Gaia Vince neatly summarised what organisations must have as they integrate accounting for climate resilience into their businesses:
We need to look at the world afresh and develop new plans based on geology, geography and ecology — not politics. In other words, identify where freshwater resources are, where the safe temperatures are, where gets the most solar or wind energy, and then plan population, food and energy production around that.42
The use of scenario analysis to account for climate resilience takes time and experimentation to master. TCFD recommendations acknowledge this:
The use of scenarios in assessing climate-related issues and their potential financial implications are relatively recent and practices will evolve over time, but believes such analysis is important for improving the disclosure of decision-useful, climate-related financial information.43
However, emerging thinking now suggests that organisations should widen their scenario analysis because of the deep connections across the threefold crisis of climate, nature loss, and inequality.44 Creating scenario plans that integrate all three will move an organisation from being either net-zero or nature positive to becoming a net-positive entity.45 One effective way to view issues as part of a wider, dynamic whole is to employ a systems thinking approach. In terms of climate scenario analysis, this is the process of understanding how climate key drivers affect an organisation individually and how they combine as a whole to affect the entity. These must include understanding the impact of climate drivers increasing dramatic nature loss and inequality. It is important to see patterns of change and the feedback loops between these three factors. The IPCC’s 2022 report defines climate change, human society inequality, and ecosystem biodiversity as ‘coupled systems’.46 These represent grand challenges that require the engagement of a diverse range of organisations and stakeholders around the world.
Applying scenario analysis
The high-level steps in table 2, outlined by the TCFD, are designed to get you thinking about the relationships and activities an organisation will need to build and integrate into accounting for climate resilience adaptation plans. They provide a high-level summary. To understand the details of scenario analysis, consult the CGMA Tool Scenario planning: providing insight for impact or TCFD’s Task Force on Climate-related Financial Disclosures: Guidance on Scenario Analysis for Non-Financial Companies (October 2020).
Given the ‘coupled systems’ of climate, biodiversity, and social inequality, when developing climate impact scenarios, it makes sense to consider a scenario of dramatic nature loss as part of your process.
1 — Ensure governance is in place
It is important upfront that all buy into the sustainability direction of travel. An organisation’s compelling vision needs to engage internally with employees, but also externally with investors, customers and consumers, supply chain partners and local community stakeholder groups.
Governance and executive management will need to communicate a coherent case for accounting for climate resilience and adaptation planning. They must allow all stakeholders to suspend their judgements and become curious. This means upskilling employees and bringing in resources to address knowledge gaps and build a culture to support an organisation’s climate scenario analysis. Climate adaptation is a shared challenge that requires people at its core. It is worth seeking out internal influencers and examples of other organisations in your industry or supply chain that are already using climate scenario analysis on their adaptation journeys.
Governance boards are the persons or organisations given the responsibility for overseeing strategic direction, organisational accountability and stewardship. When it comes to climate-impact scenario analysis, governance boards or committees must engage in robust discussions and make more informed decisions for their organisations. The senior executives and board directors of an organisation are the individuals best enabled to reduce climate impact risks and encourage opportunities. However, to have an informed debate, they require relevant, insightful content and the ability to take a long horizonal view. This is where finance function and finance professionals have a key role in board quality by providing insightful assessments to inform climate impact decision-making.
Widening the organisational scope to include accounting for climate resilience and adaptation planning will promote systems thinking and meaningful feedback into governance, strategy and internal risk-management processes. It also breaks down barriers, allowing greater knowledge sharing and collaboration, leading to accounting for climate resilience innovation and ultimately long-term business resilience. More importantly, it makes an organisation consider its contribution to the planet’s future sustainability.
2 — Assess materiality of climate-related risks
In defining materiality, the Integrated Reporting <IR> framework says, ‘A matter is material if it could substantively affect the organization’s ability to create value in the short, medium or long term’48
This step focuses on documenting the ‘known unknowns’. Use ‘the four horsemen of the Anthropocene’ — fire, heat, drought and flood — to understand and agree upon the key vulnerabilities they each create. Then translate each of the key vulnerabilities into potential future physical risks or opportunities. Once there is common agreement, these need to be built into your organisation’s enterprise risk management (ERM) processes.
A typical ERM process (based upon a likelihood and impact approach) includes the following:
Risk or opportunity identification
Risk or opportunity assessment against its potential impact and likelihood
Planned response strategy to the risk or opportunity
Implementation of the mitigation strategy
Performance monitoring of the mitigation.
For more information on the case for risk assessment and the visualisation of risks using a heat map, download the AICPA & CIMA risk assessment tools Risk heat map, A leadership guide for the risk leader and Communicating risks using a heat map.49
The World Economic Forum’s (WEF) annual Global Risk reports describes changes occurring in the global risk landscape, from year to year, focused on the categories of economic, environmental, geopolitical, societal and technological. Within the 2023 Global Risk Report, the problems of interconnected risks are emphasised, stating that, ‘Concurrent shocks, deeply interconnected risks and eroding resilience are giving rise to the risk of polycrises — where disparate crises interact such that the overall impact far exceeds the sum of each part’50
The synthesis report of the IPCC sixth assessment report notes, ‘Actions that focus on sectors and risks in isolation and on short-term gains often lead to maladaptation over the long term, creating lock-ins of vulnerability, exposure and risks that are difficult to change’51
To help assess the associated complexities of potential ‘polycrises’ and maladaptation, KPMG has developed a proprietary methodology called Dynamic Risk Assessment (DRA).52 This methodology identifies, connects and visualizes an organisation’s risk network in the following four dimensions:
It is time to think in a more systemic way when undertaking organisational risk assessments.
3 — Identify and define range of scenarios
Here, organisations formulate the focal question for the range of scenarios and define the time horizons. These scenarios should represent a range of possible global temperature changes affected by GHG emissions. They could include a business-as-usual scenario, a 2°C increase scenario where GHG emissions are reduced, and a 3.2 to 4.5°C increase scenario based on GHG emissions remaining the same.53 TCFD guidance suggests using three or four diverse scenarios.
Any scenario must consider where an organisation’s critical business units are geographically located. A potential global average temperature will have very different impacts depending on global location. Erica Thompson notes that the use of a global mean temperature compresses
… the experiences and tragedies of billions into a single net scalar variable. Any trade-off of these variables against ‘the costs of action’ represents trade-off of lives and livelihoods that are not randomly chosen but always disproportionately come from the poorest and most vulnerable communities.54
Defining time horizons needs to balance being too short and too long. Traditionally, an organisation’s strategic planning horizons are likely to be too short term to help in the testing of resilience. Whereas a horizon that is too long may overwhelm any analysis in multiple uncertainties.
To start your organisation’s journey, it is worth reviewing existing publicly available scenarios, such as those published by the IPCC. Remember that publicly available scenarios will not have the granularity to provide insights for assessing organisation level risks. The IPCC uses Representative Concentration Pathways (RCPs) and Shared Socioeconomic Pathways (SSPs), defined as follows:
Scenarios include emissions and concentrations of the full suite of greenhouse gases (GHGs), aerosols, chemically active gases and land use/land cover.’55
SSPs ‘examine how global society, demographics and economics might change over the next century’56
Also, check out emerging local regulations and standards for any stipulated scenario range requirements.
Finally, if an organisation is investing time in climate-impact scenario analysis, the inclusion of a nature-impact scenario into biodiversity loss makes sense here.
Unilever, the consumer goods company, started their climate scenario analysis journey in 2017 with two scenarios: a 2°C increase and 4°C increase in global temperatures by 2100, with a business stress test focused on temperature trajectories in 2023.57 In 2021, Unilever added a 1.5°C scenario to consider the scientific assumptions contained in the IPCC’s AR6 report.58
Once an organisation has agreed upon the range of scenarios, they will help in the stress-testing of the climate risks and opportunities and can identify trade-offs on how uncertainties might turn into potential future risks.
4 — Evaluate business impacts
Having identified risks, this step focuses on the uncertainties of climate impact. It is about identifying and understanding the possible underlying driving forces and providing context to an organisation in which it operates. Together, the driving forces paint a picture that answers the question, ‘What would be the potential implications for our strategy if the future described in a scenario came to pass’?59
When developing organisational GHG transition plans, a useful tool is the construction of an impact pathway (e.g., inputs, activities, outputs, outcomes and impacts). This describes ‘how, as a result of a specific business activity, a particular impact driver results in changes in natural capital and how these changes in natural capital affect different stakeholders’.60
In evaluating effects of potential climate changes, using the impact pathway tool in reverse can help to reveal key organisational sensitivities. The tool focuses our attention on how the impacts of physical climate challenge the abilities of an organisation to deliver business outcomes, output and activities.
The physical climate impacts could include the ‘four horsemen of the Anthropocene’:
How does a potentially higher frequency of fire events, like wildfires, challenge an organisation’s ability to carry out business activities and deliver outputs?
How does a potential increase in heat events, like heat waves, challenge an organisation’s ability to carry out business activities and deliver outputs?
How does a potential increase in frequency and severity of drought events challenge an organisation’s ability to carry out business activities and deliver outputs?
How does a potential increase in frequency of flood events, either due to rainfall surges or sea-level rise, challenge an organisation’s ability to carry out business activities and deliver outputs?
A deeper dive into the impacts physical climate could have on key internal business variables could include:
Access to capital
Customer satisfaction and loyalty
Talent attraction and retention
Time to market.61
Other environment driving forces to consider include:
After the physical climate impact drivers have been mapped against an organisation’s ability to operate, it is worth understanding the implications on the ecosystem the business entity sits within. Many models can help here. The TCFD profiles the STEEP method (social, technology, economic, environment and political) to identifying driving force trends, patterns and uncertainties linked to climate change. Other methods your organisation may be more familiar with include PESTEL (political, economic, sociological, technological, legal and environmental) and SWOT (strengths, weaknesses, opportunities and threats). For more information on strategic planning tools, read the section within the CGMA report ‘Essential tools for management accountants’.63
Having assessed the direct physical climate impacts on an organisation, it is worth considering how ‘the four horsemen of the Anthropocene’ could affect social, technology, economic and political drivers. Once you develop a picture for each, implications must be referred back to an organisation’s reversed impact pathway of business outcomes, business outputs, business activities and inputs to business.
One of the biggest climate impacts in the social sphere is likely to be on global migration patterns. In her book How Civil Wars Start: And How to Stop Them, Barbara F. Walter, Professor of International Relations at the University of California, highlights the potential numbers:
The world is entering an unprecedented period of human migration, in large part due to climate change. As sea levels rise, droughts increase, and weather patterns change, more and more people will be forced to relocate to more hospitable terrain. By 2050, the World Bank predicts, over 140 million ‘climate migrants’ will likely flee Southeast Asia, Sub-Saharan Africa and Latin America.65
‘Climate migrants’ entering a country on a large scale can often be a flashpoint for conflict and violence as they compete with local populations for already scarce resources. Climate migration patterns could have huge implications for an organisation’s business model stability.
Other social driving forces to consider include the following:
Health and education trends
Civil stability and tensions66
It is scary on an individual level to consider that increasing temperatures may disrupt smartphone usage. In New Dark Age, James Brindle notes, ‘ “iPhone needs to cool down before you use it” pleads the error message on Apple’s latest phone when the ambient temperature rises above forty-five degrees Celsius’.67
Not only will there be increased costs of keeping technology cool, but higher temperatures are also likely to disrupt Wi-Fi reliability. Brindle points out:
In the electromagnetic spectrum, the strength and efficacy of wireless transmission will be reduced as temperature rise … Wi-Fi, in short, will get worse, not better. In one scenario, the shifting ground may even reduce the reliability of reference data for telecommunication and satellite transmission calculations.68
What are seen today as basic technological needs for many organisations could be affected by climate, challenging their ability to deliver current business models in the future.
Other driving forces to consider in technology that may be affected include:
basic research trends,
emerging technologies, and
Physical climate impacts have the potential to amplify geopolitical tensions, leading to economic instability and crises. Such disruptions can affect supply chains, increase the scarcity of materials, and lead to inflationary pressures. Barbara F. Walter writes:
A 2016 study published in the Proceedings of the National Academy of Sciences found that armed conflicts were more likely in ethnically fractionalized countries after climate-related disasters. Between 1980 and 2010, conflict in almost a quarter of these countries coincided with climatic calamities that acted as threat multipliers. If a country was already at risk of civil war, natural disasters tended to make things worse. In a world where drought, wildfires, hurricanes and heat waves will be more frequent and more intense — driving greater migration — the downgraded will have even more reasons to rise up.70
It is worth understanding an organisation’s infrastructure locations and supply chains against one of the annual global democracy indexes. Where operations are located within countries shifting, in either direction — between flawed democracies and hybrid regimes — there is a link between climate impact and increased economic fragility, making business more difficult.71
Other economic driving forces to consider include the following:
Regional/ national variations
Financial capital trends
We have already detailed the rise in mandatory regulation and future standards focused on climate-related disclosures. It is important, however, to also understand any external, current, and future reporting requirements and how these affect ways of doing business. External or political driving forces in understanding these requirements may include the following:
Once a range of climate scenarios has been debated and agreed upon, the scenarios must then inform an organisation’s strategic direction and future adaptation planning.
5 — Identify potential responses
Here, organisations must think about how to reallocate resources, reorientate production, and reimagine their business models. The outcome is building future organisational strategic resilience and must lead to the creation of an organisation’s adaptation plan. Potential responses need to be geographically specific to an organisation’s infrastructure.
In How to Avoid a Climate Disaster, Bill Gates suggests a three-stage approach to climate change:
Stage 1: Reducing the risks posed by climate change through steps like climate-proofing buildings and other infrastructure.
Stage 2: Developing early warning systems and being prepared to be able to respond to future emergencies.
Stage 3: Have plans for a recovery period after a disaster (including insurance for rebuilding and plans for displacement).74
6 — Document and disclose
It is important to build a narrative for each of the organisation’s climate impact scenarios and to document the narrative in an adaptation plan. Adaptation plans articulate the new capabilities that will be developed to build organisational climate resilience and antifragile business models. Findings and outcomes of the progress must also be socialised with risk and audit committees and embedded in future strategies. To foster engagement with longer-term climate impact, identify champions and build associated key performance indicators (KPI) linked to adaptation across an organisation.
Two examples of publicly available adaptation plans from 2021 include Network Rail, UK’s public sector body responsible for Britain’s railway infrastructure, and the European Investment Bank (EIB), owned by the EU member states.75
Disclosures on climate-scenario analysis tend to be presented as part of an annual reports. For details on what should be disclosed, refer to the organisation’s local standards and regulations. A high-level summary of mandatory climate-related disclosure trends can be found in the section titled, ‘What is accounting for climate resilience?’
The reality of accounting for climate resilience is that, although organisations end up with adaptation plans based on several scenarios, it must become a continuous evolutionary process. Advice from the TCFD acknowledges, ‘Scenarios also have a shelf life, so a process to periodically refresh and update them is needed’.76