Companies of all sizes and across all industries can all relate to the old adage, “Hope for the best but prepare for the worst.” That’s why scenario analysis has been used to incorporate ‘wild card’ outcomes into strategic planning. After the economic downturn during the ‘great recession’ of 2008-2009, Congress passed the Dodd-Frank act requiring mandatory stress testing, a type of scenario analysis, to understand the health of our banking system.
The last several years have shown us, however, that it’s becoming more of an imperative to add climate change scenario analysis into long-term financial and operational disclosures. For instance, oil and gas companies have been pressured by investors to run and share the outcomes of their scenario analyses.
From droughts in the West that lead to fires and water restrictions, to severe storms in the East that affect transportation and supply chain, to southern hurricanes that temporarily halt oil and gas production, climate change is affecting cities and businesses.
Organizations must consider how climate-related risks and opportunities may evolve and their implications on business using scenario analysis, a forward-looking assessment of risk.
Using published global climate-related scenarios (both physical and transitional) businesses have a starting point to tailor their own analysis for disclosure and decision-making. Let’s look at the evidence: In October 2012, Hurricane Sandy extended over 1,000 miles and brought some of the highest storm surges to New Jersey, New York and Connecticut. In New York City, loss estimates exceeded $19 billion with the Metropolitan Transportation Authority sustaining roughly $5 billion in damages to the city’s infrastructure and lost revenue. In late August 2017, Hurricane Harvey hit Houston and surrounding areas with a vengeance, dumping 51.88 inches of water over six days, creating a 1-in-1,000 year flood event, and causing more than $125 billion in damage, second only to Hurricane Katrina in 2005. While businesses in these areas may have been prepared for a typical hurricane or winter storm season, these atypical events created enormous losses that few expected.
In 2015, the Financial Stability Board (FSB) established the Task Force on Climate-Related Financial Disclosures (TCFD) and developed four disclosure recommendations that organizations should use in their financial filings. These recommendations are geared mainly toward companies in the financial, industrial, materials, utility and real estate sectors, but can be adopted by any large or small company holding debts or assets.
Climate-Related Financial Disclosure Recommendations
- Disclose the organization’s governance around climate-related risks and opportunities.
- Disclose the actual and potential impacts of climate-related risks and opportunities on the organizations’ business, strategy and financial planning where such information is material.
- Disclose how the organization identifies, assess, and manages climate-related risks.
- Disclose the metrics and targets used to assess and manage relevant climate-related risks and opportunities where such information is material.
Reporting and disclosures can be done in financial filings, sustainability reports, or other reporting framework disclosures such as CDP and PRI, with no additional costs involved. The recommendations have already gained widespread global support (primarily in Europe) and, like other efforts such as RE100 or We Mean Business Coalition, it is a voluntary, company-driving initiative. So far, TCFD is backed by 290 organizations and the G20 finance ministers—investors, associations, policymakers and companies with a market cap of over $6.6 trillion.
This effort provides a response to company stakeholders and investors that are looking for greater clarity and transparency on the impacts of climate on an organization’s current and future financial performance. A recent survey found that 17 percent of European pension schemes consider the financial impact of climate change in their investments, up from five percent in 2017.
The survey also uncovered that 10 percent of companies incentivize boards to prioritize climate risks, while 34 and 28 percent, respectively, are considering physical risks and regulatory and transition risks associated with climate change beyond six years.
On our Coast to Coast Sustainability Tour, we discovered that water scarcity and infrastructure is and will continue to be a huge concern for many businesses coast to coast, particularly in Houston where memories of Harvey are still fresh. A similar scenario recently played out in the Carolinas after Tropical Storm Florence hovered over the region for several days, dumping feet of rain. These types of extreme weather events are expected to increase in frequency and intensity. Climate change scenario analysis is an essential tool to determine current and future water risks. Is your business prepared?