Climate scenario anxiety and legal risk

Are you suffering from climate scenario anxiety? If so, you’re not alone. It’s been apparent recently talking with people in business, finance and policy. If the anxiety is well-grounded, the implications are potentially significant, including for legal risk.

A climate scenario describes a plausible future state under conditions of uncertainty based on assumptions about the trajectory of global warming and its possible impacts. Scenario analysis involves assessing alternative scenarios to reach a view on the implications of climate risks and opportunities for a given private or public body.  

Practice remains nascent but scenario analysis is now widespread, partly due to the recommendations of the Taskforce on Climate Related Financial Disclosures (TCFD), taken over this year by the International Sustainability Standards Board (ISSB).

The ISSB’s IFRS S2, para 22, requires relevant entities to disclose sufficient information to enable users of general purpose financial reports to understand their climate resilience. To assess their climate resilience entities are to use climate-related scenario analysis, commensurate with their circumstances. For the ISSB, ‘climate resilience’ is an entity’s capacity to adjust to climate-related changes, developments or uncertainties, including its ability to address climate-related risks and opportunities. For some entities, this or standards like it are or will be embedded in law. In other cases, it creates good practice expectations that could also have a legal edge.

It is clearly important, therefore, to use reliable scenarios. And that is where the anxiety comes in.

As if constructing and assessing scenarios were not challenging enough, reports from a number of bodies and academics in recent months have questioned how they are being used and their accuracy, some suggesting a massive disconnect between economic outcomes predicted by common scenarios created by economists and the views of the scientific community. Outcomes predicted by the latter are substantially less benign. The UK’s Institute and Faculty of Actuaries is the joint publisher of one of them, the regulator of UK actuaries – a respected professional body when it comes to measuring the financial impact of future events and managing risk, one would have thought.

I am neither a scenario-modeller nor scientific expert. However, if these concerns are well-grounded there would seem to be a range of commercial, financial, policy and legal risks.

In the light of that, what sort of questions should market operators be asking? These might be a good start:

  • Are we using scenario analysis to help in achieving our commercial and financial goals and discharging associated legal duties and, if not, could they be a valuable tool in helping us to do so? What sort of reliance should we place on them?
  • Do we understand the shortcomings of scenario analysis and the scenarios we are using and how do we deal with these? If we are using climate scenarios, is there a divergence between those and those in the reports?
  • If there is a divergence, why is that? Is one or the other unreliable, so that it can and should be disregarded, or can they help to inform each other (and decision-making and disclosures) in some way? How?
  • If current scenarios have shortcomings, what decisions have been made in reliance on them that may be unsound as a result and what disclosures have been made that may require correction?

One organisation that's already asking them is the UK’s USS…