The Grantham Institute has released a report which aims to set out a framework for commercial financial institutions that wish to incorporate climate concerns in scenario analysis. It focusses on key concepts that firms need to understand and put together in order to create transition scenarios for their business strategy and risk management. Climate financial scenario analysis is challenging. The climate transition will create structural economic change that is not straightforward to model.
To help users understand the financial implications of climate change, scenarios should contain well-developed narratives. Transition scenarios are complex and require rich narratives to explain assumptions and provide the right information about economic agents’ behaviours. For risk management purposes, scenarios should help deepen understanding of climate related drivers of market, credit, operational and other risks. For strategic planning, firms need to identify the changes to their business models necessary to support the transition to a lower carbon economy.
The ultimate aim of climate financial scenarios has to be to enable assessment of risk and reward at the level of the economic agents that financial firms have exposure to.
Read the report (Imperial College London).