The Seven Steps of Climate-related Scenario Analysis
Planners and decision makers are often required to develop strategies in the face of an uncertain future. Climate change adds an additional (and substantial) layer of uncertainty to the mix.
Scenario analysis is an established method for developing and stress testing management responses under such conditions of deep uncertainty. Effectively a ‘what-if?’ test, each scenario presents a combination of plausible and internally consistent future events to planners and decision makers. A set of scenarios is used to span a range of possible futures that are outside the timespans of day-to-day decision-making.
In June 2017, the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (FSB TCFD) suggested that “organizations should use scenario analysis to assess potential business, strategic, and financial implications of climate-related risks and opportunities…”. The FSB followed this with a Technical Supplement on the use of Scenario Analysis.
Point Advisory have found the FSB’s technical supplement to be useful in application. However, we have also found that some organisations have difficulty in translating the FSB’s guidance into tangible steps. To assist, we have developed the following seven-step approach:
- Establish the organization’s context: Scenarios should be relevant to the organisation’s environment, including markets and competition, supply chains, etc. The planning horizons will be important in defining scenarios’ own milestones.
- Understand current governance: Scenarios will facilitate decision making; scenario development therefore need to be cognisant of how decisions are made.
- Assess climate-related risks and opportunities: This step could be the subject of its own article (or text book). Climate related future scenarios will modify these risks, but it is important to have a solid starting point and understand the risk areas to make sure scenarios have a higher level of resolutions within those areas.
- Develop the scenario set: This is the crux of the matter. Based on research and consultation, a set of scenarios can be defined. To ensure they are useful all assumptions should be clearly stated and then reviewed by key internal participants. The resulting scenarios should be plausible, internally consistent, relevant and challenging.
- Apply the scenarios: The scenarios are but a tool. Planners and decision makers use them to explore the implications of scenarios on decisions, strategies or objectives. This is the “stress test” and the key question to be asked is: How would existing (or proposed) strategies, decisions or actions perform under each scenario?
- Use the results of scenario analysis to influence strategic planning or to improve existing management responses. This is best done by embedding insights from the previous steps into processes, policies and the culture of the organization.
- Close the governance loop: Monitor, review, document, disclose and repeat as appropriate.