Resources

Scenario analysis is primarily a tool to enhance strategic thinking on climate-related risk and opportunity.

Climate-related scenarios are plausible, challenging descriptions of how the future may unfold. These descriptions are based on coherent and internally consistent sets of assumptions about the drivers of future physical and transition risk and opportunity (and the relationships between them).

Undergoing a scenario analysis is to an organisation what a wind tunnel is to a plane: This is about exploring how it could behave under challenging but plausible conditions it may face and how the aircraft can be improved.

The purpose of scenario analysis under NZ CS 1 is to help entities to explore the climate-related risks and opportunities they may face and the resilience of their business model and strategy.

This exploratory analysis must include, at a minimum, a 1.5°C climate-related scenario, a 3°C or greater climate-related scenario, and a third climate-related scenario. These scenarios should integrate elements of physical and transition risk and opportunity.

Entities are required to undertake their own scenario analysis at entity level as part of NZ CS 1, not sector level scenario analysis. However, sector specific scenarios will facilitate this process and reduce the overall resource required to undertake the analysis and will allow entities to focus on its specific risks and opportunities, business model and strategy.

The TCFD has published comprehensive guidance on the use of scenario analysis in disclosing climate-related risks and opportunities. Further information is also available in the External Reporting Board’s Guidance for All Sectors.

Sectors can develop climate-related scenarios. To be plausible and decision-relevant for Climate Reporting Entities (CREs), sectoral scenario analysis benefits from participation of the entire sector. The expertise, experience, and perspectives of the sector, in combination with insights and perspectives from outside the sector, provide the key ingredients for relevant and compelling scenarios.

Primary users, including investors, have indicated a strong desire for comparability in disclosures, which is one of the main drivers for the introduction of Aotearoa New Zealand’s mandatory regime. The challenge for CREs is to bridge the divide between the scales of analysis available globally and nationally, and what is relevant to them as an individual entity. Sectoral scenarios offer the most practical and flexible means of doing so. Although not a mandatory approach, sectoral collaboration is likely to provide greater comparability and lead to higher quality scenarios, while imposing fewer resource demands on CREs.

Figure 1: The role of sectoral scenarios in creating a shared scenario architecture for the use of CREs in New Zealand

In Appendix 1 of the Guidance on Getting Started on Scenario Analysis at the Sector Level, the XRB has developed guidance on broadly aligned sets of scenarios, pathways and projections that can form a shared architecture for sectoral scenarios. These are loosely based on the structure of the NGFS climate scenarios. This approach to envisioning futures which are differentiated by the scale of physical and transition risk they embody is gaining traction globally. Adopting it as the structure for sectoral scenarios in New Zealand will help to align sectors with global financial climate-related risk analysis practices. These cones provide high-level assumptions and building blocks which are plausible and broadly coherent, and can be used to paint a picture of the world an entity might find itself in.