Integrating climate-related risks and opportunities

Actions

• As part of the strategy disclosure, fund managers could explain the impact that it has had on product development and mandate design.
• Explain whether the impact of climate-related scenarios on future outcomes has been considered as part of the investment process, both in terms of expected risk and return and the identification of new opportunities (see “Scenario analysis” box below).
• Describe the process and outcomes from engaging with companies and other investee entities on climate-related risks and opportunities.
• Provide details of voting records on climate-related resolutions (if applicable).

Actions

• As part of risk management disclosure, managers should report on the higher risk companies that do not intend to report on climate-related risks and opportunities in line with the TCFD recommendations (to highlight the need to escalate engagement efforts).
• If scenario analysis is undertaken, disclose the process, assumptions, conclusions and actions that arose from the analysis, including the overall resilience of the portfolio to a 2°C or less scenario.
• Related to the above, describe the assessment of the companies and/or assets most at risk from transition and physical impact risks, under what climate scenario, and over what timeframe.
• Explain how these risks are being managed, monitored and mitigated.

Actions

• Provide, at a minimum, GHG emissions on an annual basis, in line with the TCFD recommendations.
• Describe any additional metrics or standards that have been applied to the investment process and reporting frameworks.
• Explain the chosen methodology and rationale, including any assumptions and shortcomings.
• Describe how these metrics have affected investment decisions and internal processes (including engagement activities and valuations of investee entities).
• Disclose any climate-related goals or targets that the organisation has adopted.
• Explain how progress against these goals is being monitored and reported over time.

Useful resources for integrating climate change into investment processes:

PRI resources on ESG integration across asset classes

including:

• listed equity
• fixed income
• private equity
• infrastructure
• property

PRI resources on selecting, appointing and monitoring managers

PRI resources on climate change

World Bank and GPIF (2018) Incorporating ESG into Fixed Income Investment

FSB TCFD (2017) Final Report: Recommendations on Climate-related financial disclosure

IGCC, ClimateWorks and RIAA, Assessing Climate Change Risks and Opportunities for Investors: Property and Construction Sectors

QIC (2017) Climate Change: Building Resilience in Infrastructure Assets

OECD (2018) Integrating Climate-related factors in Institutional Investment

Acclimatise (2018) Lenders Guide for Considering Climate Risk in Infrastructure Investments

Scenario analysis

Scenario analysis featured in the TCFD recommendations, raising a number of questions for investors about how this can be embedded into investment processes. What is scenario analysis? As the TCFD report noted, scenario analysis is “a process for identifying and assessing the potential implications of a range of plausible future states under conditions of uncertainty”. The TCFD noted that scenarios are not designed to deliver precise outcomes or forecasts; rather, in the case of climate change, it is a process that “allows an organisation to explore and develop an understanding of how various combinations of climate-related risks, both transition and physical risks, may affect its businesses, strategies, and financial performance over time.”

Why is this relevant for investors? As with other investment issues, there is a high degree of uncertainty about how future climate change scenarios could play out and their likely investment impact. For those companies and assets with high exposure to the transition and physical risks of climate change, the impact on future expected earnings could be significant, depending on how the transition plays out. In aggregate, this could have a meaningful impact on financial returns at the asset and portfolio level.

Investors need to adopt a systematic approach to analyse these potential impacts, drawing on the latest evidence and future possible scenarios to support a well-informed and considered assessment, including (but not limited to) the 2°C or less outcome that governments around the world have committed to achieving via the Paris Agreement. What do investors need to do? Scenario analysis will already be a feature of some investors’ strategy and risk management processes, particularly in regard to considering economic and political scenarios, whereas other investors may not currently use scenario analysis or stress testing as part of the investment process at all.

There are some simple and straightforward steps that investors can take to get started on the journey, including:

• Become familiar with the TCFD climate-related recommendations, including the technical guidance on scenario analysis.
• Keep it simple! Consider starting with a qualitative framework and build out to consider more quantitative outcomes when the knowledge, expertise and familiarity with the processes builds amongst the board and management team.
• Become familiar with the tools and research around how climate scenarios can be used in practice.
• Have a clear game-plan agreed in terms of how the scenario analysis process will be overseen (governance arrangements), and how it will feed into investment strategy and risk management processes on an ongoing basis.

Further information, examples and resources on utilising scenario analysis as part of investment processes are provided in the PRI’s An asset owner’s guide to the TCFD recommendations.