpublicdebtorequitytodiscloseinlinewiththerecom-mendations.TheNGFShasalsoidentifiedscenarioanalysisasanimportanttooltohelpcentralbanksandsupervisorsassesstheimpactsofclimatechangeonthemacroeconomy,thefinancialsystemandfinancialfirms.TheNGFSisstillintheprocessofconsideringhowscenarioanalysiscouldbeimplementedintoauthorities’toolkits.Thefirstcomprehensivereportexpressesfourrecommendationsforcentralbanksandsupervisors:(i)integratingclimate-relatedrisksintofinancialstabilitymonitoringandmicro-supervision,(ii)integratingsustainabilityfactorsintoown-portfoliomanagement,(iii)bridgingdatagaps,and(iv)build-ingawarenessandintellectualcapacityandencouragingtechnicalassistanceandknowledgesharing.Thereportalsoissuestworecommendationsforpolicymakers:(v)achievingrobustandinternallyconsistentclimateandenvironment-relateddisclosure,and(vi)supportingthedevelopmentofataxonomyofeconomicactivities.Insummary,whilesomeactorsinthefinancesector,especiallyinafewleadingcountries,havestartedtousescenario-basedanalysisforclimate-relatedriskandopportunityassessment,itisfarfromcommonplace.Thenextsectionwillsumma-riseexistingmethodologiesforscenario-basedportfolioanalysisinlinewiththeTCFDrecommendations.6.Thefourglobalscenariosexploretechnologyandpolicybreakthroughs,andcombinationsthereof.The‘policyshock’scenarioseestheeffectiveglobalcarbonpricerisinggloballybyUSD100/tCO2duetoadditionalpolicymeasures.The‘technologyshock’scenarioseestheshareofrenewableenergyintheenergymixdoubleduetoatechnologicalbreakthrough.The‘doubleshock’scenarioseesbothdevelopments(risingcarbonpricesandtechnologybreakthrough)coincide.Finally,the‘confidenceshock’scenarioseescorporationsandhouseholdspostponeinvestmentsandconsumption,duetouncertaintysurroundingpolicymeasuresandtechnologydevelopments.23ChangingCourseOverviewofMethodologies2.OVERVIEWOFMETHODOLOGIES7Thissectionprovidesabroadoverviewofsomeoftheavailablemethodologiesforscenariodesignanduseintheanalysisofthephysicalandtransitionrisksofclimatechange.ThefulllistofscenarioprovidersandassessmentmethodologiesexaminedforthepurposeofthisreportcanbefoundintheAppendix.Thislistisnotintendedtobecomprehensiveoranendorsementofanyonemethodology;rathertheintentionistohigh-lightthemainpointsofconvergenceaswellaskeydifferencesandareasfordevelopmentacrossarangeofmethodologies.Informationaboutthemethodologiesisbasedonpubliclyavailablematerials,exceptforthepilotproject’smethodology,whichisdetailedinSection3.Toeffectivelydescribethemethodologiesforbothtransitionandphysicalriskassessment,thisreportmapsthemseparatelyagainsttheirtreatmentofthefollow-inganalyticalelementsasillustratedinFigure3:1.Scenarios.Transitionandphysicalriskscenariosusedbydifferentmethodologiesmayconvergeordivergeonmanyunderlyingassumptions,suchaspopulationgrowthanddegreeofinternationalcooperation;however,forthepurposesofthismapping,thefocusliesontheirtemperatureoutcome.ThisisinlinewiththeTCFDrecommendations,whichproposetheexplicituseofatleasta2°Cscenario.2.Hazards(orshocks).Physicalandtransitionriskscanhaveseveralmanifestationsandmethodologiesdonotalwayscoverthefullsetofpossiblehazards.Physicalriskfromclimatechangecantaketheformofacuteorchronichazards,whiletransitionriskcanarisefrompolicyandtechnologychanges(orshocks).3.Impactassessmentmethodologies.Atthecoreofeachmethodologyliesitsimpactassessmentmethodology.Thiscomponentisthemostimportantaspectincomparingmethodologiesforscenario-basedanalysis.Thisreportusesthesamescope-depthframe-worktodistinguishbetweenmethodologiesinthephysicalandtransitionrisksectionsofthissection:i.Thescopeofassessmentcanextendacrossacounterparty’s8macroeconomicenvi-ronmentanditsvaluechain(specificallythesupplychain,operationsandassets,andmarket).ii.Thedepthofassessmentacrossthemacroeconomicenvironmentandvaluechaindependsonwhethermethodologiesdistinguishbetweenacounterparty’sexposure,sensitivityorvulnerabilityandadaptivecapacityinrelationtotherisk.Sections2.2and2.3providemoredetailedexplanationsofthisframeworkforphysicalandtransitionriskassessments,respectively.4.Outputs.Outputsofscenario-basedriskassessmentscanbeeitherqualitativeorquanti-tative,oracombinationofthetwo.Qualitativeoutputsmostoftentaketheformofriskratings,whichevaluateriskforeachcounterpartyonafinitescale.SomemethodologiesproducingquantitativeoutputsattempttoquantifyfinancialrisktothecounterpartytoproduceauniqueValueatRiskfromclimatechangefigureforeachcounterparty,whileothersexamineaveragereturnsorborrowercreditratings.5.Resolutionofanalysis.Dependingontheirtargetaudience,methodologiesexamineimpactsonvariouscounterparties,rangingfromcountriestoindividualcorporatefacilities.7.Reviewoftoolkitswasbasedonpubliclyavailabledocumentationandinterviewswithproviders.Effortshasbeenmadetoensurethemethodologiesarerepresentedasaccuratelyaspossible8.Thetermcounterpartyisusedthroughoutthisreporttorefertoentitiesaffectedbytherisk,rangingfromcountriestocompaniesandindividualfacilities.Assuch,differentmethodologiesexaminedifferentcounterparties,butmaydosousingsimilarmethodologies24ChangingCourseOverviewofMethodologiesFigure3:Analyticalelementsofscenario-basedimpactassessmentsSource:VividEconomics2.1.SCENARIODESIGNThefirststepinscenariodesignisconstructingappropriatenarrativesforunder-lyingassumptionsaroundtheclimate,theeconomy,andsocieties.Theoverarchingassumptionofmanyscenariosiseitheraglobaltemperaturetarget,suchas2°Cofwarmingabovepre-industrialtemperaturesby2100,oraGHGemissionspathway,whichcanbemappedtotemperatureandotherclimatechanges.However,therewillbeseveraladditionalnarrativeassumptions,whichmayincludecarbonpricingdevelopmentsovertime,radiativeforcingvaluesoremissionspathways,energydemandandmix,driversofdemandsuchaslifestylechanges,resourceavailability,andrelativetechnologycosts.Whichvariablesenterthemodelasassumptions,andwhicharedeterminedwithinthemodel,willdependonthemodelathandanditsfocusareas.Theseassumptionscanthenbetranslatedintoconsistentscenariooutputsforanal-ysisusingvariousmodels,rangingfromsector-andphysicalhazard-specificmodelstointegratedassessmentmodels(IAMs).Assumptionsneedtobetranslatedintovari-ablesusingmodelsthatareconsistentacrossthesysteminquestion,beitaspecificsector,theentireeconomy,ortheclimatesystem.Toillustrate,assumptionsaboutvehiclestockandcomposition(electricornon-electric)willaffectdemandforfossilfuelsandmodellingthesetwoseparatelywouldleadtoinconsistentoutputs.Sector-specificmodelsfocusonconsist-encywithinafocussector,hazard-specificmodelstranslateclimatepathwaysintoimpactsonspecifichazards,suchascoastalflooding,andIAMsoftenconsistofacombinationofsector-specificmodelstolinkenergy,economyandclimatevariables.Examplesofthesemodelsinclude:◼Land-usemodels.Thesemodelstracetheimpactsofclimatechangeandmitigativeactiononland-usesectors.Therearenumerousexamplesofland-usemodels,suchastheInternationalInstituteforAppliedSystemsAnalysis’s(IIASA)GlobalBiosphereManagementModel(GLOBIOM)coveringagriculture,forestryandbioenergy;thePotsdamInstituteforClimateImpactResearch’s(PIK)ModelofAgricultural25ChangingCourseOverviewofMethodologiesProductionanditsImpactontheEnvironment(MAgPIE)coveringagriculture,bioen-ergyandwater;andUniversityofBonn’sCommonAgriculturalPolicyRegionalisedImpact(CAPRI)modelcoveringagriculture.Forfurtherinformationontheseandotherland-usemodelsusedinclimate-relatedassessments,seetheJRCScienceforPolicyReportonglobalagricultureby2050(Meijletal.,2017).◼Energysystemmodels.Themostwell-knownandwidelyusedscenariosgeneratedbyenergysystemmodelsarethoseprovidedbytheInternationalEnergyAgency(IEA),whichcapturetheentireenergy-usechainoftheeconomybutexcludenon-energysectorssuchasland-useandindustrialprocessemissions.IRENA’sRemapscenariodevelopsaplanfordoublingtheshareofrenewablesintheworld’senergymixby2030,whileGreenpeaceexaminesafullydecarbonisedenergysystemby2050initsAdvancedEnergy[R]evolutionscenario.Furtherexamplesofscenariosfromenergysector-fo-cusedmodelsincludeShell’sMountains,OceansandSkyscenarios,aswellastheBPEnergyOutlook.◼Climatemodels.Thesecomputer-basedrepresentationsoftheatmosphereareusedtomodeltheresponseoftheclimatetoGHGemissions.Climatemodels,alsoknownascirculationmodels,simulatetheevolutionofclimaticvariablesincludingtemperature,precipitationandsea-levelriseataspatialresolutionofbetween10and300km,typicallyupto2100.ClimatemodelsvaryintheirassumptionsandthereforeproducevaryingestimatesoftheimpactofGHGemissionsontheclimate.Typically,theoutputsfrommultipleclimatemodelsarecombinedtoproduceacentralestimateandanindicationofuncertainty.28climatemodelsareusedinthiswaybytheIPCCinitsclimatechangeAssessmentReports.◼Hazardmodels.Hazardssuchasdrought,flood,hurricanesorsea-levelriseareassessedwithhazard-specificmodels.Thesemakeuseoftheoutputsofclimatemodelstomodelchangesinriskbetweenpresentdayandfutureconditions.Forexample,modelsoffuturefloodriskuseestimatesofthechangeinlikelihoodofextremeprecip-itationeventsderivedfromclimatemodeloutputs.Theseestimatesarethencombinedwithhydrologicalmodelstoproduceestimatesofchangesinfloodriskundervariousclimatescenarios.Similarly,theoutputofclimatemodelscanbeprocessedtoproduceregionalestimatesofchangesindrought,hurricaneorriskfromotheracutehazards.ExamplesofhazardmodelsincludeClimateCentral’sSurgingSeasglobalmodelofsea-levelriseandtheWorldResourcesInstitute’smodelsofwaterstressdeliveredintheWaterRiskAtlas.◼Macroeconomicmodels.Computablegeneralequilibrium(CGE)modelsarethemostcommonlyusedmacroeconomicmodels.Theyallowimpactassessmentofchangesinonepartoftheeconomyonthewholesystem.Theyincludevariablessuchasanecono-my’sfactorsofproduction(capitalandlabourallocation),sectoralcomposition,interna-tionaltradeandvariousothermacroeconomicvariables.Examplesofsuchmodelsusedinclimate-relatedassessmentsincludeWageningenEconomicResearch’sMAGNETmodel,OrtecFinance’suseoftheCambridgeEconometricsE3MEmodel,andVividEconomics’useoftheVividEconomy-Wide(ViEW)model.◼Integratedassessmentmodels(IAMs).IAMsconsiderthesocioeconomicfactorsdrivingGHGemissions,thebiogeochemicalcyclesandatmosphericchemistrythatdeterminehowtheseemissionsaffecttheclimateand,throughthis,humanwelfare.Theyoftenembedmanyofthemodelsreferredtoabove,suchasanenergysystemsmodel,andaland-useandaclimatemodel.ExamplesofsuchmodelsincludethePotsdamInstituteforClimateResearch(PIK)RegionalModelofInvestmentsandDevelopment(REMIND)model,theGlobalChangeAssessmentModel(GCAM)developedbytheJointGlobalChangeResearchInstitute(JGCRI),theTIMESIntegratedAssessmentModel(TIAM)usedbyvariousresearchinstitutes,andPBLNetherlandsEnvironmentAssessmentAgency’sIMAGEmodellingframework.IAMsareoftenusedtoproduceclimatescenarioswhichcombinetheanalysisofphysicalandtransitionimpacts.Thesescenariosaimtoidentifytheoptimallevelofpolicy,acknowledgingtheinteractionsbetweenpolicyandphysicalimpacts.ThemostcommonlyusedprovideroftheseintegratedmodelsistheIPCCthroughtheRepresentativeConcentrationPathways(RCPs).TheRCPscombineassumptionsonfutureclimatepolicy26ChangingCourseOverviewofMethodologiespathwayswithclimatemodelling.Forexample,theRCP8.5scenariodescribesafuturewherecontinuoususeoffossilfuelsresultsinrisingCO2andmethaneemissions,withfallingemis-sionsgrowthratespost-2050.Inparallel,theSharedSocioeconomicPathways(SSPs)narra-tivesprovideconsistentassumptionsarounddemographics,urbanisation,economicgrowthandtechnologydevelopments,settingthestageonwhichemissionreductionsmayormaynotbeachieved(Hausfather,2018).Carbonbudgetsandnarrativesfromthesemodelsoftenformkeyinputsforotherscenariosthatfocusonareasoftheeconomyortheclimateinmoredetail.92.2.METHODOLOGIESFORPHYSICALRISKIMPACTASSESSMENTThissectionprovidesanoverviewofmethodologiesforphysicalriskimpactassess-menttodate.First,itdetailstheframeworkforcategorisingphysicalriskimpactmethod-ologiesaccordingtotheirscopeanddepth.Second,itprovidesahigh-levelmappingofexistingmethodologiesagainsttheirtreatmentoffivemethodologicalelements:scenarios,physicalhazards,impactassessment,outputsandresolutionofanalysis.Finally,itdrawsoutthefindingsfromthemappingintermsofkeycommonalitiesandareasthathavenotbeensignificantlyexplored.Physicalimpactsofclimatechangecantaketheformofacuteorchronichazards.Acutehazardsencompassextremeweathereventsthatareoftenhighlylocalisedandproduceimmediateimpacts,suchastropicalandextratropicalcyclones,wildfiresandfloods.Chronichazards,bycontrast,representtheslow,incrementalimpactsoflong-termchangesintheclimate.Thesecouldinclude,forexample,highertemperatures,risesinsealevels,themeltingofglaciers,desertificationorchangestoprecipitationpatternsandwateravailability.Figure4summarisestheframeworkfordistinguishingbetweendifferentmethod-ologiesforassessingphysicalimpactrisks.Fourimpactchannelsdescribethescopeofassessment:◼Macroenvironment.Extremeweathereventsoftendestroyoutputandreduceproduc-tivity,whilechangesinaveragetemperaturescouldweakenorstrengthenproductivitydependingonthestartingpoint.Thismeansclimatechangewillaffecttheaggregateoutputofgoodsandservices(orGDP)ofcountries.Insomeinstances,supply-sideshocksduetoclimatechangecouldalsocauseinflationarypressures,which,ifunan-ticipated,mayresultinchangesinrealinterestrates.Atthesametime,thedifferentialimpactsthatclimatechangehasoncountriescouldaffectregionaltradebalancesandexchangerates.Thesevariablescontributetothebroadermacroeconomicenvironmentofacounterparty,andchangestothemduetoclimatechangewillaffectacounter-party’seconomicperformance.Suchmacroeconomicimpactsarenotfullyreflectedinabottom-upassessmentlookingdirectlyatsupplychain,operationsandassets,andend-usemarkets(asdescribedbelow).◼Supplychain.Acuteorchronicphysicalimpactsofclimatechangecanhavesignificanteffectsontheavailabilityandpricingofinputsforacounterparty’sproductionprocesses.Thisisindependentofthelocationofthecounterparty’sownoperations,giventhatcomplexsupplychainsspantheglobe.DuringtheThaifloodsof2011,carmanufacturerToyotaexperiencedbusinessinterruptionatthreeofitsplantsineasternThailand—notbecausetheyweredirectlyaffectedbythefloods,butduetoashortageofpartsfromkeysuppliersinaffectedareas(TheAssociatedPress,2011).◼Operationsandassets.Themostdirectimpactchannelwouldbetheeffectsofaphysicalhazardonafirm’soperationsandassets.Thesecouldrangefromthelong-termlabourproductivityimpactsofpermanentlyhighertemperaturestobusinessinterrup-tionsduetoextremeweatherevents.Therearemanypossiblereasonsforassetdamageorbusinessinterruptionsfollowingextremeweatherevents:forcedevacuations,damagetophysicalassets(productionfacilities,infrastructureorrealestate),ormigrationoflabourforcecouldallcausedisruptions.9.Forfurtherelaborationontheinteractionsbetweenmodelslistedinthissection,refertotheSENSESproject(http://senses-project.org/).HeadedbyPIKandfundedbytheEuropeanResearchAreaforClimateServices,thisaimstoco-produceinteractivevisualisations,practicalguidelinesandmanualsforclimatechangescenarioswithseveralstakeholdersby2020.27ChangingCourseOverviewofMethodologies◼Market.Furtherdownthevaluechain,ifacounterparty’scustomers(orend-users)areaffectedbythephysicalimpactsofclimatechange,thiscouldaffectthedemandforitsproducts.Theremaybeimmediatedemandshocksfromextremeweatherevents,suchaswhendemandforconstructionmaterialssurgesafterahurricane,orgradualshiftsfromchronicchangestotheclimate,suchasareductioninskitourisminregionsexperi-encinggraduallywarmertemperatures.Figure4:FrameworkforcategorisationofphysicalriskimpactassessmentmethodologiesSource:VividEconomicsbasedonI4CE,2018Thedepthofassessmentdependsonamethodology’sunderstandingofacoun-terparty’svulnerabilitytotherisk,whichconsistsofthreecomponents:exposure,sensitivityandadaptivecapacity:◼Exposureofacounterpartytoaphysicalriskisdeterminedbyitsgeographicallocation,whichwilldeterminethelikelihoodofitbeingaffectedbyaclimatehazard.◼Sensitivitytothishazardwouldthenbedeterminedbyitsdependenceonfactorsmostlikelytobeaffectedbythehazard,suchasnaturalresources.◼Adaptivecapacity,orabilitytoadjusttothehazardandmitigateitseffects,refersexplicitlytothecapacitytoadapt,beitthroughchangingsuppliersorcustomerbase,orthroughadaptingassets,asopposedtotheadaptivecapacityofthecounterparty’ssuppliersorcustomers,whichareinsteadpartofitssensitivity.ThefullmappingofphysicalriskassessmentmethodologiesisprovidedinFigure5.Itsetsoutabroadoverviewofthecoverageofcurrentmethodologiesoffourcoremeth-odologicalelements:scenarios,physicalhazards,outputsandphysicalriskimpactassess-ment.Toprovidethenecessarycontextforeachmethodology,themapalsoincludesthelevelofanalysisofeachmethodology.Subsections2.2.1to2.2.5delvedeeperintotheresultsofthismapping.28ChangingCourseOverviewofMethodologiesFigure5:OverviewofphysicalriskassessmentmethodologiesPhysicalriskimpactassessmentScenariosRisksMacroSupplychainOperationsMarketOutputCounterparties<°2C2°C3°C�°4CPolicyTechnologyExposureSensitivityAdaptivecapacityExposureSensitivityAdaptivecapacityExposureSensitivityAdaptivecapacityExposureSensitivityAdaptivecapacityQuantitativeQualitativeFacilityFirmSectorCountryProvider427Acc1Acc2C4CDCWMerMIS()OFNote:427–FourTwentySevenphysicalriskscores,Acc1–AcclimatiseforUNEPFIBankingPilot,Acc2–AcclimatiseAwareforProjects,C4–Carbone4ClimateRiskImpactScreening(CRIS),CD–CarbonDeltaClimateValueatRisk,CW–ClimateWise(withVividEconomics)Managingthephysicalrisksofclimatechange,Mer–MercerTRIPframework,MIS–Moody’sInvestorsServicesovereignriskratings,OrtecFinance–Climate-savvyscenariossetSource:VividEconomics2.2.1.ScenariosMethodologiesforphysicalriskassessmentmostcommonlyincludeascenarioresultinginmorethan4°Cofwarmingrelativetopre-industrialtemperaturesaswellasatleastonelowertemperaturescenarioideallycompliantwiththeParisAgreement.Byrepresentingseveralclimatepathways,thesemethodologiesallowuserstodirectlyexploretheeffectsofalow-carbontransitioninlinewiththeParisAgreementonthephysicalimpactsofclimatechangerelativetoaworldwithunabatedclimatechange.Intheshort-to-mediumterm,thephysicaleffectsunderadecarbonisationpathwaywouldbesimilartooneofunabatedclimatechange.However,formedium-tolong-termanalyses(from2040),includingabelow2°Cscenario,particularlyincombinationwithoneof4°Cofwarming(orhigher),couldhighlightthesignificantdifferencesinexpectedphysicaleffectsofclimatechangeasrecentlyhighlightedin(IPCC,2018).Forinstance,oneprovider,OrtecFinance,conductsanalysisfora2100horizon,including4°Candwellbelow2°Cscenarios,andcombinesphysicalandtransitionriskassessment.Thisallowstheassessmentofboththechangingphysicalrisksamongsignificantlydifferentpolicypathwaysaswellastheirtrade-offswithtransitionriskovertheshort-to-longterm.Otherprovidersconsideronlyasingletemperaturepathwayorincorporateforward-lookingdatainotherways.Acclimatise(AwareforProjects)examinesGlobalClimateModel(GCM)projectionsinlinewiththeIPCC’sRCP8.5,likelytoresultinmorethan4°Cofwarming(IPCC,2014b).Thisdataisreliedonforthosehazardsforwhichitisavailable,inadditiontohistoricaldataonobservedeventsinthelocationofaproject.Moody’sInvestorsServicereliesmainlyonhistoricaldataonextremeweathereventsbut29ChangingCourseOverviewofMethodologiesdoestakeintoaccountthelikelylonger-termeffectsofdifferentclimateprojectionsfromtheWorldBankandtheInternationalMonetaryFund,aswellasvulnerabilityscoresfromtheUniversityofNotreDameGlobalAdaptationIndex(ND-GAIN),whichrelyonRCP4.5projections(Chenetal.,2015)forsomeindicators—ascenariothatislikelytoresultinaround3°Cofwarming(IPCC,2014b).CarbonDelta(UNEPFIInvestorPilot)focusesonaBusinessasUsual(BaU)scenario,offeringan‘averageimpact’anda‘tailrisk’variationwhichexploresthe95thpercentileofphysicalimpacts.2.2.2.PhysicalhazardsWhiletheabovemethodologiescoveracutehazards,analysisofchronichazardsislesscommon.Emphasisofmethodologiestodatehasbeenonacuteextremeweathereventslinkedtoassetimpairmentandbusinessinterruptions,ratherthantheeffectsofgradualchangesintheclimateonabroadrangeofbusinessactivities.Thisislikelytobelinkedtothedifferenttemporalnatureofthesehazards:acuteclimateshocksarelikelytohaveshort-livedeffectsonabusiness,forexample,throughtemporarybusinessinterrup-tion,whilechronicchangesintheclimateleadtolonger-termimpactsandmorefundamen-talchangesinthenatureofthebusiness.Thesecouldincludegradualchangesinworkerproductivityorwateravailabilityovertime,aswellasthelossofviabilityofpreviouslyviablebusinessmodels.Itisthereforelikelythatdifferentmodellingcapabilitiesareneededtoestimatethetwotypesofhazard.Notonlydothesetwomanifestationsofphysicalclimatechangevaryconsidera-blyandhencerequiredifferentmodellingmethodologies,thespecifichazardscoveredwithineachvarysignificantlytoo.Mostmethodologiescoveratleastonehazardlinkedtochangesintemperatureorprecipitation.Foracutephysicalrisks,themostcommonlycoveredhazardsarewildfires,coastalfloodsandtropicalstorms.Extremetemperatures,heatwaves,extremeprecipitation,droughts,landslidesandriverfloodsarealsocommon.Amongmethodologiesthatcoverchronicphysicalhazards,mostincludechangesinaveragetemperature.TheCarbone4methodologycoversaparticularlywidesetofrisks,manyofwhicharenotincludedinanyoftheothermethodologies.Itistheonlyonethatexaminestheacuteriskofgroundwaterfloodsandthechronicrisksofurbanheatislands,coastalerosion,andbiodiversitymigrationandloss.2.2.3.ImpactassessmentmethodologiesMostmethodologiesfocusontheimpactsofphysicalclimatehazardsonacoun-terparty’soperationsandassets,whichsomethensupplementwithassessmentofthebroadervaluechain.Forcorporatecounterparties,thedisruptionoftheirownoper-ationsanddamagetotheirphysicalassetsconstitutethemostdirectchannelsofimpact,asdescribedabove.Asaresult,thisformstheuniquefocusformanymethodologies.AllmethodologiesexceptforMoody’sInvestorsServiceandOrtecFinance(whichfocusonclimate-informedmacroeconomicrisksatacountrylevel)examinetheimpactsofphysicalhazardsonoperationsandassets.Theothertwoelementsofthevaluechain(upstreamanddownstream)arelesswellstudied:FourTwentySeven,Acclimatise(UNEPFIBankingPilot)andCarbone4providethemostcomprehensivepicture,bycoveringafirm’sexposureandsensitivitytoallthreeimpactchannelswithinthevaluechain.However,forallmethodologies,thegranularityfor‘upstream’supplychainand‘downstream’marketimpactassessmentisatthecountry–sectorlevel,meaningimpactsdependonthecountriesoforiginorsaleandtherelevantsector,ratherthanbottom-upanalysisofsuppliersandcustomers.Mercer(TRIP)includesanalysisofthesensitivityofacounterparty’ssupplychainbyexaminingtheimpactsofchangingaccesstoresources,particularlywater,ontheenergyandagriculturalsectors.Analysisofthemacroeconomicenvironmenthasexclusivelycoveredsovereigncounterpartiestodate,andsomeprovidersincludetheresultsincompany-levelriskassessments.FourTwentySeven,Carbone4andMoody’sInvestorsServiceprovideriskratingsforsovereignswhich,bynecessity,considercountries’macroeconomicenviron-ments.FourTwentySevenandCarbone4includetheresultsoftheirsovereignriskassess-mentsintheircompany-levelanalyses.FourTwentySevenincludesitscountryclimaterisk30ChangingCourseOverviewofMethodologiesindicatorsinthesupplychainandmarketriskanalysesofcompanies,whichconsidercoun-triescontributingtothesupplychainandcountrieswhereproductsaresold.Mercer’sTRIPframeworkconductsanalysisfortheUSusingsectoraldamagefunctionsandextendstheseresultstoothercountriesusingsovereignexposureandsensitivityindicators.Integrationofmacroeconomicimpactsintotheassessmentofcorporatecounterpartiesemergesasaclearareaforpotentialfuturedevelopment.OrtecFinancereliesontheCambridgeEconometricsE3MEmacroeconomicmodeltoassessthecountry,sectorandtechnology-levelimpactsofclimatechangeonvariablessuchasGDP,inflationandinterestrates.OrtecFinancethenintegratesthisintoastochasticfinancialmodelinordertoexpresstheserisksintofinancialriskmetrics.Whileexposureandsensitivityofcounterpartiesarecommonlyassessed,fewmethodologiesincludemeasuresoftheiradaptivecapacitytomitigatephysi-calclimaterisk.Acrossthefourimpactchannels,methodologiesconsistentlycoveracounterparty’sexposureandsensitivity,buttherearefewmethodologiesthatincludeitsadaptivecapacityintheirimpactassessment.TheClimateWise(withVividEconomics)methodologyincludes‘adaptationmodelling’,whichincorporatesproperty-andcommu-nity-leveladaptationmeasuresintotheanalysisofphysicalimpactsonUKrealestate.10Thisanalysishighlightsthepotentialreductioninlossesassociatedwithmoreresilientprop-erties,beitthroughnew-buildsorretrofits.Moody’sInvestorsServicemeasuresacountry’sadaptivecapacitythroughitseconomicandfiscalflexibilityinsettingupinstitutionsneededtofosterresiliencetoclimate-relatedshocks.Economicdiversification,politicalstabilityandfiscalresponsibilityaretakenasdeterminantsofacountry’scapacitytorespondeffectivelytoashockandtheassociatedcosts.FourTwentySevenandCarbone4usesimilarprox-iestoassesscountries’capacitytorespondtophysicalclimateimpactsintheirsovereignriskratings.OrtecFinance,throughtheCambridgeEconometricsmacroeconomicmodel,capturescountries’developmentlevelsandeconomicdiversification,whichcanalsoactasproxiesofcapacitytorespondtoshocks.Theseexampleshighlighttheimportanceandadditivenatureofadaptivecapacityanalysisinphysicalriskimpactassessments.However,theyalsohighlightthatthistypeofanalysisiscurrentlyverydifficulttoundertakeunlessitiseitherhighlyregionallyfocused(asinClimateWise(withVividEconomics))orhighlyaggregated(asinMoody’sInvestorsServiceandCarbone4).Thisisduetoalackofavailabledataontheresilienceofindividualphysicalassetsattheglobalscale.IncreaseddisclosureasencouragedbytheTCFDrecommen-dationscouldplayavitalroleinmakingthisdataavailableandcorrespondingtypesofassessmentspossibleinthefuture.2.2.4.OutputsSomemethodologiesprovidequalitativeriskratings,whichvaryconsiderablyinthelevelofdetailtheyprovide.Allmethodologiesprovidetheseriskratingsonanindi-vidualhazardbasis.Carbone4andFourTwentySevenevaluateriskforallcounterpartiesandprovideratingsfromleastexposed(0)tomostexposed(100)withinthesampleofcompaniestheyexamine.Atthelessgranularendofthespectrum,Acclimatise’sAwareforProjectsratestheriskofaprojectagainsteachphysicalhazardaseither‘High’,‘Medium’or‘Low’,andMoody’sInvestorsServiceratessovereignsusingfourratings,from‘Leastsuscep-tible’to‘Mostsusceptible’.Othermethodologiesprovidequantitativefinancialoutputs:Acclimatise(UNEPFIBankingPilot),CarbonDelta(UNEPFIInvestorPilot),ClimateWise(withVividEconomics),MercerandOrtecFinance.FortheUNEPFIBankingPilot,Acclimatisedevelopedamethodologythatallowsbankstoassesstheimpactsofphysicalclimateriskonrevenuesandcostsofgoodssold,whichareusedtoevaluatechangesinprobabilityofdefaultofcounterpartiesandsectorportfoliosintheagricultureandenergysectors.Forrealestateassets,changesinloan-to-valueratiosareusedtodeterminethevalueatriskfromclimatechangeunderdifferentfuturepathways.Thismethodologyisthereforeprimarilyaimedatbanks,althoughitmaypotentiallybeadaptedtoinvestors’needs.BothCarbon10.HazardmodellingonthisprojectwasconductedbySayersandPartnersLLPandETHZurich.31ChangingCourseOverviewofMethodologiesDelta(UNEPFIInvestorPilot)andClimateWise(withVividEconomics)produceafinan-cialestimateofaverageannuallossesforindividualcounterparties.CarbonDeltaprovidesCVaRestimatesforindividuallistedcompanies,disaggregatedfordebt,equityandrealestateassets.ThefocusoftheClimateWise(withVividEconomics)methodologyisontheaverageannuallossesforindividualrealestateassets,althoughthemethodologyisextend-abletootherassets.OrtecFinancecalculates,attheassetclasslevel,impactsonportfolioexpectedreturns.Mercer’sTRIPframeworkprovidesadifferentkindofquantitativeoutput:itestimatesthechangesinfinancialreturnsforportfolios,assetclassesandsectorsduetoclimate-relatedrisksandopportunities.Sectoralsensitivityheatmapsareconstructedbasedoncurrent-dayevidenceandforward-lookingqualitativejudgmentusing0.25incrementsonarelativescalefrom-1to1.Theseinitialheatmapsformthebasisofsimilarheatmapsforassetclasses,whichrelyonthesectoralcompositionof,forexample,developedmarketglobalequity,supplementedbyfurtherexpertadjustment.2.2.5.ResolutionofanalysisFormanymethodologies,themostgranularcounterpartyofanalysisisaphysicalasset,forwhichdatasetstendtobeproprietaryorreliantoninvestors’owndatabases.Carbone4,CarbonDelta(UNEPFIInvestorPilot),ClimateWise(withVividEconomics)andFourTwentySevenincorporateanalysisoftheimpactsonindividualrealestateassets.Carbone4furtherincludesinfrastructureassets,whichalsoformsthefocusofAcclimatise’sAwareforProjects.Forcorporatecounterpartiesmorebroadly,physicalassets,suchasproductionfacilities,areassessedonlybyCarbonDelta(UNEPFIInvestorPilot)andFourTwentySeven.Forthisanalysis,thetwoprovidersrelyonproprietarycorporatelocationaldatasets.Dataavailabilityandprocessingcapacityposesignificantchallengesforphysicalriskimpactassessments:corporatefacilitydatabasesareavailableforpurchaseforspecificsectors,butcanexhibitmajorgapsincoverage,particularlyiftheintentionistoconductaglobalimpactassessment.Relianceoninvestors’owndatabasesofphysicalassetscanbeafirststep,buteveninvestorsdonotalwayshavefullinformationontheirrealestateandinfrastructureportfolios,letaloneothertypesofphysicalassetsownedbyinvesteecompanies.Othersconductimpactassessmentatthecountryandsectorlevel,whichrequireslessgranularlocationaldataonphysicalhazards.Moody’sInvestorsServicefocusesontheanalysisofsovereignsanddoesnotcapturecountryexposuretoindividualclimatehazards.Instead,itreliesontheND-GAINVulnerabilitycountryindicestoassessexpo-sure,sensitivityandadaptivecapacity.OrtecFinanceanalysisproducescountry-levelGDPimpactsduetophysicalandtransitionrisk,supplementedwithsomeinformationonsectoralcomposition.TheE3MEmodelproducingtheseGDPimpactstakesphysicalriskdatapercountryperyearasinputs.Mercer(TRIP)usesamodelofdamagesatthesectorandcountryleveltoconstructapictureoftheimpactsofvariousphysicalhazards.TheAcclimatisemethodologyfortheUNEPFIBankingPilotalsousessector-specificclimatechangeimpactmodelsforchronichazardsintheagricultureandenergysectors.Foracuteevents,themethodologyreliesononlinehazard-specificdataportalssuchasPrincetonClimateAnalyticsGlobalDroughtRiskProduct.2.3.METHODOLOGIESFORTRANSITIONRISKIMPACTASSESSMENTThissectionprovidesanoverviewofcurrenttransitionriskimpactassessmentmethodologies.Itfollowsthesamestructureastheprevioussection:First,itintroducestheframeworkforcategorisingtransitionriskimpactmethodologiesaccordingtotheirscopeanddepth.Second,itmapsexistingmethodologiesagainsttheirtreatmentofsignifi-cantmethodologicalelements.Finally,itdrawsoutthekeyfindingsofthismapping.Thisreportfocusesontwotypesoftransitionhazard(orshocks):policyandtechnol-ogy.Policyhazardsdescribetheadditionalcostsorrevenuesthatcouldarisefromchangesinacounterparty’spolicyenvironment.Policycanimposeadirectpriceoncarbon,throughacarbontaxorETS,oritcanimposeanindirectcarboncost,forexamplethroughrenew-ableobligationsorcoalproductionrestrictions.Mostmethodologiessummarisepoliciesunderasinglecarbonprice,ratherthangoingintodetailonthepolicysuiteusedtoachieve32ChangingCourseOverviewofMethodologiesthisprice.Technologyhazardsincludethechangesinrelativetechnologyprices,suchasthroughthefallingcostsofrenewableenergygenerationandenergystoragetechnologiesrelativetotraditionalfossilfuel-basedtechnologies.Thetwotypesoftransitionhazardareoftencloselylinked,aspoliciesdirectlytargetshiftsinrelativetechnologycoststoacceleratethetransitiontolow-carbontechnologies.TheTCFDfurtheridentifieslegalandreputationriskastransitionrisk;however,thesearenotdirectlycoveredbyanyofthemethodologiesexaminedlikelyduetodifficultiesassociatedwithquantifyingtheseimpacts.TheTCFDidentifiesthefollow-ingcategoriesoftransitionrisk:policyandlegal,technology,marketandreputation.Thisreportexaminesmethodologies’coverageofpolicyandtechnologyrisk,aswellasmarketrisk.Marketrisk,ortheriskthatcompanies’supplyanddemandpatternschangeduringalow-carbontransition,isheretreatedwithinpolicyandtechnologyrisk,asthesetwoareseentobethedriversunderlyingmarketrisk.Legalriskfromclimate-relatedlitigation,andreputationriskfromchangingperceptionsofcompanies’emissionsperformances,arenotcurrentlyexamineddirectlybyanyofthemethodologiesconsidered,astheinformationtoestimatethemissparse.Asaresult,legalandreputationriskshavenotbeenincludedastransitionhazards(orshocks)inthissection.Figure6summarisestheframeworkfordistinguishingbetweendifferentmethodolo-giesfortransitionriskimpactassessment.Fourimpactchannelsdescribethescopeofassessment:◼Macroenvironment.AseconomiespursuethegoalsoftheParisAgreement,trans-formativepolicyandtechnologychangeswillaffecttheoutputofdifferentgoodsandservices.Thisislikelytochangethesectoralcompositionandcompetitivepositionsofeconomiesontheinternationalmarketthroughexchangeratesandtradebalances.Atthesametime,technologicalbreakthroughsorsuddencarbonpriceincreasesmayinflictunexpectedpriceshocksandcreateinflationarypressure.Ifsomeregionsadvancetechnologyorintroducecarbonpricingbeforeothers,thiscouldalsoleadtochangesintradepositionsorexchangerates.Suchmacroeconomicimpactsarenotfullyreflectedinabottom-upassessmentlookingdirectlyatsupplychain,operationsandassets,andend-usemarkets(asdescribedbelow).◼Supplychain.Policyshiftsaffectingacounterparty’ssupplierscouldaffectitscostofproductionifhigh-carbonsupplierspassthroughcarbonpricestothecounter-party.Asanexample,aftertheintroductionoftheEUETSin2005,someelectricitygeneratorspassedthroughmorethan100%ofthecostincreasetoconsumers.11Thiscoulddoubletheburdenofacarbonpricingschemeonhigh-carboncounterparties,whichwillalsohavetopaythecostsoftheirownemissions,andmightforcethemtoconsideralternative,lower-carbonsuppliers.Counterpartiesmaydosoinanycaseifrela-tivetechnologycostsarechanging,andlow-carbon,cheaperalternativesemergeregard-lessofcarbonpricing.ThisimpactchannelcoversbothScope2andScope3emissions.◼Operationsandassets.Themostdirectchannelofimpactdescribestheeffectsofpolicyandtechnologyshiftsonacompany’sownoperationsandScope1emissions.Thiswouldincludethecostimpactsofpolicychangesencouragingalow-carbontransi-tionandshiftsinrelativetechnologyprices.◼Market.Formanycounterpartieswhoseproductsareemissions-intensivetoconsume,policyandtechnologyshiftswillbefeltalmostexclusivelythroughmarkets(examplesincludeallindustriesrelatedtotheextractionoffossilfuels,includingoil&gasandcoalmining).Forexample,fossilfuelproducersdonottendtobeparticularly(Scope1)emis-sions-intensive,soifacarbonpriceisintroduced,thedirectcostimpactislikelytobequitesmall.However,fossilfuelsproducesignificant(Scope3)emissionsinconsump-tion,meaningthattheproducer’scustomerswillfaceapotentiallyverylargecostimpactand,asaresult,reducedemandfortheproducer’sproducts.Marketeffectscouldalsobesubstantialinothersectors,asconsumerpreferencesmayshiftduringalow-carbontransition,forexample,togreatersubstitutionofpaperforplasticproducts.11.Themajorityofestimatesofcostpassthroughrateswerebetween38%and83%.(Sijm,Hers,Lise,&Wetzelaer,2008).33ChangingCourseOverviewofMethodologiesFigure6:FrameworkforcategorisationoftransitionriskimpactassessmentmethodologiesSource:VividEconomicsbasedonI4CE,2018Thedepthofassessmentdependsonamethodology’sunderstandingofacounter-party’svulnerabilitytotherisk,whichconsistsofthreecomponents:◼Exposureofacounterpartyisdeterminedbyitsgeographicallocation,whichwilldeter-minetheclimatepolicyithastocomplywith.◼Sensitivitytothishazardwillthendependoncounterpartyemissionsintensity,whichdeterminestheincreaseincostsitwillexperienceperunitofoutputitproduces.Furtherdownthevaluechain,customers’sensitivitytocarbonpricingoftheirconsumptionwilldependontheirrelativepreferencesandresponsetopriceshocks.◼Adaptivecapacityisdescribedbyacounterparty’sabilitytoshiftawayfromhigh-car-bonsuppliersandcustomers,passthroughcosts,orabatetheiremissionsdirectly—forexample,throughenergyefficiencymeasures.Adaptivecapacityisdependentonthesubstitutabilityofacounterparty’sinputsandproductsforlow-carbonalternatives.Ifcurrentinputsareeasilysubstitutableforlower-carbonalternatives,thecounterpartyhasmorecapacitytoadapttotransitionrisk.Atthesametime,iftheproductsthecounter-partyproducesarenoteasilysubstitutableforlow-carbonalternatives,suchascement,itmayfinditeasiertopassthroughcoststoconsumers.ThefullmappingoftransitionriskassessmentmethodologiesisprovidedinFigure7.Asforphysicalrisk,thismappingprovidesabroadoverviewofthecoverageofcurrentmethodologiesoffourcoremethodologicalelements:scenarios,transitionhazards,outputsandtransitionriskimpactassessment.Toprovidethenecessarycontextforeachmethodol-ogy,themapalsoincludesthelevelofanalysisofeachmethodology.Subsections2.3.1to2.3.5highlightthekeyfindingsofthismapping.34ChangingCourseOverviewofMethodologiesFigure7:OverviewoftransitionriskassessmentmethodologiesTransitionriskimpactassessmentScenariosRisksMacroSupplychainOperationsMarketOutputCounterparties<2C2C3C>4CPolicyTechnologyExposureSensitivityAdaptivecapacityExposureSensitivityAdaptivecapacityExposureSensitivityAdaptivecapacityExposureSensitivityAdaptivecapacityQuantitativeQualitativeFacilityFirmSectorCountryProvider2diiC4CDCTMerMISOFOWSchTPITruVE1VE2Note:2dii–2degreesInvestingInitiativePACTAtool,C4–Carbone4CarbonImpactAnalytics,CD–CarbonDeltaClimateValueatRisk,CT–CarbonTracker2degreesofseparation,Mer–MercerTRIPframework,MIS–Moody’sInvestorsServicesovereignriskratings,OrtecFinance–Climate-savvyscenariosset,OW–OliverWymanforUNEPFIBankingPilot,Schroders–CarbonValueatRisk,Tru–TrucostCarbonEarningsatRisk,TPI–TransitionPathwaysInitiativeTPITool,OrtecFinance–Climate-SavvyScenarios,VE–VividEconomics1–ViEW,2–Net-ZeroToolkitSource:VividEconomics2.3.1.ScenariosMostmethodologiesincludea2°Cscenario,oftenincombinationwithatleastoneotherscenario,andIEAscenariosformthebasisofanalysisformostmethodolo-gies.Allmethodologiesexaminedforthepurposesofthisreport,exceptforSchroders(thismethodologyutilisesaUSD100/tCO2carbonpriceratherthanatemperaturealign-mentscenario),includea2°C-compliantscenario.Themajoritysupplementthiswithatleastoneadditionalscenario.The2dii,Carbone4,CarbonTracker,Mercer,Moody’sInvestorsServiceandTPImethodologiesalluseIEAscenarioseitherdirectly,orasastartingpointformorecustomisedscenarios.Asaresult,themostcommonlycited2°CscenariosaretheIEA’sWorldEnergyOutlook450andEnergyTechnologyPerspectives2Dscenarios.CarbonDelta(UNEPFIInvestorPilot)usesscenariosfromavarietyofproviders,includ-ingthoseproducedbyPIK’sREMINDmodel,GCAM,developedbytheJGCRIandPBLNetherlands,andEnvironmentAssessmentAgency’sIMAGEmodellingframework.OliverWyman(UNEPFIBankingPilot)alsoreliedonPIK’sREMINDmodelaswellasIIASA’sMESSAGEmodel.VividEconomicsdesignsbespoketransitionscenarios,exploring35ChangingCourseOverviewofMethodologiesvarioustechnologycostandpolicytimingassumptions.FortheNet-ZeroToolkit,theseareconstructedincollaborationwithImperialCollegeLondon,usingTIAM.2.3.2.Transitionhazards(orshocks)Byusingcomprehensivetransitionscenariosgeneratedusingenergysystemmodels,mostmethodologiescoverbothpolicyandtechnologyrisks.Theintegratedassess-mentmodelsusedtoproduceprominentscenariosbyprovidersliketheIEAorPIKtendtoincludemodellingoftheenergysystemandrelyonassumptionsaboutpolicychangesaswellasrelativetechnologycosttrajectoriesofkeylow-carbontechnologiescomparedwithtraditionalfossilfuel-basedtechnology.Asaresult,methodologiesthatusethesescenariosorothersgeneratedbyIAMsautomaticallyconsiderbothtypesofrisk.Onemethodologyfocusesexclusivelyonpolicyrisk:SchrodersimposestransitionriskthroughapriceofUSD100pertonneonallglobalcarbonemissions.2.3.3.ImpactassessmentmethodologiesMostmethodologiesfocusontheimpactsoftransitionriskonacounterparty’soperationsandassets.Allbutthreemethodologies—whichfocusonthemacroeconomicenvironment—examinethedirecteffectsoftransitionriskoncounterpartyoperationsandassets(Scope1emissions).Thismostcommonincludeseitheranassessmentofthecostsfromcarbonpricingacounterpartywillfaceunderdifferentscenariosorevaluationofthealignmentofacounterpartywithdifferenttemperaturetargetsusingcarbonfootprints.Halfoftheproviderssupplementthiswithanalysisofthemarketand,toalesserextent,thesupplychain.Analysisofthemarketisrelativelycommon,asaroundhalfoftheexaminedmethodologiesconsidershiftsincustomerbehaviourinresponsetopolicyortechnologyshifts.OpportunitiesforcounterpartiesduetogrowthingreentechnologiesareexaminedbyCarbonDelta(UNEPFIInvestorPilot),Mercer,OliverWyman(UNEPFIBankingPilot)andVividEconomics(Net-ZeroToolkit).Mercerassessesopportunitiesatthesametimeasrisks,usingthesamesectoralsensitivityheatmapmethodologydescribedinSection2.2.3.OliverWyman(UNEPFIBankingPilot)assesstheopportunitiesforbanksfromalow-carbontransition,examiningsectoralinvestmentattractivenessandinteractionswithbankstrengths.CarbonDelta(UNEPFIInvestorPilot)andVividEconomics(Net-ZeroToolkit)quantifycompany-levelopportunitiesusingpatentdata.Thisdataisusedtoidentifyrelativelyinnovativecompaniesingrowinglow-carbonsectorsandtoestimateperformance.Supplychainanalysisistheleastrepresentedalongthevaluechainandtypicallyreliesoninput–outputtablestoassessthelikelihoodofproductioncostincreasesfromsuppliers.Threemethodologiesexaminethemacroeconomicimpactsofclimatechangetran-sitionrisk:OrtecFinance,Moody’sInvestorsServiceandVividEconomics.OrtecFinancefirsttranslatesscientificclimatemodelslikethoseinformingtheIPCCreportsintoannualimpactsonnationalGDPfor59countriesandregionsusingtheCambridgeEconometricsmodelE3ME.Thismodelincludescompleterepresentationoftheinterac-tionsoftheeconomy,theclimateandlandandenergysystems.OrtecFinanceusestheseGDPimpactstoestimateshocksovertimetomorethan600financialandeconomicvaria-bleslikeinterestratesandinflation,basedonhistoricalrelationships.VividEconomicsalsoutilisesaCGEmodel:theVividEconomy-Wide(ViEW)model,whichincludesdetailedrepresentationsofenergy,foodproduction,internationaltrade,investment,manufacturing,miningandservices.Moody’sInvestorsServiceexaminestheimpactsofloweroil&gasdemandundervariousdecarbonisationpathwaysonoil&gasexportingcountries’creditrisk.Moody’sassumesthatimpactsfromthesechangesinpricesanddemandwillbetrans-mittedtosovereigncounterpartiesthroughtheoil&gasdependenceofeconomicstrength,fiscalstrengthandexternalvulnerability.Whilemanymethodologiescovercounterparties’exposureandsensitivitytotran-sitionriskalongthevaluechain,assessmentofadaptivecapacityislesscommon,althoughisusedmorefortransitionriskthanforphysical.Alongthevaluechain,mostmethodologiesexaminetheadaptivecapacityofacounterpartyinitsmarket,mostcommonlybyintegratingcostpass-throughcapacity.Schroders,TrucostandVivid36ChangingCourseOverviewofMethodologiesEconomics(Net-ZeroToolkit)modeltheeffectsofclimatecostspassedthroughtoconsumersonequityvalueimpact.Similarly,OliverWyman’sBankingPilotriskfactorsinclude‘changeinrevenue’,aratingofthelikelihoodofdemanddecreaseduetoproductsubstitutionsorcostpass-through,basedonindustrypriceelasticityofdemandandpricecross-elasticityofdemandrelativetohigh-carbonproducers.Carbone4examinescompanyexpendituresonlow-carbontechnologies(inotherwords,emissionsabatement)aspartofitsforward-looking,qualitativeassessmentofcompanyalignmentwithalow-carbontransi-tion.VividEconomics(Net-ZeroToolkit)coverscounterpartyadaptivecapacityalongthesupplychainandoperationsandassetsbyexaminingsectoremissionsabatementopportuni-tiesquantitatively.Theseexampleshighlighttwoinitialareasforfuturedevelopmentoftransitionriskassessmentmethodologies:analysisofcounterparties’macroeconomicenviron-mentandcapacitytoadapttotransitionrisk.Impactsofalow-carbontransitiononthemacroeconomicenvironmentcouldbesignificant,especiallyifthetransitionoccursnotinagradualandsmoothway,butinadelayedandmoreradicalmanner.Manyofthemeth-odologiesconsideredinthisreportlimittheiranalysistocompanyvaluechainsandignorethepotentialmacroeconomicimpactsofatransition—forexample,thepotentialeffectsofstringentglobalcarbonpolicyontheeconomiesofcountriesdependentonhigh-costproductionoffossilfuels.Companiesinthesecountriesnotdirectlyinvolvedintheproduc-tionormitigationofcarbonemissionscouldneverthelessbesignificantlyaffectediftheeconomytheyoperateinundergoesstructuralchange.Asaresult,couplingcompany-levelanalysiswithassessmentofthemacroeconomicenvironmentappearsapotentialnextstepforimprovingtransitionriskassessment.Atthesametime,adaptivecapacityanalysishasnotbeencommoninmethodologiestodatebutcouldsignificantlyalterthepotentialimpactsofalow-carbontransitiononcountriesandcompanies.Wherethisanalysisispresent,itdoesnotrelyoncompany-specificdataasthisisnotavailableonalargescale.Iftransitionriskassessmentsaretoincorporatecompany-specificadaptivecapacity,moregranulardatafromcompaniesisneeded—fromTCFDreportingforexample.Inaddition,thereisscopeforthedevelopmentofabottom-upmethodologytotransitionriskimpactassessmentforrealestate.ApartfromCarbonDelta(UNEPFIInvestorPilot),noothermethodologiescitedinthisreportexaminetheimpactsoftransitionriskonindividualrealestateassets.However,consideringtheirexperiencewiththeCarbonDeltamethodology,whichcombinestop-downandbottom-upanalysis,realestateinvestorswithintheInvestorPilotGrouppointedouttheneedforamoreintensivebottom-upmethodology.Thisbottom-upmethodologyshouldthen,forexample,addressthepotentialchangestolocalregulationsonenergyefficiencyretrofitting,theareawhereinvestorsexpectmostofthetransitionrisktobefeltintherealestatesector.2.3.4.OutputsMostoutputsareestimatesoffinancialimpactsagainstahypotheticalbaseline,expressedintermssuchasClimateValueatRisk.CarbonDelta(UNEPFIInvestorPilot),Schroders,TrucostandVividEconomicsprovideoutputsintheformofvalueatriskfromclimatechangeatthecompanylevel.SchrodersprovidestheshareofcurrentEBITDAatriskforglobalequitymarketsifacarbonpriceofUSD100/tCO2wereintroducedimme-diately.Similarly,TrucostestimatestheexposureofcompaniestofuturechangesincarbonpricesandusesthistoestimatetheCarbonEarningsatRisk.Thiscanthenbeusedtoesti-matetheimpactonequityvaluations,asisthecaseintheS&PCarbonPriceRiskAdjustedIndexSeries.VividEconomics’Net-ZeroToolkitandCarbonDelta(UNEPFIInvestorPilot)relyonsimilarmethodstocalculatethevalueimpactforlistedcompaniesbutalsoconsidertheimpactofgreenopportunitiesonearnings.WhileVividEconomics’Net-ZeroToolkithasfocusedonequitytodate,CarbonDelta(UNEPFIInvestorPilot)breaksdownthesediscountedcostsintoseparateCVaRfiguresforfirmequity,debtandrealestate.Otherfinancialoutputstakevariousforms,rangingfromimpactsonexpectedreturnstogrossvalueadded(GVA)andsunkcapitalexpenditure.CarbonTrackerassessestheproportionofcompanycapitalexpenditureoutsideofanemissionsbudget.OrtecFinancecalculatesimpactsonportfolioexpectedreturnsattheassetclasslevel.Oliver37ChangingCourseOverviewofMethodologiesWyman’smethodologyfortheUNEPFIBankingPilot,inlinewiththecorrespondingphys-icalriskassessmentfromAcclimatise,assessestheimpactsoftransitionriskonprobabilityofdefaultorcreditriskratings.TheTRIPframework,alsobyMercer,providesestimatesofthechangesinfinancialreturnsduringalow-carbontransition,asdetailedinSection2.2.4.Moody’sdeterminesthethree-notchcreditratingranges(forexample,Baa1-Baa3)ofsovereignsovertime.VividEconomics’ViEWmodelproducesestimatesofannualGVAgrowth,unmitigatedcarbonexposureofoperations,andimprovementsincarbonintensity.Non-financialoutputstendtotaketheformoftemperaturealignmentassessments(or‘Science-BasedTargets’).12Theseindicatetheemissionspathwayofacounterpartyrelativetoatemperaturetarget’scarbonbudget.Providersrelyondifferentmethodstoconstructtheseemissionspathways.TheTPIToolusescompanies’currentemissionsinten-sitiesincombinationwiththeemissionstargetstheyhavesettoconstructfutureemissionsintensityandcomparesthistosector-specificemissionsintensitybenchmarks.Insteadofcompanyemissionreductiontargets,thePACTAtoolusesfacility-leveldataoncurrentandplannedproductioncapacityandcomparesfutureproductiontothefairsharequantity(basedoncurrentmarketshare)undera2°Cscenario.CarbonDelta(UNEPFIInvestorPilot)alsoprovidesatemperaturegaugeforclients’portfolios,basedonactualsectoralcarbonintensitycomparedwiththatimpliedbyglobalcarbonbudgetsofdifferentdegreetargets.FurtherdetailsonthismethodologyareincludedinSection3.3.Carbone4’sClimateImpactAnalyticsdoesnotprovideanexplicittemperaturealignmentassessment,butfocusesonthecalculationofinducedandavoidedemissions,supplementedwithqualitative‘forward-lookingratings’whicharebasedonanalysisofcompanydisclosuresofinvestmentsandR&Dexpendituresthatwillcontributetoalow-carbontransition,aswellasrelatedcorporatestrategy.2.3.5.ResolutionofanalysisThemostgranularanalysisofmostmethodologiesisatthefirmlevel,whichsomethenaggregatetosector-leveland,toalesserextent,country-levelresults.Modelsfrequentlycombinesector-andfirm-levelassessments,bysupplementingsectoralimpactsofalow-carbontransition(suchassectoralcarbonpricesandcostpass-throughpoten-tial)withcompany-specificinformation(suchasprofitability).Toprovideanexampleofthisprocess,fortheUNEPFIBankingPilot,OliverWymanstartswithariskexposureassessmentatthe‘segment’level—subsectorsbasedoncharacteristicsrelevanttotransitionrisk—andusesthesesensitivitiestoassesscompany-levelimpacts.Twomethodologieslimitanalysistothecountryandsectorlevel.Mostmethodologiesprovidingfirm-levelanalysisalsoprovideaggregateresultsfromthisanalysisatthesectorlevel.Afewprovidersfocusentirelyonsector-andcountry-levelassessment:Mercer,Moody’sInvestorsService,OrtecFinanceandVividEconomics(ViEW).Asset-levelanalysesareoftenlimitedtotheoil&gassector,exceptfortheCarbonDelta(UNEPFIInvestorPilot)methodology,whichconductsabottom-upassess-mentacrosssectorsusingproprietaryfacility-leveldata.CarbonTrackerandVividEconomics(Net-ZeroToolkit)conductasset-levelanalysisforindividualwellsintheoil&gassectortoassesstheextentofassetstranding.Theydothisbyconstructingprod-uctsupplycurvesandassessingtheamountofproductionthatiswithindifferentcarbonbudgets.CarbonDelta(UNEPFIInvestorPilot),ontheotherhand,usesitsproprietarycorporatelocationdatabasetoassignemissionreductionrequirementstoindividualfacili-tiesbasedona‘fairshare’approach.ThenextsectionofthisreportdetailsCarbonDelta’sCVaRmethodology,includingfurtherinformationontransitionriskimpactassessmentinSection3.3.12.Science-basedtargetsprovidecompanieswithapathwaytosustainablegrowthbyspecifyingbyhowmuchandhowquicklytheyneedtoreducetheirGHGemissions.Referto:https://sciencebasedtargets.org/38ChangingCourseBuildingBlocksoftheInvestorPilotmethodology3.BUILDINGBLOCKSOFTHEINVESTORPILOTMETHODOLOGY13ThissectionprovidesadescriptionoftheCarbonDeltamethodologyco-developedintheUNEPFIInvestorPilotthroughiterativeconsultationsbetweentheInvestorPilotGroupandCarbonDelta.Itlaysoutastep-by-stepframeworktocalculatetheClimateValueatRisk®(CVaR)metricforcompanies,assets,securities,andport-folios.TheCVaRmetricassessestheimpactofclimatechange-relatedrisksandoppor-tunitiesonanasset’smarketvalue,underaspecifiedclimatescenarioovera15-yeartimehorizon.Theriskattheportfoliolevelisdeterminedthroughupwardsaggregation,takingintoaccountcompanyassets,theirlocation,andthetradedsecuritiesacrossdifferentassetclassesassociatedwiththeenterprise.Thissectionfirstdescribestheprocessbywhichclimatechangerisksandopportunitiesareidentified,modelled,andquantifiedintocostsandrevenues.Itthendetailsthemethodologybywhichthesecostsandrevenuesareaggre-gatedtoaCVaRforequities,bondsandrealestateassets.Figure8providesanoverviewoftheCarbonDeltamodellingprocess.Figure8:ThefinaloutputsoftheCarbonDeltamethodologyarequantifiedcostsorrevenuesandtheCVaRSource:CarbonDeltaCarbonDeltaassessesthefinancialimpactofclimatechangeovera15-yeartimehorizonacrosstwopillars:physicalriskandtransitionrisk.14—Physicalrisksrelatetochronicextremeweatherhazards(suchasextremeheat),acuteextremeweatherhazards(suchashurricanesandfloods),andopportunities(suchaslessharshwintersincolderregionsduetotemperaturerise).Transitionriskincludestheriskfromchangingpolicy(suchasincreasinglystringentclimatelegislationenactedtomeetdecarbonisationtargetsinthecountryofoperation),aswellastheopportunitiespresentedbylowcarbontechnologies.Eachpillarisexplainedinfurtherdetailinthefollowingsections.PhysicalrisksandopportunitiesarecoveredinSection3.2,andtransitionrisksandopportunitiesarecoveredinSection3.3.Section3.4thendiscussesthecalculationofanaggregateCVaRmeasure,andhowcompany-levelestimatescanbeaggregatedforportfolioanalysis.3.1.SCENARIOANALYSISANDINTEGRATEDASSESSMENTMODELS◼Thephysicalriskanalysisconsiderstwoscenarios:averageandaggressivephysicalrisk.Inordertoassessthepotentialcostimposedbyphysicalrisk,theCarbonDeltameth-odologymodelstheprobabilitydistributionoftheannualcostfromweatherextremesforassetsatanygivenlocationinaBaUworld(noactionistakentoreduceemissions).The13.ThissectionwasauthoredbyCarbonDeltaandcompiledbyVividEconomics14.Theterm‘risk’isusedintheCarbonDeltamethodologytoencompassbothpositiveopportunitiesandnegativeoutcomesthatcouldpotentiallyariseasaresultofclimatechange.39ChangingCourseBuildingBlocksoftheInvestorPilotmethodologyaveragescenarioreferstotheexpectedvalueofthecostdistributionunderBaU.Theaggressivescenarioisderivedfromthe95thpercentileofthecostdistributionforBaUandexplorestheunlikelybutextremepotentialoutcomesofaclimatescenario.◼Thetransitionriskanalysisconsidersfourscenarios:3°C,2°Cand1.5°C,andBaU(or4°C)scenario.Thethreetemperaturescenarioswerechosenforduetotheircentralrolesininternationalclimatechangenegotiations..WhatiscurrentlycommittedaspartoftheNDCstotheParisAgreementisconsistentwitha3°Cscenario.The‘wellbelow2°C’isinternationallyagreedgoalunderthelandmarkParisAgreement,the1.5°CtargetgainedprominenceaftertheOctober2018IPCCreport.Thekeydifferencesbetweenthesethreetemperaturescenariosarethe‘carbonbudgets’thattheglobalecon-omyispermittedtoreleaseintotheatmosphere.ThesescenariosarecomparedwiththeBaUbaselinescenario,whichisalignedwith4°Cwhichtakesintoaccounthistoricalemissionsdataandassumesthatnoactionistakentoreducecarbonemissions.Figure9summariesthescenariosconsideredwithinphysicalriskandtransitionrisk.Figure9:CarbonDeltaassessesclimateriskacrosstwomainpillars;transitioneffectsandphysicalimpactsSource:CarbonDeltaIntransitionriskanalysis,CarbonDeltautilisesforecastsoffuturecarbonpricesfromthreeIAMstocalculatethecostsoncompaniesundervariousscenarios.TheIAMsusedare:1.RegionalModelofInvestmentsandDevelopment(REMIND).REMINDisaglobalmulti-regionalmodelincorporatingtheeconomy,theclimatesystemandadetailedrepresentationoftheenergysector.Itallowsfortheanalysisoftechnologyoptionsandpolicyproposalsforclimatemitigation.TheREMINDmodelwasdevelopedbythePIKinGermany.2.IntegratedModeltoAssesstheGlobalEnvironment(IMAGE).IMAGEisanecological–environmentalmodelframeworkthatsimulatestheenvironmentalconse-quencesofhumanactivitiesworldwide.Itrepresentsinteractionsbetweensociety,thebiosphereandtheclimatesystemtoassesssustainabilityissuessuchasclimatechange,biodiversityandhumanwell-being.TheIMAGEmodellingframeworkhasbeendevel-opedbytheIMAGEteamundertheauthorityofPBLNetherlandsEnvironmentalAssessmentAgency.3.TheGlobalChangeAssessmentModel(GCAM).GCAMisadynamic-recursivemodelwithtechnology-richrepresentationsoftheeconomy,energysector,landuseandwaterlinkedtoaclimatemodelthatcanbeusedtoexploreclimatechangemitigationpoliciesincludingcarbontaxes,carbontrading,regulationsandaccelerateddeploymentofenergytechnology.TheJGCRIisthehomeandprimarydevelopmentinstitutionforGCAMbasedintheUS.40ChangingCourseBuildingBlocksoftheInvestorPilotmethodology3.2.PHYSICALIMPACTASSESSMENTTheCarbonDeltamethodologymodelstwotypesofphysicalclimaterisk:chronicrisks,whichmanifestslowlyovertime,andacuterisks,whicharetheresultofextremeweathereventssuchastropicalcyclones.Thismethodologycoverstheeconomicimpactsduetoassetdamageandbusinessinterruption,butnotthoserelatedtosupplychainrisksorpotentialbusinessopportunitiesto,forexample,theinsurancesectororthosethatprovideadaptationtechnology.ImpactsareestimatedunderaBaUscenario,ratherthandifferentpolicyscenarios.Moreextremephysicalrisksarecoveredintheaggressivescenario.Assessmentmethodologiesforchronicandacuterisksarediscussedinturnbelow.3.2.1.ChronicrisksImpactsfromchronicrisksmanifestprimarilythroughbusinessinterruption,duetoreductioninlabourproductivityandavailability,orchangesintheefficiencyofproductionprocesses.TheCarbonDeltamethodologyconsiderstheeffectsofbusinessinterruptionforfiveclimatehazards:extremeheat,extremecold,heavyprecipitation,strongsnowfall,andseverewindconditions.CarbonDeltausesaglobalhistoricaldatasetcover-ingthelast39yearsfromtheEuropeanCentreforMedium-rangeWeatherForecast’sERAInterimReanalysisprojecttoassesstheimpactofthesehazards.HistoricaldataisusedtoprojectanannualdistributionoftherelevantclimatevariablesunderaBaUscenarioforthecoming15-yearperiod.Theannualcostofbusinessinterruptionisthenestimatedaccordingtothenumberofdaysonwhichthehazardintensityexceedsarelevantthreshold.Themethodol-ogyassumesthatafixedproportionofrevenue,specifictoeachsector,islostoneachofthesedays.Basedonscientificpublicationsincombinationwithinformationfrommediareports,CarbonDeltahasestablishedacomprehensivematrixofvulnerabilityfactorsthattranslateexceedancestomonetarycost.Thevulnerabilitymatrixcoversallhazardtypesanddefinesspecificfactorsfor31distinctextremeweathersectorsandsubsectors,providedintheAppendixII.Furthermore,aregionalvulnerabilityreductionthatreflectsadaptationtotheregionalclimateisincorporated.Therationalebehindthisreductionisthatthevulnera-bilitytoweatherextremesislowerinregionswheretheseeventsarefrequent,andthelocalbusinessesareexperiencedindealingwiththeconsequences.Forexample,inequatorialregions,dayswithtemperaturesover30°Caremorecommonandthereforetherearemorelikelytobelocaladaptationstosuchevents.Beingafunctionofthenumberofannualthresholdexceedances,thereductionamountsupto50%inregionswherethresholdsarefrequentlyexceeded.Thus,thecostofbusinessinterruptionpersectorandextremeweathertypeiscalculatedas:Cost=numberofexceedances×vulnerability×vulnerabilityreduction×optimalrevenueTheimpactofclimatechangeon(chronic)physicalrisksisdeterminedbythechangeofcost('deltacost')inrelationtoabaseyear.Itisimportanttonotethattoday’sclimatehasalreadyundergonesignificantchangesduetoanthropogenicGHGemissions.Lookingforward,itiscrucialtodetermineonlytheprojecteddiffer-encebetweentoday’sclimateandthefutureclimate.CarbonDeltawouldconsiderthattoday’sclimatewithitscurrentprofileofphysicalhazardsandexposuresisalreadypricedintocompanies’expectations.Accordingly,thedeltaofthecostsinanygivenyeariscalculatedas:Deltacost=costfutureyear−costbaseyearSinceboththecurrent(baseyear)andthefuturecost(futureyear)aremodelled,acostreductionovertimewillmanifestasanetgain.Anexampleofthisistherela-tionshipbetweenextremecoldandcompanyperformance.Aslargeareasofthenorthernhemisphereareprojectedtoexperienceasignificanttemperatureincrease,coldextremesbecomelessfrequentandthecorrespondingcostsarereduced.41ChangingCourseBuildingBlocksoftheInvestorPilotmethodology3.2.2.AcuterisksAcuteclimaterisksoccurfromrarenaturalcatastrophesindistincttimeintervalsandaremodelledusingphysicalclimatemodels.Acutephysicalrisksthatmanifestintheformofcatastrophiceventssuchascoastalfloodsortropicalcyclonesaremodelledinmuchgreaterdetailbecausethereisabetterunderstandingoftheserisks,whichhavehistoricallybeenthefocusoftheinsuranceindustry.TropicalcyclonesProjectionsofthefuturefrequencyandintensityoftropicalcyclonesareobtainedfromtheopensourcenaturalcatastrophemodelCLIMADA.ThecurrentfiguresarebasedontheRCP4.5scenario.However,theyarestronglyalignedwithalternativescenariosasdifferencesaresmallforthesame15-yeartimeframe.CLIMADAisalsousedtoquantifytheseverewindandflooddamagecausedbytropicalcyclones.Themodelisbasedonasimilarinsurancemodelandiscurrentlymain-tainedbyETHZurich.CLIMADAusesastochastictropicalcyclonegeneratorbasedonanextensivedatasetofhistoricalstorms.Foreachbusinesslocationthedistributionofwindspeedsisevaluatedandcombinedwithregionallycalibrateddamagefunctionstoobtainadistributionofassetdamagecosts.Theeconomicimpactoftropicalcyclonesisquantifiedastheamountofdamagedonetofixedassets.Thedamageexpectedannuallyforeachbusinesslocationiscalcu-latedastheproductofthevalueofthefacility,andtheproportionofdamageexpected.Theassetvalueofenterpriselocationsisproxiedbyreportedgrossfixedassets,andtheexpecteddamageasapercentagecanbeextractedfromCLIMADA.Thecostdeltaisagainestimatedasthedifferencebetweenfutureandcurrentcosts.CoastalfloodingTheCarbonDeltamethodologymodelsboththeassetdamageandbusinessinter-ruptionimpactofcoastalflooding.Inordertodetermineflooddamages,theinundationofanassetatagivensiteismodelleddependingonthelocaltopographyandthestatisticaldistributionofextremesealevelsatthecoast.TheCarbonDeltamethodologyemploysabias-correctedversionoftheglobaldigitalelevationmodelSRTMtodetermineifanassetwillbereachedandsubsequentlyinundatedbyafloodevent.Itthencombinestheheightoftheinundationattheassetsitewithdepthdamagefunctionstodeterminethefractionsofassetdamageanddurationofbusinessinterruption.TheoccurrenceandintensityoffloodeventsismodelledviaaPoissonprocessandextremevaluestatistics,respectively.Localfloodprotectionlevelsareincorporatedintothemodelviatherelatedreturnperiodofthedesignfloodheight.Whereverpossible,specificinformationontheprotectionheightisemployed.Intheabsenceofsuchinforma-tion,protectionagainstthelevelofafloodwitha100-yearreturnperiodisassumed.Forfutureyears,thelocaldistributionsofextremesealevelsareshiftedaccordingtotheexpectedregionalsea-levelrise.Theshifttypicallytranslatesintomorefrequentandintensefloodevents.Themethodologymakesuseofalargeensembleofsea-levelrisescenariosalsogivenintheIPCC’s5thAssessmentReport.Thetotalannualcostofcoastalfloodingisacombinationofassetdamageandbusi-nessinterruptioncost.Thecostofassetdamageistheproductofannualassetdamageandassetvalue.Theextracostofbusinessinterruptionistheshareofrevenuelostduetoflooding.Thus,thetotalcostisgivenas:Cost=annualdamage×assetvalue+annualshareofrevenuelostduetobusinessinter-ruption×annualrevenueThecostdeltaisagainestimatedasthedifferencebetweenfutureandcurrentcosts.42ChangingCourseBuildingBlocksoftheInvestorPilotmethodologyBox2outlinesthemethodologyforphysicalimpactsonrealestateassets.Box2:Physicalimpactsonrealestateassets◼CarbonDeltausesthesamemethodologytoassessphysicalriskforrealestateasitdoesforcompanyassets.Itcoverstheeffectsofextremeheat,extremecold,coastalflooding,tropicalcyclonesandextremewindforcommercialandresidentialbuildings.◼Totalyearlydamageiscalculatedas:◼Numberofextremeeventsxpercentageofbuildingdamagedpereventxgrossvalueofbuilding◼Estimatesofvulnerabilitytodamage(thepercentageofabuildingdamagedperevent)comefromCLIMADAfortropicalcyclonesandcoastalflooding,andfromPIKforextremewind.◼Inadditiontophysicaldamage,forextremeheatandcold,thecostorheatingandcoolingisdeterminedbydefiningacostofexceedingaspecifictemperaturethreshold(>30°Cand>35°C,and<-10°Cand<0°C,respectively)◼Thetotalcostofphysicalrisksisthesumofadditionalheating/coolingcostsanddamagecosts.Totalpresentvalueofthelifetimecostisestimatedasdiscountedtotalcostover40years(forcommercialbuildings)or60years(forresidentialbuildings)fromthelastretrofit.Thediscountrateis8%.◼PhysicalValueatRiskisthepresentvalueofcostinrelationtogrossassetvalue.3.3.ASSESSMENTOFTRANSITIONRISKSANDOPPORTUNITIESThissectionfocusesontherisksandopportunitiesthatarisefromtransitioningtoalow-carboneconomy.Althoughcomplyingwithemissionreductionpolicieswillcertainlyimposeasignificantfinancialcostforsomecompanies,thetransitiontoalow-carbonecon-omyalsoprovidesuntappedgrowthpotentialforothers.ThissectiondescribesCarbonDelta’smethodologyforquantifyingthepotentialpolicyrisksandtechnologicalopportuni-tiesassociatedwitharangeoffuturedecarbonisationpathways.3.3.1.PolicyriskTheCarbonDeltamethodologyforassessingtransitionpolicyriskbeginswiththequantificationofcountry-andsector-levelGHGreductiontargetsdefinedbytheNDCsandalignedwiththeREMINDmodel.Themodellingbeginswiththequantifica-tionofcountry-levelGHGemissionreductiontargetsembeddedwithintheNDCsoftheParisAgreement,whichwouldleadtoapproximately3°Cofwarmingabovepre-industriallevels.Thesetargetsarethenbrokendownintosector-leveltargetsbasedondetailswithintheNDCsaswellasrecentlyproposednational-levelclimateregulations.Country-andsector-leveltargetsinthe2°Cand1.5°CscenariosarecalculatedbyamplifyingtheemissionreductiontargetsintheNDC-compliant3°Cscenario,maintainingthesectoraldistributionofthetarget.Thebaseline3°Cscenariousescurrentcountry-levelemissionsfromtheWorldResourcesInstitute(WRI),forecastingBaUlevelsin2030accordingtoUNEPRisoeandotherexternalsources.15Theseforecastemis-sionslevelsarethenlinearlydownscaledtomeet1.5°C-and2°C-compliantlevelsinlinewiththeUNEPGapreport(UNEnvironment,2018a).CarbonDelta’scompanyproductionfacilitydatabaseisusedtofurtherdisaggre-gatesector-leveltargetstothecompanylevel.Sector-leveltargetsareassignedtoindi-vidualcompanyfacilities,andthenaggregateduptocompanylevelinordertoestablisheachcompany’s‘reductionrequirement’.CarbonDeltareferstothisasatop-downandbottom-uphybridmethodology.15.Externalsourcesincludenationalemissionsforecasts,thePIK,theWRIaswellastheUnitedNationsEnvironmentProgramme(UNEP)RisoeCentreonEnergy,ClimateandSustainableDevelopment.43ChangingCourseBuildingBlocksoftheInvestorPilotmethodologyThecompany-levelcostsassociatedwithmeetingtheemissionreductiontargets,andtheresultingpolicyriskCVaR,arecalculatedusingestimatesoffuturecarbonprices.TheseestimatesarecalculatedusingvariousIAMsIntegratedAssessmentModels(IAMs)exploringdifferentassumptions,asdetailedinSection3.1.Country-andsector-levelreductionrequirementsNDCsarefirstnormalisedacrosscountriesinordertoarriveatconsistentandcomparablecountry-levelreductiontargets.AlthoughNDCsprovidearangeofinfor-mationaboutacountry’sGHGreductiontargets,theyarenotalwaysdirectlycomparableacrosscountries.SomeNDCsareexpressedintermsofabsoluteemissionreductions,whileothersareexpressedintermsofemissionsintensityinrelationtothecountry’sfutureGDP.Thebaseyearandthetargetyearalsousuallydifferacrosscountries.Importantly,thereisa‘conditional’componenttosomeNDCs,whichhingesontheavailableclimatefinanceflowsandcooperationbetweencountries.Wherethereisnospecificinformationonwhetheraconditionaltargetislikelytobeenforced,themethodologyassumesa50%enforcementratefortheconditionaltarget.Thesectoralburden-sharingofnationaltargetsisinferredfrominformationintheNDCs.Governmentshaveahistoryofdistributingnationalemissionreductiontargetsacrosssectors,consideringthecircumstancesofacountry’s(orregion’s)economy.Forexam-ple,theprocessofinitialallocationofallowancesintheEUETSwashighlydifferentiatedbysector,consideringissuesofcompetitiveness,‘carbonleakage’andpotentialimpactsonthelabourmarket.ThispatternispresentinNDCs,whichoftendisclosedetailsaboutthepath-waytoachievingthenationalemissionreductiontargets.Insomecases,theNDCsincludeanexplicitsectoralbreakdownoftheemissionreductions;inothercases,theburden-sharingmustbeinferredfromthedetailsofthepolicyinitiativesincludedintheNDC.Company-levelreductionrequirementsSector-leveltargetsaredisaggregatedtocompanylevelusinga‘fairshare’principle,underwhichcompaniesareresponsibleforreducingtheiremissionsinproportiontotheirshareofthesector’scarbonfootprint.Inthiscase,thecarbonfootprintisthelevelofScope1GHGemissionsaspertheWRI/WorldBusinessCouncilforSustainableDevelopmentGHGProtocol.CarbonDeltacalculatestotalsector-levelemissionsforeachcountryusingathird-party-verifieddataset—specifically,acombinationoftheNationalInventorydatasubmittedtotheKyotoProtocoltotheUNFCCC,andtheIEA’sWorldEnergyStatisticsdatabase.16ThemethodologyallocatestheGHGemissionstocompanyfacilitiesaccordingtotheirsize,location,productioncapacity,numberofemployeesandrevenuemarketshareinthesector.Acompany’sshareofsectoralGHGemissions(equivalentbyassumptiontotheirrevenuemarketshare)isassignedtoindividualfacilitiesusingCarbonDelta’sglobaldatabaseofcompanyfacilities.Thedatabasehasbeendevelopedthroughmonthsofdatagatheringanddataaugmentation,integratingseveralcommercialdatabasesandsystem-aticweb-crawlingandusingaproprietaryfunctionthatcombinesmulti-regionalinput-out-put(MRIO),salesdata,productioncapacity,specificlocation,sizeandnumberofemployees.Thedatacoversmorethan600,000facilitiesandcontainsinformationonestimatedsales,annualGHGemissions,sectorandultimateowner,amongstotherfields.CarbonDeltausesthisinformationtoestimatefacility-levelGHGemissionsandthenaggregatefacilityleveldatauptoeachglobalcompanywhoownsthefacilities.16.TheNationalInventorydatacoversGHGScope1emissionsfromtheenergy,industrialprocesses,agriculture,transport,commercial,residentialandothersectorsintheyears1990to2014forthe42Annex1countries.TheIEA’sWorldEnergyStatisticsdatabaseprovidesproduction-basedsectoralemissionsdataforallnon-AnnexIpartiesaswellasannualenergystatisticsdatafor170countriesandregionalaggregates.44ChangingCourseBuildingBlocksoftheInvestorPilotmethodologyTranslatingemissionreductiontargetstofinancialcostsTocalculateacompany’scostsassociatedwithreachingemissionreductiontargets,CarbonDeltausescarbonpriceestimatesfromIAMs.Toestimateannualemissionreductioncosts,CarbonDeltaaccumulatestheGHGreductionrequirementspercompanyoverthenext15yearsonanannualbasisandmultipliesthereductionamountwiththecarbonpriceestimatesproducedbytheREMIND,IMAGEand/orGCAMmodels.Thisresultsinanestimatedcostassociatedwithreachingareductiongoal,suchasthe3°Cscenario,ineachsectorandcountryover15years.Theformulaisasfollows:Totalcost=requiredGHGreductionamount×pricepertCO2eBox3outlinesthemethodologyfortransitionimpactsonrealestateassets.Box3:Transitionriskimpactsonrealestateassets◼BuildingsplayacrucialroleinthedecarbonisationofcountriesastheyareakeydriveroffinalenergyconsumptionandasignificantsourceofGHGemissions.◼CarbonDeltacomputesthecostofmeetingreductiontargetsforeachfacility,combiningbuildingspecificestimatesofemissionsandenergyconsumptionwithcarbonpricesfromPIK’sREMINDmodel.◼Similartocompany-levelestimatesoftransitionrisk,building-levelreductiontargetsareestimatedusingatop-downapproachofdisaggregatingcountries’NDCsfor3°Cand2°Cscenarios.Forthe1.5°Cscenario,allbuildingsareassumedtoreachcarbonneutral-ityby2050.A‘floorareagrowth’factorisaddedtothebuilding-levelrequirementsinceitisassumedthatfloorareawillincreaseinthefuture,therebyincreasingthereductionrequirement.◼Eachbuilding’sBaUemissionstrajectoryiscalculatedusingself-reportedScope1and2emissions,andcountry-andbuildingtype-specificemissionsintensityreductionpathways.Whereself-reportedemissionsarenotavailable,abenchmarkisassumedbasedonthestartofthereductionpathway.◼ThedifferencebetweenthetargetandBaUtrajectoriesistherequiredemissionreduction.◼AnnualcostiscalculatedastheemissionreductionmultipliedbythePIKcarbonpricefortheappropriatescenario.Thetotalpresentvalueofthelifetimecostisestimatedasdiscountedtotalcostover40years(forcommercialbuildings)or60years(forresiden-tialbuildings)fromthelastretrofit.Thediscountrateis8%.◼1.5°C,2°Cand3°CPolicyValueatRiskisthepresentvalueofcostinrelationtogrossassetvalue.3.3.2.TechnologyopportunitiesTheCarbonDeltamethodologyusespatentsfiledasaproxyforcompanies’low-car-boninnovativecapacityinordertoidentifypotentialbeneficiariesinaworldwithstrictclimatepolicies.Patentdatabasesallowanevidence-basedviewofwhichfirmswillbethelikelybeneficiariesunder3°C,2°Cor1.5°Cclimatepolicyscenarios.Patentappli-cationdataisfirstextractedfrom40nationalpatentofficesusingthePATSTATdatabase,thenfilteredforthosethatweresuccessfulinthecategoryoflow-carbontechnologies.Themodelcurrentlyexamines65millionuniquepatentsthathavebeengrantedfrom40patentauthoritiesworldwide.CarbonDeltausesmachinelearningtechniquestomatchpatentdatatocompanies.Patentsareassessedforqualityandassignedascorebasedonfourmeasuresdevel-opedincollaborationwiththeSwissFederalInstituteofIntellectualProperty:1.Forwardcitations–thenumberoftimesthepatenthasbeencitedbyotherpatents.Thisincreasesthepatent’svalue.2.Backwardcitations–thenumberoftimesthepatentreferstoother,olderpatenttech-nologies.Thisreducesthepatent’svalue.45ChangingCourseBuildingBlocksoftheInvestorPilotmethodology3.Marketcoverage–thesizeofthemarket(orjurisdiction)thatthepatentwasgrantedprotectionin,scaledbyGDP.Therefore,thehighertheGDPoftotalmarketfiling,thehigherthepatentvalue.4.TheCooperativePatentClassificationsystemcoverage–thistagspatentsintorelevantgroups(suchasConstruction,Electricity,EmergingTechnologies)andsubgroups.Thehigherthenumberofpatentgroupstagged,thehigherthevalue.Eachcompany’sgreenprofitpotentialisthenforecastforthenext15yearsbasedonpatentvalue,sectoralgreenrevenueandthecompany’scurrentprofitmargin.Thevalueofeachpatentisassessedonthebasisof:(i)thequalityofthepatent(asabove);(ii)thedateofgrantingthepatent(assuminga20-yearholdingperiod);and(iii)itsemissionssector.Foreachcompany,theaggregatedpatentvalueineachemissionssectorrepresentstheshareofthetechnologyopportunitiesithas.Greenrevenuesaresubsequentlycalculatedbymultiplyingthecompany’slow-carbonpatentvalueshareofpatentsintheemissionssectorwiththetotalgreenrevenuesinthisemissionssector.Thetotalgreenrevenuesinasectorareequaltothetotalpolicycostsinthesector,ascalculatedinSection3.3.1onpolicyrisk.Thisisbasedontheideathatgreenrevenuesareinessenceashiftofthereductioncoststorevenueforcompanieswhichlicenseorproducelow-carbontechnologies.Greenrevenuesareconvertedtogreenprofitsbymultiplyingtherevenuesbytheemissionssector’sprofitmargin.Forexample,assumeCompanyC’spatentsinthe‘hightechmanufacturing’sectorobtainascoreof1.243basedonthefourcriteriadescribedabove.Thensupposethissectorasawholehaspatentswithatotalscoreof3,401in2019,makingCompanyC’spatentsvalueshare0.037%.CompanyC’sgreenrevenuein2019isthen0.037%ofthetotalpolicyriskcostinthehightechmanufacturingsector(say,USD39,134,411).Finally,itsgreenprofitisgreenrevenuemultipliedbyitsprofitmargin.Thegreenprofitiscalculatedsimilarlyforthenext15years,to2033,andthenaggregatedasoutlinedinSection3.4.3.4.AGGREGATINGIMPACTSTOTHEINVESTORPORTFOLIO3.4.1.PortfolioClimateValueatRiskTheCarbonDeltamethodologystartsbycalculatingtheclimatecosts/profitsincurredbyanenterpriseoverthenext15years,foreachclimatechangetransitionscenario(1.5°C,2°C,3°Cor4°C)andeachmodel(physicalrisks,policyrisksandtechnologyopportunities)underconsideration.Aftermodellingthenext15years,theCarbonDeltamethodologyassumesthatsuchclimatecostsorprofitswillgrowuntilmiddleofthecentury,eventuallypeak,andthendecreaselinearlytozerobeforetheendofthecentury,atapointwhenscientistsrequirecarbonneutralitytoreachtheselectedscenarioobjective,asillustratedinFigure10below.Thisisrelatedtothefactthatcostsorprofitsrelatedtoemissionreductionswillbehighestwhenthegreatestreductionsarerequiredandthendecreaseasemissionsfallandeventuallyreachzero.46ChangingCourseBuildingBlocksoftheInvestorPilotmethodologyFigure10:CarbonDeltacalculatesclimatecostsandprofitsoverthenext15years,thenassumesalineardeclineSource:CarbonDeltaThistimeseriesofclimatecostsandgreenprofitsisthendiscountedtopresentvalue.Thediscountingfactorsareinlinewiththecurrentweightedaveragecostofcapital(WACC)oftheenterprise,obtainedfromBloombergorReuters.InthefirstfewyearsthediscountingfactorsusedareessentiallytheWACCoftheenterprise,andinlateryearscorre-spondmoretoasectoraverageofWACCvaluesinordertomakethemodelmorerobustandstabletoshort-termfluctuationsoftheenterprise’sWACC.TocomputetheCVaRoftheenterprise,CarbonDeltadividesthepresentvalueoffuturecostsorprofitsbythemarketvalueoftheenterprise.Theformulausedisasfollows:Wherethemarketvalueoftheenterpriseiscomputedasthesumofthemarketvaluesoftheequityanddebtoftheenterprise.Inadditiontoanenterprise-wideCVaR,CarbonDeltaalsocalculatesanequityCVaRandadebtCVaRforeachenterprise.Thesecorrespondtothevalueatriskfortheequityanddebtholdersoftheenterprise.Itthereforemakessensetounderstandhowmuchthepresentvalueoffutureclimatecostsorprofitsimpactsequityholders,andhowmuchitimpactsdebtholders.Inordertodothis,themethodologymakesuseofastructuralmodelofcreditriskknownastheMertonmodel.Thiswasdevelopedinthe1970sandisthestart-ingpointofmanycreditriskmodelsusedbyfinancialinstitutionsandratingagenciestoday.Insimpleterms,theMertonmodelconsiderscertainfundamentalsoftheenterprise(forexample,themarketvaluesofequityanddebt,theaveragematurityofthedebtandameas-ureofequityvolatility)aswellasthepresentvalueofclimatecostsorprofitscomputedbyCarbonDelta,andoutputsasplitofthesecostsorprofitsintoequityanddebtcostsorprofits.TheequityanddebtCVaRsoftheenterprisearethencomputedasfollows:and47ChangingCourseBuildingBlocksoftheInvestorPilotmethodology3.4.2.PortfoliowarmingpotentialThefinalelementoftheportfolio-levelimpactassessmentisthemeasurementoftheportfolio’swarmingpotential,whichisbasedonacompany-levelassessmentofemissionsintensityrelativetovarioustargets.CarbonDeltaassociateseachcompanywiththetemperaturewithwhichitsemissionintensitytrajectoryforthecompanymostcorresponds,assumingemissionsintensitiesstayconstantoverthenext15years.CarbonDeltadeterminestherelationshipbetweenemissionsintensityandtemperaturebysectorandusesthisrelationshiptoestimateacompany’ssectoralwarmingpotential.Figure11summariseshowthewarmingpotentialiscalculatedforafictionalcompanyinSectorX.Theremainderofthissectionexplainstheunderlyingcomputationalstepsindetail,aswellasthemethodforaggregatingsectoralwarmingpotentialsfirsttothecompanyasawhole,thentotheentireportfolio.Figure11:SchematicdisplayofCarbonDelta’swarmingpotentialcalculationNote:MonetaryfiguresinthischartrefertoannualrevenueSource:CarbonDeltaThemethodologystartsbydeterminingsectoralwarmingfunctions,whicharedefinedbytherelationshipbetweenthecarbonintensityandthetemperatureoutlinedimplicitlybycarbonbudgetsassociatedwithdifferenttemperaturetargets.Valuesthatstemfromthisrelationshipmayinprinciplebeinfinitelysmallorlarge.Thus,themethodologyprescribesminimumandmaximumvalues.Theminimumtemperature,regardlessofsector,hasbeensetto1.3°C.TheIPCCstatesthat‘thegloballyaveragedcombinedlandandoceansurfacetemperaturedataascalculatedbyalineartrendshowawarmingof0.85[0.65to1.06]°Covertheperiod1880to2012[…]theunrealizedglobalwarmingisabout0.6°Cwithoutanyfurtherincreaseinradiativeforcing’(IPCC,2014a).Themaximumtemperatureissetto6°C,whichisaworst-casewarmingscenariobytheyear2100thatiscitedbytheIPCCamongotherleadingclimatescientists.Companysectoralcarbonintensitiesarethenusedtodetermineacompany’stemperaturealignmentinthatsector.Acompany’ssectoralemissionintensityiisesti-matedbythefollowingformula:Thisformuladividesacompany’ssectoralemissionsin2030bythesumofitscurrentreve-nueandgreenrevenueinthatsectorinthesameyear.Theresultwouldbethesameifallnumberswereexpressedin2018terms,asanannualgrowthrateof3%isassumedforemis-sionsandrevenuesovertheperiod2018–30.Thisemissionsintensitybysectorcanthenbeusedtoobtainthecompany’ssectoralwarmingpotentialfromtherelevantcurve.48ChangingCourseBuildingBlocksoftheInvestorPilotmethodologyToarriveatthecompany’ssector-wisewarmingpotential,thesesector-specificwarmingpotentialsareweightedbythecompany’sshareoftotalrevenuecomingfromthatsector.Foreachsectorinwhichthecompanyisactive,thesector-specificwarm-ingpotentialiscalculatedasabove.Toarriveatthecompany’ssector-wisewarmingpotentialT,thefollowingformulaisused:Themethodologyfurthercalculatesacompany’ssector-agnosticwarmingpotential,whichdoesnotaccountforthesectortheemissionsaregeneratedin.Acompany’ssector-agnosticemissionsintensityiscalculatedasitstotalemissionsdividedbyitstotalrevenue.Thisemissionsintensityisthenusedtoextractthewarmingpotentialfromasector-agnosticcurve.Thecombinedwarmingpotentialisassumedtobetheaverageofthesector-levelandsector-agnosticwarmingpotential.Forexample,ifacompanyisactiveonlyinthetransportationsectorandhasasectoralwarmingpotentialof3.6°Candasector-agnosticwarmingpotentialof6°C,itsoverallwarmingpotentialis4.8°C.Toarriveattheportfoliowarmingpotential,companiesintheportfolioareassessedfortheirwarmingpotentialasabove,andaposition-weightedwarmingpotentialiscalculated.3.5.INNOVATIVEELEMENTS,GAPSANDNEXTSTEPSThissectionsummarisestheInvestorPilotGroup’sunderstandingoftheinnovativeelementsofandgapsintheCarbonDeltamethodology,aswellasCarbonDelta’sperspectiveonnextstepsfortheCVaRmethodology.Whileinvestorsprovidereflec-tionsontheirindividualexperienceswiththeCarbonDeltamethodologyinthecasestudiesinSection5,thissectionprovidesahigh-levelsummaryofthefeedbackreceivedforCarbonDeltaoverthecourseoftheInvestorPilotProjectinTable1.ItalsoprovidesCarbonDelta’sperspectiveonfutureimprovementstoitsevolvingproductofferinginBox4.Table1:Keyinnovativeelements,gapsandnextstepsfortheCarbonDeltamethodologyCategoryComponentInnovativeelementsGapsPhysicalriskScenariosInclusionofboth‘average’and‘aggressive’physicalscenariosunderBaUAnalysisofphysicalimpactsacrossdifferentpolicyscenariosoverlongertimeframesRiskassessmentmethodologyConstructionanduseofbusinessinterruptiondatasetbysectorDemonstrationofhighdegreeofgeographicalvariationinphysicalriskInclusionofarangeofphysicalrisks:extremeheat,extremecold,heavyprecipitation,strongsnowfall,severewindconditions,coastalfloodingandtropicalcyclonesAccountingforfacility-specificriskreductionmeasuresoradaptivecapacityDistinctionbetweentemporarydisruptionsandlong-termeffectsofextremeweathereventsIncorporationofadditionalhazards,suchasdroughts,landslides,riverfloodsandothersTransitionriskScenariosInclusionofarangeofpolicyambitions:1.5°C,2°Cand3°CfrommultiplemodelsCarbonpricesfromthesemodelslosethenuanceofdifferentpolicyinstrumentsandtheireffectsRegionalcarbonpricesinthemodeldonotcapturethepotentialdifferentiationinpolicyambitionacrossregions49ChangingCourseBuildingBlocksoftheInvestorPilotmethodologyCategoryComponentInnovativeelementsGapsRiskassessmentmethodologyRelianceongranularphysicallocationdatabaseforpolicyriskexposureassessmentUseofpatentdataforevaluationofgreenopportunitiesExaminationoftransitionriskforrealestateassetsExtensiontoScopes2and3,includinganalysisofproductsubstitutability,costpass-throughandabatementpotentialBottom-upanalysisofthelocalrisksofenergyefficiencyretrofittingregulationforrealestateassetsmaybemorerelevanttorealestatethanemissionreductionrequirementanalysisPatent-basedquantificationofgreenopportunitiesmaybeskewedtowardscertainregionsandsectorswithhigherpatentingratesAggregationPortfolio-levelimpactestimationUseofMertonmodeltodisaggregateequityanddebtimpactsUseofcompany-specificWACCsProvisionoftemperaturegaugeforportfoliosinadditiontotheCVaRClimate-relatedrisksandopportunitiesmayleadtostructuralshiftsinWACCsSource:InvestorPilotGroupinterviews,consultationwithCarbonDeltaBox4:NextstepsfortheCarbonDeltamethodology◼Analysisofclimateriskexposureinthesupplychain◼IntegrationofScope2and3emissionsdataintoCarbonDelta’smodels◼Extensionofthenumberofscenariosavailableforinvestorswithafocusonlongertimehorizons(utilisingCarbonDelta’sexistingback-endmodellingtoyear2100)◼Continuationofidentificationofcompaniesthatareclimateinnovators◼Assessmentandintegrationofdatarelatingtocompanies’utilisationofrenewableenergy◼Furtherexpansionofthefacility-andasset-leveldatabase◼Publicationofafollow-upreportonrealestateelaboratingonnextstepsofthismethodology50ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorlds4.COMPARINGCLIMATEVALUEATRISKACROSS1.5°C,2°CAND3°CWORLDS17ApplyingtheMethodologyforPortfolioAnalysisDespitetheinfancyofleveragingclimatescenarioanalysesforinvestmentdecisionmaking,scenarioanalysisbringstolightusefulandsubstantialresultsthatreinforcetheneedtounderstandtheimpactofclimatechangeoninvestmentportfoliosmorethoroughly.Thiscanyieldvaluableinvestmentinsightswithregardstoclimate-relatedmaterialityanalysis.Itisimportanttopointoutthatscenarioanalysisisneitheraforecastnorsensitivityanalysis.Instead,scenarioanalysisshedslightonpossiblefutures.Forinstance,howtransitionandphysical18impactsaffectaninvestor’sportfolioundera1.5°C,2°C,3°Cor4°Cwarmingworldbytheendofthecentury.Furthermore,towhatextentinvestorscouldfaceincreas-ingrisklevelsifpolicyactionsgetdelayedorifextremeweatherimpactsreachtheupperboundsofestimatedranges.Thischapterhighlightsresultsderivedfromacasestudyonfourportfolios:◼aMarketPortfolioof30,000companies19◼aTop1,200CompaniesPortfoliothatcloselymimicstheMSCIWorldIndex20◼aCoalPortfolio,and◼aRenewableEnergiesPortfolioTheanalysisaimstoprovideinsightsastohowresultscandiffergreatlydependingonthecompositionofindividualportfolios.Theanalysisispresentedfirstonoverallportfolio-levelandthenfurtherbrokenouttosector-levelanalysistoshedlightontheportfolio’sclimatehotspots.ThisportfolioanalysissectionisthenfollowedbyCaseStudiesfromparticipatinginvestorsoftheUNEPFITCFDPilot.Inthissection,theindividualparticipatinginvestorspresentarangeofscenariosandanalysisrelatingtotheiruniqueportfolios,investmentscenariosandassumptionswhichtheyhadidentifiedduringthepilotphase.ThedatasetofthecasestudyanalysisisbasedonCarbonDelta’sanalyticalresultsasattheendofFebruary2019.2117.ThissectionwasauthoredbyCarbonDeltaandcompiledbyVividEconomics18.Therearedistinctlimitationstophysicalanalysisunderthetimelinesusefulforinvestmentdecision-making.Themodellingbeinglimitedtoatimewindowof15years,withinwhichthemanifestationofphysicalimpactsremainlimitedandsimilarbetweenemissionspathways.Itisbeyondthose15yearsthatthephysicalimpactsofclimatechangeareforecastedtodrasticallyintensify,especiallyunderhigherGHGemissionspathwaysincludinga3°Cone19.CarbonDeltacarriedoutthisanalysison30,000companiesequallyweighted20.CarbonDeltacarriedoutthisanalysisonaportfolioconstructedofthetop1200companiesbyglobalmarketcapwhichisarepresentativeanddiversifiedinvestmentuniversefortheparticipatinginvestorgroupmembers21.CarbonDelta’smethodologyanddatasetiscontinuouslyimprovedandupdatedtofollowthedatareleasesofexternaldatasourcesandproviders.Bywayofexample,CarbonDeltarecentlyupdatedthecomputationofemissionreductiontargetsinlinewiththe2018annualUNEnvironmentEmissionsGapReport(UNEnvironment,2018a).Thisreportindicatesamorestringent1.5°Ctarget;thus,companies’reductiontargetshavenowincreasedwhichhasresultedinhigherClimateValue-at-Risknumbersaswell.CarbonDelta’smethodologyhenceisbasedonthemostup-to-dateclimatedataavailableinthemarket.51ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorlds4.1.THEMARKETPORTFOLIOOverall,climatechangeisamaterialriskwhichwillaffectthefutureperformanceofinvestmentportfoliosAnalysisofa‘MarketPortfolio’whichconsistsofapproximately30,000publiclylistedcompaniesandrepresentstheinvestablemarketatlargehighlightsclimate-relatedinvest-mentrisk.The1.5°Cscenario,inlinewiththelatestIPCCspecialreport,exposesasignifi-cantamountoftransitionrisk,affectingasmuchas13.16%ofoverallportfoliovalue(Table2:PolicyRisk,1.5°C).Consideringthattotalassetsundermanagementforthelargest500investmentmanagersintheworldtotalUSD81.2trillion,22thiswouldrepresentavaluelossofUSD10.68trillion.Thegoodnewsisthatcompanieshavealreadyactivelystartedworkingonthetransitiontoalowcarboneconomy.Theresultingcreationoflowcarbontechnologyopportunitiesthereforeoffsetsthishighpolicyrisknoticeably(Table2:TechnologyOpportunity,1.5°C).Thephysicalriskimpactisnegativeat-2.14%23andwouldincreasefurther,iftheworldisnotsuccessfulincurbingGHGemissionssignificantlyoverthenexttwodecades.Ofextremeimportancearedistinctlimitationstophysicalanalysisunderthetimelinesusefulforinvestmentdecision-making.Thismodellingislimitedtoatimewindowof15years,withinwhichthemanifestationofphysicalimpactsremainslimitedandsimilarbetweenemissionspathways.Itisbeyondthose15yearsthatthephysicalimpactsofclimatechangeareforecastedtodrasticallyintensify,especiallyunderhigherGHGemissionspathwaysof3°Candbeyond.Therefore,althoughanalysisresultsforphysicalrisklooksimilaracrossthescenariosforthefirst15yearsshown,muchhighercostsforphysicalriskforhighwarmingscenarios(3°Candbeyond)outto2100shouldbeanticipatedwheninterpretingCVaRattheaggregatelevel.Overall,consideringthatlowcarbontechnologyopportunitieswillhelpoffsetthepolicyrisk,andphysicalriskisminimalforthereasonsmentionedabove,thetotal,aggregatedvaluelossunderthe1.5°Cscenarioissubstantialat-4.56%orUSD3.7trillionofftheassetsoftheworld’s500largestinvestmentmanagers.Theresultsforthe2°Cand3°CscenariosarefurtheroutlinedinTable2below.Table2:ResultsfortheMarketPortfolioof30,000companiesModelDegreeScenarioPolicyRisk[%}PhysicalRisk[%]TechnologyOpportunity[%]AggregatedClimateVaR[%]REMINDwithAverageClimateModel1.5°C-13.16-2.1410.74-4.562°C-8.166.94-3.363°C-2.893.21-1.84Source:CarbonDeltaDeeperinsightsintothetrueclimateimpactsofthismarketportfolioarepresentedbelowbybreakingouttheanalysisfurthertosector-level.22.WillisTowersWatson,201823.Asdiscussedintheprevioussection,thereislittledifferentiationbetweenscenariosforphysicalimpactssinceactualcostsarecomputedovera15-yeartimehorizon52ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorldsUtilities,TransportationandAgriculturesectorsareundergoingthegreatesttransformationTable3:Sector-levelresultsforPolicyRiskillustratetherangeofclimate-relatedimpactsacrosstheportfolioDegreeScenarioAgricultureServicesManufacturingMining&PetroleumRefiningOtherIndustryTransportationUtilityServiceNo.ofEquities3011606711728110510702647131.5°CSectorAverageforequitiesinportfolio[%]-82.5-6.6-16.4-22.4-10.7-61.1-50.6CVaRContribution[%]6.025.846.76.02.83.98.82°CSectorAverageforequitiesinportfolio[%]-68.2-3.8-9.9-12.5-6.4-39.6-35.3CVaRContribution[%]8.124.245.75.42.74.19.93°CSectorAverageforequitiesinportfolio[%]-37.9-1.4-2.9-4.4-1.9-16.8-16.3CVaRContribution[%]12.623.938.15.42.24.912.8Source:CarbonDeltaTable3presentsthePolicyRiskforeachscenario(1.5°C,2°Cand3°C)andshowstheweightedaverageCVaR(%)foreachsector,aswellasthesectorcontributiontotheoverallCVaRandthetotalnumberofcompaniesinthesector.Drillingdowntheanalysistosector-levelhighlightsthoseindustriesthatareexposedtoahighdegreeofclimaterisk.Utilities,Transportation,AgricultureaswellasMining,PetroleumandRefiningstandout.The1.5°CscenariooutlinesthattheAgriculturesectorisclearlyundergoingthegreatesttransformationwithPolicyRiskat-82.5%andasectorcontributionof6%.Notableisalsothemanufacturingsector:althoughtheoverallclimate-relatedriskismoremoderateatonly-16.4%thissectormakesupalmosthalfoftheclimaterelatedinvestmentexposureoftheoverallmarketportfolio(Table3:46.7%CVaRContribution).Forinvestmentmanagersitisthereforecrucialtoanalysesectorholdingscarefullyinordertoidentifythosecompaniesthatwillbesuccessfulintomorrow’slowcarbonworld.AconcreteexamplewouldbeaUtilitycompanythathasalreadychangeditsoverallenergy-mixtotiltmoreheavilytowardsrenewableenergies.TheManufacturingSectoratlargeisdrivinglowcarboninnovationAddressingclimatechangeandlimitingglobalwarmingrequireseconomicpoliciestosupportthegreenenergytransition.Low-carbontechnologiesarethusacceleratedinascenariowheretheworldismoreambitiousinreducingCO2emissions,inlinewiththelatestIPCCreport.Thiscouldtranslateintoanincreasedpotentialingreenrevenuesforcompanies,whichinturnwouldhelptoincentivisethetransitiontoagreeneconomy.Theanalysispresentedherehighlightsthegreatpotentialoflowcarbontechnologiesandtheneedtointegratetransitionopportunitiesintotheanalysis.AsoutlinedinTable2,overalltechnologyopportunitiescontribute+6.94%underthe2°Cscenario.Whenaddingupallgreenprofitsofthis30,000-companyuniverse,thisrepresentsapproximatelyUSD2.1trillioningreenprofits.Greenrevenueopportunities,however,varysubstantiallybetweensectors.Table4presentsthesectoraverage(%),thenumberofcompaniesineachsectoraswellasthesector’scontributiontotheportfolio’sCVaR(expressedasShareofCVaR).Notably,themanufacturingsectorwhichcapturesthehighestsectortechnologyopportunitiesat+16.6%alsostandsoutwithashareof77%ofoverallclimaterelatedinvestmentrisk.Theanalysisthereforeidentifiesthesectorasadrivingforce53ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorldsinthelowcarbontransitionandnotesitascrucialtobeconsideredfortheanalysisandidentificationofgreeninvestmentopportunities.Asdefinedforthepurposesofthisanalysis,theManufacturingSectorcontainsadiverserangeofcompanies,suchasproducersofautomobiles,smartgridsystemsandwindturbinesbutalsoinformation&telecommunication,electronicsystems&equipmentaswellasautomotivesystemmanufacturers.Table4presentsthesectorresultsatlargeunderthe1.5°C,2°Cand3°Cscenarios.Table4:Sector-levelresultsfortechnologyopportunitiesillustratetherangeofimpactsacrosstheportfolioDegreeScenarioAgricultureServicesManufacturingMining&PetroleumRefiningOtherIndustryTransportationUtilityServiceNo.ofEquities2034145410177259491541.5°CSectorAverageforequitiesinportfolio[%]5.33.915.09.014.51.09.4ShareofCVaR[%]0.3615.3677.021.844.060.021.342°CSectorAverageforequitiesinportfolio[%]5.12.69.56.68.80.45.3ShareofCVaR[%]0.1613.5879.601.813.550.031.273°CSectorAverageforequitiesinportfolio[%]5.01.34.02.94.40.12.5ShareofCVaR[%]0.1012.7778.403.643.640.051.40Source:CarbonDeltaDelayedpolicyactionresultsinincreasingpolicycostsDelayingtheimplementationofclimatepolicies,intheory,willresultinhighercostsascompanieswouldneedtotransitionmoresuddenly.TheIntegratedAssessmentModelGCAM4SSP4bytheJointGlobalChangeResearchInstituteisbasedonthepremiseof“DelayedAction”.InTable5,theresultsofGCAM4areshownalongsidethosefromREMINDwhichasa‘middle-of-the-roadscenario’andassuch,muchcloseralignedwiththeconservativeassumptionsofthewell-knownETPmodelfromtheInternationalEnergyAgency(IEA).UndertheGCAM4scenariothepolicyriskincreasesfrom-8.16%to-9.13%,potentiallycostinginvestorsadifferenceofcloseto1%ifgovernmentsweretodelaypolicyaction.Forthisanalysis,thesumoftheoveralldiscountedcostsfrompolicyriskforeachcompanyinthisMarketPortfolio,covering30,000companies,wascomparedtheresultingcostimpactforthetwomodels.Thecostsareenormous;USD4.3trillionandUSD5.4trillion,respec-tively.DelayingpolicyactionunderGCAM4resultsinacostincreaseofUSD1.2trillion.Evenworse,delayingactionwouldnotjustincreasepolicyrisk,butalsoresultinmuchgreaterphysicalimpactsfromextremeweatherhazards(notincludedhere).Table5presentstheoverallresults.Table5:Policyriskforadelayedandnon-delayedscenarioModelDegreescenarioPolicyrisk[%]PolicycostREMIND(immediate)2°C-8.164.3trillionUSDGCAM4SSP4(delayed)2°C-9.135.4trillionUSDDifference-0.971.2trillionUSDSource:CarbonDelta54ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorldsIncreasinglevelsofextremeheatwillaffectbusinessoperationsinamajorwayThephysicalriskimpactofthesevenextremeweatherhazardsanalysedareenumeratedinTable6.Resultsforawell-diversifieduniverseof30,000companiesidentifiesincreasinglevelsofextremeheatasthedominantriskaffectingbusinessoperationsinthefuture.Therearemanyacademicstudiesthathavemodelledhowvulnerableindustriesaretoincreasinglevelsofheat,forexampleintheconstruction,foodandagriculturalsectors.Moreover,extremeheatmayalsohaveknock-oneffectsonemployeesthemselves.24Coastalfloodingisanotherhazardthataffectsbusinessoperationsinamajorway,causingsignificantdamagetoplantsandofficebuildings.Interestingly,precipitationriskcomesoutslightlypositiveunderboththeaveragechangeandaggressivechangescenarios.Thisseemscounter-intuitiveatfirstsightwhenwereadinthenewsthattropicalcyclonesareusuallylinkedwithheavyrainfalls.Forexample,duringthe3daysthathurricaneHarveycausedmuchdestructioninthecityofHouston,inexcessof1,000millimetresofprecipitationweremeasured,morerainthanmostcitiesintheworldexperienceduringawholeyear.However,analysisshowsthat,particularlyinWesternEuropeandNorthAmerica,thetrendtowardsdrierclimatesincreasesactuallyresultsinreducedprecipitationlevelsoverall.ThetablefurthermoreoutlinesthattheMarketPortfoliobenefitsfromdecreasinglevelsofextremecoldandsnowfall.Thisis,forexample,thecaseinsouthernpartsofCanadawherelesssnowfallwillleadtolessbusinessinterruptioninsuchindustriesasAirlines.Intheprocessofaggregatingfromfacilitytocompanyandfinallytoportfolioleveltheanal-ysisconsidersspatialcorrelationsbetweenfacilitiesofthesamecompanyandcorrelationsbetweendifferenthazards.DuetothesediversificationeffectstheoverallphysicalVaRisindeedlowerthanthesumofallindividualVaRs.Finally,whenconsideringtheaggressivephysicalscenario,theoverallriskimpactincreasesslightlyfrom-2.1%to-2.2%.Thisdemonstratesonceagainthebenefitofawell-diversifiedportfolioinhedgingagainstclimate-relatedphysicalrisks.Table6:PhysicalRiskfortheAverageandAggressiveclimatemodelsandeachspecificweatherhazard.PhysicalhazardAverageclimate[%]Aggressiveclimate[%]ImpactfromPhysicalHazards-2.1-2.2Extremecold0.50.4Extremeheat-2.3-2.3Precipitation0.030.02Extremesnowfall0.040.04Extremewind-0.01-0.02Coastalflooding-0.3-0.3Tropicalcyclones-0.1-0.2Source:CarbonDelta24.Seppänen,FiskandLei,200655ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorldsPhysicalriskexpectedtobehighestintheServicesandManufacturingsectorsAnalogoustothetransitionriskanalysis,sectoranalysisofthephysicalCVaR25showsthattheriskisdistinctforsectorswithvaryingimpactsontheoverallportfolio.Table7presentsthesectoraveragesaswellasthesectorcontributiontoClimateVaRoftheportfolio.Thenumberofcompaniesinthesector26arealsopresentedtoprovideanunderstandingofthecontributionofequitiesineachsector.TheresultsshowthattheTransportation,ConstructionandAgriculturesectorshavethehighestabsolutephysicalriskwith3.9%,3.3%and3%respectively,whileassetlocationsintheServicesandManufacturingsectorsarepredominantlyaffectedbyphysicalriskintheportfolio,withcontributions50.3%and35.2%(Table7,ShareofCVaR).Table7:PhysicalRiskfortheaveragescenariobysectorandcontributionDegreeScenarioAgricultureServicesManufacturingMining&PetroleumRefiningConstructionTransportationUtilityServiceAverageSectorAveragePhysicalRiskforequitiesinportfolio[%]-3.0-2.2-2.2-2.4-3.9-3.3-2.1No.ofEquities16310,9607,553756713208484ShareofCVaR[%]150.335.23.95.91.52.2Source:CarbonDeltaTheEastern&WesternUnitedStatesareheavilyaffectedbyincreasinglevelsofheatwhileIndonesianandEasternChinesecompanyfacilitiesareexposedtohighfloodingriskBreakingdownthephysicalriskanalysistofacility-levelhelpsinvestorstounderstandthedirectimpactsfromphysicalhazardsandgainfurtherinsightsabouttheeffectofclimatechangeontheportfolio’sassetlocations.Figure12demonstratesthatcertainlocationsareexposedtoconsiderablyincreasinglevelsofextremeheat,asforexampletheEasternpartoftheUnitedStates,whilecoastalflood-ingisamajorriskinSouthEastAsiaandChina.Safeguardstooperationsfromadaptingbusinesspracticesoradoptingresilienttechnologiescouldlimitcostsbutduetoalackofavailabledataarenotconsideredinthephysicalriskanalysismodelapplied.Theindivid-uallocationresultsinTable7showcaseaproductionfacilityofaleadingUShealthcarecompanyisexposedtoaboveaverageextremeheatrisk,whichcouldleadtocostsofUSD150millionforonelocationalone.AnothermajoroilproducerhasonefacilityexposedtofloodingriskinIndonesia,whichcouldleadtocostsofUSD125million.25.Fordetaileddescriptionofwhatthephysicalriskimpliesforeachsector,pleaserefertoSection3.326.NotethatthenumberofequitieshavechangescomparedtoTable4andTable5.ThisisduetothatsomeequitiesmayhaveaPolicyRiskand/orTechnologyOpportunity,butnoPhysicalRisk,andviceversa.56ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorldsFigure12:AnonymouscompanylocationsthatareexposedtosignificantlevelsofacutephysicalclimaterisksSource:CarbonDeltaFurthertonoteisthat5outofthetoptenhighrisklocationsarebasedinChina.Bothincreasedheatlevelsandcoastalfloodingwillaffectthesecompanies’facilitiesinamajorway.InTable8,Mining&Petroleum,Chemicals,ManufacturingandServicesectorcompa-niesarerepresented.Theseinsightsemphasisetheneedtodrilldowntolocationlevel,incombinationwithsectoranalysis,tofullyunderstandtheimpactofextremeweatherontheportfolio.Table8:Top10locationsexposedtoPhysicalRisksbasedonSectorandHazardLocationEnterpriseSectorHazardSumofCostsfornext15Years(millionUSD)UnitedStatesHealthcareServicesExtremeHeat-151ColumbiaRetailBusinessServicesPrecipitation-141IndonesiaOilproducerMining&PetroleumRefiningCoastalFlooding-125ChinaEnergycompanyMining&PetroleumRefiningExtremeHeat-112ChinaEnergycompanyMining&PetroleumRefiningExtremeHeat-107ChinaEnergycompanyMining&PetroleumRefiningCoastalFlooding-102IndonesiaCommunicationsTelecommunicationsCoastalFlooding-98.51ChinaEnergycompanyMining&PetroleumRefiningCoastalFlooding-90.79TunisiaChemicalsmanufacturerChemicalsExtremeHeat-89.84MexicoPlasticmanufacturerHeavyManufacturingExtremeHeat-89.68Note:Companieshavebeenanonymised.Source:CarbonDelta57ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorldsThemarketportfolioisfarfrombeingalignedwitha2°C,letalone1.5°CworldTheneedtoalignwitha2°CworldbecomesevenmoreapparentwhenlookingattheMarketPortfolioresultsundertheWarmingPotentialanalysis.Thisextremelywelldiver-sifiedportfolioiscurrentlyalignedwithatemperatureof3.4°C,whichisagooddistanceawayofffromachievingthe2°CalignmentgoaldefinedintheParisAgreement,letalonethemoreambitious1.5°Cgoal.BreakingthewarmingpotentialdownfurtherbysectorsinFigure13emphasizesthemisalignment.Agriculture(5.4°C),Mining,Petroleum&Refining(5.2°C),Transportation(5.2°C)andUtilityServices(4.8°C);allhavealarminglevelsofwarmingpotential.Inthiscontext,themodelhelpsinvestorstoshifttheirinvestmentsintomoreclimate-friendlysectorofcompaniesinordertosetastrategicpathforalignmentoverthecomingyearstoeventuallyachievea2°Coreven1.5°Calignmentgoal.Overall,theresultsclearlypointoutthatmorerapidpolicyaction,ontheonehand,isurgentlyneededtopreventclimatechangebeyond2°Cofwarming.Ontheotherhand,theanalysisalsooutlinesthatcompanieshavealreadystartedtoactandareactivelyworkingonthelowcarbontransition,asevidencedbythesignificantamountofgreentechnologyopportunitiesinthisMarketPortfoliouniverse.Thisinturnrepresentsimportantstockselectionopportunitiesforinstitutionalinvestors,nottobemissed.Figure13:PortfolioTemperatureGaugeNote:Thethermometershowsthewarmingtrajectoryofthisportfolioandrelatesittoimportanttargettemperaturesinglobalclimatechangenegotiations.Thisportfolio’swarmingtrajectory(markedinblue)considerstheweightedwarmingtrajectoryofallportfoliopositions.Currentandfuturecarbonintensityplayacentralroleinthiscalculation.TheformulaforcalculatingfuturecarbonintensityisprojectedScope1emissionlevelsdividedbycurrentrevenuesplusforecasted,patentedgreenrevenues.Source:CarbonDelta58ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorlds4.2.THETOP1,200COMPANIESPORTFOLIOAtfirstsight,climate-relatedimpactsonadiversified“Top1,200Companies”PortfolioappearmodestThe‘Top1,200Companies’Portfolioiscomprisedofthetop1,200companiesbymarketcapandcloselymimicstheMSCIWorldIndex.ThisanalysisisperformedinthesamewaytheanalysisaswasdoneintheprevioussectionfortheMarketPortfolioof30,000companies.Interestingly,theoverallportfolio-levelresultscomeoutclosetozeroforthesetop1,200companieswithanoverallpositiveClimateValue-at-Riskof+0.05%forthe1.5°Cscenarioandslightlynegativeresultsforthe2°Cscenarioat-0.46%.Table9presentstheoverallresults.Whenlookingattheresultsinthetablemorecloselyitbecomesapparentthattechnologyopportunitiesactuallyoutweighthenegativeimpactfrompolicy&physicalrisks.Moreover,theaveragephysicalriskimpactisonaggregateverymoderateat-0.72%comparedtotheMarketPortfoliowhichcameoutat-2.2%overall.Table9:Resultsforthetop1,200companiesbyglobalmarketcapModelDegreeScenarioPolicyRisk[%}PhysicalRisk[%]TechnologyOpportunity[%]AggregatedClimateVaR[%]REMINDwithAverageClimateModel1.5°C-3.79-0.724.560.052°C-2.072.32-0.463°C-0.840.75-0.80Source:CarbonDeltaDeeperinsightsonthetrueclimateimpactsofthistop1,200companyuniversecanbegainedbybreakingdowntheanalysistosector-level.SeeTable10belowformoredetails.Atsectorlevel,climate-relatedrisksbecomeacutelyapparentTable10:Sector-levelresultsforPolicyRiskillustratetherangeofclimate-relatedimpactsacrosstheportfolioDegreeScenarioAgricultureServicesManufacturingMining&PetroleumRefiningOtherIndustryTransportationUtilityServiceNo.ofEquities3557336521148511.5°CSectorAverageforequitiesinportfolio[%]-71.4-0.6-2.5-8.1-2.7-14.1-50.2CVaRContribution[%]3.68.419.29.90.313.145.42°CSectorAverageforequitiesinportfolio[%]-49.7-0.3-1.4-4.0-1.3-6.8-27.2CVaRContribution[%]4.79.319.69.10.311.745.43°CSectorAverageforequitiesinportfolio[%]-35.0-0.1-0.4-1.7-0.5-2.3-11.7CVaRContribution[%]8.110.314.19.40.39.648.2Source:CarbonDeltaDrillingdowntheanalysistosector-levelinTable3highlightsthoseindustriesthatareexposedtoahighdegreeofclimateriskwhilealsohighlightinghowdiversificationcanhelptoreducetheserisks.Utilities,TransportationaswellasMining,PetroleumandRefiningstandout.AlthoughtheAgriculturesectorhasthehighestabsoluterisk,undera1.5°Cscenario,theUtilitySectorcontributesmoststronglytotheoverallPolicyRiskwitha59ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorldscontributionof45%(Table3,CVaRContribution:45.4%).Manufacturing,ontheotherhand,hasamuchlowerriskof-2.5%,butgetsasizeablecontributionof19.2%,inlinewiththeresultsintheMarketPortfolio.‘GreenRevenues’undera1.5°CWorldaresixtimesthatofa3°CWorldAsoutlinedinTable9above,overalltechnologyopportunitiescontribute+2.32%underthe2°Cscenario.Whenaddinguptheentiregreenprofitsofall1,200-companyuniverse,thisrepresentsapproximatelyUSD1.4trillionandinterestinglyoutweighsthepolicycostofUSD1.15trillion(seeTable12below).Further,theTop1,200companiespossessroughlyasmuchashalfofthegreenrevenueopportunitiesascomparedtothe30,000securitiesoftheMarketPortfolio(USD2.1trillion).ForthisTop1,200CompaniesPortfolio,greenrevenueopportunitiesonceagainvarysubstantiallybetweensectors.Similarly,aswiththeMarketPortfolio,Table11outlinesthattheManufacturingsectorcontainsthosecompanieswiththelargestgreenrevenueopportunities,withacontributionofapproximately85%totheportfolio’sCVaR.Table11:Sector-levelresultsfortechnologyopportunitiesillustratetherangeofimpactsacrosstheportfolioDegreeScenarioAgricultureServicesManufacturingMining&PetroleumRefiningOtherIndustryTransportationUtilityServiceNo.ofEquities337730736934421.5°CSectorAverageforequitiesinportfolio[%]0.130.6412.013.533.190.323.37ShareofCVaR[%]0.017.785.73.60.30.22.42°CSectorAverageforequitiesinportfolio[%]0.050.276.281.551.370.131.39ShareofCVaR[%]0.0046.488.13.10.30.21.93°CSectorAverageforequitiesinportfolio[%]0.020.082.070.470.400.040.37ShareofCVaR[%]0.05.689.52.90.30.21.6Source:CarbonDeltaDelayedpolicyactionresultsinincreasingpolicycostsFortheDelayedPolicyscenario,performedinthesamemannerasfortheMarketPortfolio,theresultsshowanincreaseincostsunderthe2°Cscenarioof140BillionUSDbetweentheGCAM4andREMINDmodels.Table12presentstheoverallresults.Table12:Policyriskforadelayedandnon-delayedscenarioModelDegreescenarioPolicyrisk[%]PolicycostREMIND(immediate)2°C-2.07-1,15TnUSDGCAM4SSP4(delayed)2°C-2.48-1,29TnUSDDifference-0.41140bnUSDSource:CarbonDelta60ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorldsPhysicalimpactsdriveupClimateValue-at-RiskfurtherThephysicalriskimpactsforthesevenextremeweatherhazardsanalysed(Table13)ontheTop1,200companiesshowsmoderateriskimpactsonaggregateportfoliolevel.Whenconsideringtheaggressivephysicalclimatescenario,theoverallriskimpactincreasesfrom-0.72%to-0.80%.Extremeheatandcoastalfloodingmostheavilyaffecttheportfo-lio’sfacilitieswith-0.7%and-0.1%respectively,againroughlyinlinewiththeresultsoftheMarketPortfolio.Theoverallmoderateclimaterisklevelsindicatesthatthemajorityofcompanyfacilitiesinthisportfoliouniversearenotbasedinhigh-risklocations.Table13:PhysicalRiskfortheAverageandAggressiveclimatemodelsandeachspecificweatherhazard.PhysicalhazardAverageclimate[%]Aggressiveclimate[%]ImpactfromPhysicalHazards-0.72-0.80Extremecold0.10.1Extremeheat-0.7-0.7Precipitation0.020.02Extremesnowfall0.0030.003Extremewind-0.003-0.01Coastalflooding-0.1-0.2Tropicalcyclones-0.03-0.04Source:CarbonDeltaPhysicalriskexpectedtobehighestinCommercialBuildingsandServicesandManufacturingAnalogoustotransitionriskanalysis,sectoranalysisofthephysicalCVaR27showsthattheriskisdistinctforsectorswithvaryingimpactsontheoverallportfolio.ThesectorresultsfortheTop1,200companiesshowthatServicesandManufacturinghavethehighestcontri-butiontoCVaR,at47.2%and31.9%,withabsolutephysicalimpactsof-0.58and-0.78.Bylookingatthelocation-specificimpactsnext,wecandrilldownintotheunderlyingriskimplicationsonfacility-level.Table14:PhysicalRiskfortheaveragescenariobysectorandcontributionDegreeScenarioAgricultureServicesManufacturingMining&PetroleumRefiningOtherIndustryTransportationUtilityServiceAverageSectorAveragePhysicalRiskforequitiesinportfolio[%]-4.36-0.58-0.78-1.33-0.96-0.83-1.41No.ofEquities254833651104749ShareofCVaR[%]1.447.231.98.30.64.26.9Source:CarbonDelta27.Fordetaileddescriptionofwhatthephysicalriskimpliesforeachsector,pleaserefertoSection3.361ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorldsLocation-specificphysicalimpactscouldbelargeFigure14demonstratesthattheEasternpartoftheUnitedStatesstandsoutintermsofextremeheatimpactonceagain,whilecoastalfloodingisamajorriskimpactinSouthEastAsia.Figure14:AnonymouscompanylocationsthatareexposedtosignificantlevelsofacutephysicalclimaterisksSource:CarbonDeltaOneimportantpointtonotefromTable15,below,isthatfouroutofthetoptenhighrisklocationsarefromcompaniesintheServicessector.Thisisinlinewiththelargecontribu-tiontotheCVaRaspresentedinthetable.Asareminder,ManufacturinghasthesecondlargestCVaRcontribution,butisnotrepresentedinthistoptenhighrisklocationlist.Instead,Mining&PetroleumRefiningandUtilitycompaniesarerepresentedbutcontributemuchlesstotheoverallCVaR.Theseinsightsemphasisetheneedtodrilldowntolocationspecificlevel,incombinationwithsectoranalysis,tofullyunderstandtheimpactofextremeweatherontheportfolio.Table15:Top10locationsexposedtoPhysicalRisksbasedonSectorandHazardLocationEnterpriseSectorHazardSumofCostsfornext15Years(millionUSD)UnitedStatesInsurancecompanyServicesExtremeHeat-151IndonesiaEnergycompanyMining&PetroleumRefiningCoastalFlooding-125UnitedStatesInsurancecompanyServicesExtremeHeat-52.03SingaporeEnergycompanyMining&PetroleumRefiningCoastalFlooding-51.87CostaRicaRetailcompanyServicesPrecipitation-47.94BrazilCommoditycompanyMining&PetroleumRefiningExtremeHeat-47.22JapanEnergycompanyUtilityServicesCoastalFlooding-42.84UnitedStatesTelecommunicationscompanyServicesExtremeHeat-42.55UnitedStatesEnergycompanyMining&PetroleumRefiningExtremeHeat-39.51MexicoEnergycompanyUtilityServicesTropicalCyclones-36.33Note:Companieshavebeenanonymised.Source:CarbonDelta62ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorldsHowalignedaretheTop1,200companieswiththe2°Cworld?TheTop1,200CompaniesportfoliotrackingtheMSCIWorldIndexiscurrentlyalignedwithatemperatureof3.2°C,roughlyinlinewiththecountryspecificpolicypledgesoftheParisAgreement,knownastheNationallyDeterminedContributions(NDCs).However,justaswewitnessedintheMarketPortfolio,thisalignmentisstillwayofffromachievingthe2°Cor1.5°CgoalsoutlinedintheParisAgreement.Onceagain,similarlytotheMarketPortfolio,Agriculture(5.6°C),Mining,Petroleum&Refining(5.3°C),Utilities(5.2°C)andTransportation(5.1°C)sectorsallhaveratheralarminglevelsofwarmingpotential.Figure15:PortfolioTemperatureGaugeNote:Thethermometershowsthewarmingtrajectoryofthisportfolioandrelatesittoimportanttargettemperaturesinglobalclimatechangenegotiations.Thisportfolio’swarmingtrajectory(markedinblue)considerstheweightedwarmingtrajectoryofallportfoliopositions.Currentandfuturecarbonintensityplayacentralroleinthiscalculation.TheformulaforcalculatingfuturecarbonintensityisprojectedScope1emissionlevelsdividedbycurrentrevenuesplusforecasted,patentedgreenrevenues.Source:CarbonDelta63ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorlds4.3.THEMATICPORTFOLIOS:COALANDRENEWABLEENERGYWhiletheassessmentoftheMSCIWorldIndexTrackerresultedinmoderateriskfindsanda3.2°Calignment,itisimportanttonotethatclimaterisksandtemperaturealignmentcanvarygreatlydependingonportfolioconstruction.Thebelowtablesandtemperaturegaugesdisplaytheresultsoftwoadditionalthematicportfolios.Thefirstisaportfolioofcompa-nieswithsignificantcoalexposure,suchasutilitieswithcoal-firedpowergenerationbusinesssegmentsaswellascoalandligniteextractioncompanies.Thesecondportfolioisformedofcompaniesoperatingintherenewableenergysectorwithafocusonsolar,wind,wavepowerandelectricvehicles.Comparingthesetwothematicportfoliosrevealsalargeamountofpolicyriskcoupledwithalowamountoftechnologyopportunitiesinthe‘coalportfolio’,whereastheoppositeistruefortherenewableenergyportfolio.Physicalriskshappentobeminorriskcontributorsinbothportfolios,withextremeweatherCVaRsatjust-0.2%.InthebelowtablesyouwillfindthescenariospecificbreakdownatportfoliolevelfortheCoalandRenewableEnergyPortfolios.Table16:ResultsforaCoalPortfolioModelDegreeScenarioPolicyRisk[%}PhysicalRisk[%]TechnologyOpportunity[%]AggregatedClimateVaR[%]REMINDwithAverageClimateModel1.5°C-38-0.20.1-38.12°C-8.60.1-8.73°C-4.20.1-4.3Table17:ResultsforaRenewableEnergyPortfolioModelDegreeScenarioPolicyRisk[%}PhysicalRisk[%]TechnologyOpportunity[%]AggregatedClimateVaR[%]REMINDwithAverageClimateModel1.5°C-1.1-0.850.748.82°C-0.531.830.53°C-0.115.414.5Source:CarbonDeltaThewarmingpotentialoftheCoalPortfolioat5.3°CiscomparablewiththatoftheMining&PetroleumaswellasUtilitysectorresultsfromthepreviousTop1,200Companiesanal-ysis.Bycontrast,therenewableenergyportfolioachievesawarmingalignmentofbelow2°C,whichnoneofthetraditionalinvestmentsectorscurrentlyachieve.However,bothportfoliosalsolacktherequiredlevelsofdiversificationforinstitutionalassetownersbutareneverthelessinterestingcasestudiestounderpintheneedtoconsiderclimate-relatedriskanalysisinportfolioconstructionandinvestmentdecision-making.Aglanceatthebelowtemperaturegaugeswillemphasizethealignmentdisparitybetweenacoal-focussedandrenewableenergy-focussedportfolios.64ChangingCourseComparingClimateValueatRiskAcross1.5°C,2°Cand3°CWorldsFigure16:PortfolioTemperatureGaugeforCoalandRenewableEnergyPortfoliosNote:Thethermometershowsthewarmingtrajectoryofthisportfolioandrelatesittoimportanttargettemperaturesinglobalclimatechangenegotiations.Thisportfolio’swarmingtrajectory(markedinblue)considerstheweightedwarmingtrajectoryofallportfoliopositions.Currentandfuturecarbonintensityplayacentralroleinthiscalculation.TheformulaforcalculatingfuturecarbonintensityisprojectedScope1emissionlevelsdividedbycurrentrevenuesplusforecasted,patentedgreenrevenues.Source:CarbonDeltaCASESTUDIESCasestudieswereauthoredbythenamedfinancialinstitutionsandreflecttheviewsoftheauthors,withcompilationbyVividEconomics.ThestatementsherewithdonotnecessarilyrepresenttheviewsofUNEPFinanceInitiativeorVividEconomics.5.OPERATIONALISINGTHEMETHODOLOGY66ChangingCourseOperationalisingtheMethodologyThissectionpresentscasestudiesofinvestorimplementationoftheInvestorPilotmethodologyco-developedwithCarbonDelta.Aspartoftheproject,eachinvestorinthePilotGroupwasabletoanalyseatleastoneportfolioandtrialdifferentscenariosincollaborationwithCarbonDelta.ThissectionpresentstheresultsandevaluationofthisanalysisfromseveralPilotGroupmembers,focusingondifferentaspectsofthemethodologyandtheuseofresults.Casestudiesareorganisedaroundtwokeythemes:1.Stress-testingthemethodologyandresultsreceived.Thesecasestudiesrepresentdeep-divesintotheresultsofCarbonDelta’sportfolioanalysisforeachinvestor,focusingontheuniqueareasthatinstitutionschosetoexplore.Theseincludetheexpansionofscenariostomoreaggressivephysicalriskanddelayedpolicyresponsescenarios(Aviva,Nordea),thenon-linearityofriskacrossdifferenttemperaturepathways(ManulifeInvestmentManagement),andtheperformanceofactivelymanagedportfoliosrelativetorelevantindices(Rockefeller).AnothercasestudyfromCDPQexam-inestheimportanceofconsideringvaluechainsandnon-substitutabilityofproductsinriskassessment.2.Integratingscenarioanalysisintointernalprocessesorexternalengagement.Thesecasestudiesfocusonthepotentialintegrationofthepilotprojectresultsintointernalprocesses.Theyexaminethebenefitsofengag-ingwithscenarioanalysis(Addenda),highlighttheinter-actionsbetweenthemethodologyandtheidentificationofmetricsforfuturerealestateassessment(Investa),exploreevolvinginternalriskmanagementprocessessurroundingclimate-relatedrisks(KLP),compareCarbonDeltaresultstoclimaterisksignalsprovidedbyESGdataproviders(TDAM),drawouttheimplicationsforinternalscenarioanalysistoolsandriskmanagementpractices(NBIM,LaFrançaise),andelaboratehowinstitutionscanutilisetheresultsinengagementwithinvesteecompanies(DNB).Inthecasestudies,investorshighlightthefollowingkeybenefitsfromengagementwithscenarioanalysisusingthepilotmethodology:◼Consideringphysicalandtransitionrisktogethercanprovidevaluableinsightsintotheirinteractionsandresultsinamorecomprehensiveandconsistentriskassessmenttoolforinvestors.◼Thediversityofimpactsacrossdifferentscenariosinbothphysicalandtransitionassessmentsemphasisestheimportanceofconsideringarangeofscenarios.◼TheCVaRmeasurecouldfacilitateinternaldiscussionbyquantifyingriskthatmayhavepreviouslyhavebeenassessedonlythroughratings,andcangeneratemoreinterestinternally.◼Someinvestors,infutureengagementwithinvesteecompaniesontheneedfordisclosureofmaterialclimate-relateddataandriskmanagement,arelikelytoutilisetheresultsoftheassessmentassupportingevidenceoftheneedforaction.However,investorsalsonotedthatscenarioanalysisshouldnotformthesolebasisforcorporateorinvestordecision-making.◼Resultshighlightthatactivemanagementcouldconsid-erablyreduceclimate-relatedriskexposureofportfolios.However,membersalsoemphasisetheneedtofurtherdevelopscenarioanalysismethodologiestomoreaccuratelycapturetheextentofclimate-relatedrisksandopportu-nitiesforinvestors.Themethodologydevelopedforthepurposesofthisprojectpresentedacomprehensivestart-ingpointandallowedmanyinvestorsafirstinteractionwithin-depthscenarioanalysis.Yetitalsohighlightedtheneedforfurtherimprovementstomethodsofscenarioanalysisifresultsaretobecomeincreasinglycredibleandusefulforinvestordecision-making.SuggestionsforimprovementsarediscussedindepthinSection6.2.67STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyAVIVA:AGGRESSIVEPHYSICALRISKSCENARIOSAvivaisanassetownerwithmorethanGBP487billioninassets,aninsurerwithgrosswrittenpremiumsofmorethanGBP28.7billion,andanassetmanagerwithassetsundermanagementofmorethanGBP426billion.Itprovides33millioncustomersaroundtheworldwithinsurance,savingsandinvestmentproducts.AvivahascommittedtoimplementtherecommendationsoftheTCFD(includingconductingclimate-relatedscenarioanalysis),andwehavereportedontheserecommendationssince2016.AvivajoinedtheUNEPFIInvestorPilottosupportthedevelopmentofconsistentandcomparablehigh-levelscenar-ios(includingcommonelementsregardingthemodellingoftheimpactofphysicalandtransitionrisk)withotherinsurersandassetowners.Aviva’sTCFDscenarioanalysisprojectAviva’sChiefRiskOfficerandtheGroupGeneralCounselandCompanySecretaryaretheexecutivesponsorsoverseeingour2018disclosure.ThisyearAvivainitiatedaprojecttocreatebest-in-classclimate-relatedscenarioanalysiscapabilitytoenhanceourdisclosure.Theprojectcoverstheidentificationofappropriateclimate-relatedscenarios,assessmentofthosescenarios,anddevelopmentofreportingformatsfortheresultsofthescenarioanalysis.InclusionofmoreaggressivephysicalriskscenarioOneofthemainchallengesweidentifiedaspartoftheprojectwaswhetheramoreaggres-sivephysicalriskscenarioshouldbeincludedinthescenarioanalysis.UndertheIPCCRCP8.5scenario,whichassumesemissionskeeprisingatcurrentlevels,itisconsideredaslikelyasnotthattheglobalaveragetemperaturerisefrompre-industriallevelswillexceed4°Cbytheendofthecentury,anditishighlylikelyinthisscenariothattemperaturesexceed3.5°C.Thus,amoreaggressivephysicalscenarioof,say,6°Cisplausibleby2100,particularlywhenfactoringintheriskofclimatetippingpointscausingrunawaywarming.Howeverascanbeseenfromthegraphbelow,theworstphysicaleffectsarelikelytomanifestthemselvesonlyinthesecondhalfofthecentury,andintheshort-to-mediumtermthereisrelativelylittledifferenceintemperaturerisesbetweeneachIPCCscenario.68STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyFigure17:Globalaveragesurfacetemperaturechangesrelativeto1986-2005Source:IPCC,2014aIncontrast,theeffectsfromthetransitiontoalow-carboneconomyarelikelytobefeltoveramuchshortertimeframeandtodifferconsiderablybetweeneachIPCCscenario.Asaresult,ifscenarioanalysisisconductedoverrelativelyshorttimehorizonsthenthediffer-encesinthelong-termimpactofphysicalriskineachscenario,aswellasthelevelofphysi-calriskcomparedwithtransitionriskineachscenario,couldbeunderstatedand,asaresult,inappropriateconclusionsdrawnabouttheimpactonthebusinessofdifferentstrategies.Thatsaid,ifphysicalandtransitionrisksarenotbeinglookedatconsistentlythenitismoredifficulttounderstandthecombinedeffectoftheaggregateriskindifferentscenarios,astacklingmitigationandadaptationchallengespresentseveraltrade-offs.Furthermore,itcouldbearguedthatthelongerthetimehorizonusedforthescenarioanalysis,thelessdecision-usefulitbecomes.Toaddressthesepoints,itwasagreedwithintheUNEPFIPilotGroupandwiththeproject’sconsultant,CarbonDelta,touseaconsistent15-yeartimehorizon—withtheabilitytolookatshortertimeperiods—forbothtransitionandphysicalrisk.Inaddition,moreaggressivephysicalriskswouldbecapturedbylookingatahigher95thpercentileofhistoricalextremeweatherobservations,aswellastheexpectedoutcomeunderan‘average’BaUdevelopmentscenario.SeeFigure18belowforanexampleofcoastalflooding.Toanalyseamoreaggressivephysicalriskscenario,atahigher,95%confidencelevel,riskdatasetswerecompiledforeachhazard.ThehazardsthatCarbonDeltamodelledincludeextremeheatandcold,heavyprecipitation(Precip)andsnowfall,coastalflooding(CF),windstorms,andtropicalcyclones(TC).Inaddition,unlikeintheexpectedcase,adependencestructurewasdefinedbetweenhazards.69STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyFigure18:Increaseindamagesas%ofassetvaluefromexpectedvalueto95thpercentileforcoastalfloodingSource:CarbonDeltaFigure19belowshows,basedonoutputfromCarbonDelta,thedifferenceinestimatedimpactwhencomparingtheaggressive(95%percentile)scenariotoanaverageBaUscenarioontheMSCIWorldindex,presentedbyhazard.Inthemoreaggressivephysicalriskscenario,theoverallriskalmostdoublescomparedwiththeexpectedscenario.However,thedifferencedependsstronglyonthehazardconsidered.Figure19:AvivaanalysisofdifferencesbetweenaverageandaggressivescenariosacrossphysicalhazardsSource:Aviva,CarbonDelta70STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyAggressivescenariosforphysicalrisksrequirefurtherattentionTheintroductionofamoreaggressivephysicalriskscenariobyCarbonDeltaenablesthepotentialimpactofmoreextremephysicalriskoutcomestobeassessedoveradecision-use-ful,consistentandcomparabletimeframewiththatusedfortransitionrisks.However,werecognisethatthereisfurtherworktodotorefinethismethodology,includingpotentiallyintroducingmorelong-term,sophisticatedscenarios,whichcouldrevealsomeofthevaria-bilityinoutcomesindicatedbyclimatemodels.Beforethisisdonethemodelremainssensi-tivetoassumptionsmadeaboutgrowthofphysicalcostsbeyond15years.Itisparticularlyimportanttounderstandthepotentialimpactofvariousoutcomeswhenaggregatingphysicalriskswithtransitionrisksunderdifferentscenarios,orsimplycompar-ingtheimpactofdifferentscenarios.Forexample,onewouldexpectthecostsofphysicalrisksintheBaUscenariotogrowmuchmorerapidlythanintheIPCC’sambitiousmitiga-tionscenario(RCP2.6).CarbonDeltacurrentlyoffersninetransitionriskscenariosyetonlytwophysicalriskscenarios.Amoreproportionatenumberofphysicalriskscenarioscouldbedevelopedtocouplewiththevarioustransitionriskscenarios.Wewouldrecommendadjustingtheoutputstotakeaccountofthisimbalance.Inaddition,wewouldexpectthemodellingofdependenciesbetweenhazardstobefurtherrefinedovertime.71STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyCDPQ:VALUECHAINSANDNON-SUBSTITUTABILITYOFPRODUCTSIntroductiontotheCDPQ’sstrategytoaddressclimatechangeCreatedin1965,CaissededépôtetplacementduQuébec(CDPQ)isalong-terminstitu-tionalinvestorthatmanagesfundsprimarilyforpublicandparapublicpensionandinsuranceplans.AsofDecember31,2018,itheldCAD309.5billioninnetassets.AsoneofCanada’sleadinginstitutionalfundmanagers,CDPQinvestsgloballyinmajorfinancialmarkets,privateequity,infrastructure,realestateandprivatedebt.ItannouncedandlauncheditsinvestmentstrategytoaddressclimatechangeinearlyOctober2017.Theorganisationhasbuiltitsstrategyonfourpillars,withaclearefforttomakeitsimpactquantifiableandensureimplementationacrossthewholeinvestmentprocess.Thesepillarsare:1.Factoringclimatechangeintoallinvestmentactivitiesanddecisions.2.Increasinglow-carboninvestmentsby50%by2020.3.Reducingthecarbonfootprintperdollarinvestedby25%by2025.4.Exercisingstrongerclimateleadershipwithintheindustryandwiththecompaniesintheportfolio.ThisstrategytoaddressclimatechangewasdevelopedfollowingtheTCFD’sfinalrecom-mendationsinJune2017,whichincludethe‘Descriptionoftheresilienceofthestrategy,takingintoconsiderationdifferentclimate-relatedscenarios’.CDPQbelievesthattheresilienceofitsportfolioneedstofactorinclimate-relatedrisks.Theanalysisoftransitionandphysicalriskmodellingiscomplexattheportfoliolevel;therefore,CDPQjoinedtheUNEPFIInvestorPilotGrouptodevelopamoreprecisemethodology.Atthebeginningof2018uptothelaunchoftheUNEPFIreportinApril2018,theinter-nalgroupresponsibleformeasuringthecarbonfootprintoftheportfolioandpilotingtheclimatechangestrategywithintheorganisationwasmandatedtoworkontheclimate-relatedscenarioanalysiswithUNEPFIandadozenotherinvestmentpeers.AsworkprogressedwithCarbonDelta,afewpointsneededclarificationsbyourinternalgroups.UsingtheconstituentsoftheMSCIWorldindex,thesubjectsbelowwereanalysedandthensharedwithUNEPFI.Exploringlinkageswithintheenergysector’svaluechainAstheenergysectorhasarathercomplexvaluecreationchainthatishardtograspbystandardsectorclassification,thissectionfocusesonissuesencounteredwhileanalysingthissector’spolicyVaRprovidedbyCarbonDeltaundera2˚Cpathway.Table11presentsdataregardingcertainstepsoftheoil&gasvaluechainrepresentedbyGeneralIndustryClassificationStandard(GICS)sectors.72STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyTable18:CDPQcomparisonofsectorsthroughspecificvaluechainsGICSsectorsPolicyVaR2˚CpathwayAv.MinMaxStandard-devConstituentsOil&gasequipment&services0%0%0%0%7Integratedoil&gas-7%-13%-3%12%14Oil&gasexploration&production-4%-12%0%3%25Oil&gasrefining&marketing-4%-8%0%3%9Oil&gasstorage&transportation-3%-4%-1%1%12Note:ThistableomitsoneoutlierintheStoragesectorandanotherintheIntegratedsectorSource:CarbonDeltaTheseresultshighlightcertainkeyelements:◼Theoil&gasstorage&transportation(storage)subsectorhasaloweraverageVaR(-3%)thanthatrelatedtotheoil&gasexplorationandproduction(production)sector(-4%),whichisinlinewiththeexpectedresult,asahighnumberofassetsintheformerhavelong-termcontractswithoilproducers,meaningthatcarbonpricingshouldhavethesameimpactonStorageandProduction.◼Wenote,however,thatoilandgasextractedandtransportedwillneedtoberefinedanddistributedtofinalconsumers.Refininginparticularisacarbon-intensivebusinessthatislargelyundertakenbytheIntegratedoil&gassubsector.ItwouldthenbefairtoassumethattheStorageandProductionsubsectorsshouldhavethesameVaRasthatoftheIntegratedsubsectorsincethetransitionwillultimatelyaffecttheentiresectoralvaluechain.◼Integratedoil&gas(integrated)hasthehighestaverageVaR(-7%).AscompaniesintheIntegratedsubsectorwillbeaffectedallalongtheirvaluechainbycarbonpricingpolicies,fromextractiontotheirgasstations,itappearslogicalthatthissectorshouldhavethehighestpolicyVaR,especiallywhencomparedwiththeoil&gasproducers,whichshouldnotbeimpactedasmuch.◼Thereseemstobenopolicyriskintheoil&gasequipment&servicessector.Thisresultiscounter-intuitiveascompaniesinthissectorprovideservicestotheotherplay-ersintheProductionsector,whichshouldsufferfrompolicyriskandindirectlyimpactthevaluechainofequipment&servicescompanies.WenotethatthemethodologyconsidersonlyGHGreleaseduponproductionoffossilfuelsandotherderivedproductstoassignatransitioncost.However,thefinancialimpactofthelikelydeclineindemandforthesefuelsthatisanticipatedinthescenariosusedinthisanalysis,whichmaytaketheformofstrandedassets,loweroilprices,decliningsalesanddecliningprofitability,isnotincludedinthisanalysisanditshouldbeatitscore,especiallyfortheoil&gassector.Weacknowledgethatdoingsoinasufficientlydifferentiatedmannertoreflecttherelativestrength,weaknessandcompetitivepositioningofindividualcompa-niesinthisvastsectorisnotablycomplicated,particularlyforoutsiderstothesebusinesses.Non-substitutabilityofproductsWithinthenext15years,someproductswillbesubjecttoregulatorycosts,butitwillprobablybetooshortatimeframeforthemarkettofindasubstitutefortheseproducts.Intuitively,productslikecementorsteelwouldfitinthiscategoryofassetsandthissectionthereforefocusesonthosesectors.73STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyTable19:CDPQtotalVaRofcementandironandsteelsectorsCarbonDeltasectorsAverageregulatoryVaRAverageRangeStandarddeviationConstituentsCement-32%-100%to-3%43%7Ironandsteel-11%-37%to23%14%19Source:CarbonDeltaUsingtheIEA’s2˚Cpathway,twokeyconclusionsweredrawn:◼Cementproductionisexpectedtokeepongrowinguntil2050,buttheglobalemissionsofthissectorwillhavetobereducedthroughtechnologicalmeanstofollowa2˚Cpathway.Theintuitionisthattheimpliedcarbonreductionisnotgoingtohappenwith-outadditionalcosts,andthepresenceoftechnologiesnotyetcommerciallyavailable.Consideringthehighlyprobableabsenceofcementsubstituteswithinthenext15years,theexpectedpolicycostswillbepassedthroughtoconsumers,thusleadingtoamuchlowerpolicyVaRthanthesectoraverageof-32%showninTable19.◼TheIEA’s2˚CscenarioregardingtheIronandSteelsectoralsoshowsanincreaseinthedemandfortheseproductscombinedwithareductionofcarbonemissionsuntil2050.Evenifthissectorishighlycarbon-intensive,withoutasubstituteitisexpectedthatpolicycostswillbepassedontoconsumers.This-11%VaRseemsalsoaggressive,butwinnersandloserscanbeeasilyidentifiedacrossthisindustrybasedontheresultsobtainedbythepilot,asthespreadbetweenpolicyVaRsishighwithinthissector.Theseresultsseemtobemoreinlinewithnaturaltransition,evenifsomecompaniesareshowntobeheavilyimpacted.ConcludingremarksInconclusion,climate-relatedscenarioanalysisofinstitutionalinvestors’portfoliosisverycomplexandthisexercisehasbeenagreatopportunitytodelvedeeperintothematterinacollaborativeeffortbackedbythedetailedmethodologyelaboratedthroughthispilot.Thedatagatheredonphysicalrisksisofinterestindifferentiatingcompaniesasitisbasedonstatisticalclimatedataandastandardmethodologyacrossallsectors—anapproachwellsuitedtothistypeofrisk.TransitionVaRresultsareparticularlyusefulincomparingcompanieswithinanindividualsectoraspresumablythequestionofproductdemandorprice(suchasinOil&Gas)andoftheabilityofcompanieswithinasectortopassthetransitioncoststotheirclients(suchasinCementorSteel)aremattersthatarelikelytoaffectasectorrelativelyuniformly.ThetransitionVaRresults,thoughimperfectinanabsoluteinvestmentuniverse,doprovideaninsightintowhichcompaniesmaybebetterpositionedinanindividualsector.However,aggregatingresultsattheportfoliolevelisproblematicbecauseoflikelysectoraldistortionsresultingfromthemethodology.Wewouldguessthattheoil&gassectorisprobablyriskierthansuggestedbythetransitionVaRobtainedwiththecurrentmethodologybecauseoffutureproductdemandandpriceissues,whereasthetransitionVaRofsectorssuchasSteelandCement,wheretherearenoforeseeablealternativestoday,isprobablyoverstated.Clearly,furtherresearchisneededtoconsiderhowclimatechange-relatedcostswillspreadthroughtheeconomy,andtotakeintoaccounttheScope3emissionsoffossilfuelproduc-ers,distributorsandmarketers(inpriorityoverothersectors),sothatbettercomparabilityacrosssectorscanbeachieved.Thecomplexityoftheexerciseforassetowners,whoareoutsiderstothecompaniestheyown,underpinstheurgentnecessityforcompaniestoundertakescenarioanalysisthem-selves,astheyarebetterplacedtoknowthegranularityoftheirindividualassetsandbusi-nesslines,assessdemandimpactsontheirproducts,theirabilitytopassthecarboncosttotheirclients,andtheirownstrategytoaddressclimatechange(amongotherthings).Webelievethatscenariosshouldbestandardised,atleastatthesectorlevel,toallowforbettercomparisonbetweencompanies.74STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyMANULIFEINVESTMENTMANAGEMENT:THENON-LINEARITYOFCLIMATERISKACROSSGEOGRAPHICALLYDISTINCTPORTFOLIOSManulifeInvestmentManagementhasextensiveexperienceininvestinginpublicmarketsassetclassesglobally.Asaresult,webelieveacomparisonofgeographicallydistinctequityportfolioscanhelpinvestorsevaluatethepotentialdifferenceinimpactofclimateriskondifferentregions,withimplicationsforassetallocation.Accordingly,thiscasestudyanal-ysestheimpactofclimateriskoncompaniesincludedintwoexistinginvestmentportfo-lios—onecomposedofCanadianequities,theotherofAsianequities—underthreeclimatescenarios.28Furthermore,itidentifiesthephysicalhazardsofclimatechangethatcarrythehighestpotentialnegativeimpactattheportfoliolevelandtheindustriesineachportfoliothatarepotentiallymostexposedtotheserisks.Ouranalysisalsooffersadiscussionoftwocompaniesineachportfoliothatshowgreaterexposurestoclimaterisk.ThisanalyticalworkillustrateshowManulifeInvestmentManagementcurrentlyseekstointegratetheevaluationofclimateriskinitsinvestmentprocesses.29QuantifyingclimateriskAccordingtothemethodologyusedintheUNEPFITCFDInvestorPilot,climatetransi-tionrisk–orthegeneralcostassociatedwithmovingfromacurrentBaUscenariointhedirectionofamorecarbon-neutralfuture—representsthegreatestportfoliorisk.Thisisfollowedinmagnitudebyphysicalhazardrisk—orthecostimpactassociatedwithextremeweatherevents,whichweidentifyintheseportfoliosasextremeheat,coastalflooding,andtropicalcyclones.Bothclimatetransitionandphysicalhazardrisksmaybepartiallyoffsetbylow-carbontechnologyinnovationsuchascarbonextractionorsequestration—particularlyforthosecompaniesthathaveinvestedinR&Dgearedtowardsobjectivesofsustainability.Inthefirsttwotables,theCanadianandAsianequityportfoliosareassessedintermsoftran-sitionrisk,technologicalopportunity,andtotalportfolioVaR.TheCanadianportfolioinvestsprimarilyinlargemarketcapitalisationCanadianequities,benchmarkedagainsttheS&P/TSXindex.TheAsianportfolioinvestsinequitieswithprimaryinterestinChinabenchmarkedagainstanaggregatedMSCIChina/HongKongindex.Thelattercolumn,‘TotalportfolioVaRinbps’,includestheimpactofphysicalhazardrisk,andthedetailsforthisdimensionofclimateriskacrossthetwoportfoliosarediscussedindepthinthecasestudy.28.ThiscasestudyincludesonlyScope1carbonemissionsfromtheunderlyingcompanies,whichmeasuresdirectcarbonemissionsfromoperations.Scope2,whichincludesindirectemissionsfromtheconsumptionofenergy—forexample,electricity—isnotincludedintheanalysis.FutureanalysesmaybedevelopedtoincorporateScope2andScope3carbonemissions.PortfolioholdingswerecurrentasofAugust8,2018.29.Thiscasestudyisforillustrativepurposesonly.TheinvestmentprocessmaychangeatanytimeandtheintegrationofESGfactors,includingclimaterisk,mayvarybetweeninvestmentstrategies.75STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyTable20:ManulifeCanadianequityportfolioresultsScenarioUnweightedaggregateVaRfromtransitionrisk(%)Multipleofthe3°CscenarioUnweightedaggregateVaRfromtechnologyopportunity(%)Multipleofthe3°CscenarioTotalportfolioVaRinbps(portfolioweighted)3°C-12.65n/a0.77n/a-32.02°C-48.783.9x2.873.8x-106.31.5°C-99.777.9x6.919.0x-199.9Note:VaRfromtransitionriskandtechnologyopportunityrepresentstheaggregatedownsideriskexposureandupsidepotential,respectively,expressedasapercentageoftheportfolio’smarketvalueunderthreeclimatescenariosofdecliningseverity:3°C,2°C,and1.5°Cincreases,respectively,inaverageglobaltemperatures.Source:Manulife,CarbonDeltaTable21:ManulifeAsianequityportfolioresultsScenarioUnweightedaggregateVaRfromtransitionrisk(%)Multipleofthe3°CUnweightedaggregateVaRfromtechnologyopportunity(%)Multipleofthe3°CTotalportfolioVaRinbps(portfolioweighted)3°C-16.74n/a4.99n/a-117.02°C-135.708.1x17.203.5x-315.11.5°C-177.6010.6x40.408.1x-390.1Source:Manulife,CarbonDeltaOneofthefirstconclusionstodrawfromourinitialassessmentisthattheAsianequityportfolioissubjecttogreaterrelativetransitionriskunderallthreeclimatescenarios,aswellasagreaterpotentialopportunityfromtechnologicalinnovation.TherearetwoprimaryreasonsfortheAsianportfoliotopotentiallyincurhigherrisk.First,theaveragecarbonintensityofAsiancompaniesishigher,whichcouldbeattributedtomultiplefactorssuchasthecurrentgreaterconsumptionofcoalforenergyproductionatthecountrylevelcomparedwithCanada.Second,theriskofphysicalhazardsinAsiaismoresevere,whichisillustratedinthetotalportfolioVaRcolumn.AccordingtoclimatefirmFourTwentySeven,Chinaleadstheworldincoastalrisksfromclimatechange,with145millionpeoplelivingonlandthreatenedbyrisingseas(DeutscheAssetManagement&FourTwentySeven,2017).Forthepurposeofthisanalysisitshouldbenotedthataconservative,forward-look-ingemissionpricecurvewasassumed,alongwithnon-aggressiveestimatesfromphysicalhazardsrisk;ifouranalysishadbeenbuiltongreaterseverityassumptions,thetotalimpactsontheportfoliowouldbegreater.However,andperhapsmoreimportantly,wenotehowthedataillustratesthenon-linearimpactoftransitionriskandtechnologicalopportunity.Inotherwords,themorerestrictivethewarmingscenario—inotherwords,themorestringenttheemissiondecar-bonisationrequiredtoachievemorelimitedglobalaveragetemperatureincreases—thegreaterthenegativeimpactoneachportfolio.Thisnon-linearityisalsoevidentinthetotalportfolioVaR.ItshouldalsobenotedthatthesectorweightsbetweenthetwoportfoliosislikelytoaccountforaportionofVaRdifferentials,asseeninthetablebelow.76STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyTable22:ManulifesectorweightsforCanadianandAsianequityportfoliosSectorCanadianequity(%)Asianequity(%)BasicMaterials5.60.7Communications7.225.6Consumer,cyclical5.19.6Consumer,non-cyclical6.69.1Energy18.16.9Financial34.238.5Industrial14.23.1Technology9.11.3Utilitiesn/a5.2Source:Manulife,CarbonDeltaTheParisAgreement’scentralaimistostrengthentheglobalresponsetoclimatechangeriskbylimitingtheglobaltemperaturerisethiscenturyto2°Cabovepre-industriallevelsandtopursueeffortstolimitthetemperatureto1.5°C.ThecarbonstringencyscenarioiswitnessedinathreefoldincreaseintotalportfolioVaRfortheCanadianequityportfolio,movingfrom3°Cto2°C.Furthermore,reducingtemperaturerisebyanother0.5°Cto1.5°C,identifiedasacriticalthresholdbytheIPCCinOctober2018(IPCC,2018),impliesanincrementalthreefoldincreaseintotalportfolioVaR.Incrementalchangesinclimatescenariosimplyincreasinglylargedimensionsofriskthatdwarftheincreasinglylargeimpliedtech-nologicalopportunityimpactforbothportfoliosinthestudy.PhysicalhazardriskRegardlessofgeographicalregion,thelargestphysicalhazardisextremeheat.Forbothportfolios,extremeheatexhibitstheclearesttrendunderclimatechange,withhotregionsbecomingevenhotteralongwitharisingfrequencyofextremeheateventsinvirtuallyeveryrelevantgeographicalzone.Unsurprisingly,thekeycostinputdrivingtheportfolio-levelimpactofthishazardishighercoolingcosts.Theunderlyingdatafromrunningtheanalysisshowsthatcoastalfloodingisnextinorderofmagnitudeforthesampledportfolios.Stormsurgeandcoastalfloodingareextremelylocalisedandcontingentonthefactorsofsea-levelrise,elevation,anddynamictopography.Thekeycostinputsdrivingtheimpactofthisriskareassetdamageandbusinessinter-ruption.Whileitispossibleforacompanytoprotectitselffromfinanciallossthroughinsurance,itsmarketvaluationwillremainsusceptibletoimpairmentuntilitsfinalfinancialexposureisknown.Thethirdphysicalhazardriskcommontobothportfoliosistropicalcyclones(hurri-canesandtyphoons).Thesestormsbringintensewindandrain,whichcausepropertydestructionandbusinessinterruption,andcancompoundtheeffectsofcoastalflooding.ThetablebelowassessesthetotalportfolioVaRofthesehazardsforbothportfolios.77STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyTable23:ManulifetotalportfolioVaRofthesehazardsforbothportfoliosPhysicalhazardUnweightedaggregateVaRforAsianequityportfolio(%)UnweightedaggregateVaRCanadianequityportfolio(%)AsianequityportfolioimpactrelativetoCanadianequityportfolioExtremeheat-48.9-12.104.1xCoastalflooding-9.8-0.7912.3xTropicalcyclones-2.4-0.624.0xSource:Manulife,CarbonDeltaExtremeheatTable24:ManulifeindustryrankingbyexposuretoextremeheatriskRankAsianequityCanadianequity1ElectronicequipmentFood&staplesretailing2Realestatemanagement&developmentOil&gasandconsumablefuels3BanksBanks4ConstructionmaterialsAutocomponents5Oil&gasandconsumablefuelsMetals&miningSource:Manulife,CarbonDeltaWhilethediversityofindustriesexposedtoextremeheatisimportanttorecognise,theport-folios’largestindustryexposures—banksandoilandgas—areaffectedtodifferentdegrees.Notably,theimpactontheAsianequityportfolioisthreetimesmoresevereinbothindus-tries.TheprimaryreasondrivingthisresultisthatclimatescienceindicatesthatextremeheatwillbemoresignificanttotheAsiaPacificregionthantoNorthAmerica.TheUnitedNationsFrameworkConventiononClimateChange(UNFCCC)statesthat‘thenumbers[ofpeople]affectedwillbelargestinthemegadeltasofAsiaandAfrica’(UNFCCC,2011).CoastalfloodingTable25:ManulifeindustryrankingbyexposuretocoastalfloodingriskRankAsianequityCanadianequity1ElectronicequipmentBanks2Oil&gasandconsumablefuelsCapitalmarkets3RealestatemanagementanddevelopmentMetals&miningSource:Manulife,CarbonDeltaTropicalcyclonesTable26:ManulifeindustryrankingbyexposuretotropicalcycloneriskRankAsianequityCanadianequity1DiversifiedtelecommunicationsOil&gasandconsumablefuels2BanksCapitalmarkets3ElectronicequipmentBanks4Oil&gasandconsumablefuelsFood&staplesretailingSource:Manulife,CarbonDelta78STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyCompanieswiththehighestlevelsofclimateriskWithintheAsianequityportfolio,thetwosecuritieswiththelargestunweightedVaRarebothstate-ownedenterprises.Thefirstisacementcompany,whoseindustryisoneofthelargestcarbon-emittersglobally(Harvey,2018).However,thereiscurrentlynoequalalterna-tivetocementthatcanmatchitsdurabilityandstrength,whichmeansthishigh-climate-riskindustryisrelativelyinsulatedfromcompetitivemarketforces.Thesecondcompanyisinthedownstreamoil&gasmarket.AccordingtoarecentreportbytheCarbonDisclosureProject(CDP),thiscompanybearsthehighestriskintermsofphysicalhazards,drivenbyextremeheatandcoastalflooding(Fletcher,Crocker,Smyth,&Marcell,2018).ThetwocompanieswiththehighestVaRintheCanadianequityportfolioresideintheoil&gasindustryandheavyequipmentservices.Inthefirstcase,climatetransitionriskrepresentsthevastmajorityofclimateriskexposurewithaslightoffsetbytechnology.Ascarbonpricesbegintoascend,thiscompanyfacestheriskofwhethertheproductionofoilwillcontinuetomakeeconomicsense.Thesecondcompanyisanindustrialcompanywithexposuretotheoil&gasandminingindustries.Itskeyrisk,withexposuretomultiplesectors,willbethestabilityofdemand.Thecostofcarbonemissionsislikelytoriseovertime,forcingthecompanytofaceahighprobabilityofslowingdemandforitsservices.IntegratingclimateriskmanagementintheinvestmentprocessClimatechangepresentsacomplexsetofinvestmentconsiderationsthatmayimpactcorporateprofitability.Companiesinallsectorsfacetransitionriskandphysicalhazardriskdimensionsofclimatechange,andtheseriskscanmaterialiseindifferentanddynamicways.ManulifeInvestmentManagementbelievesthatthosecompaniesthataremostproactiveaboutmitigatingtheserisksarelikelytobecomethemostresilient.Regardlessofthestrat-egyadopted,establishinggreaterresiliencytoclimateriskwillbesignificantataskforexecu-tivesandcorporateboardsofdirectors.Consequently,webelievethattheevaluationofclimateriskinourportfolioswillbecomeincreasinglyimportantovertime.Theincorporationofscenarioanalysisusingdifferentwarmingassumptionscanhaveadramaticimpactonvaluation.AtManulifeInvestmentManagement,weaspiretointegratetheevaluationofESGfactors,includingcarbonemissionsandclimatechangeimpacts,throughoutourdue-diligenceandinvestmentdeci-sion-makingprocesses.Evidenceshowsthatsomeindustrieswillbemoreexposedtoeitherclimatetransitionriskand/orphysicalhazardrisk.Inalignmentwiththisconclusion,westructureourengagementwithcompaniestodeepenourunderstandingoftheirclimatemitigationstrategiesandtoencouragegreaterclimateriskresiliency.Atthesametime,weseektoidentifyopportunitiesforgrowthamongcompaniesthatareposi-tioningthemselvesforindustrydisruptionandthepromotionofasmoothertransitiontolower-carbon-emissionmodels.Finally,wesupportengagementactivitiesthroughcompanydialogueandcollaborativeengagementinitiatives,30andseektosupportproxyitemsthatareintendedtomitigateclimaterisksorsupportcompanyadaptationtoclimatechange,whetherthroughmanagementproposalsorshareholderresolutions.30.ManulifeInvestmentManagementservesontheSteeringCommitteeoftheClimateAction100+,afive-yearinitiativeledbyinvestorstoengagesystemicallyimportantGHGemittersandothercompaniesacrosstheglobaleconomythathavesignificantopportunitiestodrivethecleanenergytransitionandhelpachievethegoalsoftheParisAgreement.Investorsarecallingoncompaniestoimprovegovernanceonclimatechange,curbemissionsandstrengthenclimate-relatedfinancialdisclosures.Referto:http://www.climateaction100.org/.79STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyNORDEA:DELAYEDPOLICYRESPONSENordeaAssetManagementisoneofthelargestassetmanagersintheNordics,managing€205billionindifferentassetclasses.NordeaAssetManagement’smissionistodeliverreturnswithresponsibilitybasedonactivemanagementandthoroughriskmanagement.Integratingclimateriskaswellasothersustainabilityrisksintoinvestmentdecisionsiscrit-ical,sinceneglectingtheseriskscouldhaveanegativeimpactoninvestmentperformancethroughunwantedriskexposuresandmissedopportunitiesthroughoutthetransitiontoalow-carboneconomy.NordeajoinedtheUNEPFIPilottogetherwithotherinvestorssincewewelcomeTCFDrecommendationsandwanttocontributetothedevelopmentoftoolstoassessclimate-relatedrisksthroughscenarioanalysis.DelayedpolicyresponseAglobalpolicyresponsethatwouldlimitglobalwarmingfromrisingabove2°Cascomparedwithpre-industriallevelsdoesnotseemlikelytobereachedwithintheforeseea-blefuture.Thus,weexplorewhatapotentialcostcurvewouldlooklikeifapolicyresponsetoclimatechangeweretocomethroughinfiveyears.Wealsocomparethiscostcurvetowhata2°C-alignedpolicyresponsewouldsuggesttoday,aswellasagainstaBaUscenario.Alldatapresentedinthecasestudyassumesapolicyresponsethatwouldbealignedwitha2°Cworld.Howrealisticthatisinitselfisbeyondthescopeofthiscasestudy.UsingtheCarbonDeltamethodologyundera‘delayedpolicy’response,wefindthatcostsarehigherthelaterapolicyisimplemented,andwefindstrongdifferencesintermsofimpactonsectors.Webelievethatasectorfocusismostrelevantintermsofscenarioanalysisasitisconfirmedbythis,andothermodels,thatsectorsarenotequallyexposedtoclimate-relatedrisks.Wealsobelievethatthereissubstantialdifferenceamongcompa-nieswithinsectors.Finally,weexplorewhetherpolicyriskwilltaketheformofaninstantaneousimpactratherthansmoothandgradualpricing.Wearguethatclimatepolicy,specificallyrelatingtosettingapriceoncarbon,willberapidlytransmittedtofinancialassets.Currentstateofaffairs:Transitionriskislikelythree-to-fiveyearsoutInthiscasestudywetrytoexploreawayofusingtheCarbonDeltamodelforconductingscenarioanalysisonaglobalbenchmarkagainstadelayedpolicyresponsetowardsclimatechange.Thelong-termtemperaturegoaloftheParisAgreement,withvoluntarycommit-mentsbycountriesglobally,iskeepingtheincreaseinglobalmeansurfacetemperaturefromrisingabove2°Cascomparedwithpre-industriallevelsby2100.However,asshownbelow,goingbeyondthecurrentpoliciesinplace,andincorporatingpledgesandtargetsbycoun-triestoday,bringstheprojectionsofanincreaseinpre-industrialtemperatureswithinthebandof2.7–3.0°C.80STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyFigure20:Warmingprojectionsto2100Source:ClimateActionTracker,2019AsreportedbyClimateActionTracker,veryfewcountriesarelivinguptotheirvoluntarilysubmittedNDCs.TheUS,theworld’slargesteconomy,hasannouncedthatitispullingoutoftheParisAgreement.WhiletheParisAgreementdoesnotstandandfallwithonesignatory,webelievethatthecurrentstateofaffairssignalstheorderofimportancebeingattributedtoclimatechangefromapolicyperspective.Againstthecontextoutlinedabove,wearguethatapolicyframeworkintermsofwhateven-tuallytricklesdowntocorporatebottomlinesmostlikelyliesbeyondathree-to-five-yearhorizon.Wearguethatitispreciselybecauseofthisuncertaintyaroundapolicyresponsethatscenarioanalysisiscrucial,giventhattheassociatedcostsareprofound.Delayedpolicyresponse–moreexpensiveWithinthescopeofthiscasestudyweexploretherisks—definedascostsduetopolicyresponsesonaglobalbenchmark—thatcomeintoeffectinfiveyears.Weassumethatgoinginto2024,aglobalpriceoncarbonwillbeadoptedwiththeambitionofstayinginlinewiththeParisAgreement.Thiswould,bydefault,triggeramoreaggressivepolicyframeworkintermsofdecarbonisationoftheeconomyascomparedwithwhatacredibleresponsewouldrequiretoday,alsoshowninthegraphasthe2°Cscenario.ThisscenarioisrepresentedbytheREMINDmodelandassumesthatthereisaglobalpriceoncarbonineffectasoftodayandisincludedonlyasreference.Incontrast,theDelayedscenariorepresentsa2°Calignedpolicyframeworkandcomesintoeffectinfiveyears,usingGCAM.The2°Cpolicyframeworkfiveyearsoutrepresentstherequirementsforachievinga2°CeconomyandcomesatalargercostcomparedwithimplementingpoliciesThenotionofincurringmorecostsfromamoredelayedpolicyresponseisalsodiscussedin(IPCC,2018).WorthnotingisthatwithinthescopeofthisanalysiswehavenotusedthefullCarbonDeltamodelthatwouldalsoincludetransitionopportunities.Wearetryingtozoominonthecostsinducedbyregulatoryaction.Indirectcostsandopportunitiesfrombothphysicalcircumstancesandtechnologicalaspectsareworthdivingintoseparatelyaswell.Differentpolicyresponses(orlackthereof)inducedifferenttypesofriskandopportunitiesonboththetechnologicalandphysicalside(extremeweatherevents,risingsealevel,amongothers).81STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyCostcurvesfromdifferentpolicyinitiativesFigure21:Nordeacostcurvesofthe2°CandDelayedscenariosSource:Nordea,CarbonDeltaInadditiontothe2-°CscenarioandDelayedscenario,wehaveincludedaBaUscenariowhichassumesnocostsinducedbypolicies.ThepossiblecostsrangebetweenUSD0(BaU)toroughlyUSD3.5trillion,onacumulativebasis,attheendofyear2033(Delayedscenario).ThedifferenceinthecumulativecostsbetweentheDelayedscenarioandthe2°C-scenarioisroughlyUSD0.7trillionover15years.WebelievethatbeinginaBaUscenarioandlook-ingatthedifferentimplicationsintermsofaggregatedcostsrepresentsaviolentdeparturefromwhatiscurrentlybeingpricedin.Onecouldarguethatintheabsenceofpolicyrisks,itisrightlysonotpricedin.However,asfaraseconomicsisconcerned,webelievethatthepolicyriskmoduleoftheCarbonDeltamethodologyhelpsusunderstandandarticulatethedifferentdistributionofoutcomesanddemonstratesthatpolicy-relatedclimatechangerisks,oncematerialised,representfat-tailedeventsthat,attheveryleast,deservebeingmonitoredandconceptuallyunderstood.82STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyFigure22:NordeaVaRacrosssectors:notallcostsareequallyspreadacrosssectors,butrathercentredSource:Nordea,CarbonDeltaThefigureshowstheweightedaverageVaRacrosssectorswithinaglobalbenchmark.Notethatwehavechosenthefoursectorsforillustrativepurposes.Itshouldroughlybeinter-pretedasthetotalcostsinducedbyclimatechange-mitigatingpoliciesondifferentsectorsrelativetothecurrentmarketvaluestoday.Themagnitudeofcosts,asmodelledbyCarbonDelta,variessignificantlyandillustratestheimportanceofunderstandingwherethemainriskslie.Aninstantaneousimpactratherthansmoothandgradualpricing?ClimatechangehasbeenhighontheagendaforNordeaAssetManagementforseveralyearsandmethods/toolsforscenarioanalysisareimportanttofurtherassessthecomplexrisksrelatedtoclimatechange.ThecaseandtheuseoftheCarbonDeltatoolfordifferentportfoliosareimportantstepstofurtherdevelopourassessmentofclimate-relatedimpactsonourholdings.Wewouldarguethatsincefinancialmarketsreactrapidly,apolicyresponsealignedwitha2°Cscenariowouldnotbeasmoothandgradualprocessunderwhichportfolioscanberebalancedbut,intheoryattheveryleast,arelativelyquickprocessofincorporatingthewholecostcurverepresentedbyaDelayedscenario.Itisworthemphasisingthisashereinliestherisksonfinancialassetsfromaninvestor’sperspective.WewanttohighlightthatCarbonDelta’spolicyriskmoduleusesnumerousassumptions,somemoreandsomelessrealistic.Forexample,potentialimprovementscouldincludecostpass-throughanalysisinthemodel,whichwouldreduceestimationerrorsbysomemargin.However,lookingattheimplicationsfromtheabovescenariosonanaggregatedlevelhighlightstheoverarchingpictureandshouldhelpestablishfocusareasforclimatechangeriskmanagementandactiveownershipactivities.Thiscouldpotentiallyfocusonpushingcompaniestoreassesstheimportancebeingattributedtoclimateriskmanagementandproperdisclosurearoundthese.Asafinalnoteinthisstudy,andinadditiontothecostpass-throughpotentialreferredtoabove,CarbonDelta’spolicyriskmoduledoesnotcurrentlycapturecompany-specificeffortstomanagetheserisksanddiversifydifferentbusinessmodelsawayfromcarbonrisks,whichwouldprovidemoregranularityingeneral,andwestronglyrecommendtakingstepstofurtherdevelopthemodelinthisdirection.83STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyROCKEFELLER:APPLYINGSCENARIOANALYSISTOACTIVELYMANAGEDSTRATEGIESRockefellerCapitalManagementL.P.isaglobalinvestmentadvisoryandassetmanagementfirmthatprovidesanarrayofservicestoindividuals,familiesandtrusts,aswellaspensions,foundations,endowmentsandotherinstitutions.RockefellerAssetManagement(RAM)offerstailoredinvestmentstrategieswithaglobalsectorfocusthatincorporatesanin-depthESGanalysis.Itisanactivemanagerandrunsconcentrated,long-onlyportfolios.In2018,weappliedtheclimatemodelgeneratedbytheUNEPFITCFDInvestorPilotProjectto90%ofRAM’sassetsundermanagement.Climatechangeisakeytopicofengagementwithportfoliocompaniesheldinourcoreinvestmentstrategies.Anintegratedfundamentalapproachtoassessingclimate-relatedrisksandopportunitiesAmajorityofRAM’sclimate-relatedrisksandopportunitiesareembeddedwithinitscoreinvestmentstrategies.Climate-relatedrisksandopportunitiesareassessedbyboththeInvestmentAnalystsandtheInvestmentCommitteeforallportfoliocompaniesenteringRAM’scorestrategies,regardlessofinvestmentobjective.Risks,riskmitigationstrategiesandopportunitiesareresearched,deliberatedandpresentedonanindividualcompanybasistotheInvestmentCommitteealongsideotherelementsoffundamentalvaluation.TheChiefInvestmentOfficerchairstheInvestmentCommitteeandsitsonboththeExecutiveManagementTeamandRiskCommitteeoftheFirm.Climate-relatedriskstoportfoliocompaniesareidentifiedthroughabottom-upassess-mentthatconsidersthecompany’spastemissionsperformance,strategytoreducefutureemissions,regulatoryandphysicalriskswithinitsoperations,aswellasriskstoitsproductportfoliofromdemandandtechnologydisruption.RAMjoinedtheUNEPFIPilottorunourassumptionsthroughclimatemodelsthatconsiderthedifferentregulatoryandphys-icalrisksassociatedwithdifferentemissionspathways.Althoughweappliedthemodeltoapproximately90%ofRAM’sassetsundermanagement,forthepurposesofthiscasestudywearefocusingontheresultsfromourGlobalEquityandGlobalESGEquityStrategies.Thesetwowereselectedduetotheirsimilarbetaandperformancetrackrecord.Inadditiontogainingmoreinsight,wethoughtitwouldbeinterestingtoseeifconsideringphysicalandpolicyriskswouldcreatemoredispersionbetweenthesetwostrategies,oratleastalterourperceptionoftheirriskprofiles.WealsoconsidertheresultsfromourGlobalESGFossilFuelFreeEquityStrategytoexaminehowexcludingtheenergysectorvaluechainprovesbeneficialordetrimentalunderthepilotprojectmodel.Modellingpolicyrisk:GlobalEquityvsGlobalESGvsGlobalFossilFuelFreeForthepurposesofthismodel,thedifferencesinthescenariosareinherentlyaboutdeter-miningpolicyriskandthecostofthoserisks.TheCVaRresultswereinlinewithourexpec-tationsonarelativebasis:ourGlobalESGFossilFuelFreeEquityStrategyfaredbetterthanbothourGlobalESGEquityStrategyandourGlobalEquityStrategyundera1.5°Cand2°Cscenario.ThisismostlyattributabletotheGlobalESGFossilFuelFreeEquityStrategy’sexclusionoftheenergysectorvaluechain,whichshouldfacetheheaviestregu-latoryheadwindsunderthesescenarios.TheGlobalESGFossilFuelFreeEquityStrategydoesnotcontainproducers,refiners,transportersorvendorsoffossilfuels,andexcludesutilitiesthatgeneratepowerfromnon-renewableresources,andreturnedaCVaRof-1.1%.84STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyTable27:RockefellerportfolioCVaRresultscomparisonPortfolioname:GlobalESGFossilFuelFreeEquityStrategyGlobalESGEquityStrategyGlobalEquityStrategyPortfolioVaR:-1.1%-1.4%-2.6%.Source:Rockefeller,CarbonDeltaAsanticipated,theGlobalESGEquityStrategyhadalowerCVaRat-1.4%thantheGlobalEquityStrategyat-2.6%.Ascarbonfootprintingisthebasisforpolicyriskanalysisunderthismodel,wecannotetheresilienceofboththeGlobalESGFossilFuelFreeEquityStrategyandtheGlobalESGEquityStrategyrelativetotheGlobalEquityStrategy.ThiswastobeexpectedgiventhattheGlobalESGStrategyhaslessofanallocationtoenergyandutilitystocksrelativetotheGlobalEquityStrategyandthebenchmark.Additionally,allenergyandutilitynamesthatqualifyfortheGlobalESGEquityStrategymusthaveemis-sionreductiontargetsinplaceandaplantoreducethoseemissions,andshowatrackrecordofmeetingorexceedingtargets.However,althoughthecarbonfootprintforGlobalESGEquityStrategyis35%lessthanthatofGlobalEquityStrategy,itisonly20%morethantheGlobalESGFossilFuelFreeEquityStrategy,despiteholdinganactiveweightofenergycompanies.Lookingdeeperintotheanalysiswecanunderstandwhy:therelianceonScope1emissionsdataasthebasisforthepolicyriskassessment.ForboththeGlobalESGandGlobalEquityStrategies,energynamesdonotcomprisemostofthepolicyriskonanabsoluteorportfolio-weightedbasis.SincethemodelconsidersonlyScope1emissions,thereisasectorbiasdependingonhowcarbonisconsumedalongacompany’svaluechain.AmajorityofemissionsforcompaniesinthematerialssectorfallintotheScope1category,whereasthemajorityofemissionsintheenergyandtransportationsectorswouldbeconsideredScope3.Asaresult,materialscompaniescontributedthehighestpolicyriskonanabsoluteandportfolio-weightedbasisforallthreestrategies,followedbytransportationandenergyforGlobalESG,withenergycominginfourthforGlobalEquity,behindutilitiesandtransportation.TherelianceoncurrentScope1emissionsfordeterminingtheforwardemissionstrajec-toryofacompanyhighlightedagapinthemodelthatconflictswithourownfundamentalresearch.Carbonfootprintingisabackward-lookingmetric,anditislikelytorequiremoreforward-lookingnuancetoquantifypolicyriskwithmoreaccuracy.Here,theintrinsicandmacrocontextofthesectoriscriticaltoconsider.Forexample:Whilematerialscompa-nieswouldneedtoevolvetheiroperationsawayfromfossilfuelpowerandheatgeneration,energycompanieswouldhavetochangetheirbusinessmodelsentirely.Thisisadynamicthatclearlyshowsagreaterinherentrisktoenergycompaniesaschanginganentirebusinessmodelrequiressubstantiallymoreinvestmentthanmerelyshiftingoper-ationalinfrastructure(suchaskilnsandpowerplants).Additionally,demandformaterialssuchascementislesslikelytobedisruptedbyemergingtechnologieswhencomparedtothepotentialdemandforfossilfuelstobedisplacedbyrenewablesandelectricvehicles.TheimportanceoffundamentalresearchGoingastepdeeper,ourownassessmentshaveconcludedthatthecarbonpolicyriskprofilesofourmaterialsholdingsvarywidely,whereasthemodelgaveussimilarriskandenterprisevaluefigures.Asanexample:weholdtwocementcompanies,andwhiletheyareclassifiedinthesamesubsector,wedeemonecementcompanyashavingsignificantlyhigherriskthantheother.Whileonecompanycommitsmorethan80%ofitsR&Dbudgettodevelopinglower-embeddedcarbonalternativesandhassetascience-basedtargetinlinewiththe2°Cscenario,theothercompanyhashistoricallyfallenshortofitsemissionreductiontargets.Whileonecompanyhasintegratedcarbonreductionintoitscoreopera-tionaldirectives,theotherhasnotmadeassetallocationdecisionstothateffect,nordoesthisissueseemtobeembeddedinseniormanagement’sstrategicdecision-making.ThiskindofinsightandinformationwasgatheredthroughfrequentmeetingswiththeC-suitesandsitevisitswithoperationaldivisionheadsforbothcompanies.Thistypeofanalysisiscurrentlynotreflectedinthemodel,leadingthepolicyandenterpriseriskforbothcompa-niestoberelativelyinlineforallscenarios.85STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyPhysicalrisk:GlobalEquityvsGlobalESGGiventhattheemissionsconcentrationscurrentlyintheatmospherewilldictatetheclimateconditionsupto2035,thereshouldnotbemuchvariationintheestimatedphysicalrisksacrossscenarios.Interestingly,thephysicalrisksembeddedinboththeGlobalEquityandGlobalESGEquityStrategiesarequitesimilar.Coastalfloodingandextremeheatmakeupthemajorityofthephysicalriskstobothstrategies.However,onequestionthisanalysisdidraisesurroundsthe‘ExtremeWeatherCostonEnterprise’metric,whichestimatesthereasonablecosttorepairdamagesfromcertainphysicalrisks.ThecompanywiththehighestExtremeWeatherCostonEnterpriseforbothstrategiesisaconsumerhealthcompanythatownsandoperatespharmaciesthroughoutNorthAmerica.Asaresultofitsexposuretoheat,highwindsandfloodingfromhurricanes,themodelhasdeterminedthatitwillhavethehighestcostsonanannualbasis.Interestingly,70%oftheGlobalEquityStrategyand60%oftheGlobalESGEquityStrategy’stoptencompaniesshowingthehighestExtremeWeatherCostonEnterpriseallhavethousandsofretaillocations.Thisraisedaquestionsurroundingtherealcoststorepairretaillocationsversusthecostandtimeitwouldtaketorepair,say,asemiconductormanufacturerneedingtoreplaceexpensive,bespokeindustrialmachinery.Thereisalsotherisktorevenuedisruptionthatneedstobeconsidered.Althoughabusinessmighthavefewerlocations,whichreducesthelikelihoodofanextremeweathereventimpactingoperations,itcouldraisetheriskthatanextremeweathereventcouldstopacriticalpartofthemanufacturingsupplychainorrequirehundredsofmillionsofdollarsinrebuildingcapitalequipment.Despitethisgapinthemodel,physicalriskdatapointswouldbehelpfultoourprocessasweengageourportfoliocompaniesaroundresiliencyplanningforextremeweatherevents.InvestmentimplicationsThisprocesshaselicitedkeyquestionsforRAM:shouldwebeinvestingtodaytoprepareforafutureoflesslikelypolicyscenarios?Giventhatincreasingclimatevolatilityisasystemicrisktoglobalmarkets,shouldwebeinvestingtodecreasethelikelihoodofwarmingtrajec-toriesdespitelaggingpolicy?Canwe,infact,doboth?Thebestwecandetermineisthatpushingemissions-heavyindustriestodecarbon-isecouldbemoreeffectivethandivesting.Itservesthepurposeofbothreducingtheamountofcarbonintheatmosphereandminimisingregulatoryriskfromcarbonpricingschemes.Theflexibilityofactivemanagementwouldallowustotakeadvantageofoppor-tunities,shouldtheprobabilitiesofthe1.5°Cand2°Cscenarioincrease.Regardless,thephysicalandpolicyriskvaluesgeneratedbythismodelcanenableamorepreciseengage-mentwithourportfoliocompanies.ChallengesforactivemanagersandconcentratedportfoliosThecoreofRAM’sresearchapproachistoworkcloselywithcompaniesinanefforttounderstandtheirriskmanagementapproachestoclimatechange,includingemissionstargetsetting,remunerationtiedtoenergyoremissionreduction,capitalexpenditureforefficiencyimprovements,targetsforrenewablepowerprocurement,andcapitalallocationtowardlesscarbon-intensiveprojects,amongothers.Asignificantgapinthemodelisthatisdoesnotprovideaplacetoreconciletheinformationgleanedfromthistypeofresearchwithassumptionsfromthedatasets.Thesubsequentiterationofthismodelshouldincludeawaytoprojectfutureemissionstrajectories.Suchprojectionscouldbeadjustedtoreflectcompanycommitmentsandnotjustpolicyrisks.Anotherissuearisesforactivemanagerswhenitcomestofinancialmodellingforconcen-tratedportfolios.EverycompanyacrossRAM’scoreinvestmentstrategieshasbeenvaluedaccordingtoouranalysts’bespokeproprietarymodels,withdifferingassumptions,perspec-tivesanddiscountrates.ThecurrentmodeldoesnotallowforanadjustmenttotheWACCordiscountratesusedtodetermineterminalvalues.Therefore,itisdifficulttoembedthemagnitudeoftherisktothefuturevalueofacompanywhenthereisadisagreementastowhatthatfuturevaluewillbe.Applyingblanketmodellingforvaluationdoesnotfullyserveourpurposesasanactivemanager.86STRESS-TESTINGTHEMETHODOLOGYANDRESULTSRECEIVEDChangingCourseOperationalisingtheMethodologyRAM’sanalystsspeakwiththemanagersofourportfoliocompaniesonaregularbasistogaininsightonthemyriadofissuesthatachangingclimateposestotheirbusinesses.Acrit-icalpartoftheseconversationsistoapplyshareholderpressuretochallengetheirprocesses,advocateformoreaggressivetargetsforemissionreductions,aswellasencouragingthemtobuildtheinternalmanagementstructureneededtomakerealprogressonclimateissues.Inthisregard,theunderlyingdatafromthemodelwouldbeveryusefulaswecouldusetheindividualriskmetricsandenterpriseestimatestobetterunderstandacompany’sownassumptionsontheriskstheyface.Giventhespeculationregardingemissionstrajectoriesandthelikelihoodofthe1.5°Cand2°Cscenarioscomingtopass,itwillbechallengingforRAMtopracticallyapplytheaggre-gateCVaRforinvestmentpurposeswithoutfurthercustomisation.However,wehopethatbyundertakingthisexercise,wecandiscusstheoutcomesofthisanalysiswithourportfoliocompaniesasawaytochallengeandencouragethemtoconductasimilartypeofpolicyandregulatoryriskmodellingaspertheUNTCFDrecommendationguidelines.RAM’shopeisthatthisexercisecandeepentheconversationbetweencompaniesandtheirinvestorsandencouragethesystematicdisclosureofclimaterisksandopportunitiesthroughoutthepublicmarkets.87INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyADDENDACAPITAL:THEREALBENEFITSOFSCENARIOANALYSISANDDISCLOSURECOMEFROMTHEPROCESSITSELFAddendaCapitalisaCanada-basedinvestmentmanagementfirmofferingabroadrangeofinvestmentstrategiesacrossequities,fixedincomeandcommercialmortgages.Addenda’sapproachtosustainableinvestingfocusesonintegratingESGissuesintoallitsinvestmentprocessestodeliverhigher-qualityportfolios.Addendahasbeenconsideringclimate-relatedissuesinitsinvestmentprocessesformanyyears.Forinstance,wehavebeenaCDPclimatesignatorysince2009andin2015AddendaCapitalsignedtheMontrealCarbonPledgeandwasthefirstCanadianinvestmentmanagertopubliclydisclosethecarbonfootprintofallitsequityfunds.WewelcomedtheestablishmentoftheTCFDin2015andhavebeenusingitsfinalrecommendationstoinformbothourinternalactivitiesandourengagementdialogueswiththeentitiesweinvestin.WejoinedtheUNEPFITCFDPilotProjecttohelpusimproveourpracticesanddisclosure.PreparingourowndisclosuredroveinternalactionWhenAddendaCapitaljoinedthepilotgroup,wealsomadeacommitmenttoaddresstheTCFD’srecommendationsinareporttoourstakeholdersabouthowweareidentify-ingandmanagingclimate-relatedrisksandopportunities.ThiscommitmentmeansthatallofAddenda’sinvestmentteamsshouldbefamiliarwiththeTCFDrecommendations.Eachteamhashadanopportunitytoreflectuponitsexistinginvestmentprocessesandclimate-relatedconsiderations—somemoresothanothers.Thosereflectionsandenhancedawarenessofhowotherinvestorshavebeenevolvingtheirapproachestothinkingaboutclimatechangehavetriggeredsomeimprovementstoourownpracticesandhavealsoledtotheidentificationofnewapproachestobedevelopedinthefuture.AusefulexerciseinvolvedourSustainableInvestingteammeetingwithmembersofoneofourinvestmentteamstoreviewtheTCFDrecommendationsandtodiscusshowthatteam’sinvestmentprocesswasaddressingtheactionsitemisedinthedisclosurerecommendations.Forthisexercise,wedeemedeachteamtobethe‘organisation’atthecoreoftheTCFDrecommendationsanddiscussedtheteam’scurrentactivities,sharedthescenarioanalysisworkbeingdevelopedbythepilotprojectgroup,sharedexamplesofTCFD-baseddisclo-surefromotherinvestmentmanagers,anddiscussedpossibleimprovements.Followingthoseinteractions,wedocumentedouractivitiesandpreparedthecontentthatwillinformourdisclosuretoourclientsandotherstakeholders.Someoftheclimate-relatedtooland/orprocessimprovementsweareconsideringwilltakelongertoimplement,butotherswereimplementedquicklybecauseourinvestmentteamssawthepotentialvalueandtheywererelativelyeasytoimplement.Onesmallexampleisthedevelopmentanduseofaquickreferenceguidetoclimate-relatedrisks,theirtimeframes,andrelatedopen-endedquestionstoconsider.Thisshortguidehashelpedourinvestmentteamsclarifytheirclimate-relatedquestionsandrelateclimateconsiderationstodriversoffinancialandinvestmentperformance.Scenarioanalysisisnotperfect,butwelearnsomethingnewwitheachevolutionAddendajoinedtheUNEPFIInvestorPilotwiththehopethatbyworkingwithalargegroupofsophisticatedinvestors,andbyappointinganexpertconsultanttohelpuswithscenarioanalysis,wecouldhelpcontributetothedevelopmentoftheindustry’sunderstand-ingofandabilitytoimplementtheTCFD’srecommendationsincludingscenarioanalysis.Unfortunately,wehavenotestablishedaharmonised,industryapproach,butworking88INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologywiththeotherpilotprojectinvestorsandCarbonDeltahasimprovedourunderstandingofscenarioanalysisasappliedtoourowninvestmentprocessesandasundertakenbytheentitiesweinvestin.WorkingwithCarbonDeltatounderstanditsmethodologyasitexistedatthebeginningofthepilotproject,andworkingalongsideCarbonDeltaandtheotherpilotprojectinvestorsasthemethodologywasimproved,wasinformativeforusaswecontinuetodevelopourownapproachtoscenarioanalysis.Forinstance,estimatesofglobalandnationalGHGtrajec-toriesbasedonNDCsandrelatedestimatesofcarbonpricesareusefulmacroeconomicestimatesthatwecanconsiderwhenthinkingabouthowthetransitiontoalow-carbon,climate-resilientsocietymightoccur,andtheimpactthattransitionwillhaveonnationaleconomiesandsectors.Consideringhowcarbonpricesmightevolve,howphysicalimpactsmightmanifestthemselves,andwhattheeconomymightlookindifferentscenariosareallusefulexercisesthatwewillrepeatasourunderstandingandthetoolscontinuetoevolve.Themethodologyfortranslatingthesehigh-levelestimatesandscenariooutputsintocompa-ny-specificimpactsislesswelldeveloped.Ouranalysisuncoveredseveralmethodologicalchallenges,suchasestimatingtheimpactoftheabilityofacompanytopassthroughcarboncoststoitscustomersordeterminingitsoptimalmixofoperatingandcapitalexpenditurestoaddresscarboncosts.Wehavenotyetaddressedthesechallengesquantitativelybutwehavebeenabletoincorporatesomeconsiderationoftheseissuesintoouranalysisofhowcompaniesarerespondingtoclimatechange.Workingthroughthechallengesandlimitationsofclimatescenarioanalysishasalsoinformedouranalysisoftheclimate-relateddisclosurebeingprovidedbythecompaniesweinvestin.Wearebetterpreparedtoaskquestionsaboutkeyassumptionsthatcompaniesaremaking.Forexample,whenreviewingthescenariospresentedbyanenergycompany,wecanevaluatethecogencyofeachscenario’seconomicgrowthandenergyconsumptionbyfueloutputcharacteristics.AvaluableexerciseInconclusion,developingourownclimatedisclosureandbetterunderstandingclimatescenarioanalysishashelpedusimproveourownprocessesandanalysisandshouldhelpusdeliverlong-termvalueforourinvestmentpartners.89INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyDNB:PORTFOLIOSCENARIOANALYSISANDCOMPANYENGAGEMENTTheDNBGroupisNorway’slargestfinancialservicesgroupandDNBAssetManagement(DNBAM)isawhollyownedsubsidiaryofDNB.DNBAMisamongtheleadingassetmanagersintheNordicregion,managingapproximatelyUSD69billion31inequities,fixedincome,multi-assetandalternativeinvestmentstrategiesonbehalfofinstitutional,high-net-worthindividualsandretailclients.WeofferbothactivelyandpassivelymanagedstrategiescoveringNorwegian,Nordic,andglobaldevelopedandemergingmarkets.ClimatechangehasbeenoneofDNBAM’slong-termfocusareasformanyyearsaswerecognisethatitcanmateriallyimpactcompanyvalue,bothpositivelyandnegatively.OurambitionistomakeameaningfulcontributiontowardsthegoalsoftheParisAgreementbytakingalong-termviewandeffectivelymanagingtherisksandopportunitiesassociatedwiththetransitiontowardsalow-carboneconomy.Centraltodeliveringonclimatechangearetheavailabilityandqualityofdataforuseinourinvestmentdecision-makingprocess—so-calledESGintegration.TheTCFDrecommendationsarethereforewelcomedasaframeworkforincreasingthetransparencyandqualityofclimate-reporting.Therecommendationsandtheworkonscenarioanalysisprovideasystematicapproachtostructure,anddescribeandcommunicateclimateriskandopportunitiesatportfoliolevel.Theinvestorpilotalsoworkstobuildcompetencyinthefinancialeffectsofclimatechange.InvestorengagementtodayWeengageregularlyandextensivelywithNorwegianandinternationalinvestorsonthetopicofclimatechange.Ourclimatestrategyoutlinesourexpectations,howweengage,andwhentoexcludecompanies.AspartofaproactiveengagementweareconductingtogetherwithotherNorwegianinves-torsontheimplementationoftheTCFDrecommendations,wehavemetwithorwillmeetselectedNorwegiancompanieswithinsectorsthatarehighlyexposedtoclimate-relatedrisksandopportunities:energy,materials,transport,foodandbeverages,seafood,andbanks(withaNordicfocus).Throughthisworkwecommunicatetocompanieswhichmetricsareusefulinputstoourinvestmentdecision-makingprocess,asoutlinedinourexpecta-tionsdocumentonclimatechange.Thisengagementalsoservesasachannelforgatheringinformationtodeterminecompanies’preparednessformitigatingclimate-relatedrisksandopportunitiesandtheirstrategicdirection.InternationalinvestorengagementsonclimatechangeincludeourparticipationinClimateAction100+.Thisfive-yearinitiativeledbyinvestorstargetstheworld’slargest100+GHGemittersandotherglobalcompaniesandaimstoimprovegovernanceonclimatechange,curbemissionsandstrengthenclimate-relatedfinancialdisclosures.Ascollaboratinginves-torsinEquinorandMaersk,wehavehadinsightfulmeetingswiththesecompaniesandarehappytoseethatEquinorcontinuestobeworld-leadinginregardtoitsscenarioanalysiswork,andthatMaerskhasrecentlycommittedtobecomecarbon-neutralby2050(withoutoffsettingcarbon).Moreover,weparticipateinseveralUNPRI-ledinvestorcollaborationsonmethaneemissionsanddeforestation(forsustainablepalmoil,soyandcattle).TheTCFDPilotiscomplementarytoourcurrentengagementefforts,presentinganoppor-tunitytostress-testourunderstandingofcompaniesusingquantitativeindicators,wherepreviousengagementhasprimarilyreliedonqualitativeassessments.31.AsatDecember31,2018.90INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyEvaluationofquantitativeresultsAspartofthedevelopmentprocessofthescenarioanalysismethodology,CarbonDeltahasanalysedourDNBNordenIndeksportfolio.DNBNordenIndeksisapassivelymanagedequityfundthatcloselytracksitsbenchmark,VINX.Aswithallfundsweoffer,companiesthatarenotinlinewithDNB’sGroupStandardforResponsibleInvestmentsareremovedfromthefund.Weselectedthisfundforanalysisaswewishedtoassesstheresultsinregardtoabroadportfoliothatinvestsinmarketsinwhichwehavedetailedcompanyandsectorknowledge,suchthatwewerebetterplacedtoassesstheaccuracyoftheresults.WefurtherwishedtocheckthedatacoverageofcompaniesofNordicmedium-to-large-capcompanies.Inadditiontothis,wehavetestedfourportfoliosinthetool:aglobalfixed-incomefundandthreesustainability-themedclimate-tiltedfunds.Ourintentionwastotestwhetherourclimatestrategiesperformasexpectedinthetool.Inlinewithourexpectations,allthreesustainablestrategiesreturnedpositiveaggregatedCVaRs.WealsoobservedhigherCVaRsforstrategiesutilisingpositivescreening.Nonetheless,wewouldhaveexpectedthepositivecontributiontobeevenhigherforourfundwhichinvestsinclimatesolutionstocks.Thepositiveimpactislikelytohavebeendownplayedastechnologyopportunitiesarecapturedthroughlow-carbonpatents,andmaynotaccuratelyreflectthepositivecontributionof‘green’productsandservices,includingprovenrenewableenergiesandenergyefficiency.Thishighlightsapotentialpointofimprovementmovingforward,wherewewouldexpecttoseeagreaterreflectionofcompaniescontributingpositivelytothetransitiontoalow-car-boneconomy.TheresultspresentedinthiscasestudyapplyonlytotheNordenIndeksfund.Figure23:DNBportfolio,scenarioandresultsinformationNote:Scenarioinformation:2°Cscenario,REMIND(average),combinedVaR:-0.7%Source:DNB,CarbonDeltaInterpretingtheresultsentailsfirstunderstandingtheaggregated,high-levelcharacteristicsoftheportfolio—sectorandcountryexposureintermsofrevenuegenerated.Inaddition,itrequiresin-depthknowledgeoftheunderlyingholdings—theirbusinessmodelsandregionalexposures,amongotherfactors.Tounderstandthedriversbehindtheresults,wedeep-diveintothecompanyresultsusingtheunderlyingdataandcompanyfactsheetsfromCarbonDelta.Theresultsofthescenarioanalysisshowrelativelyminornegativeimpactstotheportfolioundera2°Cscenario,withanaggregatedCVaRof-0.7%.Thereisgooddatacoverageoftheportfolio,with95%oftheholdingscoveredbyCarbonDelta’sdata.91INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyAttheportfoliolevel,theresultsarereasonablerelativetootherportfoliosandthestrat-egiesemployedbyeach.Anyunexpectedresultsariseatthecompanylevel.Forexample,oneofthemostexposedcompanieswasaNorwegianfishfarmingcompany,whichwasestimatedtobeathigherriskthanseveralairlinecompanies.Whilethiswassurprisinggiventherespectivesectors,onfurtherinvestigationwefindthatthisisdrivenbythecompany’sveryhighestimatedScope1emissions.Theseestimatedemissionsweresignificantlyhigherthantheairlines’emissions.CarbonDelta’smethodologyreliesonestimatedtop-downdata,whichisbeneficialinthatitincreasesthetotalcompanycoverageavailableinthetool.However,aweaknessofthisapproachisthataccuracymay,insomecases,becompromised.Themethodology’srelianceonScope1emissionsmaynotfullycapturenuancesbetweencompaniesandmaythereforeprovideanincompletepictureofcompanyemissionsasScope2andScope3arenotconsidered.Similarly,companies’avoidedemissionsarenotaccountedfor.Werecognisethatthereisnotyetastandardmethodologyforcalculatingthis.Themodel’srelianceonestimatedemissionsfiguresmayevenbecounterproductiveincompanyengagementswherethedatadrasticallydiffersfromself-reporteddata.Companiesmaybegintoquestionthevalueoftheirreportingtoinvestorsandmayquestionthevalidityofthescenarioanalysis.Ideally,wewouldliketoseecompaniesusingthisasmotiva-tiontoreporttheiremissionswheretheydonotcurrently.Moreover,itistheroleofinvestorstocommunicatetocompanieswhichreportingchannelsarevaluable.Furthermore,themethodologyplacesfishfarmingcompanieswithininthecarbon-intensiveagriculturesector.Astheemissionsprofilesofagriculturecompaniesvarysignificantly—forexamplemeatproducersversusfishfarmers—itwillbenecessarytoutilisemoregranularsectorbreakdownsinfutureiterationsofthemodeltodistinguishbetweenthese.Throughthepilotmodellingexercise,welearntthatitwouldbeusefultocompareself-reportedcompanyemissionswithtop-downaggregateestimationswherepossible.Thiswouldhelptheanalysttounderstandthecompanyagainstindustrybenchmarks.ScenarioanalysisresultsasausefulengagementtoolWeviewtheinitialresultsofourportfolioscenarioanalysisasanimportantfirststepinanalysingcompanies’preparednessandengagingwiththemontheirexposuretotransitionalandphysicalrisksandopportunities.Engagementwithcompanieswillraiseawarenessofthesignificanceofclimate-reportingtoinvestors,allowingustocommunicatewhichreport-ingchannelsandmetricsarevaluable.Forcompaniesthatdonotalreadydiscloseorhaveprocessesinplace,wehopetoencouragethesetobegindisclosingforincreasedtransparencyandtoavoidtheirimpactbeingmodelled.Forthosecompaniesthatdodisclose,wewishtoidentifyifthereareanysignificantdifferencesinourresultscomparedwiththecompanies’ownassessments,andtolearnwhatisdrivingthedifferences.Differencesmayresult,forexample,fromvaryingmethodologies,limitations,andassumptions.Understandingdiffer-entapproachestoscenarioanalysismayuncovernewandbetterwaystoapproachportfolioscenarioanalysis,orsector-specificconsiderations.Understandingandincorporatingthefindingsfromengagementswillbeusefuladditionalinputsforourin-housecompanyassessmentsofcompanies,andnecessaryinsense-checkingandvalidatingtheresultsofthescenarioanalysis.Engagingwithcompaniesprovidesasystem-aticapproachtoassessingcompany-levelresults,whichhastheaddedbenefitofallowingustogatheradditionalinformationandclearlycommunicatingtheimportanceofclimate-reportingtocompanies.Thisdatawillbeusedintheinvestmentprocessasaninputforfurtheranalysisandvaluationsconsideringcompanyimpactsofclimate-relatedrisksandopportunities,whichultimatelyinforminvestmentdecision-makingandportfolioconstruction.92INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyINVESTA:IDENTIFIEDMETRICSFORFUTUREREALESTATEASSESSMENTSInvestaandclimateriskAsalong-termownerandmanagerofcommercialofficebuildingsinAustralia,theresil-ienceofourcitiesandthelifesystemsInvestareliesonlikepublictransportandhealthcareareofkeymaterialoperationalrisktoInvesta.Since2012,InvestahasbeenworkingwiththeAustralianBusinessRoundtableforDisasterResilienceandSaferCommunitiestodriveawarenessinthepropertysectorofresilienceriskandnecessarymitigationinvestment.AsInvesta’scarbonreductionstrategy‘GettingtoZero’articulates,Investaaimstoexpandourboundaryofinfluencetoincludeinvestorsandourbroadercommunity.Pleasingly,theTCFDwillenableadirectdialoguearoundtheresiliencyofrealassetsandultimatelytheassociatedfinancialexposures.DuringFY18,InvestaengagedinvestorsdirectlytogaugeexpectationandbestpracticeapproachestoTCFDreporting.Atthesametime,inconjunctionwiththeUNEPFIInvestorPilot,Investaappliedclimatechangescenariostoassesskeymaterialrisksandtheassociatedfinancialexposures.Resultsshowedthatitsportfolioiswellpositionedtomitigatethetransitionalrisksidentified,whilemoreworkisrequiredtoassessthephysicalrisks(mostnotablyfluvialfloodingandheatwaves)posedtotheassessedportfolio.Quantifyingclimateriskfor100%ofassetsunderownershipToensurethemaximumbenefitfrominsightsgainedfromtheprogramme,Investasubmit-ted100%ofassetsunderownershipandmanagementtotheUNEPFIanalysis.ThisisinrecognitionofthefactthatclimatechangeposesarisktothewholeInvestaportfolio,ratherthanjusttoparticularlyvulnerableoutlyingassets.AssetsincludedareinSydney,Brisbane,Melbourne,PerthandCanberra.Investa’sproudhistoryofclimatechangeandcarbon-reportinghasbeentoincludeallassets,irrespectiveofperformance,inannualenvironmentalperformancereporting,whichhasbeencarriedoutsince2004.OverthistimeperiodInvestahasreporteda61%reductionincarbonemissionsintensity,atremendousoutcomewhichdemonstratesitsabilitytoactivelymitigatetheclimateimpactofitsportfolio.OlderassetscarryriskbutcanmakestrongefficiencygainswithinvestmentInvestaiswellplacedtoachievethe1.5°Creductionrequirements.In2016,itsetacarbonreductiontargetofnetzerocarbonemissionsby2040.Pleasingly,Investa’sexcellenttrackrecordofmonitoringandmanagingcarbonemissionperformancehasresultedintheportfoliobeingwellplacedtorespondtothetransitionalrisksposedbyclimatechange.ThisisbestquantifiedwhenconsideringthatInvesta’scerti-fiedScienceBasedTargetofnetzeroemissionsby2040istargetingaportfolio-wideemis-sionsintensityof20.72kgCO2/sqm/yrby2033,wellwithintherangedefinedbythe3°Cand2°Cscenarios,asshowninthefigurebelow.Mappingthe(linear)reductionsrequiredtomeetthetargetemissionslevelby2033underthe3°C,2°Cand1.5°Cscenariosforthewholeportfolio(asshowninthefigurebelow)illustratesthatwithacontinued4%annualemissionreductiontrajectory(consistentwithhistoricalreductions),Investa’sportfolioiswellplacedtomakethesereductions.Since93INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologysettingtheNetZeroby2040targetin2015,theInvestaportfolioispresently(2018dataset)1.6%aheadoftherequiredemissionreductionsrequiredtomeetthistarget.Figure24:InvestahistoricalemissionsperformanceandprojectedemissionstrajectoriesundervariousscenariosSource:InvestaGiventhatInvesta’sportfolioistrackingaheadofthetransitionalriskposedbythe3°Cand2°Cscenarios,thegreatesttransitionalriskisposedbya1.5°Cfuture.Acrossthe28assetssubmittedtotheassessment,0.21%oftotalvaluewasdeemedtobeatriskinthe1.5°Cscenario.Note,thisquantifiedriskrepresentsexclusivelythetransitionalrisksposedbya1.5°Cscenario,notthephysicalclimaterisks.OfthetotalVaRunderthe1.5°Cscenario(0.211%oftotalgrossassetvalue),85%stemsfromolderassetswithinInvesta’sportfolio.Thisisbecausetheseassetspossessolderformsofbuildingtechnologyandasaresultarenotasenergy-efficient(andcarbon-efficient)asnewerassets.Despitethis,stepshavestillbeentakentoensurethattheriskexposuretotheseolderassetsismitigated.Energyefficiencyinitiatives,eveninthetwomostcarbon-intensiveassets,haveregistered42%and29%emissionreductionsoverthepasttwoyears,asshowninthefigurebelow.Whilethesetwoassetsarethemostcarbon-intensiveintheportfolio,ifthespecialistprop-ertymanagementteamscancontinuethisprogresstowardsthe2033horizonofthescenarioanalysismodelled,thetransitionalrisksposedbya1.5°Cfuturewillbemitigated.94INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyFigure25:InvestacarbonemissionreductionsatAsset1andAsset2overtheperiodFY12-FY18Source:InvestaEnhancingtransitionalriskmodelsApotentialenhancementtothemodellingoftransitionalriskswouldbetheinclusionofScope3emissions.Thesearemorecomplicatedtomeasure,andharderstilltoreduce;however,realactiononclimatechangerequiresvigilancearoundthetotaloperationalcarbonfootprint.TheScienceBasedTargetInitiativesector-basedapproachrequiredthemeasurementandreductionofScope3emissionstoachieveanapprovedtarget.Investawillcontinuetomonitorandworkwithkeystakeholders(includingtenants,industrybodiessuchastheGreenBuildingCouncilofAustralia,andinternationalbodiesincludingtheGlobalRealEstateSustainabilityBenchmarkandtheScienceBasedTargetsinitiative)toreducetheportfolio’sScope3emissions.LocationofassetsmattersInadditiontotheageofassets,theotherfactorwhichinfluencedsusceptibilitytothetransitionalrisksofclimatechangeislocation.Geographicaldifferencesprovidetwoimportantdistinctions:◼Thelocalclimatedeterminestheworkrequiredtoconditiontheasset’sindoorenvi-ronment,withtheheatofsummerandwintercoldexperiencedtodifferentdegreesindifferentAustraliancities.Inaddition,naturalhazardsdifferacutelybetweencities,requiringavaryingsuiteofmitigationmeasures.Brisbaneexperiencescyclonesandflooding;Sydneyweathersseverestormevents;whereasMelbournewillexperienceextremeheatwaves.ThescenarioanalysishasdemonstratedthattheimpactofthecontrastingmeteorologicalcontexthasanimmediateeffectonVaR.◼Beyondjusttheclimatecontext,thelocalenergygridalsodemonstratedavarianceinVaR.Thecompositionofthestateenergygriddeterminesthecarbonintensityoftheassetswhichdrawtheirenergyfromthelocalgrid.Thisisduetodifferingenergy-gener-atingcapacitybetweenstates,withsomestatesmoredependentonhigh-carbonsourcesofenergy,whileothershavemorerenewableenergyinthemix.ThesecalculationsaremadebytheAustralianFederalGovernment’sDepartmentofEnvironmentwhoseannualNationalGreenhouseAccounting(NGA)FactorsdeterminethecalculationofcarbonintensitiesofInvesta’sbuildings.ThelatestNGAfactorsusedtocalculatetheemissionsprofileoftheportfolioareprovidedinthetablebelow.95INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyTable28:InvestaNGAfactorsacrossAustraliancitieswhereportfolioissituatedSydneyBrisbaneMelbournePerthEmissionsfactor(kgCO2-e/kWh)0.830.791.080.70Amountofassets16633Source:InvestaTheimpactofNGAfactorsishighlightedwhencomparingthreeassetsacrosstheportfolio.Thesethreeassetssharesimilarcharacteristics;theyarethethreelargestassetsconsideredbyCarbonDeltabyNLA—allinexcessof60,000sqm—andareconsidered‘Premium’or‘A’-gradeaccordingtothePropertyCouncilofAustralia’sclassification.DuetothedifferencesinNGAfactors,relativelysmalldifferencesinenergyconsumptionresultinlargerdiscrepancieswhencomparingemissionsprofiles,andlargerdifferencesstillwhenconsideringthemodelledVaRina1.5°Cscenario.Figure26:Investavariancebetweenenergyintensity,emissionintensityandVaRacrossgeographiesSource:InvestaThisspeakstotheneedtoassessthegeographyofinvestmentswhenconsideringassetacquisitionanddivestment.Further,giventhenatureoftheenergygrid(andininstanceswhereassetsareunabletogeneratepoweronsite,whichisverydifficultforcommercialassetswithlimitedscopeforrooftopsolar),energyadvocacyhasanimportantroletoplay.Individualstates’commitmenttorenewableandlow-carbonsourcesofenergyplaysaroleinreducingthetransitionalclimateriskposedtoassetswithintheirgeographicalboundaries.Forexample,twoassetswithsimilarenergyintensities(yetsignificantlydifferentemissionsintensities)arepresentedbelow.96INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyTable29:InvestavariancebetweenenergyintensityandemissionsintensityacrossgeographicaldifferencesEnergyintensity(kWh/sqm/yr)Emissionsintensity(kgCO2/sqm/yr)Asset1101.9965.53Asset2102.4385.93Source:InvestaForthisreason,InvestawillcontinueitsimportantadvocacyworkthroughindustrybodiessuchasthePropertyCouncilofAustralia,encouragingbothstateandfederalgovernmentstocommittostableenergypolicy,integratingclimatepolicyandreducingthecarboninten-sityoftheAustralianelectricitymarket.Thiswillhelpmitigatethetransitionalrisksposedbyclimatechange.GlobalanalysisappliedatalocallevelGiventhatclimaterisksaregeographicallydependent,thoroughasset-andcity-specificanal-ysisisrequiredtoadequatelyidentifytheclimaterisks,especiallythephysicalrisks,presented.WhiletheanalysisconductedundertheUNEPFIInvestorPilotisawonderfulstart,thechallengesposedbyconsideringmultipleassetclassesacrosstensofcountriesandhundredsofcitiesposesauniquechallenge.Giventhebreadthofthetask,notallphysicalclimateriskscouldbeassessedintherequireddetail.Withthoserisksthatwereassessed,analysislackedthedepthrequiredtoproperlyprojectandvaluerisk.Forexample,therisksposedbyfluvialfloodingandheavingprecipitationwerenotconsid-eredintherealestatemodelduetothecomplexityofmodellingfluvialflooding.Whilethereareplanstointegratesuchphysicalriskintofutureanalysis,itrenderstheexistinganal-ysisincomplete.ThisisparticularlyconcerninggiventheprevalenceoffloodinginBrisbane,wheresixofInvesta’sassetswereassessed.Anotherexampleconsidersheatrisk.Theanalysisreturnedlimitedriskposedbyheatwaves,withsomeassetsreturningapositiveimpactwhenassessed(meaningextremeheatpeaksweredecreasingforthoseassetsinquestion).ThisisinconflictwithlivedexperienceinAustraliancities,with2018beingthethird-hottestyearonrecordaccordingtotheFederalBureauofMeteorology.ItisdifficulttoreconcileCarbonDelta’sriskassessmentagainstpresenttrends,withInvesta’sassetssubjectedtoincreasinglyhotterandlongersummers.Wewillthereforeconductfurtheranalysisatanindividualasset/cityleveltoconsiderthefullextentofrisksnotabletobecoveredbythepresentassessment—chieflyheatandfluvialflooding.Conclusion:FutureassessmentofScope3,fluvialfloodingandheatwavesTheinitialresultsoftheUNEPFI’sTCFDInvestorPilotanalysisshowcasesthestrengthofInvesta’sportfoliotorespondtothetransitionalrisksposedby3°C,2°Cand1.5°Cclimatescenarios.Whilstthe1.5°Cscenariorequiresthesteepestreductioninemissions,Investa’sambitiouscarbonreductiontargetandexistingtrackrecordofreducingemissionswillallowtheportfoliotomitigatetherisksidentified.Assetlocationwasanidentifiedvariableimpactingclimateresilience,withInvestatoconsidergeographywhenassessingassetsagainstthephysicalandtransitionalrisksidenti-fiedinthisanalysis.Finally,while,theanalysisconductedtodaterepresentsastartingpoint,Investaiscommit-tedtoenhancingtheanalysisofphysicalrisks(specificallyfluvialfloodingandheatwaves)andexpandingtransitionalriskstoincludeScope3emissions.97INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyKLP:ANEVOLVINGFOCUSONCLIMATERISKMANAGEMENTKLPisNorway’slargestprivatepensioncompany.Itdeliverssafeandcompetitivefinancialandinsuranceservicestothepublicsector,andtoenterprisesassociatedwiththepublicasectorandtheiremployees.Responsibleinvestmentingeneral,andafocusonclimatechangeinallrelevantaspects,isatthecoreofKLP.ClimatechangehasbeenakeysustainabilitypriorityforKLPformorethanadecade.Basedonthelackofcompany-levelGHGemissiondataandstrategiestoaddressthese,KLPbecameapartnertotheCarbonDisclosureProjectmorethantenyearsago.Thiswasafirstandfundamentalsteptowardsimprovingourunderstandingofpossiblecarbonrisksassociatedwithcompaniesandindustrysectors.In2014,weimplementedanexclusioncriterionaddressingthemostcoal-intensivepowerproducersandminingcompanies.Thiswasmotivatedbythepossibilityofreducingexpo-suretopossiblefutureclimaterisks,aswellasofconveyingamarketsignalonacceptablebusinessconductinlightoftheneedtolimitglobalwarming.In2017,theexclusioncrite-rionwasexpandedtoincludecompanieswithactivitiesinbituminoussands(tarsands).Inparalleltotheseexclusions,KLPhasincreaseditsdirectinvestmentinrenewableenergyprojectssuchassolarandwind.Currently,ourinvestmentinrenewableenergyis2.5timesthatofourinvestmentinoilandgas,andweaimtoincreaseourgreeninvestmentwithUSD1billioneachyearintheperiod2018–22.Ontheproductside,weoffergreencreditforfossil-freemortgagesandsavingproducts.In2018,weinitiatedaclimateriskscreeningprocessfollowingananalyticalapproachdesignedinalignmentwiththeTCFDrecommendations.Theobjectiveistodevelopourinternalclimatechangecompetenceinordertoidentify,assessandintegrateclimaterisksinourstrategiesandoperationsinapracticalandvalidmanner.KLP’sparticipationintheUNEPFITCFDpilotgroupfeedsintothisinternalproject.ThisprojectwillalsoformthebasisforourfirstTCFDreportinginourannualreportfor2018andinformtheroadmapforourclimateriskworkinthecomingyears.98INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyFigure27:KLP’sapproachtoclimateriskassessmentisstructuredinaccordancewithTCFDrecommendationSource:KLPThetermriskscreeningreferstotheidentificationofmaterialriskfactorsthatemergeand/orchangeduetoclimate-relateddevelopment—inotherwords,physicalclimaticandweather-relatedconditionsandapolitical,societalandtechnologytransitiontoalow-orzero-carboneconomy.Ourapproachtoriskscreeningisto(i1)identifyriskfactors;(ii,(2)considertheirdevel-opmentindifferentclimatechangescenariosandconsiderwhethernewriskfactorscouldemergeinthefuturedescribedinthescenario’sdepictions;,and(iii3)undertakenaninitial,high-levelconsiderationofthepossibleconsequencestoKLP.Thesestepsaimtoidentifyrisksandassociateduncertaintiesthatcanbeprioritisedforfurtheranalysis.Therisk-screeningprocessentailsallthekeybusinessoperationsofKLP.RiskidentificationandconsiderationofconsequencesisconductedtowardsKLP’senterpriseriskgoalsandexaminedagainstourintegrityasapensionproviderinNorway.99INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyFigure28:KLP’sclimateriskscreeningprocesscoversallkeybusinessoperationsSource:KLPAggregatedresultsandacomparisonofcumulativeequityholdingswithaspecialESGfundKLPhasanalysedtheCVaRforallitsfunds,aswellasforthecumulativelistedequityandbondholdingsofitsmanagedpensionsonbehalfofitsowners.ThecumulativeVaRforbondsandequitiesissummarisedinTable30forthreetransitionriskscenarios,andthe‘worst-casescenario’consideringextremeweather.Anoverallobser-vationoftheresultsisthatKLP’sgloballydiversifiedfundsachieveaVaRwhichiscloseto0%.Thisisperhapsanexpectedresultconsideringthe‘zero-sum’assumptionusedinthemodel,whichimpliesthatthecumulativecostsassociatedwithcarbonpricesprovideanincomeopportunityfromgreentechnologiesequaltothetotalcarboncostsusedinthemodel(suchthattotalcarboncosts=totalgreenrevenuepotential).100INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyTable30:KLPestimatedVaRforcumulativeholdingsinlistedbondsandstocks.3°Ctransitionriskscenario&tailriskextremeweather2°Ctransitionriskscenario&tailriskextremeweather1.5°Ctransitionriskscenario&tailriskextremeweatherListedbonds-0.02%-0.26%-0.33%Listedequities-1.59%-2.20%-2.97%Notes:Analysiscoversapproximately90%ofsecurities,representingapproximately90%ofthevalues.Source:KLP,CarbonDeltaFigure29showsabreakdownoftheVaRcontributionforKLP’scumulativeholdings.Themodelassumesthattheintroductionofacarbonpricewillalwaysbenegative,andforallthreetransitionriskscenarios,thisconstitutesthelargestnegativecontributiontotheVaR.Estimatednewincomefromregisteredgreentechnologypatentsisthesecondmostimpor-tantcontribution,whileextremeweatherhasthelowestcontribution.Figure29:KLPVaRcontributionperscenarioforcumulativeholdingsinlistedbondsandstocksSource:KLP,CarbonDeltaWhileKLP’scumulativeholdingsinequitiesandbondshasanegativeaggregatedVaRinallthreescenarios,thisisnotthecaseforallofKLP’sfunds.Asanexample,Figure30comparestheVaRofthecumulativeequitiesholdingsandKLP’seco-labelledfund‘KLPAksjeGLobalMerSamfunnsansvar’(benchmarkedagainsttheMSCIWorldindex).Thelatterfundisfossil-free;itexcludescompanieswithlowESGscores,andoverweighsthosewithhighESGscores.AsshowninFigure30,thereareonlyminordifferencesbetweentheweightedVaRcontri-butionfromextremeweather,whiletheeco-labelledfundexhibitslessnegativeexposuretocarbonprice,andahigherexposuretoestimatedrevenueincreasefromgreentechnologies.ThefundhasaminornegativeVaRof0.3%intheBaUscenario,butreceivesapositiveVaRwhenmorestringentemissionrestrictionsareintroducedinthemodel.101INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyFigure30:KLPVaRcontributionbyscenarioforcumulativeequityholdingsandaspecialisedESGindexfundSource:KLP,CarbonDeltaFigure31showstheindustrysectors(GICSlevel3)withthemostnegativecontributiontoVaRforKLP’scumulativeequityholdings.Themodelpresentsutilitiesastheriskiestindustrysector,whichisalogicalresultconsideringthattheanalysisconsidersonlyScope1emissionsanddoesnotincluderevenueincreasefromrenewableenergyproduction.Powerproducersthatrelyonfossilenergysourcesaredirectlyexposedtocarbonprices.However,thiscostcanbepusheddowntheirvaluechain—forexample,toenergy-intensiveindustriessuchasaluminum,whichhavealargerelativeshareofitsemissionsfromScope2sources.Similarly,thebulkofemissionsfromoilandgascomesfromScope3sources—inparticular,downstreamScope3whenoilandgasisburnt.AfurtherassessmentoftheresultsshowninFigure31couldfocusonwhethertherisksareunderestimated,asmarketrisksassociatedwithaswitchfromoil&gastootherlow-/zero-carbonalternativesarenotspecifiedinthemodel.102INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyFigure31:KLPtenindustrysectorswiththelargestnegativeVaRcontributionforcumulativeequityholdingsSource:KLP,CarbonDeltaOntheopportunityside,Figure32showtheunweightedVaRforthetenmostpositivesectorsinoureco-labelledfund.ThegreybarshowstheobservedmaximumandminimumVaRforindividualsecurities,whilethereddotshowstheaverageVaRforsecuritiesinthesector.Theresultsindicateaninterestingtrendwherebyvariousproducersofgoodsusedinindustrialapplicationsandbyconsumersaredevelopinggreenerproducts,whichmaycontributetoavoidedemissionsfurtherdownthevaluechain—suchasincreasedavailabilityofgreenerconstructionandproductionvehiclesandequipmentandelectriccars.103INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyFigure32:KLPunweightedVaRforthetenindustrysectorswiththemostpositiveaverageunweightedVaRSource:KLP,CarbonDeltaReflectionsontheresultsThecooperationintheUNEPFIprojectingeneral,andtheworkwiththeserviceprovidertodeterminethemodellingapproachinthisproject,hasbeenaninterestingjourneyforKLPthathasraisedawarenessandstimulatedlearning.TheoutputfromtheanalysisfeedsintoourwiderprojectonmappingclimateriskfactorsandassessingtheiruncertaintyforKLPasawhole.AkeytakeawayforKLPistheacknowledgementthatquantitativeclimaterisksassessmentisahighlycomplextask.ThishasimplicationsifoneintendstoadheretotheTCFDrecom-mendations.Forinstance,theTCFDrecommendationsrequireabroadscopeofriskfactorstobeincluded,suchasvariouspoliticalinterventionstoreduceGHGemissionsbeyondcarbonpricing,changeincustomerpreferencesfavouringgreenerproductsandservices,changeincommodityprices,technologydisruption,andchangesinstakeholderexpecta-tionstocorporateclimatestewardship.Onlyafewsubsetsoftransitionriskfactorsareincludedinthisstudy,whichsuggestthatwhiletheappliedmodelisaproductivestepintherightdirection,furtheramendmentswouldbenecessarybeforeclimateriskassessmentcanbeeffectivelyimplementedinourinvestmentstrategiesandprocesses.Whileitdoesseemadauntingtasktoidentifyandaddressallmaterialtransitionriskfactors,weareleftwithaquestionofhowmuchthevalidityoftheclimateriskassessmentneedstobeimprovedinordertocomplywiththeTCFD,oralternatively,toaddvaluetoourinvest-mentprocessesandriskanalysis.Itmayseemclosetoimpossibleto‘modeleverything’,yet,byexcludingkeyfactorsthatmaybematerialdriversofthefinancialperfor-manceofcompanies,climateriskassessmentswillremainincomplete.Lookingforward,KLPhopestoseemoredatapresentinthemarketthatcanexpandtheclimateriskassessmentinacredibleandpracticalfashion.Anotherdimensionwhichisdifficulttomodel,andwhichhasnotbeenincludedinthisstudy,concernshowmarkets,valuechainsandindividualcompaniesarelikelytorespondtoclimateriskexposures.DifferencesinCO2intensityandtheabilitytopushcarboncostsdownthesupplychainareexamplesofdatapointsthatwouldallowforamorepreciseanaly-sisonthesecuritylevel.Similarly,competitionbetweensectors,suchasintermodaltransport104INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyshifts(suchasmoretransportthroughshort-seashippingattheexpensiveofland-basedtrucks)orastrongerpushformorelightweightmaterialsuchasaluminiumattheexpenseofsteel,aremarketbehavioursthatarenotcapturedexplicitlyinthemodellingapproachofthisproject.Whilesuchdynamicsarehardtomodelwithadecentlevelofprecisionandcredibility,thesearestillreal-worldquestionsthatneedtobescrutinisedwhenassessingfinancialconsequencesfromclimate-relateddevelopmentonacompanylevel.Failuretoencompasskeydynamicsmayresultinclimateriskassessmentsbeingdeemedunrealisticandinaccurate.Notwithstandingthesechallengestoquantitativeclimateriskassessment,thereisnoalter-nativebuttokeepworkingtoimproveourknowledgebase,data,methodsandtools.TheTCFDitselfhasstatedthatalong-termviewonmaturingtheclimateriskconceptinthefinancialsectorisnecessary,andKLPiscommittedtoparticipateonthisjourney.WehopethattheproductivecooperationthroughtheUNEPFITCFDInvestorPilotprojectwillbecomeevenmoreeffectiveinthefuture,andthattherewillbetransparencyinhowindi-vidualcompaniesconducttheirclimateriskassessmentsothatwecanlearnfromeachother.Inthiswaytheglobalbusinesscommunitycanworkcollectivelytowardsstandardisationonhowclimaterisksareanalysedandreported.105INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyLAFRANÇAISE:CLIMATEVARMETRICSPROVIDERELEVANTINVESTMENTSIGNALSLaFrançaiseGrouphasbeenintegratingclimate-relatedrisksininvestmentanalysisforalongtime.ThisintegrationwasfacilitatedbytheParisAgreement(ConferenceoftheParties,COP21)andresultinginitiatives.ResponsibleinvestmentisattheheartoftheGroup’sinvestmentstrategyandwebelievethatclimatechangeisakeycomponentoffutureeconomicgrowthandsocialstability—inotherwords,tomorrow’ssocietywillbebasedonalow-carboneconomy.LaFrançaisehasshownESGstrategiccommitmentanddevelopedanindustryleadingin-houseexpertiseonresponsibleinvestmentwithInflectionPointbyLaFrançaise.ThisistheGroup’sresearchandexpertisecentreonESGtopicsandstrategicinvestmentfactors.LaFrançaiseisconvincedofthebenefitsofintegratingESGandclimatefactorsintoinvest-mentprocesses.Weacknowledgethatclimatechangeisakeyissueforourportfoliocompa-nies.Therefore,theGrouphasdevelopedarangeofproductsaddressingtheenergytran-sitionchallengesincludingthemovetowardsalow-carboneconomy.TheCarbonImpactGlobalEquitystrategywaslaunchedaheadofCOP21inJune2015.Thisinvestmentstrat-egyhassincebeenappliedtoothergeographiesandtofixedincome.TheGrouphasalsopioneeredresponsiblerealestatesince2010.Sociallyresponsibleinvestingrealestatefundsweredevelopedin2012and2014,andanimpactrealestatefundin2017.Weareeagertouseforward-lookingindicatorsand,assuch,wearedelightedtobepartoftheTCFDInvestorPilot.WearesupportersoftheTCFDbutexperiencedtheimplementa-tionchallengesoftherespectiverecommendationsfirst-handwhenreportingunderArticle173oftheFrenchEnergyTransitionlawduringthepastthreeyears.TheworkofthePilotgrouphelpsusidentifymorepreciselyclimatechange-relatedrisksandopportunities.Itfacilitatestherespectiveintegrationinourinvestmentdecisionsandsupportsthedialoguewithinvesteecompanies.Asweaimtoenlargethescopeofourresponsibleinvestmentsolutionsandtheimpact-reportingofourinvestments,webelievethatCVaRcouldbeausefulmetricinthisregard.CarbonImpactGlobalEquitystrategyThiscasestudyprovidestheCVaRresultsforourCarbonImpactequitystrategythatwehavebeenmanagingsince2015.Thisstrategyinvestsinallglobalsectors.Theportfoliomanagerselectscompaniesbelongingtothreebroadcategories:(i)companiesinhigh-emit-tingsectorsthataretransitioningtoalow-carboneconomy;(ii)enablingcompaniesthatprovideproductsandservicesinsupportoftheenergytransition;and(iii)companiesthatarealreadypartofthesolution,suchasrenewableenergycompanies.Wemeasuretheimpactofthisstrategybythecarbonfootprintoftheportfolio,whichhasdemonstratedsignificantlow-carbonperformancesinceinception—aboutthree-quartersbelowtheglobalreferenceindexattheendof2018.Furthermore,wecalculateavoidedemis-sionsfortherenewableenergycompaniesintheportfolioasanimportantimpactmeasure.Sincebothofthesecarbonmeasuresarebasedonreporteddataorequivalentestimates,theyofferlimitedinsightintofuturecarbonperformance.Atthecompanylevel,wecanachievebetterresultsthroughfundamentalanalysis.Herewecoveracompany’sgovernance,strategyandriskmanagementaswellastargetsandmetricsrelatedtoclimatechangeonacase-by-casebasis.However,thereisagrowingneedtodevelopmoresystematicforward-lookingclimateimpactmetrics.ThisisoneofthereasonswejoinedtheTCFDInvestorPilotandwhywehavechosenthisstrategyforthecasestudy.106INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyAnotherimportantreasonforchoosingtheCarbonImpactstrategyisourambitiontoincludeadditionalinformationinourresearchprocessfromsourcesthatareindependentofcorporatedisclosures.Examplesincludebigdatasetsformeasuringinnovationcapacitybasedonpatentsanddatasetsforassessingphysicalrisksbasedonthelocationofphysicalassetslikeproductionfacilitiesorinfrastructure.Ourin-depthknowledgeoftheportfoliocompaniesshouldenableustocriticallyassesstheresults.Theportfoliointhiscasestudy,theCarbonImpactGlobalEquitystrategy,hasthefollow-ingprofile:◼Assetclass:equities.◼Sectorexposure:allsectors.◼Geographicexposure:globaldevelopedandemergingmarkets.◼Investmentstrategy:activelymanagedequityportfoliowithalow-carbonfootprint;focusoncompaniesthatareintransitiontoalow-carboneconomy.◼PortfoliocompositionasofQ32018.TheCVaRanalysiswaspreparedbyapplyingthePIKREMINDmodel.Weselectedthestandard2°Cscenariobecauseitiswidelyusedandwell-rehearsed,andcreatesareferencepointbeforeconductingfurtherstresstests.TheaggregatedCVaRof+4.0%isshowninTable31.ThispositiveoutcomesupportstheinvestmentideabehindtheCarbonImpactstrategy.ItwillencourageustorollouttheCVaRtoolintheappraisalprocessofnewinvestmentideasandtoconsidertheCVaRasaforward-lookingmetricinportfolioreporting.Table31:LaFrançaiseCVaRportfolioanalysis–summaryresultsScenarioWeightedClimateVaRMonetaryRiskCoverageTransitionScenarios.Selected:REMIND4.7%0.05mUSDPolicyRisk(2°C)-0.2%-0.002mUSD95.5%TechnologyOpportunity(2°C)4.9%0.05mUSD75.7%PhysicalScenarios.SelectedModel:Average-0.7%-0.007mUSDAggregateClimateVaR4.0%0.04mUSDSource:LaFrançaise,CarbonDeltaTheportfolio’sCVaRconfirmsourexpectationswhenconsideringthethreecomponentsindividually:◼ThetransitionrisksareclosetozerowithaCVaRof-0.2%—suchthatonaggregatetheportfolioholdingshavealowexposuretotransitionrisksortheyseempreparedtomiti-gatetheexpectedimpactfromhighercarbonprices.Thisisinlinewiththelow-carbonprofilethatthecarbonfootprintingismeasuring.However,itisamuchmorecompre-hensiveresultgiventhatadynamiccarbonpriceisanintegralpartoftheVaRmodel.◼Theportfoliorepresentsadedicatedclimatestrategywithafocusontransitionoppor-tunities.Thisisclearlyvisiblewitha4.9%CVaRfortechnologyopportunities.Thispositivevalueisdrivenbytransitionopportunitiesfromcompaniesactiveinareaslikeenergyefficiency,electricvehicles,batterytechnology,digitalisationandrenewableenergy.OurassessmentisbasedonacomparisonofthecompaniesidentifiedwiththelargesttechnologyopportunitiesbytheCVaRmodelandourexistinginvestmentcasesoftheenablingcompaniesintheportfolio.Sincethereisasignificantoverlap,weconsidertheCVaRtoolassuitableforidentifyingandvaluingenablingtechnologiesinthiscase.◼TheportfolioisexposedtophysicalriskswitharespectiveCVaRof-0.7%,whichisanimportantinsightgiventhatphysicalrisksturnouttobethreetimeslargerthantransitionrisks(-0.7%versus-0.2%).107INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyAdetailedanalysisoftheextremeweatherscenariosincludedinthephysicalriskassess-mentshowspositiveandnegativeexposures.Thedrivingfactorisextremeheatwith-0.7%CVaR,whereaseachoftheremainingsixcomponentsaresignificantlysmallerinmagnitude,therebyoffsettingeachother.Itisworthnotingthatithasbeendifficulttoassessphysicalrisksarisingfromclimatechange.Therefore,thenewmetricsprovideusefulinformationforourstockselectionandpotentiallyforengagement.Forexample,wearelikelytoinvestigatenextwhatmeasurescompanieshaveinplacetomitigatetheirphysicalrisks—beitthroughcapitalinvestment,insurancepoliciesorboth.Table32providestherespectiveresultsforaglobalequityindex(developedandemergingmarkets)thatwetypicallyuseasareferenceforperformanceanalysisoftheCarbonImpactGlobalequitystrategy.TheaggregatedCVaRofthisindexis-0.7%,comparedwith+4.0%fortheportfolio.Themaindifferenceisamuchhigherpolicyriskfortheindexandamuchlowercontributionfromtechnologyopportunities,againhighlightingthestockselectionoftheCarbonImpactstrategy.Table32:LaFrançaiseCVaRglobalreferenceindex–summaryresultsScenarioWeightedClimateVaRMonetaryRiskCoverageTransitionScenarios.Selected:REMIND0.1%0.001mUSDPolicyRisk(2°C)-2.3%-0.02mUSD96.6%TechnologyOpportunity(2°C)2.4%0.02mUSD80.2%PhysicalScenarios.SelectedModel:Average-0.8%-0.008mUSDAggregateClimateVaR-0.7%-0.007mUSDSource:LaFrançaise,CarbonDeltaTheresultsfortheCarbonImpactStrategyasshownabovearesupportiveofthestatedinvestmentstrategy;however,wearemindfulthattheseresultsaresubjecttochangeintheshorttermduetofurthermodeladjustments.Furthermore,weneedtogainsignificantlymoreexperienceworkingwithsuchatooltobetterunderstandandinterpretthedifferentmetrics.Therefore,moretimewillpassbeforewewouldallowtakingcorrectiveactionintheportfolioconstructionphasebasedontheresults.ThiscasestudyhasshownthattheCVaRmetricprovidesrelevantinvestmentsignals.Itcouldultimatelyleadtoportfolioadjustments.Itimmediatelysupportsthedecision-makingprocessbyraisingawarenesswithintheinvestmentteamandbyaskingnewquestions.108INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyCVaR—ausefulriskmanagementtoolwithearlystageadvancementpotentialAnimmediatebenefitfromusingtheCVaRtoolwillbethepossibilitytorunalternativeclimatescenariosinordertoconductcriticalreviewsofthosefindings—especiallyatthecompanylevelandtocomparedifferentportfolios.Asdiscussedabove,thetoolhasalreadyhighlightedsomelessobviousriskfactorslikephysicalrisks.Theseinsightsarelikelytobecomeevenmorepronouncedasweapplymoreaggressivescenarios.Lookingatanumberofalternativescenarioswillalsomitigatethe‘interpretationrisk’impliedbyasinglemetricliketheaggregateCVaR—suggestingalevelofmeasurementaccuracythatisnotcurrentlyavailable.Atthisstage,wethereforeconsidersuchmetricsasadditionalforward-lookingindicatorsthatarecertainlyusefulinchallengingexistinginvest-mentbeliefs.AmeasureliketheCVaRenrichesouranalyticcapabilitiesratherthanreplacingexistingtoolsandmetrics.Asactiveinvestors,wewanttoknowsignificantdetailsaboutcompany-specificsituations.Therefore,weneedtoensurethatthemeasurementmethodologiesdiscussedherereflecttheavailableinformationset.Unlesstheresultsarerobustatthecompany-level,thereislittlecredibilityforaggregatinginformationattheportfoliolevel.WhenaClimateVaRmodelpassesthe‘credibilitytest’oftheportfoliomanagementandresearchteamsitwillbeputtouse.WewilladvocateforawidespreadadoptionofTCFDreportingbycorporatesfromallsectors.Theapplicationofforward-lookingclimatemetricswillhelpourinvest-mentdecisionprocessbyprovidingnewinsight.109INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyNORGESBANKINVESTMENTMANAGEMENT:SCENARIOANALYSISISAUSEFULTOOLFORASSESSINGRISKSNorgesBankInvestmentManagement(NBIM)isresponsibleforinvestingtheinternationalassetsoftheNorwegianGovernmentPensionFund.ClimatechangehasbeenastrategicfocusareaforNBIMsince2006.Thisisreflectedinboardprinciplesandourresponsibleinvestmentpolicies.OurmanagementoftheclimaterisksandopportunitiesinourinvestmentsislargelyalignedwiththeTCFDrecommendations,whichbroadlyreflectourclimatechangeexpectationstowardscompanies.WejoinedtheUNEPFIInvestorPilottoworkwithpeerinvestorstodevelopguidanceandmethodsonTCFD-aligneddisclosure.Weseektocontributetothedevelopmentofmethodologiesthatcanhelpusbetterassessclimaterisksandopportunities.PilotProjectequitymodellingresultsAspartofthepilot,CarbonDeltaassessedpotentialtransitionandphysicalclimatechangeimpactsonourequitiesportfoliothroughto2032.32Itsmodelcalculatestheportfolio’sVaRbyaggregatingthepotentialimpactofpolicyrisksandtechnologyopportunitiesundera2°Cscenarioandextremeweatherevents(physicalimpacts)oncompanies’revenues.Theoutputssuggestourequitiesportfoliocouldhaveapotentialdownsideriskof1.3%undersuchascenario.TheaggregatedVaRfromtransitionrisksandopportunitiessuggestapotentialdownsideof0.4%.Extremeweathereventssuggestapotentialdownsideof1.0%—forexample,fromextremeheatandcoastalflooding.Evaluatingthepotentialfinancialimplicationsofclimateoutcomesisusefulinprovidingaviewonpotentialclimaterisksandopportunities,butitisimportanttounderstandthecontextofmarkets,sectorsandcompaniesandtheirbusinessmodelswhenanalysingtheseresults.TherelevanceofScope1,2and3GHGemissionsdiffersacrosssectors.Oneofthelimi-tationsofthescenarioanalysismethodologyofthispilotstudyisthatthemodelcalcu-latesclimatetransitionrisksandopportunitiesbasedonScope1GHGemissions,with-outaccountingforScope2and3GHGemissions.Thislimitsinvestors’abilitytodrawconclusions—forexample,onthepotentialimplicationsforsomesectorssuchasoil&gas,coalmining,banks).Inaddition,themodeldoesnottelluswhowillbearthecarboncosts(whethercompaniesareabletopasscarboncoststhroughtoconsumers).Modellingtheextenttowhichcompaniescancaptureopportunitiesfromthelowcarbontransitionisnotstraightforward.CarbonDelta’smodelusescompanies’low-carbonpatentsasaproxytoestimatethepotentialrevenuesfromclimate-relatedopportunities.Althoughthismethodologymaybemoreapplicabletosomesectorsthantoothersthatdonotneces-sarilyrelyonconductinglow-carbonR&D,itisoneofthefewmethodsavailabletoestimatecompanies’revenuesfromthelow-carbontransition.Companies’planscanprovideinvestorswithaviewofhowpreparedcompaniesaretomitigateandadapttoclimateissues;however,thereislimiteddisclosureoncompanies’forward-lookingplans.WWF,incollaborationwith2°InvestingInitiative,conductedastudyontheclimatealignmentofEuropeanassetowners’portfolios,basedontheParisAgreementClimateTransitionAssessment(PACTA)tool(WWF,2018).Themethodol-ogyconsiderscompanies’five-yearproductionandinvestmentplans.Thismethodologyprovidesdifferentinsightstoinvestors—forexample,ontheexpectedfuturetechnologymixofinvestmentportfoliosandwhethertheyarealignedwithspecificclimateoutcomes.32.EquitiesportfolioasofDecember31,2017.110INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyNBIM’sinternalscenarioanalysistoolAsillustratedbytheUNEPFIPilot,weconsiderscenarioanalysistobeavaluabletooltoassessuncertainoutcomes—forexample,thepotentialimplicationsofdifferentclimateoutcomesfordifferentsectors,companiesandassets.Wearedevelopinganin-housemodelforanalysingthepotentialimpactsofclimatescenariosontheequityportfolio,sectorsandcompanies.Theobjectiveofthisworkistounderstandhowclimateriskcouldaffecttheportfolio’sreturninthelongterm.WelookatfuturecashflowsandGHGemissionsatacompanylevelandexplorehowfutureregulationssuchascarbonpricingmechanismscouldaffectdifferentcompanies,industriesandregions.Weincorporatecarbonpriceesti-matesfromfiveIAMs:IMAGE,MESSAGE-GLOBIOM,REMIND,WITCHandGCAM.ThemodelsconsiderprojectionsfromdifferentSharedSocioeconomicPathways(SSP)(IIASA,2018).Oneofthechallengeswehavefacedinthedevelopmentofourtoolisthelackofhigh-qualityandcomparabledatafromcompanies.Inaddition,quantifyingtheimpactofclimaterisksoncompanies’earningsandvaluationswithalong-termhorizonpresentsitsownsetofchallenges—forexample,consideringthemuchlongertimeframecomparedwithtraditionalfinancialanalysis.LearningsfromthepilotAsenvisagedbytheTCFD,thereisstillsomewaytogobeforeinvestorsandcompaniescanfullyimplementtheTCFDrecommendations—forexample,onmethodsforscenarioanal-ysisandtheavailabilityofhigh-qualitydatatoconductthese.TheUNEPFIPilotprovidedausefulforumtodebatethecomplexitiesofconductingscenarioanalysisacrossdifferentassetclassesandtranslatingtheseresultsintomeaningfulfinancialinformation.CarbonDelta’smodelintegratesscenariosfromtheREMINDmodel,oneofthevariousinternationallyrecognisedIAMs.Whendisclosinginformationrelatedtoscenarioanalysis,itisimportanttobetransparentaroundtheassumptionsofthescenariosandmodelsusedandtounderstandhowthesecandriveresults.Scenarioanalysisisausefultooltoassesspotentialrisksinourportfolioandcanalsobeusedtosupportourcompanyengage-ments.Dependingontheintendeduseofscenarioanalysisresults,differentlevelsofdataaccuracymaybeneeded—forexample,itisimportanttohaveahighdegreeofaccuracywhenengagingwithcompaniesandconductingfundamentalinvestmentanalysisonsecuri-tiesorrealassets.CarbonDelta’smodelaimstoovercomethechallengesofinsufficientandinconsistentdisclosureamongcompaniesbyestimatingtheirGHGemissions.Thismodelalsoaddressessomeofthecomplexitiesofconductingphysicalscenarioanalysis—forexample,byinte-gratingasset-specificinformationandmodellingthepotentialeffectsofextremeweathereventsinthoselocations.Thisemphasisestheneedforcompaniestodisclosematerialclimatedata,includingasset-leveldata,inaconsistentandcomparableway.111INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyTDASSETMANAGEMENT:COMPARINGVARIOUSCLIMATERISKAPPROACHESTDBankGroupistakinganenterpriseviewofclimate-relatedrisksandopportunitiesandstartingtoassessbusinesssegmentsmoremateriallyexposedtoclimaterisks.InadditiontotheUNEPFITCFDInvestorPilotProject,TDhasparticipatedintwootherUNEPFIpilotstudies—lendingandinsurance—andactivelyparticipatingduringthiscriticaltimewhenmethodologiesforassessingclimateriskarebeingdeveloped.TDAssetManagement(TDAM)isawhollyownedsubsidiaryofTD,33havingassetsundermanagementofUSD268.6billion.34ThisNorthAmericaninvestmentmanagementfirmservesalargeanddiversifiedclientbase,includingpensionfunds,corporations,institutionsandhighnetworthandretailindividuals,andhasleadingmarketpositionsinpassive,quanti-tative,andactiveportfoliomanagement.ThediscussionbelowreviewstwoTDAMportfoliosusingCarbonDelta’sscenarioanalysistoolundera2°Cscenario—awarminglevelinlinewiththatagreedintheParisAgreementonclimatechange.Fortheportfoliosanalysed,theutilitiessectorstandsoutasamajorcontributortoclimaterisk.Wedelveintothissectorandnotehowclimatedataofdiffer-entproviderscansenddifferentsignalsattheindustrylevel.Asweproceedinourendeavourtoassessbank-wideclimaterisks,lessonsfromallthreepilotswillhelprefineourprocessesandbuildconsistencyinclimateriskanalysisacrossbankactivities.Portfolioresults:UtilitiesdrivethemajorityofCVaRTotrialCarbonDelta’sclimatescenariotool,TDAMprovidedholdingsdatafortwoequityportfolios—onethatholdsglobalequities(withitslargestrevenueexposuresinAsiaPacific,Europe,theUS,andCanada)andisbenchmarkedagainstMSCIACWI;andthesecondonepredominatelyconsistingofCanadianequitiesandbenchmarkedagainsttheS&P/TSXCompositeIndex.Bothportfoliosaregenerallytiltedtosmaller-cap,dividend-payingnameswithlowervolatilityandbetametrics.Withrespecttoindustries,theseportfoliosareconcentratedinstaples,telecommunications,utilities,insuranceandrealestate.Theresultsaregiveninthetablebelow,withtransitionriskandphysicalriskaddinguptoatotalCVaR,orthepotentiallossaportfoliocouldfacegiventhecoststhattheunderlyingcompanieswouldincurtoachieveaglobalwarmingof2°C.FortheGlobalEquityportfolio,CarbonDelta’smodelestimatesaCVaRof-5.2%,withthemaindriversoflosscomingfrompolicyrisk(-5.5%)andthephysicalriskfromextremeheat(-0.9%).TheCanadianEquityportfoliohasalowerCVaRof-3.2%,withsimilardrivers(policyriskVaRof-3.2%and-0.4%fromextremeheat).33.TheTDBankGroupmeansTheToronto-DominionBankanditsaffiliates,whoprovidedeposit,investment,loan,securities,trust,insuranceandotherproductsorservices.Alltrademarksarethepropertyoftheirrespectiveowners.34.AssetsundermanagementasofDecember31,2018forTDAssetManagementInc.,TDAMUSAInc.,TDGreystoneAssetManagementandEpochInvestmentPartners,Inc.TDAssetManagementoperatesthroughTDAssetManagementInc.inCanadaandthroughTDAMUSAInc.intheUS.TDGreystoneAssetManagementrepresentsGreystoneManagedInvestmentsInc.,awhollyownedsubsidiaryofGreystoneCapitalManagementInc.(GCMI).AllentitieslistedareaffiliatesandwhollyownedsubsidiariesofTheToronto-DominionBank.112INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyTable33:TDAMresultsundera2°CscenarioScenarioGlobalequityCanadianequityTransitionscenariosVaR(model:REMIND)-4.4%-3.1%Policyrisk-5.5%-3.2%Technologyopportunity1.5%0.08%PhysicalscenariosVaR(model:average)-0.9%-0.1%AggregatedCVaR-5.2%-3.2%Portfoliowarmingtrajectory3.4°C3.5°CNote:CarbonDeltafiguresareasofJanuary21,2019.TheresultspresentedinthistablearecalculatedonaweightedbasisSource:TDAM,CarbonDeltaUtilitiesdrovethemajorityofCVaR,makingup73%inthecaseoftheCanadianEquityportfolioand52%fortheGlobalEquityportfolio.Thisistobeexpectedgiventhattheutilitiessectorhashighcarbonemissionsandcarbonintensity(totaltCO2e/sales)relativetoothersectors,demonstratingthesignificantpartutilitieswillneedtoplayindecar-bonisingtheeconomy.EnergyandindustrialswerealsomajorcontributorstoCVaR,withindustrialsmoreimpactfultotheGlobalEquityportfoliogivenitsgreaterportfolioweight(18%vs11%intheCanadianEquityportfolio).ConsumerstaplesalsocontributedtotheCVaRoftheGlobalEquityportfolio,withtwoSoutheastAsianagricultureproducersseenashighcontributorstorisk.AgriculturalactivitiesareknownsourcesofGHGs,withagri-culturalcompaniestypicallyhavinghighcarbonintensity.CarbonDeltaalsopredictstheportfolio’swarmingtrajectory,whichassumesunderlyingcompaniesgoforwardwithBaU,withoutregardtoapolicytarget.Warmingislargelyafunc-tionofacompany’sScope1carbonemissionsbeforeconsideringthefinancialimplicationsforthatcompany.ThoughtheCanadianEquityportfoliohaslowertransitionriskthantheGlobalEquityportfolio,theCanadianEquityportfoliohasaslightlyhigherwarmingtrajec-toryat3.5°C.WheretheutilitiessectoristheprimarydriveroftransitionriskandCVaR,financials(banksandinsurancecompanies)drivethewarmingtrajectoriesforbothportfolios.ThefiguresbelowshowacomparisonofthesectorproportionsofCVaR,warmingtrajec-tory,andportfolioweightstodemonstratewhichsectorshaveanoutsizedimpactcomparedwiththeirweightintheportfolio.Financialscomprisethelargestportionofbothportfo-lios,20%fortheGlobalEquityportfolioand25%fortheCanadianEquityportfolio,butcontributeonlyasmallamounttotheCVaR(ortransitionriskwhenconsideredinisolation).However,financialsmakeup14%and19%oftheGlobalEquityandCanadianEquityport-folios’warmingtrajectoriesrespectively.113INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyFigure33:TDAMCVaR,warmingtrajectoryandweightsbysector–GlobalEquityportfolioSource:TDAM,CarbonDeltaFigure34:TDAMCVaR,warmingtrajectoryandweightsbysector–CanadianEquityportfolioSource:TDAM,CarbonDeltaIntheGlobalEquityportfolio,afewsectorsappeartopresentgreatergreenrevenueoppor-tunitiesbasedontheCarbonDeltaanalysis,asseeninFigure34.Greenrevenueopportu-nitiesaremeasuredbythequalityofacompany’sportfoliooflow-carbonpatents,whichhelpguidethetransitiontoalower-carboneconomy.Thecompaniesprojectedtobenefitmostfromgreenrevenuesinthisportfolioincludeindustrials,informationtechnology,andconsumerdiscretionary.Innovativetechnologiesformoreefficientproductionprocesses,lowerexhaustequipmentandvehicles,andindustrialemissionsmonitoringtoolsaresomeofthesolutionsthatthesecompaniesareapartof,allofwhichcouldmakethesecompa-niesmorecompetitiveinalow-carboneconomy.114INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyFigure35:TDAMbreakdownofCVaR(GlobalEquityportfolio)bysectorandfactorSource:TDAM,CarbonDeltaComparingclimaterisksignalsAsenvironmentalquestionsfromclientsarebecomingmoredetailed,thetoolstosupple-mentfundamentalresearchandexistingESGdatahavebecomemoreimportant.Thosetoolsallowustobringintheexpertiseoforganisationsthathavestudiedenvironmentalissuesandknowhowbesttothinkthroughtheassociatedclimaterisks.ThediscussionbelowtakessomeoftheCarbonDeltaresultsfortheGlobalEquityportfolioandcomparesthemtothesignalsgivenbySustainalyticsdata.Thehopeistospuradditionalconversationtodecipherthevarioussignalsofmajorenvironmentaldataproviders.SustainalyticsisaproviderofESGdata,providingvariousmetricsandratingstobetterunderstandwherecompaniesfalloneachofthosethreepillars.Aspartoftheseofferings,SustainalyticsprovidesaCarbonRiskRating,indicatingacompany’sfinancialexposuretoandmanagementofmaterialcarbonrisks.Thoughthisapproachisdifferentfromscenarioanalysis,itdoesprovideaninformedassessmentoftransitionriskthroughitscomprehensivecoverageofacompany’scurrentemissions(Scope1and2);adistinctionbetweenmanageableandunmanageablerisks(risksthatareintrinsictoaparticularsubind-ustrythatcannoteasilybemanaged);andanevaluationofhowacompany’sclimateriskmitigationstrategyhelpsmanagetherisksthatarewithinitscontrol.Thisisaforward-look-ingratingthatincorporatestransitionrisksthataredrivenbyclimateregulation,carbonpric-ing,alternativeproducts,shiftingconsumerpreferences,andsupplyconstraints.SeveralofthetoptencompaniesidentifiedbyCarbonDeltaascontributingtotransitionriskfortheGlobalEquityportfoliocomefromtheutilitiesandindustrialssectors.InFigure36,wefocusinonelectricutilities,plottingeachelectricutilityaccordingtohowitstandsonbothoftheseclimateriskmeasures,andlookingforparallelsbetweenwhichholdingsCarbonDeltadeemsmostriskyversusSustainalytics.Asdisplayed,themeasuresdeviateaccordingtowhichelectricutilitiesareconsideredtobethemostexposedtotransitionrisk,whichcallsintoquestionwhichfactorsaremostcriticalandperhapsbeingleftoutofonemeasureortheother.115INTEGRATINGSCENARIOANALYSISINTOINTERNALPROCESSESOREXTERNALENGAGEMENTChangingCourseOperationalisingtheMethodologyFigure36:TDAMcomparisonofclimaterisksignalswithinutilities–CarbonDeltavsSustainalyticsNote:GraphisbasedonunweightedfiguresSource:TDAM,CarbonDelta,SustainalyticsTheadditionalclimatedataandscenariosprovidedbyCarbonDeltahavefurtherenrichedthewayTDAMthinksaboutclimaterisks.However,continualcomparisonofthemorehighlyusedenvironmentaldataproviderscouldbeworthwhileinorderfortheindustrytobecomemoreacutelyawareofthesimilarities,differences,andareasseeingorinneedofimprove-mentwhenitcomestomeasuringenvironmentalriskstoinvestments.Thetransparencythatdevelopsfrommakingthesecomparisonscouldencouragegreatercomfortin,andfasteradoptionof,necessaryclimateriskanalysis,particularlygivenTCFD’srecommendations.116ChangingCourseFutureDirections6.FUTUREDIRECTIONS6.1.INTERNALCAPACITYDEVELOPMENTInvestorsshouldconsiderbuildingin-housecapacitiesandtoolstointegratescenarioanalysisinlinewiththeTCFDrecommendations.TheTCFDrecommenda-tionsemphasisetheuseofscenarioanalysisinassessingtheimpactofclimatechangeontheentirebusinessovertimeandinenhancingcriticalstrategicthinkingwithintheorgan-isation.Italsohighlightstheimportanceofassessingarangeofscenariosthatchallengeconventionalwisdomaboutfuturedevelopments,orsignificantlychangethestateoftheworldfrom‘businessasusual’,includinga2°C-compliantscenario.IfscenarioanalysisistobecomeacomponentofclimateriskmanagementandcompanystrategyasenvisionedbytheTCFDrecommendations,investorsmayneedtodeveloptheinternalcapacitytointegratetheseassessmentsfortheirowndecision-making,whileatthesametimeestablish-ingstandardisedandcomparabledisclosuresthatsupportregulatoryassessmentsaimedatensuringfinancialsystemstability.Thepilotprojecthighlightedthattherearearangeofcapacitiesrequiredtoeffec-tivelyconductscenario-basedanalysis,centredaroundfourkeyareas:◼Technical.Conductingscenarioanalysisrequiressignificanttechnicalexpertise,startingfromthevastamountofdatarequired,todesigningthemethodologyandinterpretingtheresultsgenerated.Formanyinvestors,thistechnicalexpertisedoesnotexistin-house,andwouldrequireconsiderabletimeandresourcestobuildup.Externalprovidersofscenario-basedanalysis,suchasthosepresentedinSection2,offerreadilyavailablesupporttoinvestors.However,somein-housetechnicalcapacitywillremainessential,asresultsreceivedfromexternalproviderswillneedtobeinterpretedandstress-testedtodrawoutthekeylessonsfortheindividualinvestor.◼Riskmanagement.Linkingtheresultsofscenarioanalysisintocoreriskmanagementpractices,asrecommendedbytheTCFD,requiresriskmanagementteamstobeinvolvedinscenarioanalysis.Thiswouldallowthemtoadviseonwhattypesofoutputswouldbemostusefulininteractionwithexistingriskassessmentmethodologies,providefeedbackonmodellingelementswhererelevant,aswellasstress-testresultsagainstexistingriskdatabasesandpracticesatthecompanyandportfoliolevel.◼Strategy.Toensurethatscenario-basedanalysisprovidesvaluablelessonsforstrategicassetallocation,andtoactiontheselessonswhereappropriate,activeassetmanagersorotherstaffinvolvedinstrategicdecision-makingshouldalsobeinvolvedintheprocess.Thisinvolvementcouldincludemanagershighlightingthelevelofinformationtheywouldfindusefultoconsiderinstrategicdecisions,aswellastherequiredscopeanddepthofanalysisforresultstoberelevanttothewidercorporatestrategy.◼Governance.Top-levelbuy-intoscenarioanalysisisessentialtoenablealltheabovecapacitiestobedevelopedwithintheorganisation.Executiveofficialsneedtobeconvincedofthebenefitsofscenario-basedanalysistoprovidetheresourcesrequiredtobuilduptheabovecapacities.Further,actioningthelessonsfromscenario-basedanal-ysisinstrategicdecisionswillneedtobeoverseenbyanexecutiveofficial.Thesefocusareasillustratetheimportanceofinvolvingtheentireorganisationinscenario-basedanalysis.Tocoverallthecapacitiesrequired,investorteamsshouldincludetechnical,riskmanagement,andcorporatestrategyexperts,withappropriategovernancecapacity.Somepilotgroupmembersintendtousetheresultsofthepilotprimarilyinengage-mentwithinvesteecompanies,whileothersfeltresultswerenotyetcredibleenoughforthispurpose.Resultsfromthepilotprojecthavebeenusefultoinvestorsinidentifyingdriversofrelativeperformanceofinvesteecompaniesunderdifferentclimatepathways.Somemembersindicatedthattheyintendtousetheseresultsinfutureengagementswithcompanies,particularlythosewithrelativelypoorperformanceordatadisclosure.However,117ChangingCourseFutureDirectionsotherinvestorsalsoindicatedthatresultsarenotyetsufficientlymaturetobeusedforthispurpose,astheyweredoubtfulthatinvesteecompanieswouldfindtheresultscredibleandacceptthemasevidencefordiscussion.InvestorPilotGroupmembersagreedthatscenarioanalysismethodologiesshouldnotinformstrategicassetallocationdecisions,however,somefelttheymaybeabletodosointhefuture.Itwascommonlyagreedthatanalysisfromthepilotprojectshouldnotbeusedasabasisforinvestmentordivestmentdecisions,asresultsforindividualcompaniesdidnotalwaysreflecttheinformationinvestorsheld—forexample,onemissionreductiontargetsorstrategicvisioninrelationtoclimatechange.Whilesomeinvestorsindi-catedthatwithfurtherimprovements,theanalysiscouldbeusedforthispurposeinthefuture,othersfeltthatthiswouldconflictwiththeirfiduciaryduty.Thislattergroupofinvestorshighlightedtheimportanceofengagementoverdivestment,whichcouldleavegainsorprofitunrealisedandleavethewholesystemworseoffasaresult.6.2.IMPROVINGTHESCOPEANDDEPTHOFANALYSISThepilotprojecthighlightedseveralkeyareasfordevelopmentofscenario-basedanalysisforinvestorsinthefuture.Thissectionhighlightsthemostcommonareasoffeedbackfrominvestorsonwhatfuturedevelopmentstheyconsidernecessarytoimprovethecredibilityandgranularityofresults.Itcombinesthisfeedbackwiththelessonslearntfromtheevaluationofavailablemethodologiesforphysicalandtransitionrisktodate,toarriveataclearsetofrecommendationsforfurtherbuild-outofexistingmethodologies:◼Thesetofexaminedscenariosshouldincludescenariosthateffectivelycapturethekeyrisksaroundclimatechange,includingtailriskeventsanduncoordinatedordelayedpolicyaction.Itisinsufficienttoexamineonly‘smooth’transitionstoalow-carboneconomy,inwhichuniversalglobalcarbonpricesstartrisingtodayanddevelopgraduallyovertime,withperfectinformationonthisscheduleavailabletoallcompaniesinthemarket.Inreality,suddenincreasesincarbonpricingthatmayresultfromdelayedpolicyactionorlackofregionalcoordinationcouldpresentconsiderablethreatstofinancialstability.Whenconsideringthephysicalimpactsofclimatechange,particularlyovershortertimehorizons,manymethodologiesfocuson‘average’impactsoveragivenperiod.However,giventhepotentiallycatastrophiceffectsof‘tailrisk’events,explorationoftheseeventscanhelpillustratetheimportanceofconsideringlow-risk,high-impacteventsinlong-terminvestmentdecisions.◼Toensurethatinteractionsbetweenphysicalandtransitionriskaresufficientlycaptured,analysesshouldextendbeyondthenext10–15years.Whilechangestotheclimateintheshort-to-mediumtermwillvarylittleacrossdifferentclimatepolicypathways,thepotentialimpactsofthesepoliciesontechnologiesandmarketscouldbevast.Inotherwords,physicalrisksinthe2020swillvarylittleacrossdifferenttemper-aturepathways,anddivergencewillbecomesignificantonlybeyondthe2040s.Thenumberofscenariosconsideredinphysicalriskassessmentsisthereforelikelytodependontheassessmenttimehorizon:thelongerthehorizon,themorethephysicalimpactsofdifferenttemperaturepathwayswilldiverge.Atthesametime,someinvestorspointedoutthatduetothehighdiscountratesappliedinthefinancialsector,evenifanalysesareextended,thepotentiallycatastrophicphysicalimpactsbeyond2050willappearsmalltoday.Therefore,theseimpactsshouldbereportedandconsideredbeforeandafterdiscountingtogiveanideaoftherelativemagnitude.Otherinvestorscautionedthathorizonsbeyondthenext15yearsmightnotbeapplicableforsectorswithshortertypi-calassetlifetimesandproductionhorizons.◼Scenario-basedanalysisshouldconsidertheentirevaluechainofacompanyaswellasthebroadermacroeconomicenvironment.Manymethodologiestodatehavefocusedontheimmediateimpactsofphysicalortransitionriskoncompanies’oper-ationsandassets.However,theimpactsoftheserisksonthebroadervaluechaincanbesignificant:priceshockstokeyinputsandshiftsinconsumerbehaviourcantrans-lateintoconsiderablefinancialimpactsonacompany.Atthesametime,physicalandtransitionriskwillimpactthemacroeconomicenvironmentinwhichcompaniesoperate,aschangestokeyvariableslikesectoralcompositionandinternationalcompetitivenesscouldhavesignificanteffectsoncompanyperformance.118ChangingCourseFutureDirections◻Indoingso,methodologiesshoulddistinguishmoreclearlybetweenScope1,2and3emissionsinordertocapturecompanycarbonfootprintsandassociatedriskswithgreateraccuracy.Formanyexistingmethodologiesforscenarioanalysis,Scope1emissionshaveformedthebasisforcalculationofthefuturecostincreaseacompanymayfaceunderstringentclimatepolicy.However,companiesarelikelytofacefurthercostsfromtheirScope2emissionsthroughthegenerationofpurchasedenergy,aswellasotherrepercussionsfromtheirindirectScope3emissions.◼Analysisneedstoextendbeyondexposureassessmenttothesensitivityandadaptivecapacityofindividualcounterpartiesandfacilities.Limitingassessmenttocompanyexposuretoriskignoresthecompany-specificcharacteristicsthatcouldmitigateorexacerbatethisrisk.Somesectorswillbemoresensitivetophysicalortran-sitionriskandtherewillbefurtherdifferencesbetweencompaniesinthesamesector.Inparticular,companiesthathavealreadyadaptedtorisksorhavegreatercapacitytodoso—forexample,throughresilientinfrastructureoremissionsabatement—shouldoutperformtheircompetitorswhentheserisksmaterialise.◻Aspartofthisextension,futureanalysis,particularlyofphysicalclimaterisk,couldalsoexplicitlyconsidercompanyinsurancecoverinimpactassessment.Anothercomponentofacompany’sadaptivecapacitytoclimate-relatedrisksisitsexistinginsurancecover.Companiesinclimatedisaster-proneareaswithgoodinsurancecoverareunlikelytoexperiencethefullnegativeimpactsoftheseevents.◼Forthepurposesofinvestors,scenarioanalysismethodologiesshouldcontinuetoexpandontherangeofassetclassescovered,including,forexample,commodities,sovereigndebtandinfrastructure.Todate,manymethodologiesfocusexclusivelyontheclimate-relatedrisksandopportunitiesforlistedequityandcorpo-ratedebt.Othersfocusexclusivelyonsovereigndebtorrealestateandinfrastructure.However,diversifiedportfoliostodayincludemanymoreassetclasseswhichmaybeaffecteddifferentlyacrossclimatepathways.Asaresult,methodologiesthatconsistentlyexaminetheimpactsofvariousscenariosontheentiretyofthediversifiedportfolioneedtobedevelopedifresultsaretobecomemoredecision-usefulforinvestors.Intheinterestofpursuingtheseimprovements,thereisaclearneedforbetterdisclosureofclimate-relateddatafrominvesteecompanies.Themoregranularthedatadisclosedbyinvesteecompanies,themoreinformativescenario-basedanalysiscanbeforinvestors.Analysistodatehasreliedonsectoralindicatorsofresilience,suchasnatu-ralresourcedependenceandabatementpotential.However,thesecouldvarysignificantlyacrossasector,andmoredataonindividualcompanies’sensitivitiesandadaptivecapacitytophysicalandtransitionriskisneeded.Companiesshouldthereforeexpandtheirreportingnotonlyofcarbonfootprints,butalsoofvariableslikekeyinputsandlocationofvulner-ablesuppliers,insurancecover,andplannedabatementandresilienceinvestmentsandtheircosts.Inaddition,fossilfuelextractioncompanies’productiontimingandvolumeunderdifferentscenarioscould,ifpubliclyreported,enablemoregranularanalysisoftheriskofassetstranding.Thisincludesdataonindividualfacilitiessuchasproductionsitesandrealestate,whichshouldcoverlocation,aswellaskeyclimate-relatedcharacteristicssuchasfloodresilienceorenergyefficiency.Todate,manyscenarioanalysisproviderseitherdonotusethistypeofdataorrelyonproprietarylocationdatabasestoconductfacility-spe-cificassessment.Ifscenarioanalysisistobecomemorecommonplace,particularlyforsmaller-scaleinvestors,dataonindividualfacilitiesneedstobecollectedandmadeavailablemorecomprehensively.6.3.FUTURECOLLABORATIONANDALIGNMENTOFKEYACTORSIndustrycollaborationplayedaninvaluableroleinthepilotprojectasinvestorspursuingtheiruniqueinterestsresultedinamoreholisticmethodology,andfutureeffortscouldencourageinvestorstocontinuestress-testingmethodologiesforscenarioanalysiscollaboratively.ContinuousengagementwithCarbonDeltaonthepilotmethodologycontributedsignificantlytoinvestorunderstandingofthekeyelementsofscenario-basedanalysisandallowedinvestorstocollaborativelysuggestimprovementstothemethodology.Forexample,overthecourseofthepilotproject,investorshighlighted119ChangingCourseFutureDirectionstheneedforadditionalscenarios,resultingintheinclusionofmoreaggressivephysicalrisk,aswellasdelayedpolicyactionscenarios.Multipleinvestorsworkingtogetherwhilepursu-ingtheiruniqueintereststhereforeresultedinamoreholistictoolthanifeachinvestorhadundertakentheanalysisseparately.PilotgroupmembersfurtherpointedoutthatusingthesamemethodologyasotherinvestorsprovidedthemwithsomereassurancethatresultswouldbecomparableandinformativeinTCFDreportingacrosstheindustry.Thereremainsanopenquestionaroundtheroleofstandardisationofscenarios,modellingframeworksandoutputs,forthepurposesofinvestorTCFDdisclosurearoundscenario-basedanalysis.Whilemanypilotgroupmembersagreethatsomedegreeofstandardisationwouldbehelpful,opinionsdivergeonhowextensivethisstand-ardisationshouldbe,andwhetheritshouldapplytoscenarios,modellingframeworksandoutputs.Investorsvoicedconcernsaroundintellectualpropertyandcompetitiveadvantagewhendiscussingcompletestandardisation;however,manyhighlightedthatalistofcommonscenariosaswellasformatofoutputscouldbehelpfulwithoutaffectingtheseareasofconcern.Inaddition,investorspointedtowardsthelackofstandardisationinthefieldofotherclimate-relatedriskmanagementtools,suchasESGriskratings,wheremanyexternalprovidersofferverydifferentproducts.Toadvance,theTCFDwillhavetoconsidertheissueofstandardisationanditspurposeinenablingcomparabilitymorethoroughly.Aspartofamovetowardsincludingclimatechangeinstress-testing,financialregu-latorscouldprovideasetofshocksorscenariostheywouldlikeinvestorstouseinscenario-basedanalysisoftheirportfolios.AsoutlinedintheIntroductiontothisreport,regulatorsaremovingtowardsincludingclimatechangeinregularstress-testsofthefinan-cialsystem.TheNGFSisalsoplanningtodevelopvoluntaryguidelinesforscenarioanalysis.Thiscouldbesupplementedbyprovidinginvestorsandthebroadersetofpubliclyreport-ingcompanieswithasetofscenariostoexamineusingtheirownmethodologies,basedonacommonsetofassumptions.Companiescouldthensupplementthesecommonscenar-ioswiththeirown,uniquescenariostoexplorefurtherassumptionsofinterest.Investorsnotedthatthismaybeparticularlyrelevanttoindustriesmostlikelytobeaffectedbyclimatechange,suchasthoseintheoil,gasandcoalsectors.Imposingasetofscenarioscouldensurecompaniesconsidersufficientlyunfavourablescenariosandprovideinvestorswithmorevaluableinformationabouttheirinvesteecompaniesthaniftheseweretochoosetheirownscenarios.Sometransparencyofmodellingmethodologies—ratherthanfullstandardisation—wouldfurtherenablecomparability,whilereducingtherisksofcorrelatedmodelerrorsandpreservingtheincentiveformethodologicalimprovements.Whilesomemembersproposedstandardisationofmodellingmethodologies,mostdisagreedbasedontherisksof‘herding’previouslyonfinancialstability,andthedisincentivestodevelopingbettermethodologies(andtheassociatedintellectualproperty)thatmightprovideapoten-tialcompetitiveedge.Inaddition,pilotgroupmembersagreedadditionalguidanceondisclosureofclimatescenarioanalysiswouldhelpinvestorsinterpretothers’results,beitinves-teecompaniesorotherinvestors.Themorecompaniesthatincorporatescenario-basedanalysisinclimate-relatedreporting,themoreimportantitwillbethattheirresultsarecomparable,evenifusingseparatemethodologies.Toenableinvestorstointerprettheseresults,guidancefromregulatorsonwhatkeyassumptionstodisclose,whatelementsofthemethodologytodetail,andwhattypesofoutputstoreportwouldbevaluable.Finally,outputstandardisationcouldaidinvestorsininterpretingresultsfromdifferentcompanies,byallowingthemtoexaminethesamesetofimpactmeasuresthroughout.Todate,thoseconductingscenarioanalysishaveprovidedarangeofdiffer-entoutputs,asSection2highlighted.Thiscanmakeitdifficultforinvestorstocompareinvesteecompanies’scenario-basedriskassessments.Outputstandardisationmightinvolverecommendingonetypeofwell-definedoutput,suchasaquantitativevalueatriskfigure,tobecomethefocusoffuturescenario-basedanalysis.Providerscouldthencontinuetooffertheirexistingoutputtypesbutsupplementthesewiththe‘recommended’output.Themostusefulformatofoutputsforinvestorsshouldbeexploredfurtherinfutureindustrycollaboration,whichcouldformalogicalnextstepforclimate-relatedreportingstandards.120ChangingCourseAppendixiAPPENDIXIFulllistofprovidersofphysicalandtransitionriskassessmentsreferencedinthisreportProviderNameofmethodologyandsourceType(s)ofrisk2°investinginitiative(2dii)PACTAtool(2°InvestingInitiative,2016)TransitionFourTwentySeven(427)Equity,fixedincome,sovereignandmunicipalriskscores(DeutscheAssetManagement&FourTwentySeven,2017)PhysicalAcclimatiseAwareforProjects(Acclimatise,2018)PhysicalAcclimatiseUNEPFIBankingPilot(UNEPFI&Acclimatise,2018)PhysicalCarbonDeltaClimateValueatRisk(UNEPFIInvestorPilot)PhysicalandtransitionCarbone4ClimateImpactAssessment(Carbone4,2016)TransitionCarbone4ClimateRiskImpactScreening(Carbone4,2017)PhysicalCarbonTrackerInitiative2degreesofseparation(CarbonTrackerInitiative,2017)TransitionClimateWise(withVividEconomics)Managingthephysicalrisksofclimatechange(CambridgeInstituteforSustainabilityLeadership,2019)PhysicalMercerTRIPframework(Mercer,2015)PhysicalandtransitionMoody’sInvestorServiceSovereignriskratings(Moody’sInvestorsService,2016,2018)PhysicalandtransitionOrtecFinanceClimate-savvyscenariosset(OrtecFinance,2019)PhysicalandtransitionOliverWymanUNEPFIBankingPilot(UNEPFI&OliverWyman,2018)TransitionSchrodersCarbonValueatRisk(Schroders,2017)TransitionTransitionPathwayInitiative(TPI)TPITool(TransitionPathwayInitiative,2018)TransitionTrucostCarbonEarningsatRisk(Trucost,2019)TransitionVividEconomicsNet-zerotoolkit(HSBCGlobalAssetManagement&VividEconomics,2019)TransitionVividEconomicsViEW(EY&VividEconomics,2018)TransitionSource:VividEconomics121ChangingCourseAppendixIIAPPENDIXIICarbonDelta’sextremeweatherbusinesssectorsystemSectorCodeAgricultureEXW-AGAgricultureLivestockEXW-AG-LSAgricultureOtherAgricultureEXW-AG-OAAgricultureMaizeAgricultureEXW-AG-MAAgricultureWheatAgricultureEXW-AG-WACommerceandServicesEXW-CSCommerceandServicesInsuranceEXW-CS-INCommerceandServicesLaboratoryEXW-CS-LACommerceandServicesHealthcareServicesEXW-CS-HSCommerceandServicesLuxuryServiceEXW-CS-LSCommerceandServicesIndoorLeisureEXW-CS-ILCommerceandServicesOfficeEXW-CS-OFCommerceandServicesRealEstateEXW-CS-RECommerceandServicesRetailEXW-CS-RTCommerceandServicesStorageEXW-CS-STCommerceandServicesBasicServiceEXW-CS-BSIndustryEXW-INIndustryConstructionEXW-IN-COIndustryInfrastructureEXW-IN-IFIndustryMiningEXW-IN-MIIndustryProductionPlantEXW-IN-PPPowerEXW-PO-POPowerCoalPowerEXW-PO-CPPowerFossilOtherPowerEXW-PO-FOPowerHydroPowerEXW-PO-HPPowerNaturalGasPowerEXW-PO-NGPowerNuclearPowerEXW-PO-NUPowerSolarPowerEXW-PO-SPPowerWindPowerEXW-PO-WPTourismEXW-TOTourismOutdoorLeisureEXW-TO-OLTransportationEXW-TRTransportationInlandShippingEXW-TR-ISTransportationRailTransportationEXW-TR-RTTransportationRoadTransportationEXW-TR-ROTransportationSeaTransportationEXW-TR-SETransportationAirTransportationEXW-TR-ATSource:CarbonDelta122ChangingCourseAppendixiiiAPPENDIXIIIINTERVIEWQUESTIONSThefollowingquestionswereposedininterviewstoinves-torsinvolvedintheInvestorPilot.Intervieweesfromotherorganisationsweresenttailoredquestions.Context:theroleofinvestmentininvestors’perspectivesonclimatechangeandtheemergingunderstandingoflong-termexposure◼Howdoesyourorganisationdefineitsownimpactonclimatechange?Doyouhaveclimate-relevantKPIs?◼Towhatextentdoyouthinkthefinancesectorasawholeisstartingtorealise(andmitigate)itsownimpactonclimatechange?Wherehasthemostprogressbeenmadeandwhatisthehighestpriorityareanowcomparedto5yearsago?◼Whichinstitutions/organisationsencourageyouasaninvestortoconsidertheimpactsofyourinvestmentsonclimatechange?Howso?◼TCFDiscurrentlyrecommendedpractice;howdoyouviewthepotentialformandatoryclimate-relateddisclosure?◼TCFDisaboutlong-runfinancialsystemstability.Howdoesyourorganisationviewandaddress(ifatall)the‘tragedyofthehorizon’?◼DoyouseeanyrelevanceforTCFDapproachinthewidercontextofachievingtheParisAgreement?Ifso,whatdevelopmentsdoyouexpectinthenext5years?Operationalisingthemethodology:lessonslearntfromthepiloting◼Ifyouhadtoidentifythreekeylessonsfromtheinvestorpilot,whatwouldtheybe?◼Inwhatwayhasthepilotadvancedyourexistingorplannedclimate-relateddisclosurepractices?◼Wheredoyouseeclimate-relatedscenarioanalysissittinginyourorganisationnowandinthefuture?◼Doyouforeseeconcretelyintegratingscenarioanalysisintodecisionmaking,andifso,how?◼Whatadditionalelementswouldyoufindusefulinascenarioanalysismethodology?Whichissuesdoyoufeelhavenotbeen(sufficiently)addressedintheCarbonDeltamethodology?◼Whatkindoftools,platforms,orothersupportmecha-nismsaidyourorganisationinincorporatingtheTCFDrecommendations?Whatkindoftools,platforms,orothersupportmechanismstoaidyouinincorporatingtheTCFDrecommendationscouldbedevelopedinfuture?◼Whatrole(ifany)doyouseeforstandardisationorharmonisationinconductingscenario-baseddisclosure?Howmightsuchstandardisationbeachievedinyourview?StateofimplementationoftheTCFDrecommendations◼Whatpressuresdoyoureceivefromclientstodiscloseonclimatechange,ortoaddressclimate-relatedissuesinyourinteractionswiththemmoregenerally?◼Howdoyoureportonclimate-relatedconsiderations?Inasustainabilityreport?◼Whatissomeofthemostadvancedclimate-relatedreportingyouhaveseentodate,byafinancialorinvestee?Why?◼How/whendoyouuse(investeeorotherfinancials)climate-relateddisclosure?◼Doyouhaveanygeneralobservationsontheclimate-relatedreportingyouhavereceivedfrominvesteecompaniestodate?Whataretheprevailingissues?◼Haveanyofyourinvesteecompaniesdisclosedscenarioanalysisresults?Ifso,whatwasyouropinionofthisdisclosure?123ChangingCourseAcronymsACRONYMSBaUBusinessasUsualCAPRICommonAgriculturalPolicyRegionalisedImpactCDPCarbonDisclosureProjectCDPQCaissededépôtetplacementduQuébecCGEComputablegeneralequilibriumCOPConferenceofthePartiesCVaRClimateValueatRiskDNBAMDNBAssetManagementEBITDAEarningsbeforeinterest,tax,depreciationandamortisationEIOPAEuropeanInsuranceandOccupationalPensionsAuthorityESGEnvironmental,socialandgovernanceETSEmissionstradingschemeGCAMGlobalChangeAssessmentModelGCMGlobalClimateModelGDPGrossDomesticProductGHGGreenhousegasGICSGlobalIndustryClassificationStandardGLOBIOMGlobalBiosphereManagementModelGVAGrossvalueaddedIAMIntegratedassessmentmodelIEAInternationalEnergyAgencyIIASAInternationalInstituteforAppliedSystemsAnalysisIMAGEIntegratedModeltoAssesstheGlobalEnvironmentIPCCIntergovernmentalPanelonClimateChangeIRENAInternationalRenewableEnergyAgencyJGCRIJointGlobalChangeResearchInstituteKPIKeyperformanceindicatorMAgPIEModelofAgriculturalProductionanditsImpactontheEnvironmentNBGNon-BindingGuidelinesNBIMNorgesBankInvestmentManagementNDCNationallyDeterminedContributionND-GAINUniversityofNotreDameGlobalAdaptationIndexNFRDNon-FinancialReportingDirectiveNGANationalGreenhouseAccountingNGFSNetworkforGreeningtheFinancialSystemPACTAParisAgreementClimateTransitionAssessmentPIKPotsdamInstituteforClimateImpactResearchR&DResearchanddevelopmentRAMRockefellerAssetManagementRCPRepresentativeConcentrationPathwayREMINDRegionalModelofInvestmentsandDevelopmentSSPSharedSocioeconomicPathwayTCFDTaskForceonClimate-RelatedFinancialDisclosureTDAMTDAssetManagementTEGTechnicalExpertGroupTIAMTIMESIntegratedAssessmentModelTPITransitionPathwayInitiativeUNEPUnitedNationsEnvironmentProgrammeUNEPFIUNEnvironmentProgrammeFinanceInitiativeUNFCCCUnitedNationsFrameworkConventiononClimateChange(UN)PRIUnitedNationsPrinciplesforResponsibleInvestmentVaRValueatRiskViEWVividEconomy-WideWACCWeightedaveragecostofcapitalWRIWorldResourcesInstitute124ChangingCourseGlossaryGLOSSARYAcuteriskRiskfromrapidonsetweatherevents,oftenhighlylocalisedwithimmediateimpactsBusinessAsUsualScenariosthatarebasedonasetofassumptionsthatbuildonhistoricalnormsinprojectingtheglobalenergysystemCarbonleakageDisplacementofemissionsfromonelocationtoanotherowingtoshiftingtradepatternsfollowingtheintroductionofacarbonpriceinonejurisdictionbutnotinothersChronicriskRiskfromslowonset,incrementalweatherchanges,oftenwithgraduallyaccumulatingimpactsClimateValueatRisk(CVaR)TermusedtospecificallydescribeCarbonDelta’sphysicalandtransitionriskassessmenttool.CounterpartyEntitytowhichanexposuretofinancialriskmightexist.Inthisreport,describesentitiesaffectedbyclimate-relatedrisk,rangingfromcountriestocompaniesandindividualfacilities.LegalriskRiskfromclime-relatedlitigationMarketriskRiskthatcounterparties’supplyanddemandpatterns,andrelativecompetitivenesschangeduringalowcarbontransition.PhysicalriskUmbrellatermforrisksfromthephysicaleffectsofclimatechangePolicyriskRiskfromclimate-relatedpolicychanges(suchascarbonpricing)RadiativeforcingInfluenceofclimaticfactorsontheamountofradiantenergyaffectingtheEarth’ssurface.ReputationriskRisktocounterpartyreputationfromactionsittakesrelatedtoclimatechangeScope1emissionsDirectemissionsfromsourcesthatanorganisationcontrolsorownsScope2emissionsDirectemissionsfromtheconsumptionofelectricity,heatorsteamScope3emissionsIndirectemissionsfromanorganisation’sactivities,includingbothupstreamanddownstreamemissionsTechnologyriskRiskfromchangesinrelativetechnologycostsduetoinnovationTragedyofthehorizonMisalignmentbetweenregulatoryandeconomicactors’timehorizonsandtheimpactsofclimatechange.TransitionriskUmbrellatermforrisksfromthetransitiontoalow(orzero)carboneconomyValueatRiskMeasureoftheriskofinvestmentloss.Inthisreportoftenusedas‘ValueatRiskfromclimatechange’whenreferringtoscenarioanalysismethodologiesotherthanCarbonDelta(forwhom‘ClimateValueatRisk’refersspecificallytotheirproprietarytool).125ChangingCourseReferencesREFERENCES2°InvestingInitiative.(2016).2°CPortfolioAssessmentDocumentation.Retrievedfromhttp://www.transitionmoni-tor.com/wp-content/uploads/2017/04/2-Degrees-Invest-ing-Initiative-2D-Portfolio-Assessment-Tool-Methodolo-gy-Briefing.pdfAcclimatise.(2018).AwareforProjects:Fast,ComprehensiveClimateRiskScreening.Retrievedfromhttp://www.acclimatise.uk.com/wp-content/uploads/2018/11/Aware_brochure_Nov2018.pdfAmericanMeteorologicalSociety.(2018).Heatwaves,droughtsandfloodsamongrecentweatherextremeslinkedtoclimatechange.BankofEngland.(2015).BreakingtheTragedyoftheHorizon–climatechangeandfinancialstabilitySpeechgivenbyGovernoroftheBankofEnglandChairmanoftheFinancialStabilityBoardLloyd’sofLondon.(September),1–16.Binham,C.,&Crow,D.(2018).CarneyplanstotestUKbanks’resiliencetoclimatechange.RetrievedfromFinancialTimeswebsite:https://www.ft.com/content/0ba2390a-ffd4-11e8-ac00-57a2a826423eCambridgeInstituteforSustainabilityLeadership.(2019).Physicalriskframework:Understandingtheimpactsofclimatechangeonrealestatelendingandinvestmentportfolios.CarbonTrackerInitiative.(2017).2degreesofseparation:Transitionriskforoilandgasinalowcarbonworld.Retrievedfromhttp://2degreeseparation.com/Original-report.htmlCarbone4.(2016).CarbonImpactAnalytics.Retrievedfromhttp://www.carbone4.com/wp-content/uploads/2016/08/CarbonImpactAnalytics.pdfCarbone4.(2017).ClimateRiskImpactScreening:Themethodologicalguidebook.(November),1–33.Retrievedfromhttp://crisforfinance.com/wp-content/uploads/2017/11/CRIS-Guidebook_Publicversion_Nov2017.pdfChazan,G.,&McGee,P.(2016,April26).Germanyseeksleadinelectriccarracewith€1bnsubsidies.FinancialTimes.Retrievedfromhttp://www.ft.com/cms/s/0/37be63a8-0c50-11e6-9456-444ab5211a2f.html#axzz47brRFo5MChen,C.;,Noble,I.;,Hellmann,J.;,Coffee,J.;,Murillo,M.;,&Chawla,N.(2015).UniversityofNotreDameGlobalAdaptationIndexCountryIndexTechnicalReport.45.ClimateActionTracker.(2019).CountryAssessments.Retrievedfromhttp://climateactiontracker.org/DeNederlandscheBank.(2018).AnenergytransitionriskstresstestforthefinancialsystemoftheNetherlands.OccasionalStudies,16(7).DeutscheAssetManagement,&FourTwentySeven.(2017).Measuringphysicalclimateriskinequityport-folios.DeutscheAssetManagementGlobalResearchInstitute,(November),32.Retrievedfromhttp://427mt.com/wp-content/uploads/2017/11/Physical_Climate_Risk_FourTwentySeven_November2017.pdfEIOPA.(2018).2018InsuranceStressTestreport.https://doi.org/10.2854/613482EY,&VividEconomics.(2018).WestpacNZ:ClimateChangeImpactReport.(April).Retrievedfromhttps://www.westpac.co.nz/assets/Sustainability/Westpac-NZ-Climate-Change-Impact-Report.pdfFletcher,L.,Crocker,T.,Smyth,J.,&Marcell,K.(2018).Beyondthecycle.CDP,(November).Retrievedfromhttps://6fefcbb86e61af1b2fc4-c70d8ead6ced550b4d-987d7c03fcdd1d.ssl.cf3.rackcdn.com/cms/reports/documents/000/003/858/original/CDP_Oil_and_Gas_Executive_Summary_2018.pdf?1541783367Harvey,C.(2018).CementProducersAreDevelopingaPlantoReduceCO2Emissions.RetrievedfromE&ENews,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