Yesterday, the Financial Markets Authority (FMA) released its scenario analysis information sheet (Information Sheet), which details its compliance expectations for scenario analysis disclosures required under the climate-related disclosures (CRD) regime.
Who should read this? Why?
All Climate Reporting Entities (CREs) and directors and officers of CREs should read this Information Sheet.
The Information Sheet sets out:
- how the FMA will apply the CRD framework relating to scenario analysis;
- what the FMA will look for when determining compliance with those standards; and
- other considerations that may help CREs ensure they meet the disclosure requirements.
What does it cover?
The External Reporting Board’s (XRB) Aotearoa New Zealand Climate Standard 1: Climate-related Disclosures (NZ CS 1), issued as part of the CRD regime, requires CREs to undertake scenario analysis and disclose how the process was conducted.
Broadly, the Information Sheet is focused on communicating the FMA’s compliance expectations in monitoring and enforcing the CRD regime in respect of both the scenario analysis process employed and the climate-related scenarios analysed by CREs.
Application to ‘scenario analysis process’
Scenario analysis is defined in NZ CS 1 as “a process for systematically exploring the effects of a range of plausible future events under conditions of uncertainty”.
The Information Sheet describes how the FMA will apply the definition of “scenario analysis” when assessing whether a CRE’s disclosure about the process it undertakes is in accordance with the CRD framework.
The FMA considers that ‘systematically’ suggests CREs should be, at a minimum, undertaking a series of active measures as part of their process, “with a clear series of steps in an organised manner, to explore the effects of a range of plausible future events under conditions of uncertainty.”
The FMA considers the phrase “exploring…under conditions of uncertainty” means that CREs should be taking an exploratory, not a normative (or predictive), approach to scenario analysis. An ‘exploratory approach’ involves exploring how different futures could plausibly play out from the present to the chosen time horizon, rather than a ‘normative approach’ which would involve starting with a desired outcome and working backwards to the present.
In the FMA’s view, constructing climate-related scenarios using a set of parameters and assumptions is consistent with an ‘exploratory approach’ because there are multiple pathways that could align with different temperature outcomes.
Application to ‘climate-related scenarios’
In their climate statements, CREs must explore what climate-related risks and opportunities they will face in a 1.5°C climate-related scenario, a 3°C or greater climate-related scenario, and a third climate-related scenario of choice.
Climate-related scenario is defined in NZ CS 1 as “a plausible, challenging description of how the future may develop based on a coherent and internally consistent set of assumptions about key driving forces and relationships covering both physical and transition risks in an integrated manner.”
The FMA sets out in its Information Sheet how it will assess whether a CRE’s description of its scenario narratives meet the definition of “climate-related scenario”. We summarise the FMA’s expectations (at a high-level) below:
|“How the future may develop”||
CREs should describe one plausible and challenging pathway leading to a certain future, rather than a range of possibilities.
Scenarios should avoid use of the words “may”, “could” or “likely” and instead use “results in” (or similar cause-and-effect language).
The pathway should be possible, believable, and reasonable in the context of the scenario’s temperature outcome.
For this to occur, CREs should include sufficient detail in narratives to explain how, and by when, events occur, and the material impacts of each event.
|“Challenging”||CREs need to “think outside the box” and explore assumptions that will challenge ‘business-as-usual’ thinking, and conventional wisdom, when constructing climate-related scenarios.|
|“Coherent and internally consistent”||Assumptions about climate impacts must be connected by cause-and-effect, and related to one another (and not mutually exclusive).|
|“Key driving forces and relationships”||
External factors that persistently influence the trends and patterns that determine an outcome within a scenario.
Assumptions based on STEEP (social, technological, environmental, economic and political) factors are likely to form the basis for these driving forces.
|“Physical and transition risks in an integrated manner”||Scenarios should not be constructed to consider either physical and transition climate-related risks in isolation. The interplay between each, including the flow on effect of impacts, should be explored.|
The Information Sheet makes clear that a CRE is required to undertake scenario analysis to help identify “its” climate-related risks and opportunities, meaning the scenarios must be relevant to the CRE’s own operations, business model and strategy.
How a climate-related scenario is relevant to a CRE will depend on the circumstances of each CRE, including the industry and geographic location the CRE operates in, and any other specific characteristics relating to its operations.
The Information Sheet has a ‘FAQs’ section where the FMA answers a variety of questions related to a number of relevant topics including:
- sectoral scenario analysis;
- quantification of scenarios and modelling;
- scenario analysis process;
- relationship with other disclosures; and
- scenario analysis for Managed Investment Scheme managers.
Scenario analysis is a new concept for most entities in New Zealand and it is one of the more complex aspects of the CRD regime. Accordingly, we welcome this Information Sheet from the FMA setting out the FMA’s compliance expectations.
Although the Information Sheet does not address the technical nature of the analysis underpinning these disclosures, the FMA’s detailed interpretation of ‘scenario analysis’ and ‘climate-related scenario’, and the FAQs section, will be useful to CREs.
In preparation for releasing climate statements, the first being released in early March or April 2024, we recommend CREs read this Information Sheet in tandem with the following XRB’s guidance notes:
- Scenario analysis: Getting started at the sector level
- Climate-related Disclosures Staff Guidance: Guidance for All Sectors
Financial institutions and NZX-listed companies which are CREs should also consider the Climate Scenario Narratives for the Financial Services Sector Report released by the Financial Services Council earlier this year.For our recent articles on the CRD regime please see below:
- Proposed exemption for climate-related disclosures timing challenge
- FMA releases further climate disclosure guidance
- MBIE publishes exposure draft for the climate-related disclosures regulations
If you have any questions about the Information Sheet or about the CRD regime generally, please contact one of our experts.
This arcticle was co-authored by Hannah Cross, a law clerk in our Banking and Financial Services team.
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