Creating climate scenarios that serve the needs of the financial system is challenging. They are needed to understand the potential economic and financial impact of transitioning to a low-carbon and resilient economy. To be of use to the sector, scenarios need to be able to both describe the impact of emissions reduction on the financial resilience and investment needs of individual economic agents, so that risks can be assessed, but also set out a future where capital can be allocated in a way that solves the climate problem.
Climate financial scenarios are a new concept and a holistic framework for creating them does not yet exist. In addition, the topics they seek to address are complex and outside of observed economic history and not always easy to explain with established models and data. Finally, there is considerable uncertainty surrounding the actions the world might take to lower emissions, which makes it difficult to define plausible scenarios.
Scenarios can help with multiple activities, ranging from business planning to risk management, and users will have their own starting point, perspectives and requirements. This paper, a collaboration between HSBC and Grantham Institute seeks to capture some of these perspectives and constructs a framework that different users within a firm can use as they start to implement climate scenarios and analyse results. It lays out the steps required to bridge the gap between the policy actions and technological choices that drive emissions reduction and the resulting impact on the operating and financial conditions of economic agents. It discusses the need for different models and methods to overcome issues of complexity and uncertainty and stresses the value of qualitative analysis and a rich narrative before embarking on scenario modelling.