The External Reporting Board (XRB) has published its Staff Guidance for Entity Scenario Development (Guidance).
This Guidance will help climate reporting entities (CREs) with their scenario analysis process, one of the requirements of the Aotearoa New Zealand Climate Standard 1 (NZ CS 1).
The Guidance is available here.
Who should read this? Why?
The XRB has written this helpful Guidance for almost anyone that may be involved in the scenario analysis process– from directors and C-suite of CREs, to the internal project champion and others strategy team at CREs to participants undertaking the analysis on the ground. The Guidance is also aimed at external service providers to a CRE and those requesting such support.
Users of climate reporting should also read this document to help them understand a CRE’s disclosures reading its scenario analysis and what those disclosures actually mean for them and for the CRE.
What does it cover?
A key message is that climate change will be central to an entity’s overall business strategy. The XRB says:
climate-related scenario analysis asks difficult questions about an entity’s ability to operate, generate sustainable revenues, protect its assets, limit its liabilities, and finance itself, in a rapidly changing world. … For most entities, the scenario analysis process is expected to raise existential questions, which other types of analysis can fail to reveal, and which a stand-alone plan cannot properly address. The insights gained from this exercise will inform the entity’s strategic repositioning, and the transformation the entity will need to initiate to become low-emissions and improve its climate resilience.
The Guidance has six sections that align with the six-step scenario analysis process recommended by the Task Force on Climate-related Financial Disclosures (TCFD).
Each section includes:
- Summary of key outputs to document
- Conditions for a successful process
- Recommendations about the use of sector scenarios
- Considerations for MIS managers
- Tips on how to leverage the thinking for future work
We summarise these six sections below.
Step 1: Engage stakeholders and prepare an effective group
As climate change is central to a CRE’s overall strategy, the scenario analysis process must be mapped out with contributions from stakeholders across the board, both internal and external. The process should have a clear mandate from the highest governing body and a clearly documented project charter identifying roles and responsibilities and objectives.
Before the process can begin, scenario participants need to understand the implications of climate change and the climate context the CRE and its stakeholders are operating within.
Step 2: Define the problem
Defining the ‘focal question’ and the CRE’s value chain and system boundaries will set the parameters within which the scenario analysis process is undertaken.
The XRB says that using sector-level scenarios will be useful to define the scope of the scenario analysis and time horizons, but these scenarios should be tailored for the CRE’s specific circumstances.
Step 3: Identify driving forces and critical uncertainties
Driving forces are “broad-scale external factors that may affect the outcomes of the focal questions” (for example, rising transport costs and new carbon taxes) and must be considered when creating climate-related scenarios. Sector-level scenarios will likely have a documented list of driving forces for CREs to refer to.
The most influential and most uncertain driving forces will become the CRE’s critical uncertainties. The different ways in which these critical uncertainties could play out will be the key differentiating characteristics between scenarios.
Step 4: Select temperature outcomes and emissions pathways
Not only do CREs need to define each scenario by a temperature outcome, but the scenarios also need to describe the emissions pathway taken to reach that temperature outcome – often the pathways are where the critical uncertainties lie.
When defining the scenarios by temperature outcomes and emissions pathways, the XRB highlights that CREs should not take the sector scenarios at face value but rather a baseline to build on using the CRE’s own analysis.
An interesting condition for success the Guidance suggests for this step is tasking at least one participant (the ‘black hat’) to challenge existing value chains and business models to avoid ‘groupthink’ and keep discussions open.
Step 5: Draft narratives and quantify
When drafting narratives, CREs can use scenario archetypes already done by various international organisations, but with caution, and supplemented by entity-specific information.
The XRB says the scenario narratives are not lists of assumptions, but instead “a richly developed and evocative ‘movie of the future’”. Appropriate aspects of each narrative should be quantified (not just financial impacts) to evaluate the CRE’s strategic resilience.
Step 6: Assess strategic resilience
This step requires robust quality checking and interrogation of each scenario as to the implications for the CRE’s strategy and business model.
From there, participants can draft strategy options to increase the CRE’s climate resilience. The XRB says this is an integral part of scenario analysis, but a fully formed strategy and implementation plan is not expected.
The Guidance suggests a key output of a plan for reviewing and reiterating the CRE’s scenario analysis, noting that disruptive change may trigger a need for high-level revision.
Guidance for MIS managers
The XRB includes a specific note to MIS managers given their unique climate-related disclosure (CRD) requirements for each separate fund. The scenario analysis process does not necessarily need to be undertaken for each separate fund in isolation. Rather, the Guidance states that funds can be grouped based on similar characteristics and therefore exposures to climate-related risks and opportunities.
Further, the XRB acknowledges that it may be more efficient for MIS managers to think at a higher level than fund level during the scenario analysis process, in order to assist with making long-term strategic decisions for managing climate-related risks and opportunities.
Our view
The Guidance is yet another useful and easy to read guide from the XRB. It recognises that it will take collaboration across a wide range of different roles and responsibilities with the CRE to undertake a successful scenario analysis process. Climate-related risks and opportunities will affect CREs as a whole and therefore must be addressed at all levels, not just at board level.
The XRB explains that the Guidance is to assist CREs with their scenario analysis process, rather than the disclosures of scenario analysis. But of course, the process forms the basis of what is reported in CREs’ climate statements, so it is very important to get it right. We recommend reading this Guidance in its entirety, for it contains many helpful outputs and conditions for success.
Earlier this year, the FMA released a scenario analysis information sheet – our previous alert on this information sheet is available here.
That information sheet is focused on the FMA’s expectations in monitoring and enforcing the CRD regime. It provides high-level principles and discussion of the disclosure of scenario analysis, rather than the process itself as in the present Guidance.
This Guidance and the FMA’s information sheet should be read in tandem.
What next?
The XRB has said it will be running a series of webinars to support the Guidance.
We will continue to provide updates on any guidance documents that are released to help CREs with their climate reporting.
If you have any questions about the Guidance, NZ CS-compliance or any related CRD matters, please contact one of our experts.
This article was co-authored Hannah Cross, a Solicitor in our Financial Services team.
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