Improving climate analysis with the University of Exeter

The precise effects of climate change are highly uncertain. But identifying what these effects could be and integrating them into our investment decision-making processes can help us to prepare for the financial risks that climate change may bring. That’s why we’ve worked with the University of Exeter to develop four new climate scenarios that are more useful for our investment decision-making.

Climate scenario analysis is a vital tool to help us assess the financial risks we face as investors under various future climate outcomes. The analysis helps us to prepare for complex and uncertain futures by including climate considerations in our investment decision and risk management processes.

We completed our first climate scenario analysis in 2022 (you can read about this in our TCFD report) but we identified significant limitations with the available scenarios:

• They don’t capture the complex interrelated risks of climate change. For example, they don’t model climate tipping points, when a small change in the climate triggers a larger and often unstoppable change elsewhere.

• They often look at climate risks in isolation and don’t fully capture the potential knock-on effects, like mass migration, war, and political and social instability.

• They use very long time horizons and smooth transitions that are not realistic representations of how economic and financial markets are likely to behave over the next 5-10 years.

These limitations and the long term outlook make it difficult to properly embed climate considerations into our more immediate transition planning and financial decision-making. We, like many other investors, have a Net Zero ambition that includes an interim target of halving the emissions of our portfolio by 2030. We must therefore pay close attention to shorter term changes to politics, markets and extreme weather events when assessing the long-term financial impacts of climate change and investing in our members best financial interests.

We aren’t the only investors facing these challenges. All investors must evolve their investment processes to capture the ever-growing uncertainties of climate change. Long-established views on macro and financial variables may no longer hold as we enter a new paradigm. In such a world, analysis using forward looking scenarios is a powerful tool.

The new climate scenarios developed in collaboration with University of Exeter better reflect the real-world risks and opportunities that frame our investment decision-making over the short and medium term. They switch the focus away from climate pathways and towards the changes in politics, economics, asset prices and extreme weather events.

Our report with University of Exeter – No Time To Lose - New Scenario Narratives for Action on Climate Change – presents these four new climate scenarios. They range from optimistic, with drivers working in harmony and rapid decarbonisation, to pessimistic, where a toxic political climate compounded by dysfunctional markets frustrates progress. They aim to present a richer, broader, and more realistic range of possible scenarios on which we can base our investment decisions.

• Scenario 1. Roaring 20s – policy and markets align

• Scenario 2. Green Phoenix – market-driven, while policy lags

• Scenario 3. Boom and Bust – policy steps up after fossil fuel surge bursts

• Scenario 4. Meltdown – policy failures compound weak growth

We aim to lead in the development of this new approach to climate scenario analysis that is less focused on precise estimation and more on understanding how real-world dynamics could play out in a complex world where climate risks cannot be looked at in isolation from political, economic, and technological factors.

We believe these new scenarios will enable us to address some of the questions we raised about climate analysis in our 2022 TCFD report. We’ll draw out the investment implications of the new scenarios over the next 12-18 months and embed them into transition planning and financial decision-making appropriately. This will allow us to refresh our next climate scenario analysis in line with the statutory requirements.

We hope this work represents the beginning of a much-needed shift in climate-related strategic decision making within the investment industry, which is a cause for cautious optimism.

You can read the full report on the Exeter website. For more on our Net Zero ambition and the progress we’re making, visit our journey to Net Zero.