Scenario analysis: Investors need to become comfortable with “less robust climate data and disclosure”

TCFD guide published by the new Investor Leadership Network

Investors need to become comfortable with “less robust climate data and disclosure” if they want to make progress with the key scenario analysis elements of the Taskforce for Climate-related Financial Disclosures (TCFD) framework, according to new guidance from an international group of institutional investors.

That’s one of the pieces of advice in a new TCFD guide published by the new Investor Leadership Network (ILN) comprising the likes of the Ontario Teachers’ Pension Plan, CalPERS, Aviva and PGGM. They say the “state of disclosure should not drive decisions to do or not do scenario analysis”.

TCFD Implementation: Practical Insights and Perspectives from Behind the Scenes for Institutional Investors’ shares the experiences of the 12 ILN investors on getting to grips with the TCFD.

Investors, the document says, are keen to see “some kind of industry consensus” or a common approach to scenario analysis.

Many of the investors, it adds, are currently working to develop their own in-house scenario analysis methodology.

But because it is still “early days” and there are still “many questions” on scenario analysis the report believes scenario analysis should not be treated as “an easy off-the-shelf-one-off approach”.

The report cites the Paris Agreement Capital Transition Assessment (PACTA) tool, created by 2 Degrees Investing Initiative (2Dii) with the support of the Principles for Responsible Investment (PRI) as an example of an “off-the-shelf” tool.

Such tools, the guide argues, are often “highly complex” with “questionable” data quality that is “clouded by assumptions that can stifle real-life investment application”.

In March, RI reported that Danish labour market pension fund giant ATP had raised similar concerns about tools like PACTA when it launched its own internal climate scenario analysis project.

“The report makes clear those working on climate scenario analysis need to do better at informing users on data quality and what the challenges are with regard to data, notably related to the complexity of mapping corporate relations”, said Jakob Thomä, Managing Director at 2Dii.He compared scenario analysis to a “moody teenager” that is “not quite ready to stand on its own feet maybe, somewhat confused as to its final identity, but old enough to sit at the table”.

2Dii is currently in the process of “revamping” its Transition Monitor application to create more clarity on these issues and improve usability, Thomä told RI.

Scenario analysis will become a mandatory part of the PRI reporting assessment for signatories in 2020 and PACTA, as the first freely available, off-the-peg tool, is likely to be a popular option, particularly among investors with limited resources.

Barbara Zvan, Chief Risk and Strategy Officer at OTPP, described scenario analysis as “the hardest, most challenging part” of the TCFD, one that needs to be experimented with and given time to mature.

She added that we “shouldn’t expect people to get the scenario analysis stuff done first” and stressed that the other parts of the TCFD “bring huge value too”.

The report also reveals that much of the scenario analysis done so far has tended to focus on the asset level rather than the portfolio level.

Such an approach, the guide warns, could, however, be “myopic” and miss “the structural impacts [of climate change] on the (global) economy as a whole”.

The report also adds that investee companies are in the best position to conduct their own scenario analysis, with the investors concluding that it is “just too complicated for investors to obtain reliable data”.

But translating companies’ TCFD reports into investment decisions was “challenging” the report says.

The new guide also nods to the debate about the data that should underpin climate scenarios, stating that “there is a lack of guidance on the best source to use for transition risks and our respective strategies”.

International Energy Agency (IEA) scenarios, which are mentioned in the guide and are used by PACTA, have been criticised for being too fossil fuel friendly. This is something the PRI is trying to address with its Inevitable Policy Response initiative.

The ILN was set up in 2018 with a working group, following Canada’s G7 presidency, to help implement the TCFD. The remaining investor members are Aimco, Allianz, CDPQ, CPP Investment Board, Generali, Natixis, OMERS and OP Trust.