Table 1 1

Climate scenario analysis focus areas and future enhancements

Table 1 – Climate scenario analysis focus

areas and future enhancements

Focus area Future enhancements

1. Scenario generation
Scenario scope: a range of scenario time horizons need to
be considered to capture the emergence of both short
and long-term risks. This will enable scenario analysis to
better inform strategy and business and transition planning.
Greater consideration of 1.5°C scenarios is also required,
reflecting the substantial difference in physical risk impacts
between 1.5°C and 4°C futures.
1.1 P rovide greater consideration of short-term scenarios
with immediate impacts over the next few years
which allows for alignment with business planning
horizons.
1.2 Offer real time physical event tracking, e.g. hurricanes,
and corresponding estimated financial impacts.

Scenario integration: growing focus on integration of 1.3 P

 roduce fully integrated, self-consistent scenarios,
physical and transition risk assessments. Some tools cover including physical and transition risk.
both physical and transitions risk, but internal scenario
consistency is limited, using separate models with similar
temperature pathway narratives.

Macro-economic expansion: to tailor the scenarios to 1.4 E

 xpand macro-economic detail for published and
their business and gain firm-specific insights and impacts, bespoke scenarios, including sector and country-level
banks need to build on published climate scenarios, overlays.
or enrich their own bespoke scenarios with detailed
macro-economic data. This includes paths for interest rates,
inflation, asset markets, real estate prices and labor
markets, coupled with sector and ­country-level overlays.

2. Impact quantification
Tail risk coverage & probability: despite a high degree of coverage 2.1 Model different within-scenario event probabilities as
across different ‘RCP’ physical risk scenarios, there has been sensitivity analysis, e.g. leveraging catastrophe models
limited ‘within scenario’ coverage of the uncertainty / volatility of from the insurance space.
estimates. A ‘point estimate’ is often supplied with a scenario,
which obscures the degree of uncertainty even within a single
temperature pathway. Physical risk events can be ‘fat tailed’,
meaning there is merit in conducting sensitivity analysis
on extremes, as well as simply taking scenario averages when
modelling a physical risk pathway. The PRA Dear CEO letter
(October 2022) highlights the need for firms to quantify the
impact of these tail events.

© 2023 KPMG AG, a Swiss corporation, is a subsidiary of KPMG Holding AG, which is a member firm of the KPMG global organization of
independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. All rights reserved.
 Table 1 2
Climate scenario analysis focus areas and future enhancements

Table 1 – Climate scenario analysis focus

areas and future enhancements (continued)

Focus area Future enhancements

Breadth of risk coverage and second-order effects: 2.2 Include quantitative mechanisms for assessment of
current tools typically do not provide comprehensive nature-related and market-based risks in the context of
coverage of all the risks that may manifest due to climate scenario analysis.
risk. The ECB 2022 thematic review on climate-related and
environmental risks (November 2022) noted that most risk
assessments by banks were not comprehensive across
drivers, geography and time horizons. For example, it found
that impacts of biodiversity loss, water stress and other
­natured-related risks, which can have significant second and
third-order economic effects, were not adequately
considered by banks. Failure to consider second-order
effects creates potential for a significant underestimation
of climate risk impacts.

Data gaps: a need for more granular data, including physical 2.3 E
 xpand coverage and granularity of scope 1,
asset data, emissions data and transition plan assessment 2 and 3 emissions data.
data. There has been an increasing degree of partnership 2.4 E
 nhance transparency around the use of proxies
between tool providers and data providers, increasing where real data is unavailable.
coverage of scope 1, 2 and 3 emissions data, which is a 2.5 C
 ollaborate with data providers to enhance granularity
positive development. and coverage.

3. Response evaluation
Output interpretation: banks require interpretability of 3.1 P
 rovide auxiliary text, graphs and heatmaps
outputs from tool providers relating to quantified impacts of to supplement quantitative risk outputs.
physical and transitions risk. Some providers have started 3.2 S
 upply enriched bespoke scenarios including
supplying auxiliary text, graphs and heatmaps to supplement metadata
quantitative risk outputs to facilitate the interpretability of
outputs. In terms of climate scenarios, the majority of
climate risk tool providers use a combination of IPCC, IEA
and NGFS scenarios, with enriched metadata to help
interpret the output. This richness of metadata is also less
readily available for bespoke climate scenarios.

Model documentation: banks require a high degree of 3.3 P

 rovide detailed model documentation sufficient
methodological transparency, documentation and control for model validation
regarding their models to perform the necessary 3.4 S
 upply test results or sufficient access to perform
independent validation and sensitivity analyses. Model testing covering data, methodology and
documentation needs to be in line with the US Fed implementation
and OCC’s SR11/7 guidance on model governance.

© 2023 KPMG AG, a Swiss corporation, is a subsidiary of KPMG Holding AG, which is a member firm of the KPMG global organization of
independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. All rights reserved.