Chapter 9: Climate and Nature Risk Assessment

Learning Objectives
After reviewing this chapter, you should be able to:
 Differentiate between climate risk measurement and assessment, and how these
processes are crucial to effective climate risk management.
 Know the major international and regional protocols for climate risk and their
requirements or recommendations across industry.
 Discuss the IFRS S1 and S2 standards and their context in the wider ecosystem of
reporting frameworks. Compare the differences between the TCFD and ISSB standards.
 Know the different types of data sets and tools available for climate risk assessment.
 Understand ISSB and TCFD recommendations for scenario analysis.
 Demonstrate the ability to walk your organization through a physical and transition
climate risk assessment.
 Identify similarities, differences, and interdependencies among climate and nature
risks.
 Know the key components and steps of the TNFD and LEAP framework.
 Understand the impacts and opportunities nature risk presents for companies and
financing.
 Outline the challenges in financing biodiversity and ecosystem projects.
 Understand the drivers of water risk.
 Demonstrate ability to carry out a water risk assessment for an organization.
 Apply current practices and lessons from case studies to climate and nature risk
assessments.
This chapter delves into the application of tools and methodologies to assess climate risk,
emphasizing practical case studies. Additionally, we explore emergent areas in nature and natural
capital risk assessment, focusing on critical aspects such as biodiversity and water risk. This builds
on the foundational concepts introduced in Chapter 3, which discussed the financial risks
associated with climate change. It also extends the discussions from Chapters 6 and 7 on
measuring, managing, and modeling climate risks through scenario analysis.

In Chapter 6, we discussed climate risk measurement and management. Climate risk measurement
and assessment are two interconnected processes that help organizations understand and manage
the potential impacts of climate change . Climate risk measurement is about quantifying these
impacts, while climate risk assessment is about understanding the nature of these impacts and
how they might affect different sectors and systems. Both processes are crucial for effective
climate risk management.

As Chapter 6 illustrated, climate risk measurement involves quantifying climate-related risks. It

uses various methodologies to identify material climate risk drivers and their transmission
channels, map and measure climate-related exposures, and translate climate-related risks into
quantifiable financial risk metrics.
Climate risk assessment is a systematic process to identify potential hazards from climate-related
events, trends, forecasts, and projections. It involves understanding the likelihood of the impact,
and the resulting consequences. The assessment of climate risks is best undertaken across
populations, sectors, and systems because direct impacts can have cascading effects. Whereas
climate change directly determines hazards, vulnerability and exposure depend on socioeconomic
factors. Planning adaptation regionally and locally requires an understanding of these three factors
to produce a climate risk assessment (Bank for International Settlements, 2021).
Corporate entities are increasingly recognizing the importance of assessing and managing climate
risk due to its potential impact on their operations, financial performance, and strategic planning.
The assessment of climate risk involves understanding both physical risks and transition risk.
Case Study: Climate Risk Assessment in the Insurance Industry
Regulatory strategies for assessing climate risk in the insurance industry are changing significantly.
Authorities are increasingly requiring insurers to integrate climate risks into their enterprise risk
management (ERM) systems (Bank for International Settlements, 2021). There's a growing
movement in which insurance regulators factor climate-related risks into their supervisory and
regulatory practices, enhancing regulatory instruments to account for these risks more effectively.
The Federal Insurance Office (FIO) recommends that state insurance regulators across the board
establish and implement guidelines for monitoring climate-related risks, and promote the inclusion
of these risks in insurers' risk-management practices (Federal Insurance Office, U.S. Department of
the Treasury, 2023).
Insurers are urged to include climate risks in their own risk and solvency evaluations (ORSAs), even
without direct regulatory mandates. Methods like stress testing and scenario analysis are
employed to enhance the comprehension of climate risk exposures, and to offer indicative loss
projections. These models generally convert potential future climate scenarios into stress factors,
which are then applied to financial statements or risk variables.
9.1.1 Fundamental Principles of Climate Risk Assessment

Climate risk assessment is a process that helps businesses identify, analyze, and manage the
potential impacts of climate change on their operations. It involves understanding both the
physical risks, such as extreme weather events and long-term shifts in climate patterns, and
transition risks, which are associated with the societal and economic shift to a low-carbon economy
(The Network for Greening the Financial System (NGFS), 2022).

9.1.2 Regulation and Climate Risk Management

There is a growing recognition of the need to manage climate-related financial risks within the
financial sector and beyond. In the financial sector, the landscape of climate risk regulation is
characterized by a combination of national and international efforts to develop principles and tools
for managing climate-related financial risks.
The regulatory landscape is also shaped by the work of international organizations such as UNEP
FI which has developed a comprehensive overview of more than 40 climate risk assessment
methodologies. This includes tools that cover both physical and transition risks, focusing on
enhancing the readability and usability of climate risk tools for financial institutions. The UNEP FI's
Climate Risk Landscape report provides insights into the changing regulatory landscape and
potential developments, as well as key guidelines and methodological tools.

Before diving into the details, here are some common opportunities of climate risk assessment
(see Table 9.1).
Table 9.1 Opportunities of Climate Risk Assessment

Category Description

Innovation and new In the finance sector, development of new financial products like green bonds and
markets loans, opening up new markets

Enhancing risk management strategies by incorporating climate risks, potentially

Risk management
reducing losses from climate-related events

Reputation and Addressing climate risks proactively to enhance brand reputation and gain a
competitive advantage competitive edge

Better access to capital for institutions committed to sustainability and climate risk
Access to capital
management

Subsidies and incentives for investing in green finance, technologies, and efficiency
Regulatory incentives
improvements

Box 9.1 Nature Risk in Climate Risk

In the traditional discussion, nature risk is not well included in either physical or transition risk. A
well-defined taxonomy of climate risks, including physical, transition, and natural capital risks, is
essential for meaningful reporting and communication across stakeholders (Buhr, 2022).
Source: Buhr, B. ESG for Credit Investors: Operational, Climate and Natural Capital Risks, Societe Generale 2014; Buhr, B.
Assessing the Sources of Stranded Asset Risk: A Proposed Framework, Journal of Sustainable Finance & Investment

9.1.4 Global and Regional Protocols and Frameworks for Climate

Risk Assessment

Global
The Network for Greening the Financial System (NGFS). In terms of climate risk assessment, the
NGFS's work is crucial. As discussed in chapter 7, one key methodology the NGFS uses is scenario
analysis, a flexible 'what-if' framework that explores the risks that could materialize under different
possible future conditions. The NGFS has developed a common set of scenarios to provide a
foundation for analysis across many institutions, creating consistency and comparability of results
(Network for Greening the Financial System, 2021). These scenarios consider various factors such
as the relevance to the local context, the severity of the scenario, the time horizon of the scenario,
and assumptions on socioeconomic context and climate.
Besides FIs, the NGFS also encourages central banks and supervisors to integrate climate factors
into financial stability monitoring and supervision. This includes closing climate-related data gaps,
strengthening climate-related financial disclosures, incorporating the reporting of climate risks into
supervisory processes, and enhancing capacity to conduct climate risk analyses (Network for
Greening the Financial System, 2020).
The International Sustainability Standards Board (ISSB), IFRS S1, and IFRS S2 . The ISSB is an
independent, private-sector body that develops and approves IFRS Sustainability Disclosure
Standards (IFRS SDS). Established in 2021, the ISSB operates under the oversight of the IFRS
Foundation and aims to create a global baseline of sustainability disclosures to further inform
economic and investment decisions (The International Financial Reporting Standards Foundation,
n.d.).
The ISSB's standards are particularly relevant for companies undertaking climate risk assessment.
The ISSB has acknowledged that climate-related scenario analysis encompasses a range of
practices, and has decided to require entities to assess their climate resilience using climate-
related scenario analysis. This analysis should be commensurate with the entity's circumstances
and inform the identification of climate-related risks and opportunities (IFRS, 2022). The ISSB
standards are designed to be applied globally and are built on the concepts that underpin the IFRS
Accounting Standards. They aim to improve trust and confidence in company disclosures about
sustainability and create a common language for disclosing the effects of climate-related risks.
IFRS S1, or the General Requirements for Disclosure of Sustainability-related Financial Information,
prescribes how an entity prepares and reports its sustainability-related financial disclosures. It sets
out general requirements for the content and presentation of those disclosures. The objective of
IFRS S1 is to require an entity to disclose information about its sustainability-related risks and
opportunities that could affect its access to finance or cost of capital over the short, medium, or
long term (IFRS, 2023).
IFRS S2, or Climate-related Disclosures, sets out the requirements for disclosing information about
an entity’s climate-related risks and opportunities. The objective of IFRS S2 is to require an entity
to disclose information about its climate-related risks and opportunities that could affect its access
to finance or cost of capital over the short, medium, or long term. This standard integrates and
builds on the recommendations of the Task Force on Climate-related Financial Disclosures (IFRS,
2023).
9.1.4 Global and Regional Protocols and Frameworks for Climate
Risk Assessment (Continued)

Comparison: TCFD and NGFS

The TCFD and the NGFS are unique and complementary initiatives aimed at addressing climate-
related risks in the financial sector. The TCFD develops voluntary guidelines for climate-related
financial disclosures, enabling companies to inform stakeholders about their climate risk exposure
and management strategies. Conversely, the NGFS, which consists of a network of central banks
and financial supervisors, concentrates on integrating climate and environmental risk management
into the financial sector, including the development of a scenario analysis framework to evaluate
these risks. Together, both entities strive to enhance understanding, management, and mitigation
of climate-related financial risks, advocating for increased transparency and the disclosure of
climate-related risks and opportunities (Deloitte, n.d.).

Comparison: ISSB and TCFD

The ISSB standards were developed to provide a global baseline for sustainability reporting. The
goal is to improve the consistency, comparability, and reliability of sustainability information
disclosure. Although both TCFD and ISSB focus on climate-related risk assessment and scenario
analysis, the ISSB provides more-specific standards for disclosure (IFRS S2) and requires entities to
use scenario analysis to align with a company’s specific circumstances. The TCFD offers a broader
set of recommendations that can be applied across different sectors and jurisdictions, emphasizing
integrating climate-related risks into overall risk management. Both aim to provide decision-useful
information to stakeholders and support organizations in managing climate-related risks and
opportunities (IFRS, 2023).
The ISSB has built upon and consolidated the TCFD recommendations into its standards.
Companies that apply the ISSB standards will meet the TCFD recommendations and do not need to
apply both. However, the ISSB standards go beyond the TCFD recommendations in some areas
(see Table 9.2). For example, IFRS S1 captures sustainability-related issues beyond climate, and
IFRS S2 requires Scope 3 emissions reporting (SASB, 2023).
The Financial Stability Board has announced the completion of the TCFD's work and requested the
IFRS Foundation to take over the monitoring of companies' progress toward climate-related
disclosures, a responsibility previously held by the TCFD (SASB, 2023). This means that starting in
2024, as the ISSB Standards start being applied around the world, the IFRS Foundation will take
over the TCFD’s monitoring responsibilities (see Figure 9.1 and Table 9.3).
According to TCFD, “Concurrent with the release of its 2023 status report on October 12, 2023, the
TCFD has fulfilled its remit and disbanded. The FSB has asked the IFRS Foundation to take over the
monitoring of the progress of companies’ climate-related disclosures.” (source: https://fsb-
tcfd.org/ )
Figure 9.1 Architecture of the TNFD Recommendations and Alignment with ISSB and TCFD
Source: TNFD, 2023

Table 9.2 TCFD and ISSB Recommendations

Aspect TCFD Recommendations ISSB Recommendations

Concentrates on climate-related financial Focuses on sustainability-related financial

disclosures across four thematic areas: information, including climate-related
Scope
governance, strategy, risk management, and disclosures (IFRS S1 and IFRS S2).
metrics and targets Emphasizes the disclosure of GHG emissions

IFRS S1 (General Requirements for Disclosure

Four thematic areas: governance, strategy, risk of Sustainability-related Financial
Structure
management, metrics and targets Information) and IFRS S2 (Climate-related
Disclosures)

Scenario Emphasizes scenario analysis, including a 2°C or Requires entities to use scenario analysis
analysis lower scenario proportionate to their circumstances

Risk Categorizes into transition risks and physical Addresses climate-related risks and
categories risks opportunities

Requires disclosure of absolute gross

Recommends disclosures on GHG emissions and emphasizes Scope 3
Requirements governance, strategy, risk management, and emissions. Builds on and
metrics and targets related to climate-related
risks and opportunities
incorporates TCFD
recommendations
 Aspect TCFD Recommendations ISSB Recommendations

Years of The TCFD recommendations were established in

The ISSB standards (IFRS S1 and IFRS S2)
implementatio 2017, with the TCFD disbanded in 2023 after
were released in 2023
n fulfilling its remit

Table 9.3 International Standards

Source: David Carlin, UNEP-FI, 2024
9.1.4 Global and Regional Protocols and Frameworks for Climate
Risk Assessment (Continued)

International Standards ISO 14091 & ISO/TS 14092

Both standards developed by the International Organization for Standardization (ISO) provide
guidance on climate risk assessment and adaptation planning.
 ISO 14091:2021 provides guidelines for assessing the risks related to the potential
impacts of climate change. It outlines how to understand vulnerability and develop and
implement a sound risk-assessment process.
 ISO/TS 14092:2020 specifies requirements and guidance on adaptation planning for
local governments and communities. It supports these entities in adapting to climate
change based on vulnerability, impacts, and risk assessments. The document assists in
setting priorities and developing and updating an adaptation plan in collaboration with
relevant interested parties.

Climate Risk Integration Framework by Business for Social

Responsibility (BSR)
BSR guides companies through identifying, assessing, and prioritizing climate risks, and integrating
that process into existing risk-management systems. The framework builds on existing research,
the TCFD, and insights from interviews with corporate sustainability professionals. The framework
is designed to be adaptable to different sectors. (BSR, 2023)
Box 9.2 Key Steps of the BSR Framework
 Identify climate risks. The framework guides companies in conducting a climate risk
assessment, which includes defining assessment parameters and identifying potential
climate risks.
 Integrate climate risks into ERM. It provides a standardized approach for integrating
climate risks into ERM systems, which supports the business case for a climate-
integrated ERM system.
 Prioritize risks. Companies are guided on how to prioritize climate risks among other
company risks using qualitative and quantitative risk assessment criteria.
 Governance. The framework includes a section on governance to assess and
strengthen a company's governance of climate-related issues.

Source:(BSR, 2023)
The United Nations Office for Disaster Risk Reduction (UNDRR)
UNDRR has established a comprehensive risk assessment and planning framework in the context
of climate change. This framework acknowledges the complexity of climate change risks and can
be contextualized to national and local needs (UNDRR, 2022).

The United Nations Environment Programme Finance Initiative (UNEP

FI)
UNEP FI has developed a climate risk tool dashboard, which provides a comprehensive overview of
metrics, methodology, assumptions, and common use cases for climate risk assessment (unepfi,
2021).

The International Civil Aviation Organization (ICAO)

ICAO provides guidance on climate risk assessment and adaptation planning for the aviation
sector. This guidance is intended for use by airports, aircraft operators, and air navigation service
providers across the global aviation network, as well as by states at the national and international
levels (ICAO, 2021).

S&P Global Physical Risk

S&P Global's Physical Climate Risk solution is built on the latest-generation climate models,
geospatial data, ownership mapping, and vulnerability pathways, offering actionable financial
impact analysis and a clearer view of exposure to climate risks. The solution identifies physical
risks from climate change, which can be acute or chronic.

9.1.4 Global and Regional Protocols and Frameworks for Climate

Risk Assessment (Continued)

Regional
The U.S. Environmental Protection Agency (EPA)
EPA provides guidance on reporting climate risks and opportunities in North America. This guidance
aligns with TCFD and includes resources to help organizations conduct, assess, and reduce their
greenhouse gas emissions (EPA, n.d.).

The European Environment Agency (EEA)

In the European Union, EEA provides resources for climate risk assessments, including the
International Standard ISO 14091 and ISO 14092, which set the standards for various methods and
outputs of risk assessments at regional and local levels (The European Climate Adaptation Platform
Climate-ADAPT, n.d.).

Table 9.4 Global and Regional Protocols and Frameworks

Country Latest
Exchange or
or Type Description Update
Institution
Region Date

The UK's Third Climate Change Risk Assessment (CCRA3),

published on January 17, 2022, is conducted every five
UK years under the Climate Change Act of 2008 and is based
Department on the Independent Assessment of UK Climate Risk, which
for is the statutory advice provided by the Climate Change 17 Jan
UK Report
Environment, Committee (CCC) (Department for Environment, Food & 2022
Food & Rural Rural Affairs, UK, 2022). The CCRA3 considers 61 UK-wide
Affairs climate risks and opportunities across multiple sectors of
the economy and prioritizes eight risk areas for action in
the next two years.

LSEG has created a practical guide to help companies

integrate climate-related risks and opportunities into their
operational decision-making and reporting processes
(London stock exchange, 2022). This guide is intended to
support best practices and educate companies on
London Stock effectively integrating and communicating climate-related
Guidanc information. It recommends a three-stage process (LSEG, 14 Jan
UK Exchange
e 2021): 2021
Group (LSEG)
 Disclosure diagnosis and context
 Integration of climate-related risks and
opportunities
 Disclosure of climate-related practices and
data

Under President Biden's administration, the US has taken

a proactive stance on climate change through several
executive orders (EOs): EO 13990, "Protecting Public
Executiv Health and the Environment and Restoring Science to 20 May
USA White House
e Order Tackle the Climate Crisis;" EO 14008, "Tackling the 2021
Climate Crisis at Home and Abroad;" and EO 14030,
“Executive Order on Climate-Related Financial
Risk” (Garcia, 2023).

Reporting Corporate Climate Risks and Opportunities by

U.S.
EPA: Through climate risk and opportunity reporting,
Environmental Guidanc 13 Nov
USA organizations can report to the public how they are
Protection e 2023
identifying, assessing, and managing climate-related risks
Agency (EPA)
(physical and transition) and opportunities (EPA, 2024).

Corporates subject to carbon cap and trade programs and

The New York renewable fuel standards use markets to meet obligations
Stock Guidanc and manage their risk most cost-effectively. Market 28 May
USA
Exchange e participants can deliver carbon allowances, carbon 2021
(NYSE) offsets, and renewable energy certificates to a range of
registries in Europe and North America (NYSE, n.d.).

Hong Hong Kong Guidanc An issuer should specify its criteria for identifying 25 Mar
Kong Exchanges and e “significant” climate-related issues that affect its business 2022
Clearing activities. In doing so, it may cross-reference information
Limited (HKEX) disclosed in its ESG report.
Issuers should implement action steps to lay the
groundwork for effective climate-related disclosures,
including integrating climate change into key governance
processes and enhancing board-level oversight through
audit and risk committees; looking specifically at the
 Country Latest
Exchange or
or Type Description Update
Institution
Region Date

financial impacts of climate risk and how it relates to

revenues, expenditures, assets, liabilities, and financial
capital; and adapting
existing enterprise-level and other risk-management
processes to take account of climate risk (HKEX, n.d.).

The EU has initiated the European Climate Risk

Assessment (EUCRA) to comprehensively assess current
European
and future climate change impacts and risks related to 07 Mar
EU Environment Policy
the environment, economy, and wider society in 2023
Agency (EEA)
Europe (The European Climate Adaptation Platform
Climate-ADAPT, n.d.).

This sustainability reporting standard covers disclosure

requirements regarding climate-related hazards that can
European Regulati lead to physical climate risks for the undertaking, and its 22 Dec
EU
Commission on adaptation solutions to reduce these risks. It also covers 2023
transition risks arising from the needed adaptation to
climate-related hazards (EUR-Lex, 2023).

9.1.5 Data Sets and Tools for Climate Risk Assessment (Financial
Institutions)

Climate risk assessment in the financial sector involves using various tools and datasets to understand and manage the potential financial
risks associated with climate change.
Several tools and methodologies have been developed to help financial institutions assess these risks. For instance, the United Nations
Environment Programme Finance Initiative (UNEP FI) has developed resources to inform financial institutions on the structure, coverage,
and methodologies of commonly used tools (unepfi, 2022). S&P Global Market Intelligence has developed an approach called Climate
Credit Analytics, in collaboration with Oliver Wyman, which captures the effect of both physical and transition risk on corporates (S&P
Global , 2023).
The methodologies, models, and data for analyzing these risks continue to evolve and mature. Therefore, financial institutions must stay
updated with the latest tools and datasets to assess and manage climate-related risks effectively.
Data on weather, climate, and environmental change, including natural disasters, are essential for climate risk assessments. These data
help us understand the vulnerability to and impacts of climate risks (see Table 9.5).
Table 9.5 Real-time Data and Historical Event Databases
9.1.6 Scenario Analysis

TCFD's recommendations on scenario analysis

Scenario analysis is a crucial aspect of TCFD reporting. Despite its complexity and demanding
analytical modeling, it is essential in integrating considerations of short-, medium-, and long-term
impacts of climate change into the current decision-making landscape (cdsb, 2021).
The TCFD advises organizations to assess the resilience of their strategies, considering various
climate scenarios, including a 2°C or lower scenario. These scenarios should encompass physical
risks and transition-risk shifting. Steps include:
 Integrating scenario analysis into strategic planning and/or ERM processes;
 Assessing materiality of climate-related risks;
 Identifying and defining the range of scenarios;
 Evaluating business impacts;
 Identifying potential responses.
To access the scenarios, refer to Chapter 7, which highlights publicly available climate-related
scenarios from reputable sources such as IEA and IPCC.
Box 9.3 Case Study: Scenario Analysis at S&P Global
This case study explores how S&P Global conducts scenario analysis and underscores its
importance in assessing climate risks.
S&P Global's scenario analysis is informed by leveraging the expertise of Sustainable1 ESG
Analysis to assess the impact of each risk and opportunity within the TCFD framework, thereby
assessing materiality. Despite many of the TCFD risks being assessed as not material or having a
low potential financial impact in the short-to-medium and long term, S&P Global's commitment to
transparency and risk management includes addressing all risks, even those with low potential
impact.
The company's risk management approach involves identifying and assessing climate-related risks
to disaster recovery from natural disasters and implementing governance frameworks and policies
to mitigate these risks. This includes the operational risk management function, which oversees
the management of material, non-financial risks from climate change related to enterprise risk,
technology risk, and operational resilience.

Source: S&P Global

ISSB's recommendations on scenario analysis
The ISSB, while building on the TCFD's groundwork, mandates the use of climate-related scenario
analysis for companies to report on climate resilience and identify climate-related risks and
opportunities.
When determining the inputs to its analysis, a company considers all “reasonable and supportable
information” available at the reporting time. Entities are also advised to contemplate incorporating
a scenario in alignment with the most recent international climate change agreement, such as the
Paris Agreement, as needed. Adherence to the Paris Agreement or a specific 1.5°C scenario is not
mandated, as these are not explicitly hardcoded into the requirements. Entities have flexibility in
their choice of scenarios (IFRS, 2022). The ISSB also acknowledges that "off-the-shelf scenarios"
can be used, such as those provided by IEA and IPCC.
It also emphasizes the iterative nature of using scenario analysis to inform climate resilience
assessments, indicating that it may take multiple planning cycles to achieve.

Differences between ISSB’s and TCFD’s Recommendations on Scenario

Analysis
Both emphasizes the importance of scenario analysis in assessing and disclosing climate-related
risks and opportunities. However, there are differences, particularly in how they are implemented
and the level of detail and specificity required in disclosures.
 Specificity and detail: ISSB includes more detailed information around where in the
company’s business model and value chain risks and opportunities are concentrated,
compared to the TCFD's recommendations. IFRS S2 also requires companies to
consider the applicability of industry-based disclosure topics and provides additional
specificity in certain areas that align with TCFD recommendations, but goes beyond
them in requiring disclosures not specified by the TCFD.
 Implementation and compliance: The ISSB standards (S1 and S2) are mandatory for
compliance and include specific, replicable, and detailed requirements, making them
more prescriptive than the TCFD's recommendations. The TCFD provides a framework
for scenario analysis, but the ISSB's standards require adherence to methodologies and
disclosures.
  Support and guidance: Both the TCFD and ISSB offer guidance and support materials
for conducting scenario analysis. However, the ISSB explicitly aims to provide practical
support to preparers, including making use of materials developed by the TCFD to
guide companies in scenario analysis.

Box 9.4 Case Study: How the ISSB's Practical Support for Scenario
Analysis Differs from the TCFD's Guidance
ISSB: A clear example can be seen in the ISSB's explicit requirement for companies to use scenario
analysis when describing their assessment of climate resilience. The ISSB differentiates between
scenario analysis (a “what-if” analysis) and resilience assessment (a “so-what” analysis), and
tailors the type of analysis to the company's specific circumstances, including its exposure to
climate-related risks and available resources (KPMG, 2022). TCFD: In contrast, the TCFD's guidance
is more general, providing a broad framework for companies to consider various scenarios and how
they might affect the organization. The TCFD encourages companies to start with any form of
scenario analysis and develop their approach over time, focusing on the integration of findings into
business strategy and decision making.

9.1.7 Scenario Analysis Case Studies

Climate stress testing and scenario analysis

The objective of climate scenario analysis and stress testing is to assess the impact of climate-
related risks on an organization's business under different future scenarios.
Stress tests are assessments led by regulators to evaluate how well financial institutions can cope
with financial and economic shocks that may arise from climate change. It helps institutions
evaluate their resilience in both short-term and long-term scenarios. Its crucial role in climate risk
assessment is to provide a structured approach to examine the potential impacts of climate-related
risks on an organization's operations and strategies. This, in turn, enhances resilience and the
ability to manage climate-related risks effectively.
Scenario analysis allows organizations to explore the potential range of climate change
implications. This broader perspective helps organizations identify the main climate-related risks to
which they are exposed, and to test the adaptability of business.
Both results enable organizations to identify the main climate-related risks to which they are
exposed, and test the resilience of their business models. The following case studies are examples
of stress testing from Hong Kong and the UK.
Box 9.5 Case Study: Hong Kong Monetary Authority's Climate Stress
Test Initiatives for 2023
The Hong Kong Monetary Authority (HKMA) prepared a prescriptive climate risk stress test (CRST)
for 2023 following a successful pilot exercise in 2021. The pilot exercise involved 20 central retail
banks and seven branches of international banking groups, accounting for 80% of the banking
sector’s total lending. The results of the pilot test indicated that under extreme scenarios, climate
risks could cause significant adverse impacts on the banking sector, but overall, the sector
remained resilient to climate-related risks. The CRST, which ran from June 2023 to June 2024, is
part of the regular supervisor-driven stress test exercise. It aims to obtain a more-comprehensive
assessment of authorized institutions’ (AIs) exposures to climate risks, and further strengthen their
management capabilities. More than 30 AIs have already confirmed their participation in the
exercise (HKMA, 2023).
Table 9.6 Exposures Directly Affected by Climate Risks
Source: (HKMA, 2023)
The 2023-2024 CRST exercise will feature several enhancements compared to the pilot exercise.
These include the introduction of a new five-year scenario, additional assessment requirements,
and more-detailed reporting standards (HKMA, 2023). The new five-year scenario is designed to
assess the potential impacts on participating AIs, and aligns with those typically adopted by AIs in
their internal stress tests. The detailed reporting standards have been developed for each scenario
and include an expanded set of metrics with sufficient granularity in terms of risk factors, business
sectors, and geographic locations to support supervisory analysis and comparison of results across
AIs.
Despite these advancements, the HKMA acknowledges the challenges of conducting a robust
climate-focused scenario analysis, including insufficient data, difficulty modeling, and measuring
the risks. Therefore, the HKMA will be pragmatic in reviewing AIs’ implementation, along with the
proportionate approach suggested (HKMA, 2021).
Box 9.6 Case Study: Bank of England Climate Stress Tests for the UK
Banking System
In 2021, the Bank of England conducted its first exploratory scenario exercise on climate risk, the
Climate Biennial Exploratory Scenario (CBES). This exercise assessed the financial risks from the
physical effects of climate change and the transition to a net-zero economy (Bank of England ,
2022).
The CBES required participants to make granular assessments of their largest counterparties,
particularly emphasizing banks’ and insurers’ ability to evaluate the net-zero transition. The CBES
explored three different climate-policy scenarios, each spanning 30 years, to generate a range of
possible future outcomes for global temperatures and the economy. The exercise was not used to
set capital requirements, but to enhance the Bank's understanding of the financial stability
implications of climate change (Bank of England , 2021).
The results of the CBES revealed several insights for the appropriate design and execution of
climate stress tests. For example, the exercise drove improvements in firms' risk management and
understanding of how the CBES incorporated some key differences in design relative to climate
stress tests run elsewhere (see Figure 9.2; Bank of England, 2022).
Figure 9.2 CBES Results
Source: Bank of England
Box 9.7 Case Study: Climate Stress Testing, AXA, 2022 (AXA, 2022)
AXA conducts climate stress tests through a comprehensive and multifaceted approach. The
process involves the following key steps:
Scenario development: AXA develops climate scenarios that cover a range of potential future
climate conditions. These scenarios are informed by scientific research and consider both physical
and transition risks associated with climate change. The scenarios include different pathways such
as Early Action, Late Action, and No Additional Action, reflecting varying degrees of global efforts to
mitigate climate change.
Risk identification: The company identifies climate-related risks that could affect its insurance and
investment portfolios. This includes assessing the physical risks from natural catastrophes (e.g.,
acute impacts from changes in the frequency and severity of hurricanes, floods and chronic
impacts e.g. sea-level rise) and transition risks related to the shift toward a low-carbon economy.
Modeling and analysis: AXA XL, the property & casualty and specialty risk division of AXA, uses
catastrophe modeling and in-house scientific expertise to assess the impact of climate scenarios on
its portfolios. This involves analyzing changes in hazard, exposure, and vulnerability over time. The
company also works closely with external academic partners to further understanding of climate
risks and integrate this into its models.
Stress testing: The stress tests involve applying the developed climate scenarios to AXA's
portfolios to evaluate the potential financial impacts. This includes assessing the resilience of the
company's business models to physical and transition risks under different climate pathways. The
stress tests cover both invested assets and insurance liabilities.
Quantification of risk: Through the stress-testing process, AXA quantifies the financial risks
associated with climate change. This includes estimating potential losses from natural catastrophes
and evaluating the impact of transition risks on investment portfolios.
Incorporating uncertainty: AXA acknowledges the inherent uncertainty in climate risk
assessments and stress tests. The company focuses on illustrating and communicating the
uncertainty, limitations, and challenges associated with these approaches to ensure that business
decision making properly incorporates the quantification of risk.
Action and adaptation: Based on the outcomes of the stress tests, AXA identifies necessary
actions to manage and mitigate identified risks. This may include adapting underwriting, pricing,
and reserving strategies; and fostering prevention initiatives. The company also considers
management actions such as realistic repricing to absorb potential financial impacts.
Reporting and disclosure: AXA discloses the results of its climate stress tests and its approach to
managing climate-related risks in its annual Climate and Biodiversity Reports. This transparency
helps stakeholders understand the company's resilience to climate change and its efforts to
contribute to the transition to a low-carbon economy.
Source: AXA

Table 9.7 Scenario Analysis and Climate Risk Assessment Tools

Tool Name Type Description

The World Bank also offers Climate and Disaster Risk Screening Tools
Climate and Disaster
Free for a detailed evaluation of current and future climate and disaster
Risk Screening Tools
risks.

Analyzes alignment of portfolios with decarbonization pathways,

PACTA by 2 Degrees
Free tracking capital expenditures over a five-year horizon. Developed
Investing
with PRI.

Utilizes financial network algorithms to estimate climate-adjusted

Climafin Free financial metrics for portfolios under various climate scenarios.
Customizable analyses available for a fee.

Cambridge Projects sectoral prices, emissions, and energy usage under different
Free
Econometrics climate scenarios. Customizable analyses available for a fee.

Transition Pathways Assesses issuers' management quality, carbon performance, and

Free
Initiative transition readiness. Developed with PRI and FTSE Russell.

CARIMA by University Develops "carbon betas" to measure price volatility under various
Free
of Augsburg scenarios.

Assesses financial risk to infrastructure under climate scenarios.

ClimateWise Free
Produced by the University of Cambridge.

The GESI – CDP The GESI – CDP Scenario Analysis Toolkit is another resource that
Commercia
Scenario Analysis supports companies in determining the financial impacts of climate-
l
Toolkit related risks.

The ECLR Climate Risk Tool analyses the vulnerability of

The ECLR Climate Commercia organizations' physical sites to climate change and models both
Risk Tool l classical climate risks, such as floods and heatwaves, and less-
common risks.

Commercia Estimates asset valuation variation under climate scenarios.

Climate Risk Toolkit
l Developed by Vivid Economics. Some data public.

Carbon Impact Commercia Assesses firm-level transition readiness, strategic orientation, and
Analytics l emissions. Developed by Carbone4. Public and for-fee options.

Carbon Delta— Commercia Estimates climate-stressed valuations of securities. Developed by

Climate VAR l MSCI and the Potsdam Institute.

Commercia Assesses issuer-level financial metrics changes under potential

Climate Excellence
l climate scenarios. Developed by PwC. Some information public.

Commercia
ERM Screens portfolio for financial impact of risk under scenarios.
l

MATLAB Climate Commercia Uses models to assess transition risks under different policy
Scenario Explorer l scenarios.

Moody’s ESG Commercia Assesses issuer-level physical and transition risk exposure, and
Tool Name Type Description

l climate governance.

Ortec Finance Commercia Estimates macroeconomic variables and asset class returns under
Climate Maps l climate scenarios. Developed with Cambridge Econometrics.

Assesses bond and equity portfolios' issuer alignment with a 2-

Portfolio Climate Commercia
degree scenario and carbon emissions. Developed by ISS ESG. Some
Impact Report l
information public.

S&P Global Market Commercia Tools estimate impact of carbon tax and creditworthiness based on
Intelligence l carbon emissions and scenarios. Some data public.
9.1.8 Physical Risk Assessment

Acute and chronic climate risks

Physical climate risks are generally categorized into two main types: acute and chronic, as outlined
in Chapters 3 and 6.

Steps in physical risk assessment based on NGFS

Physical risk assessment is a structured approach to identify, analyze, and evaluate risks,
particularly those associated with physical factors such as climate change. The process can be
broken down into six key steps according to NGFS (NGFS, 2022):
1. Define needs and objectives: This step may require several iterations if the data and resources
identified in the next step are insufficient to meet the initially defined objectives.
2. Identify available data and resources: The identified data and resources will also inform the
effort invested overall and over each step of the process.
3. Define the scope and approach: Based on the needs, objectives, and available data and
resources, the scope (e.g., regions and sectors) and approach of the assessment are defined. This
step may require a staged approach, moving from a qualitative assessment to a more-
sophisticated quantitative assessment as more data and expertise become available.
4. Generate climate scenarios: This step involves generating plausible climate scenarios that
explore a range of different options. The NGFS provides a set of reference scenarios that can be
used as a common starting point for analyzing climate risks to the economy and financial system.
However, organizations may also choose to develop their own scenarios if they require a more-
specific or tailored analysis. At least 2 scenarios are required. These scenarios should enable
identifying and assessing climate-related macroeconomic and financial risks, considering the
geographic distribution of hazards and exposures, and capturing key sensitivities and
nonlinearities.
5. Estimate the impacts: This step involves estimating both the direct impacts (physical damages)
and, when possible, indirect impacts occurring through the main transmission channels to the
economy and the financial sector. Estimating indirect impacts requires a more-sophisticated
analysis and more granular data.
6. Present and interpret the results: The presentation should focus on the order of magnitude
(refers to the size or extent of the impacts of climate risks) and trends, and clearly discuss
uncertainties, assumptions, and limitation such as lack of data.

Box 9.8 Case Study: Physical Climate Risk Assessment by S&P and
Oliver Wyman
One case study of physical risk assessment based on the TCFD recommendations is provided by
S&P Global and Oliver Wyman, which illustrates how the interplay between physical and transition
risk can affect a company. The case study uses Climate Credit Analytics to evaluate the company's
assets, which are primarily data-center buildings. The physical risk is evaluated based on the
asset's geo-location, asset type, and various impact functions associated with hazards to which
these assets may be exposed. This comprehensive approach allowed for a detailed analysis of the
physical risks stemming from climate change, including but not limited to extreme weather events
and long-term shifts in climate patterns. This analysis underscored the importance of integrating
climate risk considerations into the company's strategic planning and investment decisions by
identifying the specific risks and their potential impacts.
Source: S&P Global

9.1.9 Transition Risk Assessment

Steps in transition climate risk assessment

Assessing transition climate risk involves understanding and managing the risks associated with
transitioning to a lower-carbon economy. This process is crucial for organizations aiming to
mitigate potential financial impacts due to policy, legal, technology, and market changes.
Discover and Prepare:
 Identify the team or person responsible for climate risk assessment within the
organization.
 Conduct a gap analysis and benchmark against industry best practices and TCFD
recommendations.
 Understand stakeholder, customer, or investor requests for climate reporting.
Assess Risks (based on EPA):
  Conduct a GHG inventory to determine the organization’s Scope 1, 2, and 3 emissions.
 Identify historical extreme weather events the organization has experienced and the
associated financial impacts (The U.S. Climate Resilience Toolkit is a resource).
 Conduct a scenario analysis to assess forward-looking transition risks and opportunities
and physical climate risks the organization may face in the future.
 Conduct an assessment to determine the relevance and importance of these risks and
opportunities to the organization’s strategic and financial position under the scenarios
analyzed.
 Establish goals, metrics, and targets to reduce and manage climate risks and
opportunities now and in the future.
 Develop a transition and adaptation plan that describes the actions the organization is
taking to achieve these goals, metrics, and targets, and the efforts being taken to
manage and minimize the risks of not achieving these goals, metrics, and targets.
Standardize Approach for Specific Sectors:
 For sectors like real estate, follow standardized guidelines to assess and disclose
climate transition risks as part of property valuations (ULI, 2023).

9.2.1 Nature Risk Assessment Overview

Nature risk refers to the risks associated with the loss of natural assets. These risks can directly
affect businesses and economies by affecting operations or introducing regulatory or cost changes
to mitigate nature loss. Nature risk can also contribute to systemic geopolitical risk, because
nature's assets such as clean air, plentiful fresh water, fertile soils, and a stable climate provide
vital public goods on which human societies rely for their functioning. (McKinsey, 2022)
Nature risk assessment identifies and evaluates the potential adverse effects that nature-related
factors can have on a business. These factors can include the degradation of natural resources,
climate change, and biodiversity loss, among others (WWF, 2019).
The assessment process focuses on two key aspects: the business's dependencies on nature and
its impacts on nature.
Box 9.9 Case Study: S&P Global Sustainable1 Launches New Nature &
Biodiversity Risk Dataset
Introduction
S&P Global Sustainable1's Nature & Biodiversity Risk dataset is designed to help companies,
investors, and other stakeholders understand and manage their exposures to nature-related risks
and impacts. This dataset is aligned with TNFD and includes a number of new nature-related risk
metrics.

Data input by companies

Companies need to input data that reflect their direct operations' dependency on nature and their
impact on biodiversity. This includes information on their reliance on various ecosystem services
and the resilience risk of the ecosystems providing these services. The dataset considers 21
different ecosystem services on which a business might depend.
The system outputs several key metrics:
 Dependency score: This score describes the level of risk associated with a company's
reliance on the 21 different ecosystem services. It is a scale from 0 to 1.0, where 0
represents no dependency risk and 1.0 represents very high dependency.
 Ecosystem footprint: This metric measures a company's operational impact on nature
and biodiversity. It combines land area affected by the company, ecosystem integrity
degradation, and ecosystem significance to calculate the equivalent impact on the
most globally significant Key Biodiversity Areas (KBAs).
Source: S&P Global Sustainable1
9.2.2 Importance of Nature Risk Assessment

In the context of climate risk assessment, nature-related risks encompass a broad range of
potential threats and impacts associated with the degradation of natural ecosystems, biodiversity
loss, and other environmental changes.
Nature risk is distinct from climate risk but closely associated with it. Climate-related risks
specifically refer to challenges from changes in climate patterns. Climate change can contribute to
the degradation of nature, affecting ecosystems and biodiversity. Conversely, actions to address
climate change, such as mitigation and adaptation efforts, may unintentionally affect nature.
Sectors with high exposure to climate-related risks, like mining, oil and gas, and agriculture, often
face significant nature-related risks. The close association between these risks emphasizes the
importance of considering both nature and climate in comprehensive risk management strategies
(Samantha Power, 2022).

9.2.3 Biodiversity and Ecosystem Risk

Biodiversity and ecosystem risks represent nature risk, and interplay with climate risk assessment.
Although nature risk and climate risk are interdependent, they are distinct. Climate change can
negatively affect ecosystems or species, contributing to nature risk. For example, climate change
warms ocean temperatures, which can kill coral reefs, a natural defense against storm surges.
However, damage to natural assets contributing to nature risk can also occur independently of
climate change (McKinsey, n.d.). For instance, human activities such as deforestation, overfishing,
and pollution can lead to biodiversity loss and ecosystem degradation, which are nature risks not
directly related to climate change.
Moreover, nature risk and climate risk can amplify each other. For example, the loss of natural
assets like forests can exacerbate climate change by reducing the planet's capacity to absorb
carbon dioxide, a greenhouse gas. Conversely, climate change can accelerate the loss of
biodiversity and degrade ecosystems, increasing nature risk (Oxford, 2023).
Businesses need to understand their impact on and dependency on biodiversity to mitigate these
risks and adapt their practices accordingly (see Table 9.8).

Table 9.8 Biodiversity’s Effects on Businesses

Risk Type Description Potential Business Impact

Operational risks due to resource dependency,

Risks related to biodiversity loss or
Ecological scarcity, and quality; disrupted supply chains and
ecosystem degradation.
operations.

Risks where parties seek

Extra legal costs and compensation expenses;
Liability compensation for biodiversity-related
increased insurance premiums.
loss/damage.

Changes in consumer preferences and Shifts in demand; need to adapt products and
Market
requirements. services; potential loss of market share.

Risks linked to policy, law, technology, Access to capital; compliance costs; depreciation
Financial
or market changes. of asset values; loss of investment opportunities.

Reputationa Pressure to manage ESG risks, Brand image and trust; consumer and investor
l including biodiversity. relations; potential boycotts or divestments.

Addressing both nature risk and climate risk is crucial for sustainable development. However,
nature risk is in many ways a more-difficult problem to address than climate change because it has
no single unit of comparison, unlike greenhouse gas emissions for climate change.
Measuring Biodiversity
Assessing biodiversity presents a more-challenging task than climate change measurement, which
utilizes a standardized metric (tonnes of CO equivalent). To evaluate biodiversity, various
2

frameworks and metrics have been introduced, including the Global Biodiversity Score, the
Biodiversity Credit Alliance Taskforce, the IUCN Species Threat Abatement and Restoration (STAR)
Metric, the UK Biodiversity Net Gain metric, and the Natural England Biodiversity Metric 4.0
(climateimpact, 2023).
Figure 9.3 The Inclusion of Nature in Regulation and Industry Initiatives is Accelerating
Source: Boston Consulting Group (BCG)
In the context of climate risk assessment, particularly in the financial sector, there are several
guidelines and frameworks for conducting biodiversity-related corporate reporting.
 UN Convention on Biological Diversity (CBD): The UN CBD is the most important and
encompassing international agreement in the field of biodiversity. It promotes the
conservation of biodiversity, the sustainable use of its components, and the fair and
equitable sharing of benefits. The CBD plays a crucial role in shaping the global policy
landscape for biodiversity and ecosystem risk assessment (United Nations, n.d.).
 Biodiversity Application Guidance by Climate Disclosure Standards Board
(CDSB): This guidance is designed to ensure that investors receive the biodiversity-
related information needed for effective capital allocation. It is structured around the
first six reporting requirements of the CDSB Framework, which include governance and
management (CDSB, n.d.).
 Science-Based Targets Network (SBTN): This network, a component of the Global
Commons Alliance, is developing guidance on setting science-based targets (SBTs) for
nature. This can be particularly relevant in the context of climate risk assessment and
biodiversity reporting (Science Based Targets, n.d.).
 Partnership for Biodiversity Accounting Financials (PBAF): This is an international
partnership of banks, asset managers, and investors. They offer a new and free
standard for financial institutions to measure the impact of loans and investments on
biodiversity. The 'PBAF Standard 2022' describes the requirements and
recommendations for carrying out a biodiversity footprint assessment (PBAF, n.d.).
 Global Biodiversity Framework (GBF): This framework recommends that legal and
policy measures be taken to encourage companies to regularly monitor, assess, and
disclose their risks, dependencies, and impacts to reduce negative impacts on
biodiversity and increase positive impacts. This can be a useful reference for
companies in their biodiversity reporting efforts (CBD, n.d.).

Box 9.10 The Partnership for Biodiversity Accounting Financials

PBAF is an initiative that provides a framework for financial institutions to assess and disclose the
impact and dependencies of their loans and investments on biodiversity. Fifty-six financial
institutions with over $11 trillion in assets under management are participating in PBAF, with more
joining every month. The initiative is open to all financial institutions that are interested in
collaborating toward a single global approach to biodiversity accounting (PBAF, n.d.).

Source: PBAF “Taking biodiversity into account: PBAF Standard v 2022 Biodiversity impact
assessment – Footprinting”

TNFD released a case study on the Bank of Nature, showcasing how financial institutions can
integrate nature-related financial disclosures into their reporting practices. Here are data and tools
recommended for accessing nature related dependencies and impacts (TCFD, 2023):
 Exiobase (Exiobase consortium)
 FairSupply (FairSupply)
 Trase (Global Canopy, Stockholm Environment Institute)
 ENCORE (WCMC – UNEP)
 Nature Risk Profile (S&P Global)
 Integrated Biodiversity Assessment Tool – STAR Metric (IBAT) (BirdLife International,
Conservation International, IUCN, UNEP-WCMC)
 Biodiversity Risk Filter (WWF)
 Global Environmental Impacts of Consumption (GEIC)
 FABIO (Buckner et al. 2019)
 GIST Impact (GIST Impact)
 Sustainacraft (Sustainacraft)
 Corporate Biodiversity Footprint (Iceberg data lab)
Some natural capital accounting tools exist to help organizations assess the value of nature to
assist this assessment:
 NatureAlpha (NatureAlpha)
 inVEST (Natural Capital Project)
 Co$tingNature (King’s College London, AmbioTek, UNEP-WCMC)
 GIST Impact Biodiversity

9.2.3 Biodiversity and Ecosystem Risk (Continued)

The TNFD is an international initiative that aims to provide a framework for organizations to
address environmental risks and opportunities, particularly those related to the loss of biodiversity
and degradation of ecosystems. The TNFD's mission is to enable businesses and finance to report
and act on their nature-related dependencies, impacts, risks, and opportunities. The ultimate goal
is to support a shift in global financial flows away from activities that harm nature and toward
those that are beneficial (TCFD, n.d.).
Box 9.11 The Latest TNFD Disclosure
The TNFD has announced that 320 companies and financial institutions have pledged to adopt
nature-related corporate reporting guidelines, with some starting this practice with their 2023
annual reports. Revealed at Davos, this initial group spans various industries and regions,
encompassing publicly listed companies with a combined market capitalization of $4 trillion.
Additionally, over 100 financial entities, including major asset owners and managers with $14
trillion in assets under management, as well as banks, insurers, and key market intermediaries like
stock exchanges and accounting firms, are part of this commitment.
The TNFD's disclosure framework consists of four pillars: Governance, Strategy, Risk & Impact
Management, and Metrics & Targets.
 The Governance pillar refers to the processes, controls, and procedures used to
monitor and manage nature-related issues.
 The Strategy pillar refers to the approach used to manage nature-related issues.
 The Risk & Impact Management pillar refers to the processes used to identify,
assess, prioritize, and monitor nature-related issues.
 The Metrics & Targets pillar focuses on assessing performance concerning nature-
related issues, measuring progress toward established targets, and complying with
legal or regulatory requirements.
The TNFD and TCFD represent complementary efforts to integrate environmental considerations
into financial reporting and decision-making: TNFD on nature and biodiversity, and TCFD on climate
change.
The TNFD's recommendations are voluntary, but there are signs that nature-based regulation is
increasing in many jurisdictions around the world. Over time, countries may refer to the TNFD in
their disclosure regulation, leading to convergence of the TNFD with the GBF as implemented at
the jurisdictional level (McKinsey, 2023).

The LEAP (Locate, Evaluate, Assess, Prepare)

The LEAP methodology provides a systematic framework for organizations to pinpoint and evaluate
nature-related challenges, essential for addressing climate and nature risks. Developed by TNFD,
this approach is suitable for organizations of any size, operating in different sectors and regions. Its
goal is to aid in the thorough examination needed to prepare disclosure statements that comply
with TNFD guidelines. Additionally, it offers value to organizations aiming to understand their
nature-related concerns, regardless of whether formal disclosure is mandated.
Key Concepts in LEAP
 Drivers: underlying causes of environmental change, including physical risks and
transition risks
 Dependencies & impacts: How organizations rely on nature (dependencies) and the
effects their operations have on the environment (impacts), highlighting the
importance of both qualitative and quantitative assessments in understanding nature-
related risks
 Threshold: The critical point where an environmental condition leads to significant or
irreversible changes, vital for assessing risks
 Biodiversity indicators: Metrics for evaluating biodiversity health and the impact of
human activities on ecosystems, crucial for risk assessment and decision making
 Baselines, reference condition: The initial state of an ecosystem or environmental
condition, used as a reference for tracking changes over time and essential for risk
evaluation and strategy development

9.2.3 Biodiversity and Ecosystem Risk (Continued)

Exploring the impacts of biodiversity and ecosystem risk management

on businesses, financial institutions, and associated opportunities
Climate change has significantly altered marine, terrestrial, and freshwater ecosystems globally,
leading to species loss and increased diseases. It affects ecosystems at multiple levels, from the
populations that make up ecosystems to the services they provide to communities, economies, and
people.
Species respond to environmental conditions based on habitat needs, and climate change poses
challenges to biological diversity. For instance, temperature changes affect the growth and
development of plants and animals (USDA, n.d.). Climate change also drives terrestrial biodiversity
loss and affects ecosystem carbon storage. More specifically, the impact of biodiversity and
ecosystem risk are the following:
 Nature-related risks and business impact:
Biodiversity poses a set of risks for businesses. These include supply-chain disruptions, material
shortages, price volatility due to increased cost of raw materials, smaller crop yields from overused
lands and unsustainable farming practices, disrupted business operations, and loss of customers in
nature-reliant industries. For instance, the Dutch Central Bank found that 36% of the portfolio
values of Dutch financial institutions were exposed to high or very high nature-related risks (UNEP
FI, 2023).
 Investor concerns and corporate action:
Investor concern over nature-related risks is a primary catalyst for corporate action and reporting
on biodiversity. This is similar to the role of investors in driving climate disclosure. For example, the
United Nations estimates that every $1 spent on ecosystem restoration will result in between $3
and $75 of economic value, indicating a clear economic benefit for businesses.
 Nature-positive financing:
Achieving nature-positive financing will require a collective effort from governments, investors, and
local communities to align incentives, deliver financing at scale, and standardize nature-positive
financing (EEA, 2023).

Financing mechanisms available for biodiversity and ecosystem projects

Funding sources for biodiversity and ecosystem initiatives vary widely, including public funding,
private investment, and from blended finance (combining public and private funds). The worldwide
financing for conserving biodiversity is estimated to range from $78 billion to $91 billion annually,
encompassing both public and private funds, from both domestic and international sources (OECD,
2021). The financial shortfall for activities related to the Convention on Biological Diversity (CBD)
is projected to be between $599 billion and $824 billion every year. To bridge this gap, it is
necessary to boost funding, cut back on detrimental investments, and enhance the efficiency of
conservation efforts (biofin, 2022).
 Public finance: includes domestic flows from national and subnational governments,
and international flows such as Official Development Assistance (ODA). These funds are
often used to improve the coverage and effectiveness of protected area networks and
to restore degraded ecosystems (OECD, 2020).
 Private finance: includes impact investments, which are investments made into
companies, organizations, and funds to generate a measurable, beneficial social or
environmental impact alongside a financial return.
 Blended finance: involves strategically using public or philanthropic funds to mobilize
private capital for sustainable development and conservation outcomes. Public-private
partnerships (PPPs) are a form of blended finance where public and private resources
are combined to achieve sustainability goals (Solidaridad Network, 2023).

Meanwhile, the challenges in financing biodiversity and ecosystem projects include:

 Data availability and standardization: Biodiversity data often have problems with
availability, completeness, accessibility, consistency, and standardization. These
problems hinder investment decisions due to the lack of assessment of ecological
impacts.
 Complexity of biodiversity loss: Unlike climate change, where metrics such as carbon
dioxide emissions can be easily quantified, the complexity of biodiversity loss requires
a wider pool of metrics and interactions for its risk assessment (Cemla, 2021).
 Lack of standard tools and methods: The complexity of biodiversity means that both
private and public actors have a role to play, despite the lack of standard tools and
methods. Both must reduce their impact on nature and decrease their dependence on
ecosystem services, especially those most likely to deteriorate over time (Eco-act,
2022).
 Funding gaps: Funding gaps for biodiversity conservation are politically and
institutionally engrained and result largely from stakeholders with conflicting interests
and strong lobbies. Mobilizing civil society and private-sector support through local and
national dialogue is fundamental (CBD, 2021). The COP28 Presidency and its partners
announced $1.7 billion in funding committed to finance a series of new initiatives for
forests and the ocean to meet climate and biodiversity goals in tandem (COP28 ,
2023). The World Bank Group is devoting 45% of its annual financing to climate-related
projects, indicating a significant focus on addressing climate change and its impact on
biodiversity and ecosystems (World Bank Group, 2023).
 Lack of information on biodiversity impact: Many companies still have scant
information about their impact on biodiversity, making it difficult for investors to assess
the risks and uncover investment opportunities.
 Reliance on public funding and philanthropy: Despite its promise, private
investment alone is not a panacea or a substitute for public financing, philanthropy, or
ODA. Concessional public financing, grants, and donations remain essential
contributors to biodiversity financing.
Challenges
In summary, assessing nature risks is challenging because of the complex nature of ecosystems,
the interconnectedness of biodiversity loss and climate change, the vast scope of the issue,
uncertainties in regulations, and limitations in existing risk assessment methodologies. Overcoming
these challenges demands a multidisciplinary research effort, enhanced data collecting and
modeling methods, and a forward-thinking strategy for incorporating nature risk into climate risk
management frameworks.

9.2.4 Water Risk Assessment

Potential impacts of climate change on water resources and water-

dependent sectors
Climate change has significant potential impacts on water resources and water-dependent sectors.
These impacts can be broadly categorized into effects on water supply, water quality, agriculture,
and energy production.
 Water supply/quantity: Climate change will continue to disrupt the stability of water
resources on local, regional, and national scales. In many areas, climate change is
likely to increase people's demand for water while shrinking water supplies. Persistent
droughts in some areas, accelerated by warming temperatures, are depleting water
resources, especially in the West (EPA, n.d.).
Both water supply and quantity are important to assess the water risk. This distinction is
important in discussions about water risk because it emphasizes not just the presence of water
but its sufficiency to meet demands. The IPCC report and other sources acknowledge the
critical role of these factors in affecting both the supply and the quantity of water, underscoring
the importance of precise terminology in discussing water risks (EPA, n.d.).
 Water quality: Climate change is expected to impair water quality. Increased rainfall
can lead to more runoff of sediments, nutrients, pathogens, and other substances into
water bodies. This can result in increased pollution and degradation of water quality,
affecting both human consumption and ecosystem health (EPA, n.d.).
 Energy production: The energy sector, particularly hydroelectric power generation
and cooling processes for thermal power plants, is another significant consumer of
water.
 Agriculture: Climate change can disrupt food availability, reduce access to food, and
affect food quality. Changes in temperature, atmospheric carbon dioxide, and the
frequency and intensity of extreme weather could significantly impact crop yields.
Changes in precipitation patterns, extreme weather events, and reductions in water
availability may all result in reduced agricultural productivity (EPA, n.d.). For example,
climate change may affect the production of maize (corn) and wheat as early as 2030,
with projected declines in maize crop yields and potential growth in wheat yields
(NASA, 2021).

Water risk assessment and its role in nature risk assessment

Water Risk Assessment (WRA) is a critical tool used to identify, manage, and mitigate water-related
impacts from issues such as local water stress, pollution, and climate change. It evaluates an
enterprise's exposure to water-related risks and serves as a basis for managing them within the
enterprise and its supply chain.
WRAs typically include a two-way evaluation
 Location or physical risk: This involves assessing the likelihood of water-related
natural hazards, available water quantity and quality, and the baseline water stress,
which is the water supply versus how much water is withdrawn.
 Regulatory risk: This involves assessing the regulations set by local and national
governments to manage corporate water use, including the monitoring of water stress,
prices, and allocation regulations for water withdrawal and wastewater treatment.
In addition, WRAs also consider reputational risk, which involves the potential negative impact on a
company's reputation due to its water-management practices. WRAs are conducted at both basin
and operational levels. Basin-level assessments provide a broad overview of water risks in a
particular region, while operational assessments focus on a company's dependence and the impact
of its activities on local water resources (Anthesis Group, 2022).
How WRAs play a role in nature risk assessment
Identifying water-related risks: WRA helps identify potential water-related risks for a company
and its operations. This includes local water stress, water quantity and quality disruptions, and
water-based political challenges. These risks can be at the operational level within the company's
facilities, at the watershed level across their supply chains, and at the enterprise level due to their
overall water management practices (St. Paul, 2023).
Managing and mitigating risks: Once the risks are identified, companies can prioritize and
mitigate these risks. This is crucial to help ensure business continuity on multiple levels. Poorly
managed water risks can affect the profitability of a specific business and can have broader
implications for surrounding businesses and communities. On the other hand, companies with
water risks in their operations can sustain long-term value creation by applying the precautionary
principle and outlining strategies related to beneficial products and services, including nature-
based solutions.
Adaptive business strategy: Developing water resilience requires a company to realize an
adaptive business strategy, transparency, and in-region stakeholder engagement at the basin
scale. Understanding the importance of water risks and their financial materiality is an important
factor for investors to consider.

Box 9.11 Highlights: Actionable insights for organizations to effectively

manage and mitigate water-related risks (limno, n.d.)
Assessing Water-Related Natural Hazards
To assess water-related natural hazards, organizations should first identify the physical risks
associated with water in their operational and regional contexts. This involves analysing historical
data on natural events like floods, droughts, and storms that could impact water availability and
quality. Tools and methodologies from reputable organizations such as the World Resources
Institute (WRI) and the World Wildlife Fund (WWF), including the WRI's Aqueduct Water Risk Atlas
and the WWF's Water Risk Filter.
Determining Water Quantity and Quality Availability
Determining the availability of water quantity and quality involves conducting a site water-balance
analysis, which tracks the source of water and its discharges at the site level. This analysis should
consider both current conditions and future scenarios influenced by climate change, as changes in
hydrologic cycles can disrupt water supply. Additionally, Geographic Information System (GIS)
spatial analysis can be used to extract water risk indicators for specific site locations to provide
insights.
Contextualizing with Baseline Water Stress Levels
Baseline water stress levels indicate the ratio of water withdrawals to available renewable water
supplies. High levels of water stress suggest that significant portions of available water are being
used, leading to competition among users and potential scarcity. Organizations can use tools like
the WRI Aqueduct Water Risk Atlas to assess baseline water stress levels in their areas of
operation.

Understanding Water Supply Replenishment and Withdrawal Rates

This involves evaluating the natural replenishment rates of water sources (e.g., through
precipitation and aquifer recharge) and comparing these rates to the volume of water withdrawn
for operational and community use. Organizations should consider both direct withdrawals and
indirect water use within their supply chains. This analysis helps in identifying potential risks of
over-extraction and guides the development of sustainable water management practices.

Water risk assessment policy landscape

Water risk and water risk assessment are regulated through a combination of laws, regulations,
and guidelines at various levels, including national, regional, and organizational levels.
 The Organisation for Economic Co-operation and Development (OECD) identifies four
major risks related to water: too much water (flooding), too little water (drought), too
polluted water, and disruption to freshwater systems. The OECD encourages its
members to manage water risks and disasters cooperatively, adopting a water risk
management policy as an all-hazards approach to country risk (OED, n.d.).
 The World Resources Institute has developed the Aqueduct Water Risk Atlas, a global
water risk mapping tool that helps companies, governments, and other users
understand where and how water risks are emerging worldwide (WRI, 2021).
 The United Nations University Institute for Water, Environment and Health provides a
preliminary quantitative global assessment of water security challenges, targeting
national water policy actors worldwide (UNU-INWEH, 2023).
 The U.S. Government's Global Water Strategy 2022-2027 outlines a whole-of-
government approach to reducing water-related conflict and incorporating
humanitarian and fragility considerations into water security and sanitation
partnerships and investments (Global Waters, 2022).
Financing mechanisms available for water management and
the challenges associated with nature risk assessment
Financing mechanisms for water management are diverse and can be used to fund various aspects
of water infrastructure, including drinking water, stormwater, wastewater, and sewage treatment.
Traditional financing for water system improvements and maintenance is predominantly handled
by utilities through cash financing, which draws from current revenue, or debt financing, which
raises upfront capital through municipal bonds.
Innovative financing mechanisms can help attract new financial resources to water and sanitation
services. These mechanisms focus on mobilizing market-based repayable financing, such as loans,
bonds, and equity to bridge the financial gap to meet water-related goals.
Governments can employ a variety of economic and financial policy instruments to influence
behavior and generate revenues for water management and the delivery of water supply. For
example, the U.S. EPA’s Water Finance Clearinghouse is a significant development that links water
operators with sources of finance (Newsha Ajami, 2018).
Other financing mechanisms include new funds targeting climate change adaptation and
mitigation, co-financing, and the provision of insurance or guarantees by financial institutions (FAO,
n.d.).
Water-based finance mechanisms can provide supplemental financing and protect watersheds, but
creating a new environmental services market requires a long-term investment of resources (CBD,
2001).

9.3 Conclusion

This chapter provides a comprehensive understanding of climate risk assessment with case
studies, encompassing its foundational principles, global and regional protocols, and its impact on
various sectors and industries. Nature risk assessment, particularly in terms of biodiversity,
ecosystems, and water, has been emphasized as a vital strategy for mitigating climate risks in
corporate and financial contexts. The financial implications of these nature-related risks,
frameworks for measurement and disclosure, and the intricacies of financing mechanisms,
recognizing both the opportunities and challenges they present, were also covered.
Chapter 10: Transition Planning and Carbon Reporting

Learning Objectives
After reviewing this chapter, you should be able to:
 Describe the drivers of transition plans, including regulation, and the different use
cases for transition plans.
 Describe the key principles for good transition planning: ambition, including the
“strategic rounded approach,” action, and accountability.
 Demonstrate knowledge of emerging transition planning international and national
standards, as well as sector-specific guidance.
 Know principles for setting SBTi Net-Zero targets.
 Demonstrate an understanding of the five core elements of a good practice transition
plan: Foundation, Implementation Strategy, Engagement Strategy, Metrics & Targets,
and Governance.
 Understand the two distinct approaches (equity share and control) that can be used to
consolidate GHG emissions.
 Demonstrate ability to walk through GHG calculation steps by scope according to
operational boundaries and calculate emissions given a set of activity data, conversion
factors, and global warming potentials.
 Define financed emissions and why Scope 3 emissions are essential for financial
organizations to measure.
 Understand how financial institutions measure financed emissions and use emissions
metrics to measure risk.
 Calculate a financial institution's attribution factor and financed emissions.
 Know the asset classes covered by the PCAF Standard and describe the PCAF Data
Quality Score guidance, understanding hierarchies of data quality.
 Understand emerging mandatory and voluntary reporting requirements for financial
institutions.
This chapter provides an introduction to transition planning and carbon reporting, two fundamental
activities for firms seeking to assess and manage their climate-related risks and opportunities. It
provides an overview of recent developments in transition planning and introducing some of the
key principles for good-practice transition plans. The chapter then dives into the key building
blocks of a transition plan, building on the guidance available on this topic to date. Finally, it
discusses the basics of carbon reporting for corporates and financial institutions, outlining the main
concepts and frameworks of which practitioners should be aware.

10.1 Transition Planning

As discussed in Chapter 8, many companies across both financial and non-financial sectors have
published climate-related commitments, often in the form of net-zero targets. A target can only be
achieved, however, if a company has an underlying strategy for delivery. Currently, it is often
difficult for interested parties, including those internal to a company, to assess whether a company
has a credible path to reaching its targets, as well as what impacts this will have on a firm’s
business model, products, operations, and value chain. This lack of information also creates
challenges for policymakers looking to understand where companies are experiencing difficulties in
successfully navigating the transition, and to identify where targeted government policies could
help overcome barriers.
In light of these challenges, the concepts of transition planning and transition plans have gained
global traction.

Box 10.1 Key Concepts

In approaching this topic, it is helpful to distinguish among the process of transition planning,
a transition plan, and transition finance. In May 2023, the Network for Greening the Financial
System (NGFS) published a stocktake of emerging practices relating to transition plans, in which it
explains the difference between the two concepts as follows:
“Transition planning is the internal process undertaken by a firm to develop a transition strategy
to i) deliver climate targets that firms may voluntarily adopt or that are mandated by legislation or
the appropriate authority, and/or ii) prepare a long-term response to manage the risks associated
with a transition to a low emissions economy. […]
Transition plans are a key product of the transition planning process and are an external-facing
output for external audiences, such as investors and shareholders and regulators.”
There are a variety of different existing definitions of a transition plan. A widely recognised one is
provided by the International Sustainability Standards Board (ISSB) in the IFRS S2 Climate-related
disclosure standard:
“A climate-related transition plan is an aspect of an entity’s overall strategy that lays out the
entity’s targets, actions or resources for its transition towards a lower-carbon economy, including
actions such as reducing its greenhouse gas emissions” (Source: IFRS S2).
A third important concept in this context is transition finance. Caldecott (2022) reviews various
definitions of transition finance and proposes a consistent overarching definition: “Transition
Finance
is the provision and use of financial products and services to support counterparties, such as
companies, sovereigns, and individuals, realise alignment with environmental and social
sustainability.”
This definition has a number of key features and benefits, namely it:
 applies to companies, as well as sovereigns and households;
 covers sustainability topics beyond climate mitigation;
 is not just about raising capital, but also about the provision of financial services that
can support the transition;
 can apply across all asset classes;
 encompasses labelled instruments, but is not just about labelled ones, such as “use of
proceeds,” and emphasises the importance of sustainability-linked instruments;
 makes clear that all finance can become transition finance.
However, as of December 2023, there are no internationally agreed-upon definitions or technical
criteria for transition finance. Work on this topic is ongoing in multilateral processes, such as the
G20 Sustainable Finance Working Group, individual jurisdictions, and private-sector initiatives, such
as the Glasgow Alliance for Net Zero.

A key driver of this momentum is the private sector itself. In particular, there is a trend of financial
institutions asking the companies they invest in or lend to, to prepare and disclose their transition
plan. The reason behind this pressure is that the information often is regarded as relevant to
investment decision making, or seen as an important input into an investor’s own transition effort.
For example, the investor initiative Climate Action 100+ is asking the world’s largest corporate
greenhouse gas emitters to disclose and implement transition plans. The Glasgow Financial
Alliance for Net Zero (GFANZ), a network of global financial institutions, has developed guidance
for transition planning by financial institutions, as well as setting out the member’s expectations for
real-economy transition plans. Similar guidance on investor expectations has also been produced
by the Institutional Investors Group on Climate Change. There are also individual investors who are
vocal about the need for corporate transition plans. For example, Norges Bank Investment
Management, which manages the assets of Norway’s sovereign wealth fund, updated investee
expectations on climate change in 2023, asking firms for credible transition plans that cover scope
1, scope 2, and material scope 3 emissions.
In addition, there is a growing number of governments, regulators , and multilateral institutions
that are exploring the role of requirements related to transition planning and transition plans. As
summarized by the NGFS, there are different policy or regulatory objectives that such transition-
plan requirements could support. These include achieving climate outcomes through corporate
action, maintaining market integrity, and preventing greenwashing, as well as effectively managing
climate-related micro- and macroprudential risks (NGFS, 2023). As of December 2023, key
government and regulatory initiatives related to transition plans and transition planning included
those in Table 10.1.
Table 10.1 International/Multilateral Initiatives

Organization Description

G20 Sustainable The G20 SFWG aims to identify barriers to sustainable finance and support the
Finance Working alignment of the international financial system to the objectives of the 2030
Group (SFWG) Agenda and the Paris Agreement. In 2021, they developed a voluntary Roadmap
for Sustainable Finance that identifies 5 Focus Areas and a series of priority
actions. The SFWG provides annual updates on progress, as well as developing
additional recommendations on various priority areas identified by the G20
Finance Ministers and Central Bank Governors.
In 2022, the SFWG developed a series of high-level principles for Transition
Finance, set out recommendations for improving the credibility of private-sector
financial institution commitments and scaling up transition-finance instruments.
The principles call on issuers to disclose up-to-date transition plans which can
underpin transition-finance instruments. Several of their recommendations also
encourage companies to develop transition plans and support capacity-building
efforts amongst officials, regulators, and the private sector on sustainable finance
issues, including transition plans (G20 SFWG, 2022). Similar recommendations
were included in the 2023 Progress Report.
In 2024, the Brazil G20 Presidency announced that advancing credible, robust, and
just transition plans would be one of four G20 SFWG Priorities, so more work on
Organization Description

this topic is expected.

In June 2023, the ISSB issued two standards: (1) IFRS S1 General Requirements for
International Disclosure of Sustainability-related Financial Information, and (2) IFRS S2 Climate-
Sustainability related Disclosures.
Standards Board The IFRS S2 standard contains several disclosure requirements relating to how an
(ISSB) entity has responded to, or plans to respond to, climate-related risks and
opportunities, including any transition plan it has.

In July 2023, the FSB published its progress report on the FSB Roadmap for
addressing Climate-Related Financial Risks. In this report, it notes the growing
interest in the role of transition plans in enabling an orderly transition, and as a
Financial Stability
source of information for authorities looking to assess micro- and macroprudential
Board (FSB)
risks. It is setting up a Transition Plans Working Group to, “as an initial task,
develop a conceptual understanding on the relevance of transition plans and
planning by financial and non-financial firms for financial stability.”

The NGFS is conducting work to examine “the relevance and extent to which
financial institutions’ transition plans (i) relate to micro-prudential authorities’
roles and mandates, and (ii) could be considered and used most effectively within
their supervisory toolkit and in the overall prudential framework” (NGFS, 2023).
Network for Greening
In a first phase of work, they conducted a stock-take exercise, the results of which
the Financial System
were published in May 2023. In that document, they highlighted two key priorities
(NGFS)
for future work: (1) engaging with other international authorities and standard
setters, and (2) advancing the discussion on the relevance of transition plans and
planning to microprudential authorities’ mandate, supervisory toolkit, and the
overall prudential framework.

In its 2023 Work Program, IOSCO committed to setting up a workstream on

International
transition plans that will consider the role of securities regulators with respect to
Organization of
transition-plan disclosures. They also endorsed the two inaugural ISSB standards,
Securities
calling on its 130 member jurisdictions to consider ways in which they might
Commissions (IOSCO)
adopt, apply, or be informed by them.

In November 2023, as part of its ongoing work to address climate-related financial

risks, the BCBS launched a consultation on bank-specific Pillar 3 disclosure
Basel Committee on requirements for climate-related financial risks. The draft text includes a
Banking Supervision requirement to disclose the effects of material climate-related financial risks on its
(BCBS) strategy and decision-making, including its climate-related transition plan. It is
expected that the Committee will publish a revised or final proposal in the second
half of 2024. (BCBS, 2023)

The IPSF runs a Transition Finance Working Group that, in 2022, launched a set of
voluntary Transition Finance Principles, followed by an interim report on their
International Platform
implementation in 2023. They strongly emphasise the importance of transition
on Sustainable
plans as a building block of transition finance and recommend that the ISSB
Finance (IPSF)
consider developing further guidance on transition-plan disclosures as part of
broader sustainability reporting (IPSF, 2023).

Financial Sector Groupings

Jurisdiction Description

In late 2023, the Australian treasury consulted on a proposed Sustainable Finance Strategy
containing a series of measures across three pillars to underpin the development of
Australia Australia’s sustainable finance markets. The first pillar contains a series of proposed
priorities to improve transparency on climate and sustainability, including supporting
credible transition planning and target setting (Australian Government, 2023).

European In the EU, the Corporate Sustainability Reporting Directive requires companies to disclose
Union (EU) social and environmental information according to European Sustainability Reporting
Standards (ESRS).
In addition, there are ongoing discussions around a Corporate Sustainability Due Diligence
Directive. In December 2023, the EU Parliament and Council reached a political agreement
that, if passed, would introduce a requirement for companies to adopt and put into effect
 Financial Sector Groupings

Jurisdiction Description

plans to transition their business to align with the 1.5°C temperature goal.
Finally, there are proposals to expand the supervisory mandate of the European Central
Bank (ECB) to include the increased supervision of the transition plans of financial
institutions. As proposed, such an expansion would give the central bank a mandate to
intervene if it finds that a bank’s transition plan is inadequate from a prudential
perspective (European Council, 2023).

In 2021, the UK government announced that it would take steps toward making
publication of transition plans mandatory as part of a broader plan to become a net-zero-
aligned financial center.
To inform future requirements, they established the public-private Transition Plan
Taskforce (TPT) with a mandate to develop a Transition Plan Disclosure Framework that
United enables companies to prepare and disclose robust and credible plans. The Disclosure
Kingdom (UK) Framework was finalized in October 2023.
The Financial Conduct Authority (FCA) is expected to consult on introducing disclosure
requirements aligned with the TPT Framework at the same time as implementing UK-
endorsed ISSB standards as part of their listing requirements. The UK government also
committed to consulting on introducing requirements for the UK’s largest companies to
disclose their transition plans.

The Monetary Authority of Singapore conducted a consultation in late 2023 on three

related proposals to introduce guidance on transition planning for banks, asset managers,
Singapore and insurers. These set out draft supervisory expectations that Financial Institutions
should have a sound transition planning process (MAS, 2023). Further updates are
expected in 2024.

In September 2023, the U.S. Treasury issued a set of 9 voluntary Principles for Net-Zero
Financing and Investment to promote consistency and credibility in the climate
United States commitments of financial institutions, and encourage the adoption of emerging best
(US) practices. Principle 1 states that, to be credible, an institution’s net-zero commitment
should be accompanied or followed by the development and execution of a net-zero
transition plan.

Overall, transition plans are becoming a critical building block of the global sustainable finance
architecture, and the guidance available to practitioners is rapidly maturing. Some of the most
comprehensive guidance available on transition plans has been developed by the TPT and GFANZ.
In October 2023, the TPT launched its Disclosure Framework, setting out three overarching
principles for good-practice transition planning and providing detailed disclosure recommendations
across 5 core elements of a transition plan (see Figure 10.1).
Figure 10.1 TPT Disclosure Framework
Source: TPT, 2023, TPT Disclosure Framework

These elements mirror the five themes of a transition plan identified by GFANZ in its guidance, making the two guidance bodies
highly complementary (see Figure 10.2).

Figure 10.2 GFANZ Financial Institution Net-Zero Transition Plan Framework

Source: GFANZ, 2023, Financial Institution Net-zero Transition Plans

Box 10.2 The Use Cases of Transition Plans

Box 10.2 The Use Cases of Transition Plans

Across these different fora, there are different use cases for transition plans that are being
explored. In 2023, the Transition Plan Taskforce summarized some of the main use cases that are
currently under discussion, outlining that transition plans can:
 “Set a blueprint for actions within the reporting entity enabling it to direct strategy,
promote coordinated, purposeful actions, and support a whole-of-organisation
transformation.
 Improve the information available to investors and lenders, enabling them to price risk
and make capital allocation decisions.
 Support policymakers and regulatory authorities to understand the trajectory of the
economy- wide transition and how this both influences, and is influenced by, climate
policy in order to inform future policymaking.
 Particularly in the case of financial services firms, allow supervisors and regulators to
assess whether an entity’s strategy for managing the transition is sufficient given its
exposure to climate- related risks and opportunities, and whether its transition-related
claims to clients and consumers are well founded.
 Help stakeholders hold entities to account for their public climate commitments.
 Act as a reference point for financial instruments and products directed towards
financing the climate transition, helping the markets for climate and transition finance
instruments to scale with integrity.
 Provide forward-looking strategic information to the wider capital markets ecosystem,
including data services, credit ratings, and other tools, to support the mainstreaming of
sustainability in finance” (Source: TPT, 2023).
In 2023, the NGFS provided an overview of transition plan use cases, similarly highlighting that
transition plans can be valuable to a broad range of actors, including government, corporate and
financial regulators (see Table 10.2).
Table 10.2 Categories of Transition Plan Use Cases
Source: NGFS, 2023

10.1.1 Principals for Transition Planning

The Transition Plan Taskforce (TPT) recommends that good practice transition plans should be
guided by three overarching principles: ambition, action, and accountability (TPT, 2023).
Video

10.1.1 Principles for Transition Planning: Ambition

Firstly, the TPT argues that a good-practice transition plan should be ambitious. In 2023, the
UNFCCC conducted the first Global Stocktake, concluding that the world is not on track. To achieve
the Paris Agreement's mitigation targets, global greenhouse gas (GHG) emissions need to be cut
by around 43% by 2030 and 60% by 2035 from 2019 levels, aiming for net-zero CO emissions by
2

2050 (UN, 2023). The world is similarly lagging adaptation goals, with the UN Environment
Programme estimating that there is an estimated investment gap of $194 billion to $366 billion per
year in adaptation efforts in emerging markets alone.
In light of this background, various guidance developers agree that it is critical that private-sector
transition plans reflect the urgency to take ambitious action on both mitigation and adaptation.
GFANZ recommends that a transition plan be consistent with achieving net zero by 2050, at the
latest, in line with commitments and global efforts to limit warming to 1.5 ºC, above pre-industrial
levels, with low or no overshoot.
The TPT’s recommendations emphasise that the ambitions of a transition plan should go beyond
reducing firm-level emissions, recognizing that tackling firm-level emissions alone may lead to
suboptimal outcomes. For example, a narrow focus on entity-decarbonization may lead firms to
make important contributions to emissions reductions but ignore other levers they have to
accelerate the transition, such as proactively engaging with governments to call for more-
ambitious policy action.
In other cases, it may even lead to unintended consequences. A firm may be incentivized to sell off
carbon-intensive assets (e.g., to entities facing lower regulatory pressures to decarbonize) without
this having any tangible impact on overall emissions. Such instances of “paper decarbonization”
are particularly a risk in the financial sector, where firms could rapidly decarbonize their balance
sheets (e.g., by reducing exposures to hard-to-abate sectors) without this leading to real-world
reductions in emissions.
To avoid these pitfalls, the TPT recommends that practitioners take a strategic and
rounded approach when defining the ambition of their plan, explicitly considering three channels
of action (see Figure 10.3).

Figure 10.3 A Strategic and Rounded Approach

Source (TPT, 2023)
Taking a strategic and rounded approach can help firms prioritize actions that meaningfully
contribute to the economy-wide transition. For instance, by considering a rounded approach, an
organization may realize it can effectuate more GHG reductions by leveraging its brand influence
on its supply chain, rather than exclusively focusing on marginal operational emission reductions.
Similarly, it may enable a financial institution to pursue opportunities for accelerating the managed
phase-out of high-emitting assets, such as coal power plants, as part of its transition plan.

10.1.1 Principles for Transition Planning: Action

Secondly, the TPT emphasises that a good-practice transition plan needs to be focused on actions,
providing detail on the concrete steps a firm is planning to take to achieve its ambition. The scope
of relevant actions here can be quite broad. For example, they may include changes that the entity
is making to internal governance and decision-making processes, such as introducing a carbon
budget for employee travel; steps it is taking to change business operations, such as investing in
new technologies to reduce the emissions intensity of productions processes; or actions taken to
engage externally with suppliers, customers, investee firms, policymakers, or others.
In setting actions, the TPT recommends that entities should:
 follow the mitigation hierarchy (i.e., prioritize steps to reduce Scope 1, 2, and 3
emissions over investing in carbon credits),
 avoid carbon lock-in when making decisions with long lifetimes,
 support their actions with appropriate resourcing plans, and
 be aware of key assumptions they are making and assess the key external factors on
which their transition plan depends (e.g., policies, demand shifts, technological
innovation, etc.), and take steps to mitigate potential delivery risks.
10.1.1 Principles for Transition Planning: Accountability
Finally, the TPT recommends that practitioners ensure accountability in their transition planning by
making it subject to appropriate internal governance and external reporting. Key recommendations
under this principle include:
 integrating transition planning into existing organizational processes for business and
financial planning,
 defining clear internal roles and responsibilities for both the delivery and the oversight
of the transition plan, and
 taking steps to align the organizations’ culture and incentive structure with the
ambition of the plan, including material information about your transition plans in
general purpose financial reports (e.g., annual reports, reporting annually on progress
against metrics and targets).

Box. 10.3 The Chapter Zero Board Toolkit

Given that an entity’s transition planning activities will need to be integrated into its broader
strategy, most guidance providers explicitly recognize that a company’s Board (or equivalent
governance body) will play an important role in this process. For example, GFANZ recommends
that financial institutions establish a clear mandate, role, and authority for the Board and its
committees in the oversight of transition planning. To ensure that Board directors are equipped for
exercising effective oversight, Chapter Zero has prepared a Transition Planning Toolkit aimed at
non-executive directors. This toolkit contains:
 a briefing, exploring the role of NEDs in transition planning;
 a scorecard, which can help assess board effectiveness and company readiness for
transition plan disclosures;
 a “governance compass” to support board committee meetings; and
 a Board capability tool to assess the knowledge, skills, and competencies that the
Board needs for effective oversight.
These resources can also be useful for practitioners within companies looking to engage their
senior management and Boards on transition planning.

10.2 Setting and Delivering Ambition, Action and Accountability

This section examines how institutions can best demonstrate the three key principles of ambition,
action, and accountability in their transition planning. It does so by introducing the five core
elements identified in both the TPT and GFANZ frameworks.
Video
10.2.1 Foundations

Any transition plan needs a foundational element, covering the firm’s overarching transition
objectives and priorities, articulating the high-level implications for its business model and the key
assumptions on which the plan depends. Well-designed objectives can help institutions build and
maintain long-term value (e.g., by managing exposure to physical risks such as extreme weather
events and asset stranding, as well as transition risks, such as litigation or regulatory risks). They
can also enable a shift toward higher-value product strategies.
As outlined above, a strategic and rounded transition plan should contain objectives on ambitious
emissions reductions, managing climate-related risks and opportunities, and using available levers
to accelerate economy-wide decarbonisation (TPT, 2023). For financial institutions (FIs) specifically,
a key question will be how their transition plans affect their investment and lending activities. This
is because that is where a large proportion of their emissions are likely to lie (Scope 3), but it is
also where they have the largest lever for supporting the transition of the wider economy. This is
reflected in SBTi guidance for financial institutions, which stresses that FI targets need to cover
Scope 1 and 2 emissions, as well as Scope 3 emissions related to investment and lending activities.
Box 10.4 Setting Good Practice Decarbonization Targets
In setting decarbonization objectives, companies should cover all scopes of emissions and follow
existing best-practice resources on target setting. Critical guidance and standards are provided by
the Science-based Targets Initiative (SBTi), which also serves as an external validation of science-
based targets (SBTi, 2023). The SBTi Net-Zero Standard provides four elements that comprise a
net-zero target.
Interim, 5- to 10-year targets that are aligned with a 1.5⁰C pathway that, once achieved, can be
replaced by new short-term targets (the second element); these serve as milestones toward the
long-term targets that provide a quantitative metric of the extent to which value chain emissions
must be reduced to reach science-based climate goals. Targets must account for residual
(unabated) emissions, which are those emissions that remain even after an organization has
implemented all technically and economically feasible opportunities for mitigation, and which it
expects to remain even when the net zero target is achieved. The agriculture industry is a good
example of where residual emissions are likely to lie, as any meat production causes greenhouse
gas emissions, and it is unlikely that the world will completely cease all meat production any time
soon. The third element of the net-zero target is that these emissions must be removed and
permanently stored. Finally, investments can be made to mitigate emissions falling outside a
company’s “value chain” to support the transition to net zero beyond a company’s direct actions;
this is known as Beyond Value Chain Mitigation (BVCM). BVCM is not a requirement in setting a
science-based target, but a recommendation (see Figure 10.4).

Figure 10.4 The Four Elements of SBTi Net-Zero Targets

Source: The four elements of SBTi net zero targets. (SBTi, 2023)

Given the forward-looking nature of transition-plan objectives and the interdependencies across
firms and value chains, companies will have to make assumptions in developing their plans. These
could, for example, relate to the costs and availabilities of technology alternatives, the policy
environment, changes in consumer behavior, the supply of renewable energy, or emissions-
reduction initiatives implemented by suppliers. Understanding what these assumptions are and
what the implications might be if they aren’t met will be important, both for senior management
teams looking to manage the delivery of the plan, as well as for external stakeholders looking to
assess its credibility. The TPT therefore emphasizes that it is important for firms to articulate key
assumptions underpinning their objectives, and the external factors on which the delivery of the
plan depends. Firms can look to improve the quality of their plan by, where available, drawing on
independent, reputable analyses to inform relevant assumptions.
Box 10.5 How to Ensure That Transition Plans Support a “Just
Transition”
There is increasing global recognition that the transition toward net zero and climate resilience will
have distributional implications. In this context, an increasing number of governments, academics,
trade unions, private firms, and civil societies are drawing attention to the importance of working
toward just transition, defined by the International Labour Organisation as follows:
“A Just Transition means greening the economy in a way that is as fair and inclusive as possible to
everyone concerned, creating decent work opportunities and leaving no one behind” – ILO, 2015.
Private-sector transition plans have an important role to play, given the wide range of implications
that company action will have on people, including their workforce, the communities in which
companies operate, and their customers.
To support financial institutions in developing just transition plans, the LSE Grantham Research
Institute has set out three core factors that financial institutions should take into account in the
design and delivery of their plans:
1. Anticipate, assess, and address the social risks of the transition.
2. Identify and enable the social opportunities of the transition.
3. Ensure meaningful dialogue and participation in net zero planning.
Source: LSE GRI, 2022

10.2.2 Implementation Strategy

It is recommended that companies underpin their objectives with a robust implementation

strategy, covering any changes an entity is planning to make to its business activities, products
and services, and internal policies to achieve its objectives. For example, this could relate to any
changes a company is planning to make to its production processes (e.g., to lower operational
emissions) or its product design (e.g., to increase the share of recycled materials used).

Box. 10.6 Case Study: Turning Objectives Into Concrete Implementation

Steps
Johnson Matthey, a multinational chemicals company has developed a net zero roadmap outlining
the concrete implementation steps it plans to take to reach its 2040 target to reach net zero for its
Scope 1 and 2 emissions. This provides an example for how long-term targets can be underpinned
by concrete operational steps that are being taken before 2030.

Source: Johnson Matthey, 2023 Annual Report, pg. 26.

Changes in business strategy as a result of a transition plan are likely to come with financial
implications. For example, implementing their transition plan may require corporates to increase
certain types of expenditures, such as increased funding for research & development activities or
sizeable capital expenditures to install low-emissions technologies. A transition plan could also
have other financial implications, such as changes to asset lives or asset valuations. Companies
will therefore also need to integrate their transition-planning activities into ongoing wider financial
planning. Financial institutions will need to understand how their foundations and business
objectives might affect their risk appetite, activities, and decision making in deployment of
financial products and capital / insurance, and their policies and conditions (see Box 10.7 for
Financial institution specific sub-elements on implementation strategy).

10.2.3 Engagement Strategy

The third element of a transition plan that TPT and GFANZ both call out is a firm’s “Engagement
Strategy.” Companies often need to cooperate with other actors in the ecosystem to meet their
transition goals. “Engagement” refers to the steps companies take to influence the decision
making and actions of others, including companies, policymakers, civil society stakeholders, etc.
(GFANZ, 2022). Both the TPT and GFANZ framework distinguish among:
(1) engagements with companies in the value chain (including clients and portfolio firms, in the
case of financial institutions),
(2) engaging with industry peers, and
(3) engaging with government and the public sector.
Engagements within the supply chain can be an important lever for firms looking to tackle Scope 3
emissions or reduce the vulnerability of their supply chains to possible disruptions from physical
impacts of the changing climate. For example, firms may set up capacity-building programs and
encourage suppliers to meet decarbonization or adaptation targets.
Client and portfolio company engagement is particularly relevant for the transition plans of
financial institutions, given their typically high proportion of Scope 3 emissions, but also their
ability to support the transition of their counterparties. Voting is an important aspect of
engagement for financial institutions, most notably those with investments in listed equities
(institutions with investments solely in fixed-income securities do not enjoy voting rights, but can
still engage with the issuing entities). Interestingly, research has found that successful
engagements relating to environmental, social, and governance issues can lead to positive
abnormal returns for the investor (Dimson et al., 2015). However, the voting records of some of the
world’s largest asset managers has historically been criticized for being a headwind to ambitious
transition plans, rather than a tailwind, with data showing these institutions are hesitant to back
action-oriented resolutions that could be transformative for climate goals. ShareAction (2023) and
the IIGCC (2022) provide recommendations for setting ambitious, practical voting policies.

Box 10.7 Developing Effective Engagement Strategies for Financial

Institution
The Institutional Investors Group on Climate Change provides guidance on how financial
institutions can effectively engage with their portfolio companies on their transition plans. A key
resource is their Net Zero Stewardship Toolkit (2022). This publication suggests five steps toward
an effective engagement strategy:
 setting time-bound objectives with a subset of priorities and escalation plans,
 dialogue with priority companies to communicate expectations in line with the
investor’s net zero strategy,
 progress assessment to determine the efficacy of initial dialogues, escalation (voting or
non-voting), and,
 a review at the end of each engagement cycle (recommended to be annual) to assess
which companies have made sufficient progress, and to set new priority companies for
the following period. An escalation strategy can aid investors in setting time-bound
actions and improving the quality of engagement campaigns.
Further guidance on good practice escalation plans has recently been published by ShareAction
(2023).
Engaging with industry peers can be valuable to support knowledge-sharing and the dissemination
of emerging best practices across companies. It can also be used to engage collectively with
governments and civil society to push for additional progress on policy and regulation (UNEPFI,
2022), or to collaborate to solve joint challenges. For example, investors looking to engage specific
companies or sectors on their transition plans may find it powerful to do so as a coalition. A
number of such collaborations have been launched that bring together large numbers of major
investors and companies; ClimateAction100+ (CA100+), ShareAction, and the Investor Policy
Dialogue on Deforestation (IPDD) are just a few examples.
10.2.4 Metrics and Targets

Video

The fourth element of a transition plan is the quantitative metrics and targets used to tie actions to
goals and measure progress over time. Disclosure of targets allows institutions to be held
accountable to stakeholders throughout the transition timeline.
Greenhouse gas emission metrics and targets play a central role in transition plans, as reducing
unabated greenhouse gas emissions to zero is critical for transitioning to a Paris-aligned pathway.
Although it is central to most transition plans, care should be taken when using GHG metrics to
compare corporate entities, as differences between the underlying measurement systems that
model GHG Inventory and the double-entry bookkeeping systems used for financial reporting can
reduce the comparability of the underlying data (Jia et al., 2022). Further information relating to
carbon reporting can be found in Section 10.3, which delves deeper into the breakdown of GHG
emission into Scopes 1, 2, and 3, and the specific requirements for carbon reporting.
In addition, entities may also use a broad set of other metrics and targets to track progress against
their objectives. For example, the TPT further contains disclosure recommendations covering any
business, operational and financial metrics, and targets applied by the company (TPT, 2023).
Such additional targets can be used to provide a link between overarching emissions-reduction
targets and specific operational targets related to the underlying business. Similarly, internal
governance metrics, such as levels of linkage with climate issues in remuneration and frequency of
stakeholder feedback, can support operationalization of a strategy. Which metrics and targets are
likely to be meaningful indicators of transition progress is highly sector dependent. For example, in
the hard-to-abate industries, investment in and predicted future production capacity ratios
between high and low carbon production may be relevant (e.g., Mt of steel produced using Arc
Furnace via renewable energy versus Mt of steel produced using unabated blast furnace via
burning of coal). Transport operators may look at using fleet-based metrics (e.g., fleet share of
EVs). Service companies may need to consider revenues from high carbon versus low or zero
carbon sources with their clients.
Metrics and targets can also be used to measure progress against transition plan objectives that go
beyond entity-level decarbonisation. For example, a firm may set itself targets related to water
consumption to manage risks arising from disruptions to water supply caused by changing
precipitation patterns. Alternatively, a financial institution may set itself targets related to the
financing of climate solutions or to managing the exposure of its financing portfolios to physical
and transition risks.
Finally, there may also be metrics and targets that entities include in their transition plan because
there are specific regulatory requirements to do so, or to follow sector-specific best practices. For
example, companies disclosing under the European Union’s Corporate Sustainability Reporting
Requirements (CSRD), are required to make reference to CapEx that is aligned to the European
Taxonomy, as well as significant CapEx amounts related to coal, oil, and gas-related economic
activities. Where such standardised metrics are integrated into reporting requirements, they can
be important to support users in their assessment of plans, and facilitate comparison across
companies.
10.2.5 Governance

The final element of a transition plan is its governance. Effective governance structures play a
crucial role in facilitating the execution of transition plans and ensuring accountability for climate
goals and targets. The first factor to consider is the role of the Board and senior management in
the design and oversight of the transition plan. Establishing key individuals in senior positions with
defined roles and responsibilities, and aligning compensation appropriately, establishes a positive
tone and promotes the allocation of necessary resources for implementation. Transition plans will
typically be approved and overseen at a high level by the board of directors. Below the board of
directors will be a management structure responsible and accountable for implementing the plan.
The culture set by these individuals can help or hinder a transition plan, and evidence suggests a
healthy culture can be valuable to companies (FRC, 2016).
Secondly, aligning the internal culture to the overarching objectives of the transition plan can
support delivery. The Financial Conduct Authority (FCA) published a discussion paper on
governance in 2023 (FCA, 2023). Part of the exercise of creating this document involved input from
industry sources, including Deloitte, which set out its seven pillars to an effective culture (Ferguson
and Strachen, 2023). These pillars included purpose, which is defined here as a company’s explicit
drive to create value beyond profit, specifically for people and the planet. This purpose must be
communicated clearly both internally and externally to deliver value. Another of the seven pillars is
challenge and diversity of thought; an engaged, informed workforce can aid senior management in
providing ideas and feedback on transition plans and beyond. In fostering an environment in which
employees are best able to contribute to a sustainable and inclusive business, feedback is critical.
This can be achieved through regular surveys and/or workshops.
Thirdly, incentives and remuneration can be a powerful tool to incentivize delivery. An increasing
number of companies have begun tying pay to climate outcomes. As of 2022, around 82% of senior
executives globally have ESG targets in their pay (PWC, 2022). Investors such as Cevian Capital
and Allianz AG have been joining forces to call for greater alignment between pay and climate
goals (Stobbe and Zimmerman, 2022). It is important to implement such incentive structures
correctly; however, a 2021 report showed over half (55%) of these ESG targets were based on non-
material factors according to the SASB Materiality Map (PWC 2021).
Finally, transition plans require expertise, and it will be necessary for companies allocate sufficient
resources toward identifying gaps in skills and knowledge, and toward hiring and/or training. Firm-
wide training may in some circumstances be appropriate, and can help firms ensure that they are
contributing to a just transition by providing a positive social impact for their workers. Initiatives
relating to training and competence in sustainable finance are being launched continually; a recent
example is the Monetary Authority of Singapore’s 12 technical skills and competencies needed for
professionals to perform various roles in sustainable finance. The demand for climate-related
expertise has seen a commensurate rise in qualifications available; GARP’s Sustainability and
Climate Risk Exam is an excellent example of this.
Box 10.8 The Sector Specificity of Transition Planning
Although the five elements outlined above can be generically relevant to all companies, the details
of a transition plan will depend significantly on the sector of the preparing company. A number of
relevant tools and guidance documents are available to aid in navigating these nuances:
 The TPT provides a sector summary that complements its Disclosure Framework, and
sets out decarbonization levers and metrics and targets for 40 sectors. For many of
these sectors, an accompanying literature guide provides additional sources of sector-
specific information and guidance. The TPT has also provided draft Deep Dives on
seven sectors: asset managers, asset owners, banks, electric utilities and power
generators, food and beverages, oil and gas, and metals and mining.
 The IFRS provide a series of sector-specific information relating to requirements for
disclosures related to climate risks and opportunities; these are largely derived from
SASB standards.
 The Assessing Low Carbon Transition project (ACT) was set up to aid in assessing
company alignment with a low-carbon future, and utilizes a methodology based
broadly on the SBTi approach. ACT offers sectoral assessment methodologies, with
additional sectors added throughout 2023 and 2024.
 Particularly pertinent for financial institutions are the Transition Pathway Initiative’s
(TPI) Sectoral Decarbonisation Pathways, which are used widely by investors to assess
their investee companies. These pathways are based on IEA scenarios, with data
supplemented by additional sources, and are freely available online. Benchmark
pathways are created that align with a 1.5⁰C, below 2⁰C, and current pledges
scenarios.
10.3.1 Introduction to Carbon Reporting

Video

A fundamental building block for sound transition planning is robust and reliable carbon reporting.
Carbon reporting is the process of documenting and disclosing GHG emissions by organizations.
This is a crucial aspect of any corporate governance aiming to address climate-related risks and
opportunities. It helps companies and financial institutions understand and manage climate
impacts, align their business strategies with global sustainability goals, influence investor
decisions, and build stakeholder trust. Therefore, it is a vital tool that enables organizations to be
accountable and transparent about their climate impacts. Additionally, carbon reporting is
increasingly becoming a regulatory requirement, highlighting its significance for environmental
stewardship and legal compliance.
Although comprehensive emissions measurement is progressing slowly, there has been a 24%
increase in the disclosure of GHG emissions by almost 19,000 companies through CDP in 2022
(CDP, 2023). This marks an increase of over 140% compared to the disclosure in 2020, indicating
that businesses are becoming more aware of the broader impact of their activities.

10.3.2 Organizational Boundaries: Equity Share vs. Control

Approach

According to the Greenhouse Gas Protocol, the boundaries that determine the operations owned or
controlled by the reporting company can depend on the consolidation approach taken: the Equity
Share Approach or the Control Approach. Both approaches offer different perspectives on how a
company accounts for its GHG emissions, especially in scenarios where operations are not wholly
owned.
Equity Share Approach: In this approach, a company reports GHG emissions from operations based
on its share of equity in the operation. This method is straightforward and aligns the reported
emissions with the company's economic interest in an operation. For instance, if a company owns
30% of another entity, it would report 30% of that entity's emissions. The equity share approach is
particularly relevant when considering the economic risks and rewards proportionate to ownership
interest. This approach takes precedence over the formal ownership structure, ensuring that the
reported emissions accurately reflect the company's economic interest. The method simplifies
reporting by directly linking a company's reported GHG emissions to its percentage of ownership,
thereby making it easier for companies to calculate and communicate their carbon footprint.
Furthermore, it ensures that emissions reporting is proportionate to the economic risks and
benefits a company faces, offering a more accurate reflection of its environmental responsibility
based on its level of investment. However, there are drawbacks to this approach. It may not fully
capture the environmental impact of a company's operations, especially in joint ventures where
the company has significant operational influence but less than proportional ownership.
Additionally, this approach could allow companies to underreport emissions by strategically
allocating investments in a manner that minimizes reported emissions, rather than genuinely
reducing their environmental impact.
Control Approach: This approach involves reporting 100% of the GHG emissions from operations
over which a company has control. Control can be either operational or financial. Under operational
control, a company reports on emissions from operations where it or its subsidiaries have the
authority to implement operating policies. Financial control, on the other hand, involves reporting
emissions from operations where the company has the ability to direct the financial and operating
policies and benefit from these operations. In this approach, the economic substance of the
relationship takes precedence over legal ownership. A notable aspect of the control approach is
that it does not account for emissions from operations in which the company has a financial
interest but lacks control. By adopting this method, companies provide a comprehensive view of
their direct environmental impact, promoting full accountability for the emissions resulting from
operational decisions. This aligns emissions reporting with management responsibility, as it is
based on the degree of operational or financial control, thus accurately reflecting the company's
real influence over its environmental footprint. However, this approach has its challenges. It can
lead to the double counting of emissions in complex ownership structures where more than one
entity may assert control over the same operations. Additionally, it may not fully capture the
broader environmental impact of a company's investments, especially when the company holds
significant financial interests without direct control.

10.3.3 Scope 1, 2, and 3, and Financed Emissions Revisited

Video
Carbon reporting involves several key concepts that are essential for understanding and accurately
measuring an organization's carbon footprint. As discussed in Chapter 1, the primary greenhouse
gases, such as carbon dioxide (CO ), methane (CH ), and nitrous oxide (N O), are typically the focus
2 4 2

of reporting efforts due to their significant impact on climate change. Although fluorinated gases
(HFCs, PFCs, SF6, and NF3) are also monitored, they receive less attention in reporting as their
atmospheric concentrations and contributions to global warming are comparatively lower.
As highlighted in Chapters 4 and 6, GHG emissions are categorized into Scope 1, 2, and 3
emissions. Notably, financed emissions are a specific subset of Scope 3 emissions, particularly
relevant to financial institutions.
Scope 1 emissions: These are direct emissions from sources that are owned or controlled by the
company. For instance, if a manufacturing company operates a factory, all the GHG emissions from
the factory, such as those from combustion in boilers or vehicles it owns, are classified as Scope 1.

Scope 2 emissions: These emissions are indirect and result from the generation of purchased
electricity, steam, heating, and cooling consumed by the company. For example, if the same
manufacturing company purchases electricity to power its factory, the emissions produced during
the generation of that electricity at the power plant are Scope 2 emissions.

Scope 3 emissions: This category covers all other indirect emissions that occur in a company’s
value chain. It includes emissions linked to the company’s activities but occurring from sources not
owned or controlled by the company. For instance, if the manufacturing company outsources part
of its production process to another firm, or if it sells products that emit GHGs during their use,
such as automobiles, these emissions are part of Scope 3. For Scope 3 emissions, two methods -
direct measurement and estimation - are employed, with the International Sustainability Standards
Board (IFRS, 2023) recommending prioritization of direct measurement for its accuracy.
Operational boundaries help delineate which emissions are accounted for in each scope, ensuring a
structured and methodical approach to GHG inventory and reporting.

Financed emissions: Financed emissions refer to GHG emissions that are attributed to the loans,
investments, and financial services offered by financial institutions. This term categorizes the
emissions generated by projects or companies that receive financial support from banks, asset
managers, insurance companies, and other financial entities. As a subset of Scope 3 emissions,
financed emissions are integral to Scope 3, Category 15 (Investments) of the GHG Protocol's
Corporate Value Chain (Scope 3) Accounting and Reporting Standard. These emissions represent
the indirect impact of a financial institution's activities and are essential for assessing the broader
climate impact of their investment and lending decisions.

10.3.4 Calculating and Reporting Emissions

Calculating and reporting GHG emissions across all three scopes is a multi-step process that
involves gathering data, applying conversion factors, understanding global warming potentials, and
aggregating emissions according to specific scopes and operational boundaries. This process is
crucial for organisations to accurately assess and report their climate impact.
To calculate GHG emissions, entities should begin by identifying sources of emissions within their
operational scope, crucial for determining the GHG inventory's scope. In some cases, firms may
then be able to directly measure the GHG emissions by monitoring their concentration and flow
rate at the source of emissions. More commonly, however, firms will have to rely on calculated
estimates, for which they should select an appropriate GHG emissions calculation approach,
tailored to their size, operational nature, and data availability, in alignment with GHG Protocol
standards.
More commonly, firms can derive emissions estimates using a multistep process starting with
gathering activity data. This process involves collecting accurate and relevant activity data, such
as fuel consumption or electricity usage.
In a next step, entities will need to choose a relevant emission factor, which they can use to derive
the total emissions from that particular activity. Generally speaking, the GHG protocol recommends
that companies use source- or facility-specific factors where these are available. Where these
aren’t available, however, firms may need to rely on general estimates. When considering emission
factors, it's important to understand the different data sources and their implications.
Fuels, for example, often have the same emissions factors globally because their chemical
composition and combustion properties are consistent, making them relatively fungible across
different geographies. This fungibility means that organizations can apply standard emission
factors for fuels from widely recognized sources with confidence in their accuracy.
In contrast, scope 2 emissions, which involve indirect emissions from the consumption of
purchased electricity, heat, or steam, are heavily influenced by the grid infrastructure or the
proportion of energy sources used to generate electricity in a specific region. Therefore, the
emissions factors for scope 2 emissions vary significantly depending on the geographic location
and the energy mix. Regionally specific emissions factors that account for the local grid mix can
often be found in official sources, such as from the US Environmental Protection Agency (EPA,
2024).
Additionally, for more granular data on specific sectors or activities, organizations might refer to
the Emission Factor Database (EFDB), which offers emission factors for a wide range of processes
and industries globally (IPCC, 2023). These guidelines are instrumental in calculating emissions for
specific activities, such as agricultural practices, industrial processes, and waste management,
further emphasizing the need for accurate source identification and the use of appropriate
emission factors tailored to the specific conditions and operations of each entity.
Once the total emissions of different GHGs have been estimated, these can be converted into a
single estimate of CO e by weighting the emissions of individual gases with their Global Warming
2

Potentials. The GHG Protocol offers a helpful tool that allows practitioners to conduct this
conversion using widely recognized estimates of different gases (WRI & WBCSD, 2013). This
process can be summarized below:

Activity data * Emission factor = Emissions * GWP = Emissions in CO e 2

Figure 10.5 provides an example of this basic calculation method: it transforms the activity data—
600,000 MMBtu of natural gas—into metric tonnes and then applies emission factors to estimate
CO , CH , and N O emissions (note, emissions factors may be in kilograms or grams and should be
2 4 2

converted to metric tonnes). These emissions are converted into CO equivalents using their
2

respective GWPs (1 for CO , 28 for CH , and 273 for N O), resulting in a combined impact of 31,869
2 4 2

mt CO e, which reflects the potential warming effect of the gases emitted. GWPs are often
2

presented in ranges depending on estimation methods used (e.g. N O as 265-298). This basic
2

equation, based on activity data, allows organizations to compile emissions at the corporate level,
offering a comprehensive perspective of their GHG emissions footprint to guide mitigation efforts.

Figure 10.5 Basic Calculation Method

Once the GHG emissions have been accurately calculated using the outlined multistep process,
these metrics can be reported in line with the GHG Protocol, relevant jurisdictional requirements, or
voluntary initiatives.

10.3.5 Scope 3 and Financed Emissions for Financial Institutions

Play Video
In the case of financial institutions, Scope 3 Category 15 – financed emissions play a particularly
critical role. Financial institutions typically exhibit low direct emissions (Scope 1 and 2), whereas
their Scope 3 emissions, stemming from their support for various businesses and projects, outpace
their direct emissions by 700 times (CDP, 2021). Understanding and managing their financed
emissions is therefore critical for any financial firm looking to make well-informed decisions as part
of its transition plan.
In line with the Paris Agreement, financial institutions can benefit from measuring financed
emissions in absolute terms as a baseline to address climate impacts. However, it may be
additionally beneficial for them to use normalized data in their work, which involves converting
absolute emissions into emission intensity metrics per specific units of activity or output. This
normalization helps in climate transition risk management, target setting, and the development of
financial products. The market offers diverse emission intensity metrics tailored for various
purposes, each with unique advantages. For reference, Table 10.3 lists the most used emission
intensity metrics outlined by the Partnership for Carbon Accounting Financials (PCAF), providing a
practical resource for risk management professionals in the financial sector.
Table 10.3 Financed Emissions
Metrics

Source: PCAF (2022). The Global GHG Accounting and Reporting Standard Part A: Financed
Emissions. Second Edition.

Box 10.9 Leveraging Transition Finance for Lower Emissions and Risk
Mitigation
The relationship between emissions and risk, especially for financial institutions, highlights the
essential role of transition finance in combating climate change. Financial institutions are now
embedding transition finance metrics and ratios into their strategies, acknowledging their
significant role in promoting decarbonization through informed capital allocation. This integration
enables the assessment and management of risks linked to the low-carbon economy transition,
ensuring investments are aligned with global climate objectives.
Financial institutions are crucial in closing the funding gap for the transition, especially in sectors
with high emissions. Utilizing transition finance metrics allows for the prioritization of investments
in projects and companies poised for emissions reduction, facilitating a quicker move toward
sustainability. This focus illustrates the sector's dedication to a smooth and inclusive transition,
aiming to contribute significantly to keeping global warming below 1.5 degrees Celsius (GFANZ,
2023).
The GFANZ (2023) framework of transition finance metrics, as outlined in Table 10.4, directs
financial institutions toward supporting a low-carbon global economy. It segregates metrics into
Real-Economy Transition, Expected Emissions Reduction (EER), Portfolio/Financed Emissions, and
Plan Execution, serving as vital tools to boost the impact of financial activities on climate goals.
These metrics range from allocating capital to Paris-aligned assets to financing key decarbonization
technologies and evaluating the expected emissions reductions of investments. This framework
advocates for a comprehensive approach in tackling climate change, emphasizing the importance
of forward-looking measures to grasp the transition finance landscape's complexities fully.
Table 10.4 Indicative Transition Finance Metrics for Decarbonisation
Area Metric Examples

Proportion of portfolio dedicated to Paris-

Real-Economy Transition Capital mobilized
aligned assets

Number of sustainable aviation fuel plants

Real-Economy Transition Technology impact financed; number of physical assets under
MPO strategy

Expected Emissions Expected emission Quantifies the expected impact of investments

Reduction (EER) reduction on emissions reductions

Portfolio/Financed Total GHG emissions associated with the

Absolute emissions
Emissions investment portfolio

Portfolio/Financed Emissions relative to a financial parameter

Intensity-based metrics
Emissions (e.g., revenue, invested capital)
 Area Metric Examples

Net-zero aligned Development and offering of products and

Plan Execution
products/services services aligned with net-zero objectives

Senior management Proportion of senior management equipped

Plan Execution
contribution with climate knowledge
Source: GFANZ, 2023.
The uptake of transition finance metrics signifies a shift toward sustainable finance, incorporating
environmental concerns into financial decision-making. This movement fosters transparency,
accountability, and resilience in the financial sector, positioning it as a key player in the global shift
toward a sustainable, low-carbon economy.

10.3.5 Scope 3 and Financed Emissions for Financial Institutions

(Continued)

Measurement Challenges of Financed Emissions

Video
There are several challenges that companies commonly face in arriving at reliable estimates of
their financed emissions. For instance, the Partnership for Carbon Accounting Financials (PCAF)
highlights issues such as limited data availability, which often hinders the accuracy and
comprehensiveness of emissions calculations, and the generalized nature of certain calculation
options that rely on assumptions and approximations from region and sector averages. This can
lead to less-robust and more-uncertain calculations compared to those based on specific borrower
or investee data (PCAF, 2023).
Additionally, PCAF points out inconsistencies in measurement approaches, the impact of timing of
emissions related to seasonal variability or different fiscal calendars of financial institutions, and
the challenges posed by market value fluctuations on assets under management, which can affect
the goal of reducing relative financed emissions (PCAF, 2023). In a similar way, the European
Central Bank emphasizes the limited availability of emissions data, particularly for smaller banks or
those with portfolios composed mostly of small, non-listed counterparties. This lack of data
necessitates reliance on proxies for Scope 1, 2, and 3 emissions reporting, leading to significant
discrepancies and variability in emissions data (ECB, 2022). The ECB also notes the absence of a
common database for climate data and the need for improved estimation methods and increased
reliability in emissions reporting (ECB, 2022).
This situation is exacerbated by the absence of a standardized approach to accounting and
reporting on financed emissions, highlighting the need for improved data quality and
standardization in this field.
Data Quality and Reporting Standards
Video
In light of these challenges, there have been efforts to push for more consistency in how financial
institutions measure and report financed emissions, recognizing that they will often grapple with an
incomplete and asymmetric data landscape. Emerging guidance grapples with this challenge by
combining guidance on how to calculate emissions for different asset classes with guidance on how
to establish and report on the quality of the underlying data.
Hierarchies of data quality in the context of financed emissions refer to the classification of data
based on its reliability and accuracy for emissions reporting. This hierarchy often prioritizes
reported and verified emissions data as the most reliable, followed by various methods of inferred
and estimated emissions. Financial institutions face challenges in this hierarchy due to the
difficulty in accessing high-quality corporate-reported emissions data. As a result, they often rely
on alternative data sources, leading to inconsistencies and inaccuracies in emissions reporting.
The PCAF financed emission standard plays a crucial role in this debate. The standard provides a
structured approach to calculating financed emissions across various asset types, including listed
equity and corporate bonds, business loans and unlisted equity, project finance, commercial real
estate, mortgages, motor vehicle loans, and sovereign debt.
An important concept in the PCAF standards is the so-called attribution factor, defined as “the
proportion of the emissions of the borrower or investee that are allocated to the loan or
investments.”
Figure 10.6 outlines the PCAF method for calculating financed emissions, where the emissions a
financial institution is responsible for are determined by multiplying the emissions of the investee
using an attribution factor. For example, if a bank has a $50 million loan to a company with $500
million in total equity and debt, and the company has 100,000 tonnes of CO2 emissions, the
attribution factor is 0.1 (50/500). The bank's financed emissions for this company would then be
10,000 tonnes of CO2 (0.1 * 100,000). This approach allows financial institutions to account for and
report on the emissions they indirectly finance through their investment activities, reflecting their
contribution to climate impact.

Figure 10.6 The General Approach to Calculate Financed Emissions

Source: PCAF (2022). The Global GHG Accounting and Reporting Standard Part A: Financed
Emissions. Second Edition.
In addition to reporting financed emissions, the Standard requires companies to disclose a Data
Quality Score, based on the PCAF scoring system, which, as depicted in Figure 10.8, categorizes
GHG emissions data quality on a scale from 1 to 5:
 Score 1 implies an error margin of 5%-10% and represents the most reliable category
of audited emissions data or actual primary energy data. This would be akin to a
financial institution using verified data in line with standards such as the Greenhouse
Gas Protocol.
 Score 2, without third-party audit but still based on primary data, would likely have a
slightly higher error margin, though the specific percentage is not defined.
 Score 3, which uses averaged sector-specific data, introduces more uncertainty due to
its aggregated nature.
 Score 4's proxy data, based on regional or country averages, and Score 5's estimated
data with limited support, represent the least reliable categories, with
Score 5 potentially exhibiting an error margin as large as 40-50%. The progression from Score 5 to
Score 1 reflects a transition from high-uncertainty estimates to data with a significantly reduced
error margin, enhancing the overall reliability of financed emissions reporting.

Figure 10.7 PCAF Data Quality Scoring System

Source: PCAF (2022). The Global GHG Accounting and Reporting Standard Part A: Financed
Emissions. Second Edition.
Together, the PCAF Standard and its Data Quality Score offer a comprehensive method for financial
institutions to measure and report GHG emissions linked to their loans and investments in a
manner that also communicates the levels of uncertainty in the underlying data. There are
important efforts underway to mainstream the application of the PCAF standard, for example
through collaborations with CDP that aim to align their data quality systems with the standard
(PCAF & CDP, 2023). These initiatives are crucial in the development of methodologies for
calculating and reporting financed emissions, emphasizing the importance of standardized,
transparent, and reliable emissions data for financial institutions in their transition toward
decarbonization.
10.3.6 Emerging Mandatory and Voluntary Reporting
Requirements

The global trend toward more stringent, standardized, and mandatory reporting is evident, driven
by a growing recognition of climate-related financial risks and the need for enhanced transparency
in the financial sector's role in addressing these risks. In the US, the SEC's proposed rule
emphasizes the need for detailed climate risk disclosure, including Scope 1, 2, and 3 emissions,
leaning toward mandatory reporting influenced by investor demands and frameworks like TCFD.
The UK aligns with these trends, with the FCA issuing robust reporting guidelines, including
mandatory disclosures of financed emissions for pension funds under Department for Work and
Pensions rules, reflecting a broader adherence to TCFD and ISSB standards. In the European Union,
the SFDR mandates financial institutions to report financed emissions by June each year, as part of
a comprehensive EU framework for sustainability and transparency.
In addition to these mandatory reporting requirements, voluntary initiatives such as the Net-Zero
Banking Alliance (NZBA) and the Glasgow Financial Alliance for Net Zero (GFANZ) have developed
guidelines for financial institutions focused on financed emissions. These frameworks encompass
the development of detailed net-zero transition plans to guide the shift toward net-zero emissions
in portfolios by 2050, the setting of science-based targets for emissions reduction by 2030, and the
imperative of transparently measuring and publicly disclosing GHG emissions linked to financed
activities. These initiatives align reporting with established frameworks like TCFD, SBTI, and PCAF
standards, ensuring consistency. Additionally, they emphasize regular target and strategy reviews
to stay in line with evolving scientific and policy developments. Financial institutions endorse these
frameworks by actively participating in these alliances, committing to their guidelines, and
integrating the specified reporting and target-setting processes into their operations.
Box 10.10 Analyzing Nordic Investment Bank’s (NIB) Financed Emissions
Calculation
The NIB adopts a multifaceted approach to calculate financed emissions, striking a balance between precision
and feasibility. This strategy acknowledges the challenges and complexities inherent in emissions reporting
within the financial sector.
NIB primarily relies on GHG emissions data obtained from counterparties, typically sourced from sustainability
reports or corporate disclosures. This approach offers valuable insights into Scope 1 and Scope 2 emissions,
though the quality and granularity of this data can vary significantly due to diverse reporting standards and
capabilities. To enhance transparency, NIB engages with counterparties to encourage consistent and accurate
emissions reporting, but its success depends on the willingness and capability of these entities to provide such
data.
In cases where counterparties lack emissions reports, NIB turns to PCAF's proxy data, which employs
standardized emission factors derived from industry averages. Although this offers a practical solution for data
gaps, it involves a degree of estimation and may not fully mirror the unique circumstances of each
counterparty. The estimation process considers the sector and geographic location of the counterparty,
recognizing its substantial influence on emission profiles. However, generalized sectoral and regional data may
not capture distinctive or emerging trends within specific sectors or locations accurately.
One significant challenge NIB faces is the inconsistency in emissions-reporting standards across different
regions and sectors, which can lead to discrepancies in attributed emissions from its investments. The reliance
on proxy data, while essential, introduces a level of generalization, potentially overlooking the distinctiveness
of individual counterparties. To mitigate these issues, NIB continuously refines its methodologies, staying
informed about developments in emissions reporting and GHG accounting, and adapting its techniques to
improve accuracy and relevance.
In 2022, NIB's lending financed emissions totalled 1.06 million tonnes, with a predominant contribution from the
power and heat sector. The bank has also set specific targets for 2030 across various sectors, aligning with
Science-Based Targets initiative (SBTi) standards. Notably, NIB has excluded financing for projects involving
fossil fuels, including upstream mining or extraction activities. The strategy also encompasses sector-specific
approaches to decarbonization, including considerations for commercial real estate and airports with low
climate impact infrastructure. NIB places a strong emphasis on accurate climate data collection and
transparent reporting, adhering to international standards. Furthermore, NIB actively engages with
stakeholders, including clients and investors, to facilitate a comprehensive transition to a net-zero society, and
integrates climate risk into its risk-management framework in line with the TCFD recommendations.