The trouble with climate scenarios is that everyone has their own

Financial regulation is another area where scenario analysis might yield limited results.
Climate change scenarios are everywhere. These data-driven exercises in mapping out multiple visions of a warmer future appear in corporate sustainability reports, investment portfolio analyses, and consultancy offerings.

Scenario analysis can be a great way of structuring one’s thinking about the future, which is essential to understanding climate change. It’s also time-consuming, sometimes misapplied, and perhaps even slowing down attempts at tackling the actual problem.

Scenario-based decision-making was originally a military tool and made its way into the world of business via Royal Dutch Shell Plc in the 1960s. Up until a few years ago, however, it was still confined mostly to a few big energy and mining companies.

The current popularity of climate scenarios in finance and industry is almost wholly due to the Taskforce for Climate-Related Financial Disclosure, which in 2017 recommended that companies produce multiple scenarios of “plausible futures” as a way to analyze and disclose how different climate outcomes might affect them financially. (Michael R. Bloomberg, founder and majority shareholder of Bloomberg News parents company Bloomberg LP, is the chair of TCFD.)

Some of the companies adopting TCFD recommendations have put considerable effort into developing their own scenarios, a long and tedious process. Before a company can get started on the painstaking work of modeling, its analysts first have to understand the assumptions about population growth, energy technology, and international cooperation that shape the model inputs. And the learning curve doesn’t stop there—each of the many, many steps involved in scenario development presents new and grinding challenges for teams of consultants and in-house sustainability experts.

There are obvious benefits from scenario analysis becoming a regular corporate practice. It’s smart for companies and financial institutions to familiarize themselves with IPCC reports and get on good terms with energy transition experts and climate scientists. Scenario analysis also makes sense as a way to approach strategy within an organization—not just on climate change but cyberattacks, pandemics and more.

As a method of informing markets or society at large, however, the focus on scenarios has been less successful. That’s what TCFD found in its latest status report, which tracks uptake of its voluntary reporting framework. Climate disclosures often fail to provide data that allows comparisons between companies. Even within a single company’s report, TCFD found, there isn't enough information about how the company would fare against the events described in the scenario.

That makes all these carefully crafted disclosures not “decision-useful,” as TCFD’s report notes, particularly for investors who want assess numerous companies across their portfolios. Instead, investors have taken to applying off-the-shelf scenarios or else developing their own.

Financial regulation is another area where scenario analysis might yield limited results. The Network for Greening the Financial System, an alliance of central banks focused on the environment, recently published the first version of its own scenarios for its members to use to avoid climate-related failures. But most central banks are far from deploying these exercises, let alone acting on them in a way that has real-world effects.

As the coronavirus pandemic took hold, many central banks acted swiftly to shore up companies, buying up bonds and loans backed by all kinds of polluting businesses. In the rush, there was no effort to skew toward less harmful companies, although both the Bank of England and the European Central Bank have indicated this is something they may do in future. A global health crisis is unlikely to be a good time to make sudden changes, but wrangling knowledge about climate change into traditional financial regulation might take years.

 
A working paper published late last year by Hughues Chenet, Joshua Ryan-Collins, and Frank van Lerven argues that financial supervisors and central banks needn’t bother with elaborately detailed scenarios and stress tests now that they’ve acknowledged the significance of climate change. Instead, the authors argue that financial authorities should recognize a warming world requires a precautionary approach. Climate change “cannot be treated as conventional financial risks to which probabilities can be assigned,” they write, questioning the usefulness of both historical data and elaborate projections.

Scenario analysis has helped introduce financial experts to a level of detail about climate science and decarbonization they might otherwise never have encountered. Those fine details might require less focus now that the general direction of climate change is unmistakably clear and extremely urgent.


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