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
markets bonds and loans, opening up new markets

Enhancing risk management strategies by incorporating climate risks,

Risk management
potentially reducing losses from climate-related events

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

Better access to capital for institutions committed to sustainability and

Access to capital
climate risk management

Subsidies and incentives for investing in green finance, technologies, and

Regulatory incentives
efficiency 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

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

IFRS S1 (General Requirements for

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

Requires entities to use scenario

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

Categorizes into transition risks and Addresses climate-related risks and

Risk categories
physical risks opportunities

Requires disclosure of absolute

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

The TCFD recommendations were

Years of The ISSB standards (IFRS S1 and
established in 2017, with the TCFD
implementation IFRS S2) were released in 2023
disbanded in 2023 after 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
years under the Climate Change Act of
2008 and is based on the Independent
UK Department Assessment of UK Climate Risk, which is
for the statutory advice provided by the
17 Jan
UK Environment, Report Climate Change Committee
2022
Food & Rural (CCC) (Department for Environment,
Affairs Food & Rural Affairs, UK, 2022). The
CCRA3 considers 61 UK-wide 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 effectively integrating
London Stock
and communicating climate-related 14 Jan
UK Exchange Group Guidance
information. It recommends a three- 2021
(LSEG)
stage process (LSEG, 2021):
• 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,
Executive 20 May
USA White House "Protecting Public Health and the
Order 2021
Environment and Restoring Science to
Tackle the Climate Crisis;" EO 14008,
"Tackling the Climate Crisis at Home
and Abroad;" and EO 14030, “Executive
Country Latest
Exchange or
or Type Description Update
Institution
Region Date

Order on Climate-Related Financial

Risk” (Garcia, 2023).

Reporting Corporate Climate Risks and

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

Corporates subject to carbon cap and

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

An issuer should specify its criteria for

identifying “significant” climate-related
issues that affect its business activities.
In doing so, it may cross-reference
information disclosed in its ESG report.
Issuers should implement action steps to
lay the groundwork for effective
climate-related disclosures, including
Hong Kong
integrating climate change into key
Exchanges and 25 Mar
Hong Kong Guidance governance processes and enhancing
Clearing Limited 2022
board-level oversight through audit and
(HKEX)
risk committees; looking specifically at
the 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 and
European
future climate change impacts and risks 07 Mar
EU Environment Policy
related to the environment, economy, 2023
Agency (EEA)
and wider society in Europe (The
European Climate Adaptation Platform
Climate-ADAPT, n.d.).
 Country Latest
Exchange or
or Type Description Update
Institution
Region Date

This sustainability reporting standard

covers disclosure requirements
regarding climate-related hazards that
can lead to physical climate risks for the
European 22 Dec
EU Regulation undertaking, and its adaptation
Commission 2023
solutions to reduce these risks. It also
covers 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

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

Analyzes alignment of portfolios with

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

Utilizes financial network algorithms to estimate

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

Projects sectoral prices, emissions, and energy

Cambridge
Free usage under different climate scenarios.
Econometrics
Customizable analyses available for a fee.

Transition Assesses issuers' management quality, carbon

Pathways Free performance, and transition readiness.
Initiative Developed with PRI and FTSE Russell.

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

Assesses financial risk to infrastructure under

ClimateWise Free climate scenarios. Produced by the University of
Cambridge.

The GESI – CDP Scenario Analysis Toolkit is

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

The ECLR Climate Risk Tool analyses the

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

Estimates asset valuation variation under

Climate Risk
Commercial climate scenarios. Developed by Vivid
Toolkit
Economics. Some data public.
Tool Name Type Description

Assesses firm-level transition readiness,

Carbon Impact
Commercial strategic orientation, and emissions. Developed
Analytics
by Carbone4. Public and for-fee options.

Estimates climate-stressed valuations of

Carbon Delta—
Commercial securities. Developed by MSCI and the Potsdam
Climate VAR
Institute.

Assesses issuer-level financial metrics changes

Climate
Commercial under potential climate scenarios. Developed by
Excellence
PwC. Some information public.

Screens portfolio for financial impact of risk

ERM Commercial
under scenarios.

MATLAB Climate Uses models to assess transition risks under

Commercial
Scenario Explorer different policy scenarios.

Assesses issuer-level physical and transition risk

Moody’s ESG Commercial
exposure, and climate governance.

Estimates macroeconomic variables and asset

Ortec Finance
Commercial class returns under climate scenarios. Developed
Climate Maps
with Cambridge Econometrics.

Assesses bond and equity portfolios' issuer

Portfolio Climate alignment with a 2-degree scenario and carbon
Commercial
Impact Report emissions. Developed by ISS ESG. Some
information public.

Tools estimate impact of carbon tax and

S&P Global Market
Commercial creditworthiness based on carbon emissions and
Intelligence
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

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

Risks where parties seek

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

Changes in consumer Shifts in demand; need to adapt

Market preferences and products and services; potential loss
requirements. of market share.

Risks linked to policy, law, Access to capital; compliance costs;

Financial technology, or market depreciation of asset values; loss of
changes. investment opportunities.

Brand image and trust; consumer

Pressure to manage ESG
Reputational and investor relations; potential
risks, including biodiversity.
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
CO2 equivalent). To evaluate biodiversity, various 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

The G20 SFWG aims to identify barriers to sustainable

finance and support the alignment of the international
financial system to the objectives of the 2030 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
G20 Sustainable for improving the credibility of private-sector financial
Finance Working institution commitments and scaling up transition-finance
Group (SFWG) 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 this
topic is expected.

In June 2023, the ISSB issued two standards: (1) IFRS

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

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
Financial Stability a source of information for authorities looking to assess
Board (FSB) micro- and macroprudential 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
the Financial System
exercise, the results of which were published in May 2023.
(NGFS)
In that document, they highlighted two key priorities 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

International a workstream on transition plans that will consider the role
Organization of of securities regulators with respect to transition-plan
Securities disclosures. They also endorsed the two inaugural ISSB
Commissions standards, calling on its 130 member jurisdictions to
(IOSCO) consider ways in which they might 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
requirements for climate-related financial risks. The draft
Basel Committee on
text includes a requirement to disclose the effects of
Banking Supervision
material climate-related financial risks on its strategy and
(BCBS)
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

International
2022, launched a set of voluntary Transition Finance
Platform on
Principles, followed by an interim report on their
Sustainable Finance
implementation in 2023. They strongly emphasise the
(IPSF)
importance of transition plans as a building block of
Organization Description

transition finance and recommend that the ISSB 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’s
Australia 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).

In the EU, the Corporate Sustainability Reporting Directive requires

companies to disclose 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
European put into effect plans to transition their business to align with the
Union (EU) 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
United Transition Plan Disclosure Framework that enables companies to
Kingdom (UK) prepare and disclose robust and credible plans. The Disclosure
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
 Financial Sector Groupings

Jurisdiction Description

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, and insurers. These
Singapore
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 commitments of financial
United States
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 CO2 emissions by 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 (CO2), methane (CH4), and nitrous oxide (N2O), are
typically the focus 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 CO2e by weighting the emissions of
individual gases with their Global Warming 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 CO2e

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 2, CH4, and N2O
emissions (note, emissions factors may be in kilograms or grams and
should be converted to metric tonnes). These emissions are converted into
CO2 equivalents using their respective GWPs (1 for CO2, 28 for CH4, and 273
for N2O), resulting in a combined impact of 31,869 mt CO 2e, which reflects
the potential warming effect of the gases emitted. GWPs are often
presented in ranges depending on estimation methods used (e.g. N 2O as
265-298). This basic 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
Real-Economy
Capital mobilized dedicated to Paris-aligned
Transition
assets

Number of sustainable aviation

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

Quantifies the expected impact

Expected Emissions Expected emission
of investments on emissions
Reduction (EER) reduction
reductions

Total GHG emissions

Portfolio/Financed
Absolute emissions associated with the investment
Emissions
portfolio
 Area Metric Examples

Emissions relative to a financial

Portfolio/Financed Intensity-based
parameter (e.g., revenue,
Emissions metrics
invested capital)

Development and offering of

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

Proportion of senior
Senior management
Plan Execution management equipped with
contribution
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.