2024 is the year when CSRD will be on everyone’s lips in business. The new requirements for sustainability reporting are challenging. One of 2050’s foremost experts on the subject, James Hennessy, elaborates on a problem that many companies will encounter, i.e., if their current climate-related risk and scenario analyzes are ready for CSRD.
“The undertaking shall explain how it has used climate-related scenario analysis, including a range of climate scenarios, to inform the identification and assessment of physical risks and transition risks and opportunities over the short‑, medium- and long-term.” — ESRS E1, Paragraph 21
What is climate-related scenario analysis and how is it incorporated into the ESRS?
The Corporate Sustainability Reporting Directive (CSRD) entered into force in January 2023. Companies subject to the CSRD start reporting according to the European Sustainability Reporting Standards (ESRS) in 2025 (for the 2024 year).
The ESRS specify the content that should be included in the disclosures and is largely based on existing sustainability reporting frameworks, standards and guidelines, including but not limited to the Taskforce on Climate-related Financial Disclosures (TCFD) Recommendations.
While the specific Disclosure Requirements that are applicable to a reporting entity will be driven by the entity’s Double Materiality Analysis, most large companies will likely conclude that Climate Change is a material topic. This makes the ‘ESRS E1 — Climate Change’ Topical Standard a key focus for many of our clients.
Climate-related scenario analysis is a climate-focussed ‘process for identifying and assessing a potential range of outcomes of future events under conditions of uncertainty.’ (ESRS Annex II). A well planned and executed scenario analysis process ‘helps companies in making strategic and risk management decisions under complex and uncertain conditions…thus contributing to the development of greater strategy resilience and flexibility[1]’.
The ESRS specify that a reporting company shall (non-exhaustive)[2]:
- Explain how it has:
- Used climate-related scenario analysis, including a range of climate scenarios, to inform the identification and assessment of physical risks and transition risks and opportunities over the short‑, medium- and long-term (ESRS E1, Paragraph 21)
- Defined short‑, medium- and long-term time horizons and how these definitions are linked to the expected lifetime of its assets, strategic planning horizons and capital allocation plans (ESRS E1, AR 11)
- Identified physical hazards and transition events and screened whether its assets and business activities (i.e. Value Chain) may be exposed to these events and hazards over the short‑, medium- and long-term (ESRS E1, AR12-AR15)
- Assessed physical hazards (informed by high emissions climate scenario(s)) and transition events (informed by scenario(s) consistent with the Paris Agreement & limiting climate change to 1.5°C with no or limited overshoot) (ESRS E1, AR12-AR15).
- Disclosure its:
- Material impacts, risks and opportunities (ESRS 2, Paragraph 46)
- Anticipated financial effects from material physical and transition risks and potential climate-related opportunities, including the proportion of assets at material risk (i) before considering climate change adaptation and mitigation actions, and (ii) addressed by climate change adaptation and mitigation actions (phased-in, not required in Year 1) (ESRS E1, Paragraph 64–67).
[1] TCFD (2020), Guidance on Scenario Analysis for Non-Financial Companies, October 2020.
[2] Below includes reference to some Disclosure Requirements in ‘ESRS 2: General Disclosures’, given the requirements in the ‘ESRS E1 – Climate Change’ Topical Standard ‘should be read and applied in conjunction with the disclosures required by ESRS 2’
Why will companies struggle to meet the climate scenario analysis-related ESRS Disclosure Requirements?
Meeting the climate scenario analysis-related ESRS Disclosure Requirements will be a challenge and risk for many companies, as a majority of companies:
- Are not currently reporting in-line with TCFD recommendations (TCFD directly informs, or aligns with, many of the climate-related ESRS disclosure requirements), which leaves little time to implement and refine ESRS-aligned climate-related scenario analysis. For example, 2050’s Transparency Index 2023 , found that less than half (47%) of companies listed on the Stockholm Stock Exchange report according to TCFD guidelines
- That have started to implement TCFD and/or climate-related risk and opportunity assessments either do not report, or have difficulty implementing, scenario analysis-related disclosures, such as the ‘resilience to strategy’ disclosure. For example, research published by TCFD in the TCFD 2023 Status Report indicates that ‘resilience to strategy’ is the:
- Least reported — Least reported of all the TCFD recommended disclosures in 2022 (11% of companies in the review population with TCFD-aligned disclosures).
- Most difficult — Most difficult to implement of all the TCFD recommended disclosures, with 88% of companies in the review populating indicating that this was either ‘very difficult’ or ‘somewhat difficult.’
How can you work towards making your climate-related scenario analysis CSRD-ready?
To progress towards ESRS-aligned climate scenario analysis, companies should (non-exhaustive):
- Identify key internal (and external) stakeholders to involve in the process, with a focus on incorporating a broad range of complementary perspectives from a variety of business functions (e.g. Sustainability, Procurement, Supply Chain, Operations, Product Development, Sales & Marketing, Risk, Accounting & Finance)
- Understand and map their Value Chain (i.e. the ‘full range of activities, resources and relationships related to the undertaking’s business model and the external environment in which it operates…from conception to delivery, consumption and end-of- life’ (ESRS Annex II))
- Select an appropriate range of climate-related scenarios, which, at a minimum, align with ESRS requirements (i.e. a high emissions climate scenario(s) and scenario(s) consistent with the Paris Agreement and & limiting climate change to 1.5°C with no or limited overshoot)
- Identify and consider a broad range of transition events (e.g. covering Policy & Legal, Technology, Market and Reputation-related transition events) and physical hazards (e.g. covering a range of acute and chronic climate-related hazards), taking a Value Chain-wide perspective
- Assess materiality of climate-related risks and opportunities, taking into account Value Chain-specific assumptions and outputs from the chosen climate-related scenarios and, where possible, applying existing in-house enterprise risk management frameworks, risk thresholds and processes
- Define, agree and implement risk-based climate change mitigation and adaptation policies, targets and action plans, including making appropriate CAPEX and OPEX provisions.
- Be transparent, including limitations of the scenario analysis process adopted.
The above will make you more CSRD-ready and, for CDP reporters, may also improve your CDP score.
So, is your climate risk and scenario analysis process CSRD-ready?
James Hennessy, senior consultant, 2050