®

@GARP
SCR I Sustainability and Climate Risk

2024
®

CERTIFICATE
Sustainability and
Climate Risk Exam

@Pearson
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Contents

1.11 Mitigation 19
Chapter 1 Foundations of 1.12 Geoengineering 22
Climate Change: 1.13 Mitigation Targets 23
What Is Climate Summary 24
Change? 1
References 25
Questions 27
Introduction to the Problem 2 Answers 29
Observations of Climate Change 4
1.1 Modern Climate Change 4
1.2 Climate Change before Humans 5
Chapter 2 Sustainability 31
Causes of Climate Change 6
1.3 Energy Balance 6
1.4 T he Greenhouse Effect 7 Sustainability 32
1.5 How Humans Are Changing 2.1 Introduction to Sustainability 32
the Climate 7 2.2 Sustainability, ESG, and
1.6 Attribution of Modern Warming 10 Climate Change 33
1.7 Summary Statement on Attribution 2.3 Sustainable Development Goals
of Modern Warming 11 (SDGs) and the 2030 Agenda 34
2.4 Ecosystem Services & Natural
Future Warming 12 Capital 39
1.8 Shared Socioeconomic Pathways 12
2.5 Sustainability at Corporations and
1.9 Impacts of Modern Climate Change 14 Financial Institutions 40
Policy Responses 17 2.6 Private-Sector Sustainability
1.10 Adaptation 18 Coalitions and Frameworks 45

iii
 References 48 4.3 Climate Risk and Financial Policy 85
4.4 Climate Risk and Financial
Questions 49 Supervision 89
Answers 50 4.5 Private-Sector Sustainability and
Climate Risk Frameworks 91
4.6 Nature, Biodiversity, and Climate
Chapter 3 Climate Change Change 92
Risk 51 4.7 Broader Societal Implications and
Conclusions 93

References 95
Climate Change Risk 52
3.1 Introduction to Climate Risk 52
Questions 96
3.2 Types of Climate Risk 53 Answers 97
3.3 Physical Risks 55
3.4 Transition Risks 61
3.5 Stranded Human Capital and the Chapter 5 Green and
Just Transition 66
Sustainable
3.6 Transmission into Finance, the
Economy, and Key Sectors 67
Finance: Markets
and Instruments 99
References 69
Questions 71
Answers 72 Green and Sustainable Finance:
Markets and Instruments 101
5.1 Introduction to Green
and Sustainable Finance 101
Chapter 4 Sustainability and 5.2 Trends and Flows in Sustainable
Climate Policy, and Climate Finance 101
Culture, and 5.3 Sustainable and Green Financial
Products and Instruments 104
Governance 73
5.4 ESG and Climate Integration
in Investing 110
5.5 Existing and Emerging Definitions
Sustainability and Climate Policy,
and Taxonomies 115
Culture, and Governance 75
5.6 Conclusions and Prospects 117
4.1 Introduction to Sustainability and
Climate Policy, Culture, and References 118
Governance 75
Questions 120
4.2 International Sustainability and
Climate Policies 75 Answers 122

iv ■ Contents
 7.3 Scenario Parameters and
Chapter 6 Climate Risk Applications to Physical and
Measurement and Transition Risk 162
7.4 Scenario Analysis Use Cases:
Management 123 Corporate 168
7.5 Scenario Analysis Use Cases:
Finance & Investment 168
Climate Risk Measurement and
7.6 Conclusions 170
Management 124
6.1 Introduction to Climate Risk References 172
Measurement and Management 124
Questions 173
6.2 Introducing Climate Risk
Transmission: Micro and Macro Level 126 Answers 175
6.3 Micro (Company-Level) Climate
Risks 128
6.4 Macro Climate Risk: Systemic Chapter 8 Net Zero 177
Risk and Financial Stability 132
6.5 Climate Risk Measurement:
Data and Analysis 135 Net Zero 179
6.6 Climate Risk within Enterprise 8.1 Introduction to Net Zero 179
Risk Management 141 8.2 The Spread of Net-Zero
6.7 Conclusions 147 Targets 181
References 147 8.3 The Implications of Net Zero
for Different Actors 185
Questions 148 8.4 Transition Plans 189
Answers 149 8.5 Interim Targets and
Pathways 192
8.6 Use of Metrics 195
Chapter 7 Climate Models 8.7 Reporting 200
and Scenario 8.8 Conclusion 201
Analysis 151 References 202
Questions 205
Climate Models and Scenario Answers 206
Analysis 152
7.1 Introduction to Scenario Analysis 152 Glossary 207
7.2 Global Reference Scenarios 155 Index 213

Contents ■ v
 PREFACE
To our SCR Candidates:
In a very short time, sustainability and climate risk­
management issues have started to up-end economies and
drive financial institutions, companies, and governments to
develop strategies to prepare for climate change.
Assessing climate risks and developing scenario analyses
of the physical adjustments, transitions costs, and financial
implications that will accompany climate change requires
a broad-based understanding of science and an analysis of
related risks. This is especially true as global economies and
institutions move from carbon-based economies to those
driven by sustainable energy sources.
Real economy and energy firms have focused intensely on
the physical and transition consequences of climate change
to assets, supply chain, and operations, among other areas.
Financial institutions are focusing heavily on the costs of
transition, evolving policy, regulations, financing, credit, and
global macroeconomic outlooks.
Building strategies to prepare for climate change neces­
sitates recognizing and understanding the broad number of
threats and opportunities it presents. Understanding how
related risks interconnect presents numerous and unique
challenges.
vi ■ Preface
Integrating climate factors into a business strategy requires
the company to ensure that all its major functional areas
have trained personnel to test climate strategies' resiliency
and effectiveness.
Climate risk is complex for institutions, investors, analysts,
and the global regulatory community. Data is still a chal­
lenge. Related analytics can be misleading, or so uncertain
as to affect transactional due diligence, risk exposure calcu­
lations, or even reporting requirements.
GARP's Sustainability and Climate Risk (SCR®) certificate
program considers these issues and more. The program's
curriculum is dynamic, fact-based, and unbiased. Its
coverage is directly informed by senior climate risk-related
practitioners from around the globe who participate
as members of the SCR Advisory Committee, in addi-
tion to GARP's own senior SCR certification program
professionals.
This year, to remain current, the SCR's content expanded to
build on its basic climate risk-related theories and concepts.
Its curriculum has been enhanced to include geoengineer­
ing techniques, natural climate risk-mitigation strategies,
recent examples of greenwashing, clarifications around
evolving sustainability standards, net-zero transition plan­
ning, and updated case studies.
Simply being a bit ahead of peer organizations in
addressing climate risk issues is no longer an acceptable
goal for firms. Integrating climate issues and concepts into
a firm's risk appetite and overall risk profile must now be a
priority.
We wish you the very best in your pursuit of the SCR
certificate and in achieving your individual or company­
related sustainability and climate risk-related achievements.

In only a few short years, the SCR program has estab­

lished itself globally as the leading tool to develop a base
understanding of climate issues. It provides a highly effec­
tive avenue for individuals and company staff to become
Rich Apostolik
knowledgeable about, understand, and contribute toward
meeting climate risk and sustainability goals. President & CEO

Preface ■ vii
 PREPARING FOR
THE 2024 SCR EXAM
Congratulations on your decision to increase your aware­
ness of sustainability and climate risk and join a growing
community of Sustainability & Climate Risk (SCR) certificate
holders.
The SCR Exam is practice oriented. Exam questions reflect
the theory presented in program materials and true-to-life
work experience. Exam candidates must not only under­
stand sustainability and climate-risk concepts, but should
also be able to apply these concepts in real-life settings.
The program curriculum covers skills and knowledge areas
necessary to understand today's rapidly evolving climate­
risk landscape. The SCR Exam is comprehensive, testing
candidates on a number of sought-after sustainability and
climate-risk standards and practices.
In an effort to offer optimized learning tools for SCR Exam
candidates, GARP created study materials to increase the
likelihood of a successful Exam outcome. Access to the fol­
lowing Study Materials is complimentary for all candidates
registered to take the SCR Exam in 2024:
SCR Study Guide and Learning Objectives. This guide
includes a complete list of chapter topics, required online
readings, and key learning objectives.
viii Preparing for the 2023 SCR Exam
SCR eBook. The official eBook for the SCR Exam includes
required readings across the eight chapters of the curricu­
lum. Each chapter begins with a set of learning objectives
to guide candidates through key concepts of the chapter.
Review questions at the end of each chapter provide can­
didates with regular knowledge checks. A Glossary of key
terms and an abbreviations list appear at the end of the
book. NOTE: The abbreviations list is available for reference
during the SCR Exam.
Required Online Readings. In addition to information
contained in the 2024 SCR book, the SCR Exam covers a
selection of online material from leading academics and
practitioners. These online readings are a required part of
the SCR curriculum and may be reflected in the SCR Exam
questions.
SCR Practice Exam. This SO-question multiple-choice exam
includes sample questions similar to questions covered on
the SCR Exam. These questions broadly reflect material
assigned for 2024 and represent a multiple-choice question
style the SCR Advisory Committee considers appropriate.
Explanations are included for correct and incorrect answer
choices.
SCR Curriculum Errata. If candidates identify a potential These Study Materials are available at https://www.garp.
error or discrepancy in the curriculum, they may con- org/scr/study-materials.
tact GARP directly. GARP reviews all errata submissions
Best of luck in your study preparation. We appreciate your
received and posts updated errata, including appropriate
support of the SCR Program.
corrections. Visit the GARP website regularly for the latest
SCR Curriculum errata summary. Regards,

GARP Learning Platform. The platform is accessible via

the candidate portal on any device -mobile, tablet, or
desktop computer. Through the platform, candidates can
Beth Gould Creller
monitor their performance and determine strengths and
SCR Program Manager
weaknesses. Candidates can access the SCR curriculum and
create their own study plans through flashcards, end-of­
chapter questions, and the full-length Practice Exam.

Preparing for the 2023 SCR Exam ■ ix

 ®
SCR ADVISORY
COMMITTEE

Members
Piyush Agrawal Novera Khan
Deputy Chief Risk Officer Chief Risk Officer
BMO NRG Energy

Steven Bullock Robert Litterman

Managing Director Chairman
Global Head of Research and Methodology Risk Committee
S&P Global Sustainable1 Kepos Capital LP

Ben Carr Charmian Love

Global Head of Climate Risk Products Global Director of Advocacy
Bloomberg L.P. Natura&Co

John T. Colas Michael Marano

Partner and Vice Chairman CEO
Financial Services Americas MillPoint, Inc.
Oliver Wyman
William May
Neha Coulon SVP
Managing Director, Head of ESG, EMEA Global Head of Certifications and Educational Programs
J.P. Morgan Private Bank GARP

Beth Gould Creller Jo Paisley

Sustainability & Climate Risk (SCR) Program Manager President
GARP GARP Risk Institute

Sandro Diez-Amigo Julie Pullen

Research Lead Partner and Chief Scientist
Market Accelerator for Green Construction Propeller Ventures
International Finance Corporation

x ■ SCR® Advisory Committee

Corinne Raux Tianyin Sun
Senior Advisor Deputy Director
EU Taxonomy Center for Green Finance Research
UNEP-FI National Institute of Financial Research of Tsinghua
University
Tony Rooke
Executive Director Jakob T homa
Head of Transition Finance SOAS Professor in Practice & Research Director
°
GFANZ 2 Investing Initiative

Michael Sheren Michael Wilkins

President & Chief Strategy Office Executive Director
MVGX Professor of Practice
Fellow Centre For Climate Finance And Investment
Cambridge University Institute for Substantiality Leadership Imperial College Business School

Daren Smith
Chief Investment Officer
Public Equities
Abu Dhabi Investment Council

SCR® Advisory Committee ■ xi

 AUTHOR
ATTRIBUTIONS

Chapter 1: Foundations of Climate Director

UK Centre for Greening Finance and Investment
Change: What Is Climate Change?
Krister Koskelo
Andrew Dessler, PhD
Researcher, DPhil candidate
Professor of Atmospheric Sciences, Reta A. Haynes Chair
Oxford Sustainable Finance Programme
in Geosciences
University of Oxford
Texas A&M University

Chapter 2: Sustainability Chapter 4: Sustainability and Climate

Policy, Culture, and Governance
Ben Caldecott, PhD
Director, Oxford Sustainable Finance Programme and Ben Caldecott, PhD
Lombard Odier Associate Professor of Sustainable Finance Director, Oxford Sustainable Finance Programme and
University of Oxford Lombard Odier Associate Professor of Sustainable Finance
University of Oxford
Director
UK Centre for Greening Finance and Investment Director
UK Centre for Greening Finance and Investment
Krister Koskelo
Researcher, DPhil candidate Krister Koskelo
Oxford Sustainable Finance Programme Researcher, DPhil candidate

University of Oxford Oxford Sustainable Finance Programme

University of Oxford

Chapter 3: Climate Change Risk Ira Poensgen

Research Assistant
Ben Caldecott, PhD
Oxford Sustainable Finance Programme
Director, Oxford Sustainable Finance Programme and
University of Oxford
Lombard Odier Associate Professor of Sustainable Finance
University of Oxford

xii ■ Attributions
Chapter 5: Green and Sustainable Chapter 7: Climate Models and
Finance: Markets and Instruments Scenario Analysis
Ben Caldecott, PhD Ben Caldecott, PhD
Director, Oxford Sustainable Finance Programme and Director, Oxford Sustainable Finance Programme and
Lombard Odier Associate Professor of Sustainable Finance Lombard Odier Associate Professor of Sustainable Finance
University of Oxford University of Oxford

Director Director
UK Centre for Greening Finance and Investment UK Centre for Greening Finance and Investment

Krister Koskelo Krister Koskelo

Researcher, DPhil candidate Researcher, DPhil candidate
Oxford Sustainable Finance Programme Oxford Sustainable Finance Programme
University of Oxford University of Oxford

Chapter 6: Climate Risk Measurement Chapter 8: Net Zero

and Management Ben Caldecott, PhD
Ben Caldecott, PhD Director, Oxford Sustainable Finance Programme and
Director, Oxford Sustainable Finance Programme and Lombard Odier Associate Professor of Sustainable Finance
Lombard Odier Associate Professor of Sustainable Finance University of Oxford
University of Oxford
Director
Director UK Centre for Greening Finance and Investment
UK Centre for Greening Finance and Investment
Anthony Limburg
Krister Koskelo Researcher, DPhil candidate
Researcher, DPhil candidate Sa"i'd Business School
Oxford Sustainable Finance Programme University of Oxford
University of Oxford

Attributions ■ xiii
 REVIEWER
ATTRIBUTIONS

Chapter 1: Foundations of Climate Chapter 5: Green and Sustainable

Change: What Is Climate Change? Finance: Markets and Instruments
Tyler McCandless, PhD Ryan P Friel, FRM, SCR
Director of Data Science
Tomorrow.io Chapter 6: Climate Risk Measurement
and Management
Chapter 2: Sustainability
Hae Eun Geraldine Kim
Aymen Karoui, Ph.D., SCR
Director, Methodology and Portfolio Research Chapter 7: Climate Models and
Morningstar-Sustainalytics
Scenario Analysis
Chapter 3: Climate Change Risk Phillip North

Joerg Osterloh, CFA Chapter 8: Net Zero

Director Enterprise Risk Management
Coca-Cola Europacific Partners Snehil Jain
Data Science & Analytics Professional

Chapter 4: Sustainability and Climate

Policy, Culture, and Governance
Neha Khanna

xiv ■ Attributions
Foundations of
Climate Change:
What Is Climate
Change?

■ Learning Objectives
After completing this reading you should be able to:

• Define climate change and differentiate between
weather and climate.
• Know the general trends of modern climate change,
such as observed surface temperature, sea ice
coverage, etc.
• Know the primary greenhouse gases and aerosols, their
sources, and relative contribution (e.g. global warming
potential, atmospheric lifetime) to climate change.
• Explain non-human and human mechanisms that
contribute to climate change.

• Describe the Earth's climate history, and different • Understand the distribution, frequency, and intensity
methods for measuring non-anthropogenic climate of climate driven environmental impacts across
change. geography and time.

• Understand how the Earth's energy balance, • Understand the distribution, frequency, and intensity
greenhouse effect, and radiative forcing affect the of climate driven socioeconomic impacts across
climate. geography and time.

1
 • Explain the different approaches and key
considerations of climate change adaptation,
including maladaptation.
• Understand how energy sources can contribute to or
mitigate climate change. Identify and discuss mitiga­
tion opportunities, strategies, technologies, and
associated challenges.
• Understand the opportunities and drawbacks of
implementing geoengineering techniques to combat
climate change.
• Explain carbon budgets and emissions trajectories
to stay within mitigation targets. Know key numeric
global emissions limits, commitments, and scenario
paths.
Climate change is one of the most important issues of
our generation and future generations. Choosing how
to respond requires both a knowledge of the science
as well as an understanding of our policy options. This
chapter will give a brief summary of these two aspects
of the climate problem.
Chapter Outline
1.1 Modern Climate Change
1.2 Climate Change before Humans
1.3 Energy Balance
1.4 The Greenhouse Effect
1.5 How Humans Are Changing the Climate
1.6 Attribution of Modern Warming
1.7 Summary Statement on Attribution of Modern
Warming
1.8 Shared Socioeconomic Pathways
1.9 Impacts of Modern Climate Change
1.10 Policy Responses
1.11 Mitigation
2 ■ Sustainability and Climate Risk Exam
1.12 Geoengineering
1.13 Mitigation Targets
INTRODUCTION TO THE PROBLEM
Weather refers to the exact state of the atmosphere at a
particular location and time. So, if you tell someone that the
° °
current temperature outside is 55 F/13 C, you're talking about
the weather. Climate refers to the long-term patterns or statis­
tics of the weather. If you hear that the average daily high tem­
° °
perature for your city in August is 84 F/29 C, that's climate.
A simple analogy to explain the difference between
weather and climate involves tossing a six-sided die. The
day's weather is the result of a single roll of the weather die.
Climate is the statistics from many rolls of the die. You can
determine the climate simply by looking at the die-you do
not have to roll it. If, for example, you see that hot tempera­
tures appear on three sides of the die and cold tempera­
tures appear on the other three, then you can infer that hot
and cold temperatures are equally likely.
When we talk about climate, temperature is the most
commonly referred to quantity, but there are many other
quantities such as precipitation, humidity, cloudiness,
visibility, and wind that tell the full climate story. Because
there is a lot of day-to-day and year-to-year variability in the
weather, the climate is typically estimated from the statistics
of the weather over a period of several decades, typically
30 years or more.
Climate change describes the long-term differences in the
statistics of weather measured over multi-decadal periods.
For example, if the average temperature of a city during
the period 1990-2020 is warmer than the average tempera­
ture during the period 1900-1930, then we can say that the
climate changed between these periods. If we go back to
our weather dice analogy, climate change means that the
dice are changing. As the climate warms, for example, we
would find that hot temperatures now appear on 4 of the
6 sides of the temperature die. Note that cold temperatures
can still occur in a warmer climate-but not as often.
Climate change is sometimes referred to as global warming.
In its most literal sense, someone might think global
warming only refers to increasing temperatures, while cli­ the climate (e.g., precipitation, sea level). In practice, how­
mate change also includes changes in all other aspects of ever, most people use the two terms interchangeably.

(a) Surface thermometer (b) Satellite temperature

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(a) Global annual average temperature ( C), relative to the 1850-1900 average; data have
been smoothed to remove short-term fluctuations. (b) Satellite measurements of the global monthly
average temperature anomaly (0 C), relative to the 1991-2020 period. (c) Arctic sea-ice extent (in millions of
square kilometers) in September of each year. (d) Global average cumulative mass change of the world's
glaciers, tonnes/m2. (e) Ocean energy content (Joules) of the top 2000 m of the world ocean, relative
to the 1979-1994 mean. (Boyer, Tim P.; Smolyar, Igor V., et al. [2018). World Ocean Atlas 2018. NOAA
National Centers for Environmental Information.) (f) Global-average sea level change, measured by
satellite-borne instruments, in millimeters. The seasonal cycle has been removed.

Chapter 1 Foundations of Climate Change: What Is Climate Change? ■ 3

OBSERVATIONS OF CLIMATE
CHANGE
1.1 Modern Climate Change
While we have a greater number of high-quality weather
observations in the last several decades, we have an adequate
observational history of the last 150 years covering enough
of the planet that we can measure climate change over that
period. Figure 1.1a shows change in global average tempera­
ture since the late-nineteenth century, estimated from thermom­
eters distributed across the planet. The surface thermometer
°
record shows that the Earth has warmed by 1.2 C over this time
(calculated as the difference between the 1850-1900 average
and the 2013-2022 average). As of early 2023, the warmest year
in the record was 2016 followed by 2020, 2019, 2017, and 2022.
Figure 1.2 shows how the warming in Figure 1.1a is distributed
across the planet. The warming is not uniform-land warmed
more than the ocean and the northern hemisphere warmed
more than the tropics or the southern hemisphere. This is
important because about 85% of the world's population lives
on land in the northern hemisphere, meaning that they have
experienced more warming over the past 150 years than the
global average warming seen in Figure 1.1a.
The data in Figures 1.1 a and 1.2 have been independently
verified. Several independent scientific groups have gener­
ated their own surface temperature record (for example,
NASA, NOAA, and the UK Hadley Center) from the raw sta­
tion data, and these all show similar warming. In addition,
temperature change
,·J.· 4.0
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2.0
1.5 °C
1.0
0.5
0.0
@jijUjf.j The distribution of modern warming
(in °C). Warming is calculated as the difference
between the 1850-1900 average and the
2009-2018 period.
4 ■ Sustainability and Climate Risk Exam
several of the groups publicly released the code and data
used to generate their estimates of warming in order to
be transparent with the data and the analyses that were
done. This allows anyone to be an independent reviewer
of the data and analyses, and yet there have not been any
legitimate issues in the data or analyses found.
Nevertheless, any sample of data (the temperature obser­
vations at observational sites) from the true population
(the true temperature change everywhere over all time)
may contain biases or other data issues that the scientific
community has not yet recognized. For this reason, scientists
look for a comprehensive analysis with multiple indepen­
dent confirmations of important scientific conclusions. As
described below, there are many data sets that confirm the
warming seen in the surface thermometer record.
The trend in the global-average temperatures measured
by instruments onboard satellites during the period of
overlap (Figure 1.1b) agrees well with the trend in the
surface temperature record (Figure 1.1 a). We can also look
at indirect evidence of warming, that is, the effects that
warming would cause our planet to experience. Figures 1.1c
and 1.1 d show that ice on the planet is disappearing­
something we would expect in a warming climate.
About 93% of the heat trapped by greenhouse gases goes
into heating the oceans, so we can also look to see if energy,
or heat, is accumulating in the oceans (IPCC, 2013). Figure 1.1e
shows the heat content of the top 2 km/1.25 miles of the ocean,
and it shows that the oceans are gaining energy. Finally, Figure
1.1f shows that sea level is rising linearly. There are two key con­
tributing factors to the rise in sea level. One contributor is the
melting of grounded ice (melting of floating ice does not raise
sea level). When it melts and the water runs into the ocean,
the total amount of water in the ocean increases and sea level
rises. Figure 1.1d shows that we are losing grounded ice on the
planet, and we expect that to drive an increase in sea level. Sec­
ond, water expands when it warms. Figure 1.1e shows that the
oceans are indeed heating, and the resulting thermal expansion
should also raise sea level. These two processes have contrib­
uted about equally to sea level rise over the past century.
Putting all of this evidence together, recent reports from the
Intergovernmental Panel on Climate Change (IPCC) have
described the confidence in the warming of the climate
system since the early twentieth century as unequivocal,
meaning beyond doubt. This arises because the conclusion
is supported by many independent data sets and statistical
analyses, and there is no single error or confounding factor
that would generate a false warming trend in all of them. As
a result of this consistency, there is virtually no chance that
enough of these data sets could be wrong by far enough,
and all in the same direction, that the overall conclusion
that the climate is currently warming is wrong.
1.2 Climate Change before Humans
To put today's warming into context, it is useful to consider
the Earth's entire climate history. The measurements
described in the previous section go back at most 170
years, so a different strategy is required to look further back
in time without the same types of observational systems
(i.e., thermometers). What we need are long-lived, geological,
chemical, or biological systems that have the climate
imprinted on them. Then, we can make measurements today
that provide evidence what the climate was like in the past.
For example, scientists can extract climate information from
tree rings. Tree growth follows an annual cycle, which is
imprinted in the rings in their trunks. As trees grow rapidly in
the spring, they produce light-colored wood; as their growth
slows in the autumn, they produce dark wood. Because trees
grow more and produce wider rings in relatively warm and
wet years, the width of each ring yields information about
temperature and precipitation around that tree in that year.
Scientists today can measure the size of the rings of a tree and
then estimate the local climate around the tree for each year
during which the tree was alive. Trees can live for centuries,
and by combining the record from modern trees with trees
that were cut down centuries ago and, for example, used in
timber of old buildings, we can extend the tree-ring record to
give us climate information going back about a millennium.
There are many different proxies that cover different
regions and different time frames. For example:
• Tree rings: These measurements can reveal climate
variations in regions where trees grow and experience
seasons for the last millennium.
• Corals: Analysis of the skeletons of these sea creatures can
yield climate conditions in the ocean over millions of years.
• Speleothems (e.g., stalactites and stalagmites): These cave
structures can yield estimates of the climate in the region
around the cave over the past few hundred thousand years.
• Ice cores: Measuring the chemical composition of ice
(mainly in Greenland and Antarctica) yields estimates of
the climate over the past million years or so.
Chapter 1 Foundations of Climate Change: What Is Climate Change?
• Ocean sediment cores: Analyzing the composition of the
mud at the bottom of the ocean provides information
about the climate covering the past tens of millions of
years.
Analyzing these data show that the Earth has experienced
large climate fluctuations over its history. Figure 1.3a shows the
temperature over the past 70 million years. About 50 million
years ago, the Earth was much warmer than it is today-so
much so, in fact, that there was no permanent ice on the
planet. Since then, the climate has generally been cooling.
Figure 1.3b shows the last 410,000 years, and it shows that
the planet has been cycling between cold periods, known
as ice ages, and interglacials (warmer periods). These
cycles take approximately 100,000 years to complete.
The last ice age reached its coldest point about 20,000
years ago, and it ended about 10,000 years ago, and,
since then, we have enjoyed a rather pleasant interglacial
period.
Figure 1.3c shows the last 11,000 years, since the end of the
last ice age, a period known as the Holocene. This estimate
shows that temperatures peaked about 7,000 years ago and
then started a slow, long-term decline that bottomed out in
a period 200 to 300 years ago, known as the Little Ice Age.
After that, the Earth began warming, and in the late 201Os,
°
it was about 1 C warmer than the Little Ice Age-roughly
comparable to peak temperatures of the mid-Holocene.
These estimates of the Earth's past climate allow us to
reach several important conclusions about the modern
warming we are presently experiencing. First, the global
average temperature difference between an ice age and an
° °
interglacial is about 6 C, so the 1 C warming the Earth has
experienced since the nineteenth century is not an insignifi­
cant amount of warming. In addition, human society, made
up of mega-cities and trillions of dollars of infrastructure
on a global scale, has only been around since the indus-
trial revolution (around 1800) and, since that time, society
has experienced a small range of global temperatures. As
our climate continues to warm, we will soon be departing
from conditions under which human society developed and
thrived. More troubling, the warming we are experiencing is
very rapid. For example, the warming over the past century
°
(approximately 1 C in about a century) is around 16 times
faster than the average rate of warming coming out of the
°
last ice age (roughly 6 C in 10,000 years corresponds to an
°
average warming of 0.06 C/century).
■ 5
(a)
I- Temperature
5.0 �--'=============='--- 300
(b)

2.5 ----------------- -- ------------ 280

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(c)

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Years before present

blh'ilJi1 (a) Reconstructed global average surface temperature over the past 70 million years, relative
to today's temperature (Westerhold, T., Marwan, N., & Drury, A. J., et al. [2020]. An astronomically dated
record of Earth's climate and its predictability over the last 66 million years. Science, 369, 1383-1387,
doi: 10.1126/science.aba6853.) (b) Temperature of the southern polar region (solid line) over the past
410,000 years, relative to today's temperature, constructed from an Antarctic ice core. Carbon dioxide
(dotted line) is from air bubbles trapped in the ice. (Petit, J. R., Raynaud, D., Lorius, C., Delaygue, G.,
Jouzel, J., Barkov, N. I., and Kotlyakov, V. M.. Historical Isotopic Temperature Record from the Vostok Ice
Core. United States: N. p., 2000. Web. doi:10.3334/CDIAC/cli.006.) (c) Global temperature of the last
11,000 years, relative to the 1961-1990 average, based on multiple proxy records (CDIAC; Marcott, S. A.,
Shakun, J. 0., Clark, P. U., & Mix, A. C. [2013]. A reconstruction of regional and global temperature for
the past 11,300 years. Science 339, 1198-1201. doi: 10.1126/science.1228026.)

CAUSES OF CLIMATE CHANGE
1.3 Energy Balance
The source of energy for the Earth's climate is sunlight,
which is mainly visible radiation and provides about
340 W/m2 of energy to the Earth (global and annual
average). About 30% of this incoming sunlight is
reflected back to space by clouds and other reflective
elements of the climate system, meaning that net solar
energy absorbed by Earth is 238 W/m 2. In the 1820s,
Joseph Fourier recognized that this meant that the

6 ■ Sustainability and Climate Risk Exam

Earth had to also be radiating an equal amount of
energy back to space. This radiation back to space is in
the form of infrared radiation, but for this analysis con­
sider it heat.
The amount of energy radiated by an object is determined
by the temperature of the object-as the object heats up, it
radiates more energy. This means that the amount of heat
radiated by the Earth to space is determined by the temper­
ature of the planet. Therefore, for a given amount of energy
from the Sun, there is a temperature of the planet that will
give you an equal amount of energy radiated back to space.
This is the most important rule of the Earth's climate: energy
balance. The energy reaching the Earth from the Sun must
be equal to the energy the Earth radiates back to space, and
this determines the temperature of the climate system.
1.4 The Greenhouse Effect
It turns out that the temperature of the planet is not the
only thing that determines the amount of energy the Earth
radiates to space. The composition of the atmosphere also
matters-in particular, the amount of greenhouse gases in
the atmosphere. Greenhouse gases are a part of the atmo­
sphere that absorbs infrared radiation (or radiant heat).
In the 1820s, Joseph Fourier recognized that these gases
reduced the amount of energy the Earth radiated to space,
so a planet with more greenhouse gases in the atmosphere
must be warmer than one without. This is what scientists
mean when they talk about a greenhouse effect.
As the mass of greenhouse gases in our atmosphere
increases, the atmosphere traps more heat, leading to higher
temperatures. This possibility was first recognized by scien­
tists more than a century ago, first by the Swedish chemist
Svante Arrhenius in 1896 and again, with more supporting
evidence by the British engineer Guy Callendar, in 1938.
Merely having an atmosphere does not produce a greenhouse
effect; the atmosphere needs to have the right composition to
absorb infrared radiation. The majority of Earth's atmosphere
consists of molecular nitrogen (N2}, oxygen (02), and the inert
gas argon (Ar). These simple molecules do not interact with
infrared radiation and therefore generate no greenhouse
effect to warm the surface. Rather, the greenhouse effect is
caused mainly by minor constituents in the atmosphere: water
vapor (H 2 0), carbon dioxide (CO2), and other components like
methane that we will learn about later.
Chapter 1 Foundations of Climate Change: What Is Climate Change?
Water vapor is the most important greenhouse gas in the
atmosphere-meaning it traps the most heat-and carbon
dioxide is the next largest contributor. The amount of water
vapor in the atmosphere is highly variable, ranging from a
few percent in warm tropical marine regions to a fraction
of a percent in cold polar regions. Carbon dioxide's strong
contribution occurs despite the fact that it made up only
0.0417% of our atmosphere in 2022. This is an awkwardly
small number, so the concentration is usually written as 417
parts per million (ppm), meaning that, in every million mol­
ecules of air, about 417 molecules are CO2.
1.5 How Humans Are Changing the
Climate
The previous section showed that the Earth's climate is
determined by the amount of greenhouse gases in the
atmosphere. In this section, we discuss the evidence show­
ing that greenhouse gases in our atmosphere are increasing
as a result of human activity.
1.5. 1 Carbon Dioxide
We have been directly monitoring the abundance of carbon
dioxide in the atmosphere since the middle of the twentieth
century. The measurements are plotted in Figure 1.4, which is
often referred to as the Keeling Curve after Charles D. Keeling,
400
380
E
Q.
N 360
0
340
320
1960 1970 1980 1990 2000 2010 2020
W:i•ikJii The record of annual average atmospheric
carbon dioxide since the middle of the twentieth
century. Data measured at Mauna Loa, Hawaii by
Dr. Pieter Tans, NOAA/GML and Dr. Ralph Keeling,
Scripps Institution of Oceanography. Data downloaded
from the NOAA Earth System Research Laboratory/
Global Monitoring Division (www.esrl.noaa.gov/gmd/
ccgg/trends/data.html, retrieved 2020-11-29).
■ 7
the scientist who initiated the measurements in 1957. The mea­
surements clearly show a long-term upward trend. As we
discussed in the last section, we can therefore expect that the
climate should be warming-and, as we saw in Section 1.1, it is.
This increase in carbon dioxide is primarily due to the com­
bustion of fossil fuels. This conclusion is confirmed from
multiple sources of data. If we look at carbon dioxide con­
centration in our atmosphere over the last few centuries
(not shown), we see that carbon dioxide began increasing
at the beginning of the nineteenth century, at the same
time the world economy began generating energy from
fossil-fuel combustion (IPCC, 2007).
Scientists have observed that, for the past 50 years, the
increase in carbon dioxide in the atmosphere each year
averages 44% of what humans released into the atmo­
sphere in that year (Global Carbon Project, 2020). Of the
56% that is removed, about half is absorbed into the ocean
and leads to ocean acidification, which we will discuss later
in this chapter. The other half is absorbed by the land bio­
sphere through enhanced plant growth.
The fact that the increase in atmospheric carbon dioxide each
year is (on average) slightly less than half of what humans
emit is one of the key pieces of evidence that the increase in
atmospheric carbon dioxide is due to human activities. If the
increase were due to some non-human process, it seems
unlikely that it would track human emissions so closely.
The chemical composition of atmospheric carbon dioxide
also shows that the increase in Figure 1.4 is due to
fossil-fuel combustion. The analysis is based on isotopes
of carbon. All carbon atoms have six protons, but carbon
atoms can have different numbers of neutrons, which are
called isotopes. The most abundant isotope is carbon-12,
containing six neutrons to go with the six protons, but less­
abundant isotopes include carbon-13, with seven neutrons;
and carbon-14, which has eight neutrons.
The potential sources of carbon dioxide (e.g., volcanoes, fos­
sil fuels, etc.) release carbon dioxide with different amounts of
these various isotopes. Chemical analysis of the atmosphere
shows that the carbon dioxide being dumped into the atmo­
sphere over the past half century has an isotopic composition
that is consistent with carbon dioxide from fossil fuels.
By looking at air bubbles trapped in glacial ice, we can mea­
sure chemical composition of atmospheric carbon dioxide
back through time. These measurements tell us that, in the
late 1700s, before the industrial revolution, there was about
8 ■ Sustainability and Climate Risk Exam
280 ppm in the atmosphere. By the early 2020s, humans
have increased atmospheric carbon dioxide by about 50%.
1.5.2 Other Greenhouse Gases and Aerosols
The next most important greenhouse gas is methane (CH4),
which has increased from 0.8 ppm before the industrial
revolution to about 1.9 ppm in 2020. This might seem like
a small increase, particularly compared to the 130-ppm
increase in carbon dioxide, but methane is a far more
powerful greenhouse gas on a permolecule basis-each
kilogram of methane traps as much heat as 28 kilograms
of carbon dioxide. This heat-trapping power relative to
carbon dioxide is known as the global warming potential
(GWP}, and its value has important policy implications. For
example, methane's GWP of 28 means that it is 28x bet­
ter for the climate to reduce emissions of one tonne of
methane than it is to reduce one tonne of carbon dioxide.
Human activities are also increasing the atmospheric abun­
dance of other powerful greenhouse gases, such as nitrous
oxide (N20) and an entire class of molecules called halo­
carbons. These gases are found at very low concentrations
in our atmosphere-parts per billion-but they have large
GWPs (Table 1.1), so that even small increases can trap a
significant amount of heat in our climate system.
Finally, there is ozone (03), a molecule with multiple effects
on the atmosphere. It is well known for its ability to absorb
ultraviolet radiation, which is harmful to human health and
natural ecosystems. However, ozone is also a powerful
greenhouse gas that contributes to trapping heat in the
atmosphere. While humans do not directly emit ozone into
the atmosphere, they do emit the precursors that lead to
the formation of ozone, such as hydrocarbons and nitrogen
oxides. Over the past few decades, the increase in these
precursors has led to an increase in ozone in the lower
atmosphere, which contributes to the trapping of heat. It is
important to distinguish this type of ozone from the ozone
found in the stratosphere. In the 1970s and 1980s, it was
discovered that humans were destroying ozone in the strato­
sphere, but this is a different phenomenon from the increase
in lower atmospheric ozone that is warming the climate.
Another way that humans are changing the climate is through
emissions of aerosols or their precursors. Aerosols are par­
ticles so small that the buoyant forces can be similar to the
force of gravity and therefore remain suspended in the
atmosphere for days or weeks. Aerosols can affect planetary
iffl�CII■ Metrics of major greenhouse gases. Increases in abundance and fraction of heating for the
years 1750-2010. GWPs are calculated assuming a 100-year time horizon. Adapted from chapter 7 of the
IPCC's Sixth Assessment Report. (Forster, P.,T. Storelvmo, K.Armour, W. Collins, J.-L. Dufresne, D. Frame,
D.J. Lunt,T. Mauritsen, M.D. Palmer, M.Watanabe, M. Wild, and H.Zhang, 2021:T he Earth's Energy
Budget, Climate Feedbacks, and Climate Sensitivity. In Climate Change 2021: The Physical Science Basis.
Contribution of Working Group I to the Sixth Assessment Report of the Intergovernmental Panel on
Climate Change [Masson-Delmotte,V., P. Zhai,A. Pirani, S.L. Connors, C. Pean,S. Berger, N. Caud,Y. Chen,
L. Goldfarb, M.I. Gomis,M. Huang, K. Leitzel!, E. Lonnoy, J.B.R. Matthews,T.K. Maycock, T. Waterfield,
0. Yelek�i, R. Yu, and B. Zhou (eds.)]. Cambridge University Press, Cambridge, United Kingdom and
New York, NY, USA, pp. 923-1054, doi:10.1017/9781009157896.009)
Fraction of Total
Global Warming Increase in Abundance Greenhouse Radiative
Species Atmospheric Lifetime Potential (GWP) Since Pre-Industrial Forcing
Carbon dioxide 500 years 1 130 ppm 56%

Methane 11.8 years 29 1.1 ppm 15%

Nitrous Oxide 109 years 273 75 ppb 5%

Halocarbons Years to millennia 100s to 1000s A few ppb 11%

Ozone Weeks to months N/A Tens of ppb in the upper 12%

troposphere

Note: ppb = parts per billion (how many molecules of the species there are in every billion molecules of air). Carbon dioxide is removed
from the atmosphere on several time scales. The lifetime in the table is the time to remove 75% of the emissions. Ozone does not have
a GWP because of its short atmospheric lifetime.

energy balance because aerosols reflect incoming solar radia­
tion back to space, so their net effect is to cool the climate.
They also can affect cloud formation and make clouds more
reflective, which is an additional cooling mechanism.
As a result of human activities over the past two centuries,
the abundance of these aerosols has increased, and this
has generated a cooling effect that partially offsets the
warming effect of the increase in greenhouse gases. As
an example of how humans generate aerosols, when fos-
sil fuels containing sulfur impurities are burned, the sulfur
is released into the atmosphere with the other products of
combustion. Once in the atmosphere, the sulfur gases react
with other atmospheric constituents to form small liquid
droplets known as sulfate aerosols. Other types of aerosols
produced by humans include black carbon aerosols, such as
soot, which is produced by such things as the incomplete
combustion of a smoldering fire or two-stroke gasoline
engines. Mineral dust is produced by agricultural activities
(e.g., harvesting, plowing, overgrazing), changes in surface
water features (e.g., drying out of lakes such as the Aral Sea
in Central Asia and Owens Lake in the Western US), and
industrial practices (e.g., cement production).
1.5.3 Summarizing Human Impact on The
Climate
In the past 250 years, the Earth has experienced signifi­
cant anthropogenic changes to radiative forcing, which
quantifies the difference between the incoming energy
(sunlight) absorbed by the Earth and the outgoing energy
(infrared radiation) emitted by the Earth back to space.
Carbon dioxide and other greenhouse gases have caused
a combined positive (heating) change to radiative forcing,
whereas aerosols have caused a negative (cooling) change
to radiative forcing. The net human contribution, including
several other small forcings, is positive, which is illustrated
in Figure 1.5.
You might be wondering why water vapor does not appear
in Figure 1.5, particularly because it was stated that it was
our climate system's most important greenhouse gas. The
main source of water vapor in the atmosphere is evaporation
from the oceans, and it is primarily removed from the atmo­
sphere when it falls out as rain or snow. Because the amount
of water vapor in the atmosphere is regulated by evapora­
tion and condensation, it is fundamentally set by the Earth's

Chapter 1 Foundations of Climate Change: What Is Climate Change? ■ 9

 Radiative forcing, 1750-2010 decreases. Emissions of water vapor directly from human
activities contribute essentially nothing to its atmospheric
abundance.

Because water vapor's abundance in the atmosphere

2 is set by the temperature, water vapor's main role in

1s climate change is to amplify changes caused by things

like increasing carbon dioxide through a process referred
to as the water vapor feedback. This arises because a
-�
warmer atmosphere can hold more water vapor. Thus, an
·.;:; initial warming leads to increased atmospheric humidity,
.!!1
0 and because water vapor is itself a greenhouse gas,
this leads to additional warming, and that feeds back to
increase the humidity. This is an important process in our
atmosphere, and it has the capacity to double, or even
triple the amount of warming we get from carbon dioxide
alone (Dessler, 2013).

1.6 Attribution of Modern Warming

In Section 1.2, you saw that the climate is a dynamic system

1£.!jiikJd-j Radiative forcing caused by changes that has experienced changes in cyclical patterns over the
past thousands and millions of years. Here, we first describe
in the climate between 1750 and 2019. Values
all of the mechanisms that are known to change the climate.
are adapted from chapter 7 of the IPCC's Sixth
We will then assess the evidence of human influence for
Assessment Report. (Forster, P.,T. Storelvmo,
each mechanism and identify the one that is most likely
K.Armour, W. Collins, J.-L. Dufresne, D. Frame,
responsible for the majority of climate change.
D.J. Lunt,T. Mauritsen, M.D. Palmer, M.Watanabe,
M. Wild, and H.Zhang, 2021:The Earth's Energy Here are the natural processes that can affect the climate:
Budget, Climate Feedbacks, and Climate
• Tectonic processes: The Earth's continents are moving
Sensitivity. In Climate Change 2021: The
and, over tens of millions of years, this continental drift
Physical Science Basis. Contribution of Working
can substantially alter the arrangement of the continents
Group I to the Sixth Assessment Report of the
across the Earth's surface. Such changes can lead to
Intergovernmental Panel on Climate Change
changes in the climate through several mechanisms. For
[Masson-Delmotte,V., P. Zhai,A. Pirani, S.L.
example, the movement of a continent toward the poles
Connors, C. Pean,S. Berger, N. Caud,Y. Chen,
can lead to the growth of an ice sheet on the continent.
L. Goldfarb, M.I. Gomis,M. Huang, K. Leitzel!,
Because ice sheets are reflective, the growth of a con­
E. Lonnoy, J.B.R. Matthews,T.K. Maycock,
tinental ice sheet will lead to more incoming sunlight
T. Waterfield, 0. Yelekc;i, R. Yu, and B. Zhou (eds.)].
being reflected back to space, which will tend to cool the
Cambridge University Press, Cambridge, United
climate. However, this process is exceedingly slow-the
Kingdom and New York, NY, USA, pp. 923-1054,
movement of the continents occurs over geologic time
doi:10.1017/9781009157896.009. Reprinted by
scales, e.g. millions of years. Thus, this cannot be respon­
permission from INTERGOVERNMENTAL PANEL
sible for modern warming because it is simply too slow.
ON CLIMATE CHANGE [IPCC])
• Output of the Sun: The ultimate energy source for the cli­
temperature-if the Earth warms, the amount of water vapor mate system is the Sun. The observed warming trend could
in the atmosphere increases. If the Earth cools, the opposite be explained if the Sun had been getting brighter over the
happens and the amount of water vapor in the atmosphere last two centuries. Scientists have been directly measuring

10 ■ Sustainability and Climate Risk Exam

 the output of the Sun since the late 1970s, and there is no
long-term trend that could explain the very rapid warming
over that period. Prior to that time, it was more difficult
to determine what the Sun was doing because there were
no satellite measurements. Instead, the Sun's output for
this period must be inferred indirectly from other measure­
ments, such as the number of sunspots, which people have
counted for many hundreds of years, or from chemical
proxies such as the carbon-14 content of plant materiaI.
Such estimates suggest that the Sun has changed little
over the past few hundred years. Thus, we can eliminate
this as a cause of modern global warming.
• Orbital variations: The amount of solar energy reaching
the Earth is determined not only by the energy emit-
ted by the Sun but also by the Earth-Sun distance. If,
for example, the Earth moved closer to the Sun, then
the solar energy hitting the Earth would increase even
if the thermal properties of the Sun did not change. In
fact, the Earth's orbit does change in three ways: First,
the shape of the orbit changes, with the orbit cycling
between more elliptical and less elliptical over a period
of 100,000 years. Second, the tilt of the Earth, today
° °
about 23.5 ° , cycles from 22.3 to 24.5 over a period of
about 41,000 years. Third, the date of closest approach
of the Earth to the Sun, presently occurring in Janu-
ary, cycles through the calendar over a period of about
23,000 years. These variations are responsible for the ice
ages (Figure 1.3b) but could not be the cause of modern
warming because the orbit does not change much over
a century.
• Unforced variability: The previous suspects are all
examples of climate change forced by planetary energy
imbalances. However, the Earth's climate system is so
complex that it can also vary without an imposed energy
imbalance driving it. Such changes, which are caused
by complex internal physics of the climate system, are
often referred to as unforced variability. The best-known
example of unforced variability in our climate is the El
Nino/Southern Oscillation (referred to by scientists by its
initials, ENSO). El Nino events, which make up the warm
phase of ENSO, occur every few years and last a year
or so, and alternate with cooler La Nina events. Could
the modern warming be due to unforced variability? It is
very unlikely for three reasons: First, there is no theory
that explains the observed warming since the industrial
Chapter 1 Foundations of Climate Change: What Is Climate Change?
revolution, nor observations supporting unforced vari­
ability as causing this observed warming. Second, obser­
vations of the past millennium show nothing similar to
the rate and magnitude of warming of the twentieth cen­
tury. Third, computer simulations of the climate do not
support this as a cause. Thus, scientists are very skeptical
that unforced variability is playing anything other than a
minor role in modern warming.
• Greenhouse gases: The evidence supporting the cause
of the warming being the increase in greenhouse gases
over the last two centuries is immense. First, the laws of
physics tell us that adding carbon dioxide, or any other
gas that absorbs infrared radiation, to the atmosphere
should warm the planet by affecting the planet's energy
balance. Second, it is a fact that humans are adding
carbon dioxide to the atmosphere. Just based on that,
you could have predicted the warming of the climate
that we are observing. The timing of warming, begin­
ning in the nineteenth century, after the industrial revo­
lution, and the magnitude of the warming, also match
scientific theory. Finally, the geologic record shows
that changes in climate are frequently associated with
changes in greenhouse gases. For example, carbon
dioxide changes during ice-age cycles (Figure 1.3b) are
thought to play a key role in amplifying the size of the
climate variations, although the exact mechanism that
alter the concentration of atmospheric carbon dioxide
during ice-age cycles is an active area of research.
1. 7 Summary Statement on Attribution
of Modern Warming
Given the evidence supporting the hypothesis that green­
house gases are responsible for the modern warming and
the lack of support for any competing theory, there is wide­
spread agreement in the scientific community on the reality
of anthropogenic (human) influence on the climate system.
The Sixth Assessment Report (AR6) of the Intergovern­
mental Panel on Climate Change, published in 2021, came
to the following conclusion:
It is unequivocal that human influence has warmed
the atmosphere, ocean, and land. Widespread
and rapid changes in the atmosphere, ocean,
cryosphere, and biosphere have occurred.
■ 11
Thus, it is beyond doubt that humans are warming the cli­
mate system. However, that statement does not tell you
how large this human influence is. Thus, the report follows
up by saying:
The likely range of total human-caused global surface tem­
perature increase from 1850-1900 to 2010-2019 is 0.8°C to
1.3°C, with a best estimate of 1.07°C.
Since the observed warming over this period is about
1.1°C, this means that the best estimate is that humans
are responsible for 100% of the observed warming of the
climate system. Note the use of the word likely here. The
IPCC uses a set of carefully defined terms to express confi­
dence. In the parlance of the IPCC, likely denotes a confi­
dence of 66%.
FUTURE WARMING
1.8 Shared Socioeconomic Pathways
In order to predict future climate change, we must first
project how much greenhouse gas society will emit in
the future. Because of the difficulty of making a single,
confident projection of the future, a group known as the
Integrated Assessment Modeling Consortium has devel­
oped a set of alternative pathways that they believe span
the range of different futures the world may experience
over the next century or two. These are based on five
different narratives of the future, which are referred to as
Shared Socioeconomic Pathways, usually abbreviated SSPs.
The SSPs are labeled SSP1, SSP2, SSP3, SSP4, and SSP5,
and each represents a different way the world may evolve
in the future. It is worth noting that the numbers 1-5 in the
name of each scenario indicate a continuum of potential
climate outcomes, with SSP1 representing the most
optimistic and SSP5 the most pessimistic. Further-more,
SSP4 is rarely used in the climate literature, and we will not
consider it further in this chapter.
One can think of these different scenarios as mainly
differing in the amount of economic growth and the
amount of climate-safe energy that is being deployed
(Figure 1.6a), which leads to different amounts of carbon
dioxide emitted into the atmosphere each year (Figure
1.66). Given these emissions scenarios, the resulting
12 ■ Sustainability and Climate Risk Exam
atmospheric concentrations of carbon dioxide can be
calculated (Figure 1.6c) and, from this, the amount of
climate change under each scenario can be estimated by
inputting atmospheric carbon dioxide into a computer
simulation, known as a global climate model, sometimes
referred to by its initials as a GCM (Figure 1.6d).
The different scenarios describe very different worlds:
• SSP1 is a sustainable world where the world's econo­
mies gradually shift towards a more environmentally
friendly path. Because of strenuous efforts to adopt
renewable energy, emissions are currently peaking
and expected to decline throughout the rest of the
century. In fact, SSP1's emissions go negative around
2075, meaning that humans are pulling more carbon
out of the atmosphere than they are releasing. The
low emissions associated with this scenario lead to
temperature increases of 2° C/3.6°F above the pre­
industrial climate.
• SSP2 is a world that follows the trends of our world today,
leading to generally declining emissions over the twenty­
first century due to widespread adoption of renewable
energy (although slower than in SSP1). Economic growth
is similar to SSP1. The carbon dioxide emissions associ­
ated with this scenario lead to temperature increases of
3°C/5.4°F above the pre-industrial climate.
• SSP3 is a world where economic inequality gets
worse, leading to increasing conflict between regions.
Because of this, economic growth is slow and adop­
tion of new energy technology is also slow, leaving
the world almost entirely dependent on fossil fuels.
The combination of these leads to carbon dioxide
emissions increasing throughout the century, reaching
around double today's values in 2100. Temperature
increases in this world are 4.5° C/8°F above the pre­
industrial climate.
• SSP5 is a world similar in many ways to SSP1, but it is
one that emphasizes economic growth rather than sus­
tainability. As a result, economic growth in this world
is very high and fossil fuels power a significant fraction
of this growth. This leads to carbon dioxide emissions
increasing throughout the century, reaching more than
triple today's values in the late-twenty-first century.
Temperature increases in this world are 5.5° C/10°F
above the pre-industrial climate.
 GDP vs. renewable energy
(a) (b) Emissions

0
100 ------------------
SSP1
-*----------------------------- 120
SSP5

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0

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100
.!: 80 -----------------ssp2-----------------------------
rn a,
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0 40 - � 40
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� 20 20 -------------------- ------------------ ---------
SSP2
a..a, 0 ----------------------------------- --------------
SSP3 ------ -- SSP1
0 +-�*�-�- - - �- - � -- -
�- -
200 400 600 800 1000 2010 2025 2050 2075 2100
GDP in 2100 ($T) Year

(c) Carbon dioxide (ppm) (d) Temperature

6 --------------------------------------------------
1100 ------------------------------------------------SSP5 SSP5
1000 5

0.. 900 2-4

SSP3 E
u 800 0 SSP2
"'
C
3
·.:::u 700
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L
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0
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E
:1. 500 �

400 0

2010 2025 2050 2075 2100 1900 1950 2000 2050 2100
Year Year

6J!jljk$1:J (a) GDP in 2100 (trillions of 2005 US dollars) versus the sum of wind and solar capacity as a%
of total (final) energy consumption in 2100.

(b) Emissions of carbon dioxide (billions of tonnes of carbon dioxide per year).

(c) Atmospheric carbon dioxide (ppm). (Panels a-c are based on the SSP database hosted by the IIASA
Energy Program at https://tntcat.iiasa.ac.at/SspDb. Reprinted by permission from INTERNATIONAL
INST I TUTE FOR APPLIED S YSTEMS ANALYSIS)

(d) Computer simulations of global and annual average surface temperature change under the SSP
scenarios. Temperatures prior to 2014 are from model runs driven by historical forcing. Geosci. Model
Dev., 9, 1937-1958, 2016 www.geosci-model-dev.net/9/1937/2016/ doi:10.5194/gmd-9-1937-2016
© Author(s) 2016. This work is licensed under a Creative Commons 3.0 License.

No one knows which emissions trajectory will turn out to not yet been made. However, as of 2023, it seems that the
describe reality because emissions will be determined by SSP2 emissions scenario is the one we are on track to most
political decisions and technological advancements that have closely follow. Obviously, the future is not yet certain and the

Chapter 1 Foundations of Climate Change: What Is Climate Change? ■ 13

decisions we make in the next decade or two could radically
alter our climate trajectory and which SSP scenario turns out
most accurate. Because many people alive today might live
well into the second half of the century, the resulting climate
impacts would affect us, not just future generations.
While the SSPs are the most commonly used scenarios today,
you may still see references to an earlier set of scenarios,
known as the Representative Concentration Pathways, abbre­
viated RCPs. As their name suggests, these are a set of con­
centration pathways, but without corresponding economic
drivers. The more advanced SSPs were designed to span the
same range of future climates as the RCPs and for each RCP
scenario, there is a roughly similar SSP scenario (this is dis­
cussed in Chapter 7).
1. 9 Impacts of Modern Climate Change
A few degrees of global-average warming over the next
century would have significant impacts to life on Earth.
Although local temperatures can vary considerably over time,
the global average temperature of the Earth is very stable,
with random variations of just a few tenths of a degree per
year. Moreover, seemingly small changes like those in the dif­
ferent SPP scenarios in global average temperature are asso­
ciated with massive shifts in the Earth's climate. For example,
the global annual average temperature during the last ice
° warming in Figure 1.6c.
age was about 6 C colder than that of our present climate.
At that time, glaciers covered much of North America and
Europe and, because so much water was tied up in glaciers,
sea level was approximately 100 m (330 ft) lower than it is
today. The net effect of these changes was a completely dif­
ferent distribution of ecosystems.
Thus, warming of a few degrees Celsius over the coming
century (Figure 1.6d), would be comparable to the warming
since the last ice age and implies enormous changes in our
environment. This would be challenging for human progress
because humans are adapted to our present climate. We
have built trillions of dollars of infrastructure in places where
it makes sense in today's climate. We invest in agricultural
infrastructure in regions that today are good for farming.
We build cities at today's sea level. We construct storm
water infrastructure to handle storms that occur today. If
the climate changes, these assumptions will no longer make
sense. We will have to rebuild agricul-tural infrastructure in
new regions where agriculture makes sense in a changed
14 ■ Sustainability and Climate Risk Exam
climate, we will have to build coast defenses or relocate
cities in response to higher seas, and we will have to
enhance our infrastructure to handle more intense storms.
Not every single change in every region will be negative.
Warmer cold-season temperatures might have benefits:
less cold-weather mortality, benefits to agriculture of fewer
freezing events that can destroy some crops. Plant growth
may well be enhanced in some regions. But there are also
negative effects of warmer winters, such as less wintertime
insect mortality, leading to increased agricultural damage
from pests, or less wintertime precipitation falling as snow,
reducing snowpack and meltwater and stressing freshwater
supplies during the spring and summer.
1. 9. 1 Temperature
One of the most certain predictions of climate science
is that the long-term trajectory of the climate is towards
warmer temperatures. However, the warming will not be
uniform across the globe. In a continuation of the observed
patterns seen in Figure 1.2, we expect continents to warm
more than oceans and to have more warming in the north­
ern hemisphere than in the southern hemisphere. Given
that most people live on land of the northern hemisphere,
this means that the average temperature increase expe­
rienced by humans will be larger than the global average
Higher temperatures will have many negative impacts for
society. Temperature extremes can be fatal-for example,
a 2003 heat wave in Europe caused tens of thousands
of excess deaths. Higher temperatures also reduce the
productivity of people who work outside. In some regions,
temperatures are getting high enough that people cannot
work outside in the middle of the day in summer. Higher
temperatures, especially when combined with precipitation
changes, can reduce agricultural yields. Higher tempera­
tures also require people to run the air conditioners more,
and this costs money.
1. 9.2 Precipitation
Precipitation is another key aspect of climate. As the sur­
face temperature increases, there is an increase in the rate
of evaporation at the surface. Because precipitation must
balance evaporation, precipitation must therefore also
increase. More quantitatively, total global precipitation is
projected to increase by about 3% for every degree Celsius
of global average warming (Jeevanjee, 2018).
Although total rainfall is expected to increase, the increase
will not be distributed evenly. Scientists expect regions that
get a lot of rain today to get more as the climate warms,
while dry regions will become drier, a pattern referred to as
"wet gets wetter, dry gets drier."
In addition to changes in the pattern of precipitation, it is
likely that a higher fraction of total rainfall will come during the
heaviest downpours, which continues a trend observed over
the last few decades. This will tend to increase the occurrence
of flood events. The increase in the fraction of heavy events
also tends to increase the time between rain events, which,
combined with warmer temperatures, will increase the rate at
which water is lost from soils by evaporation and increase the
occurrence of drought. Thus, we get the surprising result that
both wet and dry extremes will grow more likely in the future:
When it rains, it's more likely to flood, and when it's not rain­
ing, it's more likely to create drought conditions.
There will also be shifts in the form of precipitation. Less
wintertime precipitation will fall as snow and more will fall as
rain. This is more important than it might sound: When snow
falls in winter, the water does not run off until the snow melts
in spring. Rain, on the other hand, runs off immediately and
therefore changing the form of precipitation will change the
timing of runoff. This will increase the availability of water
in winter and spring and decreasing it in summer. Places
that rely on a particular timing of runoff, such as how the
U.S. Pacific Northwest relies on summertime runoff during
their dry summers, will be impacted. Impacts would include
reduced freshwater and hydroelectric power availability as
well as reduced recreational opportunities.
Changes in precipitation will have negative impacts for
society. As with all other aspects of the climate, societies
adapt in important ways to the amount and timing of rain­
fall. Changes will require construction of costly new infra­
structure to protect against flood events in some regions and
droughts in others. It may also be politically destabilizing as it
exacerbates political tensions over access to water.
1. 9.3 Sea Level & Ocean Acidification
Sea level rise is a direct impact of climate change with the
main future driver being the melting of grounded ice. The
melt water eventually reaches the ocean, increasing the total
Chapter 1 Foundations of Climate Change: What Is Climate Change?
amount of water in the ocean and, therefore, sea level. Mea­
surements (e.g., Figure 1.1f) confirm that sea levels are already
rising as temperatures have gone up, and we can be confident
that the seas will continue to rise into the next century.
The IPCC's Sixth Assessment Report (AR6) contains predic­
tions that sea level will rise 44 to 76 cm (17 to 30 inches)
above today's levels by 2100 under the most likely emis­
sions scenario (SSP2). Even though such a sea level rise may
not seem significant, the impacts could be very serious. In
Florida, for example, a sea level rise in the middle of the
projected range would flood 9% of Florida's current land
area at high tide. This includes virtually all of the Florida
Keys as well as 70% of Miami-Dade County. It also includes
important infrastructure, such as two nuclear reactors, three
prisons, and sixty-eight hospitals (Stanton, 2007). And this
is just Florida. Multiply these impacts to account for all the
places on the planet where people live near sea level, and
you can get a feel for how big a problem this is going to be.
Because ice melts slowly, the amount predicted for this
century is just a fraction of how much sea level rise we are
committed to. Based on observations of previous changes
in climate, it has been estimated that sea level rises a few
meters for every degree of warming (Garbe, 2020). This
means that a few degrees of warming this century could
commit us to many meters of sea level rise. It may take mil­
lennia for sea level to fully respond to the warming of the
twenty-first century, or it could happen more rapidly in a
tipping point scenario (see Section 1.9.5).
Ocean acidification is another consequence of emissions
of carbon dioxide to the atmosphere. As discussed earlier,
about a quarter of carbon dioxide emitted to the atmosphere
by human activities ends up in the oceans where, in the liquid
environment of the ocean, carbon dioxide is converted into
carbonic acid. The net result is that as humans continue to
emit carbon dioxide to the atmosphere, the oceans absorb
more and more, and the oceans will become more acidic.
This can have important impacts on ocean ecosystems. For
example, decreasing the ocean's pH makes it harder for cal­
cifying species (e.g., corals, molluscs, crustaceans) to build
and maintain their shells and skeletons. These species will
find it more and more difficult to extract carbonate from the
water for use in their shells or skeletons. Eventually, ocean
chemistry will increase to the point where it is fatal for these
species.
■ 15
1. 9.4 The Albedo Effect, Polar Amplification,
and Positive Feedbacks
Similar to the "water vapor feedback" process discussed
earlier, a decline in sea and land ice can amplify warming
beyond the release of GHGs. Ice is more reflective-it has
a higher albedo-than the darker ocean or land. Thus,
previously ice-covered areas absorb more solar radiation,
heating up the atmosphere, which in turn, melts more ice,
exposing more dark areas and reducing the Earth's overall
albedo-the albedo effect.
This is the primary reason the Artie is warming faster than
other areas of Earth. Other polar and geographic charac­
teristics (e.g., more land and less ocean in the Arctic than the
Antarctic) compound this effect. This polar amplification leads
to average Arctic temperature change 3-4 times that of the
rest of the Northern Hemisphere. The impacts of this amplifi­
cation are manifold (faster melting of the Greenland ice sheet,
leading to sea level rise; melting permafrost releases GHGs
such as methane; and alteration of the northern hemisphere
jet stream, affecting weather patterns across the globe).
Water vapor feedback, polar amplification, and any other
self-reinforcing warming phenomena are "positive feed­
backs." A feedback loop either speeds up or slows down
a change in a system. As discussed, a positive feedback
accelerates a change, in this case, warming. A negative
feedback-such as a condition in which cloud cover acceler­
ated, increasing albedo-would slow down warming. How­
ever, negative feedback loops play less of a significant role
in modern climate change than positive feedback loops.
Feedback loops can play an important role in climate tip­
ping points, discussed below.
1. 9.5 Extreme Events
While we've previously been focused on average conditions,
many of the biggest impacts of climate change come from
the changes in frequency and intensity of extreme weather
events. However, when it comes to extreme events, climate
change is only one of the contributors as extreme weather
events are random in time. For example, extreme heat
waves are magnified when added on top of the long-term
warming. Another example is how strong coastal storms can
combine with sea level rise to generate extreme sea level
events.
16 ■ Sustainability and Climate Risk Exam
Until recently, it was difficult to quantitatively determine the
extent to which climate change played a role in an extreme
event. In response to this need, a new branch of climate
science known as extreme-event attribution science has
begun to give us the capability to quantify the contribution
of climate change to extreme events.
Extreme-event attribution analyses use three different
sources of information. The first technique uses statistical
analysis of historical climate. The observations can be sta­
tistically analyzed to determine the likelihood that an ob­
served extreme event occurring today could have occurred
prior to human-induced warming. By itself, however, this
type of analysis usually can't tell you whether an observed
phenomena was caused by global warming or by some­
thing else because correlation does not prove causality.
Thus, the second technique focuses on our understand­
ing of the physics of the phenomenon. In a warmer world
it should be obvious why we expect to get more frequent
heatwaves. The clarity of the connection adds to our confi­
dence that climate change is a factor in the occurrence of
heat waves. For other things, like the frequency of occur­
rence of tornadoes, we do not have a good understanding
of how this will change as the climate warms. This lowers
our confidence that tornado outbreaks are affected by
global warming.
Finally, we use computer simulations (i.e., GCMs) of the cli­
mate to evaluate frequency and intensity of extreme events.
The simulations can be run with and without the increase in
greenhouse gases, and the impact of climate change can
be quantitatively estimated. If we find that a heatwave with
characteristics of the observed event rarely or never occurs
in the simulated world without climate change, but does in
a world with simulated climate change, then it increases our
confidence that climate change was a factor in the event.
These attribution studies are now carried out for most
extreme weather events around the world. As just one
example, it has been estimated that climate change
increased the rainfall from Hurricane Harvey by about 15%
(Van Oldenburgh et al., 2017). The American Meteorologi­
cal Society puts out an annual review of extreme events
and their connection to climate change, and they find that
most extreme events have been affected by climate change
(AMETSOC). Thus, it would be correct to say the data and
analysis shows that climate change is already making many
extreme weather events more extreme.
1. 9.6 Impacts on Human Society and Natural
Ecosystems
As our climate changes, human systems will respond to
these changes; this is discussed in the next section. But
many of the impacts of climate change will be on natural
systems that humans do not manage, and those impacts
will be much more difficult to mitigate. These natural
ecosystems provide enormous benefits to human society.
For example, mangrove forests that grow in shallow salt­
water coastal regions provide protection for coastal areas
from erosion, storm surge (especially during hurricanes),
and tsunamis. Pollination by bees is a key part of the
growth cycle of many societally and economically beneficial
crops (e.g., apples, almonds, blueberries). As the climate
shifts and ecosystems are impacted, the benefits provided
by these ecosystems may disappear, and the resultant costs
will be shifted onto society. In China, for example, a decline
of wild bees has forced farmers to hire people to go from
flower to flower and hand-pollinate the flowers using tiny
brushes.
One concern for both natural and human systems is that
the climate will not warm linearly as greenhouse gases are
added to it linearly. Rather, we will add enough green­
house gas that the climate system will undergo a large and
rapid shift to an entirely new climate state-this is colloqui­
ally known as a climate tipping point. An example of an
abrupt change occurred roughly 12,000 years ago, as the
Earth was emerging from the depths of the last ice age,
when temperatures in the Northern Hemisphere plunged
several degrees in a few decades due to a disruption in the
ocean currents.
Research on potential abrupt changes has revealed several
possible places in our climate system where abrupt changes
could occur. These include:
• similar to that described above, another shutdown of the
Gulf Stream that leads to rapid, widespread changes in
climate;
• a rapid disintegration of the West Antarctic or Greenland
ice sheets, which could raise sea level by several meters
in a century or less;
Chapter 1 Foundations of Climate Change: What Is Climate Change?
• thawing of permafrost and methane hydrates, which
would release huge amounts of greenhouse gases into
the atmosphere, leading to additional warming and an
acceleration of climate change; and
• a shift in the timing and magnitude of the Indian mon­
soon, changing seasonal rainfall that billions of people
rely on.
It is difficult to assess the probability of a tipping point
occurring. Climate models do not reliably predict the
occurrence of an abrupt climate change, and many experts
view the probability to be low, although not zero, over the
coming century. If an abrupt change did occur, though, it
could be a catastrophe for both human and natural systems
because the rate of change is so high for these kinds of
events. This is why these kinds of events pose such a chal­
lenge for risk management.
POLICY RESPONSES
Our responses to climate change can be broadly split
into three categories: adaptation, mitigation, and
geoengineering. Adaptation means responding to
the negative impacts of climate change. If climate
change causes sea level to rise, an adaptive response
to this impact would be to build seawalls or relocate
communities away from the encroaching sea. Mitigation
refers to policies that avoid or minimize climate change
in the first place, thereby preventing impacts such as sea
level rise from occurring. This is accomplished by reduc­
ing emissions of greenhouse gases, primarily through
policies that encourage the transition from fossil fuels
to energy sources that do not emit greenhouse gases.
Geoengineering refers to active manipulation of the
climate system. Under this approach, our society could
continue adding greenhouse gases to the atmosphere,
but we would intentionally change some other aspect of
the climate system in order to cancel the warming effects
of the greenhouse gases. For example, we could engineer
a decrease in the amount of solar energy absorbed by
the Earth. If done correctly, this could stabilize the climate
despite continuing emissions of greenhouse gases. In the
rest of this chapter, we explore each of these options in
detail.
■ 17
1.10 Adaptation
Any climate change that is not avoided must be adapted
to. Because the climate is presently changing and, even
under the most optimistic scenario, will continue to change
for decades, adaptation must be part of our response
to climate change. Adaptation is primarily a response to
physical climate risk, which will be detailed in subsequent
chapters.
Adaptation actions can physically manifest in human-built
infrastructure or enhancement of ecosystem services and
functions, such as protection of mangrove forests to quell
storm surges or expanding forested areas to improve
water quality. Beyond physical enhancements, human
communication, processes, regulations, etc ... can be
adaptive, such as better extreme event warning systems or
more climate-informed zoning regulations. Individuals can
adapt without any direction from the government, if they
have sufficient resources. For example, when the climate
changes in agricultural areas, farmers will need to change
their farming practices to avoid bankruptcy. They can
change farming practices by switching to drought-resistant
plant species, add infrastructure to irrigate their fields more
effectively, or take any number of similar actions to adjust
to the realities of a new climate.
However, leaving adaptation up the individual has the
significant disadvantage that some of the most effective
adaptive responses take enormous resources or require
large-scale societal coordination. For example, consider
the complexities in building a seawall. Effective sea walls
cover an entire community and therefore require consen­
sus from that community on whether to make that signifi­
cant investment, and how to best make that investment.
Because of this, many of the possible adaptive responses
require a significant role be played by the government-in
both organizing decisions about large-scale infrastructure
and in providing resources. This requirement for significant
resources has profound implications for equity and justice
of adaptation. Because not everyone has those resources,
policies that rely extensively on adaptation policies run the
risk of exacerbating existing inequalities.
It is also worth noting that one person's adaptation can
modify impacts elsewhere. A good example of this is
building a levee on a river. While that may reduce flooding
18 ■ Sustainability and Climate Risk Exam
around the levee, a reduction in flooding there will push
water-and flooding-downstream. This can lead to levee
wars in which communities building higher levees force
other communities to raise their levees, reducing flood
impacts to their area but pushing flooding into other
areas.
1. 10. 1 Maladaptation
The previous example shows how an action that decreases
climate vulnerability for one community can increase
exposure to risk for another. This is maladaptation, an
intended adaptation action that actually increases climate
vulnerability. Maladaptations can increase vulnerability
immediately or sometime in the future. The negative
effects of maladaptations can include not just an increase in
vulnerability but also an increase of greenhouse gases or an
imposition of disproportional burdens on the most vulner­
able populations.
Maladaptations can increase vulnerability immediately or
sometime in the future. The negative effects of maladapta­
tions can include not just an increase in vulnerability,
but an increase of greenhouse gases or an imposition
of disproportional burdens on the most vulnerable
populations.
Insurance policies can lead to maladaptation. Home or
building insurance policies, a seemingly adaptive risk
management practice, can lead to rebuilding in areas at
increasing risk from climate impacts or provide a false sense
of security. Building sea walls or other coastal defense
structures can sometimes lead to increased erosion and
damage to neighboring areas, thus creating new vulner­
abilities and negatively impacting ecosystems. Planting
trees is often seen as a way to address climate change but
planting non-native or monoculture tree species can have
unintended consequences such as reduced biodiversity,
increased vulnerability to pests and diseases, and potential
disruptions to local water cycles.
Another issue with adaptation is that the ability of societ­
ies to adapt to climate change varies. Financially stable
and well-governed countries like the United States and
transgovernmental organizations like the European
Union will be able to adapt far more effectively than less
financially stable places without strong public institutions.
This creates a tension in the climate debate-the societies
most responsible for climate change, who historically
emitted the most carbon dioxide into the atmosphere, are
also the richest countries. Because of their wealth, they
are also most capable of dealing with the impacts. Those
who will be most negatively affected are also the poorest
countries, who have contributed the least to the climate
problem.
In addition to direct aid, governments can also imple­
ment regulations and financial incentives to encourage
citizens to adapt to a changing climate. Regulations
promoting water conservation, for example, would help
communities adapt to decreased freshwater availability
caused by climate change. Governments can also reform
existing policy that encourage us to be poorly adapted
to the present (or future) climate and that increase our
vulnerability (maladaptation) to climate change, such as
setting the price of flood insurance too low (as happens in
the United States).
Finally, governments can facilitate adaptation by providing
reliable information about climate change. Telling peo-
ple that the parcel of land they're considering building a
house on has a higher likelihood of flooding in the next few
decades may convince them to build elsewhere, saving soci­
ety the costs of rebuilding the house. T he government can
also provide technical assistance about possible responses
to climate change-that is, helping a farmer figure out what
farming practices she needs to change in order to be better
adapted to a drier climate.
1.11 Mitigation
Mitigation refers to actions that reduce emissions of carbon
dioxide and other greenhouse gases, thereby preventing
the climate from changing.
1. 11. 1 Emissions from the Current Energy
System
In our present energy system, most energy comes
from combusting fossil fuels. The amount of carbon
dioxide produced per unit of energy generated is known
as the carbon intensity. The highest carbon intensity
fuel is coal, followed by oil, and lastly natural gas
(see Table 1.2).
GHGs can be measured in grams or kilograms per million
British thermal unit (MMBtu) and organizations typically
report total emissions in metric tons (tonnes). T here
are 1,000 kilograms in a tonne. So, an organization that
used 30,000 MMBtus of propane in a year would report
1,890 tonnes CO2 = 30,000 MMBtus x (63 kg C02/MMBtu
+ 1,000 kg/tonne).
Beyond accurately reporting organizational GHG emissions,
understanding carbon intensities/emissions factors plays an
important role in energy policy discussions. Natural gas has
been heralded as a cleaner fossil fuel than coal and "coal-to­
gas switching" as a "bridge" to help countries transition to
more clean-energy. However, methane leakage, the escape
of methane during extraction or transport of natural gas, has
called into question the value of natural gas in this transition.

UMntsfJ Carbon intensity of various fuels. GHGs can be measured in grams or kilograms per million
British thermal unit (MMBtu) and organizations typically report total emissions in metric tons. Methane
(CH4) and Nitrous Oxides (N20) are measured in smaller amounts, grams. However, due to their higher
Global Warming Potential, small emissions of these GHGs can have significant impact
Fuel 1 kg C02/MMBtu g CH4 /MMBtu g N20/MMBtu
Coal 1002 11 1.6

Motor gasoline 70 3 0.60

Propane 63 3 0.60

Natural gas 53 1 0.10

1 Taken from US EPA Emission Hub https://www.epa.gov/system/files/documents/2022-04/ghg_emission_factors_hub.pdf;
https://www.epa.gov/cl i matel eadershi p/ghg-emission-factors-hub
2 Depending on type of coal (e.g., anthracite, bituminous), CO emissions factors can range from 93 - 103 kg COi/MMBtu
2

Chapter 1 Foundations of Climate Change: What Is Climate Change? ■ 19

1.11.2 Moving Toward a Cleaner Energy
System
Solving climate change requires our society replace fossil
fuels with climate-safe energy sources that do not release
carbon dioxide into the atmosphere. Solar energy is the
renewable energy source with the most potential. To satisfy
all human energy needs would require roughly 1 million
km 2 to be covered with solar energy collectors. This would
be equivalent to a square with 1,000 km on each side and
corresponds to 0.2% of the Earth's surface. Although this is
a large area, it is comparable to the total area covered by
cities, so there is no reason to believe that it is impossible
for humans to construct this area of solar panels, distributed
around the world.
Wind is another important and prolific climate-safe energy
source. Today's electricity-generating wind turbines can
individually generate as much as 10 MW of power. Consid­
ering the intermittency of wind, we could satisfy humani­
ty's energy requirement with a few million wind turbines.
It should be noted that putting up wind turbines does not
preclude using the land simultaneously for other activities,
such as agriculture. In addition, wind turbines can be put
offshore with an additional benefit that offshore wind typi­
cally blows more consistently, so intermittency is less of an
issue than for land-based wind.
Wind and solar energy have been growing rapidly over the
past decade and are emerging as important contributors to
our energy supply. The price of these energy sources has
declined rapidly over the years, and they are competitive or
even cheaper than conventional fossil-fuel energy in many
places. There is no question that this trend will continue and
wind and solar will become a bigger part of our energy mix.
The primary issue with wind and solar is intermittency-the
Sun shines only during the daytime and when not obscured
by clouds, and the wind speed varies with meteorological
conditions.
But people want power when they want it, so a grid con­
taining a significant amount of wind and solar must be
balanced with dispatchable carbon-safe energy sources.
Dispatchable sources are able to generate energy regard­
less of weather conditions, so the power is always available
and can be modulated to counteract the intermittency of
wind and solar. Hydroelectric power is generated when
20 ■ Sustainability and Climate Risk Exam
water running through a dam spins turbines and generates
electricity. It is the most widespread dispatchable renew­
able energy source in the world today, providing 16%
of the world's electricity in 2018 (IEA). Despite the many
advantages of this energy source, it seems unlikely that this
power source can be greatly expanded. Many of the world's
big rivers are already dammed, and new dams often cause
local environmental and social problems that generate sig­
nificant local political opposition.
Another significant source of climate safe and dispatch-
able energy sources is nuclear energy. Nuclear energy is a
mature technology that generated about 10% of the world's
electricity in 2018, so there is no question about its techni­
cal feasibility (Our World in Data). Nuclear power plants are
expensive to build, and this is one of the primary reasons
that few new nuclear power plants have been built in the
United States in the last few decades. Opposition to new
nuclear power plants also arises because of the environ­
mental risks of that power. One particularly frightening risk
is of release of nuclear radiation from an accident (such as
occurred in Chernobyl and Fukushima) or from intentional
release due to terrorism.
Another issue is nuclear waste, which is highly radioactive
and must be safely isolated for thousands of years.
Accidental or intentional release could cause massive
harm to humans and the environment. Additionally, there
is a risk of proliferation, as the nuclear fuel cycle might
enable diversion of materials for building a nuclear bomb,
potentially putting weapons in the hands of terrorists or
rogue nations.Advances in reactor design, particularly
small modular reactors (SMRs), hold the promise to solve
some of these problems. SMRs are physically small, so they
occupy fraction of the area of a conventional nuclear power
reactor. Their modular design would allow much of the
plant to be manufactured in a factory and transported to
the final site. These offer savings in cost and construction
time, two of the main impediments to building nuclear
power reactors today. SMRs are simpler than traditional
nuclear power plants and are expected to have safer
modes of failure. And less frequent refuel cycles may
ease proliferation concerns. Thus, many of the technical
problems with nuclear energy can be addressed. Whether
this makes nuclear energy more politically palatable
remains to be determined.
Another potentially important source of dispatchable power
is geothermal, in which water, pumped underground,
heated by the Earth, and brought back to the surface,
is used to turn a turbine and generate power. While fre­
quently used in places with active volcanism, like Iceland, it
can be used more widely than it currently is today.
Other sources of dispatchable power are more problematic.
Biomass energy refers to the process of growing plants
and then burning them to yield energy. Because the carbon
dioxide released from burning biomass was absorbed from
the atmosphere during the growth of the plant, there is no
net increase in carbon dioxide in the atmosphere. While
people have been utilizing biomass energy for nearly all of
human existence, there remain important issues with this
as a large-scale energy source. For example, a global-scale
bioenergy source will require enormous amounts of land.
This can be problematic because we already farm most pro­
ductive land, so additional land typically comes from clear­
ing forest, which causes a host of other local environmental
impacts, such as loss of native biodiversity and ecosys-
tem degradation. These issues need to be assessed and
addressed before we embark on an expansion of this
energy source.
A final option to generate dispatchable power without
emitting carbon dioxide to the atmosphere is known as
carbon capture, utilization, and storage, often shortened to
carbon capture, carbon sequestration, or by its abbrevia­
tion, CCUS. CCUS refers to a process by which fossil fuels
are burned in such a way that the carbon dioxide generated
is not vented to the atmosphere. Rather, the carbon diox­
ide is captured and used in a range of applications, such as
being incorporated in cement or plastic.
The carbon can also be stored. The most promising place to
store the carbon dioxide is to inject it deep underground in
depleted oil and gas fields, coal beds that cannot be mined,
or deep saline formations. Such storage is technically fea­
sible and has been demonstrated to work in preliminary
tests. Overall, it is presently unclear if CCUS is economically
feasible at the scale necessary to allow fossil-fuel sources to
continue to be an important source of energy without the
carbon emissions.
Battery energy storage systems (BESS) may also play a role
in two ways. Short-term storage (a few hours) can be used
Chapter 1 Foundations of Climate Change: What Is Climate Change?
to shift energy produced at the peak of solar power, around
local noon, to the peak of demand, in the late afternoon/
early evening. This would play a key role in smoothing out
the intermittency of solar energy. The cost of batteries is
coming down quickly and such short-term storage is already
a component of some grids, such as in California. Longer­
term storage (days to weeks) would potentially displace the
need for dispatchable power. At this point, however, long­
term storage at sufficient scale is not feasible. Research
on new technologies now occurring means that this may
become possible in the future.
Batteries require elements like cobalt, which come from
politically volatile regions like central Africa. In some cases,
the mining is done for low pay and in dangerous conditions,
making ethical issues in the supply chain prominent.
Recently, Chinese mining companies have moved
aggressively to gain control of strategically important
mines, potentially adding political uncertainty. Clearly, the
supply chain is a risk for future production of batteries. One
way to mitigate that risk is to recycle the batteries. This is
possible, but not widely done currently. However, given
potential supply-chain issues, efforts to recycle batteries will
inevitably increase.
Ultimately, to reach a zero-emission economy, as many
economic activities as possible must be electrified. This will
greatly increase consumption of electricity compared to a
scenario where we continue to rely on fossil fuels. That in
turn will require enhancements in infrastructure, such as
enhanced transmission lines. An enhanced transmission
system will also help reduce the impact of intermittency of
solar and wind energy by allowing the transfer of energy
from regions with excess renewable energy to regions
where demand exceeds supply.
Some important economic processes may be difficult to
electrify, including international airline flights and long­
distance trucking. For these, hydrogen energy might play
a role due to its large energy per unit mass. The hydrogen
must be produced in a way that does not produce green­
house gases, such as from electrolysis of water powered
by renewable energy. Hydrogen could also be used in
place of batteries for storage-it could be produced when
there is excess renewable power and then converted back
to electricity when more power is needed. A downside
■ 21
of hydrogen is that it is difficult to store, and it carries a
significant explosion risk, as passengers of the Hindenburg
found out. This means that any widespread adoption of
hydrogen would require significant investment in new
hydrogen infrastructure.
The clean-energy transition must be carefully managed.
A reliable and climate-safe energy system will contain a
mix of power sources: wind and solar will produce a lot of
power, but it also must contain dispatchable power that
will pick up the load when wind and solar are not able
to generate sufficient energy. One of the biggest risks is
that our existing fossil fuel energy sources are shut down
too soon, before climate-safe energy sources are able to
provide the 24-hour-per-day reliable power that everyone
expects. Maintaining reliable power may require keeping
open economically non-competitive fossil fuel plants
until the gird can be robustly maintained by climate-safe
energy.
The transition must also be managed in a way that ensures
that it is economically and politically feasible. This includes
ensuring that the transition is equitable and that access to
clean energy is available to all, regardless of income level
or location. Finally, it is critical to ensure that the transition
is done in a way that does not result in too many "stranded
assets," such as coal-fired power plants that may become
obsolete due to the shift to clean energy.
1.12 Geoengineering
A final category of solution to the climate change prob­
lem is known as geoengineering, which refers to actively
manipulating the climate system in order to prevent the
climate from changing despite continuing greenhouse gas
emissions. Geoengineering efforts can be roughly divided
into two categories.
The first category is known as solar radiation management,
and these efforts attempt to engineer a reduction in the
amount of solar energy absorbed by the Earth. The most
frequently discussed way to do this is to inject sulfur into
the stratosphere. Once in the stratosphere, this gas reacts
with ambient water vapor to form droplets that reflect
sunlight back to space, thereby increasing the reflection
of incoming solar energy back to space and cooling the
22 ■ Sustainability and Climate Risk Exam
planet. This is the same mechanism by which volcanoes cool
the planet. Thus, the physics supporting these suggestions
is robust, and we have high confidence that if schemes like
this were carried out at a sufficiently large scale, the planet
would experience cooling.
There are, however, important disadvantages with these
approaches. To begin with, such schemes may have serious
side effects. We expect, for example, that solar radiation
management will change precipitation patterns, poten­
tially causing droughts in some regions or floods in others.
In addition, solar radiation management is a governance
nightmare, potentially leading to misunderstanding around
causes and effects, and subsequently instigating politically
destabilizing conflicts.
A second category of geoengineering is known as carbon
dioxide removal. This is an effort to implement processes
that rapidly remove carbon dioxide from the atmosphere.
Planting trees is an example. As the trees grow, they pull
carbon dioxide out of the air and sequester it in wood. The
problem with trees as a carbon storage device is that they
are not permanent. You can plant a forest and, as the trees
grow, carbon is indeed pulled out of the atmosphere. But
that forest can burn down, thereby releasing all of the car­
bon back into the atmosphere. Even in the best case, trees
typically only live a few centuries.
Another option is to remove carbon dioxide from the air
chemically, a process often referred to as direct air capture.
This is like CCUS (discussed in the last section), but CCUS
removes carbon dioxide from the exhaust gas of a power
plant, whereas air capture removes carbon from the free
atmosphere. A related approach is referred to as bioenergy
with carbon capture and sequestration, more commonly
referred to by its initials, BECCS. In this process, plants are
grown, which removes carbon from the atmosphere. The
plants are then burned to produce power, and the carbon
dioxide produced is captured and sequestered.
A final category is what are referred to as natural climate
solutions. These are practices and technologies that can
help sequester carbon from the atmosphere and reduce
emissions, thereby reducing the impacts of climate change.
These solutions often involve the conservation, restoration,
and management of natural systems, such as forests, grass­
lands, and wetlands, which can absorb and store carbon

dioxide. To the extent that they eliminate emissions, there is
some ambiguity about whether these belong in mitigation
or geoengineering. Some examples of natural climate solu­
tions include:
1. Forest conservation and reforestation: Forests absorb and
store carbon dioxide from the atmosphere through the
process of photosynthesis. Protecting existing forests and
planting new trees can help sequester carbon and reduce
emissions from deforestation and land use change.
2. Agroforestry: This involves the integration of trees into
agricultural landscapes, which can aid in sequester
carbon.
3. Wetland restoration: Wetlands, such as marshes and
swamps, are important carbon sinks because they store
carbon in the soil and vegetation. Restoring wetlands
can help increase their capacity to sequester carbon
and provide other ecosystem benefits, such as improv­
ing water quality and flood control.
4. Grassland restoration and management: Grasslands,
such as prairies and savannas, can also absorb and
store carbon. Restoring and managing grasslands in
a way that promotes carbon sequestration, such as
using cover crops and reduced tillage, can help reduce
greenhouse gas emissions.
5. Soil carbon sequestration: Soil contains a large amount
of carbon, and certain practices, such as conservation
tillage, cover cropping, and the use of organic fertil­
izers, can help increase the amount of carbon stored in
the soil. This can help reduce emissions from the agri­
culture sector and improve soil health.
There are minimal technical barriers to carbon dioxide
removal schemes, but the scale required is enormous­
humans are adding more than 40 billion tonnes of CO2 into
the atmosphere every year. Carbon dioxide removal must
be able to remove a significant fraction of this at a price low
enough to not disrupt the economy. No one knows if this
can be achieved.
1.13 Mitigation Targets
The international climate agreement that the world is pres­
ently working under, the 2015 Paris Agreement, has the aim
of holding the increase in global average temperatures to
Chapter 1 Foundations of Climate Change: What Is Climate Change?
°
"well below 2 C above pre-industrial levels" while "pursu­
°
ing efforts to limit the temperature increase to 1.5 C above
pre-industrial levels." As part of the Paris Agreement pro­
cess, each country has submitted a nationally determined
contribution (NDC), a promise of global emissions reduc­
tions that the country intends to achieve.
The Biden Administration committed the United States to
cutting overall greenhouse gas emissions by 50% below
2005 levels by 2030 and reaching net-zero emissions by
2050. In support of this, the US government has passed two
laws that support climate action: 2021 's Infrastructure Invest­
ment and Jobs Act and 2022's Inflation Reduction Act. The
Inflation Reduction Act is the more significant legislation,
investing USD 319 billion in provisions related to climate
and clean energy. These investments take the form of direct
spending on infrastructure like electric vehicle charging, loan
guarantees for innovative clean energy programs, and incen­
tives and tax breaks for clean energy projects. There are also
provisions to incentivize the domestic manufacture of clean
energy components and critical minerals.
The E.U. has committed to similar reductions-in 2030,
emissions should be 55% below 1990-level emissions,
reaching net-zero emissions by 2050. China committed to
leveling off its carbon emissions no later than 2030 and
reaching net zero by 2060.
While these emissions reduction commitments are signifi­
°
cant, they are not likely sufficient to limit warming to 2 C.
Rather, commitments under the Paris Agreement put us on
°
track for 2.5-3 C of warming in 2100, with warming continu­
ing into the twenty-second century and beyond (Climate
Action Tracker).
°
So, what do we have to do to keep warming below 2 C?
A useful way to think about this problem is in terms of a carbon
budget. It turns out that the peak warming we eventually expe­
rience is determined by total cumulative emissions of carbon
dioxide since the industrial revolution began around the begin­
ning of the nineteenth century. The scientific community's best
°
estimate is that peak warming is 0.3-0.6 C for every trillion
tonnes of carbon dioxide emitted into the atmosphere.
Humans have already emitted about 2.2 trillion tonnes
between the industrial revolution and the end of 2017, so
°
we can stay under 2 C warming if we limit future emissions
to around 1.5 trillion tonnes. This is a tight budget: With
■ 23
present-day emissions exceeding 40 billion tonnes per year,
we will blow through our remaining budget by the 2050s.
°
To stay below 1.5 C is even more daunting. Our emissions
budget for that limit is 580 billion tonnes, meaning that we
are on track to exceed our budget for stabilizing below this
temperature in the 2030s.
Figure 1.7 shows emissions trajectories consistent with keep­
° °
ing the temperature of the planet below the 2 c and 1.5 C
thresholds. Because we have so little carbon budget remain­
ing, emissions need to begin declining immediately. For the
° 2000
1.5 C threshold, net emissions need to decline to 50% of
today's value by the mid-2030s and reach zero in 2050. For
°
the 2 C threshold, net emissions need to decline to 50% of
today's value by the mid-2040s and reach zero in 2080.
For both scenarios, emissions continue to decline after
they reach net zero and become negative. This means that
humans are pulling more carbon dioxide out of the atmo­
sphere than they are releasing using approaches discussed
in the geoengineering section above. These negative emis­
sions imply the removal of potentially hundreds of billions
of tonnes of carbon dioxide from the atmosphere over a
few decades. This is an enormous task, to put it mildly,
and our ability to accomplish this is entirely speculative.
SUMMARY
This chapter has provided a short introduction to climate
science and policy. The scientific community is confident
the Earth is warming, and humans are the main driver of
this warming. It is possible that warming over the coming
century will be a few degrees Celsius, an amount compa­
rable to the warming since the last ice age. According to
the IPCC, the exact amount will lead to vastly different
outcomes in different places.
This warming is already and will continue to bring
with it changes in many other aspects of the climate
system, including changes in the distribution and inten­
sity of precipitation, increases in sea level, changes in
ocean chemistry, and many others. There is also a chance
the climate system will experience a tipping point, where
the climate suddenly transitions into a new climate
regime. These changes will affect many of the things that
24 ■ Sustainability and Climate Risk Exam
40 --------------------------1 �:�:� 1·
30
(/)
20
"iii
.!!!
10 -----------: ----------
0
-10
2020 2040 2060 2080 2100
Year
bf;jliijiJ Emissions scenarios for 1.5 ° C and 2 °C.
Nevertheless, achieving either temperature target may be
unattainable without the ability to generate large negative
emissions.
° °
There are other trajectories that achieve 1.5 C and 2 C.
However, they all have a fundamental trade-off between the
speed of emissions reductions right now and negative emis­
sions later this century. If a trajectory reduces emissions more
slowly over the next decade or two, then we will need larger
negative emissions later.
humans care about, including the natural systems that we
rely on.
Humans have a range of options in response. We can try to
prevent the climate from changing (mitigation), adapt to
the changing climate (adaptation), or try to engineer a more
hospitable climate (geoengineering). Most of the discus­
sion and conflict over climate policy is over efforts to miti­
gate climate change, which requires us to transition from
fossil fuels to renewable energy.
Under the Paris Agreement, the countries of the world have
agreed to a mitigation target of limiting warming to well
°
below 2 C above pre-industrial temperatures, with an aspi­
°
rational goal of limiting warming to 1.5 C. Achieving this will
be challenging and will require emissions reductions to accel­
erate and reach net-zero sometime in the second half of this
century. It will also require negative emissions, where humans
pull more carbon dioxide out of the atmosphere than they
°
emit, with much more necessary for the 1.5 C target.
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26 ■ Sustainability and Climate Risk Exam

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

QUESTIONS
1.1 How much has the climate warmed since the nine­ cool it, so the final effect will be the difference of
teenth century? these offsetting terms.

A 0.2° c 1.5 How much warming is predicted for the twenty-first

° century? [Select the answer in the middle of the
B. 1.1 C
predicted range.]
C. 2.5 C
°

°
A 1° c
D. 4 C
°
B. 3 C
1.2 How confident are experts that the climate is pres­
ently changing?
C. °
6 C
°
D. 9 C
A. It is beyond doubt that the climate is warming.

B. It is extremely likely (95% confidence) that the

1.6 Which of the following is an example of mitigation?
climate is warming. A. Phasing out coal power

C. It is likely (66% confidence) that the climate is
warming.
D. It is more likely than not (51% confidence) that the
climate is warming.
1.3 Which of the following is NOT a greenhouse gas?
A. CO2
B. CH 4
C. H 20
D. 02
1.4 If a climate policy reduces both greenhouse gases
and aerosols in our atmosphere, what happens to the
temperature of the climate system?
A. A reduction in greenhouse gases and aerosols
both tend to cool the climate, so the combination
will lead to large cooling.
B. A reduction in greenhouse gases tends to cool
the climate, while a reduction in aerosols tends to
warm it, so the final effect will be the difference of
these offsetting terms.
C. A reduction in greenhouse gases and aerosols
both tend to warm the climate, so the combination
will lead to large warming.
D. A reduction in greenhouse gases tends to warm
the climate, while a reduction in aerosols tends to
B. Building a seawall to protect from sea level rise
C. Adding sulfur to the stratosphere
D. Expanding forested areas to improve water quality
1.7 One way to geoengineer a cooler climate is to
A. add chlorine to the ocean.
B. add sulfur to the stratosphere.
C. add oxides of nitrogen to boreal forests.
D. add ozone to the atmosphere
1.8 Which of the following is an example of carbon
dioxide removal?
A. Phasing out coal power
B. Building a seawall to protect from sea level rise
C. Adding sulfur to the stratosphere
D.BECCS
1.9 The Paris Agreement states that the world should
work to hold the increase in global average tempera­
tures to
°
A. "well below 2 C above pre-industrial levels" while
"pursuing efforts to limit the temperature increase
°
to 1.5 C above pre-industrial levels."
°
B. "well below 3 C above pre-industrial levels" while
"pursuing efforts to limit the temperature increase
°
to 2 C above pre-industrial levels."

Chapter 1 Foundations of Climate Change: What Is Climate Change? ■ 27

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

°
C. "well below 2 C above today's temperature" while 1.10 Keeping warming below the 1.5° C threshold will
"pursuing efforts to limit the temperature increase require
°
to 1.5 C above today's temperature."
A. reducing emissions rapidly, beginning today.
°
D. "well below 2 C above 1950-2000 tempera­
B. solar radiation management.
ture" while "pursuing efforts to limit the tem­
° C. negative emissions.
perature increase to 1.5 C above that period's
temperature." D. Both A and C

28 ■ Sustainability and Climate Risk Exam

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

ANSWERS
1.1 B 1.6 A
1.2 A 1.7 B
1.3 D 1.8 D
1.4 B 1.9 A
1.5 B 1.10 D

Chapter 1 Foundations of Climate Change: What Is Climate Change? ■ 29

Sustainability
■ Learning Objectives
After reviewing this chapter, you should be able to:
• Define and explain sustainability and its three
different aspects.
• Define and explain Environmental Social Governance
(ESG), Corporate Responsibility, and Sustainable
Development. Understand how different entities use
these concepts to implement and report sustainability
and climate practices.
• Explain the relationship and intersection among sus­
tainability, ESG, and/or climate change.
• Describe the key features of the United Nations
(UN) Sustainable Development Goals (SDGs) and
Millennium Development Goals (MDGs).
• Discuss strategies for implementing and aligning with
the SDGs and how the SDGs and sustainability can be
material to companies.
• Define ecosystem services, subcomponents, and
natural capital. Understand how organizations
depend upon and can impact ecosystem services.
• Trace the evolution of sustainability in governments,
corporations, and financial institutions.
• Know the different types of greenwashing. Describe
how organizations can greenwash and "greenwish"
sustainability claims as well as actions to counteract
these practices.
• Describe the life-cycle assessment (LCA) process and
how organizations use this tool to advance sustainability.
• Know the major sustainability reporting frameworks
and initiatives, their objectives, and to whom they are
targeted.
31

This chapter discusses the broad topic of "sustain­
ability," particularly as it relates to public policies,
corporate actions, and financial institutions. The broad
examination of sustainability in a policy, corporate,
and investment context is important background
before examining climate risk analysis (Chapters 3 and
6) and policy frameworks (Chapter 4) in greater detail.
This chapter starts by defining sustainability and differ­
entiating it from the concept of ESG (environmental,
social, and governance issues) and from climate risk.
This chapter also discusses international goals on sus­
tainability, notably the UN Sustainable Development
Goals (SDGs). The chapter takes a broad approach,
touching on economic development, issues of social
justice and equity (e.g., human rights), and environ­
mental protection (e.g., biodiversity), and focusing pri­
marily on concepts and general framing in preparation
for later chapters that go into greater detail.
Chapter Outline
2.1 Introduction to Sustainability
2.2 ESG, Sustainability, and Climate Risk
2.3 Sustainable Development Goals (SDGs) and
the 2030 Agenda
2.4 Ecosystem Services and Natural Capital
2.5 Sustainability at Corporations and Financial Institutions
2.6 Private-Sector Sustainability Frameworks and Coalitions
Key Learning Points
• Sustainability refers to humankind meeting its economic
needs without overburdening the environment or weak­
ening societies.
• The modern concept of sustainability originated within
the context of sustainable development, that is,
country-level economic development performed in a way
that does not overexploit natural resources or overbur­
den society. But sustainability is now applied to govern­
ments, corporations, and financial institutions alike, and
to actions by individuals.
32 ■ Sustainability and Climate Risk Exam
• Sustainability is a broad category; ESG, or measuring
the environmental, social, and governance performance
of firms, often by financial counterparties, sits within
sustainability.
• The UN's 2030 Agenda, particularly the Sustainable
Development Goals at the heart of it, have become an
important reference point and benchmark for both poli­
cymakers and for the private sector.
• Corporate sustainability practices have evolved
from being primarily motivated by corporate
social responsibility-that is, branding or moral
considerations-to considerations of financial
materiality.
• Frameworks and coalitions have been crucial in
promoting sustainability practices among private
sector actors.
SUSTAINABILITY
2.1 Introduction to Sustainability
2. 1. 1. Definition
Sustainability is defined as humanity meeting its current
needs without overburdening the natural environment or
future generations. Most definitions of sustainability place
the natural environment and its resources on equal foot­
ing with social and justice concerns and with economic
outcomes.
• Environmental sustainability means maintaining eco­
logical integrity, preserving biodiversity, and maintaining
the balance of natural systems (such as the global cli­
mate), and it means that natural resources are consumed
by humans at a rate less than that at which they can be
replenished.
• Social sustainability means that a minimum standard
of basic necessities and human rights is afforded to all
people, who have sufficient resources to keep them­
selves, their families, and their communities healthy and
secure.
• Economic sustainability means having economic
systems that are accessible to everyone and that help
to spread and generate prosperity globally. These three
elements, then, make up "sustainability" writ large.
2. 1.2 Historical Background
There have been periodic concerns about the finite nature of
natural resources stretching back at least to the eighteenth
and nineteenth centuries. These discussions about the value
of nature and the debates (and in some cases, political move­
ments and even revolutions) around sharing wealth and well­
being more equitably for the benefit of wider society started
almost as soon as the industrial revolution (which brought
unprecedented economic growth and wealth) began.
However, the concept of sustainability as applicable to
today's public policy and corporate arenas traces its roots
to actions in the 1970s and 1980s. In 1972, the first major
United Nations meeting on environmental issues took
place. That same year saw the publication of "The Limits
to Growth," a report commissioned by the Club of Rome
that argued that there were limits to economic growth due
to resource constraints. However, neither of these signifi­
cantly shaped public policy, leading to the creation of the
Brundtland Commission a decade later. Unlike the Club
of Rome report, the Commission's final report, released in
1987, proclaimed sustainable development to be compat­
ible with economic growth and defined it as "development
that meets the needs of the present without compromising
the ability of future generations to meet their own needs"
(Brundtland, 1987). This has since become the most cited
and widely accepted definition of sustainable development.
While the definition was grounded in the development
discourse of allowing the world's poorer countries to gain
access to better living standards, it later served as a basis
for defining what sustainability means for other sorts of
entities. For example, from the 1990s, corporations widely
pursued corporate social responsibility (CSR), whereby
companies undertake social or environmental activities for
the wider benefit of society (see Section 2.4). Around the
same time as companies started widely practicing and com­
municating about CSR, investors began pressing investee
companies to become more sustainable through share­
holder "engagement" (O'Rourke, 2003).
Today, sustainability is an important guiding principle for
governments, international organizations, individuals, cor­
porations, and financial institutions alike. Governments
advocate the merits of sustainability and agree on interna­
tional sustainability goals through the United Nations, such
as the Sustainable Development Goals, covered in Section
2.3. Essentially every organization involved in development,
such as multilateral development banks, seeks to align its
work with sustainable development principles. Some con­
sumers consider sustainability in making moral and ethical
choices in regard to consumption: for instance, many peo­
ple have reduced or eliminated their use of meat and dairy
products for environmental reasons.
Corporations practice sustainability through their sustain­
ability policies and strategies; through adherence to environ­
mental, social, and governance norms (ESG); and through
corporate-level commitments, which range from commit­
ments to eliminate the use of forced labor from a firm's sup­
ply chain to the alignment of a firm's business model with
Paris Agreement-compliant emissions reductions goals. Inves­
tors and financial institutions, for their part, practice sustain­
ability through the ESG policies they have in place relating
to their investing and lending activities, sustainable finance
product offerings (described in more detail in Chapter 5), and
various commitments to align with sustainability goals.
2.2 Sustainability, ESG, and Climate
Change
Discussions of sustainability can easily get bogged down in
definitional confusion or overlap. Sustainability is the broad­
est category of all. As defined in Section 2.1, it includes
actions or activities undertaken in such a way as to not
exhaust or exploit resources-human or natural-and to
allow for economic activity to continue into the future (see
Figure 2.1). The three categories of environmental, social
and economic sustainability are broad in and of themselves.
For example, environmental sustainability encompasses
considerations such as addressing climate change, striving
for clean air and water, protecting oceans, conserving habi­
tats and nature, and preserving biodiversity.
The notion of ESG, meanwhile, with "E" referring to envi­
ronment, "S" to social, and "G" to governance, began in
the financial industry and surrounding policy discussions
involving financial regulation and financial-sector sustain­
ability. The term ESG was coined in a 2005 report by the
UN Global Compact, which was endorsed by a coterie of
investment firms, including ABN Amro, Goldman Sachs, and
Westpac. Use of the abbreviation was solidified when it was
Chapter 2 Sustainability ■ 33
embedded into the UN Principles for Responsible Invest­ sustainable development or topic specific language, such as
ment, launched in 2006 (see Section 2.5). climate policy or social policy. Thus, the relationship of ESG
to government policy is very one-sided.
ESG criteria are used as a set of standards by responsible
investors to gauge companies-and sometimes other enti­ It is important to note that ESG has faced increasing political
ties such as governments-on their environmental, social, criticism recently, especially in the United States. Some have
and governance performance. argued that ESG is an opportunity to drive social change, with
others then viewing it as politicized and an offshoot of the
• Environmental criteria consider a company's relation­
Green New Deal agenda (Eccles & Crowley, 2022). Other argue
ship to climate change or to nature: Typical metrics
that the integration of material ESG risks into financial deci­
include a company's carbon dioxide emissions, water
sions is not politically motivated, but is in fact required under
usage, or its impact on deforestation.
interpretations of fiduciary duty. This has created a tumultu-
• Social metrics examine how a company treats its employees
ous environment in which some investors integrating ESG find
and manages relationships with suppliers and communities.
themselves in the epicenter of a heated political debate, and
• Governance deals with a company's leadership, includ­ have faced political pressures, or even litigation threats, espe­
ing board composition, executive compensation, risk cially from politicians that view ESG as politically motivated.
management, and other internal procedures.
Climate change-related issues, including climate risk, are
ESG information is sometimes disclosed by companies and
sometimes thought of as a subset of ESG. While they do fall
is often collected by data firms or by investors. Often, ESG
under the "E" (environmental) category, in reality climate is not
information is condensed into specific scores or ratings (see
exclusively an ESG issue. The impacts of climate change, both
Chapter 5). ESG scores and metrics are then used by financial
its physical impacts (e.g., sea level rise, increased incidence of
firms in various ways. One important purpose is their use in
extreme weather) and impacts that are related to the transition
screening companies for inclusion in ESG investment funds.
to a net-zero emissions economy, affect all stakeholders-from
Another use is for insight into banks', insurers', and investors'
companies and financial institutions to governments and indi­
firm-level ESG policies that are integrated into their lending,
viduals, including those not currently acting in sustainable ways.
underwriting, and investment practices. This can mean that
As for responses to climate change, governments set climate
certain types of clients or projects are favored over others,
policies to reduce emissions and adapt to climate change,
and that certain types of projects are restricted or even fully
which is considered part of sustainable development but not
excluded. For example, coal-fired power plants are highly
of ESG per se (see Chapter 4 for more on policies). Corpora­
emissions-intensive and not compatible with reaching interna­
tions set corporate-level climate goals, but these can be moti­
tional climate goals. Consequently, many banks have stopped
vated by bottom-up consumer pressure or government policy
financing them, insurers have stopped insuring them, and
just as much as by ESG-related pressure from investors or
investment firms have excluded coal firms from portfolios.
lenders. Figure 2.1 seeks to map out the overlapping spheres.
While non-financial corporations are more focused on sustain­
ability than ever, the use of the term "ESG" (as opposed to
2.3 Sustainable Development Goals
CSR or sustainability) occurs for them mainly in an investor rela­
tions capacity: that is, companies communicating performance
(SDGs) and the 2030 Agenda
to shareholders, lenders, and other financial stakeholders Sustainability is an area in which policymakers have set
using ESG metrics that have become standard in the financial many goals and concrete policy. A lot of sustainability ini­
industry. tiatives have occurred at the international level through

At the country level, investors can and do use ESG metrics voluntary and aspirational goals or guidelines. Despite the

for certain purposes, such as sovereign bond portfolios. relative lack of strict laws, sustainability goals have become

To give just one example, MSCI, an ESG data provider, an important focal point for many stakeholders. This is most

provides country-level ESG ratings. However, governments notably the case in the United Nations' Sustainable Devel­

themselves rarely if ever use the language of "ESG" to refer opment Goals (SDGs), launched in 2015 as part of the UN's

to their own policy actions. They prefer the language of 2030 Agenda for Sustainable Development.

34 ■ Sustainability and Climate Risk Exam

 INABILITY
bf?jifofj■ Mapping Overlapping Definitions
This graphic seeks to clarify the relationship between
the sustainability subtypes (sustainable develop­
ment, sustainable consumption, sustainable business,
and sustainable investing) and ESG Climate change's
impacts are cross-cutting and do not just fall within
sustainability. Climate policy falls under sustainable
2.3. 1 Leading up to the 2030 Agenda
The UN has played an important role in promoting sustain­
able development, as evidenced by the Brundtland report,
and it has established multiple frameworks in this area. In
1992, at the Earth Summit in Rio de Janeiro, 178 countries
adopted Agenda 21, a plan for a global partnership on sus­
tainable development. The Earth Summit introduced the
United Nations Framework Convention on Climate Change
(UNFCCC), a major convening body for global climate
decisions. The UNFCCC has played a crucial role in coor­
dinating communication regarding the scientific consensus
built by the Intergovernmental Panel on Climate Change
(IPCC) with governments. All major global-level climate policy
development, but government policies are not typi­
cally discussed in terms of ESG, which is a moniker
mainly used by the financial industry and corpora­
tions. A firm's or financial institution's climate finance
and climate risk management can be seen to sit fully
within ESG.
agreements, from the 1997 Kyoto Protocol to the 2015 Paris
Agreement, have occurred under the aegis of the UNFCCC.
In 2000, the UN adopted eight Millennium Development
Goals (MDG) to be achieved by 2015, including eradicating
extreme poverty, achieving universal primary education,
reducing child mortality, improving maternal health, and
ensuring environmental sustainability. While these MDGs
were helpful as benchmarks for generating discussions with
governments and civil society, they ultimately fell short:
Notably, the flagship goal to eradicate poverty was not
achieved. Also, the MDGs never deeply involved or engaged
private-sector stakeholders such as corporations or financial
institutions.
Chapter 2 Sustainability ■ 35
The 2030 Agenda for Sustainable Development was sub­
sequently developed and launched in 2015. It is mainly
a product of the UN, its member countries (i.e., govern­
ments), and to an extent, civil society. The Agenda, which
specifically set out to "build on the Millennium Develop­
ment Goals and complete what they did not achieve," cen­
ters on "people, planet, prosperity, and peace."
2.3.2 The SDGs and their Targets
A key strength of the 2030 Agenda so far is that it man­
ages to be broad, all-encompassing, and detailed. At its
heart lie 17 Sustainable Development Goals (SDGs), which
cover a much broader set of policies and areas than the
MDGs (see Figure 2.2). They range from environmental
and economic to social goals. Environmental goals include
those on climate action (SDG 13) and nature-related goals
to protect life on land and life in the water (SDGs 14 and
15). Social goals include those dedicated to ensuring good
health (SDG 3), quality education (SDG 4), and gender
equality (SDG 5), among others. Economic goals include
those for good jobs (SDG 8), innovation and infrastructure
(SDG 9), and responsible consumption (SDG 12) (see full list
in box).
The broad scope of the SDGs has allowed a wide range of
stakeholders to find strong agreement about at least some
of the goals. The MDGs were designed in a top-down­
process and primarily targeted at achieving development
aims in poorer countries through the use of bilateral devel­
opment aid flowing from high-income countries. The SDGs
on the other hand, were designed in a bottom-up process
and explicitly drafted to be universally applicable across all
countries, reflecting the recognition that challenges to sus­
tainability also exist in high-income countries.
In addition, the SDGs were successful in drawing in a much
wider range of actors into the debate on sustainability. The
MDGs were primarily used as a frame of reference by the

SUSTAINABLE G#u�
DEVELOPMENT 't4a,�1-' ALS

iif?jiji#.fj SUSTAINABLE DEVELOPMENT GOALS. Reprinted with permission of the United Nations
Sustainable Development Goals [https://www.un.org/sustainabledevelopmentl]. The content of this
publication has not been approved by the United Nations and does not reflect the views of the United
Nations or its officials or Member States.

36 ■ Sustainability and Climate Risk Exam

 Goal 1 No Poverty. End poverty in all its forms everywhere
Goal 2 Zero Hunger. End hunger, achieve food security and
improved nutrition and promote sustainable agriculture
Goal 3 Good Health and Well-Being. Ensure healthy lives
and promote well-being for all at all ages
Goal 4 Quality Education. Ensure inclusive and equitable
quality education and promote lifelong learning opportu­
nities for all
Goal 5 Gender Equality. Achieve gender equality and
empower all women and girls
Goal 6 Clean Water and Sanitation. Ensure availability and
sustainable management of water and sanitation for all
Goal 7 Affordable and Clean Energy. Ensure access to
affordable, reliable, sustainable, and modern energy for all
Goal 8 Decent Work and Economic Growth. Promote
sustained, inclusive, and sustainable economic growth;
full and productive employment; and decent work for all
Goal 9 Industry, Innovation and Infrastructure. Build
resilient infrastructure, promote inclusive And sustainable
industrialization and foster innovation
Goal 10 Reduce Inequalities. Reduce inequality within
and among countries
Goal 11 Sustainable Cities and Communities. Make cit­
ies and human settlements inclusive, safe, resilient, and
sustainable
public sector, multilateral institutions and civil society stake­
holders. The SDGs, on the other hand, are also increas­
ingly being used by the private sector to define entity-level
sustainability aims and monitor progress.
The 17 goals are also subdivided into 169 targets, which
provide specificity and enable accountability and the track­
ing of progress. While the broad goals help bring about a
wide span ambition of action, the breakdown of each large
lofty goal into smaller targets helps in concretizing their
implementation. This subsection will highlight examples
from a few of the goals.
2.3.3 Implementing the SDGs: Targets and
Cross-Cutting Solutions
Under Goal 4, which relates to education, the more detailed
targets include ensuring the free and equitable access of
Goal 12 Responsible Consumption and Production.
Ensure sustainable consumption and production patterns
Goal 13 Climate Action. Take urgent action to combat
climate change and its impacts
Goal 14 Life Below Water. Conserve and sustain­
ably use the oceans, seas, and marine resources for
sustainable development
Goal 15 Life on Land. Protect, restore, and promote sus­
tainable use of terrestrial ecosystems, sustainably man­
age forests, combat desertification, and halt and reverse
land degradation and halt biodiversity loss
Goal 16 Peace, Justice and Strong Institutions. Pro­
mote peaceful and inclusive societies for sustainable
development, provide access to justice for all and build
effective, accountable, and inclusive institutions at all
levels
Goal 17 Partnerships for the Goals. Strengthen the
means of implementation and revitalize the Global Part­
nership for Sustainable Development
Reprinted with permission of the United Nations Sustainable
Development Goals [https://www.un.org/ sustainablede­
velopmentl]. The content of this publication has not been
approved by the United Nations and does not reflect the
views of the United Nations or its officials or Member States.
all children to primary and secondary education; access to
early childhood care; access to technical, vocational, and
higher education; and eliminating gender disparities in
education, as well as a more short-term goal (set for 2020)
of "substantially expanding" the number of scholarships
available to developing countries. Goal 7, on affordable
energy, has detailed targets on energy access, renewable
energy, and energy efficiency (see SDG Example of Targets).
Even if these targets are not necessarily quantitative, their
specificity nonetheless is helpful in developing targeted
metrics and policies to better gauge progress.
While the original UN formulation is methodical goal by goal,
many implementations of the SDGs further several goals at
once. Many private sector stakeholders have started enumer­
ating which SDGs their activities principally align with (see
Section 2.4, including Shell case study). One example of a
Chapter 2 Sustainability ■ 37
 EXAMPLE OF TARGE TS UNDER AN SDG: GOAL 7 (AFFORDABLE ENERGY)
7.1 By 2030, ensure universal access to affordable,
reliable, and modern energy services
7.2 By 2030, increase substantially the share of
renewable energy in the global energy mix
7.3 By 2030, double the global rate of improvement in
energy efficiency
7.a By 2030, enhance international cooperation to
facilitate access to clean energy research and
technology, including renewable energy, energy
efficiency and advanced and cleaner fossil-fuel
technology, and promote investment in energy
infrastructure and clean energy technology
CASE STUDY: NATURE-BASED SOLUTIONS TARGET ING A COMBINATION
OF SDGS 13, 14, AND 15
Nature-based solutions are defined as actions to protect,
manage, or restore ecosystems that a/so address societal
and human challenges. Some nature-based solutions
are well suited to providing climate change mitigation
and adaptation benefits. This case study examines how
actions to protect ecosystems such as forests, grass­
/ands, mangroves, and wetlands (SDGs 14 and 15) can
a/so address human-caused climate change (SDG 13).
Climate change is, after all, caused by excess human­
generated carbon dioxide emissions, as well as emis­
sions of other greenhouse gases. Plants absorb carbon
dioxide from the air and use it in photosynthesis to
produce chemical energy in the form of sugars and as
building blocks for their structural tissues. The carbon
is retained in plants indefinitely so long as the plants
are alive, or in wood products, that is, lumber; but if
the plant material burns or decomposes, the carbon
dioxide is re-released into the atmosphere. In terrestrial
forests, microbes and fungi can absorb and sequester
carbon dioxide in the soil. Wetlands, meanwhile, can
retain and absorb floodwaters, which can help limit their
impact on buildings or infrastructure. Mangrove forests
along tropical coasts can substantially attenuate storm
surges and provide important habitats for fish and other
marine wildlife (see graphic).
38 ■ Sustainability and Climate Risk Exam
7.b By 2030, expand infrastructure and upgrade technology
for supplying modern and sustainable energy services
for all in developing countries, in particular least
developed countries, small island developing States,
and land-locked developing countries, in accordance
with their respective programmes of support
Reprinted with permission of the United Nations
Sustainable Development Goals [https://www. un.org/
sustainabledevelopmentl]. The content of this
publication has not been approved by the United
Nations and does not reflect the views of the United
Nations or its officials or Member States.
For nature-based climate solutions to be viable, the
World Wildlife Fund (WWF) argues they must
1) address climate change and increase ecosystem
functionality;
2) be science-based;
3) be synergistic;
4) be designed and implemented with local stakeholders
and indigenous peoples; and
5) be measurable and traceable.
In light of these conditions, it is easy to see why one
wellknown nature-based climate solution-planting
trees-can fail unless done properly. From a carbon
sequestration perspective, planting one species of tree
in orderly, dense rows may seem optimal, but this does
not produce a functional, biodiverse ecosystem, and
thus fails condition 1. Many offsetting schemes involv­
ing tree-planting only ensure that saplings are planted,
but they do not have mechanisms in place to ensure the
trees grow and stand for decades and centuries, rather
than being felled or burned; this, then, fails condition
5. Therefore, only tree-planting done in a way to ensure
biodiversity and ecosystems are supported, and tree
growth is ensured and monitored for the long term,
would actually fulfill the criteria.
© 2019 WWF (panda.org). Some rights reserved.
 CUMATE-RELATED MEASURABLE CLIMATE-RELATED
SUPPORTING ACTIONS ECOSYSTEMS
ECOSYSTEM SERVICES OUTCOMES

i!
::::[02
Carbon storage
(Vegetation)

WETIANOS�

CO-BENEFITS FOR PEOPLE AND NATURE

bf#jljl#,il Nature-Based Solutions

synergistic action for tackling multiple goals is a nature-based 1fflM¥l1

solution for climate change mitigation (see Figure 2.3).
Ecosystem Services Examples
Provisioning
2.4 Ecosystem Services & Natural
Freshwater
Capital
Timber
2.4.1 Ecosystem Services Food
As highlighted in the case study "Nature-based solutions Supporting Regulating
targeting a combination of SDGs 13, 14, and 15", eco­
Habitat Flood regulation
systems, and the services they provide, are increasingly
Nutrient cycling Erosion control
measured and valued by the private and public sector.
Ecosystem services are broadly defined as the benefits Soil formation Water purification
(directly quantifiable resources like timber production or Cultural
less tangible services like spiritual values) ecosystems pro­ Recreational
vide to humans. The Millennium Ecosystem Assessment
Spiritual
(MA) generated global interest in further understanding
Educational
the risks of increasingly degraded ecosystems worldwide.
The MA found that the majority of the world's "24 ecosys­
tem services" (e.g., provisioning of freshwater, air quality
regulation) are in decline (see Table 2.1 ).

Chapter 2 Sustainability ■ 39
• Supporting services, such as species habitat and genetic provisioning, ecosystem services such as water and timber,
diversity, are fundamental conditions that enable the as well as land and habitat protection, which can maintain
existence of all other services. regulating services that take place in wetlands and forests.
• Provisioning services generate resources, such as fresh­ Increasingly, market mechanisms, borrowing conceptually

water and food, for society that can often be traded in from more traditional emissions markets, are applied to

markets. ecosystem services. One of the most advanced water mar­

kets operates in Australia's Murray-Darling Basin. lrrigators,
• Regulating services are much less tangible and harder to
primarily agricultural operations, along with water utilities
quantify-think of how mangrove forests may lessen the
and other water managers trade water rights via brokers
impacts of hurricanes and wetlands can purify polluted
and electronic exchanges. This demand and supply create
water. These services involve the regulation of valuable
water market prices, which have fluctuated between AUD
natural processes such as carbon sequestration and
$0 and AUD $1,000 per mega liter throughout the last two
pollination.
decades.
• Cultural services are the non-material benefits and enjoy-
Water quality trading, often used to address agricultural
ment humans derive from ecosystems.
nitrogen pollution, also takes place, notably, throughout the
Businesses, communities, and governments rely on ecosys­
Chesapeake Bay area of the United States.
tem services for profits, health, safety, and stability. As dis­
cussed in Chapter 1, the Earth's oceans play an enormous
2.4.2 Natural Capital
role in climate regulation by absorbing heat and CO2. Imag­
A related concept, natural capital, takes a slightly wider
ine having to replicate the value of this ecosystem service
view of resources than ecosystem services, incorporating
through technology and manufacturing.
the value of all the world's natural assets, including geology
Organizations and governments can assess risks and
and minerals. These "abiotic" resources can even include
opportunities related to ecosystem services by examining
fossil fuels. One way to differentiate the two terms is to
their impacts and dependencies. For instance, an energy
think of natural capital as a stock of assets (abiotic and
utility that operates near and releases chemicals and
biotic) and ecosystem services (primarily biotic) as a "flow
warm water into a river depends on multiple ecosystem
of benefits" that derive from natural capital-for example,
services. It may depend on the provision of freshwater to
a forest is a natural capital asset, while the timber a forest
cool its towers; floodwater regulation from forests that
provides is an ecosystem service.
protect operating machinery; water purification from veg­
The Natural Capital Protocol and the World Resources
etation and wetlands that maintain river water quality. In
Institute Ecosystem Services Review offer methodolo­
turn, the utility could degrade or enhance each of these
gies to track organizational effects and dependencies on as
services.
well as value natural capital and ecosystem services. At a
Understanding these dependencies and impacts can inform
governmental level, the European Economic Area (EEA) is
business decisions. For instance, the utility may find that
developing an ecosystem accounting framework to measure
restoring wetlands and enhancing pollution-filtering buffer
the state of ecosystems across European nations.
crops along farmland can improve the overall water quality
of any adjacent river-enhancing these ecosystem services
may be more cost effective than incorporating new pollu­ 2.5 Sustainability at Corporations and
tion control technology. Or the utility may determine that Financial Institutions
a planned expansion will not be feasible due to projected
Combining business with meaningful social or environmen­
declines in freshwater availability.
tal responsibility and stewardship is not new. It has roots
Policy options to protect ecosystem services can in the utopian socialist experiments of certain socially con­
include traditional regulations that limit use of, primarily scious entrepreneurs of the industrial revolution, notably

40 ■ Sustainability and Climate Risk Exam

Robert Owen, whose New Lanark Mills in Scotland included
social welfare programs and became a hopeful example
for many social reformers. Similar communities existed in
many parts of the United States. John Lewis & Partners, a
British department store, is famous as an employee-owned
mutual organization that has served social goals and dem­
onstrated commercial success. From its foundation in its
current form in 1920, its employees, called partners, have
been co-owners of the business and have had a say in how
it is run.
Until recently, the likes of John Lewis have been the excep­
tion rather than the norm. Historically, the prevailing view
has been that businesses practice "pure" capitalism and
that achievement of social, environmental, or other non­
economic outcomes were the domain of governments or
CASE STUDY: CORPORATE SUSTAINABILITY REPORTING-SHELL PLC.
As one of the first large firms to issue a modern-format
sustainability report, Anglo-Dutch oil & gas firm Shell
pie. makes an interesting case study for understand-
ing how corporate responsibility and sustainability have
changed over two decades, and how these concerns are
communicated to outside stakeholders. The inaugural
1997 report frames its content primarily through the lens
of values, arguing there does not need to be a "choice
between profits and principles." Subsequent reports,
like in 2019, promote stronger action on global climate
goals. Meanwhile, the most recent report at the time
of publication, covering the year 2022 and published in
spring 2023, is much more focused on firm-level commit­
ments to specified initiatives or international goals. For
example, the firm now has a climate target to become a
net-zero emissions energy business by 2050.
2019 Sustainability Report: "Delivering Energy
Responsibly"
From the CEO Letter: "In 2019, demands for urgent
action on climate change grew ever louder.[ ...) Shell
shares this sense of urgency. We continue to take cli­
mate action on many fronts[ ...] But we-and society as
a whole-need to do much more because change is not
happening fast enough.[ ...]
This report shows much progress. But Shell must further
step up efforts on all fronts, from climate change to
other stakeholders. This line of thinking is summed up in
the famous adage of Nobel Prize-winning economist Milton
Friedman: "there is one and only one social responsibility
of business-to use its resources and engage in activi-
ties designed to increase its profits" (Friedman, M.[1970,
September 13, 1970). The Social Responsibility of Business
is to Increase its Profits. New York Times Magazine.)
In the 1980s and 1990s, however, the notion of the "triple
bottom line" was developed, placing environmental
and social impact "bottom lines" on co-equal status
with the traditional bottom line-a company's financial
performance.
The concept of corporate social responsibility (CSR)-that
a corporation also has a broader obligation to society­
gained attention in corporate boardrooms. Although the
ethical leadership to greater transparency. We must con­
tinue...to make a real contribution to people's lives. We
can only do this by keeping our approach to sustainabil­
ity at the heart of the way we do business." [*)
On climate change: "We fully support the Paris Agree­
ment's goal to keep the rise in global average tem­
perature this century to well below two degrees Celsius
above pre-industrial levels and to pursue efforts to limit
the temperature increase even further to 1.5 degrees
Celsius."(*)
Shell 2022 Sustainability Report: Excerpt
From the CEO Letter: "As we invest in the energy
needed today, our target to become a net-zero emis­
sions energy business by 2050 remains at the heart of
our strategy. We are making good progress. By the end
of 2022, we had reduced carbon emissions from our
operations by 30% compared with 2016 on a net basis,
more than halfway towards our target of a 50% reduction
by 2030."
...This report shows what we have achieved so far in our
work to be a sustainable business. We aim to do this
work responsibly, with discipline and at pace to make a
positive difference."(*)
Source: 2019 & 2022 Shell pie. sustainability reports.
[*the above quotes contain cautionary notes]
Chapter 2 Sustainability ■ 41
term was coined in the 1950s, its use was regularized in the
1990s, with many large multinational corporations launching
CSR initiatives. For example, Shell pie., a large Anglo-Dutch
oil & gas firm, formed its internal Social Responsibility
Committee in 1997, and the firm started issuing stand­
alone sustainability reports in 1998-one of the first major
global firms to do so. The first one was titled "Profits and
Principles-does there have to be a choice?" The firm has
issued annual sustainability reports ever since, with the con­
tents evolving somewhat over the years (see case study on
Shell pie).
During this period, investors started taking an interest in
the sustainability of investee companies. Proponents of
responsible investment point to early examples like the
Philadelphia Quakers, who in the mid-eighteenth century
banned investing in slave trading, and the decision by
Sweden's Ansvar Aktie Fond in 1960 to leave out shares of
companies with interests in apartheid South Africa, alco­
hol, or gambling (Chow, 2010). These are two examples of
divestment-that is, an exclusion from investments. The
notion of using shareholder pressure for "good" through
"engagement", "stewardship" and "monitoring" is a
more recent phenomenon, tracing to the notion of cor­
porate social responsibility in the 1990s and early 2000s.
(O'Rourke, 2003).
2.5. 1 Applying the SDGs in the Private Sector:
SDG Materiality and Alignment
The SDGs have become a benchmark against which com­
panies and investors measure outcomes. In particular, even
if the SDGs themselves are concerned with non-financial
outcomes for society, the environment, and the wider
economy, many of the SDGs do have material financial
effects on particular companies or industries-that is,
effects that can impact the financial bottom line. In rec­
ognition of this, individual companies have started includ­
ing references to SDGs in their sustainability and other
reporting. Consultancies promote their knowledge on
how SDGs can have material financial effects on corpora­
tions and advise firms on how to integrate SDGs in their
operations. This can occur through the development of
appropriate key performance indicators (KPls). Data firms
provide information on SDGs. Understanding SDG align­
ment has also become increasingly important and relevant
42 ■ Sustainability and Climate Risk Exam
for financial institutions analyzing corporate performance.
It is now a lens used to screen companies and analyze
entire investment portfolios. As an example, MSCI, an
investment data company, offers an SDG Alignment Tool
that covers 8,600 companies in a way that measures a
"holistic overview of [a company's] net contribution to
the UN SDGs". In parallel, using SDG alignment allows
for an easy way to present outcomes and priorities to
investors in a way that is cross-comparable between
financial firms.
2.5.2 Greenwashing and CSR
CSR is widely acknowledged as creating many opportunities
for greenwashing. According to Siano et al (2016), there are
two main types of greenwashing identified in the literature:
decoupling and attention deflection.
• Decoupling is when organisations claim to fulfill stake­
holders' expectations for action on sustainability, without
actually making any changes in what they do in practice.
Decoupling includes firms joining voluntary sustainability
initiatives established by NGOs to gain credibility by
association, the promotion of empty green claims and
policies when such commitments are unable to be imple­
mented, and the "sin of fibbing," which is making false
claims and statements.
• Attention deflection is when organisations hide unsus­
tainable practices from stakeholder attention, prepare
selective and inaccurate disclosures, make incomplete
comparisons with other products and services, and use
vague and irrelevant statements. Attention deflection
also includes the deployment of misleading texts and/or
imagery. At the extreme, companies can also undertake
falsifications to gain accreditations.
Planet Tracker (2023) argue there are in fact a wider range
of greenwashing categories. These include
• Greencrowding, which involves hiding in a crowd to
evade detection and relying on safety in numbers;
• Greenlighting occurs when companies spotlight small
green features of their operations or products in their
communications to distract from larger environmentally
damaging activities being conducted elsewhere;
• Greenshifting is when companies shift the blame for
environmental issues to the consumer;
• Greenlabelling, on the other hand, involves misleading
claims of sustainability; Greenrinsing occurs when com­
panies regularly change their ESG targets before they
are achieved;
• Greenhushing refers to under-reporting or hiding sus­
tainability credentials by corporate management teams
to avoid investor scrutiny.
Greenwashing is therefore very serious and undermines
the efforts of companies who are actually acting on sustain­
ability. Arguably it is also a form of mis-selling, and this is
one of the reasons that advertising standards agencies and
other regulators, including financial regulators, are taking
action on this issue. The UK's Financial Conduct Authority
proposed in 2022 a package of new measures including
investment product sustainability labels and restrictions on
how terms like 'ESG', 'green' or 'sustainable' can be used.
(FCA, 2022). A prominent recent greenwashing investiga­
tion launched by financial regulators targeted DWS, for­
merly Deutsche Bank's asset management arm. This was
instigated by BaFin, the German financial regulator, and the
US Security and Exchange Commission (SEC) in 2021.
Although unintentional and intentional greenwashing is
increasingly well-defined and regulated, the related con­
cept of "greenwishing" is perhaps even more widespread
and probably more challenging to address.
Greenwishing are well-intended efforts to tackle sustainabil­
ity challenges, which may not make enough of a difference
or encourage superficial changes when more structural ones
are required. This can make consumers and companies think
they are doing their bit or making a significant difference to
sustainability challenges, when they aren't. Examples could
include, for example, buying an electric vehicle when the
grid electricity used to power the car comes from coal-fired
power stations or buying soy milk for environmental reasons
when the soya is sourced from suppliers causing deforesta­
tion in the Amazon.
Perhaps the only way to really address greenwishing is to
enhance consumer and company understanding of the scale
of sustainability challenges, as well as their understanding
of what actually makes a difference. But this creates poten­
tial risk, namely people and organizations feeling disem­
powered given the scale of sustainability challenges, and
then becoming disengaged.
2.5.3 Developing Sustainable Products and
Systems: Towards a Circular Economy
Companies often conduct life cycle assessments (LCA)
to substantiate green marketing claims. An LCA should
examine every stage of a product's life cycle, that is, the
extraction of its inputs, use, and disposal, basically, a
"cradle-to-grave" assessment of a product's environmental
impacts. There are four phases of an LCA, as laid out in
ISO 14040:
1. Goal and scope definition-determine why an LCA is
necessary and to whom the results are relevant. Identify
the product and associated functions; define the prod­
uct's system boundary by identifying the processes that
contribute most to the product's environmental impact.
2. Inventory analysis-gather data on the inputs, out­
puts, and energy use of the product.
3. Impact assessment-characterize and categorize
product impacts.
4. Interpretation-evaluate completeness of the LCA;
develop conclusions and recommendations.
Beyond substantiating green marketing claims, LCAs can
help determine an organization's water, land, and energy
use, and carbon footprints. LCAs can also help organiza­
tions identify efficiency improvements, enhance supply
chain purchase decisions, as well as compare the environ­
mental impacts of similar products within a company and
competitors.
Full LCAs can be very expensive and time consuming and
are typically conducted for a few key products. There are
multiple software systems that help organizations conducts
LCAs. LCAs also focus primarily on environmental impacts,
not social or governance issues. Thus, these other ESG
issues must be considered when developing recommenda­
tions based off of LCAs.
LCAs are a building block of developing a more circular
economy, in which economic growth is "de-linked" from
consumption of finite resources. Ultimately, waste and
pollution are reduced and eliminated by design from prod­
ucts and economies. LCAs provide the data and information
essential to show evidence of progress in advancing circular
economies. Circular economy thinking can also advance the
Chapter 2 Sustainability ■ 43
 LINKING THE SDGs TO MATERIAL CONCERNS FOR CORPORATIONS: KEY EXAMPLES
Goal# SDG Example Material Concerns Key Sectors
1 No poverty Fair wages in operations; Supply chains All
2 No hunger Food supply chains; Agriculture

Food wastage Retail

3 Good health and wellbeing Employee health; All

Provision of health services; Healthcare

Drug access Pharmaceuticals

4 Quality education Access to education Education
5 Gender equality Board representation; Employment All
and hiring practices
6 Clean water and sanitation Avoidance of water pollution; Industrials

Equitable access Utilities

7 Affordable and clean energy Energy pricing Utilities
8 Decent work and economic Employment and hiring practices All
growth
9 Industry, Innovation and Innovation funding Venture capital
infrastructure
10 Reduce inequalities Executive pay All
11 Sustainable cities and Energy efficiency in buildings; Urban Construction
communities infrastructure
12 Responsible consumption and Supply chains; Recyclability and durability of Industrials, Consumer Goods
production products
13 Climate action Emissions intensity; Energy, Utilities

Climate vulnerability All

14 Life below water Overfishing; Stock depletion; Pollution Fishing

Industrials, Waste Management

15 Life on land Deforestation; Habitat destruction Agriculture, Mining
16 Peace, justice and strong Exacerbating conflict Defense
institutions
17 Partnerships for Goals Cooperation; Participation in coalitions All

SDGs, particularly SDG 12: Ensure sustainable consumption
and production patterns.
2.5.4 Moving Toward Sustainability as a
Source of Risk
While sustainability issues were once seen as a supplementary
add-on by many companies, they are now increasingly being
viewed as potentially material sources of corporate risks that
can directly or indirectly cause financial impacts and losses.
Reputational risk, for example, can be a material risk. If all
corporations are expected to have a CSR policy, and then
some corporations either do not have one or are exposed
(e.g., through investigative journalism or a non-governmen­
tal organization) to not have abided by their own policy,
these companies can sustain real losses. Serious perceived
breaches of sustainability can lead to reduced demand for
a firm's products and services, and increased scrutiny from
creditors or regulators.

44 ■ Sustainability and Climate Risk Exam

 CASE STUDY: DELTA BLUE CARBON: THE VALUE OF HOLISTIC
APPROACHES TO SUSTAINABILITY
It is crucial that private actors seeking to address sustain­
ability risks develop approaches which recognize the deep
interconnectivity between environmental, social, and eco­
nomic sustainability. For example, companies looking to
invest in carbon sequestration might be able to increase
their impact by investing in well-designed nature-based
solutions which can provide significant and cost-effective
benefits beyond climate mitigation. For example, the
Delta Blue Carbon Project (Pollination, 2022) focused on
wetland restoration in California has been successful in
But there is increased recognition that sustainability issues can
affect firms materially in ways beyond reputational risk. If a for­
estry or fishing firm overexploits resources through excessively
wide-scale logging or fishing, forests or fish stocks could be
severely depleted. If a mining firm does not properly maintain
tailings dams (for storing liquid waste), they can burst, caus­
ing floods that inflict severe damage. For example, in January
2019, the Brumadinho dam in Brazil, owned by the mining
firm Vale, collapsed. The ensuing flood killed 270 people and
polluted the downstream river's ecosystem, which prompted
an outcry from many of Vale's investors; the firm's share price
also crashed, falling by 24% on the first trading day following
the incident. These sorts of incidents can lead firms to face
pressure on many fronts, such as from regulators, making it
more difficult or costly to secure permission to operate in the
future, or from skeptical investors putting heavier scrutiny on
companies' practices. Too many such destructive incidents can
even risk a business' "social license to operate."
Many key sustainability risks that are financially material on
reasonably short timescales are climate change-related.
Therefore, climate change forms a large portion of risk­
based sustainability analyses (see Chapter 3).
2.6 Private-Sector Sustainability
Coalitions and Frameworks
2.6. 1 Private Sector Sustainability Coalitions
In the sustainability space, a particularly important role
has been played by corporate and investor groups and
generating verified carbon credits and increasing carbon
sequestration. In addition, the project has led to habitat
restoration and improvements across key ecosystem ser­
vices such as water quality improvement and increased
recreational opportunities. By strengthening physical resil­
ience, reducing dependence on costly infrastructure, and
building sustainable supply chains, businesses can reduce
their exposure to climate risks. Finally, it also creates eco­
nomic benefits by providing new revenue streams to local
communities.It has been shown that
coalitions, which have helped develop best practices on
sustainability issues (see Table 2.3).
The World Business Council for Sustainable
Development (WBCSD) was formed after the UN Rio
Summit in 1992, and it does research on corporate social
responsibility and shares best practices on sustainability
among its members.
The Principles for Responsible Investment (PRI) group,
launched in 2006, has played a similar role to the WBCSD
for investors.
By joining PRI, investors commit to
1. incorporating ESG in investments and decisions;
2. being active owners;
3. seeking disclosure on ESG issues from investee firms;
4. promoting acceptance and implementation of the
Principles;
5. collaborating to implement the principles; and
6. reporting activities and progress toward implementing
the Principles.
The PRI, as a very early coalition, has helped pave the
way for later issue-specific coalitions ranging from
groups like the Alliance to End Plastic Waste to com­
modity specific organizations like the Roundtable for
Sustainable Palm Oil (RSPO) to climate groupings such
as Climate Action 100+ (see further discussion on coali­
tions in Chapter 4).
Chapter 2 Sustainability ■ 45
1fflMY¥i
SUSTAINABILITY INITIATIVES AND COALITIONS
General/Corporate Initiatives
Name
World Business Council for
Sustainable Development
(WBCSD)
Business for Social
Responsibility (BSR)
UN Global Compact (UNGC)
Business Roundtable
Financial-Sector Initiatives
Principles for Responsible
Investment (PRI)
Principles for Sustainable
Insurance (PSI)
Principles for Responsible
Banking (PRB)
Global Impact Investing Net-
work (GIIN)
Natural Capital Finance Alli-
ance (NCFA)
46 ■ Sustainability and Climate Risk Exam
Members Description
Cross-sectoral An organization of over 200 global firms, formed in the wake of
the 1992 Rio Summit. Members come from a range of industries,
such as consumer goods (Nestle), chemicals (Dupont), or oil & gas
(BP). Firm CEOs act as council members.
Cross-sectoral A network organization that helps develop resilient business
strategies and connects member companies with sustainable
business experts.
Cross-sectoral A UN pact to encourage businesses to adopt sustainable practices.
It has 13,000 participants and representation from 170 countries.
The framework is based around ten principles on human rights,
labor, environment, and anti-corruption.
Cross-sectoral Historically a "normal" business advocacy group in the United
States, but it is included on this list for redefining the purpose
of business in 2019 as promoting "an economy that serves all
Americans" and serves all stakeholders.
Asset managers The six Principles for Responsible Investment are a voluntary and
and owners aspirational set of investment principles that offer a menu of possible
actions for incorporating ESG issues into investment practice.
Insurers Launched in 2012, the four Principles for Sustainable Insurance
are designed to guide better management of ESG issues and
strengthen the insurance industry's contribution to building a
resilient, inclusive, and sustainable society.
Global banks The six Principles for Responsible Banking provide the framework
for a sustainable banking system and help the industry to
demonstrate how it makes a positive contribution to society. They
embed sustainability at the strategic, portfolio, and transactional
levels, and across all business areas.
Asset owners, asset GIIN is a nonprofit organization dedicated to increasing the scale
managers, and and effectiveness of impact investing. Some of its resources
service providers include the IRIS+, an impact accounting system for investors to
measure, manage, and optimize their impact.
Financial sector NCFA provide the knowledge and tools that help the financial
sector and other partners work together to reduce and manage
the risks of environmental impacts and dependencies. NCFA has
a tool called ENCORE, which helps financial institutions to better
understand, assess and integrate natural capital risks in their
activities.
2.6.2 Reporting Frameworks for Sustainability
Risk
An important area where initiatives and frameworks have
been influential on sustainability is in homogenizing and
standardizing how companies disclose and report on
sustainability-related information. Broadly speaking, there
are two different types of reporting frameworks.
Global Reporting Initiative (GRI)
The first, are those which focus on providing a framework
through which companies can report on all sustainability
related impacts, regardless of whether these are financially
material to investors or not. The most prominent framework
in this field was developed by the Global Reporting Initia­
tive (GRI) which, was launched in 1997 in the wake of the
Exxon Valdez oil spill. Today, the GRI provides widely used
sustainability reporting standards through which companies
can report on their impact on a wide range of sustainability
issues such as climate change and human rights.
Sustainability Accounting Standards Board (SASB)
In the second group, are those frameworks which allow
companies to specifically report on those sustainability
issues which are financially material to investors. For exam­
ple, this includes the reporting standards developed by the
CASE STUDY: ISSB S1 AND S2 DRAFT STANDARDS
In March 2022, just months after it was first launched, the
ISSB published exposure drafts of its first two standards:
• the [draft] IFRS S1 General Requirements for Disclo­
sures of Sustainability-related Financial information,
and
• the [draft] IFRS S2 Climate-related Disclosures.
The S1 standard provides an overarching framework for
the disclosure of all material sustainability-related finan­
cial information.
The S2 standard builds on top of this framework and sets
out more granular disclosure requirements specifically
Sustainability Accounting Standards Board (SASB). SASB
was founded in 2011 to provide standards which enable
the disclosure of decision-useful information on financially
material sustainability information by companies to their
investors. SASB standards provide guidance across a broad
spectrum of sustainability issues, but break this down for
companies by singling out the most materially relevant
issues in each of 77 industries.
International Sustainability Standards Board
In 2021, SASB was one of several reporting frameworks
to be consolidated into the newly formed International
Sustainability Standards Board (ISSB). The ISSB, which was
established under the International Financial Reporting
Standards Foundation, is currently developing new financial
reporting standards for the disclosure of a broad range of
sustainability risks, with first standards expected to be final­
ized in 2023.
In addition to these frameworks which cover a wide range
of sustainability topics, there are a multitude of more issue­
specific reporting frameworks. For example, the Taskforce
on Climate-Related Financial Disclosures, have sought to
provide holistic recommendations for disclosing all kinds
of climate risks, from physical risks caused by the physical
impacts of climate change to transition risks caused by the
on the issue of climate-related risks and opportunities. In
drafting the standard, the ISSB explicitly integrated the
recommendations of the TCFD. It would require firms
to disclose all material information on their governance,
strategy, risk management, as well as the metrics and
targets used to monitor and assess climate-related risks
and opportunities.
Both drafts have undergone public consultation period
and are, as of February 2023, being redeliberated by the
board. It is currently expected that the final standards
will be issued in June 2023 and can then be picked up
and implemented by national legislators
Chapter 2 Sustainability ■ 47
 Environment Social Capital
• GHG Emissions • Human Rights &
• Air Quality Community Relations

• Energy Management • Customer Privacy

• Water & Wastewater • Data Security

Management • Access & Affordability
• Waste & Hazardous
UNIVERSE OF
• Product Quality & Safety
Materials Management SUSTAINABILITY
ISSUES • Customer Welfare
• Ecological Impacts
• Selling Practices &
Product Labeling

Leadership &
Governance Business Model
& Innovation
• Business Ethics • Labor Practices
• Competitive Behavior • Employee Health &
• Management of the Legal & Safety
Regulatory Environment • Employee Engagement,
• Product Design & Lifecycle Management
• Critical Incident Risk Diversity & Inclusion
• Business Model Resilience
Management
• Supply Chain Management
• Systemic Risk Management
• Materials Sourcing & Efficiency
• Physical Impacts of Climate Change

bf?i•Mf,!1 SASB Dimensions and Key Issues

Within SASB's five main dimensions of sustainability­

social capital, human capital, governance, business
model, and environment-it uses 26 key issues. These Boffa, R., and R. Patalano (2020), "ESG Investing:
range from issues such as greenhouse gas emissions Practices, Progress and Challenges," OECD Paris.
and water management under "environment" to labor Source: SASB website, provided for illustrative
practices and employee health under "human capital." purposes.

economic shift to a net-zero economy (see Chapter 3). The
work of the Partnership for Carbon Accounting Financials
is even more specialized, and provides guidance for how
financial institutions can measure and report their financed
emissions.
Chow, S. Y. C. (2010). Cross-country Comparison of Share­
holder Engagement for Responsible Investment. University
of Melbourne. Melbourne.
Friedman, M. (1970, September 13, 1970). The Social
Responsibility of Business is to Increase its Profits. New York
Times Magazine.

REFERENCES O'Rourke, A. (2003, 2003/07/01). A new politics of engage­

ment: shareholder activism for corporate social responsibil­
Brundtland, G. H. (1987). Our common future. Oxford ity. Business Strategy and the Environment, 12(4), 227-239.
University Press. https://doi.org/10.1002/bse.364

48 ■ Sustainability and Climate Risk Exam

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.
QUESTIONS
2.1 How is sustainability best defined?
A. Practices that avoid all use of natural resources,
exclusively using recycling
B. Meeting current needs without overburdening the
natural environment or future generations
C. Measures to reduce greenhouse gas emissions
D. Compliance with requirements by SASB
2.2 How do sustainability and ESG fit together?
A. Sustainability is a concept mainly used by the
private sector, whereas ESG is mainly used by gov­
ernments and the public sector to set policies and
regulations.
B. Sustainability is the broadest concept, encompass­
ing public and private action; ESG is typically used
by the private sector to measure companies and
screen investments.
C. Sustainability relates to compliance with SASB
recommendations, whereas ESG relates to compli­
ance with GRI recommendations.
D. ESG is limited to environmental and social action,
whereas sustainability also encompasses other
kinds of policies.
2.3 What are the Sustainable Development Goals (SDGs)?
A. A set of goals developed by the Business Round­
table for businesses to implement sustainable
practices
B. A set of goals developed by the World Bank to
govern financing directed to emerging markets
C. A set of goals developed by the Principles for
Responsible Investment (PRI) for investors to allo­
cate assets in a sustainable manner
D. A set of goals developed and agreed to by the UN
and its member countries to shape global policy
and private-sector action
2.4 What are nature-based solutions and how can they
address climate change?
A. Nature-based solutions use modified versions of
natural processes to accomplish societal goals. For
instance, agricultural crops or trees for commercial
forestry can be genetically modified to increase
their carbon dioxide absorption.
B. Nature-based solutions use natural solutions to
help human society. For example, certain plants
and insects in the Amazon rainforest have been
found to contain compounds that can help treat
certain forms of cancer.
C. Nature-based solutions protect, manage, or
restore ecosystems while also addressing societal
challenges. For example, vegetation naturally
absorbs carbon dioxide, so restoring and replant­
ing forests can help remove carbon from the
atmosphere.
2.5 What role have private-sector coalitions played for
sustainability?
A. Coalitions have encouraged the diversion and divi­
sion of sustainability reporting and frameworks
over time.
B. Coalitions have provided frameworks for com­
panies to report financially immaterial impacts to
investors.
C. Coalitions typically have strict, legally binding con­
ditions on sustainability to join, providing strong
pressure for companies to conform to the relevant
practices.
D. Coalitions can act as collective actors, pressuring
companies to change their practices or policymak­
ers to tighten regulations.
Chapter 2 Sustainability ■ 49
The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

ANSWERS
2.1 B 2.4 C
2.2 B 2.5 D
2.3 D

50 ■ Sustainability and Climate Risk Exam

Climate Change
Risk
■ Learning Objectives
After reviewing this chapter, you should be able to:
• Describe how climate risk can translate to financial
risk.
• Differentiate physical and transition risks.
• Understand how hazards/drivers, exposure, and vul­
nerability interact to manifest physical and transition
risks.
• Define stranded assets and discuss how different sec­
tors may experience stranded asset risk.
• Define and differentiate acute and chronic hazards.
Provide examples.
• Discuss uncertainty, variability, and accuracy in hazard
model predictions (e.g. frequency, timeframes).
Identify data challenges modeling direct physical risk.
• Define and provide examples of indirect risks.
• Discuss how physical and transition risks can provide
opportunities for companies and sectors.
• Identify the drivers of transition risk. Categorize
transition risks (e.g. technology, market) and provide
examples.
• Discuss human capital as a stranded asset and the
challenges associated with asset stranding and a just
transition.
• Understand current industry trends for transition and
physical risk categories and strategies companies
can take to reduce risk or manifest climate-related
opportunities.
51

This chapter provides a comprehensive introduction
to the financial risks linked to climate change that
throughout this text are referred to simply as climate
risk. It explains the two main subtypes of climate
risk: physical risk (resulting from the physical weather
impacts of climate change) and transition risk (result­
ing from the economic transformation to a net-zero
carbon economy), delving into the causes and impli­
cations of each type. Chapters 6 and 7 return to,
and expand on, the topic by explaining how financial
institutions can measure and manage climate risk
(Chapter 6) and how climate modeling is carried out,
including through scenario analysis (Chapter 7).
Chapter Outline
3.1 Introduction to Climate Risk
3.2 Types of Climate Risk
3.3 Physical Risks
3.4 Transition Risks
3.5 Stranded Human Capital and the Just Transition
3.6 Transmission into Finance, the Economy, and Key Sectors
Key Learning Points
• Climate risk can be caused by the physical effects and
changing weather patterns that result from climate change-­
physical risk-or by efforts to reduce and eliminate the
greenhouse gas emissions that cause it-transition risk.
• Climate risk results from an interaction of hazards or driv­
ing factors with exposure and vulnerability.
• Environmentally unsustainable or otherwise climate­
affected assets can suffer from unanticipated or prema­
ture write-offs due to either physical or transition risk,
thus becoming stranded assets.
• T here is significant variability between hazards as to the
accuracy with which historic data and climate models can
provide precise estimates. Global average temperatures
are near certain to increase, but uncertainty persists on
precipitation patterns.
• Physical risks can have strong direct effects, but also
indirect ones through supply chains, legal liability, or sys­
temic and second-order effects.
52 ■ Sustainability and Climate Risk Exam
• The economic transformation required to reach climate
change targets, which is a source of transition risk, is
huge and unprecedented in speed and scale.
• Transition risks manifest not only through policies but
also from technological change, reputational risk,
litigation risk, and market risk.
• Climate risk transmits into the economy through corpo­
rate and financial balance sheets and consumer spend­
ing patterns; however, the effects vary significantly by
sector.
CLIMATE CHANGE RISK
3.1 Introduction to Climate Risk
Climate-related financial risks, referred to throughout this
text as simply climate risk, are the financial risks linked to
climate change. Climate risk can affect financial balance
sheets and lead to losses through standard channels such as
diminished asset valuations or increased loan defaults.
Anthropogenic climate change is a huge subject that
involves intense and multi-disciplinary scientific inquiry,
inspires passionate political and social movements, and
raises as many political, social, and moral questions as it
does economic and financial ones. Science shows that it is
indisputable that human-caused emissions of carbon diox­
ide (CO2) and other greenhouse gases, such as methane,
are warming and disrupting the climate. Some arguments
persist over the most appropriate means and timeline
for reducing and/or eliminating emissions to mitigate
climate change. However, increasing numbers of govern­
ments are converging on a goal of net-zero emissions by
2050. This is in line with recommendations by the Inter­
governmental Panel on Climate Change (IPCC), and the
goals of the Paris Agreement of 2015 to keep the aver­
°
age global temperature rise "well below 2 C above pre­
industrial levels" and to "pursue efforts to limit the rise
°
to 1.5 C" (UNFCCC, 2015). One area where debates still
rage is over how best to address and adapt to the physi­
cal impacts of climate change, including what entities
(companies, rich countries, etc.) should bear the main
the cost.
Although the notion of climate risk is clearly linked to broader
discussions around the phenomenon of climate change, and
to international goals such as those of the Paris Agreement,
climate risk is a distinct subset of these discussions. Under­
standing the risks resulting from climate change does not
require absolute certainty from a climate model, or conclu­
sively assigning moral blame, but rather a focus on under­
standing how physical climate hazards or drivers of economic
low-carbon transition affect firms and financial outcomes.
The source of the notion of climate risk is therefore some­
what distinct from wider climate discussions. While these
wider discussions are carried out through the United Nations
Framework Convention on Climate Change (UNFCCC) and
periodic intergovernmental summits, such as the one that
resulted in the Paris Agreement, the notion and analysis of
climate risk comes largely from a combination of financial
regulators and private-sector institutions. A good example
is the Taskforce on Climate-related Financial Disclosures
(TCFD), formed in 2015 under the aegis of the G20 Finan­
cial Stability Board. This international body is chaired by
Michael Bloomberg, an entrepreneur, and is composed
largely of private-sector representatives from both financial
and non-financial corporations. The TCFD's outputs have
been particularly influential. It is best known for its final
TCFD FRAMEWORK AND RECOMMENDATIONS: FINAL REPORT (2017)
The TCFD singles out physical and transition risk as the
main sources of climate risk. It splits physical risk in two
subtypes: acute and chronic. It splits transition risk into
four subtypes: policy and legal, technology, market, and
reputational.
TCFD recommendations state that firms should disclose
on four key parameters, ranging from the concrete to
the abstract, so that firm shareholders and other stake­
holders are aware and fully informed of the progress the
firms have made in their preparedness to tackle climate
change. These are metrics and targets, that is, the met­
rics used by the firm in question to assess climate-related
risks and opportunities; risk management, that is, what
processes the firm has in place to manage climate risks;
the firm's strategy surrounding climate change; and the
governance structures the firm has in place to address
and take responsibility for climate issues, including at
board level.
Key features of the recommendations are that they are
intended to be
• adoptable by all organizations;
• included in financial filings;
report from 2017 (see below), but it has also produced
other documents and technical annexes before and since.
This chapter largely follows TCFD categorizations, notably
with regard to the subtypes of transition risk.
Viewing climate through a risk lens means zeroing in specifi­
cally on the ways in which climate change affects assets,
through hazards and drivers, exposures, and vulnerabilities
(Sections 3.2-3.4); how they transmit into the real and
financial economies affecting households, governments,
companies, and the financial institutions that lend to and
invest in them (Section 3.5); and, how different sectors are
differentially affected.
3.2 Types of Climate Risk
Climate risk is usually divided into two broad categories:
physical risk and transition risk. Physical risks
(see Section 3.3) arise from the physical climate (and
weather) impacts that result from the changing climate,
whereas transition risks arise from the economic transforma­
tion and any dislocation needed to drastically reduce, and
• designed to solicit decision-useful, forward-looking
information on financial impacts; and
• strongly focused on risks and opportunities related to
transition to lower-carbon economy.
According to the TCFD 2022 Status Report, over 3,800
organizations have become supporters of the TCFD
Recommendations, including over 1,500 financial insti­
tutions responsible for assets of $217 trillion. Based on
the fiscal year 2021 reporting of over 1,400 companies,
80% of companies disclosed in line with at least one
of the 11 recommended disclosures; however, only 4%
disclosed in line with all 11 recommended disclosures
and only around 40% disclosed in line with at least five.
Europe remains the leading region for disclosure, and
reporting on climate-related risks and opportunities is
higher than any other recommended disclosure. Despite
this, the resilience of companies' strategies under dif­
ferent climate-related scenarios continues to have the
lowest level of disclosure, while governance remains the
least disclosed recommendation.
Source: TCFD 2022 Status Report
Chapter 3 Climate Change Risk ■ 53
eventually eliminate, net greenhouse gas emissions to reach
net-zero emissions-a goal that many countries have set
for themselves to reach by 2050. However, some countries
have set slightly earlier goals (for example, Finland has set
a goal for 2035), and some countries have set slightly later
goals (for example, China has a goal for 2060), and there
are other jurisdictions that have not yet made any net-zero
commitments.
At the corporate level, vulnerability can refer to the lack of
preparation for such issues as climate change mitigation and
adaptation planning, or it can apply to a lack of financial
resilience, such as through insurance-based mechanisms.
Overall, the interaction between hazards or drivers, expo­
sures, and vulnerability then produces the overall effect of
climate risk (see Figure 3.1 ).

Physical risks result from hazards that are usually subdi­ 3.2. 1 Stranded Assets
vided into acute and chronic hazards. The former includes
The notion of stranded assets is particularly important in
weather-related or weather-exacerbated events, whose
the context of climate risk, and it has grown to be an impor­
incidence are increasing with climate change, such as floods,
tant focus of research and analytical efforts in recent years
hurricanes, droughts, and wildfires. The latter includes
to better understand climate, environmental, and broader
gradual, long-term trends such as rising average tempera­
sustainability risks. Stranded assets are assets that have
tures and sea levels. The equivalent drivers of transition
"suffered from unanticipated or premature write-downs,
risk include factors such as tighter government policies to
devaluations or conversion to liabilities" (Caldecott, 2013).
reduce emissions (e.g., through carbon taxes), technological
changes (e.g., cheaper renewables making fossil fuel-based The concept of assets being left behind by external forces,
power generation less economical by comparison), and leading to reduced valuations or complete write-downs, is not
bottom-up consumer pressures for sustainable products. new, and it links to the idea of creative destruction. While the
metaphor is obviously a physical one, the concept was first
But for both kinds of risk to become manifest, hazards (or
significantly applied to climate risk in the early 2010s in relation
driving factors) are not enough alone. In the face of these
to the notion of "unburnable carbon" (for example, known oil
hazards and factors, different kinds of assets and companies
or coal reserves that cannot be fully exploited if the agreed
will have differing levels of exposure and vulnerability. ° °
goals of limiting warming to 2 C or 1.5 C are to be met,
Exposure, here, is used in the classic financial sense of
thus making coal mines or oilfields into "stranded assets").
assets or firms that are in a vulnerable place or setting. A
From there, the concept extended quite naturally to high­
factory or warehouse in a low-lying coastal area would be
emitting industrial assets such as coal-fired power plants (see
exposed to sea level rise, and consequently so would the
Section 3.4.1) or steel plants. The concept of stranded assets
firm that owns the factory. A high-emissions facility, such as
still refers most commonly to these assets with high transition
a coal-fired power plant or a steel plant, would be exposed
risk, though the definition has been steadily expanding.
to tighter climate policy, such as a higher carbon price.
For instance, physical risks can equally create stranded
Vulnerability-a concept linked to notions of resilience, flex­
assets, indeed harkening closer to the physical meaning
ibility, and adaptation-is less of a focus in traditional finan­
of the original metaphor. Just as a boat stranded on a
cial risk, but it is integral to considerations of climate risk,
lakeshore after a drought lowers the water level, a bever­
especially physical climate risk. It refers to the propensity or
age factory can be stranded by the increased frequency of
predisposition of the asset (or firm) to suffer adversely from
climate-induced droughts limiting availability to fresh water.
its exposure to hazards. At the facility level, vulnerability to
Unlike stranded assets due to transition risk, which are likely
physical climate risk typically depends on physical infrastruc­
to be more concentrated in the energy and industrial sec­
ture: for example, of two neighboring factories in a flood
tors, stranding due to physical risk can occur across nearly
zone, only one may have flood pumps installed.
all sectors, but it is more likely to be concentrated geo­
Vulnerability can also be discussed at the facility level graphically: for example, sea level rise and increased coastal
for transition risk, referring to the ease of reducing or flooding may strand any number of facilities-warehouses,
eliminating emissions-for instance, through conversion to factories, commercial or residential properties-in
hydrogen-based production-as opposed to having to pre­ vulnerable areas without adequate flood defenses (see
maturely close a facility, thus stranding it (see Section 3.2.1). Section 3.3). That said, some sectors are more vulnerable

54 ■ Sustainability and Climate Risk Exam

 ■ Acute weather hazards Facility level: Anything in a Facility level: Extent of
(floods, cyclones, hazard zone (infrastructure, adaptive infrastructure (e.g.,
droughts) residential property, flood pumps, fire breaks)
commercial facilities)
Physical Risk ■ Chronic weather Cori;1orate level: Viability of
hazards (sea level rise, Cori;1orate level: Firms with contingency plans; access
heat, water stress) facilities/supply chains in to insurance
hazard areas

Hazards /
Climate Risk Exposure Vulnerability
Drivers

■ Policy changes (carbon Facility level: High- Facility-level: Extent of

tax, coal shutdowns) emissions assets (fossil fuel ability to decarbonize (e.g.,
power plants, steel plants, biomass or hydrogen
■ ICE vehicles) conversion)
Technological changes
Transition Risk
(cheaper renewables)
Corgorate level: Firms with Corgorate-level:
■ Consumer pressure business operations Viability/robustness of
dependent on emissions transition plans

Source: Caldecott et al. (2021)

b.f?i!itfili Physical and Transition Risk

than others-see Section 3.6 for a discussion of physical risk
in agriculture and real estate.
Although it is beyond the scope of this chapter, it should be
noted that stranded assets can also refer to assets stranded
by non-climate environmental risks. Habitat destruction and
biodiversity loss can lead to declines in, or even collapses
of, ecosystem services (for example, a lack of pollination in
a particular area stranding fruit orchards). Tighter restric­
tions on local air pollution, such as particulates and smog,
can end up stranding assets such as polluting factories or
old vehicles in areas that impose stricter curbs on pollution.
3.3 Physical Risks
Before considering physical risks as such, it is important to
understand what the physical impacts of climate change
entail. Rather than being an abstract future phenomenon,
the physical impacts of climate change are already here, and
specific events can be definitively linked to climate change
through attribution science (see Section 3.3.1 ). And in the
near future, it is certain that the effects of climate change
will continue to worsen. The exact outcome will depend
on future emissions, which affect the amount of warming.
°
Current policies put the globe on track for 3 C or more
of warming, though commonly used scenarios range from
° °
4.5 C of warming by 2100 to 1.5 C if the most ambitious
Paris goals are met. Global GHG emissions in 2030 associ­
ated with the implementation of nationally determined
contributions (NDCs) announced prior to COP26 would
°
make it likely that warming will exceed 1.5 C during the
21st century (IPCC, 2022). Often underappreciated, how­
ever, is that even if the world manages to hit these ambi­
tious targets of 1.5 C or 2 C, the physical impacts will still
° °
be severe. One important reason is that the distributional
° °
consequences are uneven: 1.5 C or 2 C of warming on
average still means more intense heat waves, more intense
precipitation, and more droughts, among other phenom­
ena. For example, the IPCC reports that a world with an
°
average of 1.5 C of warming compared to pre-industrial
times-the most optimistic of all climate outcomes-still
means heavy precipitation and flooding events will intensify
and become more frequent in most regions of the planet
(IPCC, 2023). Additionally, it should be noted that other
variables and potential setbacks could be detrimental to the
implementation of these policies; for example, the impact
of geopolitical and macroeconomic risks (e.g. war in Ukraine
or economic slowdown/acceleration in countries like China

Chapter 3 Climate Change Risk ■ 55

and India) which can have direct impacts (i.e. the war activi­
ties themselves) and indirect impacts, such as triggering the
energy crisis in Europe, which led to the expansion or even
construction of new fossil/carbon-based power plants.
From a risk perspective, physical risks result from hazards,
and as discussed above, these are typically subdivided
into acute and chronic hazards, which then interact with
exposure and vulnerability. This section covers the hazards
in detail, splitting into examinations of acute and chronic
hazards as outlined by the recommendations of the TCFD­
recommendations that have been followed by stakehold­
ers since they were put in place. It then discusses data
availability and granularity and touches on exposure and
vulnerability. Finally, it closes with a short discussion of the
(limited) opportunities from physical risks, while recognizing
that most corporate and investor action toward physical risk
will, by necessity, be focused on reducing or avoiding the
potential for losses.
3.3. 1 Acute and Chronic Climate Hazards
Physical climate hazards are typically subdivided into acute
and chronic hazards. The former includes weather-related or
weather-exacerbated events whose incidence is increasing
with climate change, such as floods, hurricanes, droughts, and
wildfires. The latter includes gradual, long-term trends, like ris­
ing average temperatures and rising sea levels (see Table 3.1).
There is a strong scientific evidence base, both from
his- torical evidence and from cross-comparing extremely
sophisticated climate models, that all of the above hazards
are linked to climate change in genera/. However, there is
a wide range in the ability of models to predict the mag­
nitude or frequency of specific hazards, the specific time­
frame of their occurrence, or their specific locations.
Key Chronic Climate Hazards:
• Average temperature rise
• Sea level rise
• Changing precipitation patterns
56 ■ Sustainability and Climate Risk Exam
Average global temperature rise makes for a good first
example, as the trend is clearest here in both historical
data, with human activities estimated to have caused warm­
°
ing of approximately 1.0 C above pre-industrial levels
(see Figure 3.2), and where climate models predict a clear
trend of further warming to come, with the main variable
being the amount of greenhouse gas emissions humanity
continues to release into the atmosphere (see Figure 3.3).
Under a high-emission scenario, temperatures are pre­
°
dicted to rise by at least 4 C by 2100, whereas under a
°
low-emissions scenario, they will stabilize around 1.5-2 C.
(For more on scenario analysis, see Chapter 7 .)
But for many other physical climate hazards, understand­
ing them is not as straightforward. While all major climate
models agree that precipitation patterns will change, they
disagree as to the magnitude and even as to whether
precipitation will increase or decrease. This is why graph-
ics from the IPCC use cross-hatching, a form of shading
that looks like diagonal squares, to indicate where models
agree. In Figure 3.4, cross-hatching indicates where at
least two-thirds of models agree whether precipitation will
° °
increase or decrease in 2100 scenarios with 1.5 C or 2 C of
warming (with large portions of the globe not covered). This
can be contrasted with the far more robust agreement on
the direction and magnitude of temperature change.
Another important point to note is that models give varying
degrees of accuracy not just for different hazards but also
for different timescales. While the models used by the IPCC
are designed to look several decades ahead and provide
reasonable and fairly robust estimates for 2100, climate
models provide only limited information for the next one or
two decades, particularly on smaller geographical scales,
because natural variability in climate can mask the effect of
human-caused changes in the climate (Fiedler et al., 2021).
Key Acute Climate Hazards:
Increased incidence of the following:
• Storms and hurricanes
• Droughts
• Heatwaves
• Precipitation extremes and floods
• Wildfires
Average Temperature Rise to Date: Projected Temperature Rise:

Global Average Temperature 1850-2020

1.2
E �
., Model mean global

1
�
ro
"' 4.0
mean temperature
ii change for high

11I
E
0.8 0 [I! emission scenario
C :,
RCPS.5
<l:
0.6
�::, Q. 2.0
+-'
0.4 ro

0.
0.0
0.2 E mean temperature
� <ii
.D change for low
0 emission scenario
nd data prepared by Berkeley Earth and combined 0 "iii
.!:l
6 RCP2.6
with ocean data adapted from the UK Hadley Centre -2.0
_Q
Global temperature anomalies relative to 1820-1900 average
-0.2 1.9 1900 1950 2000 2050 2100
Vertical lines indicate 95% confidence intervals Year
�-+---�--�--�--�---------�---r'---0.4
1860 1880 1900 1920 1940 1960 1980 2000 2020 Source: Collins, M., R. K nutti, J. Arblaster,
J.-L. Dufresne, T. Fichefet, P. Friedlingstein,
Source: Robert Rohde "Global Temperature Report for 2020" published by X. Gao, W.J. Gutowski, T. Johns, G. Krinner,
Berkeley Earth on 14 Jan 2021. Licensed under Creative Commons BY-4.0. M. Shongwe, C. Tebal di, A.J. Weaver, and
M. Wehner, 2013: Long-ter m Climate Change:
Projections, Commitments, and Irreversibility.
In: Climate Change 2013: The Physical
Science Basis. Contribution of Working
Group I to the Fifth Assessment Report of
the Intergovernmental Panel on Climate
Change [Stocker, T.F., D. Oin, G.-K. Plattner,
M. Tignor, S.K. Allen, J. Boschung, A. Nauels,
Y. Xia, V. Bex and P.M. Midgley (eds.)].
Cambridge University Press, Cambridge,
United Kingdom and New York, NY, USA.

(i!jijZfffj hlW!Uiii
Mean temperature change
at 1.s•c GMST warming

Temperature ("C)
0.5 1.5 4 6 8
Mean preeip1taUon change Mean precip1taUon change
at 1 .S-C GMST warming at 2.o·c GMST warming

-zo -10 ·5 0 5 10 ?Q JO 40 59
Source: I PCC

bM•ii¥iH Example 1 of Model Uncertainty: Global Precipitation Change

Chapter 3 Climate Change Risk ■ 57

 CESM1-BGC
MPI-ESM-LR
0.0 0.5 1.0 2.0 5.0
Reprinted from Kloster, Silvia, Lass/op, Gitta "Historical and future fire occurrence (1850 to 2100) simulated in
CM/PS Earth System Models" (March 2017) Global and Planetary Change, Volume 150, Pages 58-69.
UfWii#i-1 Example 2 of Model Uncertainty: Validating Wildfire Predictions
Of course, some climate hazards will require an interac­
tion between climate events and local conditions, such
as flooding or wildfires. Large amounts of rainfall within
a short period of time make it more likely that a river will
overflow its banks, but the particular topography of a
specific river valley also affects how and where flooding
will occur (not to mention the presence, or absence, of
human-built flood defenses). Droughts make it more likely
for fires to start, but wildfires need vegetation to burn,
meaning models must take both climate and land cover
into account-and, ideally, human land-use patterns as
well. The interaction of these multiple factors makes it par­
ticularly difficult for models to accurately predict wildfire
locations. One study to validate models, which compared
five different model-predicted wildfire areas (panels 1-5
of Example 2, above) to measurements of the actual area
burnt from satellite data (see the panel labeled GFEDv4S
above), showed that many models overestimated the burn­
ing potential in North and South America while underesti­
mating it in Africa.
58 ■ Sustainability and Climate Risk Exam
CCSM MPI-ESM-MR
NorESM1 GFEDv4s
10.0 20.0 50.0 100.0
To point out the shortcomings of, and disagreements
between, models is not to say that they are not useful,
merely that given some uncertainty in the models them­
selves, calculating actual direct physical risk is a step more
difficult (see next section).
For acute physical hazards, it is not necessary to rely on
models exclusively. The increased incidence of acute haz­
ards is already visible in the natural catastrophe data from
the past several decades of (see graph, below), and this
trend is expected to continue.
Moreover, a relatively new offshoot of climate science, attri­
bution science, is now able to show how specific events are
(partially or almost completely) caused by climate change.
According to research of this type, the devastating Australian
wildfires of 2019-2020, for example, were made at least 30%
more likely by climate change, and the huge Thai floods of
2011 would likely not have occurred without climate change.
The July 2019 heatwave over France and the Netherlands
would have been extremely unlikely to occur without human
 900

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700

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300

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200

100 I I -

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ra;:m.•j••1t•¥E'!!■'.wM

influence on climate. Similarly, the Siberian heatwave of 2020,
°
when temperatures reached a record 38 C in Verkhoyansk,
far above the Arctic Circle, would have been almost impos­
sible without human-caused climate change.The floods in
Germany in 2021 and the 2022 drought in the US are also
considered to have been exacerbated by human activity.
3.3.2 Direct Physical Risks and Data
Granularity
Understanding direct physical risks as they apply to a spe­
cific asset or company, or even country, is not straightfor­
ward. Beyond the differences between the different global
climate models' estimates for various hazards (see above),
readjusting these climate models to derive regional or local
estimates leads to less precision.
Getting precise enough data on these hazards is not neces­
sarily straightforward either. Some is available open source
or free from academic institutions or international organiza­
tions or non-governmental organizations such as the World
Resources Institute; other climate data can be bought from
specialist consultancies, some of which also offer their own
ready-made ways to evaluate exposure and vulnerability.
For some hazards, such as flooding, which depends on
hyper-local topography, resolution matters tremendously: for
instance, JBA Consulting, an industry leader in its field, sells
flood map data at a Sm X Sm resolution. Much of the other
climate data that is downscaled from global climate models
appears at a much rougher resolution, such as 100 km x 100
km, and even still suffers from lack of robustness over shorter
timescales, as discussed in Section 3.3.1.

Moreover, climate hazards do not, alone, cause climate risks
to become apparent. Firstly, certain types of physical risks
require an interaction between climate events and local
conditions, as discussed above in Section 3.3.1 with regards
to wildfires. Droughts make it more likely for fires to start,
but wildfires need vegetation to burn. Secondly, and per­
haps more importantly, as discussed above in Section 3.2,
physical risks occur only when there are also exposure and
vulnerability.
With climate data in hand, mapping exposures is not exces­
sively difficult, and it only requires precise location data to
cross-compare with climate hazards. Investors in, owners
of, or lenders to specific physical assets, such as a particu­
lar warehouse or wind farm, should already know where
the asset is located. And although a firm should know the
location of its own production and office facilities, inves­
tors in, or lenders to a firm may not currently know precise
geolocations.

Chapter 3 Climate Change Risk ■ 59

Vulnerability, however, is an area where there is still very little
visibility or data because it ultimately refers to facility-level
preparedness: Two nearby factories in the same flood-prone
area might be affected differently if only one has flood walls,
basement pumps, or worker contingency plans. A firm plan­
ning a large greenfield capital expenditure, such as a new
factory, will be able to hire consultancies that specialize in
climate engineering to evaluate the present state of adap­
tive infrastructure, such as floodwalls or the cost of building
them. But a large firm may not have detailed information on
all of its own legacy assets, let alone on interdependencies
through its supply chains (see also next section). And other
counterparties with stakes in a firm's continued well-being,
such as banks, institutional investors, auditors, or credit rat­
ing agencies, may have even more limited data access.
3.3.3 Indirect Risks: Supply Chain, Legal, and
Systemic Risks
Physical risks do not only affect assets and the companies
that own them, through exposure to hazards, but there are
several other ways in which climate-related physical risks
can affect assets and firms.
Perhaps the most straightforward of these is supply chain
risk. Of course, this risk is partly a matter of classification. Two
identical firms, one that is vertically integrated and another
that has outsourced production to suppliers, may both be
subject to the same physical risks in the production process­
only for the first, this would be counted as affecting the firm
itself, and for the second, it would count as a supply chain
risk. Nonetheless, all firms rely to an extent on suppliers.
Other severe indirect impacts with financial implications
include the infrastructure (roads, railways, airports) needed
to transport things in and out of factories and the housing of
employees. For example, if a plant is well protected from a
flood but workers have to deal with their own homes being
under water, or if the roads to and from our plant are not
usable, a company might not able to operate.
A second important kind of indirect risk is legal liability
risk, where firms suffer financial consequences after being
held legally liable. Liability risk can exist for both physical
and transition risks (see Section 3.4.1 on transition-related
liability); for physical risk issues, liability usually comes into
play with regard to the duties and responsibilities of cor­
porate management or a company's board of directors.
60 ■ Sustainability and Climate Risk Exam
For instance, a company could be sued for not adequately
preparing for physical risks. One such example currently
making its way through US courts is Conservation Law
Foundation v. Shell, an ex-ante claim by the Conservation
Law Foundation, a non-governmental organization, filed in
2017 against Shell, the multinational oil and gas firm, claim­
ing it had failed to satisfactorily prepare its Providence Fuel
Terminal for sea level rises and the increased frequency
and intensity of severe weather events ("Conservation Law
Foundation, Inc. v. Shell Oil Products US").
A third, more nebulous, category are the indirect physi­
cal risks that can be considered systemic in their propa­
gation effects and their multifaceted nature. A good
example is the nascent literature from both academia
and policymakers quantifying the effects of heat stress on
worker productivity. The International Labor Organiza-
tion, for instance, estimates that by 2030, when the global
°
temperature is expected to have risen by 1.3 C, the share
of total working hours lost will be 2.2%, or the equiva-
lent of 80m full-time jobs (up from 1.4% and 35m jobs as
recently as 1995). In monetary terms, it estimates this loss
at USD 2.4 trillion in purchasing power parity terms (com­
pared to USD 280 billion in 1995, meaning a net loss of
over USD 2.1 trillion in 35 years of climate change alone).
It further warns that these are likely to be underestimates,
as they are based on the assumption of limiting warming to
°
1.5 C by 2100, which looks extremely unlikely (ILO, 2019).
3.3.4 Opportunities, Resilience, and Adaption
While many climate risk management discussions seek to
balance risks with opportunities, when discussing physical
risk specifically, the argument is harder to make. Physi-
cal risks, at least for private-sector counterparties, tend to
bring more downside than upside. Occurrences such as hur­
ricanes, wildfires, or floods can bring huge losses through
facility destruction and business interruption. Paying large
amounts to adapt and fortify facilities against physical risks,
such as through building firebreaks, floodwalls, or better air
conditioning systems, does not produce a profit or revenue
stream per se, but rather simply avoids large losses that
would have otherwise happened. For corporations, insur­
ance availability is crucial to mitigate financial losses, and
thus insurers' willingness to pull out of coverage in cases
of particularly severe exposure to physical climate risks, as
has already occurred on a limited scale in fire-prone areas
of California and Australia, would be an additional red flag. 3.4 Transition Risks
Thus, it is easy to envision a scenario where some firms
and financial counterparties stop investing in areas that are Before discussing transition risks in detail, it is important to

most vulnerable to physical climate risks, such as low-lying take a step back to contextualize just how large the "tran­

coastal areas, leaving only the most vulnerable there, such sition" in question is. Business-as-usual scenarios assume

as homeowners unable to sell residential properties, and that with no economic transition, CO2 levels will continue

allowing physical climate risk to become a problem for gov­ to rise from the current level of around 40 gigatons (Gt) per

ernment exclusively. year to possibly around 60-120 Gt. To reach international

goals of keeping warming to below 2°C, emissions would
There is, however, some chance that the corporate sector
need to start dropping quickly and in a sustained manner
can find limited opportunities in dealing with physical risk
at an unprecedented pace (see purple and blue pathways
by partnering with governments and with other kinds of
in Figure 3.7). From decades of consistently rising global
counterparties, such as insurers and academic institutions.
emissions, the whole global economy, especially electricity
It may be in all stakeholders' interests to find solutions that
and heat production (25% of emissions), industries (21%),
allow for both burden- and profit-sharing through avoiding
transportation systems (14%), and agricultural practices
physical risks. Companies could be rewarded for staying in
(24%) (see Figure 3.8) must be thoroughly overhauled to
certain areas, or could partner with communities to build
reach net-zero emissions by 2050.
adaptive infrastructure such as flood walls that can protect
both facilities and factories and surrounding communi­ Moreover, reaching the goal of limiting warming to 1.5 C,
°

ties. Insurers, rather than simply threatening to pull cover­ an aspiration of the Paris Agreement, is nearly impossible
age, can work proactively with firms and communities to at this stage through emissions reductions and eliminations
encourage the uptake of adaptive measures (e.g., through alone (see Figure 3.9), as it is the stock of greenhouse gases
premium discounts) and share expertise on resilience. in the atmosphere that matters, not the flow. Therefore,

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Chapter 3 Climate Change Risk ■ 61
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most models and scenarios for reaching a 1.5 C equilib­
rium, including ones used by the IPCC, assume very large
amounts of net-negative global emissions (see Figures 3.7
and 3.10). Natural ways to remove carbon from the atmo­
sphere, such as planting more trees, can only address a
small fraction of these needs: To reach the scales assumed
in these models would require massive and extremely rapid
rollout of technologies and practices such as directly captur­
ing CO2 from the air (known as direct air capture, or DAC),
or bioenergy with carbon capture and storage-growing
plants, which absorb CO2 from the air, then burning them
to generate electricity, but capturing the CO2 from combus­
tion and burying it, thus resulting in net removal.
Seeing the pace and change required to meet any of these
climate goals, it is easy to imagine that these would be
pursued mainly, or even exclusively, through government
policies, and therefore that policies would be the primary
or even only source of transition risk. For decades, both
policy developers and academic economists have discussed
the optimal way to reduce (and eventually eliminate) green­
house gas emissions, and these discussions have revolved
around centralized policy options such as imposing a price
per ton of carbon dioxide emitted through a carbon tax or
limiting quantity through a cap-and-trade scheme-both
of which have been implemented in various jurisdictions
worldwide. However, currently, there is not a global carbon
tax and, despite hitting record levels in the EU on 2023, the
price of carbon is not anywhere close to high enough on its
own to reduce emissions sufficiently to reach internationally
agreed-upon targets.
Therefore, more recently, there has been a recognition that
the means through which emissions (the drivers of transmis­
sion risk) will actually be reduced will be both more varied
and less neat than simply imposing a high carbon tax that
would seem an optimal solution in economic models, but
that has so far struggled to gain ground in light of political
realities. This section follows TCFD-outlined best practices
in describing transition risk drivers as including policy and
legal risks (encompassing factors ranging from mandatory
shutdowns to legal liability); technology risks (e.g., cheaper
renewables making fossil fuel-based power generation less
economical by comparison); reputational risks (e.g., from
bottom-up consumer pressures for sustainable products);
and other risks, such as market risks.
This section concludes with a discussion of the various
opportunities presented by the transition. More so than
with physical risk, where the main focus is on avoiding or
reducing the potential for losses, the converse of transition
risk can be found in a myriad of economic and investment
opportunities presented by the speedy, wholesale transfor­
mation of the economic structure that much of the world
has committed to undertake.

62 ■ Sustainability and Climate Risk Exam

3.4. 1 Policy and Legal Risks
The sources of policy and legal risk in causing climate transi­
tion risk are varied. As already described, the classic policy
solutions for achieving emissions reductions have tended
to be either carbon taxes, setting a price on emissions, or
cap-and-trade schemes, which set a limit on quantity. But
other important policies can also lead to transition risks.
One important example is that of energy efficiency, such as
energy requirements for residential buildings or emissions
requirements for new automobiles-which can be set at
either the level of individual vehicles or at the fleet level.
Another source of policy risk is government-mandated
closures, ranging from cancellations of previously agreed
fossil-fuel infrastructure projects, such as natural gas pipe­
lines and mandatory shutdown dates for certain types of
high-emitting facilities, such as coal-fired power plants.
Other examples include energy-efficiency regulations and
limits on pollution.
Legal risks, when a firm is held liable, can result in various
consequences ranging from fines or penalties to class action
damages or changes in valuation. In relation to transition
risk, there are at least two potential strands of litigation
EXAMPLES OF TRANSITION RISK FROM SOURCES OTHER THAN CARBON
PRICES OR CAP-AND-TRADE:
• April 2019: Fiat Chrysler Automobiles (FCA), an
Italian-American automobile manufacturing group
(now part of Stellantis after a 2021 merger with
Groupe PSA of France), was forced to pay Tesla, an
all-electric American car manufacturer, hundreds
of millions of euros to avoid fines for breaking E.U.
standards on average fleet emissions. T hrough the
payment, Tesla's car output was counted as part of
FCA's fleet for regulatory purposes, thus lowering the
average fleet emissions.
• July 2020: Germany passed a law mandating the
closure of all coal-fired power plants by 2038 at the
latest and providing compensation to owners. Many
of these plants will be shutting before the end of their
operational lifetime, which can be 30-50 years, thus
becoming stranded. (For instance, Germany's last
new coal power station, Datteln 4, commissioned in
that can result in risk to companies. A relatively straight­
forward one is a tactic increasingly adopted by activist
and advocacy organizations-filing suit in court against
carbon-intensive projects on the grounds that these proj­
ects breach existing environmental rules or commitments
and should not have been approved. A prominent example
of this is the suit filed by ClientEarth, a climate litigation
NGO, against Enea, a Polish utility, alleging failure to con­
sider the material climate-transition risks of its project to
build a large €1.2 billion coal-fired power plant, Ostrd�ka
C ("ClientEarth v. Enea," 2019). (In this particular case, the
Poznan District Court did find in ClientEarth's favor in 2019,
but they did so on a technicality, meaning the judge did
not need to formally determine whether Enea had failed to
consider climate risks.)
A much broader strand of legal risk comes from nascent
efforts to directly pin legal liability on firms for their propor­
tional contribution to the physical impacts of climate change
through their emissions. A landmark case in this regard that
is slowly making its way through German courts is Lliuya v.
RWE, where a Peruvian farmer alleges that the emissions of
RWE, a German utility, partially caused the glaciers around
summer 2020, will thus only have a maximum of 18
years to run, though the owner, Uniper, may consider
closing it earlier.)
• January 2021: In his first day in office, the new US
president, Joe Biden, cancelled the permit for the
planned Keystone XL oil pipeline to cross from
Canada into the United States, thus terminating the
project. T hough there were also other reasons that
led to such a large political movement against the
project, including opposition from Native Americans
and from local ranchers, the pipeline, which would
have carried emissions-intensive Albertan oil that
was derived from tar sands (a process in which the
sand has to be heated and processed to release oil),
was also seen as incompatible with making progress
toward climate change mitigation.
Sources: Energy Central; Reuters; FT; New Yorker.
Chapter 3 Climate Change Risk ■ 63
a particular lake to melt due to their historic emissions,
which increased flood risk. This line of argument relies on
the contention that RWE can be held proportionally liable
on the basis of its pro-rata contribution to all human emis­
sions, which is estimated at 0.47% of historic CO 2 emissions
(Luciano Lliuya v. RWE AG). While still at an early stage, if
this case succeeds, legal liability risk may be a much larger
concern and source of risk for firms than it is currently.
3.4.2 Technology Risks
As much as changing technology is seen as a benefit, it can
also serve as an important driver of transition risk for older
assets and laggard firms reliant on outdated technology
that becomes less economical, or even obsolete.
Perhaps the most powerful example of these technology
risks so far involves the technological development of
renewable energy. In the past decades, wind turbines and
solar photovoltaic (PV) panels have fallen so steeply in price
that they are now cost-competitive with, or even cheaper
than, traditional power generation technologies reliant on
fossil fuels, such as coal-fired or natural gas power plants­
even without any subsidies, surcharges, or carbon taxes (see
Case Study in Section 3.6). Figure 5.8 depicts the impres­
sive 68% drop in the global weighted average levelized cost
of electricity (LCOE) of concentrated solar power (CSP) from
2010 to 2020, delineating its principal components.
Other technologies, such as lithium-ion batteries, are on
similarly steep learning curves, becoming ever cheaper.
Batteries, in turn, can be used not only for utility-scale
energy storage, further strengthening the usability of wind
and solar energy for electricity that would otherwise be
intermittent, but also for other sectors.
The continued cheapening of, and improvement of,
battery technology makes it conceivable that the trans­
portation sector will be the next to be hit by technology
risks and potential asset stranding. According to Bloom­
bergNEF, electric vehicles will hit price parity with inter-
nal combustion engine (ICE) vehicles once battery pack
prices (the single most expensive component of EVs) reach
USD 100/kWh. Based on current trends, the threshold of
USD 100 is expected to be reached around 2023. After this
point, EVs will be as affordable as, and after, even cheaper
than, combustion engine vehicles-even without subsidies
or further policy incentives, meaning there will be a strong
economic incentive to switch and that existing ICE fleets
may end up becoming stranded assets.
Reputational Risks and Consumer Pressure
Reputational risks and bottom-up or lateral pressures from
consumers, clients, suppliers, or employees can be an
important source of transition risk. The classic type of repu­
tational risk is where a firm's brand and image are tarnished

0.40
0.358 64%

� 0.20

N
0
N

0.10
- 17%

10%
9%
0.107

0.00
LCOE Total installed Capacity O&M WACC LCOE
2010 cost factor 2020

Source: IRENA Renewable Cost Database (2022), International Renewable Energy

Agency, Abu Dhabi.

bfi•ii#IH Reduction in LCOE for CSP projects, 2010-2020, by source

64 ■ Sustainability and Climate Risk Exam

by its association with industries that are seen as unsavory
(see Goldman Sachs example).
This concept is related to the more abstract notion of the
"social license to operate," whereby firms' business mod­
els must satisfy a minimum requirement of acceptability
and cannot be so noxious as to be considered immoral or
unconscionable by wider society. While it is difficult to sin­
gle out a particular firm or sector that completely went out
of business due to this alone, some sectors, such as tobacco
or certain weapon manufacturers, have at times come
close-certainly close enough for this to impact their share
prices and access to capital markets. Some of the highest­
emission, climate-unfriendly industries, such as coal and tar
sands, are now starting to become seen as broadly noxious,
and many firms exclude lending or investing in them.
Finally, but certainly no less important, bottom-up pressures
from consumers and stakeholders can also be an important
driver of change-for flexible firms, greater opportuni-
ties, and for firms that are inflexible or slow to respond,
transition risk. In consumer products sectors, as consumers
become more aware of the climate impact of their pur­
chases, agile firms will respond by increasing the selection
and availability of sustainable products, whereas staid firms
will be left behind. Consumer influence is most obvious
in household goods or food products (for example, the
increasing recognition of the high climate footprint of meat
and dairy products, which is driving part of the demand for
plant-based meat and dairy alternatives).
But using a broader definition of "consumer" to encompass
all sorts of client-supplier relationships, this type of pressure
EXAMPLE: REPUTATIONAL RISK RELATED TO CLIMATE-CASE:
GOLDMAN SACHS
Goldman Sachs is arguably the most renowned and
prestigious Wall Street investment bank; hence, the
firm takes issues of reputational risk seriously and
singles them out in its TCFD reporting. It says that
"involvement in certain industries associated with cli­
mate change" may pose reputational risk to the firm.
Specifically, it says it may lead to "reduced client and
employee loyalty, investor divestment and impacts to
client activity."
can be seen to exist also in other sectors. For instance,
Apple's commitment to carbon neutrality in its supply chain
and products by 2030 has led it to demand sustainable
raw materials, resulting, for instance, in its purchase of the
world's first zero-carbon aluminum from an Alcoa-Rio Tinto
joint venture. In a similar vein, commodity markets that
have previously been fairly homogeneous have seen a trend
toward separate labeling and marketing due to upward
pressure. A good example is the separate labeling and cer­
tification of "green steel," in comparison to normal steel,
which allows end users to differentiate between steel made
in more environmentally friendly ways (such as through
the use of hydrogen) rather than the typical method that
involves burning large amounts of coal.
3.4.4 Market and Other Transition Risks
Other notable sources of transition risks include the notion
of market risk, which in relating to climate transition risk
encompasses a broad range of potential supply, demand,
and pricing effects.
The most straightforward kinds of market transition risks
relate to the shifting demands from high-emissions products
to low-carbon products and commodities. As industries and
equipment transition to using cleaner fuels or become elec­
trified, the demand for coal will fall, potentially completely;
oil and gas demand will also likely reduce significantly,
though oil has non-combustion uses such as in petrochemi­
cals. This will then filter through to sectors such as coal
mining or bulk coal shipping. Likewise, shifts and spikes in
demand for low-carbon commodities, or commodities that
The bank has many mechanisms in place which seek to
pre-empt and mitigate climate-related reputational risk.
The bank's board of directors places "significant focus"
on issues of reputational risk in its considerations. The
bank also has a firm-wide Reputational Risk Committee,
which provides oversight over transactions that include
some climate-related dealings that may attract height­
ened reputational risk.
Source: Goldman Sachs 2019 TCFD Report.
Chapter 3 Climate Change Risk ■ 65
are needed for low-carbon infrastructure, may cause market
disruptions. For example, there have been periodic con­
cerns around the availability of lithium, crucial for lithiumion
batteries, and copper, used widely in electric vehicles and
other electric equipment.
Another kind of market transition risk that is already
manifesting itself is through shareholder perceptions or
pressures in public markets. A large portion of the value
ascribed to oil & gas firms, for instance, has historically
been due to their proven reserves. Oil majors have been
forced to write off assets; in June 2020, for instance,
oil-major BP cut the value of its assets by a full USD
17 .5 billion, and Shell pie. by USD 22 billion.
3.5 Stranded Human Capital and the
Just Transition
Assets that can become stranded are not just limited to
physical or tangible assets. Intangible assets, such as intel­
lectual property, social networks, and company reputa­
tion can also become stranded, and so can the skills and
expertise held by workers and professionals. This strand­
ing can be caused by exactly the same drivers that result
in stranded tangible assets. This is important as the size
of intangibles relative to tangibles has grown over time,
with intangible assets, particularly in advanced economies
becoming an ever-larger share of total enterprise value.
Intangible assets for S&P 500 companies, for example, hit
a record value of USD 21 trillion in 2018: intangible assets
account for around 90% of total assets.
There is also growing interest in and concern for a "just
transition," where those that could suffer most from asset
stranding, for example communities and individuals depen­
dent on industries most likely to experience asset stranding,
are supported, including, for example, through retraining
provided by companies and governments.
Distributional challenges associated with asset stranding
can create political economy frictions within countries and
across countries. Net-zero carbon transitions, particularly for
countries endowed with natural resources, imply stranded
assets in carbon-intensive sectors. In the energy sector,
stranded assets could occur upstream (e.g., reserves), mid­
stream (e.g., transmission), or downstream (e.g., genera­
tion). But other sectors could be affected too, for example,
66 ■ Sustainability and Climate Risk Exam
forests (e.g., logging concessions), transport (e.g., ports),
the built environment (e.g., offices), and agriculture (e.g.,
land-use change).
The faster the pace of decarbonization, the greater the
chance of stranded assets in different sectors and the
larger the likely economic, social, and political conse­
quences that might need to be managed. This could desta­
bilize low carbon transitions and prevent the realization
of climate objectives. The mere threat of stranded assets
could result in groups potentially affected actively or pas­
sively, frustrating or destabilizing low carbon transitions.
These groups could include the owners of assets potentially
impacted, the businesses operating assets, communities
hosting assets, and policymakers reliant on tax revenues
generated from assets.
These issues are already being felt acutely in different parts
of the world. In 2016, China announced a USD15 billion
compensation fund for unemployed iron and steel work-
ers and coal miners (Wood Mackenzie 2016). The structural
challenges facing coal mining communities in Germany and
Poland have also become a significant issue for national and
provincial governments in each country, having a significant
influence on burden sharing negotiations within the Euro­
pean Union (Krukowska 2016).
This is a particularly salient issue for developing countries
who have a right to development and access to affordable
energy (Swilling and Annecke 2010) while at the same time
facing the consequences of global warming and dwindling
levels of cheap oil, productive soils, metals, clean water sup­
plies, and forest products? How do they address widening
inequalities in income as well as the need to rebuild ecosys­
tem services and natural resources. The book considers the
theme of a just transition, which reconciles the sustainable
use of natural resources with a pervasive commitment to
sufficiency, where overconsumers are satisfied with less so
that underconsumers can secure enough. The reallocation
of resources and compensation for those individuals and
communities affected by climate change and related poli­
cies could help facilitate a just transition (Caldecott et al.
2016; Newell and Mulvaney 2013). This might be more
likely to occur in developed countries, where citizens tend
to be able to demand higher relocation costs and stron-
ger unions demand higher settlements for loss of earnings
(Funk 2014). Rosemberg (2010) suggests that job losses are
not a direct result of national climate policies, but rather are
caused by a lack of social policies and by the anticipation of
and investments in alternative mitigation measures. Thus,
providing adequate support for sectors that are losing out
in a low-carbon future and generating new employment
opportunities in low-carbon sectors are critical to ensuring a
just transition (Jagger, Foxon, and Gouldson 2013)
3.6 Transmission into Finance, the
Economy, and Key Sectors
Climate risks matter not only for the assets or firms directly
affected but also because they can propagate and have
CA SE STUDY 1: REAL ESTATE
Physical risks and real estate
Real estate is a sector particularly affected by physical
climate risk, as buildings obviously have fixed locations,
and if those locations are in vulnerable, exposed areas
they will be subject to climate risk. Wildfire and flood risk
are particularly acute for real estate. In a potentially wider
warning sign, in certain particularly wildfire-ravaged parts
of Australia and California in 2019-2020, local insurers
paused or refused to continue selling residential property
insurance. Due to the desirability of living near the coast,
and the typical location of cities along rivers for historic
reasons, flood risk is another very widespread and poten­
tially severe risk in the real estate sector. One analysis in
2019 found that 19% of retail spaces and 16% of offices in
Europe are exposed to floods and/or sea level rise, with
even higher proportions in more severely affected cities,
such as 23% in Glasgow (Four Twenty Seven, 2019).
But perhaps the most precisely documented physical risk
transmission mechanism is that of the coastal flooding risk
in the United States, from both sea level rise (a chronic
physical hazard) and the risk from an increased frequency
of storms and hurricanes (an acute hazard) transmitting into
the property market and thence to banks, insurers, asset
managers, and owners and the wider financial system. In
this particular transmission chain, empirical evidence from
academic literature gives fairly precise estimates of the
magnitude of these effects. An analysis by Bernstein and
associates in 2019 showed that US properties exposed to
sea level rise (SLR) sell for 7% less on average than equiva­
lent unexposed properties matched on key characteristics;
those exposed at 1 ft (30cm) of SLR sell at a 14.7% dis­
count, whereas those exposed at 6 ft (2m) still sell at 4.4%
an effect throughout the financial system and the broader
economy and key sectors. Ultimately, climate risk becomes
relevant to risk managers when climate change's physical
impacts, or government policies meant to reduce emissions,
have an effect on balance sheets and portfolios of firms
or financial institutions. There are a number of channels
through which these risks can propagate to corporate bal­
ance sheets and the financial system. This section explores
these through two sectoral examples: that of physical risk in
real estate (with an accompanying short section on transi­
tion risk) and that of transition risk in electricity generation
(with a section on physical risk as well.)
despite this level of SLR not expected to be reached until
2100 at the earliest (Bernstein et al., 2019). Keenan and
Bradt show that local lenders pass on proportionally more
SLR risk to secondary markets than large national banks,
indicating that they have better access to local soft informa­
tion on SLR risk (Keenan & Bradt, 2020). And Ouazad and
Kahn show that catastrophes prompt mortgage originators
in the United States to increase the share of mortgages
just below the conforming limits of mortgages eligible for
securitization by the government-sponsored enterprises
Freddie Mac and Fannie Mae, thus passing on SLR risk to
wider markets (Ouazad, 2019) (see diagram below).
Transition risks and real estate
Though transition risks are not quite as acute as physical
risks for real estate, they do still exist. The main route
through which transition risks affect real estate is through
the energy use of buildings, particularly heating. After
all, the only direct emissions from most residential or
commercial non-industrial buildings are from heating,
which often still relies on natural gas or sometimes oil in
rural areas. Electricity use can also be seen to contrib­
ute to transition risk in areas where the electricity grid
is itself still highly reliant on fossil fuel-based sources of
electricity, such as coal or natural gas.
Many jurisdictions have updated building codes to
require new builds to conform to higher energy­
efficiency standards and be heated with renewable
sources of energy. While these are sometimes grand­
fathered in for older buildings, this is not always the
case, and the UK's incoming Minimum Energy Effi­
cient Standard (MEES) shows how buildings can cause
Chapter 3 Climate Change Risk ■ 67
 transition risk. The UK uses a system where all properties
are given an Energy Performance Certificate (EPC) rat­
ing for energy efficiency on a scale from A to G, with
G being the worst. As of 2018, the average EPC for
rented property was an E. Under the MEES rule, from
April 2018, properties rated For G were not allowed to
be rented out on new leases, with the rule extending to
existing leases from 2023, with fines for non-compliance.
This could lead to transition risk for UK lenders if land­
lords' credit position deteriorates from lost rental income
due to their properties having become ineligible (if
they do not make energy-efficiency improvements), or
through the market value of Fand G properties falling.
The Bank of England has conducted analysis showing
that the energy-efficiency rating of a property is a predic­
tor of credit risk on residential mortgages.

► ► ► ►
COASTAL BANKS
Sea level PROPERTIES MARKETS
rise & Effects on
more Lower Effects on
Greater risk residential
frequent property mortgage
of current, and
storms values securitization
future commercial
and mortgage-
flooding property
backed assets
mortgages

Bernstein, A., Gustafson, M. T., & Lewis, R. (2019, 2019/11/01/).

Disaster on the horizon: The price effect of sea level rise.
Journal of Financial Economics, 134(2), 253-272.
https://doi.org/10.1016/j. jfineco.2019.03.013; Keenan &
Bradt (2020): Local lenders pass on proportionally more SLR risk
to markets. Ouazad & Kahn (2019): Catastrophes increase
mortgages just below limit, that are passed on.

Figure 3.12

CASE STUDY 2: ELECTRICITY GENERATION

Transition risks and electricity generation FINANCIAL
COUNTERPART/ES

(Lenders, Investors)

o Lower returns
o Loss of o Rising default risk
revenues
o Asset Electricity Utilities
write-offs
(stranded
assets)

CUSTOMERS

Fi ure 3.13

68 ■ Sustainability and Climate Risk Exam

 The most straightforward way in which climate risks
affect the electric utilities sector is through transition
risk. A good example is that of coal-fired power plants,
which have been an obvious focus of attention because
burning coal for electricity is one of the most emissions­
intensive processes; the CO2 emissions per MWh of
electricity output are twice as high as even those from
natural gas power plants (with 1.0 metric ton of CO2
from coal per MWh versus 0.4 metric tons per MWh from
gas, based on 2019 US data).
Coal-fired power plants can be affected directly
through transition policy risk, where mandated shut­
downs, such as Germany's phased shutdowns by
2038, means coal plants close before the end of their
operational lifetimes and become stranded assets (see
Section 3.4.1).
But coal power generation can be affected equally by
technology transition risk in the form of cost competition
from renewable technologies. From a global levelized
cost of electricity (LCOE) as high as USD 347 per MWh
for solar PV as recently as 2009, USD 190 for offshore
wind, and USD 111 for onshore wind, the LCOE for all
three had dropped to USD 39, 78, and 44 for solar PV,
offshore, and onshore wind, respectively, as of 2020,
according to data from research firm BloombergNEF.
Without taking any sort of subsidies or tax credits into
account, wind and solar are now the cheapest forms of
new-build electricity generation for two-thirds of the
global population, and the economic incentive is strong
for them to displace fossil-fuel generation even without
further policy action.
REFERENCES
Bernstein, A., Gustafson, M. T., & Lewis, R. (2019,
2019/11/01/). Disaster on the horizon: The price effect
of sea level rise. Journal of Financial Economics, 134(2),
253-272. https://doi.org/https://doi.org/10.1016/j.
jfineco.2019.03.013
Caldecott, B. H., Nicholas; McSharry, Patrick. (2013).
Stranded Assets in Agriculture: Protecting Value from
Environment-Related Risks (Smith School of Enterprise
and the Environment Working Papers, Issue. https://www.
smithschool.ox.ac.uk/publications/reports/stranded-assets­
agriculture-report-fina I.pdf
Physical risks and electricity generation
Even if the exposure of fossil-fuel power generation to
transition risk is more obvious than the connection to
physical risk, the electricity generation sector can be
significantly affected by physical climate risk, as well. Two
American examples from recent years serve to highlight
this: California-based Pacific Gas & Electric (PG&E) and
the related wildfires in 2018 and the Texas-based power
plants and an extreme cold snap in 2021.
Across the western US, climate change-induced
increases in summer temperatures and the intensifica­
tion of droughts have been a very significant contribu­
tor to wildfires, with climate change responsible for
doubling the cumulative forest fire area since 1984. In
2018, in a dry and warm spell, poorly maintained equip­
ment from PG&E, California's main power utility, ignited
fires, including the campfire that killed 84 people and
destroyed the town of Paradise. The firm has been held
liable in court and had to declare what has been termed
the "first climate-change bankruptcy."
In January 2021, an extreme cold spell caused by a devia­
tion in the jet stream led to unseasonably cold temperatures
in Texas, which froze electricity-generation infrastructure
ranging from natural gas plants and nuclear plants to
wind turbines, none of which had been "winterized." This
led to rolling blackouts across the state and several peo­
ple freezing to death. While the lack of preparedness had
as much to do with the extreme deregulation of the Texas
grid, which is separate from the rest of the United States,
as with direct climate risk, the incident serves to highlight
the need to prepare for more extremes going forward.
Caldecott, B., Kruitwagen, L., Dericks, G., Tulloch, D. J., Kok,
I., & Mitchell, J. (2016). Stranded Assets and T hermal Coal:
An analysis of environment-related risk exposure. Stranded
Assets Programme, SSEE, University of Oxford, 1-188.
ClientEarth v. Enea, (Regional Court in Poznan 2019).
Conservation Law Foundation, Inc. v. Shell Oil Products US,
(United States District Court for the District of Rhode Island).
Fiedler, T., Pitman, A. J., Mackenzie, K., Wood, N., Jakob,
C., & Perkins-Kirkpatrick, S. E. (2021, 2021/02/01). Busi­
ness risk and the emergence of climate analytics. Nature
Climate Change, 11(2), 87-94. https://doi.org/10.1038/
s41558-020-00984-6
Chapter 3 Climate Change Risk ■ 69
Four Twenty Seven. (2019). Real Estate Climate Risks How
Will Europe be Impacted? http://427mt.com/wp-content/
uploads/2019/09/Europe-real-estate-risk-9.10.2019.pdf
Funk, M. (2014). Windfall: The Booming Business of Global
Warming. Penguin Press.
ILO. (2019). Working on a warmer planet: The impact of
heat stress on labour productivity and decent work.
https://www.ilo.org/wcmsp5/groups/public/---dgreports/--­
dcomm/---publ/documents/publication/wcms_711919.pdf
°
IPCC. (2018). Impacts of 1.5 C of Global Warming on
Natural and Human Systems. In Global Warming of 1.5 °C.
An IPCC Special Report on the impacts of global warm­
ing of 1.5 °C above pre-industrial levels and related global
greenhouse gas emission pathways. Cambridge University
Press.
Jagger, N., Foxon, T., & Gouldson, A. (2013). Skills con­
straints and the low carbon transition. Climate Policy, 7 3(1),
43-57. https://doi.org/10.1080/14693062.2012.709079
Keenan, J., & Bradt, J. (2020). Underwaterwriting: from
theory to empiricism in regional mortgage markets in the
U.S. Climatic Change, 162(4), 2043-2067. https://doi.
org/10.1007/s 10584-020-02734-1
70 ■ Sustainability and Climate Risk Exam
Krukowska, E. (2016). Poland T ies Climate-Deal Ratification
to EU Concessions on Coal. Bloomberg.
Luciano Lliuya v. RWE AG, Case No. 2 0 285/15 (Essen
Regional Court).
Newell, P., & Mulvaney, D. (2013). The political economy of
the "just transition." The Geographical Journal.
Ouazad, A. K., Matt. (2019). Mortgage Finance and Climate
Change: Securitization Dynamics in the Aftermath of Natu­
ral Disasters. NBER Working Papers, w26322. https://ssrn.
com/abstract=3461490
Paris Agreement [full text], (2015).
Rosemberg, Anabella. (2010). Building a Just Transition: The
linkages between climate change and employment. Interna­
tional Journal of Labour Research, 2(2).
Swilling, M., & Annecke, E. (2010). Forthcoming. Just Transi­
tions: Explorations of Sustainability in an Unfair World. Cape
To. Just Transitions, 1-54.
Wood Mackenzie. (2016). Analysis-Four points about
China coal sector overcapacity I Wood Mackenzie. Wood
Mackenzie Analysis. https://www.woodmac.com/analysis/
Four-points-about-China-coal-sector-overcapacity
The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

QUESTIONS
3.1 What does the TCFD stand for? C. An asset that has been neglected and poorly
maintained
A. Taskforce on Climate-Related Financial Decisions
D. An asset that is uneconomical to operate
B. Taskforce on Climate, Finance, and Development

C. Taskforce on Climate-Related Financial Disclosures

3.5 What are the two subtypes of physical climate risk?

A. Acute and chronic

D. Taskforce on Climate and Financial Diversification

3.2 What four key parameters does the TCFD recom­ B. Policy and legal

mend firms disclose? C. Sudden and gradual

A. Adaptive capacity, governance, resilience, D. Hydrological and climatological

exposure
3.6 What hazards beyond sea level rise can cause physical
B. Governance, risk management, strategy, metrics climate risk?

C. Strategy, vulnerability, physical hazards, stranded A. Deforestation

assets
B. Hurricanes
D. Metrics, scores, reputational risk, liability risk
C. Landslides
3.3 What are the two main types of climate risk? D. Earthquakes
A. Environmental and physical risk
3.7 Which of the following factors beyond policy change
B. Stranded asset risk and litigation risk can cause climate transition risk?

C. Physical risk and transition risk A. Technological changes

D. Market risk and pricing risk B. Sea level rise

3.4 What is a stranded asset? C. Coastal flooding risk

A. An asset that has been surrendered by its owners D. Lack of adaptive capacity

B. An asset that has been prematurely written down,

devalued, or converted to liabilities as a result of
climate risk

Chapter 3 Climate Change Risk ■ 71

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

ANSWERS
3.1 C 3.5 A

3.2 B 3.6 B

3.3 C 3.7 A

3.4 B

72 ■ Sustainability and Climate Risk Exam

Sustainability and
Climate Policy,
Culture, and
Governance

■ Learning Objectives
After reviewing this chapter, you should be able to:

• Discuss the evolution of international climate policy. • Explain how climate policy occurs at the national and
subnational levels.
• Understand the relative scale of emissions by country.
• Describe and differentiate Scope 1, 2, and 3
• Summarize the history, outcomes, and obligations of
em1ss1ons.
major international climate agreements, and distin­
guish from the goals set in the Paris Agreement. • Recognize the challenges associated with accounting
for Scope 3 emissions.
• Understand characteristics of the Paris Agreement.
• Differentiate the types of private-sector sustainabil­
Explain the structure, benefits, and drawbacks of
ity and climate investment policies, and how public
carbon pricing policies, including carbon taxes and
policy has been used to promote adoption of green
emissions trading schemes.
finance.
Describe sector-specific climate policies, such as the
• Describe the function, purpose, and challenges of
transportation and power generation sectors.
green taxonomies.

73
 • Discuss how central banks incorporate climate change
into supervision practices.
• Identify methods used to enforce sustainable invest­
ment and disclosure policies.
• Describe the trends in private-sector climate frame­
works and identify important climate groupings.
• Understand climate-related risk and nature-related
risk.
• Explain the broader societal and cultural impacts of
climate change and policies.
This chapter examines the wider policy and cultural
context in which the move toward sustainability
and climate risk integration in the private sector
has occurred. It starts by describing international
sustainability and climate policy frameworks to
date and the challenges inherent in attempts to
reduce emissions through global agreements. It
then describes how sustainability and climate have
become part of various policy frameworks, both
public-sector and private-sector-oriented, rang-
ing from promotion to supervision and regulation.
Finally, consideration is given to potential implica­
tions, both at the micro and macro level, of how
policies and other transition drivers may impact
society and corporate culture.
Chapter Outline
4.1 Introduction to Sustainability and Climate Policy,
Culture, and Governance
4.2 International Sustainability and Climate Policies
4.3 Climate Risk and Financial Policy
4.4 Climate Risk and Financial Supervision
4.5 Private-Sector Sustainability and Climate Risk
Frameworks
4.6 Nature, Biodiversity, and Climate Change
4.7 Broader Societal Implications and Conclusions
74 ■ Sustainability and Climate Risk Exam
Key Learning Points
• There have been various attempts to agree on inter­
national climate policy globally. These efforts have
been complicated by disagreements over the optimal
amount of emissions reductions, the inherent difficul­
ties of collective action, and the fact that countries that
have sharply increased their share of emissions in the
past two decades (e.g., China, India) are different from
those responsible for accumulated historical emissions
(e.g., US, EU, Russia, Japan) and those expected to drive
future emissions unless they adopt green growth models
(e.g., Saudi Arabia, Indonesia, Brazil), raising "fairness"
questions around the potential trade-off between emis­
sions and economic development.
• The first global agreement on climate established the
United Nations Framework Convention on Climate
Change (UNFCCC) in 1992 at the Rio Summit.
• The first global compact on emissions reductions, the
Kyoto Protocol of 1997, took the form of a legally bind­
ing treaty, according to which high-income countries
agreed to reduce emissions by 5% from 1990 levels by
2008-2012.
• The subsequent Paris Agreement of 2015 took a differ­
°
ent direction, agreeing on a 1.5-2 C reduction aspiration
and inviting all countries to submit (non-binding) plans to
get there, relying on the mechanism of peer pressure.
• At the national level, carbon pricing is a widely used
policy to reduce emissions; the principal ways to estab­
lish a price on carbon emissions are through carbon
taxes or cap-and-trade schemes (which are not mutually
exclusive).
• However, carbon pricing is not the only policy option
to achieve emissions reductions; countries have also
used sector-specific policies, such as feed-in tariffs and
quota requirements for renewable power generation,
and fuel efficiency and CO2 emissions standards for
automobiles.
• In the investment space, societal and cultural trends and
sustainability and climate investment policies, led by
governments, international financial institutions, and pri­
vate investor coalitions, are helping to frame the private
sector's transition to a sustainable, green economy and
 promote the growth of green finance and sustainability­
oriented products.
• One of the most impactful policy areas where climate
change has been integrated is that of financial super­
vision: Many central banks now expect financial
institutions to integrate climate into governance, risk
management, and disclosure, and to undergo climate
stress tests to assess the resiliency of the financial sys­
tem to climate shocks.
• Financial policy also supports the growth of sustainable
finance through auditing self-described sustainable prod­
ucts, and in some jurisdictions, through top-down regula­
tory taxonomies defining what products are considered
sustainable.
SUSTAINABILITY AND CLIMATE
POLI CY, CULTURE, AND
GOVERNANCE
4.1 Introduction to Sustainability
and Climate Policy, Culture, and
Governance
To understand the private sector's approaches to sustain­
ability, climate change, and climate risk requires an under­
standing of the broader policy and cultural framework in
which these issues are gaining prominence. This chapter is
intended to contextualize and frame the private-sector tran­
sition to a sustainable, green economy. First, it describes
international sustainability and climate policies and the con­
siderations that have led them to be relatively slow-moving.
Then, it examines the increasing importance of sustain­
ability and climate policy considerations, from investment
policies to supervision and regulation of the private sector,
notably the private financial sector. The chapter also looks
at private-sector-oriented governance and coordination
frameworks on sustainability and climate change, building
on the coalitions discussed in Chapter 2.
However, just as importantly, policies and private-sector
practices are evolving within a greater context of societal
and cultural shifts on sustainability and climate, including
market expectations. Therefore, the chapter concludes with
a look at these and their implications.
Chapter 4 Sustainability and Climate Policy, Culture, and Governance
4.2 International Sustainability and
Climate Policies
There have been various attempts since the 1990s to agree
on international climate policies, mainly regarding emissions
reductions, at a global level. The first global agreement on
climate change was the formation of the United Nations
Framework Convention on Climate Change (UNFCCC)
in 1992; the first accord on emissions reductions was the
Kyoto Protocol of 1997; and, the latest and most success­
ful, so far, climate change mitigation agreement is the
Paris Agreement of 2015. Understanding why global cli­
mate policy has proved to be so difficult and slow-moving
requires an understanding of the background situation,
open questions, and the different ways that agreements
have attempted to resolve them (these are reviewed and
described in this section). In addition, sustainability and
climate-related issues have gained prominence in other
areas, including private-sector practices, financial policy,
and regulation (these are reviewed in subsequent sections).
4.2. 1 Backdrop of Climate Policies
The scientific evidence that human greenhouse gas emis­
sions are warming the planet's climate has roots stretching
back decades, and it became the consensus in the 1970s
and 1980s. In fact, it was not long after the initial discovery
of the greenhouse effect in the mid-nineteenth century­
the fact that gases such as carbon dioxide (CO 2) trap heat
in the atmosphere-that Svante Arrhenius, a Swedish sci­
entist, proposed in 1896 that fossil-fuel combustion, and
the resulting increase in atmospheric CO 2 concentrations,
would result in global warming. Scientists such as Gilbert
Plass and observers such as Guy Callendar continued to
work on collecting evidence that CO2 was warming the
Earth, although at the time many other scientists thought
the oceans' ability to absorb excess CO2 was vast, or that
natural variability mattered more than human influence on
climate. Indeed, global average temperatures were not
meaningfully rising in the 1940s, 1950s, or 1960s (in fact,
the slight cooling trend observed in the 1950s and 1960s
can retrospectively be attributed to aerosols, a type of
chemical pollution that decreased after clean air legislation
in major economies). But in the 1980s, global mean annual
temperatures started to rise significantly, and scientific
■ 75
consensus around the strong human influence on climate
solidified, leading to the formation of the Intergovernmen­
tal Panel on Climate Change (IPCC) in 1988, a UN-convened
organization of scientists, and soon thereafter to the
United Nations Framework Convention on Climate Change
(UNFCCC), a UN body dedicated to climate change.
But the understanding and wide recognition of the fact that
human-caused emissions were warming and disrupting the
global climate prompted more questions, for example con­
cerning the optimal level of emissions reductions, over the
allocation of (moral) responsibility and the potential trade­
off between emissions and economic development, and
regarding how to overcome collective action problems.
One important debate played out both within academia
and among policymakers over the optimal level of emis­
sions reductions. Economists such as William Nordhaus
developed models to assess the costs and benefits of
mitigating climate change through emissions reductions
versus the physical impacts of climate change. The original
formulation of Nordhaus's dynamic integrated climate­
economy (DICE) model from the early 1990s suggested that
warming of 3.5°C would be optimal in terms of not unduly
hampering economic growth while still mitigating the worst
climate impacts. Climate scientists have tended to be more
conservative, and more recent evidence suggests that even
BOX 4.1: UNDERSTANDING CUMULAT IVE VERSUS CURRENT ANNUAL
EMISSIONS
There is quite a contrast in emissions between the coun­
tries that are currently the largest emitters and those that
have cumulatively contributed most to rising emissions.
In terms of current annual emissions, China's by far out­
pace any other country's, and India's are also growing
rapidly. Of current (as of 2019) emissions at regional lev­
els, Asia accounts for half (50%}, with North America at
17%, and Europe at 15%.
However, because industrialization driven by coal, oil,
and other fossil fuels started far earlier in Europe and
in North America than in Asia, these countries account
for a far larger share of cumulative emissions. In many
ways, cumulative emissions matter more because
cumulative emissions reflect the stock of CO2 in the
76 ■ Sustainability and Climate Risk Exam
somewhat lower levels of warming can lead to severe physi­
cal impacts and potentially to catastrophic "tipping points,"
leading to an international consensus around a goal of limit­
ing warming to 2°C. A subsequent revisitation by academics
of the DICE model found that even it suggested an opti­
mum around 2°C once the carbon cycle and energy balance
models within it were better calibrated, and climate dam­
age estimates were updated (Hansel et al., 2020).
Another important open question revolves around the allo­
cation of (moral) responsibility, the relationship between a
country's wealth and historical emissions and the potential
trade-off between emissions and economic development.
What matters to the warming and disruption of the Earth's
climate is the stock of carbon dioxide and other green­
house gases in the atmosphere-the higher the concentra­
tion, the greater the impacts. Obviously, annual emissions
keep adding to this stock. One could therefore argue that
those responsible for the greatest share of new emissions
are the ones who must cut back the most, especially as
solutions (both technical and nature-based) to remove CO2
from the atmosphere are in their infancy and do not yet
exist at scale. However, looking backward, one can equally
argue that it is the countries responsible for the great-
est share of cumulative emissions (i.e., the total stock},
that are most responsible for climate change. Countries
atmosphere-and it is the total stock, not the annual
flow, that affects the changes in climate.
Cumulative CO2 Emissions (1751-2017) by Country
An examination of cumulative emissions finds that, while
China does still account for a substantial share-one
eighth and growing-Europe and North America come
out ahead. The United States alone is responsible for a
quarter of global cumulative emissions, and the former
28 countries of the European Union-including the
United Kingdom, France, Germany, Italy, and others-for
nearly as much, just over a fifth. North America accounts
for 29% of global emissions through 2017, the exact same
proportion as Asia. Europe accounts for a full third (33%)
 10 billion t China

8 billion t

6 billion t
United States

4 billion t

India
2 billion t
Russia
Japan
Germany
Ot ..-----�����§ United Kingdom
1800 1850 1900 1950 2000 2019

Source: https://doi.org/10.5194/essd-14-4811-2022 © Author(s) 2022. This work is distributed under the Creative Commons
Attribution 4.0 License.

6J2jijk@il■ Annual CO2 Emissions (1800-2019), Select Countries

North America Asia

457 billion tonnes CO2 457 billion tonnes CO2
29% global cumulative emissions 29% global cumulative emissions

353 billion tonnes CO2 101 billion tonnes

22% global cumulative emissions 6% global emissions

Ukraine
19 billion I
1.2%
Oceania
■ -=•1.2%
-!!
20 billion tonnes CO2
global emissions
Europe Africa South America
43 billion tonnes CO2 40 billion tonnes CO2
514 billion tonnes CO 2 3% global emissions 3% global emissions
33% global cumulative emissions
Source: Hannah Ritchie and Max Roser (2020) - "CO2 and Greenhouse Gas Emissions". Published online at OurWorldlnData.org.
This work is distributed under the Creative Commons Attribution 4.0 License.

bf.jljk@fj Cumulative CO2 Emissions (1751-2017) by Country

Chapter 4 Sustainability and Climate Policy, Culture, and Governance ■ 77

that have sharply increased their share of emissions in the
past two decades (e.g., China, India) are different from
those responsible for accumulated historical emissions
(e.g., US, EU, Russia, Japan) and those expected to drive
future emissions unless they adopt green growth models
(e.g., Saudi Arabia, Indonesia, Brazil) (see Box 4.1). This has
set up a tension in international negotiations ever since,
and it is complicated by the "fairness" questions around
the potential trade-off between emissions and economic
development.
A final important issue that forms an indelible part of the
backdrop of international climate policy is the inherent
collective action problem as such as moral hazard, informa­
tion asymmetry or short-termism. Global emissions, and
attempts to reduce them, constitute a classic collective
action problem, that is, a problem caused by disincentives
that tend to discourage joint action by individual entities
(in this case, mainly countries, but also individuals or com­
panies) in pursuit of a common goal, or where the result is
a public good that benefits everyone. The Earth's climate is
a global public good, and a healthier, less disrupted climate
benefits everyone on Earth. However, any country reduc­
ing its greenhouse gas emissions is paying the full cost of
those emissions cuts in the short term, while only receiving
a fraction of the benefits of a better climate, realized over
the long term. Thus, countries are easily disincentivized
from implementing painful emissions cuts and tempted to
freeride off the emissions cuts of others.
4.2.2 Brief History of International Climate
Agreements, from Kyoto to Paris
The origins of international climate summits can be traced
back to 1979, when the first World Climate Summit, orga­
nized by the World Meteorological Organization (WMO),
framed climate change as an issue to be addressed by
global politics. In 1988, the WMO was also the co-creator of
the Intergovernmental Panel on Climate Change (IPCC), the
scientific body that was to become ever more influential in
subsequent years and decades.
However, the history of concerted global political action on
climate starts with United Nations involvement. The 1992
Earth Summit in Rio de Janeiro, Brazil, introduced several
new UN initiatives and bodies, including the United Nations
Framework Convention on Climate Change (UNFCCC).
78 ■ Sustainability and Climate Risk Exam
Subsequent summits of the UNFCCC were called "confer­
ences of the parties," or COP for short, with the number of
the meeting attached: the first follow-up meeting, COP1,
took place in Berlin in 1995.
COP3 in Kyoto in 1997 produced the first major interna­
tional accord on emissions reductions. The Kyoto Protocol,
which took the form of a legally binding treaty, required
high-income "Annex 1" countries to attain 5% emissions
reductions compared to 1990 levels by 2008-2012, with
several mechanisms built in that attempted to promote flex­
ibility and technology transfer between countries. The first
of these, emissions-trading, was meant to allow Annex 1
countries that had made deeper emissions cuts to sell sur­
plus emissions allowances to other Annex 1 countries. The
second of these, "joint implementation," was also meant
to be between Annex 1 countries, where one country could
undertake a project involving technology transfer in a fellow
Annex 1 country. The third, the "clean development mecha­
nism" (CDM), attempted to provide a way for emissions
cuts to also be spread to developing economies. Under the
CDM, an Annex 1 country could get credit for conducting
an emissions reduction project in a non-Annex 1 country
(Napoli, 2012).
Immediately after its adoption, the Kyoto Protocol was
viewed as a resounding success and an optimistic sign for
the future. However, in retrospect, it is widely viewed as
having been a failure, as it did not achieve even the mod­
est emissions targets it had embedded within it. Some of
its failings were technical, such as the fact that the planned
emissions-trading scheme was never properly implemented.
But many of its failings were deeper and more structural.
One of the core principles of the Kyoto Protocol was the
notion of "common but differentiated responsibilities,"
which acknowledged that developed and developing
countries have different levels of responsibility in address­
ing climate change. This principle led to differentiating
between Annex 1 (developed) and non-Annex 1 (develop­
ing) countries in terms of emissions reduction obligations.
However, developing countries were not subject to any kind
of emissions reduction obligations and many experienced
skyrocketing rates of emissions growth during this time.
This made even Annex 1 countries less committed to the
Protocol. Indeed, the United States ended up never ratify­
ing the Protocol for this reason. Additionally, other reason
for the Protocol's failure include the late ratification of
the agreement by several countries, issues with the Clean
Development Mechanisms (CDM) and Joint Implementa­
tion (JI) projects that did not adequately prevent double
counting of emissions reductions, and concerns about the
additionality of these projects - whether the GHG reduction
were real and would not have occurred without the projects
(Napoli, 2012).
Expectations were high that negotiations at COP15 in
Copenhagen in 2009 would produce an improved, binding
treaty for the post-Kyoto space, as Kyoto was set to expire
in 2012. Inversely to the situation with Kyoto, the Copen­
hagen summit's acrimonious end, with no agreement on
a new binding treaty, was widely seen by commentators
and the media as an abject failure. Nonetheless, some of
the ideas first introduced at Copenhagen ended up laying
the groundwork for subsequent climate policy. For one
example, the meeting in Copenhagen was the first COP to
establish the aspirational goal that global warming be kept
°
to below 2 C. Another example is that in the absence of a
binding treaty, the Copenhagen accord invited countries of
all kinds, high-income and low-income, to submit domestic
mitigation strategies to the UNFCCC.
In 2015, COP21 in Paris built on some of these new
ideas first tentatively floated in Copenhagen. The Paris
Agreement is based not on legally binding emissions
reductions targets but on a commonly agreed aspiration to
°
keep global temperature rise "well below 2 C above pre­
industrial levels" and to "pursuing efforts" to limit the rise
°
to 1.5 C, combined with national efforts by each individual
party in this direction (UNFCCC, 2015). These national
plans, now called Nationally Determined Contributions
(NDCs), are to be submitted to the UNFCCC, and
periodically re-evaluated. However, one of the shortcom­
ings of the Paris Agreement is that the combined NDCs
submitted by countries are insufficient to achieve the goal
°
of limiting global temperature rise to well below 2 C. For
instance, the International Energy Agency (IEA) estimated
°
that the initial NDCs would lead to 3 C or more of warm­
ing, demonstrating a significant gap in global climate
ambition. Specifically, the Paris Agreement establishes a
"ratchet" mechanism, where countries are expected to
tighten their NDCs every five years, and these are to be
evaluated at COP meetings.
Chapter 4 Sustainability and Climate Policy, Culture, and Governance
The voluntary nature of NDCs and the lack of strong
enforcement mechanisms may limit the effectiveness of
the Paris Agreement in driving ambitious climate action.
While the first round of "ratcheting" seems to be work­
ing as intended, with many 2020 NDCs being much more
ambitious and countries committing to a (domestic) goal
of achieving net-zero emissions by 2050, there are still con­
cerns about the adequacy and enforcement of these com­
mitments. The voluntary nature of NDCs and the lack of
strong enforcement mechanisms may limit the effectiveness
of the Paris Agreement in driving ambitious climate action
In any case, it is already possible to say that the success
Paris has brought so far is in its different structure and
approach from Kyoto. Instead of relying on legal obligations
(which are difficult to enforce for any international treaty,
unlike domestic contracts that can be enforced by judicial
systems and appropriate penalties), the Paris Agreement
makes use of the powerful tools of inclusion and peer pres­
sure. Everyone must submit an NDC, and countries ramp
up ambitions when others do. As an example, a first version
of Japan's 2020 NDC was not significantly different from its
2015 NDC, but after South Korea adopted a goal of net­
zero emissions by 2050, Japan did too.
In addition, the framework around the Paris Agreement
explicitly recognized for the first time that many kinds of
stakeholders, ranging from subnational actors such as cit­
ies and regions to private-sector businesses and financial
institutions, could help to contribute to climate goals. The
UN High-Level Champions have been instrumental in foster­
ing collaboration and engagement among these diverse
stakeholders. One notable example is the "Race to Zero"
campaign, which the High-Level Champions have been pro­
moting to mobilize businesses, cities, regions, and investors
to commit to achieving net-zero carbon emissions by 2050.
This ambitious campaign demonstrates how the Champions
can encourage a wide range of actors to take action and
share best practices that contribute to the global climate
goals (see section 4.2.4 and Section 4.5).
4.2.3 National Climate Policies
Achieving NDCs requires having a domestic climate
policy. This section briefly reviews the principal types of
climate change mitigation (i.e., greenhouse gas emissions
■ 79
reduction) policies at the national level that countries have
in place. Overall, policies can be economy-wide-typically
a form of carbon pricing-or sector-specific. This section
reviews carbon pricing and then describes climate change
mitigation policies in two of the most emissions-intensive
sectors: power generation and transportation.
Carbon pricing refers principally to two types of policies­
carbon taxes and emissions-trading schemes, better known
as cap-and-trade schemes. Carbon taxes, which impose a
price per ton of CO2 emitted, have typically been favored
by economists. They are a classic way of internalizing an
externality by forcing emitters to pay for the social cost of
their carbon emissions, and a tax in such an instance is the
classic prescription from economic theory. The World Bank
plays a significant role in monitoring and supporting carbon
pricing initiatives worldwide, including carbon taxes and
emissions trading systems, through its "State and Trends of
Carbon Pricing" report. According to the 2021 report, there
are currently 64 carbon pricing instruments in place, which
cover about 20.1% of global greenhouse gas emissions.
However, in many of these, the price ends up being below
the USD100 per ton assumed to be needed to have a sig­
nificant effect. Additionally, these initiatives have generated
approximately USD 53 billion in government revenues,
an 8% increase compared to 2019. Carbon taxes can be
implemented at different stages of the production and con­
sumption process: upstream, midstream, or downstream.
Upstream taxes target the production or importation of
fossil fuels, midstream taxes are applied at the processing
or distribution stage, and downstream taxes are imposed
on end-users or consumers. Each approach has its benefits
and drawbacks. Upstream taxes are usually more straight­
forward to administer and have broader coverage, while
downstream taxes offer more direct incentives for consum­
ers to reduce their carbon emissions. Midstream taxes fall in
between, balancing coverage and incentives. One concern
with carbon pricing is the potential for carbon leakage,
which occurs when carbon-intensive industries relocate to
jurisdictions with less stringent climate policies, leading to a
shift in emissions rather than an overall reduction. This can
undermine the effectiveness of carbon pricing policies and
may negatively impact the competitiveness of businesses
in countries with stricter regulations. Currently, carbon
taxes exist in many jurisdictions, though they vary in scope:
80 ■ Sustainability and Climate Risk Exam
Japan's carbon tax is at the lower end, less than USD10
per ton, whereas Sweden's is currently the world's highest,
at around USD125 per ton. In addition to (or instead of)
carbon taxes, many countries have opted for cap-and-trade
schemes. In these, the total amount of emissions is capped
(and the cap gradually lowered), but emissions permits can
be traded between participants. While this limit on quantity
does end up imposing a price as well, a trading scheme is
often considered more flexible.
In general, carbon taxes and emissions-trading schemes
both have benefits and drawbacks. Carbon taxes raise reve­
nue for the government, which can then be spent on further
mitigating or adapting to climate change. Additionally, car­
bon taxes have practical advantages over emissions-trading
schemes. They are generally easier to administer, provide
greater price certainty, and can promote investment by
providing a stable price signal. Moreover, carbon taxes have
the potential to generate significant revenues and can cover
broader emissions sources. However, in at least some coun­
tries, levels of tax are frequently tweaked, which can be det­
rimental to investors or businesses that need certainty over
multiple years to make investment decisions.
Emissions trading schemes set caps on total emissions for
specific industries or sectors, allocating each company
permits based on their allowed greenhouse gas emissions.
Companies can sell, buy, or trade permits according to their
needs and reduction strategies. Selling credits incentivizes
green technology investments, while banking unused per­
mits provides flexibility and smooths market fluctuations.
However, trading schemes can cause volatile carbon pric­
ing, and exogenous shocks like financial crises can lead to
permit oversupply, decreasing incentives to reduce emis­
sions. Borrowing permits from future allocations manages
short-term emissions or price fluctuations but may pose
risks if companies become overly reliant on future permits
and neglect emission reduction investments.
Various mechanisms enhance the functioning of emis­
sions trading schemes and address potential challenges.
Price floors and ceilings help reduce market volatility and
ensure permit prices remain within a desirable range, miti­
gating the effects of volatile carbon pricing. Monitoring
and enforcement ensure system integrity, with penalties
for non-compliance maintaining the scheme's effective­
ness. Offset projects allow companies to invest in external
emissions-reducing projects, earning additional permits or
offsetting emissions. Market stability reserves help man­
age permit supply, maintaining effective permit prices and
addressing oversupply issues. Finally, international coop­
eration links emissions trading schemes across countries or
regions, creating a larger, more liquid market for efficient
resource allocation and increased cost-effectiveness in
achieving global emissions reduction targets.
Other policies have also had significant effects in reducing
emissions in specific sectors. Perhaps the sector where spe­
cific policies have had the largest impact so far is in power
generation. Renewable Portfolio Standards (RPSs) are
an umbrella term for a range of quota-based regulations
that aim to increase the supply of renewable electricity by
requiring commercial power producers to source a specific
portion of supply from renewable energy sources, such as
wind or solar power.
RPSs have been deployed in 173 countries, including
the Renewable Obligation in the UK and the Renewable
CASE STUDY: JUST ENERTY TRANSITION PARTNERSHIPS
Just Energy Transition Partnerships (JETPs) are a series of
formal collaborations among governments, private sector
entities, and civil society organizations that aim to promote
renewable energy, increase energy efficiency, and improve
energy access in underserved communities. The partnerships
aim to ensure that vulnerable communities and workers are
not left behind in the shift away from fossil fuels and that the
benefits of a clean energy economy are shared more fairly.
JETPs aim to signal to the international community that a
subset of affluent nations are committed to supporting a
climate transition in developing countries and emerging
economies. This can unlock financing to retire carbon­
intensive assets, re-skill fossil fuel workers, and promote
local economic development.
South Africa and Indonesia were the first nations to
formally launch JETPs, with support from donor govern­
ments in the form of grants, guarantees, and conces­
sional finance. They each prioritize the swift increase of
renewable power, reducing reliance on fossil fuels, and
investing in transition-aligned jobs.
The South Africa JETP was announced at COP26, when
France, Germany, the UK, the US and the EU committed
Chapter 4 Sustainability and Climate Policy, Culture, and Governance
Electricity Standard on the federal level in the United
States. Feed-in tariffs offer a guaranteed price per unit of
electricity generated at which producers can sell their elec­
tricity for a fixed period of time (usually between 15 and 25
years). Sometimes these tariffs are simply set by policymak­
ers; in other cases, they are determined through a market­
based process, such as the UK's "contract for difference"
approach. Tax incentives have a significant impact on the
deployment of renewable energy by reducing project costs
and improving their economic competitiveness compared
to conventional energy sources. In addition to cost reduc­
tions, tax incentives can provide, if designed well, market
stability and predictability, enabling investors and project
developers to make long-term investment decisions. The
Inflation Reduction Act in the United States incorporates
over 20 new or modified tax incentives, along with tens of
billions of dollars in grant and loan programs. The Act aims
to stimulate investment in and deployment of new clean
energy technology, thereby accelerating our transition to a
clean energy economy.
a total of USD 8.5 billion. South Africa has since published
its Implementation Plan, setting out priority investments
required for a transition to a low-carbon and climate resil­
ient economy. A key area of focus lies on accelerating the
decarbonization of the South African electricity grid by
scaling up renewables and ensuring the early retirement
of South Africa's large coal generation fleet.
The Indonesia JETP was launched a year later at the G20
leaders' summit in Bali, with USD 20 billion in committed
finance from the public and private sector. The proj-
ect has integrated critical aspects of the IEA Net-Zero
Roadmap, which includes the analysis showcasing that
Indonesia could achieve peak emissions in its electricity
sector by 2030 to realize net-zero emissions by approxi­
mately 2050. Vietnam also announced in December
2022 a JETP that aims to mobilise $15.5 billion of public
and private finance to support its ambitious Net Zero
2050 goal.
India and Senegal are currently negotiating to establish
similar JETPs with donor governments in the develop­
ment world.
Sources: ODI (2022), IEA (2022)
■ 81
The transport sector, notably automobiles, is also an area requirements and fuel taxes to land use regulations (see
with ample sector-specific regulation targeted at emissions Table 4.1 for selected sector-specific examples).
reductions. Both the United States and the European Union,
alongside other jurisdictions, have fuel efficiency standards 4.2.4 Subnational Climate Policies (Cities,
for cars; the EU also has CO2 emissions standards both for Regions)
individual cars and for automobile manufacturers at the fleet
Although a good portion of climate policy is conducted at
level. In the automotive space, electric vehicles (EVs), which
the national level, an increasing portion is implemented at
are far less emissions-intensive (and produce no tailpipe
the subnational level as well, such as in states, regions, and
emissions), are in a similar position to renewable energy
cities. In some cases, this is a product of state or regional
in the early to mid-2000s, in that it is a superior technol-
political systems where entities have the latitude to make
ogy environmentally but still slightly more expensive. Thus,
more ambitious policy than the federal government. In
analogous to feed-in tariffs, which are meant to subsidize
Japan, for instance, despite the lack of a national cap­
and promote the expansion of renewable power genera­
and-trade system, the Tokyo metropolitan area emissions­
tion capacity, a number of countries have implemented EV
trading scheme has been running since 2010. Similarly, in
purchase subsidies to encourage uptake of electric vehicles.
the United States, the Regional Greenhouse Gas Initiative,
Many other policies across many other sectors also contrib­ running since 2009, covers all large power plants across
ute to emissions reduction, from home energy-efficiency 12 American states that produce more than 25 MWh of

SELECTED Economy-Wide and SECTOR-SPECIFIC EMISSIONS REDUCTIONS POLICIES

Policy Sector Description
Carbon tax Cross-sectoral A tax per ton of CO2 emitted disincentivizes emissions and
collects tax revenue that can be used for further climate measures.

Emissions-trading Cross-sectoral An emissions-trading scheme reduces emissions but allows

scheme sectors to trade with each other, so emissions are reduced where
it is easiest and cheapest to do so.

Renewable portfolio Power generation A requirement of a specific proportion of electricity generation

standard coming from renewable sources

Automobile fuel Transport A requirement that individual cars, or fleets, must satisfy a
efficiency requirements minimum standard of fuel efficiency to be legally allowed

Fuel tax Transport, heating A fuel tax can lower the demand for fuel or be used to
disincentivize the use of dirtier fuels.

Building heating / Buildings Building requirements can be used to forbid the use of
energy-efficiency carbonemitting heating technologies (e.g., natural gas furnaces,
requirements oil heating) in new buildings in favor of renewable alternatives.

Ban on burning peat Agriculture and land use Generally, peat bogs and wetlands are a huge store of carbon.
bogs / wetlands Some peat bogs have historically been periodically burnt for land
management purposes, but banning burning (as in the UK) will
reduce emissions.

Green I low-carbon Transport, buildings, other Governments can use their purchasing power to opt for green
public procurement and sustainable alternatives (e.g., for public-sector buildings,
public transport, etc.), helping to spur more general uptake and
develop technologies.

82 ■ Sustainability and Climate Risk Exam

electricity. Another example is India's electricity sector,
where local initiatives, such as state-specific energy effi­
ciency measures, have driven the country's energy effi­
ciency efforts and contributed to significant energy savings.
Specific measures include Andhra Pradesh's State Energy
Conservation Mission, which has contributed significantly to
India's energy savings, with the Perform, Achieve and Trade
(PAT) scheme.
Some subnational efforts function more as networks and
advocacy efforts. C40, a global coalition of cities dedicated
to combating climate change, founded by 18 cities in 2005
and now with 97 members, is a transnational example, and
helped contribute to international pressure to bring about
the Paris Agreement. In the wake of the decision in 2017 by
President Donald Trump's administration to withdraw the
United States from the Paris Agreement, an organization
called America's Pledge was launched by entities still com­
mitted to Paris. By 2020, this comprised 25 state governors,
over 500 cities and counties, 350 institutions of higher
education, 30 healthcare systems, and close to 2,300 cor­
porations and investment firms. The US rejoined the Paris
Agreement in February 2021, but America's Pledge contin­
ues to be a prominent example of the increasing collabora­
tion between the public and private sector in these kinds of
coalitions (see also Section 4.5 on private sector coalitions).
No matter the exact format of non-state and sub-
national actor (NSA) climate commitments, these types of
commitments are, in aggregate, becoming more and more
impactful. One recent comprehensive assessment examined
nearly 80 regions, 6,000 cities, and 1,600 companies across
ten large, high-emissions economies. It found that full imple­
mentation of NSA commitments would lower emissions by
3.8-5.5% more by 2030 than national pledges in those ten
countries would do alone (Kuramochi et al., 2020).
4.2.5 GHG Emissions Accounting at the
Corporate Level
Greenhouse gas (GHG) emission accounting at the cor­
porate level is increasingly standardized, in particularly
through the Corporate Accounting and Reporting Standard
(the "Corporate Standard") from the GHG Protocol.
The GHG Protocol was established by the World Resources
Institute (WRI) and the World Business Council for
Chapter 4 Sustainability and Climate Policy, Culture, and Governance
Sustainable Development (WBCSD) over 20 years ago as
demand for an international standard for corporate GHG
accounting and reporting emerged in the late 1990s. The
first edition of the Corporate Standard, published in 2001,
has been regularly updated with additional guidance to
clarify how companies can measure emissions from electric­
ity and other energy purchases, and how they can account
for emissions from across their value chains. The GHG Pro­
tocol also has other standards and sub-protocols, including
the following:
• The Project Protocol-for quantifying the GHG emissions
reduction benefits of climate change mitigation projects.
• The Corporate Value Chain (Scope 3) Standard-for
companies to assess their entire value chain emissions
impact and identify where to focus reduction activities.
• The Product Standard-used to understand the full life
cycle emissions of a product and focus efforts on the
greatest GHG emissions reduction opportunities.
• The Policy and Action Standard-a standardized
approach for estimating the GHG effect of policies and
actions.
• The Mitigation Goal Standard-guidance for designing
national and subnational mitigation goals and a stan­
dardized approach for assessing and reporting progress
toward goal achievement.
According to the GHG Protocol, 92% of Fortune 500 com­
panies responding to the CDP used the GHG Protocol
directly or indirectly and it is the world's most widely used
GHG emissions accounting standard. The Corporate Stan­
dard and other GHG Protocol standards are integrated
into and referenced in GHG reporting guidance prepared
by different jurisdictions, including guidance produced
by EU, US, and UK regulatory agencies, and international
organizations.
At the heart of the GHG Protocol Corporate Standard is the
concept of direct and indirect emissions, as well as Scope 1,
2 and 3 emissions:
• Direct emissions are emissions from sources that are
owned or controlled by the reporting company.
• Indirect emissions are emissions that are a consequence
of the activities of the reporting company, but occur at
sources owned or controlled by another company.
■ 83
 Scope 2 Scope 1
INDIRECT DIRECT

Scope 3
INDIRECT

purchased
goods and
transportation
services •
and distribution
� purchased electricity, steam,
heating & cooling for own use
leased assets
� company
facilities
capital
goods '

RI
p rocessing of
'l"'I'
employee
fuel and commuting sold products

II
::,{'
energy related
activities
business
travel company leased assets
use of sold
transportation vehicles
products
and distribution waste end-of-life
generated in treatment of
operations sold products

Upstream activities Reporting company Downstream activities

blfiiii¥i•
Emissions are further divided into three scopes:
• Scope 1 emissions are direct emissions from owned or
controlled sources.
• Scope 2 emissions are indirect emissions from the
generation of purchased energy.
• Scope 3 emissions are all indirect emissions (not included
in Scope 2) that occur in the value chain of the reporting
company, including both upstream and downstream
emissions.
Direct emissions are included in Scope 1. Indirect emissions
are included in Scope 2 and Scope 3. While a company
has control over its direct emissions, it has influence over
its indirect emissions. Figure 4.3 above shows the different
Scopes and the relationship between them.
For many companies, particularly those facing climate risks
that could result in stranded assets, Scope 3 emissions from
the products and services they sell are by far the largest
part of overall emissions, and thus the most vulnerable to
potential climate transition risks. For example, the emissions
embedded in the oil sold by an oil and gas company will
typically be a much larger share of overall company emis­
sions than the emissions from the company's operations.
Similarly, the emissions financed through loans to pollut-
ing companies will likely be a much larger share of overall
emissions for a bank than the emissions resulting from the
operation of its offices or data centers.
Companies are under increasing pressure to announce
and implement net-zero targets encompassing emis­
sions across all three scopes. But of over 4,000 corporate

84 ■ Sustainability and Climate Risk Exam

net-zero targets analyzed at the end of 2021, only 32% of (© Lombard Odier, https://www.lombardodier.com/
corporate net-zero targets covered the entirety of Scope 3 contents/corporate-news/ responsible-capital/2021/august/
emissions-and 25% of targets only partially cover Scope 3. calculating-a-companyscarbon-fo.html).

Combined, a company's Scope 1, Scope 2, and Scope 3

emissions represent the total GHG emissions of the com­ 4.3 Climate Risk and Financial Policy
pany. But when examining the emissions associated with
In this section, we will examine the critical role of policy and
a portfolio of companies there is the potential for double
regulation in addressing climate-related risks and oppor­
counting. The GHG Protocol provides the following exam­
tunities within the private sector, focusing on investment
ple to illustrate this: The Scope 1 emissions of a power
policies, financial supervision, and regulation. As climate
generator are the Scope 2 emissions of an electrical appli­
change has evolved from a peripheral concern to a central
ance user, which are in turn the Scope 3 emissions of both
consideration for corporations and financial institutions,
the appliance manufacturer and the appliance retailer. To
it is essential to understand how policies and regulations
address this potential double counting, the GHG Protocol
maintain stability, correct market inefficiencies, and man­
Corporate Standard defines Scope 1 and Scope 2 to ensure
age externalities in the context of climate finance. This
that two or more companies do not account for the same
comprehensive guide will explore sustainability and climate
emissions within the same scope, and by properly account­
investment policies, public policy initiatives to promote the
ing for emissions as Scope 1, Scope 2, and Scope 3, compa­
adoption of green finance, and the development of green
nies can avoid double counting within Scope 1 and Scope
taxonomies and financial regulation. By emphasizing the
2. Unfortunately, it is much harder to address double count­
importance of policy and regulation in fostering a resilient
ing for Scope 3, as many companies have some degree of
and sustainable financial system, this section navigates the
influence over Scope 3 emissions and reductions. Because
complex landscape of climate risk and financial policy.
of this type of double counting, the GHG Protocol recom­
mends that Scope 3 emissions should not be aggregated.
4.3. 1 Sustainability and Climate Investment
However, due to significant interest in understanding the Policies
GHG emissions associated with financial portfolios and
International financial institutions (IFls) were some of
loan books, Scope 3 emissions from portfolio companies
the earliest to formulate investment policies with regards
are often aggregated to compare the carbon intensity of
to sustainability and ESG risks more broadly, and to cli­
portfolios. This is an issue that financial institutions and data
mate risk specifically. Multilateral development banks
providers are grappling with. For example, MSCI uses "de­
(MDBs), including global ones such as the International
duplication multipliers" to address double counting: T hey
Bank for Reconstruction and Development (IBRD, com­
estimate the amount of would-be duplicated emissions
monly known as the World Bank), and regional ones, such
across a portfolio, and adjust for it. When MSCI looks at the
as the African Development Bank (AfDB), the Asian Devel­
12,000 companies in its master climate risk dataset, it cal­
opment Bank (ADB), the European Investment Bank (EIB),
culates a de-duplication multiplier of approximately 0.205,
and the Inter-American Development Bank (IADB), are
which when applied, produces an estimate closer to the
tasked with supporting public-sector investment in physical
actual carbon footprint (https://www.msci.com/www/blog­
and human capital projects conducive to socioeconomic
posts/ scope-3-carbon-emissions-seeing/020923727 61).
development. In addition, MDBs and other Development
In contrast, some investors, such as Lombard Odier Invest­ Financial Institutions (DFls) are also tasked with support­
ment Managers, argue that a degree of Scope 3 double­ ing the development of the private sector. For example,
counting is in fact desirable: " ...we do not believe that the International Finance Corporation (IFC) is a member
double-counting is necessarily undesirable, from an inves­ of the World Bank Group, and bilateral European DFls are
tor's perspective. Carbon exposure reverberates through part of the European Development Finance Institutions
the supply chain and affects each company equally, even (EDFI) association. Because these institutions were cre­
when the responsibility for these emissions may be shared" ated with a double bottom line mission (that is, designed

Chapter 4 Sustainability and Climate Policy, Culture, and Governance ■ 85

to be financially selfsufficient but with a mandate to sup­
port socioeconomic development, as opposed to simply
maximize profits), they became some of the earliest orga­
nizations to devise explicit sustainability, ESG, and climate
investment policies.
Long before Mark Carney, the governor of the Bank of
England, helped popularize the types of climate risk to a
broader financial audience in 2015, institutions like the IFC
were writing detailed reports about climate risk. For exam­
ple, back in 2007, the EIB issued the world's first "Climate
awareness bond" dedicated to climate-related issues, which
helped launch the global market in green bonds (see Chap­
ter 5). And, as early as 2010, IFC was discussing filling the
financing gap on climate change, boasting about its USD 1
billion in investments in climate-related projects in 2009 and
its ability to leverage greater funding through attracting
private co-financing. Similarly, a 2011 IFC report examined
in detail the effects of climate on traditional risk categories,
such as credit risk, strategy risk, operational risk, and legal
risk, covering both physical and transition risk examples
(though not yet using that terminology) (IFC, 2011 ). More
recently, starting in 2019, IFC has partnered with the private
sector to develop the Operating Principles for Impact Man­
agement (OPIM), which draw on emerging best practices
to assess the impact of management systems of funds and
institutions, including their impact on environmental and
climate-related aspects.
And, in a signal of the increasing momentum behind sus­
tainability and climate investment policies, private finan-
cial institutions are replicating parts of the multilateral
and bilateral DFI model. For example, the USD100 billion
J.P. Morgan Development Financial Institution was launched
in 2020 to spur additional capital toward financing the
UN Sustainable Development Goals (SDGs) in emerging
economies.
DFls, private financial institutions, and governments have
the opportunity to collaborate and mobilize climate finance.
Debt-for-climate swaps represent one potential approach,
where creditor countries or organizations forgive or reduce
the debt of developing countries in return for commit­
ments to lower greenhouse gas emissions and adapt to
climate impacts. By facilitating the deployment of funds
towards climate-friendly initiatives and building interna­
tional partnerships, these swaps can serve as a crucial tool
86 ■ Sustainability and Climate Risk Exam
in addressing both climate change and debt. An example
from 2021 includes the Italian government's $30 million
debt-for-nature swap with the Democratic Republic of
Congo, which supports REDD+ programs to combat defor­
estation and promote sustainable land use practices while
providing debt relief.
Finally, there are innovative insurance policies and proj­
ects, such as the Global Shield for climate risks, which be
an important building block of climate investment poli-
cies. Global Shield is a climate risk insurance program that
was announced jointly by the Vulnerable Twenty (V20) and
Group of Seven (G7) member states at COP27. The aim
of the initiative to provide financial protection against the
increasing risks of losses and damages from climate change,
particularly amongst poor and vulnerable peoples. The
instrument aims to both incentivize adaptation measures
and improve preparedness for climate disasters, and pro­
vide swift financial protection when climate damages do
occur. Initiatives such as this can help address a range of
risks, including climate risks, and build resilience against the
impacts of climate change.
DFls and private financial institutions can play a key role in
developing and scaling up these insurance products, pro­
viding the necessary financial and technical resources to cre­
ate market incentives and encourage investment in climate
risk and pandemic insurance programs. For example, DFls
can provide financing and technical assistance for paramet­
ric insurance programs that protect against weather-related
risks, while private financial institutions can help develop
insurance products that cover infrastructure damage caused
by climate change.
4.3.2 Public Policy to Promote Adoption of
Green Finance
Another strand of public policy relating to finance is that
which assumes the role of promoting the presence and
activity of the private financial sector. In recent years, as cli­
mate change has become a more prominent issue, financial
sector promotion and policymaking around financial centers
have started to incorporate green elements.
Much of this work has involved setting up various
sorts of green finance "hubs" or taskforces, in some
cases with dedicated institutions. In Japan, the Japan
Financial Services Agency and two Japanese ministries
 CASE STUDY: SOVEREIGN SUSTAINABILITY-LINKED BOND S
Sovereign sustainability-linked bonds (SLBs) are a novel
debt instrument issued by governments for financing
their deficits or refinancing existing debt. Uniquely,
these bonds are linked to the sustainability targets of
the issuing government, with the bond's interest rate
directly tied to the government's progress in meeting its
sustainability goals. The sustainability target reflects the
government's commitment to environmental, social, and
governance (ESG). Failure to achieve these goals results
in an increased interest rate, thus making it expensive for
the government to borrow. SLBs are a recent addition to
the financial market and have only been issued by a few
governments to date.
Uruguay published a framework for a sovereign sustain­
ability-linked bond with innovative coupon structures
have set up the TCFD Consortium of Japan to facili­
tate dialogue between investors and companies on
climate risk disclosure. In Hong Kong, the territory's
financial regulator and quasi-central bank, the Hong
Kong Monetary Authority, has launched the Centre
for Green Finance to spread best practices and help
to green Hong Kong's financial services industry. In
Singapore, through its Green Finance Action Plan, the
Monetary Authority of Singapore has proposed guide­
lines on environmental risk management for banks,
asset managers, and insurers. In 2019, the UK set up a
Green Finance Institute, backed by the government but
staffed by bankers, to convene and lead sectoral coali­
tions of experts to broaden and promote the growth of
a green finance ecosystem. Luxembourg has a body with
a similar mission, the Luxembourg Sustainable Finance
Initiative.
Some of these networks are themselves transnational.
Financial Centres for Sustainability (FC4S), founded in 2017,
is a network to promote sustainability among 30 financial
centers, with public entities promoting their respective cit­
ies serving as the FC4S members.
The FC4S has a permanent secretariat, which provides
research on emerging issues, guidance on best practices,
and project development and support services to its
members.
Chapter 4 Sustainability and Climate Policy, Culture, and Governance
and nature targets in September 2022. The bond's inter­
est rate is tied to Uruguay's performance in meeting
two key performance indicators: reducing greenhouse
gas intensity and preserving the native forest area. The
coupon will step up or down based on whether Uruguay
meets its targets, with equal-sized coupon step-up and
step-down provisions. The bond is significant as it intro­
duces nature preservation and restoration targets, a first
for sovereign SLBs. Sustainalytics rated both metrics
as strong, with the native forest increase target being
judged as highly ambitious. Uruguay's SLB is the sec­
ond after Chile's issuance in March 2022, which focused
on reducing greenhouse gas emissions and increasing
renewable energy sources.
Sources: BIS (2022) and Sustainalytics (2022)
4.3.3 Green Taxonomies and Financial
Regulation
Another strand of emerging public policy and regulatory
responses to climate change and environmental challenges
is green taxonomies.
Until recently, policymakers and regulators had not felt
the need to create lists of economic activities considered
"green." Such green lists or "taxonomies" are now being
created in a number of jurisdictions, including ASEAN,
Canada, China, the EU, Malaysia, and the UK.
The furthest along in this regard is the European Union.
The EU Taxonomy, first published in draft format in March
2020, sets performance thresholds (referred to as "techni­
cal screening criteria") for economic activities, by sector
and subsector. To c ount as "sustainable," activities must (a)
make a substantive contribution to one of six environmental
objectives, (b) do no significant harm to the other five, and
(c) meet minimum safeguards (e.g., the OECD Guidelines
on Multinational Enterprises and the UN Guiding Principles
on Business and Human Rights).
Green taxonomies are intended to inform policy, regulatory,
and market decisions. For example, they are often accom­
panied by requirements to disclose the quantity of green
economic activities in investment products. This can then
result in green labels for such products to help guide retail
■ 87
investors. Green taxonomies are also being used to guide
fiscal policy by helping to determine, for example, in what
categories the EU's €750bn COVID-19 recovery fund can
be spent on. Over time, green taxonomies may play a key
role in determining what companies can access green subsi­
dies or incentives from governments, and possibly what tax
or other incentives investors could receive based on their
investments in green companies and assets.
Proponents argue that green taxonomies facilitate com­
parability across investments, and that they reduce the
burden associated with determining whether an invest­
ment is green. Also, green taxonomies can help to tackle
greenwashing by making it clearer what is green and what
green holdings exist in investment products. To this effect,
do-no-significant-harm provisions, including in the EU tax­
onomy, are meant to ensure that green activities make a
positive contribution to environmental outcomes and do
not harm other environmental and social objectives in the
process. And, because green taxonomies are intended to
be common frameworks for determining which activities
can be defined as environmentally sustainable, in theory this
could help to improve our understanding of the impact of
company activities on the environment, thereby helping to
green portfolios and loan books. However, while this feels
intuitively appealing, it is in fact extremely challenging to
assess every type of economic activity, determine whether
it is green or not, and then apply that consistently to every
company (see Caldecott 2019).
Potential drawbacks arising from the use of green taxono­
mies include the following:
• Binary "green" assessment. In some contexts, there
may be "shades of green," for example depending on
local and national contexts, as well as on the timing of
the assessment. For taxonomy purposes, a green port­
folio where green is "deep green" may be indistinguish­
able from a green portfolio where green is "light green."
• Lobbying. The administrative process required to
develop a green taxonomy may be open to lobbying
and political influence. For example, following lobbying
by some EU member countries and industry associa­
tions, the new technical rules on green finance issued by
the European Commission in December 2021 classified
certain natural gas power plants as green investments,
88 ■ Sustainability and Climate Risk Exam
potentially undermining the credibility of the EU green
taxonomy.
• Asset bubbles. Over time, a green taxonomy could arti­
ficially inflate the value of assets labeled green, poten­
tially creating financial stability risks.
• Sub-optimal targeting. Incentives based on a green
taxonomy could benefit not only investors in new green
assets but also owners of green assets already created,
which were already considered to be profitable at the
time of investment.
• Decreased quality. Green taxonomies might lead to a
situation where institutions focus primarily on obtain-
ing the label, rather than thoroughly evaluating the
underlying economic activities and cash flows associated
with the investment. This could result in a superficial
approach to sustainable investing, with the label taking
precedence over genuine assessment and due diligence.
In view of this potential drawbacks, green taxonomies may
end up being used for public policy and related fiscal deci­
sions, such as how to allocate subsidies, but may not play
a central role in efforts to tackle greenwashing in financial
markets. Also, there are nascent efforts underway to create
brown or transition taxonomies, which might be easier to
design and implement.
Transition taxonomies categorize all economic activities
based on their level of alignment with climate goals, recog­
nizing "brown" activities that contribute to climate change,
"green" activities that facilitate the transition to a low­
carbon economy, and "transition" activities that possess
the potential to become greener by embracing low-carbon
technologies and practices (NGFS, 2022). Investors and
policymakers utilize both green and transition taxonomies
to identify green activities and incorporate environmental,
social, and governance (ESG) factors into their invest-
ment decisions. The critical difference between the two
frameworks is that green taxonomies focus solely on green
activities, while transition taxonomies evaluate all activities
based on their contribution to the transition to a sustainable
economy. The European Union and Singapore GFIT taxono­
mies also acknowledge transitional activities, which should
outperform others in their industry, not hinder the develop­
ment of alternatives, and not perpetuate existing practices.
For both green and transition taxonomies, establishing
industry thresholds to distinguish better performers from
those with less potential to reduce emissions is crucial.
Finally, although there are efforts underway to create a
universal green taxonomy across multiple jurisdictions,
including the Common Ground Taxonomy between the
EU and China, this is likely a long way off. A report com­
missioned to explore ways for merging green taxonomies
in the EU and China found significant structural differ­
ences, and given that deciding what is green inevitably
is a political decision, different countries are likely to
have different views. However, the more modest goal of
enabling comparability across different taxonomies, espe­
cially in relation to how thresholds are set, is likely to be
easier to achieve.
4.4 Climate Risk and Financial
Supervision
While investment policies are important, perhaps the most
significant way in which climate risk has become embedded
in financial policy is in its role in supervision and oversight,
especially by central banks tasked with overseeing the sta­
bility of both individual institutions and the financial system
as a whole.
4.4. 1 Climate Integration into Central Bank-led
Supervision
In just five years, from 2015 to 2020, central banks largely
incorporated climate change into their supervision prac­
tices. In this, they followed the lead of the Bank of England
(BoE), the UK central bank and financial regulator, which
in 2014 was widely recognized as the first central bank to
begin working on these issues.
An important subsequent initiative bringing together
central banks and regulators to work on climate integra­
tion, and helping to spread best practices, has been the
Network for Greening the Financial System (NGFS). It
promotes collaboration and the sharing of expertise on
climate risk among supervisory institutions. It was founded
by three European central banks-those of the UK, France,
and the Netherlands-but the network now counts over
120 members from all continents.
Chapter 4 Sustainability and Climate Policy, Culture, and Governance
Central banks and financial supervisors have moved to
integrate climate change both into microprudential
supervision, the oversight of specific financial institutions
(usually banks and insurers) for financial soundness, and
macroprudential supervision, which examines the stability
of the broader financial system (some have even moved to
incorporate climate issues into traditional monetary policy,
though this practice is still limited).
In regard to microprudential supervision, various central
banks and supervisors have amassed, and continue to build
up, internal capacity for climate risk integration. T he BoE is
a forerunner in this space, having laid out its expectations
regarding governance, risk management, scenario analysis,
and disclosure in 2019 (see Case Study). But similar super­
visory expectations have been laid out by the European
Central Bank (European Central Bank, 2020), the Monetary
Authority of Singapore (Monetary Authority of Singapore,
2020), and the Australian Prudential Regulation Authority
(Australian Prudential Regulation Authority, 2020), among
others.
General trends on climate integration in regard to gov­
ernance and risk management cut across jurisdictions. In
governance, the supervisory expectation is that financial
institutions have structures in place to ensure climate risks
are actively managed at the highest level by senior manag­
ers and boards of directors. In risk management, firms are
often asked to use some combination of scenario analysis
and stress testing. In disclosure, the recommendations of
the TCFD are increasingly seen as best practice by regula­
tors and policymakers. In the UK and New Zealand, TCFD­
aligned reporting has been made mandatory, and other
counties are likely to follow suit. In relation to sustainability
and climate-related risks, regulators have indicated their
intention to incorporate the forthcoming ISSB standards
into their mandatory disclosure frameworks (refer to Chap­
ter 2 for more details).
Where the potential impacts of climate risks are assessed
to be material, supervisors may then expect or require firms
to demonstrate how they will mitigate these risks. In gen­
eral, climate-related prudential policies do differ somewhat
across countries, due to the different mandate scope of
relevant institutions and systematic differences in the use of
■ 89
 CASE STUDY: BANK OF ENGLAND
The Bank of England (BoE), the UK central bank and
financial regulator, now integrates climate-related risk in
all three of its main policy responsibilities- micropru-
dential policy, macroprudential policy, and monetary
policy, which are described in this case study.
Background of Climate Integration
The BoE's shift toward climate started with a 2015
speech called "Tragedy of the Horizon," by its then­
governor Mark Carney. The speech recognized and laid
out how climate change affects financial stability. Carney
argued that while most climate damage is expected far
enough in the future to be beyond typical investment
horizons, escaping financial scrutiny, climate change
would eventually cause systemic risks to the whole finan­
cial sector (hence the "tragedy" of the horizon). He spe­
cifically discussed physical, transition, and litigation risk.
Once it was accepted that climate change could cause
material risks to the financial system and that it therefore
belonged within the Bank's supervisory scope, it started
to be incorporated into the Bank's expectations and pro­
cesses. Some time later, in March 2021, the mandate of
the Bank was explicitly modified by the UK government
to include environmental goals: specifically, that the Bank
should support the greening of the country's economy
and help the country reach net-zero emissions by 2050.
Microprudential Measures
The BoE has expectations regarding, and monitors firms'
progress on, adopting a strategic approach to climate
change, which was first laid out in early 2019. While
allowing for some flexibility in line with the UK tradition
of principles-based regulation, there are four key pillars
to the BoE requirements: governance, risk management,
scenario analysis, and disclosure.
Regarding governance, the BoE requires firms to
allocate responsibility for climate-related risks to a
designated executive under UK rules that allow senior
prudential tools. However, bodies like the NGFS are helping
to spread best practices.
Stress tests are another micro- and macroprudential
tool at the disposal of central banks. Such tests, which
model the reaction of an individual financial institution
or the whole financial system to a hypothetical shock,
90 ■ Sustainability and Climate Risk Exam
executives to be held responsible. It also expects
boards to be involved in assessing climate risk. On
risk management, the BoE requires banks and insur­
ers, under their own capital adequacy and solvency
assessments, to include "all material exposures" relat­
ing to the financial risks from climate change. As for
scenario analysis, the Bank expects firms to conduct
it to "inform ... strategic planning". Finally, on disclo­
sure, the Bank expects firms to consider implement­
ing disclosures on climate risk beyond mandatory
requirements, suggesting TCFD recommendations as a
guideline.
Macroprudential Measures
For macroprudential policy, which looks at system-wide
risks, stress tests have become one of the most important
regulatory tools since the Global Financial Crisis of 2008.
From 2021, the Bank is launching a dedicated climate
risk stress test, the Biennial Exploratory Scenario (BES).
The BES will be based on scenario analysis (see Ch 7
for more details on scenarios) and make use of an early
policy action scenario, a late policy action scenario, and a
no additional policy scenario. The BES also specifies the
variables to be used, and the ways and details in which
participating institutions are expected to conduct model­
ing. The BES follows on from a first successful stress test
incorporating climate considerations, namely the BoE's
insurance stress test in 2019.
Monetary Measures
Climate has so far been less integrated into monetary
policy than into other areas of the Bank's operations. The
Bank has previously reported on the climate risk expo­
sures of the assets it owns for monetary policy purposes
(e.g., the corporate bond portfolio used for quantitative
easing). With the new mandate, the Bank is expected to
adjust how it purchases corporate bonds.
Sources: Bank of England 2015; Bank of England 2019;
PRA 2019; FT 2021
were already widely adopted by regulators in the wake
of the Global financial crisis of 2008, and they are now
being adapted to examine the potential impact of cli­
mate change. The Dutch, French, and UK central banks,
as well as the European Central Bank, are all currently
developing climate stress tests with differing degrees of
granularity, distinct climate and policy scenarios, time
horizons, and feedback loops.
Other macroprudential measures have also been proposed,
if not yet widely adopted. One is the idea of a carbon
countercyclical capital buffer, a capital requirement that
would require banks to build up a higher equity capital base
during periods of carbon-intensive credit. Another is large
exposure limits that would limit banks' (over)exposure to
carbon-intensive assets that are considered to be at high
risk of stranding. Some central banks, while not yet adopt­
ing large exposure limits as a requirement for supervised
financial institutions, have done so for the management
of their own portfolio (for example, Sweden's Riksbank's
exclusion of sub-sovereign issuers with a "large climate
footprint" from its capital management, such as the bonds
of the Canadian province of Alberta, which produces very
emissions-intensive crude oil derived from tar sands).
4.4.2 Policy Enforcement of Sustainable
Investment and Disclosure
Another type of policy enforcement of sustainability has
to do not with financial stability, but it derives from the
regulatory tradition of consumer protection, specifically
combating mis-selling or misleadingly advertising products
to consumers.
One way in which this is implemented is through audits to
determine if funds or products marketing themselves as
sustainable are in fact living up to their promise. The Finan­
cial Conduct Authority (FCA), the UK financial regulator
for conduct and financial consumer protection, found in a
2019 review in that the sustainable label was applied to a
"very wide range" of financial products, some of which did
not appear to have "materially different exposures" when
compared to products not marketed as sustainable. This
raised the specter of greenwashing, that is, marketing that
portrays products or activities as producing positive envi­
ronmental outcomes, when this is not actually the case.
A further step, beyond checks, is to have mandatory dis­
closure or marketing requirements. The European Union's
securities regulator conducted a consultation in 2020
about the appropriate marketing of sustainable funds,
with a view to drawing up guidelines and rules. The FCA,
too, has developed a set of principles intended for fund
Chapter 4 Sustainability and Climate Policy, Culture, and Governance
management firms to better realize and implement existing
requirements that disclosures must be "fair, clear, and not
misleading."
4.5 Private-Sector Sustainability and
Climate Risk Frameworks
Regarding climate change, a particularly important role has
been played by corporate and investor groupings, which
have helped spread best practices. In this regard, the trend
has been very similar to what occurred with broader sustain­
ability groupings and frameworks such as the UN Global
Compact or the Principles for Responsible Investment,
covered in Chapter 2. One of the key early groupings in
this space was the Institutional Investors Group on Climate
Change (IIGCC), which was launched in 2001 and now
encompasses over 300 members (mostly pension funds and
asset managers) in 22 countries and represents over USD
40 trillion in assets under management.
With private-sector-led frameworks, there has generally
been a trend toward greater size. This manifests not only
in groups themselves gaining members and becoming
larger, but also in ever larger groups of groups and umbrella
initiatives. The Investor Agenda, for example, consists of
the IIGCC and six other groups working with investors.
The IIGCC also helped to co-found Climate Action 100+,
an investor coalition with 575 members that represents
over USD 54 trillion in assets under management target-
ing the world's 100 most heavily emitting publicly listed
companies, with the goal of pressuring them to reduce
emissions and conform to climate targets. Climate Action
100+ has managed to push for substantial change in quite
a short amount of time, including getting Glencore, a com­
modities and mining firm, to agree to cap coal production,
and Shell pie., an oil & gas firm, to link executive compen­
sation to environmental targets. Other important group­
ings include the Net Zero Asset Owners' Alliance, and its
counterpart for asset managers (see Table 4.2 for more
examples).
In some cases (as alluded to in Section 4.2.4) there has been
an increasing trend toward combining public and private
efforts. The Chilean and UK high-level climate champions
founded the Race to Net Zero in 2020. Similar to America's
■ 91
Pledge but on a global scale, the effort is meant to bring risks are potentially more significantly mispriced and
together businesses and investors, but also cities and mismeasured than climate-related risks, due to a relative
regions, to accelerate the economic transition and help lack of awareness.
reach Paris Agreement goals. In regard to the financial sector
According to the World Economic Forum, more than half
specifically, many of the net-zero and Paris-aligned financial
the world's economic output-US$ 44tn of economic
groupings were consolidated under the Glasgow Financial
value generation-is moderately or highly dependent on
Alliance for Net Zero in advance of COP26 in November
nature (https://www.weforum.org/press/2020/01 /half-of­
2021, with the idea that a coalition spanning the entire finan­
world-sgdp-moderately-or-highly-dependent-on-nature­
cial system could better help bring broad-reaching change.
says-newreport/). Construction ($4 trillion), agriculture
The Alliance brings together 160 financial firms representing
($2.5 trillion) and food and beverages ($1.4 trillion) are the
assets of more than USD 70 trillion, all of whom must use
three sectors most dependent on nature. Sectors highly
science-based guidelines to reach net-zero emissions cover­
dependent on nature generate 15% of global GDP ($13
ing Scopes 1, 2, and 3, and agree to stringent 2030 criteria.
trillion), while moderately dependent sectors generate 37%
In October 2022, GFANZ adjusted its requirements, no lon­
($31 trillion). These sectors rely on the direct extraction of
ger mandating that all members join the Race to Zero, but
resources from forests and oceans or on the provision of
rather encouraging them to partner with the initiative. This
ecosystem services, such as healthy soils, clean water, pol­
change followed the Race to Zero's strengthened criteria in
lination, and a stable climate. As nature loses its capacity to
June 2022, which emphasized phasing out unabated fossil
provide such services, these sectors could be significantly
fuels as part of a global transition. The shift away from the
disrupted, creating stranded assets and their implications.
Race to Zero was prompted by pressure from US banks,
which faced threats, including potential legal actions, from This has been recognized by the Central Banks and Supervi­

climate denialist politicians and public figures. sors Network for Greening the Financial System (NGFS). Its
first comprehensive report, published in April 2019, stated
that "there are compelling reasons why the NGFS should also
4.6 Nature, Biodiversity, and Climate look at environmental risks [beyond climate change] relevant
Change to the financial system. For instance, environmental degrada­
tion could cascade to risks for financial institutions, as reduced
Climate risks are material and are already affecting asset
availability of fresh water or a lack of biodiversity could limit
values in different sectors and geographies, with implica­
the operations of businesses in a specific region. These could
tions for both individual companies and the global financial
turn into drivers of financial risks and affect financial institu­
system. To help address this, the Task Force on Climate­
tions' exposures to those businesses. Also, it is important to
related Financial Disclosures (TCFD) was launched at
be aware of potential greater impacts due to the combined
COP21 in Paris and charged with "developing voluntary,
effects of climate and environmental risks. Against this back­
consistent, climate-related financial risk disclosures for use
ground, the NGFS expects to dedicate more resources to the
by companies in providing information to investors, lenders,
analysis of environmental risks going forward."
insurers, and other stakeholders."
In April 2021, the NGFS launched a Study Group on "Biodi­
However, climate change is not the only significant, non­
versity and Financial Stability," and in June 2021, the Task­
linear, and potentially existential environmental risk facing
force on Nature-related Financial Disclosures (TNFD) was
companies and investment portfolios, and GHG emissions
formally established with widespread support from financial
are not the only environmental impact arising from invest­
institutions, corporates, governments and civil society,
ments. Habitat degradation and the resulting loss of natural
including endorsement from the G7 Finance Ministers and
capital are also material to a range of sectors and geogra­
G20 Sustainable Finance Roadmap.
phies, and they have the potential to create systemic chal­
lenges to global economic and financial systems, and to The TNFD framework will adopt the four-pillars of the
societies around the world. These broader nature-related TCFD: governance, strategy, risk management, metrics, and

92 ■ Sustainability and Climate Risk Exam

targets. This is to avoid repetition and maximize the poten­
tial for accelerated market adoption.
TNFD has released a three beta versions of the framework
by Winter 2022, after implementing a pilot testing and con­
sultation phase with market participants. The TNFD will not
create a new disclosure standard, but aims to "establish and
promote the adoption of an integrated risk management
and disclosure framework that aggregates the best tools
and materials."
The Intergovernmental Panel on Climate Change (IPCC) is
the UN scientific body that provides regular assessments
of the scientific basis of climate change, its impacts and
future risks, and options for adaptation and mitigation. In an
analogous way, the Intergovernmental Science-Policy Plat­
form on Biodiversity and Ecosystem Services (IPBES) is an
independent intergovernmental body that provides similar
assessments on biodiversity and nature to governments.
IPBES's last Global Assessment Report on Biodiversity and
Ecosystem Services was published in 2019 and was the first
in almost 15 years (since the release of the Millennium Eco­
system Assessment in 2005) to assess the status and trends
of the natural world, the social implications of these trends,
their direct and indirect causes, and what actions can still be
taken to stop biodiversity loss and habitat destruction. The
following conclusions can be made:
• Three-quarters of the land-based environment and about
two-thirds of the marine environment have been signifi­
cantly altered by human actions;
• More than a third of the world's land surface and nearly
three-quarters of freshwater resources are now devoted
to crop or livestock production.
• The value of agricultural crop production has increased
by about 300% since 1970, raw timber harvest has risen
by 45% and approximately 60 billion tons of renewable
and non-renewable resources are now extracted globally
every year-having nearly doubled since 1980.
• Land degradation has reduced the productivity of 23%
of the global land surface, up to US$577 billion in annual
global crops are at risk from pollinator loss and 100-300
million people are at increased risk of floods and hurri­
canes because of loss of coastal habitats and protection.
• In 2015, 33% of marine fish stocks were being harvested
at unsustainable levels; 60% were maximally sustainably
Chapter 4 Sustainability and Climate Policy, Culture, and Governance
fished, with just 7% harvested at levels lower than what
can be sustainably fished.
• Urban areas have more than doubled since 1992.
• Plastic pollution has increased tenfold since 1980.
300-400 million tons of heavy metals, solvents, toxic
sludge, and other wastes from industrial facilities are
dumped annually into the world's waters, and fertilizers
entering coastal ecosystems have produced more than
400 ocean "dead zones," totaling more than 245,000
km2 (591-595)-a combined area greater than that of
the United Kingdom.
• Negative trends in nature will continue to 2050 and
beyond in all of the policy scenarios explored in the
report, except those that include transformative change­
due to the projected impacts of increasing land-use
change, exploitation of organisms, and climate change,
although with significant differences between regions.
This scientific assessment, combined with the TNFD and
growing supervisory interest from members of the NGFS,
suggest that nature-related risks will be a growing practice
area within sustainability risk management. It is also an area
with strong mutually reinforcing connections to climate
change mitigation and adaptation. Increased concentrations
of GHG result in global warming, with significant impacts
on the stock of natural assets. Similarly, changes in biodi­
versity affect carbon, nitrogen, and water cycles, negatively
impacting the climate system. Biodiversity loss and habitat
destruction at unsustainable levels, as is currently the case,
undermines the capacity of planetary-scale cycles to limit
rising temperatures and makes humans less resilient to the
physical impacts of climate change. The recommendation
from a recent joint IPCC and IPBES workshop was clear:
Mankind needs to solve both the climate and nature crises,
or it will not solve either (https://ipbes.net/ sites/default/
files/2021-06/20210609 _workshop_report_ embargo_3pm_
CEST_ 10_june_0.pdf).
4. 7 Broader Societal Implications and
Conclusions
Reviewing policies formulated at international summits,
and at the national level by governments and regula­
tors, may make policy sound like a top-down affair. But
on the issue of climate change, corporate and financial
■ 93
norms have changed, as have societal and cultural
ones. Where previously politicians and policymakers
may have been wary of implementing strong climate
policies, now it is as often as not other stakeholders
that push them, or each other, to be more ambitious.
The mechanism of peer pressure, cleverly built as it
was into the Paris Agreement, also operates beyond its
direct scope.
In the corporate and financial space, remarkable examples
of this include Climate Action 100+ and the various net-zero
groupings of financial firms. Climate Action 100+ was a
private-sector, investor-led initiative to pressure the world's
most polluting publicly listed firms to do more on climate
change. Even though many of the jurisdictions in which
these firms (e.g., large oil & gas majors or steel manufactur­
ers) operate were not seriously restricting their emissions,

1fflntllfJ
CLIMATE GROUPINGS
General/Corporate Groupings
Name Members Description
TCFD Cross-sectoral A set of recommendations on disclosing climate-related risks
that has been endorsed by hundreds of firms, both financial
and non-financial

Science-Based Targets Cross-sectoral An organization with sector-based targets for decarbonization

Initiative

Financial Sector Groupings

Name Members Description

Institutional Investors
Group for Climate Change
(IIGCC)
Asset The organization aims to support and enable the investment
managers community in driving significant and real progress by 2030
and owners toward a net-zero and resilient future through capital allocation,
stewardship, and successful engagement with companies, poli-
cymakers, and fellow investors.

Climate Action 100+
Investors of all A coalition of 575 investors with over USO 54 trillion in assets
kinds under management that targets the world's hundred most
carbon emissions-intensive publicly listed companies, seeking
through collective shareholder engagement to pressure these
companies into alignment with climate goals

Net Zero Asset Owners Asset owners 37 investors who have committed to aligning their entire portfo-
Alliance lios with the goal of net-zero greenhouse gas emissions by 2050,
°
including full alignment with a 1.5 C scenario

Net Zero Asset Managers
Initiative
Asset managers Similar to, and founded on, the model of, the asset owner alli-
ance, this asset manager initiative is a group of asset managers
that support the goal of net-zero greenhouse gas emissions by
°
2050 and alignment with a 1.5 C scenario.

Net Zero Banking Alliance Global banks An initiative of global banks that have signed up to align with net-
°
zero greenhouse gas emissions by 2050 and a 1.5 C scenario,
with plans for stringent interim targets for 2030

Glasgow Financial Alliance All financial players GFANZ main goals are to increase net-zero commitments among
for Net Zero financial institutions and establish a forum to address sector-wide
challenges, ensuring high ambition meets credible action.

94 ■ Sustainability and Climate Risk Exam

the firms' investors stepped in to demand that they limit
emissions for reasons of corporate strategy, moral responsi­
bility, and long-term viability and profitability. Asset owners
and asset managers in the various net-zero groupings have
been able to position themselves as forerunners, placing
competitors who have not made such commitments on the
back foot. Even back-end, structural aspects of the financial
system, such as financial infrastructure, are starting to shift.
Many exchanges, for example, require sustainability and cli­
mate disclosures to list shares or bonds.
T hese changes are mirrored by changes in the broader soci­
ety. With the rise in popularity of Greta T hunberg, a young
Swedish climate activist, millions took to the streets in
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Australian Prudential Regulation Authority. (2020).Under­
standing and managing the financial risks of climate change.
Retrieved from https://www.apra.gov.au/sites/default/
files/2020-02/Understanding%20and%20managing%20
the%20financial%20risks%20of%20climate%20change.pdf
European Central Bank. (2020). Guide on climate-
related and environmental risks: Supervisory expec-
tations relating to risk management and disclosure.
Retrieved from https://www.bankingsupervision.europa.
eu/ legalframework/publiccons/pdf/climate-related_risks/
ssm.202005_draft_guide_on_climate-related_and_environ­
mental_risks.en.pdf
Hansel, M. C., Drupp, M. A., Johansson, D. J. A., Nesje, F.,
Azar, C., Freeman, M. C., ... Sterner, T. (2020). Climate eco­
nomics support for the UN climate targets. Nature Climate
Change, 10(8), 781-789. doi:10.1038/s41558-020-0833-x
High-Level Expert Group on Sustainable Finance.
(2020).Taxonomy: Final report of the Techni-
cal Expert Group on Sustainable Finance. Retrieved
from https:// ec.europa.eu/info/sites/info/files/
business_economy_euro/banking_and_finance/
Chapter 4 Sustainability and Climate Policy, Culture, and Governance
2019 to protest slow global progress on combating climate
change, and these protests significantly raised the profile
of climate change as a political issue. Extinction Rebellion,
a climate-focused civil disobedience movement in the UK,
sought to disrupt society to highlight the crucial impact of
climate change, and many of its targets were banks per­
ceived to not be moving quickly enough on climate change
or continuing to fund fossil fuels.
Going forward, it is likely that that the bottom-up popular,
societal, and consumer pressure, combined with lateral
pressure from some stakeholders (e.g., by large investors
on large corporations) will continue to spur ever tighter and
more ambitious policy frameworks.
documents/200309-sustainablefinance-teg-fi na I-report­
taxonomy_en.pdf
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pdf?MOD=AJPERES&CACHEID=ROOTWORKSPACE-a23f1
841-294d-4477-9fd7-9185625dc1fe-jqeAwCp
Kuramochi, T., Roelfsema, M., Hsu, A., Lui, S., Weinfurter,
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sais.2012.0033
■ 95
The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

QUESTIONS
4.1 What was the first international legally binding climate 4.5 What are examples of climate microprudential
accord to agree on specific emissions reductions? policies?

A. The Paris Agreement A. Carbon countercyclical capital buffer

B. The Rio Agenda B. Requirement to disclose climate risks

C. The Kyoto Protocol C. Requirement linking compensation with climate

goals
D. The Copenhagen Accord
D. Ensuring senior executives remove themselves
4.2 Which county is responsible for the greatest share of
from oversight of climate risks
cumulative emissions, and which is responsible for the
greatest proportion of current emissions? E. Economy-wide stress testing

A. The European Union for cumulative, the 4.6 Which of the following is a common climate-related
United States for current macroprudential policy?

B. The United States for cumulative, China for current A. Climate stress-test

C. China for cumulative, India for current B. Stranded asset quality review (SAOR)

D. The United States for both C. Requirement linking executive pay with climate
goals
4.3 What are the two carbon pricing policies that cover
the most sectors economy-wide? D. Mandatory firm-level climate metrics and targets

A. Feed-in tariffs and carbon taxes 4.7 What is greenwashing?

B. EV purchase subsidies and renewable portfolio A. An activity where environmental activists pour
standards green paint on symbols of pollution, such as power
plant smokestacks
C. Carbon taxes and cap-and-trade schemes
B. Illicit financial flows where money laundering is
D. Green public procurement and building heating
conducted under the pretense of investing in
standards
clean, sustainable technologies
4.4 What is a feed-in tariff?
C. Misrepresenting the degree to which a particular
A. A guaranteed price per unit of electricity, at which
asset or portfolio is exposed to climate-related
producers can sell for a fixed period of time
physical and transition risks
B. A long-term price for a natural gas contract, as
D. Marketing that portrays products or activities as
priced at a particular node in a pipeline network
producing positive environmental outcomes when
C. A tax imposed on newly produced cars with CO2 this is not actually the case
tailpipe emissions above a certain threshold

D. A tax levied on imports of animal feed

96 ■ Sustainability and Climate Risk Exam

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

ANSWERS
4.1 C 4.5 B
4.2 B 4.6 A

4.3 C 4.7 D
4.4 A

Chapter 4 Sustainability and Climate Policy, Culture, and Governance ■ 97

Green and
Sustainable
Finance: Markets
and Instruments

■ Learning Objectives
After reviewing this chapter, you should be able to:

• Understand the application of sustainable, green, and • Define and describe sustainability-linked bonds and
climate finance. loans.

• Identify trends and flows in sustainable, green, and • Explain the core components of the Sustainability­
climate finance. Linked Loan and Sustainability-Linked Bond Principles.

• Describe green, social, and sustainable bonds.
Explain the core components of the Green Bond
Principles.
• Explain green loans and their markets.
• Describe sustainable funds, green funds, and other
sustainable finance products.
• Understand the integration of ESG and climate issues
into investment and lending decisions.

99
 Understand how shareholders impact sustainability
strategy of a company.
Describe the existing and emerging approaches to
defining sustainable and green finance.
• Explain the trends in ESG disclosure requirements for
companies.
• Identify regulatory trends in sustainable and green
finance.
This chapter focuses on financial-market develop­
ments relating to sustainability issues and climate­
related risks and opportunities. The chapter begins
by explaining what constitutes "green" and "sustain­
able" finance and covers trends and investment flows.
It then includes a detailed examination of specific sus­
tainable and green finance instruments and products,
such as green bonds, green loans, and sustainability­
linked bonds and loans. The chapter considers the
integration of environmental, social, and governance
(ESG) issues into investing, both through analysis and
through investor engagement. The chapter finishes
with existing and emerging taxonomies and regula­
tory definitions, building on the policy material cov­
ered in Chapter 4.
Chapter Outline
5.1 Introduction to Green and Sustainable Finance
5.2 Trends and Flows in Sustainable and Climate Finance
5.3 Sustainable and Green Financial Products and
Instruments
5.4 ESG and Climate Integration in Investing
5.5 Existing and Emerging Definitions and Taxonomies
5.6 Conclusions and Prospects
100 ■ Sustainability and Climate Risk Exam
Key Learning Points
• Sustainable finance refers to any kind of financial product
or service that takes sustainability into account. Green
finance is specifically environmental financing, and climate
finance is climate-related financing.
• Sustainable finance and climate finance have both seen
significant growth in recent years. The single larg-
est actor providing financial flows for climate projects
are public-sector development banks. The growth in
membership and total size of climate- and sustainability­
related private-sector coalitions highlights their
importance.
• Green bonds are bonds whose proceeds are ear­
marked for environmental projects. They combine
several innovations: They are separately labeled, their
proceeds are ring-fenced, and the (planned) use of
proceeds is reported both to prospective bondholders
ex ante and to current bondholders once projects are
implemented.
• Other sustainable financial instruments include social
bonds, where proceeds are earmarked for social ben­
efit; sustainability bonds with dual environmental
and social benefits; green loans, which are similar to
green bonds but are loans; and sustainability-linked
bonds and loans, where the bond coupon or loan
interest rate is tied to the achievement of sustainability
targets.
• The market for sustainable funds is large and growing
and consists of both funds composed of sustainable
instruments (e.g., green bond funds) and funds with
shares in sustainable companies.
• Many financial institutions practice ESG integration,
which involves using and collecting data on material ESG
issues, integrating it into investing and lending decisions,
and engaging with investee companies.
• As the market has matured, there is greater regulatory
involvement and a move to standardize definitions
across borders.
GREEN AND SUSTAINABLE
FINANCE: MARKETS
AND INST RUMENTS
5.1 Introduction to Green
and Sustainable Finance
The awareness of sustainability has moved from develop­
ment and international public discourse into private-sector
corporations, including financial-market participants. Build­
ing on the examination of sustainability and corporate social
responsibility in Chapter 2, this chapter looks specifically
at the application of sustainability, especially in regard to
environmental and climate issues and finance. Sustainable
finance refers to any kind of financial activity that takes
sustainability into account, across asset classes (includ-
ing equity, debt-both bonds and loans-and other asset
classes such as commodities or derivatives) and across dif­
ferent products and services, ranging from corporate loans
to mutual funds with shares of sustainable firms, offered to
retail investors. Green finance refers to sustainable finance
focused on environment-related risks and opportunities­
often, but not necessarily, climate change. Other topics
falling under the "green" categorization can include waste
management, water usage, conservation of natural habitats,
and mitigating biodiversity loss. Climate finance refers
exclusively to financial flows relating to climate change,
whether mitigation or adaptation. The term has been asso­
ciated more with the use of public funds via development
assistance to fund mitigation and adaptation activities in
developing countries.
Sustainable finance, both in its broadest sense and relating
to its subtypes like green or climate finance, has been rap­
idly growing in popularity. Its growth can be measured in all
sorts of ways, from assets under management invested in
sustainable ways to the proliferation of specific sustainable
financial instruments.
Given the increasing awareness of sustainability, there has
been a temptation and tendency on the part of financial
firms to label their offerings or their practices "sustainable"
without a harmonization of definitions. Industry standards
and oversight has evolved both through self-policing from
industry associations and as a result of regulatory action.
Chapter 5 Green and Sustainable Finance: Markets and Instruments
There is also increasing consensus on how to integrate envi­
ronmental, social, and governance factors into lending and
investing practices, specifically scores and metrics for port­
folio analysis. Further, sustainability is an area where the use
of specific, defined, and labeled sustainable financial instru­
ments, such as green bonds, has become more popular.
In general, the trend toward sustainable finance transac­
tions, products, and offerings has been carried out by main­
stream banks, insurers, asset managers, asset owners, stock
exchanges, ratings agencies, and other parts of the financial
system, sometimes through a dedicated sustainability divi­
sion. There has also been a rise in smaller, specialist pure­
play green or ESG financial firms.
5.2 Trends and Flows in Sustainable
and Climate Finance
This section reviews trends in assets and flows in sustain­
able finance. According to a very broad definition of sus­
tainable finance used by the Global Sustainable Investing
Alliance (GSIA), sustainably invested global assets under
management stood at USD 35.3 trillion in 2020. Assets
grew by 15% in just the two years from 2018. Of the major
markets covered by the survey-namely the United States,
E.U., Canada, Australia, and Japan-Japan saw the greatest
growth in this period, with sustainable assets tripling every
year on average. The survey also indicates that a large pro­
portion of all professionally managed assets are now man­
aged sustainably: around half in Canada and Europe, and a
quarter in the United States.
Note, however, that the GSIA definition includes negative/
exclusionary screening (where the shares of certain types of
companies such as weapons manufacturers are left out of port­
folios) as a type of sustainable investing, accounting for around
half of the total. The second and third largest categories in the
GSIA survey-ESG integration and shareholder engagement­
will be the focus in the remainder of this chapter.
A similar trend can be seen in the field of climate finance.
A common way to measure trends in this market is to track all
the financial flows that are used for climate change-related
projects and investments, regardless of their source-whether
in the public or private sector or in financial or non-financial
firms. Here, the comprehensive datasets compiled by the
■ 101
 UNDERSTANDING CLIMATE FIN ANCE FLOWS BY SOURCE , INSTRUMENT,
AND SECTOR
The comprehensive accounting assembled bi-annually
by the Climate Policy Initiative, an NGO, is widely seen
as a gold standard in tracking climate finance flows from
public and private sources, ranging from governments to
public and private financial institutions to corporations
and households. In general, climate finance has more
than doubled from 2012 to 2021, from USD 360 billion
to an estimated USD 850 billion per year (see graph).
It is more insightful to examine the comprehensive break­
down by source, instrument, and targeted sector than it
is to only look at the simple amount. (See graphic).
are not far behind, with commercial banks accounting
for a somewhat smaller proportion. Financing is fairly
evenly split between debt and equity. The vast majority
of financing is related to climate change mitigation, not
adaptation, with large portions flowing into renewable
energy generation (e.g., wind and solar) and low-carbon
transport (such as electric vehicles).
Interestingly, for all the discussions of cross-border
investments and financial flows, the CPl's tallies show
the large majority of financing is domestic, with 76% of
financing from domestic sources.

In general, the largest single-actor group providing

climate financing, according to the CPl's definition, are From Global Landscape of Climate Finance 2021,
development banks-national, bilateral, and multilateral copyright© Climate Policy Initiative. Reprinted with
(USO 230 billion annually, on average). Corporations permission.

$900 bn
$850 bn

$800 bn

$700 bn
$655 bn
$600 bn
$605 bn
$500 bn $539 bn

$471 bn $454 bn
$400 bn
$391 bn
$300 bn

$200 bn

$100 bn

$0 ------------------------------
2014 2015 2016 2017 2018 2019 2020 2021

UlH'ikJ.I•
Climate Policy Initiative, provide a good reference point
(see Figure 5.1), and similarly show the rapid growth in this
space in recent years.
Yet another way to gauge the surge in sustainable and cli­
mate investing is to look at the proliferation and growth of
investor groupings and coalitions dedicated to sustainability
and climate issues, as covered in Chapter 4. For example,
in under two years from September 2019 to spring 2021,
the Net Zero Asset Owner Coalition, a group of investors
dedicated to aligning their entire portfolios with the goal
of net-zero emissions by 2050, grew from 12 members
representing USD 2.4 trillion in assets to 84 members with
11 trillion (see Table 5.1).
Finally, one can also see this growth when looking at the
evolution in the market of sustainable finance instruments
and financial products.

102 ■ Sustainability and Climate Risk Exam

 Global climate finance flows along their life cycle in 2019 and 2020. Values are average of two years' data, in USO billions

LANDSCAPE OF CLIMATE FINANCE IN 2019/2020 653

Q
BNUSD
Global climate finance flows along fhe,r/ffe cycle ,n 2019 and 2020 Values are average of two years' data, ,n USO billions ANNUAL CLIMATE
AVERAGE POLICY
SOURCES AND INTERMEDIARIES INSTRUMENTS USES INITIATIVE SECTORS

M#1J:j!IM NQ-JkhiM
Which type of organizations are sources or What mix of financial Government funds to ot�r What types of What is the
intermediaries of capital for climate finance? instruments are used? public. sources o� not f!!stimated activities are financed? finance used for?

Water & waste $24

Adaptation $49
Industry $7

Buildings & I

n
inlrastrudure $52,

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Others&
cross-sedoral $48

.,
ID
Project-level
(/1 market rate debt Land Use $1§_
$236
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C: Energy systems
!!I.
Ill
$336

:I Mitigation
Ill
$586
!'2:
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financing
(debt portion)
!! $112
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s: Balance sheet
financing Transport
..,
Ill

;,;­
(equity portion)
$156
$169

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GROWTH IN SIZE OF SELECT CLIMATE GROUPINGS
Founding Members
Name Founding Year Number
Principles for Responsible 2006 63
Investment
Taskforce on Climate-Related 2017 100+
Financial Disclosures
Climate Action 100+ 2017 225
Net Zero Asset Owners 2019 12
Alliance
5.3 Sustainable and Green Financial
Products and Instruments
This section reviews sustainable financial instruments and
products. These come in various forms, and different instru­
ments involve different sorts of counterparties. Green or
sustainability loans, like typical corporate loans, tend to
be an agreement between a small number of banks and a
borrowing company. Green and other sustainability bonds
are used by all kinds of private and public entities to raise
funds; as with other kinds of bonds, their issuance is under­
written by banks, and they are traded on secondary mar­
kets. For institutional or retail end investors, sustainable or
green fund products are available. These may consist of sus­
tainable instruments (a bond fund made up of green bonds)
or of other assets (e.g., shares of sustainable companies).
In general terms, sustainable financial products come in three
broad varieties. For some, the use of proceeds is earmarked
and ring-fenced for sustainable use (e.g., green bonds). For
sustainability-linked instruments, the financial instrument
itself is linked to sustainability targets, such as through an
interest rate penalty or reward on achievement of a specified
target. For still other products, sustainability acts as selection
criteria for inclusion (e.g., in a sustainable equity fund) or for
targeted engagement with the management of a company.
5.3. 1 Green, Social, and Sustainable Bonds
Green bonds are bonds whose proceeds are earmarked for
environmental projects. They combine several innovations:
They are separately labeled, their proceeds are ring-fenced,
104 ■ Sustainability and Climate Risk Exam
2020/1 Members
Assets (USD) Number Assets (USD)
$6.5tn 5319 (2022) $121 tn (2022)
$25tn 3960+ (2022) $220tn (2022)
$26.3tn 700+ (2022) $68tn (2022)
$2.4tn 84 (2023) $11tn (2023)
and the (planned) use of their proceeds is reported both to
prospective bondholders ex ante and to current bondhold­
ers once projects are implemented. In this way, they differ
from typical corporate or government bonds, which func­
tion as general-purpose borrowings, where the issuer can
then use the proceeds as needed.
Green bonds were pioneered by multilateral development
banks. In 2007, the European Investment Bank issued a
"climate awareness bond," and in 2008, the World Bank used
the term "green bond" to describe debt issuance. Since
these early developments, the use of these instruments has
increased exponentially. The EIB's initial USD 800 million
green bond issuance has grown to USD 270 billion in 2020.
One of the challenges in this market is that green bond issu­
ances are, so far, largely self-defined and self-policed by the
market under broad, industry-led principles and definitions
such as the Green Bond Principles from the International
Capital Market Association (ICMA). However, regulators are
also moving toward setting definitions, as exemplified by the
E.U. green bond standard (see Section 5.4).
As issuance has grown, the issuer base of green bonds has
diversified and the market has matured. From its origins
within public-sector development banks, green bond issu­
ance has been embraced by both private- and public-sector
borrowers, ranging from companies and banks to national
and municipal governments. An ecosystem has sprung up
around green bonds. As with traditional bonds, investment
banks handle the underwriting of issuance. In addition to
seeking credit ratings, it has become established industry
practice for green bond issuers to seek a rating or "second
 ICMA GREEN BOND PRINCIPLES-EXCERPTS
The[Green Bond Principles] have four core components:
1. Use of Proceeds
2. Process for Project Evaluation and Selection
3. Management of Proceeds
4. Reporting
1. Use of Proceeds The cornerstone of a Green Bond
is the utilization of the proceeds of the bond for Green
Projects, which should be appropriately described in
the legal documentation for the security. All designated
Green Projects should provide clear environmental
benefits, which will be assessed and, where feasible,
quantified by the issuer.[ ...]
Eligible Green Project categories, listed in no specific
order, include, but are not limited to:
• renewable energy
• energy efficiency
• pollution prevention and control
• environmentally sustainable management of living
natural resources and land use
• terrestrial and aquatic biodiversity conservation
• clean transportation
• sustainable water and wastewater management
• climate change adaptation
• circular economy adapted products, production
technologies and processes
• green buildings
[. . . ]
2. Process for Project Evaluation and Selection: The issuer
of a Green Bond should clearly communicate to investors:
- the environmental sustainability objectives of the eli­
gible Green Projects;
- the process[. . .]determin[ing]how projects fit within
the eligible Green Projects categories;
opinion" on the environmental credentials of green bonds
from organizations such as CICERO, a Norwegian research
organization, or Sustainalytics, a consultancy. Although
green bonds were the first labeled sustainable bond and
make up the largest portion of sustainable bond issuance,
in recent years, other types of sustainable bonds have
Chapter 5 Green and Sustainable Finance: Markets and Instruments
- Complementary information on processes by which
the issuer identifies and manages perceived social
and environmental risks associated with the relevant
project(s).[. . .]
3. Management of Proceeds: The net proceeds of the
Green Bond[. . .]should be credited to a sub-account,
moved to a sub-portfolio or otherwise tracked by the
issuer in an appropriate manner, and attested to by the
issuer in a formal internal process linked to[. . .]lending
and investment operations for Green Projects. [. . .]
4. Reporting: Issuers should make, and keep, readily
available up to date information on the use of proceeds
to be renewed annually until full allocation, and on
a timely basis in case of material developments. The
annual report should include a list of the projects to
which Green Bond proceeds have been allocated, as well
as a brief description of the projects and the amounts
allocated, and their expected impact.[ . . .]
Green Bond Frameworks: Issuers should explain
the alignment of their Green Bond or Green Bond
programme with the four core components of the
GBP[ ...]in a Green Bond Framework or in their legal
documentation. Such Green Bond Framework and/or
legal documentation should be available in a readily
accessible format to investors.[ ...]
External Review: It is recommended that issuers appoint
(an) external review provider(s) to assess through a pre­
issuance external review the alignment of their Green Bond
or Green Bond programme and/or Framework with the
four core components of the GBP[ ...]as defined above.
Post issuance, it is recommended that an issuer's man­
agement of proceeds be supplemented by the use of an
external auditor, or other third party, to verify the inter­
nal tracking and the allocation of funds from the Green
Bond proceeds to eligible Green Projects. [ ...]
Source: Green Bond Principles Voluntary Process
Guidelines for Issuing Green Bonds June 2021 (with
June 2022 Appendix). Reprinted by permission from
International Capital Market Association.
evolved. Social bonds are bonds with earmarked proceeds
for projects that will bring social benefits. As with green
bonds, the impetus initially came from a public-sector
financial institution, in this case Spain's lnstituto de Credito,
which issued the first social bond in 2015 to finance small
and medium enterprises in disadvantaged parts of Spain.
■ 105
Social bonds also have spread to the private sector.
January 2021, alone, saw issuance from firms like German
regional bank, Landesbank Baden-Wurttemberg, for financ­
ing affordable basic infrastructure and access to essential
services, and British firm Motability Operations Group for
operating a wheelchair-accessible vehicles initiative.
Sustainability bonds are a combination of the two, in that
they are meant to simultaneously address both environmen­
tal and social objectives. The issuance of social and sustain­
ability bonds increased dramatically in 2020, partly due to
the global COVID-19 pandemic, and continued to grow
rapidly in 2021 and 2022. Another variety of labeled bonds
is the SDG bond, linked to UN Sustainable Development
Goals. As covered in Chapter 2, the SDGs cover social,
environmental, and economic goals.
5.3.2 Green Loans
Green loans are loans that have been made for envi­
ronmental and climate-related projects. In international
markets, under the definition set out by the Loan Market
Association in the Green Loan Principles, green loans are
expected to ring-fence and borrowers are expected to
report on the use of their proceeds. In specific jurisdictions,
green loans are sometimes governed by slightly different,
national rules, most notably in China.
China, in its domestic market, is a notable and early adopter
of green loans. The adoption of these loans stemmed from
the government's 2007 Green Credit Policy rather than
from a private-sector initiative. This policy requires banks
to offer green credit for environmental protection, emission
reduction, and energy conservation projects, and restricts
loans to high-polluting and -emitting industries, and to ones
suffering overcapacity. The policy aims both to reduce envi­
ronmental harm and to reduce exposure to climate-related
financial risks from heavily polluting industries, thus improv­
ing financial stability (Cui et al., 2018).
In China, the proportions of green loans in banks' balance
sheets grew from 8.8% in 2013 to 10.8% at the end of 2019,
representing a cumulative total of over RMB 10.6 trillion
(USD 1.5 trillion). The vast majority of Chinese green loans
went to clean transport (45%) and clean energy (29%) in
2019. Generally, green loans in China have performed better
than conventional loans, with the non-performing loan (NPL)
ratio for green loans at 0.42% in 2018, while the overall credit
106 ■ Sustainability and Climate Risk Exam
NPL ratio stood at 1.83% (Choi, 2020). However, effects vary
significantly between large, state-owned banks, where the
green loan ratio is negatively associated with credit risk, and
smaller city/regional level commercial banks, where increases
in the proportion of green loans has been found to be asso­
ciated with greater credit risk (Zhou, 2020). In other words,
it seems that large Chinese banks' green loans tend to be
"safer" than the rest of their loan book, whereas for small
Chinese banks, green loans tend to be riskier.
Globally, green loan underwriting grew from around USD
30 billion in 2015 to around USD 90 billion in 2019. Green
loans have been highly concentrated in the power sector,
with 47% lent to renewable energy projects and another
23% to the power generation sector as of October 2020
(Nordea, 2020). Utilities make up the next largest category,
at 8%, and the first non-power sector, real estate, is in
fourth place as a recipient of 6% of green loans outstand­
ing. Indeed, on a global scale (but especially in Europe),
green loans have been overshadowed by the even quicker
growth of sustainability-linked loans, whose total volume in
2019 already exceeded that of green loans despite a later
start (see next section).
5.3.3 Sustainability-Linked Bonds and Loans
An important innovation among labeled sustainable instru­
ments has been to introduce dynamism through linking
financing to sustainability targets as an incentive, rather
than simply ring-fencing certain funds for use in green or
sustainable projects. In sustainability-linked bonds (SLB),
the coupon paid by the issuer is linked to the issuer firm's
achievement of pre-agreed sustainability targets. Similarly,
for sustainability-linked loans (SLL), the interest rate on
the loan is linked to a company's achievement of certain
sustainability benchmarks. In contrast with green bonds and
especially green loans, sustainability-linked instruments are
rapidly being adopted by a variety of sectors, tied to a vari­
ety of targets (see highlighted examples). These targets are
often called key performance indicators (KPls).
Sustainability-linked bond issuance and loan volume have
grown significantly in a very short period of time. Despite
the fact that the Sustainability-Linked Loan Principles,
which set guidelines for the market, only launched in 2019,
that year already witnessed more in SLL volume (around
USD 90 billion) than the green loan market, a more mature
labeled loan category. The Sustainability-Linked Bond
GROWTH OF SUSTAINABLE BONDS BEYOND GREEN
Green bond issuance has grown significantly in a
short amount of time, reaching over $500bn for the
first time in 2021. Social and sustainability bonds
have likewise grown quickly in issuance, although
with a later start and from a lower baseline. In 2020,
1000
■ Green ■ Social
Vl
C
800
600
SLB ■ Transition
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co
0
V)
400
::,
200
0 iiiii
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© Climate Bonds Initiative, 2022.
lif:1111!1-!I
SUSTAINABILITY-LINKED BONDS AND LOANS: SELECT EXAMPLES
DSM (EUR 1 billion loan, 2018): In a very early deal
for the sustainability-linked loan market, DSM, a Dutch
health, nutrition, and materials company, took out
a EUR 1 billion revolving credit facility with a group
of 15 banks linked to its greenhouse gas (GHG)
emissions. Specifically, the interest rate was linked
to three indicators KPls: cumulative GHG efficiency
improvements, changes in the Energy Efficiency Index
(EEi), and the proportion of the firm's electricity sourced
from renewable resources.
Chanel (EUR 600 million [2 x 300 million] bond issue,
2020): Chanel, the famous French fashion company,
issued a sustainability-linked bond in 2020 in two parts.
The first EUR 300 million tranche was tied to cutting
its corporate GHG emissions in half by 2030 and
reducing supply chain emissions by 10%. The coupon
on the bond of 1 % will be supplemented by a penalty
of 0.75% should the emissions targets not be met. The
second EUR 300 million tranche is tied to transitioning
the firm to 100% renewable energy use by 2025. The
base coupon is 0.5% and, in case of non-fulfillment, the
coupon increases to 1.0%.
Chapter 5 Green and Sustainable Finance: Markets and Instruments
when the world was hit with the COVID-19 pandemic
and many institutions wanted to raise money to help
address its impacts, saw a particularly large upsurge
in social and sustainability bond issuance compared to
previous years.
■ Sustainability
2018 2019 2020 2021
Volution (GBP 150 million loan, 2020): Volution, a
British ventilation systems manufacturer, was due to
refinance an existing GBP 120 million loan facility. After
conversations on integrating sustainability with its advisor
Rothschilds and its banking syndicate, it agreed a GBP
150 million sustainability-linked revolving credit facility.
It is tied to two KPls: the percentage of sales revenue
from low-carbon products and the percentage of plastic
processed in its owned factories from recycled sources.
Schneider Electric (EUR 650 million bond issue, 2020):
Schneider Electric, a French electrical equipment company,
issued a EUR 650 million bond issue tied to three KPls:
GHG emissions, gender diversity in its workforce, and
training underprivileged people. Specifically, the firm set
a 2025 target of 800 megatons of saved and avoided CO2
emissions; targets of reaching a workforce of 50% women,
including 40% in front-line management and 30% among
senior executives; and training one million people in
energy management. Should its performance fall short, it
has committed to pay its bondholders a penalty of 0.5% of
the nominal value of the (coupon-free) bonds.
Sources: DSM; Raconteur; Rothschild; Schneider Electric.
■ 107
Principles are even more recent, launching in 2020. Both
are industry-led sets of guidelines, with the loan guidance
developed by three loan-market umbrella organizations:
the Loan Market Association (LMA), the Loan Syndication
and Trading Association (LSTA), and the Asia Pacific Loan
Market Association (APLMA). The bond guidance was
developed by ICMA, the same body that published the
Green Bond Principles. The SLL and SLB principles are also
being further coordinated so that the sustainability-linked
market aligns better across bonds and loans. While they are
based on the Green Bond Principles to an extent, they also
SUSTAINABILITY-LINKED LOAN PRINCIPLES-EXCERPTS
"Sustainability linked loans are any types of loan instru­
ments and/or contingent facilities (such as bonding lines,
guarantee lines or letters of credit) which incentivise the
borrower's achievement of ambitious, predetermined
sustainability performance objectives. The borrower's
sustainability performance is measured using sustainabil­
ity performance targets (SPTs)[. . . ] measuring improve­
ments in the borrower's sustainability profile.
The use of proceeds in relation to a sustainability-linked
loan is not a determinant in its categorisation and, in
most instances, sustainability-linked loans will be used
for general corporate purposes. Instead of determining
specific uses of proceeds, sustainability linked loans look
to improve the borrower's sustainability profile by align­
ing loan terms to the borrower's performance against the
relevant predetermined SPTs.
The SLLP set out a framework[. . .] based around the fol­
lowing four core components:
1. Relationship to Borrower's Overall Sustainability
Strategy
2. Target Setting-Measuring the Sustainability of the
Borrower
3. Reporting
4. Review"
Sustainability-Linked Bond Principles-Excerpts
"Sustainability-Linked Bonds ("SLBs") are any type of
bond instrument for which the financial and/or structural
characteristics can vary depending on whether the issuer
achieves predefined Sustainability/ ESG objectives. In that
sense, issuers are thereby committing explicitly (including
in the bond documentation) to future improvements in
sustainability outcome(s) within a predefined timeline. [. . . ]
108 ■ Sustainability and Climate Risk Exam
have some specific elements, notably in relation to the strin­
gency requirements for KPls and sustainability performance
targets (see Sustainability-Linked Loan Principles box).
5.3.4 Sustainable and Green Funds
An additional category of sustainable finance products are
sustainable and green funds, which are primarily targeted
at institutional or retail investors. A large number of invest­
ment vehicles, both actively or passively managed, such
as mutual funds, exchange-traded funds, or other types of
funds, market themselves on their sustainable credentials.
The SLBP have five core components:
1. Selection of Key Performance Indicators (KPls)
2. Calibration of Sustainability Performance Targets (SPTs)
3. Bond characteristics
4. Reporting
5. Verification[. . .]
The KPls should be
• relevant, core and material to the issuer's overall busi­
ness, and of high strategic significance to the issuer's
current and/ or future operations;
• measurable or quantifiable on a consistent method­
ological basis;
• externally verifiable; and
• able to be benchmarked, i.e. as much as possible
using an external reference or definitions to facilitate
the assessment of the SPT's level of ambition. [. . .]
The SPTs should be ambitious, i.e.:
• represent a material improvement in the respective
KPls and be beyond a "Business as Usual" trajectory;
• where possible be compared to a benchmark or an
external reference;
• be consistent with the issuers' overall strategic
sustainability I ESG strategy; and
• be determined on a predefined timeline
Sources: SLLP 2020 and Sustainability-Linked Bond
Principles Voluntary Process Guidelines June 2023.
Reprinted by permission from International Capital
Market Association.
In practice, there is a huge variety in the types of funds that perspective, such as fossil fuels, weapons or tobacco.
market themselves as "sustainable" which makes it chal­ Finally, some, exchanges have their own green labels, such
lenging for investors to assess the credibility of this label. as the London Stock Exchange's Green Economy Label,
Some funds, such as green bond funds, consist exclusively used both for companies and for funds where over 50% of
of the sort of labeled sustainable finance instruments revenues are attributable to "environmental solutions." In
described above. Others consist of the shares of companies Luxembourg, the exchange provider has instead opted to
that engage in activities which are defined as "sustainable". set up a separate Luxembourg Green Exchange.
The determination of whether the issuing firm counts as
A look at the exchange-traded funds (ETF) market, a rapidly
sustainable is often done through the use of ESG scores or
growing segment of the overall funds market, helps show
ratings. This selection process can be done by a fund man­
how sustainable funds have proliferated in recent years. The
ager itself, or, often by an index provider such as MSCI or
largest sustainable equity ETF in terms of assets is a fund
FTSE Russell, which compile various green or ESG indices.
of U.S. equities run by BlackRock's iShares division, and it
However, to prevent greenwashing scandals from undermin­
was selected for high ESG scores based on MSCI scoring
ing the credibility and effectiveness of ESG investing, it is
methodology. As of 2023, the fund has USD 8.25 billion
crucial to exercise thorough due diligence, transparency,
in assets. The fund completely excludes firms involved in
and adherence to established standards and regulations.
industries such as weapons, tobacco, alcohol, and gam­
The DWS greenwashing scandal serves as a cautionary tale,
bling, and has "further screens" on companies in thermal
where the former sustainability chief accused the Deutsche
coal, oil sands, and oil & gas. Together, the ten largest
Bank subsidiary of inflating its ESG-integrated AUM, result­
sustainable ETFs make up USD 50.2 billion in assets (as of
ing in an overstatement of €459 billion AUM. Asset manag­
January 2023). For comparison, the largest ETF, SPY, which
ers have become more cautious with their ESG promises
tracks the S&P 500 index, has over USD 365 billion in assets
and are no longer waiting for regulations to modify their
in the same time period.
practices, as there is currently no clear definition or legisla­
tion criminalizing greenwashing, although future laws may
5.3.5 Other Sustainable Finance Products
be created to address this issue.
Finally, there are a number of other primarily consumer­
In other cases, funds will simply exclude certain sec­ facing, sustainable finance products that have started
tors deemed as particularly harmful from a sustainability to come to market. Green car loans are dedicated to

TEN LARGEST SUSTAINABLE EQUITY ETFs USD billion

iShares MSCI USA SRI UCITS ETF USD 8.25

iShares Global Clean Energy UCITS ETF 5.96

iShares MSCI USA ESG Enhanced UCITS ETF 5.59

Xtrackers MSCI USA ESG UCITS ETF 1 C 5.22

iShares MSCI World SRI UCITS ETF EUR 5.13

iShares MSCI USA ESG Screened UCITS ETF USD 4.63

iShares MSCI EM SRI UCITS ETF 4.44

iShares MSCI Europe SRI UCITS ETF 3.87

Amundi Index MSCI USA SRI UCITS ETF DR (C) 3.72

UBS ETF (LU) MSCI World Socially Responsible UCITS ETF (USD) A-dis 3.37

Data from JustETF, 2023. JustETF is a brand of JustETF GmbH. Reprinted by permission from
justETF.com.

Chapter 5 Green and Sustainable Finance: Markets and Instruments ■ 109

financing environmentally friendly cars, such as electric indicators and sub-scores are then aggregated into an overall
vehicles. Green mortgages are mortgages for energy­ score based on a ratings provider's methodology.
efficient houses. Both of these products currently only exist
ESG scores, however, are a heterogeneous space with little
in certain markets: Green car loans can be found in Sweden
standardization and a few shortcomings. One drawback is that
and Singapore, for example, and green mortgages in the
the methods to calculate them are typically proprietary, mak­
UK. Both still make up extremely small shares of the total
ing it hard for investors or lenders to see behind the scores
car loan and mortgage markets. However, industry associa­
they purchase from data providers. Another issue is that ESG
tions see potential for growth. For example, in the UK, the
ratings are not consistent with each other and are thus hard
Intermediary Mortgage Lenders' Association (IMLA) found
to compare, as rating methodologies differ substantially.
in a survey that 74% of lenders expected green mortgage
Academic studies have provided ample evidence of the lack
demand to grow, and that 14% of brokers had fielded
of cross-comparability, noting, for instance, that ratings do
enquiries about green mortgages (IMLA, 2020).
not converge over time (Chatterji et al., 2016) and that the
Another consumer-facing sustainable finance product, ESG ratings of leading providers are only correlated by about
sustainable credit cards, are unlike other sustainable 0.61, much less than standard credit ratings (Berg, 2019).
finance products in this section in that they tend to donate
Beyond the leading providers, the picture is even more
a small percentage of purchases to environmental charities
confusing, especially given the huge proliferation of ratings.
and thus are more aligned with philanthropy than with the
A report by SustainAbility (2019) found that the number
financial system per se.
of ESG ratings grew more than fivefold between 2010 and
2019, to an estimated 600 ESG ratings.

5.4 ESG and Climate Integration A good anecdotal example of issues with ESG scores is the
in Investing case of Tesla, the American electric vehicle company. It is
ranked very highly by MSCI on environmental issues and
This section reviews the ways in which investors and lend­
moderate on governance, whereas FTSE, a competing pro­
ers integrate ESG and climate considerations into their
vider, ranked it poorly on both. In this case, FTSE only took
financing activities, building on the discussion of ESG in
into account emissions from Tesla factories, not emissions
Chapter 2. T his kind of broad integration is becoming more
saved by Tesla's electric vehicles during their lifecycle, as
necessary as financial institutions commit their entire corpo­
MSCI did. On governance, FTSE scored Tesla poorly due
rate strategies and portfolios to certain climate goals, such
to lack of disclosure of information, whereas MSCI used an
as alignment with net-zero emissions by 2050.
average score for the auto industry.

5.4. 1 Use of Data and Scores
Integrating climate or broader ESG issues into investment
and lending decisions starts with metrics-a numerical
gauge for ESG and climate risks and exposures. On broader
ESG topics, scores and ratings are the most widely used
approach by investors and lenders to gauge the perfor­
mance of investee or debtor companies. A number of data
providers offer their services in this space, including Bloom­
berg, Refinitiv, MSCI, Sustainalytics, FTSE, ISS, and Vigeo
Eiris, to name just the main ones.
ESG ratings are intended to express and distill a holistic
assessment of a company into one, easily understood and
cross-comparable score or rating. ESG ratings methodologies
typically use a scoring approach, incorporating a wide range
of quantitative and qualitative indicators. T he underlying
On climate change specifically, the available data is not
straightforward either. For transition risk, carbon dioxide
or greenhouse gas emissions seem like a neutral and easily
cross-comparable quantitative metric, but they are often
estimated rather than reported by the company itself. On
physical climate risk, investors and lenders are typically reli­
ant on physical risk scores that have similar shortcomings to
ESG scores (see Chapter 3).
5.4.2 Integration into Investment Decisions
and Portfolio Analysis
Many investors and lenders are increasingly integrating ESG
and climate considerations into their operations, or they
are planning to do so given their firm-wide sustainability
commitments.

110 ■ Sustainability and Climate Risk Exam

 CREATING ESG SCORES
ESG scores are built up from raw data and turned into are taken in several stages to arrive at an overall score
indicators, and then scores, of which weighted averages (see graphic).

ESG Letter Rating

(AAA-CCC)

Pre-set score-to-letter-rating matrix

Final Industry Adjusted Score (0-10)

Adjusted relative to industry Peers. Exceptional truncations

Weighted Average Key Issue Score (0-10)

Weighted average of underlying Pillar scores

Environment Pillar Social Pillar Governance Pillar

Score (0-10) Score (0-10) Score (0-10)

Each pillar is organized into underlying themes: Pillar and Theme Scores derive
from the weighted average of underlying Issue Scores

Environmental Key Issue Social Key Issue Governance Key Issue

Scores (0-10) Score (0-10) Score (0-10)

Exposure Mgmt Exposure Mgmt Exposure Mgmt

Scores Scores Scores Scores Scores Scores

Indicators: Indicators:
Indicators: Indicators: Indicators: Indicators:
Business Business
Strategy Strategy Business Strategy
Segments; Segments;
Programs & Programs & Geographic Programs &
Geographic Geographic
Initiatives Initiatives Segments; Initiatives
Segments; Segments;
Performance Performance Co-spec Performance
Co-spec Co-spec
Controversies Controversies indicators Controversies
indicators indicators

Raw Data:
Company financial and sustainability disclosure, specialized government & academic data sets, media searches

Adapted from MSC/ "Comparing Risk and Performance for Absolute and Relative ESG Scores. An Empirical Analysis
Using MSC/ ESG Scores 2020."

Wi'ii¥iH
Chapter 5 Green and Sustainable Finance: Markets and Instruments ■ 111
In practice, there is a spectrum of organizational structures
and states of readiness within financial firms. At some firms,
there is a separate ESG or sustainability division, separate
from the main investment or lending functions of the firm,
that informs and guides these functions indirectly. Their
ESG division output, in the form of sustainability research
and company level analysis, is available for portfolio manag­
ers and other staff who are initiating transactions to con­
sider if desired. At other firms, a separate division exists,
but it is more closely integrated into the work of portfolio
managers and investment teams, with investment decision­
makers required to complete some kind of ESG assess­
ments in their investment analysis and consult with the
firm's in-house experts. Full ESG integration is where every
analyst, portfolio manager, and decision-maker is trained,
understands ESG issues, and applies ESG to their job func­
tion. Here, ESG expertise and practice is so widespread that
a separate team is not as important.
There are also a number of means through which investors
and lenders can collect ESG data on investee and debtor
companies. The primary sources for ESG scores and ratings
are 1) external providers, 2) discussions with the company,
3) corporate sustainability reports, and/or 4) regulatory dis­
closures. Finally, ESG issues can be integrated throughout
investment, management, and operational processes, from
initial investment through to regular portfolio and risk man­
agement analysis (see Figure 5.5).
ESG integration is practiced in a number of ways by various
institutional investors and banks, with slightly differing pro­
cesses and emphases on different sorts of information sources
(see examples). However, ESG integration does not occur in
isolation. Often, it is paired with engagement with companies
(see next section) or decisions about company over- or under­
weights in loan books and investment portfolios.
Indeed, although the notion of "divestment" is promoted
much more enthusiastically by activists than by investors,
there are some cases where investors have started to rule
out certain kinds of investments on ESG grounds. For
instance, many funds exclude sectors such as weapons,
tobacco, alcohol, and gambling. On climate issues, grow­
ing numbers of banks are announcing the phase-out of new
coal lending (BankTrack, 2020). Many have also commit­
ted to restrictions, exclusions, or additional requirements
112 ■ Sustainability and Climate Risk Exam
for the financing of tar sands, offshore oil & gas, hydrau­
lic fracturing, and Arctic oil projects (Rainforest Action
Network et al., 2020).
5.4.3 Shareholder Engagement
Investor engagement with company management around
sustainability has become an increasingly important channel
for the financial sector to exert influence and thereby bring
about corporate change. Financial firms practice engage­
ment for a variety of reasons, including gaining credibility
with clients, mitigating financial risks resulting from ESG­
related issues, aligning with corporate strategy, and pres­
sure from regulators. The scale of engagement activities
pressures can pressure large, emissions-intensive corpora­
tions to become more sustainable and, in aggregate, pro­
duce macroeconomic effects.
Initially, a principal focus of shareholder engagement was to
push companies for better disclosure of ESG performance
metrics (e.g., carbon emissions, water usage) and sustain­
ability policies. Investors have used shareholder resolutions
and engagement as well as public advocacy, to call for
increased and improved calculation and disclosure on ESG
factors (Srinivas, 2015). Part of the push for disclosure has
also come from regulators, notably through the TCFD.
In 2021, shareholder engagement went even further,
demanding that investee companies align with certain
targets, such as, Paris alignment, or publishing credible
plans for implementing a corporate transition to a net-zero
emissions-compatible business model. Companies that do
not oblige are "named and shamed," and their sharehold­
ers draw up, and pass, resolutions forcing management to
tackle these issues. Some investment firms have had suc­
cess at exerting this kind of climate pressure from within.
For example, Legal & General Investment Management
(LGIM), a UK asset manager, grades investee companies on
their climate performance according to in-house Climate
Impact Pledge scores, which LGIM uses to rank companies
(see LGIM Case Study).
More often, however, investors are finding success as part
of larger coalitions, such as Climate Action 100+. With
700 members representing USO 68 trillion in assets under
management, signatories to Climate Action 100+ make up
 ESG INTEGRATION

Spectrum of integration within a firm

Separe ESG All decisions and
research staff factor in
department ESG

ESG partly
integrated

Most used sources of ESG information on investee firms

Most Useful Sources of Information on Corporate ESG Performance

Corporate ESG ratings

Direct engagement with companies

Corporate sustainability reports

In-house research

Corporate ESG rankings

ESG information disclosure in filings for securities

authorities (e.g. SEC in US, ESMA in EU etc.)

Media

Other

Reprinted with permission of the SustainAbility Institute by ERM.

Parts of the investment and operational chain where ESG can be integrated

Investing Risk
Internal and Portfolio management
lending analysis and internal
decisions audit

lif.11ii¥11

Chapter 5 Green and Sustainable Finance: Markets and Instruments ■ 113

 EXAMPLES: ESG INTEGRATION IN PRACTICE
Neuberger Berman (asset manager)-ESG Integration
for Japanese investments:
The American asset manager uses two pillars to inte­
grate ESG into its investment process, the first focusing
on material environmental and social issues, and the
second on governance. The firm uses the Sustainability
Accounting Standards Board (SASB) framework to iden­
tify the factors that are likely to affect companies, indus­
tries, and sectors. The lead portfolio manager or analyst
for a company evaluates the firm in detail, including its
supply chains, through the use of company disclosure
documents and meetings with firm executives. Neuberger
Berman then blends this data, which it sources itself,
with ESG ratings from third-party providers. Neuberger
Berman uses its own scoring model to put together these
data points and determine the weighting of a particular
firm in its portfolio.
a substantial proportion of the shareholders of any publicly
listed company, and therefore Climate Action members are
able to exert much more pressure on management than any
individual investor could.
There is strong evidence of the power and results achieved
by shareholder engagement in the academic literature.
One review found that companies comply with shareholder
engagement requests at success rates ranging from 18%
to 60% (Kolbel et al., 2019). Shareholder proposals have
also been linked to subsequent increases in the ESG rat­
ings of the firms targeted for engagement, meaning that
the results of shareholder engagement can be significant
CASE STUDY: ENGINE NO.1 AND SHAREHOLDER ACTIVISM
In 2021, the hedge fund Engine No. 1 made headlines
around the world by challenging the leadership of
Exxon for its lack of climate action. In December 2020,
the impact-focused investment fund had invested
around USO 40 million dollars in Exxon shares. The
group then began to publicly argue that Exxon's
hesitancy on climate was creating risks that ultimately
threatened shareholder value. They wrote a letter to
the board of directors, criticizing the firm's history in
supporting climate denialism and asking for widespread
114 ■ Sustainability and Climate Risk Exam
Columbia Threadneedle (asset manager)-ESG
Integration through use of in-house scores:
In 2017, Columbia Threadneedle decided to build a solu­
tion for itself to cut through the tangle of different com­
mercially available ESG ratings. Drawing on its own 130
financial analysts and research staff, it developed a pro­
prietary ratings system intended to provide useful invest­
ment signals. The ratings are based partly on proven
academic models that have demonstrated their reliability
as strong indicators of companies' financial stewardship.
This model is then paired with a second model focused
on the financial materiality of ESG factors, which makes
use of SASB standards to help define materiality. Colum­
bia's model is on a rating scale of 1-5. The asset manager
applies these ratings to approximately 6000 companies.
Sources: SASB (2020), SASB (2019).
enough to show up in third-party data (Barko, 2017; Dyck
et al., 2019).
Often, engagement is paired with the threat of divestment,
which is the ultimate penalty, if all engagement efforts are
unsuccessful. This is also the case for the LGIM approach.
But this threat obviously requires market power and flexibil­
ity to be effective, meaning it can only be credibly made by
larger asset managers or hedge funds. Passively managed
funds, by definition, follow an index and therefore cannot
divest by their own choice. They shift the fund composition
only if the underlying index composition is changed, or if
the tracker index of a fund changed.
reforms. They a/so proposed four new independent
directors as candidates for the company's board. Over
the next six months, they were successful in convincing
major investors, including Vanguard and BlackRock, to
support this campaign, which ultimately led to three
new directors being appointed to at the next Share­
holder meeting in May 2021. This is a prominent exam­
ple of how investors are beginning to use their power
to pressure companies into stepping up their efforts to
tackle climate change.
 C ASE STUDY: LEGAL & GENERAL INVESTMENT MANAGEMENT
AND CLIMAT E CHANGE
Legal & General Investment Management is a large, UK­
based asset manager with over GBP 1 trillion in assets
under management. In 2016, LGIM launched its Climate
Impact Pledge, a program of targeted engagement with
about 80 companies and with the aim to speed up the
economic transition to a low- or zero-carbon economy.
This original pledge focused on the largest companies
in sectors crucial to energy transition (energy, transport,
financials) and deforestation and land use change (food
retail). Companies were assessed and ranked on a wide
range of indicators-from governance structures to
business targets and lobbying activities-to gain a well­
rounded view of their exposure to climate risks and the
available opportunities, and to produce a Climate Impact
Pledge score. The firm then published these scores and
used them to "name and shame" firms. When compa­
nies failed to demonstrate sufficient action, LGIM voted
5.5 Existing and Emerging Definitions
and Taxonomies
Amid the proliferation of sustainable finance and invest­
ments, the need for harmonized definitions has grown.
So far, much of this has been satisfied through bottom-up
approaches from market participants coming together
through industry associations that agree to voluntary guide­
lines and frameworks. However, there is also growing regu­
latory involvement in this area.
Regulatory involvement has come in many different forms and
depends to some extent on the regulatory frameworks and
traditions in different jurisdictions (as covered in Chapter 4).
Common-law jurisdictions, such as the UK and its former
colonies, typically rely more on evaluating situations as they
come up, whereas civil-law jurisdictions tend to specify laws
and rules in advance. The UK Financial Conduct Authority
(FCA) has taken a case-law approach with its proposals to
clamp down on greenwashing. The FCA aims to enhance
consumer trust in sustainable investments by introduc-
ing sustainable investment labels and consumer-facing
disclosures, pre-contractual and ongoing sustainability­
related performance information, and a sustainability entity
report for institutional investors and those seeking more
Chapter 5 Green and Sustainable Finance: Markets and Instruments
against their management and divested from them
within some of their funds-as it did, for instance, with
oil & gas major ExxonMobil in 2019.
In recent years, LGIM has made significant progress
towards achieving economy-wide net-zero emissions.
In 2019, it renewed and expanded its original pledge
by increasing the number of companies and sectors
covered, adopting a new engagement approach, and
updating its scoring methodology.
In an upgrade to its engagement practices, LGIM
divided its investee companies into two groups-a broad
group of 500 firms to which LGIM will send a letter, and
a targeted group of 50 companies it considers "pivotal"
to the transition and that will receive more involved and
frequent engagement.
Source: Legal & General Climate Impact Report, 2020.
information. Naming and marketing rules will restrict the use
of certain sustainability-related terms unless the product has
a sustainable investment label, and distributors must ensure
product-level information is available to consumers. The FCA
has proposed a general anti-greenwashing rule for all regu­
lated firms, emphasizing the need for sustainability-related
claims to be clear, fair, and not misleading. The industry
feedback from the consultation will continue into 2023.
The new guidance also restricts how some sustainability­
related terminology can be utilized in marketing for prod­
ucts that don't qualify for sustainable labels. The aim is to
avoid misleading marketing of products and to increase
transparency and consumer confidence in investments. It
places a significant emphasis on the importance of investors
to properly substantiate their sustainability claims, rather
than the regulator itself trying to define every permissible
type of sustainability claim, recognizing that this is a rapidly
evolving area of practice.
In the E.U., regulators are focused on specifying green
bond definitions, sustainable fund marketing parameters,
and the limits of sustainable economic activities in advance.
Indirect regulatory action has also played a role. For instance,
in jurisdictions where central banks practice monetary easing
through large-scale bond purchases (i.e., quantitative easing),
■ 115
the eligibility requirements for these purchases can end up
significantly affecting market practices and the growth of
nascent sustainable instruments.
5.5. 1 Defining Financial Products
Many of the labeled financial products covered in this chap­
ter were invented or standardized in a bottom-up way, by
financial market participants. Green bonds abide by the
Green Bond Principles, with extra confidence coming from
the second-opinion providers that vouch for their green
credentials, such as Sustainalytics, CICERO, or the Climate
Bonds Initiative.
The trend has been similar with social and sustainability
bonds and sustainability-linked bonds and loans. In general,
Green loans have been similar in most countries, though
their use in certain jurisdictions, such as China, is mainly due
to domestic regulatory pressure.
There has been a limited trend in regulatory involvement
at the product level. As part of the Sustainable Finance
Action Plan, the E.U. has gone the furthest toward creat­
ing a regulatory green bond standard, with consultations
undertaken in autumn 2020. As of 2022, negotiations
remain ongoing. Indirect regulator recognition has also
helped. Regulatory initiatives have encouraged the
growth of green finance, such as through the Network for
Greening the Financial System (NGFS). The recognition
by the European Central Bank in November 2020 that
sustainability-linked bonds are acceptable as collateral
has also helped grow that market.
5.5.2 Disclosure Requirements: Regulators
and Exchanges
One important trend that has grown in recent years is that
of increased disclosure requirements for companies, usually
through regulatory action.
In the E.U., a directive on disclosure of non-financial infor­
mation requires certain large firms and firms of public
interest to disclose ESG-related matters. The directive
was expanded in 2021, with all firms with more than 500
employees that are doing business in the E.U. required
to disclose. In the UK, listed firms have been required to
report on greenhouse gas emissions and diversity since
2006. Starting in 2022, the country is requiring all listed
116 ■ Sustainability and Climate Risk Exam
companies and limited liability partnerships to report on
climate risk in line with TCFD recommendations. China's
securities regulator has introduced rules to mandate all
listed firms to disclose ESG risks. In Canada, listed firms are
required to report some ESG parameters around diversity,
and all companies receiving extraordinary government sup­
port in the COVID-19 pandemic are required, in return, to
start TCFD reporting.
In other cases, disclosure requirements have come through
exchanges themselves. Exchanges can serve as important
gatekeepers, because they are the only venues where com­
panies can be publicly listed. The Shanghai and Shenzhen
stock exchanges require ESG disclosure from the firms
listed on them; one of Shanghai's requirements to conduct
an initial public offering (IPO) is to provide annual sustain­
ability reporting. At least 25 stock exchanges worldwide­
from Buenos Aires and Lagos to Lisbon and Manila-have
similar rules requiring firms to disclose ESG to be listed on
their exchanges.
5.5.3 Regulatory Trends: Defining
Sustainability by Economic Activity
An increasing amount of regulatory activity in relation to
sustainable finance involves neither financial products or
disclosures, but rather the underlying economic activity
being financed.
There has historically been some divergence on these
issues between jurisdictions, notably between China and
OECD countries. For a long time, China has allowed "clean
coal" and other types of "clean utilization of fossil fuels"
to be financed by green bonds, whereas prevailing market­
led standards in the West have not allowed fossil-fuel
financing of any kind. However, in a sign of growing moves
toward harmonization, China announced a proposal in
2020 to exclude clean fossil fuels from a revised standard,
thus bringing it in line with other countries and market-
led rules.
Regulators have also been moving to pin down the
definitions of sustainable activities in ever greater detail.
The furthest along in this regard is the European Union.
The E.U. Taxonomy, first published in draft format in
March 2020, sets performance thresholds (referred to as
"technical screening criteria") for economic activities, by
sector and subsector. The taxonomy is agnostic to financial
instruments or means of funding. Any investment or lend­
ing for a recognized activity, whether through a loan, a
green bond, or project financing, counts as sustainable.
The E.U. taxonomy is notable for its high level of prescrip­
tive detail for each and every subsector covered (see EU
Taxonomy box). To count as "green," activities must make a
substantive contribution to at least one of six environmen­
tal objectives: climate change mitigation, climate change
adaptation, the sustainable use and protection of water
and marine resources, the transition to a circular economy,
pollution prevention and control, and the protection and
restoration of biodiversity and ecosystems. They must also
explicitly do no harm to any of the other five objectives and
must meet a series of minimum safeguards.
Other countries are also developing taxonomies, including
the UK, Canada, and the ASEAN countries of Southeast
Asia. Given the E.U.'s role as the first major jurisdiction to
finalize its taxonomy, it may well end up providing a model
or template for many of these others. The UK process, for
example, is explicitly "tak[ing] the scientific metrics in the
E.U. taxonomy as its basis."
In parallel, the magnitude of global cross-border invest­
ment flows creates an incentive to harmonize definitions on
sustainable economic activities, just as there has been on
the definitions of sustainable investment products. In April
2021, for instance, China and the E.U. announced plans for
joint technical work on harmonizing taxonomies, with the
E.U. TAXONOMY: SELECT EXAMPLE CRITERIA
The technical criteria of the E.U. taxonomy set out in
detail, by sector and subsector, what activities count
as sustainable. This box highlights some illustrative
examples.
Cement manufacturing:
The manufacturing of cement is associated with significant
CO2 emissions. Minimising process emissions through
energy efficiency improvements and switch to alternative
fuels, promoting the reduction of the clinker-to-cement
ratio and the use of alternative clinkers and binders can
contribute to the mitigation objective.
Chapter 5 Green and Sustainable Finance: Markets and Instruments
aim to develop a jointly recognized classification system for
signifying which businesses are considered sustainable. The
first consultation version was published at the end of 2021,
with an updated version published in June of 2022.
5.6 Conclusions and Prospects
The field of sustainable finance has grown tremendously
within the financial sector, evolving from a niche area of
finance dominated by project finance funded by public bod­
ies, to a sizeable market segment of private finance. The
financial sector has brought its innovation capacities to bear
and come up with many kinds of novel financial instruments
that earmark funding for sustainable projects. Many of
these have sprung up organically, with standards and guide­
lines born from industry associations. Integrating ESG into
the fabric of operations occurs at an increasing number of
financial firms. How-ever, as the ESG market grows further,
there is also a trend toward more regulatory involvement as
well as cross-border harmonization of definitions.
The portion of all financial activities that incorporates sus­
tainability is expected to continue rising amid increased
stakeholder, government, and peer pressure, and as sustain­
ability becomes a societal norm. However, for sustainable
finance to develop further it likely will require further action
not only on harmonization and regulatory oversight but also
on more fundamental measures such as ways to measure
non-financial impact in cross-comparable ways.
[The eligibility of the activity/factory requires the
following:]
(A) Cement clinker: Specific emissions (calculated accord­
ing to the methodology used for EUETS benchmarks)
associated to the clinker production processes are lower
than the value of the related EU-ETS benchmark. As of
February 2020, the EU-ETS benchmark value for cement
clinker manufacturing is: 0.766 tCO2e/t of clinker
(B) Cement: Specific emissions associated to the clinker
and cement production processes are lower than: 0.498
tCO2e/t of cement or alternative binder
■ 117
 Passenger rail transport (interurban):
[These must] demonstrate substantial GHG emission
reduction by:
• Increasing the number of low- and zero emission
fleets, and improving fleet efficiency, and
• Improving efficiency of the overall transport/mobility
system
Zero direct emissions trains are eligible. Other trains are
eligible if direct emissions (TTW) are below 50g CO2e
emissions per passenger kilometre (gCO2e/pkm) until
2025 (noneligible thereafter).
Cogeneration of Heat/Cool and Power from
Concentrated Solar Technology:
Any cogeneration technology can be included in the tax­
onomy if it can be demonstrated [. . .] that the life cycle
impacts for producing 1 kWh of heat/cool and power are
below the declining threshold.
Declining threshold: The Cogeneration Threshold is the com­
bined heat/cool and power threshold of 100 gCO2e/ kWh.
• This threshold will be reduced every 5 years in line
with a net-zero CO2e in 2050 trajectory
• The threshold must be met at the point in time when
taxonomy approval is sought for the first time
REFERENCES
BankTrack. (2020). Bank moves out of coal. https://www
.banktrack.org/campaign/bank_moves_out_of_
coal#inform =1
Barko, T. C., M.; Rennebog, L. (2017). Shareholder Engage­
ment on Environmental, Social, and Governance Perfor­
mance. S. S. R. N. (SSRN). https://papers.ssrn.com/sol3/
papers.cfm?abstract_id = 2977219
Berg, F. K., Julian F.; Rigobon, Roberto. (2019). Aggregate
Confusion: The Divergence of ESG Ratings. Social Science
Research Network (SSRN). https://doi.org/http://dx.doi.
org/10.2139/ssrn.3438533
Chatterji, A. K., Durand, R., Levine, D. I., & Touboul, S.
(2016). Do ratings of firms converge? Implications for
managers, investors and strategy researchers. Strate­
gic Management Journal, 37(8), 1597-1614. https://doi.
org/10.1002/smj.2407
118 ■ Sustainability and Climate Risk Exam
• For activities which go beyond 2050, it must be tech-
nically feasible to reach net-zero emissions
Anaerobic digestion of sewage sludge:
Net GHG emission reduction from sewage sludge treat­
ment through the capture and utilization of the gener­
ated biogas in various forms and applications, often
displacing fossil fuels.
Anaerobic digestion of sewage sludge treatment is eli­
gible provided that (cumulative):
• methane leakage from relevant facilities (e.g. for
biogas production and storage, energy generation,
digestate storage) is controlled by a monitoring plan;
• the produced biogas is used directly for the gen­
eration of electricity and/or heat, or upgraded to
biomethane for injection in the natural gas grid, or
used as vehicle fuel (e.g. as bioCNG) or as feed­
stock in chemical industry (e.g. for production of H2
and NH 3).
Source: Taxonomy: Final report of the Technical Expert
Group on Sustainable Finance. Copyright © 2020. This
work is licensed under a Creative Commons Attribution
4.0 International License.
Choi, J. E., Donovan; Larsen, Mathias Lund. (2020). Green
Banking in China-Emerging Trends (CPI Discussion Brief,
Issue. https://www.climatepolicyinitiative.org/wp-content/
uploads/2020/08/Green-Banking-in-China-Emerging­
Trends-1.pdf
Cui, Y., Geobey, S., Weber, 0., & Lin, H. (2018). The Impact
of Green Lending on Credit Risk in China. Sustainability,
10(6). https://doi.org/10.3390/su10062008
Dyck, A., Lins, K. V., Roth, L., & Wagner, H. F. (2019,
2019/03/01/). Do institutional investors drive corporate
social responsibility? International evidence. Journal of
Financial Economics, 131(3), 693-714. https://doi.org/
https://doi.org/10.1016/j.jfineco.2018.08.013
FCA (2022) FCA proposes new rules to tackle green­
washing. https://www.fca.org.uk/news/press-releases/
fca-proposes-new-rules-tackle-greenwashing
ICMA. (2021). Green Bond Principles. Voluntary Process
Guidelines for Issuing Green Bonds.
IMLA. (2020). Green mortgages. http://www.imla.org.uk/ & Club, S. (2020). Banking on Climate Change: Fossil Fuel
resources/publications/imla-green-mortgages.pdf Finance Report 2020 (Banking on Climate Change, Issue.
http://priceofoil.org/content/uploads/2020/03/Banking_on_
Kolbel, J. F., Heeb, F., Peaetzold, F., & Busch, T. (2019). Can
Climate_Change_2020.pdf
Sustainable Investing Save the World? Reviewing the Mech­
anisms of Investor Impact. SSRN Electronic Journal. https://
SustainAbility. (2019). Rate the Raters 2019: Expert Views
doi.org/http://dx.doi.org/10.2139/ssrn.3289544
on ESG Ratings. https://sustainability.com/wp-content/
uploads/2019/02/SA-RateTheRaters-2019-1. pdf
Nordea. (2020, Oct 29 2020). The sustainable loan mar-
ket: A snapshot of recent developments. Retrieved Apr 30
Zhou, X. C., Ben; Hoepner, Andreas; Wang, Yao. (2020).
2021 from https://insights.nordea.com/en/sustainability/
Bank Green Lending and Credit Risk. Social Science
sustainable-loan-market/
Research Network (SSRN). https://doi.org/http://dx.doi.
Rainforest Action Network, BankTrack, Indigenous Environ­ org/10.2139/ssrn.3618744
mental Network, Oil Change International, Reclaim Finance,

Chapter 5 Green and Sustainable Finance: Markets and Instruments ■ 119

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

QUESTIONS
5.1 What is the difference between sustainable and green 5.4 What makes a sustainability-linked bond different
finance? from a green bond?

A. Sustainable finance complies with the TCFD,
whereas green finance complies with the E.U.
Taxonomy.
B. Sustainable finance refers to finance tied to
sustainability targets, whereas green finance is
general-purpose corporate financing.
C. Sustainable finance includes finance targeted
at any number of environmental or social goals,
whereas green finance refers only to environmental
goals.
D. Sustainable finance is for the Sustainable Develop­
ment Goals, whereas green finance is directed at
reforestation.
5.5 How are ESG ratings typically used?
5.2 Which type of organization is responsible for the
greatest share of all climate finance flows?
A. Private-sector banks
A. A sustainability-linked bond must always be tied to
an SDG.
B. A sustainability-linked bond must be underwritten
by a bank, whereas a green bond can be under­
written by any counterparty.
C. A sustainability-linked bond must be linked to a
particular project, whereas a green bond is general
purpose.
D. A sustainability-linked bond has its coupon linked
to the achievement of specific sustainability
targets, whereas a green bond's use of proceeds
must be earmarked.
A. ESG ratings are used to determine which
companies should be included in a sustainable
equity fund.

B. Private-sector, non-financial corporations B. ESG ratings are used to determine which

companies are eligible to issue green bonds.
C. Governments

D. Public-sector development banks

C. ESG ratings are used to determine which
companies are considered investment grade.
5.3 What characteristics separate a green bond from
D. ESG ratings are used only by financial companies
"standard' bonds"?
to integrate ESG factors.
A. Green bond funding must be for climate change
mitigation, whereas standard bonds have no usage
5.6 What is shareholder engagement when discussed in
a sustainable finance context?
limitations.
A. Shareholder engagement is when shareholders
B. Green bond funding must be for environmen­
speak with company management to complain
tal purposes, whereas standard bonds have no
about falling profit margins and poor revenue
limitations.
growth.
C. Green bonds do not require external ratings,
B. Shareholder engagement is when shareholders
whereas standard bonds do.
meet with various employees at an investee com­
D. Green bonds do not require "use of proceeds"
pany to get a better sense of why the company
disclosure, whereas standard bonds must disclose
performance is at its current level.
funding use in advance.

120 ■ Sustainability and Climate Risk Exam

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

C. Shareholder engagement is when investors engage
with company management to pressure them to
adopt sustainable business practices and align with
international sustainability goals.
D. Shareholder engagement is when shareholders
coordinate to organize a leveraged buyout of
a company.
B. The EU Taxonomy defines which types of economic
activities, by sector and subsector, count as sus­
tainable, with specific thresholds and conditions.
C. The EU Taxonomy defines which types of finan­
cial instruments are sustainable, with separate
conditions for green bonds, green loans, and
sustainability-linked bonds and loans.

5.7 What is the EU Taxonomy and how does it define D. The EU Taxonomy defines which types of
sustainability? financing are excluded from eligibility for public­
sector climate change adaptation and mitigation
A. The EU Taxonomy defines which types of compa­
funds.
nies must report which types of ESG information,
with public-interest companies required to adhere
to TCFD recommendations.

Chapter 5 Green and Sustainable Finance: Markets and Instruments ■ 121

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

ANSWERS
5.1 C 5.5 A

5.2 D 5.6 C
5.3 B 5.7 B

5.4 D

122 ■ Sustainability and Climate Risk Exam

Climate Risk
Measurement and
Management
■ Learning Objectives
After reviewing this chapter, you should be able to:
• Explain how climate risk manifests as financial risk
through micro and macro economic transmission
channels.
• Describe how climate risk affects company-level
risks including operational, credit, liquidity, and
underwriting risks, and whether these risk types pose
macro-level risks.
• Understand the associated risk metrics for and com­
ponents of each risk type.
Examine the effects of climate risk on micro
(company-level) risks such as operational, credit,
liquidity, and insurance.
• Understand transmission channels of climate risk,
and how related systemic risks potentially threaten
financial stability.
• Describe CVaR and its uses.
• Describe the data types, analytical tools, and their
sources to measure transition and physical risks at the
company-level.
• Understand how to measure transition and physical
risks at the portfolio level.
• Examine how climate risk drivers can be incorporated
into existing enterprise risk management (ERM)
frameworks.
• Discuss how ERM frameworks are used in practice
using case studies and examples.
123

This chapter describes how climate risk, both physi­
cal and transition risk, is measured and managed, ((as
described in Chapter 3). After an introduction, this
chapter covers in detail how climate risk transmits
into more traditional risk categories at the company
level, including operational risk, credit risk, liquidity
risk, and underwriting risk. It then covers how climate
risk can be a systemic risk with potential threat to
financial stability, transmitting either through one of
the previously mentioned channels or through mar­
ket dislocations (market risk) or effects on countries
(sovereign risk).
The chapter goes on to describe available data and
analytical tools for measuring both physical and transi­
tion risks, building on material from Chapter 3. Finally,
this chapter examines how climate risk can be, and
is being integrated into existing enterprise risk man­
agement (ERM) processes, ranging from governance
structures and strategy setting to risk evaluation and
disclosure. The material in this chapter sets the stage
for Chapter 7, which builds on these topics by looking
specifically at the application of scenario analysis to
climate risk management.
Chapter Outline
6.1 Introduction to Climate Risk Measurement and
Management
6.2 Introducing Climate Risk Transmission: Micro and
Macro Level
6.3 Micro (Company-Level) Climate Risks
6.4 Macro Climate Risk: Systemic Risk and Financial Stability
6.5 Climate Risk Measurement: Data and Analysis
6.6 Climate Risk within Enterprise Risk Management (ERM)
6.7 Conclusions
Key Learning Points
• Measuring and defining climate risk is a prerequisite for
being able to manage it-even more acutely so than for
many other kinds of risks.
• Climate risk affects many company-level risks, including
operational, credit, liquidity, and underwriting risks.
124 ■ Sustainability and Climate Risk Exam
• Climate risk can also constitute a systemic risk and a
potential threat to financial stability through its impacts
on entire sectors and swathes of the economy.
• Corporate greenhouse gas emissions are classified by
scope. The classifications are as follows: Scope 1 (direct
emissions), Scope 2 (emissions from energy inputted)
and Scope 3 (indirect emissions from supply chains and
products).
• Understanding transition risks requires data beyond
current emissions, notably on emission trajectories, as
well as data on a number of drivers ranging from policy
and technological changes to consumer preferences and
market sentiment.
• Physical risks can be analyzed at the asset level, or, for
ease of use, through company-level scores. Asset­
level analysis is more thorough but also more difficult;
scores are easier to use and integrate but can some­
times suffer from methodological opacity or lack of
cross-comparability between providers.
• Climate risk can be integrated into enterprise risk man­
agement in all its facets. This includes risk governance,
strategy, risk assessment, review, and disclosure.
CLIMATE RISK MEASUREMENT
AND MANAGEMENT
6.1 Introduction to Climate Risk
Measurement and Management
Risk management is a structured approach to monitoring,
measuring, and managing exposures to reduce the potential
impacts of uncertain occurrences. It has long been practiced
by non-financial corporations and financial institutions alike.
As with other kinds of risks, climate risk management, when
practiced proactively, can help mitigate the impacts of climate
change, both from physical impacts and transition impacts, on
a financial institution's portfolio or corporation's operations.
To understand and manage climate risk, it is helpful to
examine how climate risk affects various types of financial
risk, such as operational, market, insurance, liquidity, and
credit risk. This is not only because risk managers are more
familiar with these "traditional" categories of risk, but rather
because climate change transmits through these various
types of risk. Understanding these transmission channels
is therefore crucial for understanding the risks created by
climate change. For analytical clarity, this chapter starts by
looking at company-level "micro" climate risk transmission
(Section 6.2) and then goes on to discuss climate change as
a macro phenomenon, with the potential to be a source of
systemic risk and a threat to financial stability (Section 6.3).
The old cliche that "You can only manage what you can
measure" is just as true for climate risk as it is for other
types of risk. However, compared to other types of risk,
accurately measuring climate risks often requires a much
greater variety of data. Understanding transition risk not
only requires solid data on the amount of greenhouse gas
emissions attributable to a particular company or asset
but also an understanding of the evolving climate policy
landscape, technological changes, and evolving consumer
and broader societal preferences, as well as market senti­
ment. Understanding physical risk requires forward-looking
climate models and historical weather data, as well as
information on physical geography, adaptive infrastructure,
market responses, cross-correlations, and distributions (see
schematic for an example, and Section 6.4 for details).

EXAMPLE: DATA FOR UNDERSTANDING PHYSICAL RISK TRANSMISSION

INTO FINANCIAL PORTFOLIOS
This visual shows the generalized transmission chain of
physical risk into financial assets, as presented for the US
mortgage market in Chapter 3. It highlights the different
types of data and information needed to account for,
measure and manage climate risk in a financial context.
Weather and climate data and models are needed to
understand the physical hazards; topographical maps and
geolocation data are required to understand exposure;
and data on flood defenses and other adaptive measures
are important for ingunderstanding vulnerability.
In jurisdictions where mortgages tend to be retained
on bank balance sheets, banks need access to this
information to track their risk exposure and conduct
risk management. In jurisdictions such as the United
States, where mortgages tend to be securitized and sold
onwards in financial markets, this adds an additional
layer of complexity. Ultimately, end investors need
access to climate risk exposure data to be able to
adequately gauge the riskiness of their holdings.
Source: Author.
Legend:

D Physical hazards

■ Cross-correlation Real economy

• Weather data
■ Empirical data on in portfolio
■ Climate price effects of sea
models/projections ■ Duration of Financial system
level exposure
exposures
■ Geographic
variation

► ► ► ►
COASTAL BANKS
Sea level PROPERTIES MARKETS
rise & Effects on
more Lower Effects on
Greater risk residential
frequent property mortgage
of current, and
storms values securitization
future commercial and mortgage-
flooding property backed assets
mortgages

• Topographical
maps • Distribution of risk
• Data on flood ■ Disclosure I access to
defenses granular data

WH'iii·I•
Chapter 6 Climate Risk Measurement and Management ■ 125
6.2 Introducing Climate Risk
Transmission: Micro and Macro Level
Climate risk drivers can transmit to financial risk through
a number of risk types, ranging from operational risk and
credit risk to market risk. This section contextualizes the clas­
sification of these risks before the transmission channels are
covered in much more detail in Section 6.3 and Section 6.4.
Many classification schemes of climate risk transmission
channels come from central banks (and umbrella organiza­
tions made up of them, such as the Basel Committee on
Banking Supervision or the Network for Greening the Finan­
cial System). Given these institutions' focus on the health
of the macroeconomy, including maintaining price stability
and employment, their schemes distinguish between micro­
economic, macroeconomic, and financial consequences and
drivers (see Figure 6.2).
The NGFS schematic clearly shows how both transition
and physical climate risks can cause microeconomic and
macroeconomic effects. At the micro level, individual firms
and households can be impacted by property damage,
business interruption, loss of income, changes in demand,
and declines in asset valuation through asset stranding. The
macroeconomy can be affected by shifts in prices, changes
in productivity, socioeconomic changes, or labor-market fric­
tions. All of these can then cause financial risks to manifest.
However, the micro- and macroeconomic split, with finan­
cial risk relegated to a separate category, de-emphasizes
the impacts on the broader financial system, as well as any
feedback effects between it and the economy.
This chapter's focus is on corporations with less empha­
sis on households or on the macroeconomy. Section 6.3
focuses on company-specific risks, whereas Section 6.4
combines macroeconomic risks with systemic risks and
those that potentially threaten financial stability. The
following section focuses on six main risk categories,
some primarily at the company- or macro-level and others
affecting markets. The summary table below highlights
these risks, which are then analyzed in greater detail in
the following sections.

Environment- and
Economic transmission channels
climate-related risks
Transition risks Micro Credit risks
• Policy and regulation Affecting individual businesses and households • Defaults by businesses

..,I
• Technology and households
Businesses Households • Collateral depreciation
development
• Property damage and business • Loss of income (from weather
• Consumer preferences
disruption from severe weather disruption and health impacts, Market risks
• Stranded assets and new capital labour market frictions) • Repricing of equities,
expenditure due to transition • Property damage (from severe fixed income, I C
• Changing demand and costs
• Legal liability (from failure to
weather) or restrictions (from
low-carbon policies) increasing
commodities etc. I .Q
l!l
mitigate or adapt) costs and affecting valuations
Underwriting risk I u
C

• Increased insured losses I E

Physical risks Macro • Increased insurance gap
I t"'
Aggregate impacts on the macroeconomy
• Chronic
(e.g. temperature,
I ·c;
C
precipitation,
• Capital depreciation and increased investment
• Shifts in prices (from structural changes, supply shocks)
Operational risk I C
u::
agricultural
productivity,
• Productivity changes (from severe heat, diversion of investment to
• Supply chain disruption
• Forced facility closure
I
sea levels)
mitigation and adaptation, higher risk aversion)
• Labour market frictions (from physical and transition risks)
I
• Acute (e.g. heatwaves,
• Socioeconomic changes (from changing consumption patterns, �
floods, cyclones Liquidity risk
migration, conflict)
and wildfires) • Increased demand for
• Other impacts on international trade, government revenues, fiscal
space, output, interest rates and exchange rates. liquidity
• Refinancing risk

t ______________ j" t ______________ j"

Environment & climate and economy feedback effects Economy and financial system feedback effects

From A call for action: Climate change as a source of financial risk, April 2019. Reprinted with permission of the Network
for Greening the Financial System.

Wl'ilJ•fJ
126 ■ Sustainability and Climate Risk Exam
1fflMl·I•
Micro-level: How do climate risk
drivers cause company-specific
Risk Type Risk Metrics risks?
Operational risk • Proportion of facilities Physical risk leading to more frequent,
in risky areas more severe extreme weather can
cause property damage and business
• Level of company
interruption, both to a business' own
preparedness facilities and to supply chains. Heat can
also affect worker productivity.
Macro-level: Potential for
climate to cause systemic /
financial stability risk?
LIMITED-The likelihood of
risks occurring increases when
a sector exhibits high geo-
graphic concentration.

Transition risk can transmit to

operational risk in case of abrupt
policy changes leading to facility
shutdowns.

Credit risk • Probability of default Physical risk causing property dam- SIGNIFICANT-Sector-wide
(PD) age and business interruption can asset stranding or changes
lead to loss of revenues and lower in demand can impact sec-
• Loss given default
profits, worsening a firm's financial tor revenues and increase
(LGD) position and increasing probability of sector-level PD, posing finan-
• Exposure at default default. cial stability risks in the case
of important sectors and for
(EAD) Transition risk causing asset strand-
exposed financial institutions.
ing can worsen a firm's financial
position, increasing its probability of
default, ands well as increasing the
loss given default for a lender given
the lower asset valuations.

Liquidity risk • Loan-to-deposit ratio Abrupt physical and transition SIGNIFICANT-A "climate
(banks) risk-related events such as natural Minsky moment" could cause
disasters or abrupt policy changes abrupt and wide enough
• Liquidity ratios
can prompt sharp repricing and sud- repricing and dislocation to
• Bid-ask spread den market re-evaluation of firms' constitute a market liquidity
(markets) viability, leading to liquidity shocks. shock.
This can lead to widening of bid-ask
spreads. Abrupt climate events can
prompt large demand for deposit
withdrawals at banks, raising their
loan-to-deposit ratios.

Underwriting/ • [Change in] insurance Physical risk can lead to higher insur-
insurance risk premiums ance premiums for corporations,
or, in more severe cases, for certain
• Availability of insurance
facilities in extremely vulnerable
areas to become uninsurable, with no
insurance available.
SIGNIFICANT-If a number
of insurers withdraw or refuse
coverage, this might leave
firms completely without cov-
erage, potentially amplifying
risks to financial stability.

Transition risk can lead to less insur-

ranee availability. as some insurers
refuse to underwrite certain kinds of
activities and facilities, such as thermal
coal power plants.

(continued)

Chapter 6 Climate Risk Measurement and Management ■ 127

 Micro-level: How do climate risk Macro-level: Potential for
drivers cause company-specific climate to cause systemic /
Risk Type Risk Metrics risks? financial stability risk?

Market risk • [Weighted average]
carbon intensity
• [Climate] Value at Risk
• Portfolio risk scores
Physical and transition risk can
become more widely incorporated
in asset prices, both through abrupt
repricing as well as more gradu-
ally. Large-scale shifts in input and
product markets affect non-financial
corporations. Shifts in asset prices
increase the risk of financial institu-
tions' portfolios.
SIGNIFICANT-Climate risk
is expected to produce sector
and market-wide repricing of
many, if not most assets and
commodities, causing disloca-
tion and potential systemic
risk.

Sovereign risk • Proportion of budget
revenues from fossil
fuels
• Vulnerability to physical
climate risks
Physical risk can cause countries that
are particularly vulnerable, such as
Bangladesh, to have higher costs of
damage and lower GDP growth, ham-
pering long-term ability to repay debt.
Transition risk can heavily affect
countries reliant on fossil-fuel produc-
tion for a substantial proportion of
GDP and of government tax revenue.
MIXED-Many countries
have diversified economies
and geographies, but some
countries are heavily exposed
to physical or transition risk
and are likely to be severely
affected.

6.3 Micro (Company-Level) Climate
Risks
An important way in which climate risk manifests as
financial risk is through its effects on microeconomic
company-level risks such as operational, credit, liquidity,
and insurance risk, each of which are examined in turn
in this section. (Some of these channels can also pose a
systemic risk, which is discussed in Section 6.4 along with
other transmission channels).
6.3. 1 Operational Risk
in vulnerable locations and various measures of company
preparedness against external risks Climate models com­
bined with detailed data can allow at least some degree of
anticipation on what physical facilities will be affected by
these external risks.
One of the strongest effects of climate risk on operational
risk is through its effect on external risk. Acute climate
change hazards, such as wildfires or floods or chronic cli­
mate hazards, such as sea level rise, can damage or destroy
the factories, supply lines, or warehouses needed by a cor­
poration or the offices, data centers, or bank branches of a
financial institution.

Operational risk is the risk inherent in doing business, and
it reflects potential losses from inadequate or failed internal
processes, systems, human error, or outside events such as
extreme weather or terrorist attacks. These various causes
of operational risk can be classified into external risk (from
outside events), systems risk; people risk (from human
error); internal process risk, as well as legal, strategic, and
reputational risks.
Since operational risk is multifacted, it can be more difficult
to measure, but metrics include the proportion of facilities
To the extent that climate risk transmits into systems risk, it
does so in ways similar to external risk. For example, physi­
cal climate hazards such as floods or fireswild can destroy
data centers, causing systems risk to a both financial and
non-financial corporations.
Climate risk can manifest through people risk in a few differ­
ent ways. Inadequate staff training or management's lack of
attention toward physical and transition climate effects can
lead to these issues being ignored or underplayed within
an institution's operations, potentially leading to losses.

128 ■ Sustainability and Climate Risk Exam

Another way climate risk can transmit to people risk is
more direct-through the harmful effects of excess heat on
worker productivity and acuity (see ILO research mentioned
in Chapter 3).
Transmission of climate risk into internal process risk is simi­
lar to that for people risk-if a company's internal processes
and procedures do not take sufficient account of climate
risk, it can end up affecting portfolios and facilities more
deeply than anticipated.
Three other categories of operational risk are particularly
important when analyzing climate risk. One of these cat­
egories is legal risk. As described in much greater detail in
Chapter 3, legal and liability risk can end up significantly
affecting financial institutions and non-financial corporations
if they are held liable for a) neglecting to manage climate
risks, b) failing to adequately disclose their exposures to
such risks, or c) contributing to climate change. Another
category is strategic risk, where poor business decisions
around failing to align business practices with the net-
zero transition or adapt to the physical impacts of climate
change can cause significant risks. The third category is rep­
utational risk, which can severely affect institutions working
with "dirty" industries that come to be seen as having lost
their social license to operate (see the example on Goldman
Sachs in Chapter 3).
6.3.2 Credit Risk
Credit risk measures the creditworthiness or ability a bor­
rower has to pay back a loan.
Key metrics for gauging credit risk include the probability
of default (PD) and the loss given default (LGD) (i.e., the
proportion of value recovered after a default). The third key
metric used under the for banks is exposure at default (EAD).
We focus primarily on PD, as this is the most general mea­
sure of credit risk and it is applicable beyond banks (e.g., to
bond markets). LGD is expected to be highly sector-specific

VISUALIZATION OF CLIMATE AFFECTING OPERATIONAL RISK AND ITS

SUBC OMPONENTS

Climate Change OPERATIONAL RISK

Physical impacts

Internal process risk

Increased temperature
and heatwaves
Diminished worker
productivity [ Systems risk
]
More frequent floods,
storms, hurricanes
Business and supply
chain interruption
[ People risk
]
Transition impacts
Facility shutdowns
External risk
Abrupt policy shifts

iif!jij#J-5€1

Chapter 6 Climate Risk Measurement and Management ■ 129

 Impact of climate
½
transition risk
Distribution of asset
value of a borrower
Reprinted with permission of the United Nations Environment Programme.
bi!jiiii·i•
and requires high degrees of customization (ed assessment
(UNEP Finance Initiative, 2018). In general, climate risk is
expected to shift the entire PD risk distribution of a bor­
rower (see Figure 6.4, labeled for transition risk but appli­
cable for all types of climate risk).
One important transmission channel from climate to credit
risk runs through operational risk. A company whose fac­
tories, warehouses, or supply chains are particularly vulner­
able to extreme weather impacts (physical risk) or to abrupt
policy changes (transition risk) will have greater business
interruption, resulting in a loss of revenues and profits. Fur­
thermore, it weakens the company's ability to repay loans
compared to a similar company that is not exposed, thus
translating into increased PD and credit risk for a lender.
Project finance tied to a vulnerable asset, such as a ware­
house at risk of flooding, would be subject to even higher
PD and LGD than the exposure of an entire company own­
ing a mix of vulnerable and non-vulnerable assets.
Another important channel operates through valuation
effects; that is, asset stranding (as covered in Chapter 3). If
a company's core assets fall in value or even become worth­
less, this significantly affects the financial health of the firm.
With less valuable assets, a company's liabilities suddenly
weigh a lot heavier on its balance sheets and make it more
likely that the company will default on future debts and that
LGD will be greater,not to mention that the company will
also hasve less collateral to use to secure funding. The asset
stranding can be due to physical risk, such as a warehouse
in a flood prone area with a much lower resale value, or due
130 ■ Sustainability and Climate Risk Exam
Climate-adjusted PD
�
Original PD
to transition risk, if a company's high emissions factory is hit
with a regulatory shutdown mandate or a higher carbon tax.
The oil & gas sector is a good example of a sector that
has been hit by the stranded asset transmission channel.
Historically, much of the value of such firms has been
in their reserves and the expectation of their consistent
or growing revenues. The fact that many of these firms'
assets may become stranded because oil demand is
expected to fall means that these firms may become less
creditworthy than they would in the absence of climate
change. (Of course, there are still differences within the
sector-for instance, oil companies with very low extrac­
tion costs on their reserves will tend to have a smaller
proportion of stranded assets than companies with
assets that are more expensive to extract.)
A final, related channel is that of pricing effects-both
through markets for inputs (raw materials) and outputs
(products). If climate risk causes a company's raw materials
to become more expensive, or makes its products less valu­
able, this, too, can increase its credit risk. Pricing effects can
also work the other way and reduce a company's credit risk.
For instance, companies in the mining sector that extract
minerals important for mass electrification, such as copper
for wiring or lithium for lithium-ion batteries, can benefit
from higher prices of these commodities, make greater rev­
enues and profits, and become more creditworthy than they
would have been without climate change.
Policy considerations regarding the rise of credit risk due
to climate risk are being increasingly incorporated by major
credit ratings agencies, which serve as important arbiters of
credit risk for financial markets. In January 2021, S&P, one
of the three major rating agencies, revised its entire out­
look on the oil & gas industry due to "significant challenges
and uncertainties engendered by the energy transition,
including market declines due to growth of renewables,"
and shortly afterwards &P downgraded oil companies by
one notch: Exxonmobil and Chevron to AA- from AA and
ConocoPhillips to A- from A. (S&P Global Ratings, 2021).
The rise of sustainability-linked bonds and loans, as dis­
cussed in Chapter 5, can also be seen as an example of the
financial industry internalizing the linkage between credit
risk and sustainability performance. Offering a lower rate
on a loan or lowering the coupon on a bond that an issuer
must pay in return for meeting sustainability targets, as
these instruments do, implies that poor performance raises
credit risk.
6.3.3 Firm-Specific Liquidity Risk
Liquidity risk is about losing access to liquidity-the abil-
ity to quickly and easily convert assets into cash. For banks,
liquidity risk means something very specific, as banks' busi­
ness models are based on liquidity transformation: Banks
take on short-term deposits and underwrite long-term loans.
Key metrics for liquidity risk include loan-to-deposit ratios
(specifically for banks) and bid-ask spreads (specifically for
markets; also see Section 6.4.3).
Banks are particularly affected by climate risk since liquidity
is of critical importance. Climate risk drivers can prompt
depositors to draw down deposits and debtors to draw
down credit lines at the same time, dramatically increasing
loan-to-deposit ratios.
Some empirical evidence suggests that this occurs due to
physical climate risks, specifically in the wake of natural
disasters, as households and corporations withdraw depos­
its and draw on credit lines to finance cash-flow needs for
recovery. This combination puts pressure on banks' liquidity
and can lead to crystallized liquidity risks (Basel Commit­
tee on Banking Supervision, 2021). This phenomenon could
potentially affect other types of financial firms as well. For
instance, if abrupt climate-related drivers prompt inves­
tors to liquidate their fund holdings at the same time as
climate drivers are causing market dislocations, this could
cause some asset managers to suffer liquidity risk. (Market
Chapter 6
dislocations are a more meaningful source of risk through
their macro effects, their impacts on financial stability ands
well as the potential for "Minsky moments,", all of which
are discussed in Section 6.4).
For an individual non-financial company, liquidity risk only
manifests as a consequence of climate risk under specific
circumstances. An acute climate-related event, such as a
major hurricane devastating a firm's operations and under­
lining its lack of preparedness, or a fine imposed by authori­
ties for non-compliance with carbon emissions regulations,
leads investors and lenders to reassess their view of a firm's
viability so suddenly and abruptly that the firm has trouble
accessing liquidity. However, under most circumstances
and given the gradual pace of climate change, it is more
likely that climate risk filters through to companies more
gradually through increased credit risk rather than abruptly
through liquidity risk. Increased investor awareness of risks,
and increasing manifestation of climate risk, leads to higher
credit risk and thus higher cost of capital for a firm.
6.3.4 Underwriting Risk
Although underwriting risk only directly affects the insur­
ance sector, it is still important to single it out as a type of
risk affected by climate risk, especially physical climate risk,
as many other corporations and financial institutions rely on
insurance coverage as a crucial part of their risk-mitigation
strategies.
Key metrics to gauge underwriting risk from a corporation's
perspective are changes in insurance premiums and the
availability of insurance. The insurance industry itself uses a
variety of metrics and models to arrive at estimates of the
riskiness of the entities it insures, many of which are propri­
etary and not the focus here.
Insurance works best when a large pool of participants
(motorists, corporations, homeowners, etc.) all have a small,
and close-to-equal, chance of being struck by misfortune,
and when these accidents or other losses follow predictable
patterns discernible from historical data. Climate risk, partic­
ularly those related to physical impacts, present a challenge
as they can become highly concentrated. This concentration
can result in underwriting damages to facilities and proper­
ties in affected areas that are no longer economically viable.
Examples include buildings in low-lying coastal areas subject
to sea level rise and coastal flooding or buildings in wooded
Climate Risk Measurement and Management ■ 131
areas that are becoming drier and hotter due to climate
change and thus more prone to wildfire, such as in California
and parts of Australia. In areas such as these, climate risk
is very concentrated geographically, and it is intensified as
climate change progresses, with events that were previously
rare, such as 1-in-100-year events, becoming much more
common. To provide just one example, the severe heatwave
in France and the Netherlands in 2019 was estimated as a
1-in-50-year event in the current climate, but it would be a
1-in-1000-year event (or even less frequent) in the absence
of climate change (Vautard, 2019). With further warming,
the return period-the period during which such events
are expected to recur (50 years in the above example)-for
these sorts of events will continue to decrease.
For the insurer to break evenover shorter return periods
would require very high premiums; for instance, a ten-year
return period (i.e., a 10% chance of annual occurrence) of a
total destruction event in a specific location would require an
insurance premium of at least 10% of the value of the insured
property. This level of occurrence is not outlandish for many
physical risks. One study found that for an extreme rain
event in Texas equivalent in size to Hurricane Harvey (which
flooded Houston in 2017), the annual probability of occur­
rence was 1% from 1981 to 2000; 6% by 2017, when Harvey
occurred; and 18% by 2081 to 2100 under a worst-case cli­
mate scenario (Emanuel, 2017). An 18% probability of annual
occurrence is the same as a return period of just 5.5 years.
Of course, larger insurers with diversified exposures can and
do cross-subsidize to an extent, but smaller, regional insur­
ers without geographical diversity do not have that luxury.
(Insurers can sometimes offload a portion of their risk to
reinsurers, but these firms are also becoming warier of tak­
ing on additional climate risk.) There are already some anec­
dotal examples of smaller insurers that have gauged the
underwriting risk to be too high and have refused renewals
to homeowners in areas of California hard-hit by climate­
exacerbated wildfires. Most types of insurance available to
individuals or corporations are on one-year renewal cycles,
so insurers can pull coverage with relatively short notice.
Climate transition risk, too, can affect underwriting risk. The
policy, operational, and technological changes required for
a transition to a net-zero economy could cause litigation
against fossil-fuel companies or other emissions-intensive
industries, which could then transmit into insurance through
general liability or "directors and officers" (D&O) policies
132 ■ Sustainability and Climate Risk Exam
through which insurance takes on (at least part of) the finan­
cial risks of a firm being sued.
Underwriting risk increases can also affect other types of
risk. In many cases, such as home or commercial property
mortgages, lending banks require insurance coverage as a
condition of issuing a mortgage. If a company can no longer
obtain insurance coverage for physical damage, business
interruption, or directors' liability, it cannot use insurance as
one of its resilience and buffer mechanisms, which further
increases operational risk. This, in turn, increases its credit
risk from the perspective of a lender.
6.4 Macro Climate Risk: Systemic Risk
and Financial Stability
Because climate change, both through its physical impacts
and policy and societal effects to mitigate emissions and
achieve a zero-carbon transition, is such a broad phenome­
non, it can be a source of systemic risk and potentially pose
a risk to financial stability. Generally, the risk types cov­
ered in Section 6.3 can have systemic effects if they occur
widely enough, and affect entire sectors or swathes of the
economy-each of these is covered briefly in turn (Sections
6.4.1-6.4.4). But there are also other categories of risk that
operate primarily at the systemic and/or macroeconomic
level, such as market risk and sovereign risk.
6.4. 1 Operational Risk
If physical climate impacts cause operational risk to manifest
across a range of companies, this can have ripple effects
across supply chains and through to markets, customers,
and financial counterparties. For operational risk to have
this wide of an effect typically requires a particular set of
circumstances, such as geographic concentration and pinch
points in supply chains. The climate change-exacerbated
Thai floods of 2011, which significantly affected global
semiconductor production and had ripple effects across
supply chains, are a good example of the macro effects of
operational risk. But they only had a macro effect because
so many intermediate components for global semiconduc­
tor manufacturers specifically came from Thailand.
6.4.2 Credit Risk
Increased counterparty credit risk that results from climate
change can directly transmit into the financial sector and
pose a potential threat to financial stability if it occurs broadly
enough. Many climate risk drivers that lead to increased
credit risk at an individual firm can also affect entire sec-
tors. In sectors such as utilities (for those still reliant on fossil
power plants) or oil & gas, sector-wide asset stranding is
expected to occur or has already occurred, which increases
credit risk. Changing demand and cost structures resulting
from climate-related pressures can impact companies' rev­
enues and profits, as can physical climate impacts leading to
business interruption, both of which can lead to widespread
increases in credit risk. For financial institutions heavily
exposed to these sectors, this can pose a risk to the financial
institution's soundness. If exposures run across the financial
sector, increased credit risk at the company level can become
a threat to financial stability.
6.4.3 Liquidity Risk
As examined above, banks are also particularly affected by
climate risk impacts on liquidity. Given the wide reach and
potential severity of climate impacts, it is possible for liquid­
ity risk to be a source of systemic risk to the banking sector
and to therefore threaten financial stability. If enough house­
holds, corporations, and financial firms sharply increase their
demand for precautionary liquidity after a severe natural
disaster, this can be at a systemic enough scale to neces­
sitate intervention by the central bank. A good example of
the potential for this kind of course of events comes from
the aftermath of the large Japanese earthquake in March
2011-admittedly not a climate-related natural disaster, but
comparable to one. After the shock, the Bank of Japan (BoJ)
had to offer record amounts of liquidity to Japanese banks
to ensure stability in the markets: On the first business day
after the earthquake, the BoJ offered funds totaling
21.8 trillion yen, nearly three times the maximum daily
liquidity during the 2007-2009 financial crisis (Basel Com­
mittee on Banking Supervision, 2021).
Another potential concerning source of systemic liquidity risk
would be a "climate Minsky moment." A Minsky moment, in
general, is a sudden, major collapse of asset values. In 2016,
Mark Carney, then Governor of the Bank of England, warned
of the potential for a climate Minsky moment in the case of a
wholesale, abrupt and broad-based re-evaluation of climate
risks by markets, causing massive repricing of assets and a
pro-cyclical crystallization of losses (Carney, 2016). If severe
enough, such a climate Minsky moment could provoke a
Chapter 6
market-wide liquidity crunch like the shock of the global
financial crisis of 2008, if not greater.
However, it is worth noting that large-scale dislocations and
repricings resulting from climate risk are expected to be a
problem even if they do not occur suddenly enough to con­
stitute a Minsky moment and a liquidity shock. These kinds
of market changes are classified under market risk rather
than liquidity risk (see Section 6.4.5).
6.4.4 Insurance Risk
Insurance risks, particularly the specter of uninsurability, in
cases where the insurers deem climate risks to be too great
to underwrite, can have systemic effects. Even if insurers
are acting individually to reduce their exposure to climate­
related risks, these actions, taken collectively, could have
negative consequences for the financial system as a whole.
If large numbers of insurers significantly increase premiums
or completely withdraw their coverage of certain climate­
related risks, this might leave households and firms with­
out coverage, potentially amplifying the resulting risks to
finanancial stability (FSB, 2020).
6.4.5 Market Risk
At the systemic level, climate risk translates into market risk
through repricing and dislocation effects as well as through
asset stranding. The repricing effect is an important channel
through which physical or transition risks that are antici­
pated but not yet realized can more quickly and tangibly
have an impact on asset prices, whether they are physical
assets such as housing or financial assets such as shares and
bonds. The research by Bernstein and co-authors cited in
Chapter 3 shows how sea level rise and coastal flooding risk
transmits into, and is reflected in, US coastal property prices
today, with discounts ranging from 14.7% for properties
exposed at 1 ft (0.3m) of sea level rise to 4% for properties
exposed at 6 ft (1.8m) (Bernstein et al., 2019).
Of more concern to most market actors, however, are quicker,
more abrupt pricing shocks and increased volatility. These are
reflected in key metrics such as Value at Risk (VaR), or the
climate version thereof, climate VaR (see CVaR box). Other
metrics are useful for individual institutions to gauge their
own exposure to climate-related market risk, such as the
weighted average carbon intensity of a portfolio, which is a
proxy for transition risk exposure, or portfolio-level physical
risk scores (see also next section, Section 6.5).
Climate Risk Measurement and Management ■ 133
 CLIMATE VALUE AT RISK (CVaR)
Standard Value at Risk is a metric for quantifying the adapted by at /east one data provider to look specifically
level of financial risk in a firm, a portfolio, or a given at climate risk.
investment, and it is meant to give an estimate of a bad
MSC/, a data provider, sells a commercial tool called "Cli­
outcome. A standard way of calculating VaR is to take
mate Value at Risk," which, like standard VaR, is meant
an estimated profit-and-loss probability density curve of
to capture a rough estimate of climate-related financial
an investment or portfolio and then look at the lowest
losses. While the MSC/ methodology is proprietary, the
5% of the distribution to estimate tail risk. VaR is use-
firm does disclose that it includes both transition and
ful for its cross-comparability across different types of
physical risks as we// as economic data and company­
investments although it is sensitive to the data used to
/eve/ data. Climate risk, on both the transition and
construct it. For example, if the probability distribution is
physical side, is calculated as a combination of hazards,
constructed using data from a period of low volatility, it
vulnerability, and exposure that is converted into mon­
can be unrealistically "optimistic" and even the 5% cutoff
etary amounts using a financial valuation model. Aggre­
does not show a particularly significant loss. Because of
gated at the sector level, CVaR shows that construction,
its relation to market volatility, however, VaR is one of
coal, and electrical utilities are the most exposed sector­
the best metrics of market risk and has therefore been sto a combination of physical and transition risks.

Climate VaR spread by primary sectors of activity

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Adapted from MSC/ "Climate Value-at-Risk POWERING BETTER INVESTMENT

DECISIONS FOR A BETTER WORLD."

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134 ■ Sustainability and Climate Risk Exam

Climate risk drivers, both physical and transition risk, can
reveal new information about future conditions, precipitat­
ing downward price shocks and increases in market volatil­
ity in traded assets. It is also possible that climate risk could
lead to a (partial) breakdown of typical correlation pattern
between assets, reducing the effectiveness of hedges and
challenging banks' abilities to actively manage their risks.
The empirical evidence, while mixed, suggests that climate
risk is not yet priced into many asset classes (Basel Commit­
tee on Banking Supervision, 2021).
As and when climate risk drivers become priced in, it is
likely that there will be less potential for unexpected price
movements or volatility. Climate risk incorporation into
asset prices might also reduce risks to financial stability.
That said, it may also end up serving to illustrate that risks
are concentrated in certain parts of the financial system,
which could in fact increase the threat to financial stability,
particularly if it triggers amplifying behaviors among finan­
cial institutions (FSB, 2020).
It is also important to note that even if abrupt repricing has
been relatively infrequent so far, this is partly due to the
insufficiency of both governments' and companies' actions
° (Manley, 2017). A scenario-based study using modeling to
for reaching commitments such as the Paris 2 C target.
Many experts expect much more severe repricing and
market risk in the years ahead as climate policy tightens.
For instance, the Principles for Responsible Investment has
a project called the "Inevitable Policy Response," which
assumes that as the realities of climate change become
increasingly apparent and urgent, governments, firms, and
others will be forced to act more decisively, and potentially
in quite a rapid, abrupt, and disorderly way. This, in turn,
could have important implications for financial markets and
trigger repricing on much larger scale. (Note that deeper
analysis of different outcomes necessitates scenario-based
analysis, which will be covered in Chapter 7.)
6.4.6 Sovereign Risk
The transmission of climate risk into sovereign risk is exam­
ined here separately due to the unique considerations
involved. On physical risk, evaluating a country starts, as
with a company, with geographical exposures, such as the
presence or proportion of low-lying coastal areas vulnerable
to sea level rise and coastal flooding. But understanding
entire countries also means examining the size and sectoral
Chapter 6 Climate Risk Measurement and Management
composition of their economies, capacity to create adaptive
policies and responses to climate change, debt accessibil-
ity and affordability, and specific policy decisions. Moody's,
one of the top three largest credit ratings agencies, came up
with a physical risk methodology for sovereigns as early as
2016 and found that India, Pakistan, Vietnam, Cambodia, and
much of Central America and sub-Saharan Africa were the
most vulnerable. Academic research from Buhr et al. (2018)
has demonstrated empirically that countries with higher
exposure to physical climate vulnerability do face a higher
cost of capital, by up to 1.17 percentage points (Buhr, 2018).
As for transition risk effects on sovereigns, discussions are
mostly still centered on countries' reliance on fossil fuel
and other carbon-intensive exports. For instance, as tighter
climate policies, new technologies and preference changes
reduce the demand for fossil fuels, this may turn states
heavily reliant on fossil fuel exports into "stranded nations"
(by analogy to stranded assets). If this occurs, fossil-fuel
reserves become commercially unattractive to extract and
a substantial share of national wealth may permanently
lose its value, leading to a massive drop in sovereign cred­
itworthiness and a corresponding increase in sovereign risk
look at the medium-term impact of climate on countries'
GDP per capita, GDP growth, and debt ratios, and thereby
their sovereign credit ratings, predicted that 63 nations will
experience a drop in credit rating by 2030 without emis­
sions reductions (Klusak, 2021 ).
6.5 Climate Risk Measurement: Data
and Analysis
Accurately gauging transition and physical risks requires
multiple types of data as well as appropriate analytical tools
to understand their application to the user's needs (see also
Chapter 7). Transition risk requires, first and foremost, accu­
rate asset-level and company-level data on greenhouse gas
emissions but also data on policy landscapes, technological
changes, and consumer preferences to capture the various
drivers of transition risk as laid out in Chapter 3. Physical
risk requires data on current and future physical hazards,
derived from a combination of historical data and climate
models, topographical data and locational data of assets,
and information on vulnerability and adaptive capacity.
■ 135
6.5. 1 Company-Level Transition Risk Data NGO formerly known as the Carbon Disclosure Project.
These voluntary disclosures are not only typically unaudited
Measuring transition risk starts with measuring greenhouse-gas
but also vary in their breadth and detail. Beyond the many
emissions, which need to be nearly eliminated to reach a net­
companies that do not disclose at all, others disclose only
zero economy. The Greenhouse Gas (GHG) Protocol provides a
Scope 1 and/or Scope 2 emissions. Few firms disclose all of
widely accepted way of categorizing emissions. It defines Scope
the Scope 1, 2, and 3 emissions. To get around the limitations
1 as those emissions resulting directly from a company's opera­
of data availability, some data providers model the predicted
tions; Scope 2 includes upstream emissions from purchased
emissions of non- or partial-disclosing companies on sec­
electricity, heating and cooling; and Scope 3 includes all other
toral data. At the portfolio level, issues of double-counting
upstream emissions from supply chains as well as downstream
also need to be considered; for example, an industrial firm's
emissions resulting from the use, or disposal, of products and
Scope 2 emissions (from purchased electricity) would be
services sold by the company. Sectors vary widely in the propor­
tion of these different kinds of emissions. For instance, almost all counted as part of the electricity utility's Scope 1.

banks' emissions are categorized as Scope 3, as are the majority
of oil & gas firms' emissions (from the combustion of vehicles or
in the power plants of the oil and gas they sell). Meanwhile, utili­
ties have a lot of Scope 1 emissions (see Figure 6.6).
These carbon emissions data (also called corporate carbon
footprints) have some shortcomings. Most data currently
come from self-reporting by companies themselves, through
mechanisms such as an annual questionnaire by CDP, an
But transition risk is not only about current emissions but
also about whether companies have solid and credible
plans to reduce emissions in the future and to ultimately
align their corporate emissions trajectories with national
and international goals, such as alignment with the Paris
°
Agreement 2 C target or the target of net-zero emis­
sions by 2050. Various approaches seek to measure the
degree of corporate alignment. At the corporate level,

BREAKDOWN OF CARBON EMISSIONS WITHIN SECTORS:

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Adapted from Chart 5 Scope 3 of the publication Investor Guide to Carbon Footprinting, published on the 23 of
November 2015 (Kepler Cheuvreux).
GlH'iiJl?i

136 ■ Sustainability and Climate Risk Exam

there are opt-in initiatives, such as the Science-Based
Targets that companies can sign up to as well as exter­
nal parties, such as the Transition Pathway Initiative,
that seek to gauge firms' plans. Various methodologies
have been developed for temperature scores that give
a shorthand way of understanding what level of warm­
ing a company's plans are aligned with. Most of these,
however, examine which climate scenario a company's
CASE STUDY: GLOBAL RESILIENCE INDEX INITIATIVE (GRII)
Accessing data, metrics, and projects on risks can be
incredibly challenging and costly for individual firm. The
Global Resilience Index Initiative (GRII), a new public­
private initiative, is developing a tool which is intended to
fill that gap. Announced at COP26, the initiative aims to
develop an open, standardized set of climate metrics and
data which allows individuals, entities, and governments
SCHEMATIC: DISCLOSURE VS A SSET-LEVEL DATA ON CARBON
FOOTPRINTS
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- ABC Electric Power Inc_
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INVESTMENT/ LENDING
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strategy is aligned with, and thus are covered in greater
detail in Chapter 7.
Combined with new approaches to more accurately measure
carbon footprints without relying on self-disclosure, the use
of asset-level data on specific factories or power plants ulti­
mately provides a lot more granular information on which to
base investment or lending decisions (see Schematic graphic).
to more accurately measure risks to communities, infra­
structure, and ecosystems. At COP27, the initiative
launched the GRII Viewer, a demonstrator which provides
global data on hazards, vulnerability, and exposure under
different climate scenarios. It is currently expected that
the GRII will finalize this tool over the course of the year
and launch a full version at COP28.
New Model
Power plant C
(Wind farm)
�
Corporate-le el disclosure of
\ o Plant-level
v
climate alignment and
\ emissions
phyical/transition risk plans
\ o Plant-level
\ data
\
INVESTMENT/ LENDING
DECISION
Chapter 6 Climate Risk Measurement and Management ■ 137
 This schematic shows how much more granular the new
model of data collection and decision-making is than
the old one for an example firm, ABC Electric Power
Inc. Historically, ABC's shareholders, bondholders, and
bank lenders would have had to rely either on ABC's
own disclosures of emissions or on estimates from
data firms. Increasingly, however, asset-level data is
becoming available at the facility level (in this case at
the power plant level) through data firms, including
through earth observation and satellite data as well as
More sophisticated transition risk analysis typically requires the
use of climate scenarios, which is covered in Chapter 7. But for
the purpose of this chapter, the last important point to men­
tion regarding transition risk is that even data on both emis­
sions and emissions trajectories are not enough without an
understanding of the drivers of transition risk such as policies,
changing technologies, shifts in consumer preferences, and
market sentiment (as discussed in Chapter 3). There are inter­
national agencies, such as the International Energy Agency
(IEA) or International Renewable Energy Agency (IRENA);
specialist consultancies, such as Bloomberg New Energy
Finance or Rystad Energy; and large data firms, such as S&P
Global, that offer quantitative and qualitative data on policies
and new technologies, such as data on pricing of solar mod­
ules or lithium-ion batteries. Some types of data are quite dif­
ficult to come by and valuable to market participants, which
means purchasing information can be quite expensive.
6.5.2 Company-Level Physical Risk Data
The basic data for gauging physical hazards is provided by
global climate models developed by climate scientists for
the periodic reports of the IPCC; an example is the Coupled
Model lntercomparison Project, versions 5 or 6 (CMIPS
and CMIP6). Only some corporations and financial coun­
terparties have the ability and desire to bring the specialist
knowledge in-house to make direct use of these models.
Moreover, for them to be relevant and usable for firms or
investors, the output of the different models must be rec­
onciled and downscaled to give regional or local estimates.
Then, it needs to be combined with exposure and vulner­
ability data (see Schematic: Reaching Physical Risk Esti­
mates). The use of climate models to run different scenarios
is covered in Chapter 7 as part of scenario analysis.
138 ■ Sustainability and Climate Risk Exam
from open source datasets. Meanwhile, corporations
are increasingly expected to disclose not just emissions
but also on alignment and plans for addressing both
transition and physical climate risks. Thus, investors and
lenders can start to make more detailed decisions, such
as relating to project finance of specific plants or at the
corporate level, based on much more sophisticated and
granularized datasets.
Source: Author.
Some physical climate risk tools that are one notch above
simple raw data (e.g., combining climate hazard data with
topographical or vegetation data) are available for free
from governmental or non-profit organizations. Examples
include the dataset from Climate Central on projected sea
level rise, which combines sea level estimates with local
topography; the World Resources lnstitute's (WRI) data on
water stress; and the Max Planck lnstitute's index on wildfire
vulnerability, which combines drought and precipitation
estimates with vegetation cover.
That being said, many physical risk indicators have been
developed by, and are sold by, specialist for-profit consultan­
cies. One recent survey identified eight firms or organizations
that provide investors with physical climate risk analysis tools
of some kind: Acclimatise, Moody's, WRI, Four Twenty Seven
(since acquired by Moody's, the credit rating agency), Car­
bone 4, Carbon Delta (since acquired by MSCI, a data firm),
Mercer, and a collaboration between Ecolab, Trucost, and
Microsoft (ClimlNVEST, 2019). Since the survey, Trucost, a divi­
sion of S&P Global, the ratings and data firm, has also started
selling physical risk data on firms. McKinsey & Co, the global
management consultancy, acquired Vivid Economics and
Planetrics, two other firms that have also worked with inves­
tors on physical risks. Other consultancies beyond these, such
as XDI or South Pole Group, have been hired by investors on
an ad hoc customized basis on issues of physical climate risk,
but they do not provide scores or analysis for broad use.
Company or asset-level physical risk data and scores are argu­
ably the most easily interpretable approach to physical risk
analysis in a way that is accessible to lenders, investors, and
other stakeholders. Although some of the free datasets offer
a high level of geographic precision, the output is fairly unre­
fined (e.g., whether a given location is above or below the
 SCHEMATIC: REACHING PHYSICAL RISK ESTIMATES
Detailed exposure
mapping
Global climate model
o Data on
hazards
o Downscaled
models
Wl'iki·!:1
To reach an understanding of physical risks, global
climate models must be downscaled, both in spatial and
temporal resolution, as they are usually designed for
global use on multi-decadal timescales; then, exposures
2050 coastal flooding line). A real estate tool such as Moody's,
by contrast, allows real estate investors to easily gain a sense
of the exposure of their assets by overlaying the location
of buildings with the tool, which uses normalized numerical
scales to give a sense of the relative severity of extreme pre­
cipitation, hurricane-force winds, sea level rise, water stress,
and heat stress for a given geographical location or address.
Company-level scores, as sold by Four Twenty Seven,
Carbone 4, and Trucost, take this approach a step further.
The competing offerings all combine the proprietary meth­
odologies of downscaling and normalizing climate model
data with detailed facility-level location information of firms,
mainly of those that are publicly listed. By combining data
on climate hazards with the location of companies' factories
and warehouses and an estimate of vulnerability, the physi­
cal climate risk scores can tell investors about the relative
physical risk of investing in, say, Volkswagen as compared
Chapter 6
C
0
.....
:i
0
V)
Physical
risks
must be mapped geographically and combined with
information on vulnerability and resilience to arrive at
an estimate of physical risks.
to Ford or Microsoft without the need to delve deeply into
the climate models themselves or figuring out exactly where
VW or Ford have their factories or Microsoft its data cen­
ters. The scores are normalized on a 0-100 scale, and they
are available both by hazard type, and as an overall score.
These "heavily digested" scores do have their downsides,
however. The proprietary methods and datasets that they
derive from remain a "black box" to the investors who pur­
chase the scores, which is why some investors have opted to
work with "raw" data themselves or construct in-house scores.
Many of these scores also attempt to capture several hazards
in one score, meaning that the weighting and averaging meth­
odology can matter as much to the end result as the underly­
ing raw climate data. Due to the inclusion of different hazards,
different ways of measuring, and different methodologies,
scores from competing providers, or compiled internally by
different financial firms, are not necessarily comparable.
Climate Risk Measurement and Management ■ 139
6.5.3 Portfolio-Level Analysis (Transition
and Physical)
Portfolio-level analysis, as opposed to asset- or firm-level
analysis, is the type of analysis of most relevance to a finan­
cial counterparty, such as a lender or an investor. Under­
standing both transition and physical risk at the portfolio
level can be somewhat different than just understanding the
impact of these risks on a particular firm.
On transition risks, many portfolio-level approaches start
with numbers that are proportional to an amount, either
of an invested amount or of corporate revenues, rather
than simply total absolute emissions. Two common met­
rics are carbon intensity (expressed in tons CO 2e/USD
mil. revenue) and weighted average carbon intensity
(expressed in tons CO2e/USD mil. revenue). Other meth­
odologies pin a temperature or "warming potential"
on an entire portfolio. More risk-based approaches to
transition risk include stress testing (for example, model­
ing how a portfolio reacts to a transition shock such as
a sudden rise in carbon tax). However, most stress test­
ing on climate risks, especially transition risks, is heavily

EXAMPLE: A SIMPLE APPROACH TO PORTFOLIO-LEVEL PHYSICAL RISK

ANALYSIS
One relatively simple way of examining physical risk at
portfolio /eve/ is to look at the best- and worst-in-class
of an index, which the below figure from Moody's ESG
Solutions demonstrates. It shows the physical climate risk,
based on the physical risk exposure of the companies'
underlying assets to floods, heat stress, hurricanes &
typhoons, sea /eve/ rise, water stress and wildfires, as
well as a view of market and supply chain risk based on a
company's industry.
However, in a space that has changed and matured
quickly, most physical climate risk analyses currently use
and compare different climate outcomes and scenarios.

Weight(%)

D 1% □ 2% □ 4% □ 6% □ □ 8% 9%

Carrefour ■ Orange
■

■ I ■
L'Oreal
Vivendi
■
Kering LVMH Sodexo
Michelin D
-:t Airbus Accor ■■
■
Renault
� p eugeot Saint-Gobain
0
■
■
u Bouygues
Ul TechnipFMC □ Nokia .Tate l
..>I.

□
.!!!
Schneider Electric
0
a::: VINCI
V) D Safran
C
0
Essilor International --0
·,:; Pernod Ricard ■ □ Sanofi
•
<I>
Q.
■
Air Liquide
■
ArcelorMittal
Legrand
Veolia Environnement

■
■ Danone Valeo □
ENGIE

Rating

■ LafargeHolcim ■ Best D Below average

Solvay ■ Above average ■ Worst
■ ■ Average

Market & Supply Chain Risk Score

@/ijij.J-1 Best and worst-in class in France's CAC40

Source: Adapted from Moody's "Best and worst-in-class in France's CAC40 taken from GRI_Physical Climate Risk report, 2017."

140 ■ Sustainability and Climate Risk Exam

scenario-based and will be covered more deeply in
Chapter 7.
On physical risks, portfolios made up of individual physical
assets such as buildings or factories can be evaluated as a
whole fairly easily by looking at which assets are exposed to
which hazards using free and commercial tools. But sensibly
aggregating and evaluating portfolio-level physical risk is
difficult for equity or bond portfolios, where there is expo­
sure to entire companies (and all their facilities as well as
all of their supply chains). Some tools do give (rough) esti­
mates of physical hazards in monetary terms: For example,
a framework called "climate Value at Risk (VAR)" from a
company called Carbon Delta, now part of MSCI, gives a
quantitative estimate of the expected financial losses or
gains from climate risks and opportunities. In this way, it
seeks to mimic traditional VAR, a measure used heavily
by financial institutions (especially before the 2008 global
financial crisis).
6.6 Climate Risk within Enterprise Risk
Management
In recent years, the notion of climate risk as an analogous
risk to other types of financial risk, and indeed one that
affects most "traditional" categories of risk, has led to an
interest in managing climate risks proactively.
This has notably been the case with regard to including cli­
mate risk drivers in enterprise risk management (ERM), that
is, comprehensive approaches to managing risk across and
within an organization, such as a large corporation. One of
the most widely used frameworks for ERM was developed by
the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), originally released in 2004 and periodi­
cally updated. The latest version, from 2017, includes actions
and responsibilities across five broad areas, from governance
and strategy to performance, review, and communication,
with subcategories under each (see Figure 6.10). Importantly,

GOVERNANCE
G
STRATEGY &
G
PERFORMANCE
0
REVIEW
0
INFORMATION,
&CULTURE OBJECTIVE-SETTING &REVISION COMMUNICATION
&REPORTING
1. Exercises Board 6. Analyzes Business 10. Identifies Risk 15. Assesses Substantlal 18. Leverages
Risk Oversight Context Change Information
11. Assesses Severity
2. Establishes Operating and Technology
7. Defines Risk Appetite of Risk 16. Reviews Risk
Structures and Performance 19. Communicates
8. Evaluates Alternative 12. Prioritizes Risks
3. Defines Desired Culture Risk Information
Strategies 17. Pursues Improvement
13. Implements Risk
4. Demonstrates In Enterprise Risk 20. Reports on Risk,
9. Formulates Business Responses
Management Culture and
Commitment to Core Objectives
14. Develops Performance
Values
Portfolio View
5. Attracts, Develops and
Retains Capable
lndlvlduals
Reprinted with permission of Committee of Sponsoring Organizations of the Treadway Commission (COSO).

Fi ure 6.10 COSO's Enterprise Risk Management Framework

Chapter 6 Climate Risk Measurement and Management ■ 141

ERM is not considered to simply be a function or a depart­
ment, but consists of "culture, capabilities and practices that
organizations integrate with strategy-setting." Neither is ERM
simply about compiling a list of risks, having internal controls,
or using checklists; rather, COSO argues, it is a holistic modus
operandi across an entire firm (COSO, 2017).
This section is generally structured in line with the COSO
categories, as they are well suited to examining climate risk.
However, other important frameworks are also incorpo­
rated, notably regulatory ones. The TCFD, in particular, has
been a key initiator of framing climate change as a source
of risk (as described in Chapter 3), by promoting disclosure
to investors and other stakeholders and pushing scenario
analysis as a methodological tool (see Chapter 7). Another
prominent example of a regulatory initiative taking action
is the Network for Greening the Financial System (NGFS),
a consortium of central banks and supervisors. At a country
level, some countries have national-level bodies, such as
the Climate Financial Risk Forum (CFRF) in the UK, where
the country's two main financial regulators bring together
industry representatives to share their experiences in managing
climate-related risks and opportunities. The CFRF has helped
categorize and frame the management of climate risk, and this
section also partly draws on CFRF categorizations.
6.6. 1 Risk Governance and Culture
Managing climate risk properly within an institution, as with
managing any other sort of risk, starts with having struc­
tures and staff in place to monitor these risks. Successful
risk governance starts at the highest level, with the board
and senior executives. Effective risk governance can ensure
understanding and diffusion of knowledge as well as genu­
ine accountability at all levels of an institution, and it can
help increase the resilience of a firm.
Best practice governance arrangements tend to involve
multiple layers of employees and internal processes. For
instance, client-facing staff, responsible for new transac­
tions, or portfolio managers, who make allocation deci­
sions, can be tasked with making initial judgments on the
environmental and climate risks of the transactions they are
considering (see ING case study). Climate risk can also be
built into legal and compliance processes. This kind of inte­
gration can supplement and complement formalized inter­
nal risk management procedures and oversight. The TCFD
recommendations on governance have helped prompt
142 ■ Sustainability and Climate Risk Exam
many companies to institute climate risk-governance
structures and to allocate responsibility to specified senior
executives. Firms often disclose these arrangements and,
indeed, promote them as differentiating factors of their
respective firms.
Culture can seem more difficult to pin down; nevertheless,
it is just as important to risk management and climate risk
management, as are specific governance arrangements.
A corporation's culture has been defined by COSO as the
"attitudes, behaviors and understanding about risk[ ...] that
influence the decisions of management and personnel and
reflect the mission, vision and core values of the organiza­
tion" (COSO and WBCSD, 2018). For climate change and
sustainability to be reflected in a company's culture, its mis­
sion and core values should address climate risk drivers: the
tone from senior leadership should convey expectations on
climate, and employee behaviors and initiatives that are in
line with strategic corporate priorities should be welcomed
and encouraged (COSO and WBCSD, 2018).
6.6.2 Strategy and Setting Objectives, Goals,
and Targets
Corporate strategy, that is, high-level decisions on an
organization's priorities and mission, is an important com­
ponent of a holistic ERM approach in general, as well as of
any enterprise's response to climate risk drivers in particular.
An important prerequisite for strategic decisions is strategic
landscape evaluation; this is especially the case in regard to
climate issues . Understanding the full business context on
climate risk requires understanding the external environment
and megatrends, such as the expected physical, societal,
and macroeconomic impacts of climate change. But it also
requires understanding how the inputs, business activities,
and outputs of that particular company are affected by cli­
mate change.
COSO and the World Business Council for Sustainable
Development (WBCSD) have recommended starting with
megatrend analysis and then delving deeper through the use
of tools such as SWOT analysis, impact mapping, and mate­
riality assessment. A SWOT analysis (strengths, weaknesses,
opportunities, threats) uses a two-by-two matrix to compare
the (internal) strengths and weaknesses, (external) opportuni­
ties, and threats an organization is facing, and it is commonly
used for strategic planning (see ING Case Study). In impact
and dependency mapping, impacts and dependencies are
described in terms of stock and flow in relation to various circumstances, materiality assessment allows companies
types of capital, not only financial capital but also natural, to assess the relative importance of various climate risk and
human, and physical capital, among others. Because all other sustainability risk drivers. A common tool is the SASB
organizations face a unique set of challenges based on their materiality assessment framework (covered in Chapter 2).

CASE STUDY: INTEGRATING CLIMATE RISK GOVERNANCE-ING

The large Dutch bank ING has been one of the
forerunners in holistically and deeply integrating climate
change risk into its risk-governance structures. The
current level of integration is described in detail in its
annual report and its Climate Risk Report. Like many
continental European banks, the bank has a two-tiered
board structure. At the supervisory board level, the
risk committee is tasked with oversight of climate risks,
whereas at management board level, the Chief Risk
Officer has this responsibility.
From a credit risk angle, climate risk is within the remit
of the bank's Global Credit & Trading Policy Committee
(GCTP) and its Global Credit Committee-Transaction
Approval (GCC-TA), both of which include the CRO,
CFO, and Head of Wholesale Banking.
Seen horizontally, the bank describes its risk and control
structure as a "three lines of defense" model. Here, front
office staff, including relationship managers and deal
principals who actually negotiate transactions, form the
"first line of defense" and are tasked with identifying
potential environmental risks. Local and regional risk
committees at the bank, as well as regional risk managers,
constitute the "second line of defense," and regular
internal audits provide the "third line" (see graphic).

SB Supervisory board
Level Risk committee �:,
+-'
u
2
t,
�<O
0
Executive Management board _!)

Level CRO

Risk committees
GCTP
GCC-TA
ALCO bank
Non-financial risk committee
MoRMC

Regional and BU line management, Local and regional

BU level regional and risk committee
local managers

Regional and
BU risk managers

Figure taken from 2021-ING-Climate-Report, page no: 44. Reprinted by permission

from ING Group.
Fi ure 6.11

Chapter 6 Climate Risk Measurement and Management ■ 143

 EXAMPLE: SWOT analysis table for climate risk drivers

Helpful Harmful
I
Internal origin Strengths: How can a company apply Weaknesses: Do any peers face similar
its existing strengths to the physical and weaknesses or risks from climate change?
transition challenges of climate change?

External origin Opportunities: Can the company create new Threats: are climate-related (physical or tran-
solutions to climate-related challenges? Is sition) challenges creating threats to future
there a gap that can be addressed? business value?

Source: Adapted from COSO and WBCSD. (2018). Enterprise Risk Management: Applying enterprise risk management to
environmental, social and governance-related risks. https://www.coso.org/ Documents/COSO-WBCSD-ESGERM-Guidance-Fu/1.pdf

Two other key components of strategy with regards to climate
change, and emphasized by the TCFD, are time horizons
and outcome variance by scenario, which can be addressed
through scenario analysis. Climate-related risks and oppor­
tunities vary significantly over the short-, medium-, and long­
term, and organizational strategy-setting and ERM processes
to address climate change need to examine different time
horizons separately. Climate outcomes also significantly vary
based on emissions trajectories, for which scenario analysis
can help corporate preparedness (see Chapter 7).
Risk identification starts with examining the transmission
channels of climate risk drivers into financial risk (Sections
6.2-6.4) and then identifying which of these are the most
relevant for a particular organization. Not all climate risks
present an enterprise-level risk to all companies, and it is
part of risk managers' remit to translate external trends into
identifiable risks and assess the impact and severity on the
organization in question. Beyond simply "listing" pertinent
risks, risk identification involves articulating the potential
impact on business operations and strategy.

Finally, strategy is also about setting goals and targets. On
climate change, a lot of corporate goal setting revolves around
climate change mitigation and emissions commitments,
including alignment with net zero emissions (for example, as
the members of the Net Zero Asset Owners Coalition have
done}, or even commitments to being carbon negative (e.g.,
Microsoft has pledged to remove all carbon dioxide attribut­
able to its historical operations from the atmosphere by 2050).
T hese goals may be driven by a range of motivations, and they
seek various different risk objectives, such as corporate social
responsibility and keeping up with peers and societal norms
(avoidance of reputational risk) or protection from asset valu­
ation through pre-emptive corporate transition (avoidance of
stranded asset and market risk). But, once these targets are in
place, they also then help to shape future business decisions.
6.6.3 Performance: Tracking and
Measuring Risks
According to the COSO ERM framework, tracking
performance for ESG and climate risks consists of three
sub-components: risk identification, risk assessment and
prioritization, and the implementation of risk responses.
Risk assessment involves gathering data on the actual
scope of these risks. Investors and banks can use company­
level data, including scores on physical and transition risk
exposure, and they can also conduct portfolio-level analysis
to determine whether they have excess overall risk at the
portfolio level-or if they would have such a level in an
unfavorable climate scenario (as described in Section 6.5, as
well as in Chapter 3 and in Chapter 7 on scenario analysis).
A financial institution will tend to do this sort of analysis at a
counterparty level (see McKinsey case study on banking).
Non-financial companies looking inward at their own
operations will be able to source some data from external
providers or from publicly available sources, such as maps
of projected sea level rise that can be compared against
facility and asset locations. But internal risk assessment for
a company will also require assessing the vulnerability and
adaptive capacity of these facilities.
Risk prioritization is especially important in an ERM con­
text, as any large enterprise will be exposed to a multitude
of risks, and it is important to rank these in order of impor­
tance. Ranking methods include ranking by likelihood
of occurrence, adaptability and complexity, or severity.

144 ■ Sustainability and Climate Risk Exam

Various ranking methods can be adopted for this purpose,
such as ranking by the likelihood of occurrence, adaptabil­
ity, complexity, or severity. One way of ranking by severity
is to assess the potential outcomes of each risk, where
risks impacting core business fundamentals, such as prof­
its, revenues, and asset values, are deemed more severe
than those affecting ancillary outcomes such as employee
morale or land use. Another way of prioritizing risks is to
filter by the risks that the company can actually control.
As an example of such an approach, Solvay, a French
chemicals firm, has, in the past, rated risks both on impact
and on level of control, focusing on those risks with the
severest impact but over which it has the most control to
actually improve outcomes (COSO and WBCSD, 2018).

CASE STUDY: MCKINSEY & CO ON COUNTERPARTY CLIMATE RISK

ASSESSMENT IN BANKING
McKinsey gives the example of a international
banking group that has embedded climate risk into
its counterparty risk evaluation process. The process
allows the bank to assess climate risk for 2,500
counterparties on an annual basis. For the sake of
straightforwardness, the bank opted for a scorecard
system that starts with the counterparty's industry and
geographical footprint, with adjustments for the firm's
emissions intensity and reliance on fossil fuels on the
transition risk side and exposure to physical hazards on
the physical risk side. The model was especially helpful
for differentiating climate risk exposure between
counterparties within the same sector. As an example,
within the utilities portfolio, electricity providers and
multi-utilities scored more poorly than did regulated
networks.

An international banking group embedded climate risk into

counterparty ratings.

Assessment for an integrated utility Risk level Low High

Physical risk Transition risk

Anchor score Geographical physical­ Industry physical­ Industry transition­
risk anchor risk anchor risk anchor

0 0 0 0
A. Idiosyncratic Carbon intensity
adjustment Reliance on fossil fuels
0 0
Inherent risk score Inherent transition-risk score

0 0
B. Mitigation
and adaptation , '·1 .,.
Business-model protection '"
capability
in response to climate change "
"l ' -•, '
..,._
' '
{.;"·
'
' , � ·.:- ...,,.,�•)��"': ;,1 ' ;
.,.
,
-,
,
•
...

0 0
.
; ,_ _

Residual-risk
score

McKinsey
& Company

Exhibit from "Banking imperatives for managing climate risk", June 2020, McKinsey & Company, www.mckinsey.
com. Copyright (c) 2021 McKinsey & Company. All rights reserved. Reprinted by permission.
Fi ure 6.12

Chapter 6 Climate Risk Measurement and Management ■ 145

For all risks that are identified and assessed, firm manage­ implementation of ERM and provide additional checks and
ment and risk managers can take a limited number of risk balances. This kind of function can be performed, for exam­
responses. The standard COSO ERM framework counts five ple, through a periodic internal audit in addition to normal,
possibilities: acceptance, avoidance, pursuit, reduction, and continuous risk management (as at ING-see case study in
sharing. Accepting a risk means accepting it will have an Section 6.6.1 ).
impact, but not taking action. Avoidance refers to removing
the risk completely, and anything related to it. For instance, 6.6.5 Communication, Reporting,
a transition risk scenario could involve asset managers and and Disclosure
insurers declining to invest in or provide coverage for busi­
Communication to stakeholders, internal and external, is
nesses that generate revenue from thermal coal, thereby
considered an integral part of successful ERM. Obviously, the
deeming it as a highly risky sector. Pursuit refers to con­
larger a company, the less straightforward even internal com­
verting risks into opportunities. Reduction of risk occurs
munication can be, which is why organizations need processes
through improvements in processes, systems, or strategies.
in place to ensure that the board and senior management get
Sharing refers to collaboration as a risk-mitigation strategy,
timely information about climate and sustainability risk expo­
whether with suppliers, regulators, professional associa­
sure and the risk management operations undertaken.
tions, or even competing firms (COSO and WBCSD, 2018).
Communicating to external stakeholders, including inves­
6.6.4 Review and Revision tors and lenders but also credit rating agencies, employees,
suppliers, regulators, and the public at large, is likewise an
The review and revision portion of the COSO framework
important outcome of successful ERM. Of course, individual
mainly refers to additional checks and balances on the ERM
risk management decisions, particularly around sensitive
framework. This portion of ERM starts with reassessing risks
issues like controversial transactions and avoidance of repu­
in light of any substantial changes to the business context
tational risk, can be made in private. However, risk manage­
of a firm. But more importantly, it is about being self-critical
ment that is practiced fully in private is not successful risk
and responsive with regard to the effectiveness of ERM pro­
management. It is important for shareholders and lenders
cesses themselves. Any substantial changes in the external
to know that a company has a solid ERM in place to ensure
environment should ideally be flagged speedily and trigger
continued value creation in the face of the crystallization of
modified ERM responses (see Infosys example). But even
risks such as climate risk. In addition, public disclosure of
in the absence of large external changes, comprehensive
best practices in risk management can itself have a systemic
ERM involves having processes in place to monitor the
effect, helping even competing firms, and thus entire sectors,

EXAMPLE: INFOSYS-PROACTIVE MONITORING FOR CHANGES IN RISK

EXPOSURE
Infosys is a large, India-based information technology
company that does a lot of outsourcing work and
employs close to 350,000 people (as of 2023), a large
majority of whom are based in India. India is a country
that periodically suffers water stress, and Infosys
relies on water to ensure employees' well-being
(cooking, cleaning, drinking, and bathrooms) and for
landscaping and cooling at its office campuses. Infosys
considers water scarcity a significant operational risk
to its activities in India, due to the deleterious effects
of water scarcity on employee's well-being and ability
to work.
Although water is not always scarce and this risk is
not always considered severe, Infosys has set up
a monitoring system to proaetively monitor water
availability and allow it to quickly update its risk severity
assessment. The monitoring tracks, in particular, the 1)
water tables in each geographic area, 2) storage capacity
of rainwater on each office campus, and 3) availability
and cost of water for delivery via water tankers.
Each of these criteria have specific thresholds that,
if crossed, alert management to allow for follow-up
measures.
Source: WBCSD.

146 ■ Sustainability and Climate Risk Exam

to transition toward a more climate-ready and a zero-emis­
sions future. This is why the entire TCFD framework is predi­
cated on disclosure. (Many of the case studies highlighted in
this book, especially in this chapter and in Chapters 3 and 7,
are drawn specifically from companies' TCFD reports, which
would not exist without this push for disclosure and subse­
quently, helps to spread knowledge and expertise.)
6. 7 Conclusions
This chapter shows that climate risk measurement and man­
agement is possible and can be integrated into standard
REFERENCES
Basel Committee on Banking Supervision. (2021). Climate­
related risk drivers and their transmission channels. https://
www.bis.org/bcbs/publ/d517.pdf
Bernstein, A., Gustafson, M. T., & Lewis, R. (2019,
2019/11/01/). Disaster on the horizon: The price effect of sea
level rise. Journal of Financial Economics, 134(2), 253-272.
https://doi.org/https://doi.org/10.1016/j. jfineco.2019.03.013
Buhr, B. D., C.; Kling, G.; Lo, Y.; Murinde, V.; Pullin, N.; Volz,
U. (2018). Climate Change and the Cost of Capital in Devel­
oping Countries.
Carney, M. (2016). Resolving the climate paradox (Arthur
Burns Memorial Lecture, Issue). https://www.bis.org/review/
r160926h.pdf
ClimlNVEST. (2019). Physical climate risk: Investor needs
and information gaps (CICERO Report, Issue). http://hdl.
handle.net/11250/2589503
COSO. (2017). Enterprise Risk Management: Integrating
with Strategy and Performance https://www.coso.org/
Documents/2017-COSO-ERM-lntegrating-with-Strategy­
and-Performance-Executive-Summary.pdf
COSO and WBCSD. (2018). Enterprise Risk Management:
Applying enterprise risk management to environmental,
social and governance-related risks. https:/ /www.coso.org/
Documents/COSO-WBCSD-ESGERM-Guidance-Full.pdf
Emanuel, K. (2017). Assessing the present and future prob­
ability of Hurricane Harvey's rainfall. Proceedings of the
National Academy of Sciences, 114(48), 12681. https://doi.
org/10.1073/pnas.1716222114
Chapter 6
enterprise risk management frameworks. However, impor­
tantly, climate is a transversal risk, which affects nearly all
"traditional" categories of risk in some way at the company­
specific level, and it also poses a potential threat to financial
stability, constituting a source of systemic risk at the macro
level. T hus, any holistic approach to risk management must
consider climate risk at nearly every stage, from the differ­
ent drivers of physical and transition risks to the transmis­
sion channels through various types of risks into financial
risk. Ultimately, however, many of the best risk assessment
methods rely quite heavily on scenario analysis, which will be
examined and explored in the next chapter (see Chapter 7).
FSB. (2020). The Implications of Climate Change for
Financial Stability. https://www.fsb.org/wp-content/uploads/
P231120.pdf
Klusak, P. A., Matthew; Burke, Matt; Kraemer, Moritz;
Mohaddes, Kamiar. (2021). Rising Temperatures, Falling Rat­
ings: The Effect of Climate Change on Sovereign Creditwor­
thiness (Bennet Institute Working Papers, Issue.
Manley, D. C., James; Cecchinato, Giorgia. (2017). Stranded
Nations? The Climate Policy Implications for Fossil Fuel-Rich
Developing Countries (OxCarre Policy Papers, Issue).
S&P Global Ratings. (2021, Jan 26 2021). S&P Global Rat­
ings Takes Multiple Rating Actions On Major Oil And Gas
Companies To Factor In Greater Industry Risks http://
press.spglobal.com/2021-01-26-S-P-Global-Ratings-Takes­
Multiple-Rating-Actions-On-Major-Oil-And-Gas-Companies­
To-Factor-In-Greater-1 ndustry-Risks
UNEP Finance Initiative. (2018). Extending Our Horizons:
Assessing credit risk and opportunity in a changing cli­
mate. Outputs of a working group of 16 banks piloting the
TCFD Recommendations. PART 1: Transition-related risks &
opportunities. https://www.oliverwyman.com/content/dam/
oliver-wyman/v2/pubIications/2018/apri 1/EXTENDING-OUR­
HORIZON S-AW.pdf
Vautard, R. B., O.; van Oldenborgh, G. J.; Otto, F.; Haustein,
K.; Vogel, M. M.; Seneviratne, S. I.; Soubeyroux, J-M.; Schnei­
der, M.; Drouin, A.; Ribes, A.; Kreienkamp, F.; Stott, P.; van
Aalst, M. (2019). Human contribution to the record-breaking
July 2019 heat wave in Western Europe. World Weather
Attribution. Retrieved 30 Apr 2021, from https:// www.world­
weatherattribution.org/wp-content/uploads/ July2019heat­
wave.pdf
Climate Risk Measurement and Management ■ 147
The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

QUESTIONS
6.1 Which of these risks has only limited potential for sys­ C. Upstream (supply chain) and downstream (product)
temic impact on financial stability? emissions, excluding energy consumed

A. Market risk D. Emissions resulting from inputted energy

B. Operational risk 6.4 What are some key shortcomings of physical climate
risk scores?
C. Liquidity risk
A. Physical risk scores incorporate corporate carbon
D. Sovereign Risk
footprints, but not emission trajectories or Paris
6.2 Which of these is not an important climate risk trans­
alignment.
mission channel?
B. Physical risk scores incorporate multiple hazards,
A. Physical risk leads to damage and business inter­
but the methods by which these are calculated and
ruption, increasing operational risk and credit risk.
combined remain a "black box" to investors.
B. Transition risk leads to asset stranding, worsening
C. Physical risk scores only account for drought and
companies' balance sheets and leading to higher
rain-based flooding, not coastal flooding or sea
probability of default and higher credit risk.
level rise.
C. Physical risk leads to certain vulnerable geogra­
D. Physical risk scores are only available in absolute
phies being very highly exposed and requiring
and not in relative terms.
higher insurance premiums, or even becoming
6.5 Who in a financial institution is increasingly tasked
uninsurable.
with being the first to evaluate climate risk in
D. Physical risk leads to damage and supply chain dis­
transactions?
ruption, increasing market-wide liquidity risk.
A. Climate risk experts from the firm's sustainability
6.3 What are Scope 3 GHG emissions for a company?
department
A. Only emissions produced from direct company
B. Internal auditors
assets (e.g., factories)
C. Risk managers from the firm's risk department
B. Upstream (supply chain) and downstream (product)
D. Transaction decision-makers, such as portfolio
emissions, including energy consumed
managers or relationship managers

148 ■ Sustainability and Climate Risk Exam

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

ANSWERS
6.1 B 6.4 B

6.2 D 6.5 D
6.3 C

Chapter 6 Climate Risk Measurement and Management ■ 149

Climate Models
and Scenario
Analysis
■ Learning Objectives
After reviewing this chapter, you should be able to:
• Define climate scenario analysis and explain how
organizations use scenario analysis.
• Explain the definition and purpose of global net-zero
scenarios including carbon removal processes.
• Understand IPCC scenarios and associated repre­
sentative concentration pathways (RCPs) and shared
socioeconomic pathways (SSPs).
• Describe IEA scenarios and other key global reference
scenarios.
Understand the key choices that organizations need
to consider for scenario development and analysis.
• Describe how scenarios and models are used in
scenario analysis to assess transition risk.
• Explain how scenario analysis is used for assessing
physical risk.
• Examine how all types of corporations (financial and
non-financial) use climate scenario analysis.
• Describe how financial firms use climate scenario
analysis for investment processes and climate risk
exposure management.
• Explain different aspects of climate scenario analysis
using case studies.
151

This chapter describes how climate change risk
can be modeled and analyzed through the use of
scenarios, which can help companies and financial
institutions to prepare for various possible physical
and transition climate-related outcomes. The chapter
begins with an introduction to scenario analysis as
a general planning tool for companies. The chapter
then reviews various reference scenarios used by
climate scientists, policymakers, and corporations.
Then the chapter examines climate scenario analysis
as applied to physical and transition risk, building on
the material in Chapter 3. The chapter ends with a
detailed look at use cases of scenario analysis both in
corporations and in a financial context.
Chapter Outline
7.1 Introduction to Scenario Analysis
7.2 Global Reference Scenarios
7.3 Scenario Parameters and Applications to Physical and
Transition Risk
7.4 Scenario Analysis Use Cases: Corporate
7.5 Scenario Analysis Use Cases: Financial & Investment
7.6 Conclusions
Key Learning Points
• Scenario analysis refers to the use of narratives to
sketch out potential future states of the world. While it
originated in academic research in the 1950s, it was soon
applied by some large corporations, and it is now widely
used to analyze climate risk.
• Global reference scenarios have been proposed or
adopted by various NGO's including projections of
future emissions, sometimes with socioeconomic narra­
tives attached, which are a crucial input for climate sce­
nario analysis.
• The most widely-used reference scenarios are from
the IPCC, including representative concentration
152 ■ Sustainability and Climate Risk Exam
pathways (RCPs) and accompanying shared socioeco­
nomic platforms (SSPs) that allow for more societal and
economic nuance, as well as policy changes, to be incor­
porated into RCPs.
• Other important providers of reference scenarios are
the International Energy Agency (IEA), Greenpeace,
IRENA, and the NGFS.
• Scenario analysis, while often starting with these refer­
ence scenarios, requires a number of decisions to be
taken. Firstly, various parameters/assumptions must be
set, analytical tools chosen, and outputs analyzed and
interpreted.
• Transition risk scenario analysis can make use of inte­
grated assessment models (IAMs), economic models
that also include representations of societal and environ­
mental phenomena and sector-specific decarbonization
pathways.
• Physical risk scenario analysis uses physical climate
models, but it also benefits from resilience planning. The
physical impacts of climate change are projected to be
relatively similar between now and 2050 under any plau­
sible emissions trajectory, which is why short-term sce­
nario planning is more about preparedness than variation
between trajectories.
• Corporations, financial and non-financial, use scenario
analysis for strategy and stakeholder communication
to investors and regulators. Scenario analysis is also used
for resilience planning.
• Financial firms, in addition, use scenario analysis for
portfolio risk management and stress testing as well
as pre-emptively in portfolio selection. The Securi­
ties Exchange Commission (SEC) has been proposing
climate resilience disclosures for public companies.
CLIMATE MODELS AND SCENARIO
ANALYSIS
7.1 Introduction to Scenario Analysis
This chapter examines how climate models and sce­
nario analysis can be a useful tool for both non-financial
corporations and financial institutions to respond to the
challenges of climate change, including risks related to both
physical impacts of climate change (physical risks) and the
zero-carbon economic transition (transition risks).
Scenarios, as well as models (for which scenarios are used
as inputs), are critical tools for climate risk management.
Scenario analysis is flexible enough to draw together nearly
all the relevant issues, risks, and their interrelationships in
one approach, and it can yield results applicable for many
purposes, ranging from reporting to shareholders or stake­
holders and setting internal company strategy to making
investment decisions.
Scenario analysis, in its broadest sense, is the practice
of planning through describing and sketching the future
using plausible narrative stories ("scenarios"). The concept
originated in academic research in the 1950s and is often
credited to Herman Kahn, an American researcher, though
similar concepts were developed around the same time in
France. Scenario analysis spread quickly beyond academic
circles to corporations, such as General Electric, DHL, and
Shell pie., the Anglo-Dutch oil & gas firm.
Indeed, corporations in general, and Shell in particular,
played an outsize role in developing and maturing the
technique. Shell's "futures" team, which took shape in the
1960s, sent its first oil-price forecasts to executives in the
early 1970s. The founders of the team shied away from
attempting to assign probabilities, but they prioritized
plausible scenarios, even ones that seemed improbable.
The approach quickly proved its value to the firm by help­
ing it to be prepared for the kind of scenario that played
out in the oil crisis of 1973. The point of the team, however,
was not to predict the future accurately; its value was in
ensuring a firm-wide approach to preparedness, which has
continued ever since (Wilkinson, 2013). This sort of scenario
planning has, in more recent decades, been applied to a
wide variety of challenges, such as ensuring that the end
of apartheid occurred peacefully in South Africa, PepsiCo's
changes in demand in response to changing consumer food
and beverage preferences, and climate change.
In recent years, climate scenario analysis, that is, the use
of climate scenarios for analysis and decision-making, has
become a preferred tool of both non-financial corporations
Chapter 7 Climate Models and Scenario Analysis
and financial institutions. Climate scenario analysis is used
to bolster corporate preparedness in the face of physical
and transition-related climate impacts to communicate
that preparedness to investors and other stakeholders and
to guide strategy and investment decisions at all types of
firms. It is also starting to be integrated into asset allocation
and investment decisions at some financial firms.
The recommendations of the Taskforce on Climate-Related
Financial Disclosures (TCFD) are an important starting
point for understanding the role of scenario analysis. The
TCFD recommends scenario analysis as a way to "enhance
critical strategic thinking" and challenge conventional
wisdom regarding the future using plausible, distinctive,
consistent, relevant, and challenging scenarios (see box).
The TCFD essentially recommends flexible, corporate­
specific, forward-looking analysis that is not dissimilar to the
approach pioneered at Shell in the 1960s.
However, this type of high-level, strategic scenario analy-
sis is not the only use of the approach when it comes to
climate. Indeed, while each organization and firm does
face a different blend of climate-related risks and oppor­
tunities, and it can make sense to customize scenarios for
firm-specific use, analysis of climate change is often done
using a set of standard, cross-comparable scenarios. These
reference scenarios are a set of agreed-upon projections
of global emissions trajectories, with accompanying socio­
economic narratives and estimates for physical impacts (as
calculated by climate models). Sometimes, these scenarios
include sector-specific pathways. The most widely used, and
widely agreed upon, reference scenarios are those created
directly by the Intergovernmental Panel on Climate Change
(IPCC), although scenarios from the International Energy
Agency, an international organization, and from various
non-profit and academic sources are also widely used. The
use of such common reference scenarios allows for cross­
comparability, both across firm types and across different
use cases. Furthermore, combinations of scenarios are often
used in tandem to help cover gaps in coverage for a par­
ticular time frame, sector, or regional geography of interest.
Scenario analysis for climate change varies quite signifi­
cantly between the two main types of climate risk, namely
transition and physical risk (Section 7 .3). For transition risk,
■ 153
 TCFD RECOMMENDATIONS ON SCENARIO ANALYSIS-EXCERPTS
"What is a Scenario Analysis?
• message.[ ... ]
Scenario analysis is a tool to enhance critical strategic
thinking.
• A key feature of scenarios is that scenarios should
challenge conventional wisdom about the future.
• In a world of uncertainty, scenarios are intended to
explore alternatives that may significantly alter the
basis for "business-as-usual" assumptions.
Scenario Characteristics
Plausible: The events in the scenario should be pos­
sible and the narrative credible (i.e., the descriptions[... ]
should be believable).
Distinctive: Each scenario should focus on a
different combination of the key factors. Scenarios
non-financial corporations or financial institutions typically
examine whether their facilities, strategies, and portfolios
align with one of the global projected emissions trajecto­
ries. Or else, they examine the potential effects of climate
policy tightening (e.g., a higher carbon tax) on their opera­
tions and plans. For physical risk, emissions trajectories,
when "plugged in" to a physical climate model, allow for
producing estimates of temperature rise, precipitation,
weather extremes, and other phenomena. But, due to the
lag in the global climate system, the physical outcomes
of climate change are practically the same for the next
few decades (until about 2050) regardless of emissions.
Therefore, to improve firms' preparedness and resilience,
for physical risk specifically, scenario analysis is more
about using the sorts of physical climate impacts that are
already occurring and expected to continue. For physical
risk, emissions trajectories only make a difference on very
long timescales, whereas for transition risk, emissions tra­
jectories make a very significant difference even on short
timescales. There is an enormous difference for companies
154 ■ Sustainability and Climate Risk Exam
should be clearly differentiated in structure and in
Consistent: Each scenario should have strong internal
logic. The goal of scenario analysis is to explore the way
that factors interact[ ...]
Relevant: Each scenario, and the set of scenarios taken
as a whole, should contribute specific insights into the
future that relate to strategic and/or financial implica­
tions of climate-related risks and opportunities.
Challenging: Scenarios should challenge conventional
wisdom and simplistic assumptions about the future[ ...]
[and] business-as-usual assumptions.
Source: Reprinted with permission of the Task Force on
Climate-Related Financial Disclosures.
or financial institutions between continued flat or rising
emissions ("business as usual") as compared to hitting goals
such as net-zero emissions by 2050, which requires drastic
cuts by 2030.
Finally, the use cases of scenario analysis are varied and
ever broadening. Besides its use in high-level strategy set­
ting and corporate disclosure, as recommended by the
TCFD, scenario analysis is being integrated in concrete
ways by non-financial firms and financial ones alike. For
non-financial firms, climate scenario analysis can allow for
concrete preparedness actions to be taken with regard to
specific facilities (offices, factories, etc.), and it can be used
for capital expenditure investment decisions. For financial
firms, climate scenario analysis can be useful to gauge
°
portfolio alignment with goals such as the well-below 2 C
goal of the Paris agreement, to pre-empt or shape new
investment decisions by portfolio managers, or to provide a
top-down "stress test" approach where a portfolio is tested
under certain assumptions and conditions.
From being simply a "nice to have" tool or one recom­
mended as best practice, scenario analysis is increasingly
being implemented by, and even mandated by, regulators.
Stress tests, which model the reaction of both a financial
system as a whole and an individual institutions' balance
sheets to a hypothetical shock, rely on scenario analysis by
their very premise (see also Chapter 5). Stress tests were
widely adopted by regulators in the wake of the global
financial crisis of 2008 and are now increasingly being re­
purposed to examine climate change risk. The Bank of
England (BoE), the Banque de France, and the Nederland­
sche Bank (the Dutch central bank), as well as the European
Central Bank are at various stages of implementing climate
stress tests with differing degrees of granularity, distinct
climate and policy scenarios, time horizons, and feedback
loops. Starting in 2021, the BoE's climate stress test, called
the Climate Biennial Exploratory Scenario (CBES), will be
run every other year. The May 2022 report found that, while
removals, or offsets ("sinks") on an ongoing basis. To stabilize
the climate at any given temperature, whether it is the Paris
Agreement's objective of holding the increase in the global
°
average temperature to well below 2 C, or alternative efforts
° ° °
to limit temperature rises to 2.5 C, 3 C, or 4 C, we need to
achieve net-zero carbon emissions in order to stabilize the
stock of carbon in the atmosphere (IPCC, 2018).
This means reducing carbon emissions to zero in every
sector we can while also extracting and sequestering carbon
from the atmosphere using biological, chemical, and indus­
trial processes at incredibly large scales (McGlashan, Shah,
Caldecott, & Workman, 2012). We need the capacity to
capture and sequester carbon because some sectors, such
as agriculture, will have residual emissions that are nearly
impossible to stop. There are also sectors like aviation
where we do not yet have viable zero carbon alternatives.
All scenarios that result in the stabilization of global tem­

UK banks and insurers are making good progress in some peratures, at whatever temperature and over whatever

aspects of their climate risk management, there is still much
to be done to fully understand climate risks, and a lack
of available emissions data is a big issue. The US admin­
timeframe, end up at net zero. Figure 7 .1 below shows
°
different pathways for stabilizing temperatures at 1.5 C or
°
2 C, respectively. Some scenarios assume we reduce emis­

istration under President Joe Biden has also mandated sions later or more slowly, and although we ultimately reach

America's financial regulators, as of May 2021, to develop net zero, the emissions produced over a slower and later

a comprehensive approach to assessing financial-sector

climate risk, which includes scenario analysis.

7 .2 Global Reference Scenarios • Estimated pre-COVID trend

"'N 40 e 1.5°C budget
This section explains the concept of net zero and then dis­
cusses global-level climate reference scenarios, which are
u
"' 30
** • Well-below 2°C budget
CO2 emissions in 2019
CO2 emissions in 2020
key inputs for corporate and financial scenario analysis. The
"'
'iii

·e
most widely agreed upon, and the most widely used refer­
ence scenarios, come from the Intergovernmental Panel on Cl)
20
N
Climate Change (IPCC), with those from the International O
u
Energy Agency and a few other key organizations also in 10
common use.

7.2. 1 Net Zero 2010 2020 2030 2040 2050 2060 2070
Year
Net zero means reducing global emissions ("sources") to zero
in almost every sector of the global economy and balancing @jljlfl• Different net-zero pathways result in
out any residual emissions that cannot be eliminated with different temperature outcomes.

Chapter 7 Climate Models and Scenario Analysis ■ 155

transition results in higher temperatures. In contrast, scenar­
ios where action begins immediately and emissions decline
quickly, usually with emissions halving by 2030 and net zero
° °
being achieved mid-century end up keeping a 1.5 C or 2 c
outcome "alive."
All scenarios use some carbon removals to achieve the
"net" in net zero. Some scenarios ambitiously assume new
technologies will be quickly deployed at sufficient scale to
scrub carbon from the atmosphere, others use less gener­
ous assumptions about the deployment of carbon removal
technologies. These assumptions are key to determining
whether net zero can be achieved and this is not without
controversy as different carbon removals options result
in different trade-offs and have costs that will need to be
absorbed by society.
7.2.2 IPCC Scenarios (RCPs and SSPs)
The concentration of greenhouse gases in the atmosphere
is key to the Earth's climate, yet the concentration is being
swiftly altered by human activity. Because of this fact,
modeling and predicting the future trajectories of the
greenhouse gases in the atmosphere is arguably the single
most important factor to understand-more so than hav­
ing the physical parameters of a climate simulation model
exactly correct. Indeed, given accurate emissions trajectory
data, even simple climate models can perform quite well in
predicting global warming. (See Section 7.3 for more infor­
mation on models.)
Because of this, there has understandably long been a
focus among climate scientists in the IPCC to, if not defini­
tively predict the single future path of emissions, at least
lay out plausible, agreed-upon scenarios. These climate
scenarios would then provide a common starting point for
modelers. The first iteration of such scenarios was devised
in the 1990s, with assumptions about population growth,
economic growth, and emissions. From these begin-
nings among scientists, these kinds of scenarios have now
become a crucial reference point for policymakers, corpo­
rate managers, and investors alike.
Current IPCC usage and modeling is based on a combina­
tion of representative concentration pathways (RCPs)
and Shared Socioeconomic Pathways (SSPs), which are
156 ■ Sustainability and Climate Risk Exam
agreed-upon, projected, plausible emissions pathways
through 2100. These pathways represent different emis­
sions projections under basic, plausible economic and social
assumptions, while staying within physical constraints.
The RCPs were constructed by back-calculating the
amount of emissions that would result in a given amount
of radiative forcing-the difference between incoming
energy emitted by the Sun and outgoing energy emitted by
Earth (as covered in Chapter 1)-that would then result in a
given amount of warming. Because of this, the RCP names
are based on the amount of radiative forcing measured in
watts/meter squared (W/m2), and they do not correspond
neatly with the anticipated amount of warming in degrees
Celsius.
Note that because different physical climate models yield
somewhat varying predictions based on the same emissions
trajectory, the amount of warming corresponding to any
given RCP is only approximate, not absolute. For RCP 2.6,
°
the pathway often used as shorthand for "below 2 C," the
2023 IPCC report) found that there is only a 67% probability
that the global temperature increase does remain below
°
2 C (IPCC, 2023).
The table below lists the RCPs; the corresponding approxi­
mate, global average temperature rise by 2100; and the
shorthand, if used. The most widely used models tend to
be RCP 2.6 and RCP 8.5. RCP 2.6 is used as a shorthand
°
for reaching Paris goals (of limiting warming to below 2 C)
by drastically cutting emissions. RCP 8.5, sometimes called
"business as usual," and sometimes, confusingly enough,
used as a "worst-case scenario," is a scenario that assumes
continued rising emissions, leading to much higher levels
of warming. RCPs, while originating with the IPCC, can now
be found in everything from financial regulatory reports to
commercially available climate risk tools meant for corpo­
rations. As of the 2023 IPCC report, the RCPs have been
updated to include socioeconomic factors more explicitly.
For analytical clarity, the RCPs did not originally include a
socioeconomic "narrative" but only emissions trajectories
calculated using certain assumptions about energy use.
Instead, shared socioeconomic pathways (SSPs) (as cov­
ered in Chapter 1) have been developed subsequently to
be used in conjunction with the RCPs. SSPs are intended
to provide plausible scenarios for how the world evolves
1fflMYI■
PRE-2021 RCPS
Corresponding Rise in Global
Pathway Name Average Temperature by 2100
°
RCP 1.9 ~1.5 C
°
RCP 2.6 ~2.0 C
°
RCP 4.5 ~2.4 C
°
RCP 6.0 ~2.8 C
°
RCP 8.5 ~4.3 C
in areas such as population, economic growth, education,
level of globalization, level of urbanization, and the rate of
technological development.
The five SSP scenarios range from better to worse climate
change outcomes. SSP-1 sketches out a scenario of signifi­
cant focus on sustainability; SSP-2 is a "business as usual"
scenario; SSP-3 involves regional rivalry between countries;
SSP-4 has a high degree of inequality; and SSP-5 posits
fossil-fuel development.
The SSP base scenarios deliberately do not include climate
policies. The reasoning is that the SSPs can be combined
with different RCPs to explore the climate policy options
and assumptions that are necessary to limit global warm­
ing to a particular target level. Specifically, shared climate
policy assumptions capture key policy attributes such as the
goals, instruments, and obstacles of mitigation and adapta­
tion measures, and they introduce an important additional
dimension to the scenario matrix architecture.
For instance, RCP2.6 and RCP1.9 are both possible to
achieve under the baseline SSP1 assumptions, but with
tighter climate mitigation policies in the latter. RCP2.6 is a
plausible emissions pathway under both SSP1 and SSP2,
but the underlying socioeconomic drivers and outcomes
are different.
Because the SSPs took longer to elaborate than the RCPs,
they were not included in the 2014 or 2018 IPCC reports,
but they are included from 2021 onwards. So instead of
sketching an emissions pathway that is merely RCP2.6,
Chapter 7 Climate Models and Scenario Analysis
Emissions Trend to 2100
very strongly declining
strongly declining
slowly declining
stabilizing
rising
climate modelers now use a combination of SSPs and RCPs.
When examined purely through the output of emissions
pathways, the outputs look fairly similar (see graph), but
the SSPs nonetheless add value in significant other ways.
For example, SSPs may be useful for transition and liability
risk assessment, and for evaluating opportunities. In gen­
eral, because they allow many ways to achieve the same
(or similar) emissions outcomes, they provide more flexibil­
ity for models and scenarios.
Having the SSPs alongside, but separate from, RCPs allows
the two to be mixed and matched. This permits the explo­
ration of climate policy options and their impact on energy
use, land use, emissions, and economic activity in a matrix­
type format. To compare matrix rows is to compare differ­
ent levels of climate policy stringency (as rows are different
RCPs); to compare matrix columns is to compare different
baseline socioeconomic situations, but the same level of
climate policy stringency (different SSPs) (see Figure 7.3).
However, not all RCPs are achievable under all SSPs-a
high-mitigation scenario is not feasible under the SSP3
"regional rivalry" assumptions. The models that can assess
the combination of social, economic, energy, emissions, and
climate factors are called integrated assessment models.
As important as the IPCC's RCPs and SSPs are as a refer­
ence point, the IPCC is not the only organization to have
put out scenarios. Several other organizations' projections
are also used widely by governments, companies, and finan­
cial institutions.
■ 157
 UPDATED EMISSIONS SCENARIOS-"PLAIN" (PRE-2021) RCPS VS RCP-SSP
COMBINATIONS
- historical - - · RCP2.6 - SSP1 -2.6 - - · RCP4.S - SSP2-4.S RCP6.0 SSP4-6.0 - - · RCPS.S
- SSPS-8.S

120.0

100.0

N
80.0

V) 60.0
C
C
40.0

20.0

0.0

-20.0
1980 2000
dwlZ!ll'-1
When compared side by side, the pure RCP emissions
trajectories previously used by the IPCC (dotted lines)
and the combined SSP-RCP trajectories that will be used
from 2021 onwards (solid lines) do not look radically
different. But there are some notable differences. For
instance, the mix of CO2 and non-CO2 (e.g., methane)
emissions are different even between trajectories that
result in the same amount of end-of-century radiative
forcing. Also, the old RCPs started in 2007, and the new
pathways start in 2014. The 2°C-compliant SSP1-RCP2.6
has a higher starting point than the old RCP2.6, reflect­
ing higher emissions in the 2007-2014 period and a
slower initial decline, both of which are made up for by
2020 2040 2060 2080 2100
much larger expected negative emissions at the end of
the century than in the original scenario. The SSP sce­
narios are also useful in adding flexibility because they
allow for multiple ways to achieve the same (or similar)
emissions outcomes.
"Explainer: How 'Shared Socioeconomic Pathways'
explore future climate change" (April 2018) Chart
produced for Carbon Brief by Glen Peters and Robbie
Andrews from the Global Carbon Project, https:/lwww.
carbonbrief.org/explainer-how-shared-socioeconomic­
pathways-explore-future-climate-change/. Reprinted by
Permission from Carbon Brief.

7.2.3 IEA and Other Reference Scenarios
There are a limited number of global, macroeconomic cli­
mate scenarios and predicted emissions trajectories from
organizations beyond the IPCC that are used widely enough
to be considered reference scenarios.
Most important among these are the scenarios developed
by the International Energy Agency (IEA). The IEA's two
core scenarios are the 1) Stated Policies Scenario, which
reflects existing policy frameworks and announced policy
intentions, and 2) the Sustainable Development Scenario
(SDS), which combines climate and social targets and limits
°
warming to 2 C in line with Paris targets.
The IEA has also modeled net-zero emissions by 2050 sce­
narios. After years of being criticized for consistent underes­
timation of the potential for renewables and expecting the
persistence of fossil fuels, the IEA's report on net-zero of May
2021, its most comprehensive up to that point, laid out a much
more ambitious path to the achievement of net-zero (see box).
The IEA has occasionally modeled other scenarios as well, such
as a delayed economic recovery scenario in 2020 in response
to the global COVID-19 pandemic, and the impacts of Russia's
invasion of Ukraine on Global Energy markets.
Besides the IEA, there are a handful of other energy
transition and climate scenarios in wide use, such as the

158 ■ Sustainability and Climate Risk Exam

MATCHING SSPS AND RCPS SHARED SOCIOECONOMIC PATHWAYS
RCP8.5
I
I
RCP6.0

RCP4.5
--.
-0-- --
I
---0--

---0-- - -
---0--

-0-- --- -0----- -0--

---0--

RCP3.4
---0-- ---0-- ---0-- ---0-- ---0--
RCP2.6
RCP1.9
---0-- ---0-- 0 ---0-- 0
---0-- 0 0 0 0
55P1 SSP2 SSP3 SSP4 SSPS

■ Baseline O Feasible for all IAMs O Feasible for some IAMs O Infeasible

Wi1ilffi
This graphic shows how the baseline SSP assumptions
map onto RCP emissions trajectories (blue bars),
and it maps which RCPs are achievable under which
SSP scenarios, using integrated assessment models.
Reprinted from Senses (2020), Climate Change Scenario
Primer with permission of the Potsdam Institute for
Climate Impact Research.

IEA: FROM LAGGARD TO THE FOREFRONT

The International Energy Agency's annual benchmark, the Annual PV additions: historic data vs IEA WEO predictions
World Energy Outlook, is considered one of the defini­ In GW of added capacity per year• source International Energy Agency• World Energy Outlook

tive global assessments of the energy sector. However, 120.0 __. PV History please send comments to:
a.e.hoekstra@tue.nl
it has been criticized in the past for its perceived excess - WEO 2018 New Policies Scenario (NP$)
@aukehoekstra
caution and friendliness toward the fossil-fuel sector. WEO 2017 NPS
100.0 - WEO 2016 NPS
For instance, for well over a decade, the /EA forecasts

-----
- WEO 2004 REF
on renewable energy uptake have consistently under­ 80.0 - WEO 2002 REF
estimated their growth. This discrepancy has been the WEO 2015 NP$
largest and starkest within the amount of solar photo­ - WEO 2014 NPS
voltaic capacity added annually (see Figure 7.4). 60.0 - WEO 2013 NP$
- WEO 2012 NPS
In recent years, the /EA has moved towards analysis of
- WEO 2011 NP$
deeper decarbonization scenarios that do in fact embed 40.0
- WEO 2010 NPS
a strong and quick transition. In 2019, after pressure - WEO 2009 REF
from large institutional investors to include an energy 20.0 WEO 2008 REF
model compatible with 1.5 °C goal, the agency did so in
its 2020 outlook.
0.0
By 2021, the /EA published a detailed report and sce­ 1995 2005 2015 2025 2035
nario for achieving global net-zero emissions by 2050
that represented its most ambitious and comprehensive
lif?i1ik#li
analysis of this target to date. This new Net-Zero Sce­ exploration. To be on track, by 2030, the world needs to
nario left far less room for continued fossil-fuel produc­ achieve 60% of vehicle sales being electric, a phaseout
tion and use than previous /EA models had. of existing coal plants in developed economies, and over
1 TW of additional solar and wind capacity needs to be
Specifically, the 2021 net-zero scenario sets out a num­ added per year. By 2040, 50% of buildings need to be
ber of sector specific milestones that the /EA argue retrofitted and electricity generation emissions globally
need to occur to actually reach net-zero by 2050. From need to reach net-zero (see graphic).
2021, the agency says there should be no new coal
power plants, no new coal mines, and no new oil and gas Reprinted with permission of Auke Hoekstra.

Chapter 7 Climate Models and Scenario Analysis ■ 159

 Key milestones in the pathway to net zero

2025
2030
Universal energy access

2021 All new buildings are 2035

zero-carbon-ready
No new unabated Most appliances and 2040
coal plants approved 60% of global car cooling systems sold
for development sales are electric are best in class 50% of existing
buildings retrofitted
50% of heavy truck to zero-carbon-ready
No new oil and gas sales are electric levels
fields approved for
development; no
No new ICE car sales 50% of fuels used
new coal mines or
in aviation are
2050
mine extensions
1.020 TW annual solar low-emissions More than 85%
and wind additions of buildings are
zero-carbon-ready
Phase-out of Overa net-zero
unabated coal in emissions electricity
advanced economics in advanced
40 economics

35 Net-zero emissions
electricity globally
30 Almost 70% of
Phase-out of all electricity generation
unabated coal and oil globally from solar PV
25 and wind
power plants

O
N 20
u 2045
15

10

-5
2020 2025 2030 2035 2040

■ Buildings ■ Electricity and heat

■ Transport Other
Industry
/EA (2021), Net Zero by 2050, /EA, Paris https:/lwww.iea.org/reports/net-zero-by-2050, License: CC BY 4.0.
W11MiJ.1

160 ■ Sustainability and Climate Risk Exam

,mnr•>J
Source Scenario Name Description Key Dates

Peak Net-zero
emissions emissions

IEA Stated Policies The Stated Policy Scenario reflects the impact of exist- 2030 Not modelled
Scenario (STEPS) ing policy framework and announced policy intentions beyond 2040
to show how current policy ambitions affect the energy
sector through 2040.

Sustainable Devel- The Sustainable Development Scenario is fully aligned 2021 Not modelled
opment Scenario with Paris agreement goals, and it holds global tern- beyond 2040
°
(SDS) perature rise to below 1.8 C with a 66% probability and
without relying on global-level net negative emissions.

Net-Zero Scenario The Net-Zero scenario is aligned with fully net-zero 2019 2050
[2021] emissions by 2050 across buildings, transport, industry,
and power and heat.

IRENA Planned Energy A scenario based on governments' current energy plans 2030 Not modelled
Scenario and nationally determined contributions beyond 2050

1.5 ° C Scenario A pathway aligned with net-zero emissions by 2050 and 2021 2050
°
thus with maintaining warming below 1.5 C

Greenpeace Advanced Energy Pathway to a fully decarbonized energy system by 2050 2020 2050
[R]evolution

Institute for Deep Decarbon- Country-level pathways for emissions reductions that n/a n/a
°
Sustainable ization Pathways are consistent with a global 2 C goal
Development Initiative

NGFS Orderly Scenario Climate policies are introduced early and gradually 2020 2060
tightened, leading to a steady fall in all greenhouse gas
°
emissions. Warming is likely to be limited to below 2 C.

Disorderly Transi- Climate policies are introduced later and more abruptly 2030 2050
tion Scenario from 2030. Emissions reductions are sharper, leading to
higher transition risk.

Hothouse Earth Current policies are preserved, and Paris goals are not 2080 No net zero
Scenario met. Emissions continue to grow until 2080, leading to
more than 3 °C of warming and significant physical risks.

Source: /EA (2021), Net Zero by 2050, /EA, Paris https:/lwww.iea.org/reports/net-zero-by-2050, License: CC BY 4.0.

International Renewable Energy Agency's REmap (from
2016) and Greenpeace's Advanced Energy Revolution.
There are also the sector-specific scenarios of the Deep
Decarbonization Pathways Project (DDPP), run out of the
Institute for Sustainable Development, a French think-tank.
A final set of scenarios relevant particularly due to uptake
by the financial sector is that developed by the Network for
Greening the Financial System (NGFS), which is composed
of central banks and financial supervisors. While their mate­
rials have been primarily intended for central banking and
financial supervision, private-sector financial institutions
have also made use of NGFS scenarios. All these scenar­
ios can then be plugged into various modeling ensembles
to estimate impacts. As an example, central banks and
private-sector banks making use of the NGFS scenarios
have tended to use the REMIND model, a holistic model

Chapter 7 Climate Models and Scenario Analysis ■ 161

developed by the Potsdam Institute for Climate Impact other phenomena. However, due to the lag in the global cli­
Research (PIK). A more detailed analysis of key current ref­ mate system, different kinds of scenario analysis that do not
erence scenarios is below. use emissions trajectories can sometimes be more useful.

In any case, there are certain common parameters that any

7 .3 Scenario Parameters and scenario analysis must decide on before starting, no matter
what kind of climate risk is being analyzed.
Applications to Physical and Transition
Risk
7.3. 1 Choice of Parameters
The sorts of global-level scenarios and models described
Scenario analysis starts with a choice of scenario and parame­
above can be utilized to analyze both transition and physi­
ter setting. In many if not most cases, starting with a reference
cal risk. Transition risk and physical risk are on a spectrum­
scenario will be sufficient, without needing to build a bottom­
all climate outcomes are expected to have some of both,
°
up analysis of world energy use by sector from scratch. None­
with drastic emissions cuts (limiting warming to 1.5-2 C)
theless, to be applicable to the particular firm or situation at
producing high transition risk and moderate physical risk,
hand, scenarios themselves may need to be tweaked, and
whereas continued rises in emissions could result in up to
°
decisions are required on the desired analysis and outputs.
6 C of warming, with high physical risk.
All climate scenarios have several built-in parameters, or
However, the output and usability of global scenarios dif­
assumptions. These can range from macroeconomic vari­
fers for transition risk compared to physical risk. For transi­
ables (e.g., GDP growth) to energy demand and the energy
tion risk, non-financial corporations or financial institutions
mix to policies. Conducting scenario analysis requires ana­
typically examine whether their facilities, strategies, and
lytical choices on scope and methods, including quantita­
portfolios align with one of the global projected emis­
tive versus qualitative methods. Scope can also depend
sions trajectories. Alternatively, they ask the hypothetical
on data availability, for example relating to supply chains.
question of what if climate policy or other parameters
Climate scenario outputs can range from revenues or costs
were tightened. For physical risk, emissions trajectories
to asset valuations, such as from assets becoming stranded.
are meaningful to the extent that, when "plugged in" to
Table 7.3, adapted from the TCFD Technical Supplement,
a physical climate model, it is possible to derive estimates
highlights key choices to be made (parameters relating only
of temperature rise, precipitation, weather extremes, and
to physical risk are marked in red).

7.3.2 Use of Scenario Analysis for Transition

Risk
Transition-Physical Risk Conceptual Trade-Offs
> 6 °C Transition risk scenario analysis is very closely and directly
tied to emissions scenarios, whether the RCPs, IEA sce­
-"'
Vl narios, or custom-made emissions scenarios. After all, tran­
sition risk results directly from the speed, pace, and scale
·;;; of the low-carbon transition. Transition risk is higher when
..s::
>,

a.. emissions are cut more drastically (net-zero emissions by

2050 scenario versus a current policies or business-as-usual
2 °C-1.5 ° C scenario), and when emissions cuts are more abrupt (disor­
derly versus orderly transition).
Transition Risk
Typically, transition risk analysis for a corporation or
Reprinted with permission of the Task Force on Climate­ financial institution involves evaluating whether its own
Related Financial Disclosures. operations, supply chains, and portfolios are aligned with
@jljiifi?i sector-specific and/or global, macroeconomic emissions

162 ■ Sustainability and Climate Risk Exam

1fflMYIH
Parameters/Assumptions Analytical Choices Scenario Outputs
• Discount rates • Quantitative vs qualitative • Earnings/profits
• Carbon Price methods • Revenues
• Energy demand and mix
• Timescale-2030, 2050, 2100 • Costs
• Commodity prices
[2100 only relevant for long-term • Asset valuations-how badly are
infrastructure]
• Macroeconomic variables-for assets stranded?
• Scope of analysis •
example, GDP, employment Investment/capital expenditure
• • Data availability •
Geographic variation Asset allocation
• • Choice of climate hazards-for •
Demographics and employment Potential impact on productivity
example, heat, floods, extreme
• Technology • Business interruption from
weather
• Policy •
physical hazards
Extent of supply chain inclusion
• Climate system sensitivity-such • Balance of economic, social, and
as the response of climate to given
physical analysis
amount of CO 2

Source: Reprinted with permission of

the Task Force on Climate-Related
Financial Disclosures.

trajectories. (For more on the different kinds of analysis and
how it varies between the financial and non-financial sector
see Section 7.4).
On a broad, global-level scale, economic models incorpo­
rating climate change and climate policy can be helpful.
Integrated assessment models (IAMs) are broad-spectrum
models designed to allow analysis of how societal and
economic choices affect each other and the natural world,
including the causes of climate change. Used extensively by
the IPCC, they are also frequently used by academics and
sometimes by policymakers and corporations.
The most basic IAMs compare the costs and benefits of
avoiding a certain level of warming using highly simplified
equations. However, most IAMs in use are far more com­
plex, and they include representations of relevant interac­
tions among important human systems (e.g., energy use,
agriculture, trade) and physical processes (e.g., the carbon
cycle). IAMs are most heavily rooted in economics and eco­
nomic models, meaning they typically assume fully function­
ing markets and competitive market behavior, and they are
calibrated to optimize outcomes as measured by minimizing
the aggregate economic costs involved.
IAMs can answer both general questions and specific ones. For
instance, "What will the world look like with no climate policy
action?" and "What will the world look like if all countries
impose a USD 200 tax per ton of CO2 emissions in 2025?"
For most sectors, or for firms exposed to multiple sectors
(such as banks or institutional investors), sector decarbon­
ization pathways are a highly useful way of gauging transi­
tion risk. Many of these exist, including those laid out by the
IEA, the Deep Decarbonization Pathways Project, the Transi­
tion Pathway Initiative, Mission Possible Partnership (MPP),
or the Science-Based Targets Initiative. These kinds of
decarbonization pathways are constructed to be compatible
with Paris Agreement targets, so a firm making use of these
to gauge Paris Agreement alignment can mainly restrict
itself to the question of gauging whether it is possible for
the firm to align with the trajectory (although as with any­
thing, some understanding of underlying assumptions and
any model uncertainties will still be helpful and necessary).
There are also external bodies evaluating alignment with
various scenarios. For example, the Transition Pathway
Initiative, a collaboration between academia and industry,
grades publicly listed companies on their level of alignment

Chapter 7 Climate Models and Scenario Analysis ■ 163

 Philosophy Examples

• Work backwards from net Zero globally • NGFS

Top-down • Allocate emissions across sectors and regions • OECM

• Consider interlinkages across sectors and structural shift (e.g. demographics) • IEA

• Work forwards from where the sector is today • WBCSD

Bottom-up • Focus on commercially feasible, scalable action • Climate Champions

• Identify technology and policy step changes • MPP

@jlj#fij Overview of top-down vs. bottom-up pathways

l��BI Overview of current state of sectoral net-zero pathways used by financial institutions as of
Q3 2021
Network World Business
One Earth for Greening International Mission Transition Council for
Climate the Financial Energy Possible Climate Pathway Sustainable
Model System Agency Partnership Action 100+ Initiative Development
Agriculture V' V' V'
Aluminium V' V' V' V'
Cement V' V' V' V' V' V'
Chemicals V' V' V' V' V' V'
Coal V' V' V' V' V'
Commercial &
Residential V' V' V'
Sector work
Real Estate
more focused
Steel (& Iron) V' V' V' V' V' on SDGs rather
than explicit
Oil & Gas V' V' V' V' V'
decarbonisation
Power Generation V' V' V' V' pathways
Transport V' V' V' V' V'
a. Aviation V' V' V' V' V'
b. Shipping V' V' V' V'
c. Trucking V' V' V'
d. Autos V' V' V'

Source: From Our progress and plan towards a net-zero global economy Nov 2021. Reprinted by permission from
The Glasgow Financial Alliance for Net Zero.

with Paris-compliant sector trajectories. These assessments
can then be used by stakeholders or investors in various
ways. Just one example of a secondary application is the
family of TPl-linked indices that FTSE Russell, a data firm,
offers in which companies are weighted by their transition
readiness. Legal and General Investment Management
(LGIM), launched the first index-tracking fund linked to one
of these TPI indices in December 2020.
Finally, a lot of transition risk scenario analysis is done by
commercial data providers such as Carbon Delta, Car-
bone 4, Oliver Wyman, WTW, Ortec Finance, NGOs such
as 2 Degrees Investing Initiative, and consortiums such as
Climatewise, which is part of the Cambridge Institute for
Sustainability Leadership. Most of these entities provide
detailed data on different asset classes by scenario (RCP) and
time horizon for firms to be able to do in-house analysis. One

164 ■ Sustainability and Climate Risk Exam

 THE PACTA FOR BANKS METHODOLOGY
2 Degrees Investing Initiative, an NGO, has developed a
methodology called the Paris Alignment Capital Transi­
tion Assessment (PACTA) tool, which has seen consider­
able uptake both among investors, with its equities and
bonds version, and among banks, with the PACTA ver­
sion on corporate loans, or PACTA for Banks.
PACTA for Banks starts with a bank's financial exposure
to physical assets (such as steel or power plants) in the
real economy. The methodology then compares eco­
nomic units of output (e.g., tons of steel, MWh of elec­
tricity) to different climate change scenarios, allowing
the bank to know which climate pathway its clients are
on. Because the analysis uses economic units of output,
it is able to make forward-looking projections and assess
counterparties against both a "business as usual" and a
"Paris aligned" scenario.
The PACTA output metrics look to control two key cli­
mate issues:
1. The absolute production output, and limits, of high
carbon technologies. For example, fossil-fuel pro­
duction in aggregate must ultimately decrease to
achieve the goals set out in the Paris Agreement.
2. Identifying the production shift from high-carbon
to low-carbon production (and the technologies)
needed to be compatible with a Paris-aligned world.
PACTA for Banks currently covers five climate-critical
sectors: Power, Fossil Fuels, Automotive, Steel, and
methodology that provides an illustrative example is PACTA,
developed by 2 Degrees Investing Initiative, which has seen
significant uptake among large global banks (see box).
A final, ambitious approach to transition risk scenario analy­
sis is to build fully original emissions trajectories. Building
bottom-up global models of energy demand and emissions,
similar to the IPCC or IEA pathways, typically only makes
sense for large fossil fuel and commodity firms whose for­
tunes are closely tied to global changes in the energy mix.
Shell, for instance, constructs and periodically updates its
own climate and energy scenarios. The latest iteration in
the wake of the 2020 COVID-19 pandemic includes three
°
scenarios, "Sky 1.5," which is 1.5 C compatible; "Waves," a
Chapter 7 Climate Models and Scenario Analysis
Cement. Alignment results are given at the level of each
sector (and technology level within those sectors).
For power, fossil fuels, and the automotive sector, there
are viable and clear low- or zero-carbon technologies
available, so in these sectors, PACTA uses two metrics to
measure alignment:
1. Production Volume Trajectory-this measures the
alignment of a loan book and/or client's production
volume per technology/fuel against trends pre­
scribed in climate change scenarios.
2. Technology/Fuel Mix-this metric shows the sectoral
technology/fuel mix of a loan book and/or client
(e.g., what percentage of automobile production
a bank finances that is related to electric vehicles,
internal combustion engines, etc.) and how this mix
should evolve to be considered aligned with vari­
ous climate change scenarios. This identifies the
required shift to low-carbon technologies.
For sectors without clear decarbonization pathways as
yet, such as steel and cement, the methodology instead
uses the measure of emissions intensity. PACTA can com­
pare the sector-specific emissions intensity of a particular
bank's loan book with emissions intensity aligned with
climate scenarios.
Source: PACTA for Banks.
disorderly and delayed but quick transition; and "Islands,"
with a late and slow transition. Perhaps unsurprisingly, both
°
"Sky 1.5" and its predecessor, the 2 C compatible "Sky,"
assume a much larger continuing role for oil & gas through
2100 than do scenarios drawn up by neutral bodies such as
the IPCC or IEA, showing how companies' businesses and
interests potentially shape projections.
7.3.3 Use of Scenario Analysis for Physical Risk
Use of scenario analysis for physical risks is significantly
different from transition risk scenario planning in multiple
ways. One difference is that, to the extent emissions trajec­
tories matter, physical climate models are required as a first
■ 165
step to translate trajectories into physical impacts. However,
a second important difference is that, because the climate
system responds on a lag, physical impacts until about 2050
are largely "baked in" by current emissions, so emissions
trajectories do not matter on the timescale of the next few
decades, which is what the majority of policymakers, firms,
and investors limit themselves to (Four Twenty Seven, 2019).
Finally, because of this, a completely different sort of sce­
nario analysis is sometimes more useful for physical risk­
one not driven by global or sector emissions trajectories but
an exercise in operational preparedness based on plausible
future events.
Physical climate models were originally developed to help
scientists understand the functioning and operation of the
Earth's climate system. Now, they are an important tool for
scenario analysis on physical risk.
The relationship between physical climate models and
emissions scenarios goes in both directions. On the one
hand, physical climate models are used to calibrate emis­
sions scenarios to make sure that the amount of radiative
forcing resulting from the posited emissions correspond
roughly to certain temperature targets for global average
temperature rise. But on the other hand, these emissions
trajectories can then be re-inputted into models to gain an
estimate of various hazards.
The growing sophistication of newer climate models allows
them to present forecasts with greater granularity, including
at the regional level, and for a greater range of phenomena,
ranging from heat waves to precipitation patterns. This
does come with the caveat, as discussed in Chapter 3, that
physical climate models can disagree on the particulars of
many hazards when it comes to future trends. For instance,
essentially all major models predict that precipitation pat­
terns will change going forward due to climate change, but
there are disagreements among these models as to the
magnitude and particular regions affected.
Both because of the lag in the Earth's climate system and
because of the way the physical models are designed,
these models give the best accuracy on decadal timescales.
Emissions trajectories do make a significant difference in
predicting physical impacts in the second half of the twenty­
first century, which can matter for very long-term planning,
such as for physical infrastructure that is generally expected
166 ■ Sustainability and Climate Risk Exam
to last decades. And by 2100, the differences in physical
risks between RCPs are very significant (see case study on
Ortec Finance).
Another important difference that makes physical risk
scenario planning very distinct from transition risk is that
physical risk always starts at the facility level. Physical
impacts affect specific processes and sites-a flooded fac­
tory, a wildfire-ravaged warehouse, an overheated office
building-and then these effects cumulate upward through
ownership supply and investment chains. Thus, as far as
facilities are concerned, both non-financial firms and finan­
cial ones are forced to consider physical risk as an opera­
tional risk. For transition risk, industrial firms can principally
examine their own facilities or compare performance to
sector benchmarks, and even financial firms can use emis­
sions data for just a few key emissions-intensive sectors
to get an estimate of portfolio alignment. Meanwhile, for
physical risk, all sectors and a wide range of assets and
facilities are potentially affected.
As discussed in Chapters 3 and 6, examining facility-level
physical risk requires having detailed data on hazards, expo­
sure, and vulnerability, including adaptive capacity, which
many firms choose to source from commercial data pro­
viders such as Four Twenty Seven, Carbone 4, or Trucost,
whereas others evaluate these in-house.
Finally, and importantly, the combination of the lower
importance of emissions scenarios for physical risk in the
shorter term (through 2050) and of physical risk's opera­
tional nature means that the type of scenario analysis that
tends to be conducted for physical risk is, in fact, much
closer to the original tradition of scenario analysis as pio­
neered by Herman Kahn or Shell. That is to say, plausible
scenarios of physical impacts can be drawn up that can then
help prepare for impacts. For this sort of planning, physical
climate models can help to an extent in pinpointing vul­
nerable areas. But they cannot predict incidence precisely
enough to be of use for forward planning, especially not for
acute physical hazards (e.g., when a flood will hit). There­
fore, using scenarios that are based on historically plausible
circumstances, especially of the types of hazards that are
expected to increase in frequency and severity with climate
change, can provide an excellent way to build preparedness
and resilience (see Section 7.4.2).
 CASE STUDY: VERY LONG-HORIZON PORTFOLIO PHYSICAL RISKS-ORTEC FINANCE
Ortec Finance, a consulting firm, has an in-house model
called ClimatePREDICT specializing in projecting extreme
weather risk on decadal timescales. Specifically, the model
forecasts the increase in frequency as we// as the financial
impact of climate-related extreme weather risk to physical
assets and economic growth. It does this year-by-year and
across various peril classes, covering over 120 countries.
In a case study, Ortec modeled losses from extreme
weather events linked to climate change under a 4 °C "failed
transition" pathway and a 2 °C "Paris compliant" pathway.
On a timescale of the coming decades, the difference in
losses is not that great between scenarios. For the New
Projected flood damages in NYC metro area
York City metropolitan area, losses from hydrological
(flooding) events are predicted to be USO1.2 trillion in
2030 under a "Paris" scenario and USO 1.3 trillion under
a "failed" scenario. The difference between the two is
somewhat greater in 2050, but the two scenarios are still
much closer to each other than a counterfactual, hypo­
thetical baseline with no climate change (see bar chart).
However, when the outlook is extended to the end of
the century, differences between scenarios diverge
markedly. In New York by 2100, annual flood losses in a
"failed transition" 4 °C scenario are expected to be triple
those in a "Paris compliant" scenario.

$2.5 2
C $2.0 1.6
Ill

,g $1.5 1.2 1.3

1:i 0.8
0 $1.0 0.7
Vl
=:, $0.5

$0.0
2030 2050
■ "Paris" scenario ■ "Failed" scenario ■ No Climate change
10 10
NEW YORK HYD ROLOGICAL (Flood) LONDON HYD ROLOGICAL (Flood)

9 PAL/CLIMATE PREDICT 9 PAL/CLIMATE PREDICT

with expected temperature variability i:n with expected temperature variability
�
LI)

0 8 0 8 Green = LON under PARIS/1.5°C pathway

� °
Green = NY under PARIS/1.5 C pathway �
C C Blue = LON under a 3°C pathway
,g 7 Blue = NY under a 3°C pathway .2 7
= LON under FAILED/4°C pathway
1:i = NY under FAILED/4°C pathway
1:i
Vt Vt
Vl Vl Grey = LON expected losses
=:, 6 Grey= NY expected losses (no climate change) =:, 6 (no climate change)
0 o·
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Ill Ill
>,
..0 4 .•·
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..0 4
Ill Ill
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Ill Ill
Ill
3 Ill
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<l:

0+--------------------�
1950 1970 1990 2010 2030 2050 2070 2090
Reprinted with permission of Ortec Finance (www.ortecfinance.com), Climate PREDICT solution (www.climatepredict.
app). This information is dated as at 13 August 2020 and reflects Ortec Finance's modelling, views and available data at
the time of its publication. This information is prepared for discussion only and should not imply the acceptance of any
liability by Ortec Finance.
Uf.jljifl:j
Chapter 7 Climate Models and Scenario Analysis ■ 167
7 .4 Scenario Analysis Use Cases: opportunities and future demand for products. A good
example is BHP Billiton, a mining and fossil-fuel firm, which
Corporate
uses four scenarios to model differences in commodity
This section examines how climate scenario analysis is used demand over the coming three decades (see box).
for different corporate use cases, ranging from strategy­
setting and stakeholder communication to preparedness 7.4.2 Operational Risk and Resilience Planning
planning meant to increase resilience. In fact, many corporate
Another important reason for firms to conduct scenario
board of directors have created climate-related committees
analysis is to mitigate operational risk and improve pre­
to regularly report and analyze climate risks broadly on a
paredness and resilience. A company can sketch out scenar­
company's financials and strategy. This section focuses on cor­
ios where its crucial operational or supply chain assets are
porate actions applicable to all kinds of corporations, financial
hit by transition or physical risk-related shocks (e.g., a sud­
and non-financial. Section 7.5 then examines the use of sce­
den large carbon tax hike, or a huge storm) and then assess
nario analysis specifically in financial and investment contexts.
how materially this would affect the business.

7.4. 1 Strategy and Stakeholder These can be based on plausible but not realized events

Communication (as with the Citi case study) or recent true events, and are
equally applicable to financial and non-financial firms, as all
An important reason for firms to engage in scenario analysis
types of firms use at least some physical facilities and rely
is for setting corporate strategy and communicating that
on some network of suppliers and customers. This type of
strategy to investors and other stakeholders. Much of the
scenario analysis is notably good for addressing the poten­
impetus for this use of scenario analysis has come from the
tial for business disruption. Climate-linked business disrup­
wide uptake of TCFD recommendations, which many firms
tion relating to physical climate risk is not a distant future
have signed onto, and which shareholders increasingly
prospect but is already occurring. Examples include the
expect, or regulators require. Thus, many scenario analy­
2011 Thai floods or 2020-2021 Taiwanese drought, both of
ses have been published in firms' TCFD-compliant climate
which disrupted semiconductor production, and the 2019
change reports, from which many of the case studies in this
European heatwaves and drought. The latter forced produc­
chapter are sourced.
tion pauses in certain German industries, including at BASF
While communication at first may sound like a public­ chemical plants, due to the inability to transport materials
relations exercise, this use of scenario analysis in fact has by barge on the Rhine with its historically low water levels.
important consequences. If companies do not make climate
change plans and conduct analyses that are seen as credible
7 .5 Scenario Analysis Use Cases:
and thorough, investors can come after companies. A vivid
Finance & Investment
example occurred in May 2021, when an investor campaign,
spearheaded by an activist hedge fund, Engine No 1, voted This section examines how climate scenario analysis is spe­
to place two independent directors on the board of Exxon­ cifically useful for financial firms, notably for portfolio-level
Mobil, the American oil & gas giant, against management's analysis and stress testing and for ex-ante integration into
wishes. Increasing numbers of institutions have committed investment decisions.
explicitly to the alignment of their operations and strategies
with Paris agreement goals and/or more-precise targets, 7.5. 1 Portfolio Analysis and Stress Testing
such as net-zero emissions by 2050. But these institutions
An important use case of scenario analysis in the financial
cannot make these changes in practice without conducting
sector is to examine portfolio-level exposures, and gauge
scenario analyses and communicating these analyses clearly
how these would vary in different climate outcomes (i.e.,
to investors.
scenarios). Stress testing, a practice that has been in wide
Another important reason why scenario analysis matters for use by financial regulators for over a decade, has now
companies is self-interest-scenario analysis can help chart been taken up by both the public and private sectors.

168 ■ Sustainability and Climate Risk Exam

 BHP BILLITON SCENARIO ANALYSIS-EXCERPTS
Scenario analysis approach
BHP develops planning cases to inform our strategic
choices and the timing of their execution, and to under­
pin our rigorous annual corporate planning process.
These planning cases consist of plausible commodity­
specific forecast ranges (high, mid, and low cases) that
are developed through in-depth, rigorous bottom-up
analysis. [... ]
Scenarios do not constitute definitive outcomes for us.
Scenario analysis relies on assumptions that may or may
not be, or prove to be, correct.
Scenarios:
• Central Energy View reflects existing policy trends and
° Source: From Climate Change Report 2020 by BHP.
commitments, and tracks to approximately 3 C tem­
perature increase above pre-industrial levels by 2100
• Lower Carbon View tracks to approximately 2.5 °C tem­
perature increase by 2100 and accelerates decarboniza­
tion trends and policies, particularly in easier-to-abate
sectors such as power generation and light duty vehicles
• Climate Crisis scenario has strong growth with limited cli­
mate action for a decade and a half, followed by a climate
crisis which precipitates an extremely steep decarbon­
ization trajectory, societal turmoil, and low GDP growth
• 1.5°C scenario, which aligns with the goals of the
Paris Agreement and requires steep global annual
emissions reductions, sustained for decades
Adapted from BHP.

Cumulative demand in the next 30 years compared to the last 30 years

(100% = CY1990-CY2019 cumulative demand)

400

I \
I \ 350
I \
\

300

250

200

150

100

50

0
Potash Energy coal Uranium <3> Oil Natural gas Copper !2l Nickell21 Metallurgical Iron ore 11l
coal<1>
.. •· · Climate Crisis scenario -+- Lower Carbon View � Central Energy View • • • 1.5 °C scenario

(1) Iron ore and Metallurgical coal demand accounts for Contestable Market= Global seaborne market plus Chinese domestic demand
(2) Nickel and Copper demand references primary metal
(3) Nuclear power was used as a proxy for historic cumulative demand for Uranium

Wi1iUU1
As regulators such as the Bank of England start implement­
ing climate stress tests, an increasing number of financial
institutions, especially banks, are choosing to voluntarily
conduct stress tests internally and not just when mandated
by a regulator.
Often, the results are then published and used as a way for
institutions to communicate their soundness and solid ERM
practices to their own investors and other stakeholders. This
is exactly what HSBC, a large global bank, has done with a
transition risk stress test on its loan portfolio (see Figure 7.10).

Chapter 7 Climate Models and Scenario Analysis ■ 169

 CASE STUDY: SCENARIO ANALYSIS FOR PHYSICAL CLIMATE EFFE C TS ON
OPERATIONS-CITI
The large US-based bank Citi is more concerned with
operational risk than many other banks because of its
large retail banking division as well as its wide geo­
graphical footprint. Citibank recognizes that the physical
impacts of climate can cause business disruption.
In 2020, Citi conducted an operational/physical risk
scenario assessment exercise focusing on the impact of
extreme weather events on two large employee centers in
the United States, in Tampa, Florida, and New York City.
The bank selected these locations due to their stra-
tegic importance and exposure to hurricane (cyclone)
risk based on previous climate risk mapping. It then
developed three scenarios with different probabilities
of occurrence that were designed to be plausible but
severe, ranging from the most likely (1 in 25 chance) to
less likely (1 in 100) to /east likely to occur (1 in 1000).
The scenarios were as follows:
1/25: Tropical storm affects Tampa, Florida, office
complex----> Some damage to facilities
1/100: Tropical storm and then Category 5 hurricane
affect Tampa, Florida, office complex----> Facilities are
left inoperable and must be rebuilt
7.5.2 Ex-Ante Investment Integration
Although stress testing and portfolio-level analysis of climate
exposures is increasingly well-established, ex ante integra­
tion of climate scenarios into investment processes is a
newer phenomenon. Analogous to ESG, where integration
has followed on from exclusion or ad hoc analyses (as cov­
ered in Chapter 5), more proactive use of scenarios in invest­
ment decision-making does seem to be the next frontier in
investment management. Some early movers have already
announced moves in this direction (see box). Having scenario
analysis as part of the toolkit of portfolio managers and
other investment decision-makers can potentially preempt
undue exposure to climate risk or serve as an early indication
for where investment firms can focus engagement efforts.
7 .6 Conclusions
This chapter has sought to demonstrate the utility, and
indeed the necessity, of using scenario-based modeling
170 ■ Sustainability and Climate Risk Exam
1/1000: Tropical storm and Category 5 hurricane
affect Tampa, Florida, office complex and simultane­
ously a tornado hits the New York City headquarters
Facilities are left out of commission and require repair
---->
(NYC) or complete rebuilding (Tampa)
Due to data limitations, these probabilities were based
mainly on historical climate patterns, and thus do not
account for expected increases in frequency or severity
due to climate change. The scenarios a/so did not incor­
porate the impacts to local infrastructure (e.g., electric­
ity, transportation networks), but only to Citi facilities.
After completing the scenario analysis, the bank
estimated that significant physical and financial dam­
age would be incurred. Nonetheless, Citi concluded
that there would "not [be] a material impact to our
operational resilience." In particular, the bank cited
the successful example of temporary work-from-home
arrangements during the COVID-19 pandemic as a suc­
cessful coping strategy in case offices are damaged or
destroyed by climate-exacerbated weather hazards.
Source: Finance for a Resilient Future: Citi's 2020 TCFD
Report.
to properly understand the impact of climate change. The
space does have a lot of background knowledge and ter­
minology to wade through, as a lot of the groundwork, as
well as global-level scenarios, were originally developed by
scientists for scientific use. The reason to become familiar
with representative concentration pathways (RCPs), shared
socioeconomic pathways (SSPs), and integrated assessment
models (IAMs) is because they have broadened from their
original scientific use cases to be the mainstay of anyone,
including corporations or financial institutions, seeking to
understand climate change and integrate climate risk into
investment and strategic decisions.
But it is equally important to recognize how scenario analy­
sis, to be useful to non-financial and financial firms, must be
done differently for transition and physical risk, and for dif­
ferent use cases. Transition risk analysis does typically mean
starting with global reference scenarios on emissions trajec­
tories, but it also requires the use of sector-specific path­
ways and firm-specific information. For physical risk, global
CASE STUDY ON USE OF SCENARIOS FOR TRANSITION RISK: HSBC
In 2020, HSBC, a global bank, used a scenario analysis
stress testing pilot to examine its portfolio exposure to
six sectors and sub-sectors highly exposed to high transi­
tion risk. To do so, it used the NGFS reference scenarios
of an orderly and disorderly transition and of a hot­
house world.
T he sectors examined were automotive, construction,
chemicals, metals and mining, oil & gas, and utilities
(see schematic, which illustrates the level of risk the bank
is exposed to within each sector portfolio in different
climate scenarios).
In the automotive sector, the analysis was run on auto
manufacturers, with the key scenario driver being the
transition from internal combustion to electric vehicles
(EVs). In all scenarios, high EV adoption is expected, with
an even quicker uptake in the disorderly transition, which
has higher carbon taxes.
In chemicals, some are very emissions-intensive, such as
ammonia and methanol, while others are not. Carbon
pricing affects the chemicals sector in the scenarios, but
so does growth in demand due to economic expansion.
Oil & gas is expected to be hit with declining demand
for fossil fuels in both the orderly and disorderly sce­
narios. In the former, gradual increases in carbon taxes
and development of carbon removal (negative emissions)
technologies allows the sector to adjust more smoothly
than in the disorderly scenario where high carbon taxes
are suddenly imposed.
In the power generation sector, utilities differ signifi­
cantly in their current electricity mix and their abil­
ity to transition. Nonetheless, the sector is actually
expected to perform better in a disorderly transi­
tion scenario, as opposed to an orderly one, due to
a disorderly, abrupt transition increasing electricity
demand and prices.
Adapted from HSBC Holdings PLC Task Force on
Climate-related Financial Disclosures ('TCFD') Update
2020. Reprinted by permission from HSBC.

Consolidated transition risk heat map across six high transition risk sectors - illustrative results of sub-sectors
Increasing negative impact- - - •
-
Higher

♦
•■ : ____________________
Construction and building materials Sector not expected to be significantly impacted

•■
Hot house
0 from climate transition and benefits from
0 Disorderly
■
GDP growth in the Hot house scenario

Chemicals
Large impact in Disorderly scenario as higher Orderly
carbon costs outweigh the benefit from
GDP growth

-�"'
■
...►---1-----,o Metals and mining

::,
0
a.
X
w Smaller impact in Disorderly scenario than
u Orderly as total vehicle sales are higher due

0♦ ■
Ill I
V> to significant EV adoption
J: AutomC:.tive (OEM)
Small average impact due to balancing effect
•Po!, and utilities (PowerGen) . - - - - - - - - - - - - - - - - - from winners (e.g. producers with high wind/
solar) and losers (e.g. coal-based producers)

Oil and gas

■■.-------------,0 Oil and gas (Upstream) (integrated)

■■.--------------------------0 Oil and gas (Downstream)

Lower Higher
Relative impact 2 (% change between 2019 actuals and projected 2050 financials3)

Adapted from HSBC Holdings PLC "Task Force on Climate-related Financial Disclosures ('TCFD') Update 2020."
Fi ure 7.10

Chapter 7 Climate Models and Scenario Analysis ■ 171

 CASE STUDIES: INTEGRATION OF SCENARIO ANALYSIS INTO ASSE T
M ANAGEMENT
Abrdn (formerly AberdeenStandard)
In 2021, Abrdn, a UK asset manager, set out how it
intends to integrate its in-house climate scenario work
into its investment activities:
"In the coming months [as of Feb 2021), we will fully inte­
grate our climate-scenario framework and insights into
our business strategy[... ] This will include the following:
a. Integrating the results into active stock selection by
asking critical climate-related research questions that are
informed by our scenario analysis.[...]This in turn will
allow us to construct portfolios that are resilient to differ­
ent plausible climate pathways.
b. Embedding scenario analysis into our approach to
stewardship. Where material climate risks are identi­
fied, we will engage with companies to understand what
actions they are taking to mitigate them and encourage
firms to undertake their own analysis.[...]
c. Fully integrating climate risk and opportunity into our
strategic asset-allocation framework[...]
d. Developing a wide range of innovative climate-change
(including net zero) solutions for our clients."
scenarios matter only for very long-term planning because
the significant physical differences between emissions sce­
narios only really manifest after 2050, in the second half of
the century. Instead, the use of scenario planning for cor­
porate contingency planning can be more fruitful. We must
also be cognizant that there is not broad alignment nor
the data fidelity necessary for consistent scenario analysis
across companies and organizations. Over time, all stake­
holders will need to continue to advance and refine the
REFERENCES
Collins, M., Knutti, R., Arblaster, J., Dufresne, J.-L., Fichefet,
T., Friedlingstein, P., Gao, X., Gutowski, W. J., Johns, T.,
Krinner, G., Shongwe, M., Tebaldi, C., Weaver, A. J., &
Wehner, M. (2013). Long-term Climate Change: Projections,
Commitments and Irreversibility. In T. F. Stocker, D. Qin,
G.K. Plattern, M. Tignor, S. K. Allen, J. Boschung, A. Nauels,
Y. Xia, V. Bex, & P. M. Midgley (Eds.), Climate Change 2013:
172 ■ Sustainability and Climate Risk Exam
Legal & General Investment Management (LGIM)
In October 2020, LGIM and Baringa Partners, a specialist
in climate and physical risk analysis, announced the co­
development of a bespoke climate risk framework, Desti­
nation@Risk. This framework is intended to allow
• LG/M to quantify physical and transitional risks of
climate change within its investment portfolios using
these proprietary climate scenarios.
•
the degree of alignment at the company level to
coincide with Paris goals-preliminary data and initial
analysis of a sample set of 2,000 companies done for
the launch announcement showed that the majority
were not aligned to Paris.
• these scenarios and measures of alignment to be fully
integrated into all LG/M's investment activities glob­
ally through a "climate dashboard."
Source: Climate Scenario Analysis: A Rigorous
Framework for Managing Climate Financial Risks and
Opportunities, Feb. 2021.
analysis, as well as increase the data necessary, to create
consistent scenarios required to understand the impacts of
climate change in a cohesive way.
While corporations of all kinds can and do use climate
scenario analysis to decide on strategy, communicate with
stakeholders, and increase preparedness, financial firms in
particular can also benefit from the use of scenario analysis
for portfolio stress testing and as an input for investment
decision-making.
The Physical Science Basis. Contribution of Working Group
I to the Fifth Assessment Report of the Intergovernmental
Panel on Climate Change. Cambridge University Press.
Four Twenty Seven. (2019). Demystifying Climate Scenario
Analysis for Financial Stakeholders. http://427mt.com/wp­
content/uploads/2019/12/Demystifying-Scenario-Analysis_
427_2019.pdf
Wilkinson, A. K., Roland. (May 2013). Living in the Futures.
Harvard Business Review.
The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

QUESTIONS
7.1 What is scenario analysis? D. RCPs are developed by the IPCC, whereas SSPs
are developed by the IEA.
A. Analysis through deductive reasoning and directed
questioning 7.5 What is the IEA known for having historically done in
its renewable energy projections?
B. Analysis using several plausible narratives about
the future A. Inconsistently uses RCPs generated by the IPCC

C. An analytical framework that produces specific rec­ B. Inconsistency in its treatment of hydropower com­
ommendations as output pared to wind or solar

D. The use of quantitative models about the future C. Consistently underestimating the annual increases
under plausible assumptions in solar and renewable capacity

7.2 What is radiative forcing? D. Consistently using the same name for its central
scenario
A. A measure of radiation from nuclear power plants

B. The difference between incoming energy emitted

7.6 What separates a "disorderly transition" scenario
from the "hothouse world" scenario?
by the Sun and outgoing energy emitted by Earth
A. The disorderly transition has high physical risks,
C. The difference between solar radiation absorbed
and the hothouse world has high transition risks.
by the sea and energy radiated back into space
B. The disorderly transition has high transition risks,
D. The difference between radiation reflected by sea
and the hothouse world has high physical risks.
ice and that absorbed by oceans

7.3 What is a "representative concentration pathway" C. Both have high transition risks, but the hothouse
world also has high physical risk.
(RCP)?
D. Both have high physical risks, but the disorderly
A. A projected pathway of human-caused greenhouse
transition also has high transition risk.
gas emissions, usually until 2100
B. A model with detailed representations of social,
7.7 How do climate models differ from integrated assess­
ment models (IAMs)?
economic, and environmental factors
A. Climate models are based on physical science,
C. A plausible socioeconomic narrative of environ­
whereas IAMs are only grounded in economic
mental change
theory.
D. A projected pathway of climate policy stringency
B. Climate models only model the physical climate,
7.4 What is the difference between RCPs and SSPs?
and IAMs only model social and economic factors.
A. RCPs only deal with oil & gas firms, whereas SSPs
C. Climate models only model the physical climate,
deal with all kinds of corporations.
and IAMs demonstrate how social and economic
B. RCPs are narratives, whereas SSPs are quantitative factors affect each other and the climate.
scenarios.
D. Climate models and IAMs do not differ, but climate
C. RCPs only deal with projected emissions, whereas models are a type of 1AM.
SSPs provide societal and economic context.

Chapter 7 Climate Models and Scenario Analysis ■ 173

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

7.8 How does physical risk scenario analysis for corpora­
tions differ from that for transition risk?
A. Physical risk never uses IPCC models, whereas
transition risk analysis always does.
B. Physical risk analysis involves calculating impacts
on a firm's own facilities, but transition risk analysis
does not.
C. Transition risk scenario analysis is only applicable
to energy firms, but physical risk analysis is appli­
cable to all firms.
D. Transition risk scenario analysis makes heavy use
of emission trajectories, whereas physical risk sce­
nario analysis mainly looks at operational risk.

174 ■ Sustainability and Climate Risk Exam

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

ANSWERS
7.1 B 7.5 C
7.2 B 7.6 B
7.3 A 7.7 A

7.4 C 7.8 D

Chapter 7 Climate Models and Scenario Analysis ■ 175

Net Zero
■ Learning Objectives
After reviewing this chapter, you should be able to:
• Explain the concept of net zero and how it relates to
global climate goals.
• Discuss the types of key alliances in the UN Race to
Zero.
• Describe the attributes of net-zero targets, and the
challenges of navigating the net-zero transition.
• Explain the key attributes of national and subnational
net-zero target strategies and emissions reduction
approaches.
• Describe the factors that affect different sectors' abili­
ties to achieve net zero.
• Describe how organizations use transition plans
to pursue net-zero carbon emissions and the tools.
private-sector actors can use to verify the credibility
of net-zero commitments.
• Describe how net-zero pathways and interim targets
are key to achieving credible and attainable net-zero
targets across sectors.
• Identify cross-industry principles and metrics and dis­
cuss how climate-related metrics are used in reporting
and project selection.
• Understand metrics used for net-zero portfolio align­
ment, considering strengths and weaknesses.
• Describe the net-zero disclosure landscape and key
stakeholders.
177

T his chapter provides an overview of the concept of
net zero and its implications for different players in the
economy. It begins with an introduction to the scien­
tific background behind net zero and its link to global
climate ambitions enshrined in the Paris Agreement.
It further provides an overview of the key global initia­
tives that are mobilizing entities across the world to
make bottom-up commitments and pushing them to
begin the journey of reducing the climate impact of
their own organization. T he chapter then outlines the
various elements required to ensure the credibility of
these targets. It explains the crucial role that transition
plans can play in demonstrating that an organization
is integrating decarbonization ambitions into its core
strategy, and emphasizes the importance of interim tar­
gets and pathways and the transparent use of metrics
to measure progress. It ends with a discussion of the
emerging landscape of net-zero disclosure standards.
Chapter Outline
8.1 Introduction to Net Zero
8.1.1 The science behind Net Zero
°
8.1.2 Net zero and the 1.5 C target
8.2 The Spread of Net-Zero Targets
8.3 The Implications of Net Zero for Different Actors
8.3.1 Countries
8.3.2 Sub-national governments
8.3.3 Private sector
8.4 Transition Plans
8.5 Interim Targets and Pathways
8.6 Use of Metrics
8.6.1 Cross-industry principles & metrics
8.6.2 Metrics for financial institutions
8.7 Reporting
8.8 Conclusion
178 ■ Sustainability and Climate Risk Exam
Key Learning Points
• To stabilize global temperatures, it is necessary to reach
a balance between global sources and sinks of green­
house gases (i.e., global greenhouse gas emissions must
reach net zero). To have a chance of limiting global aver­
°
age temperature increases to 1.5 C, the IPCC estimates
that global emissions need to halve by 2030 and reach
net zero by 2050.
• Although we are currently witnessing a wave of coun­
tries, sub-national governments, and companies submit­
ting bottom-up net-zero pledges in support of this goal,
these differ greatly in their ambition and credibility. For
example, some pledges will only apply to carbon emis­
sions, whereas others cover emissions of all greenhouse
gases, such as methane. Some pledges include only
Scope 1 and 2 emissions, whereas others cover all
3 Scopes.
• What reaching a net-zero target implies depends on the
type of organization submitting the pledge. National
pledges generally cover all emissions produced within
its geographical boundaries. Reaching these targets will
require reducing all domestic greenhouse gas emissions
and directly removing any remaining net domestic flows
via carbon sinks. In contrast, there is no single globally
recognized standard for setting the scope of net-zero
pledges for sub-national communities or corporations.
It remains to be seen whether the work by the UN High­
Level Expert Group for net-zero Emissions Commitments
of Non-State Entities, or the voluntary framework pro­
vided by the Science-Based Target Initiative will evolve
to become a globally recognized standard.
• Transition plans can be an important tool to add credibility
to net-zero pledges. In such plans, entities have a chance
to demonstrate how their climate pledge aligns with their
broader organizational strategy, and that they have a mean­
ingful action plan to back up their commitments.
• Net-zero targets are not enough to ensure a timely transi­
tion. To overcome the credibility gap and help decision
makers manage transition risks, target setters must define
credible net-zero pathways with attainable interim targets.
• Carbon-related metrics are used to track an entity's
progress along its net-zero pathway, select projects, and
compare an entity to its peers. Along with metrics, enti­
ties must consider stakeholder needs and public disclo­
sure of the progress made.
• Portfolio alignment tools, although varied in their com­
outlining the scientific basis of the concept and explaining
how it relates to the global climate goals enshrined in the
Paris Agreement and the Glasgow Climate Pact. The chap­
ter further clarifies what net-zero pledges mean in practice
for different players in the field, and the role that transition
plans play in providing roadmaps to reaching these tar­

plexity and robustness, allow financial institutions to gets. It highlights why net-zero transition plans will become

assess if their counterparties are on a net-zero transition increasingly important for measuring and managing climate­

path by measuring how far they are diverging from a related transition risk. The chapter then introduces key met­

benchmark and what this would imply for global warming. rics for the non-financial and financial sectors and discusses

The challenge of these tools is that portfolio decarboniza­ the emerging landscape of net-zero reporting standards

tion as such does not necessarily support economy-wide and taxonomies.

decarbonization or mitigate exposure to climate risk.

• The net-zero disclosure landscape is still emerging.
Recent consolidation of standard setters and initiatives
seem to leave two key leaders, the TCFD and ISSB, at
the forefront, while new government-backed initiatives
try to incorporate some of these standards into law.
8. 1. 1 The science behind Net Zero
The concept of net-zero emissions originally emerged in
scientific discussions on the link between anthropogenic
emissions and global temperature changes (Hale et al.,
2022). It has long been understood that there is a near­
linear relationship between cumulative net emissions of

NET ZERO
8.1 Introduction to Net Zero
This chapter is designed to introduce the concept of net
zero and its role in global climate architecture. It begins by
CO2 and other greenhouse gases (GHGs) on the one hand,
and changes in global surface temperatures on the other
(for further detail, see Chapter 1 ). In short, any increases
in the global concentration of greenhouse gases in the
atmosphere lead to further warming which translates into
increases in frequency and intensity of extreme weather

Anthropogenic carbon
flows in and out of each sphere Atmosphere
are balanced; temperature
stabilized sustainably
Emissions from
Emissions from land-use change
fossil fuels and
Sinks from
industrial processes
land-use change

Sinks from air capture

and geological storage
Land and ocean
Lithosphere biosphere
Sinks from biomass capture and
geological storage

Durable net zero

lifd'iiJ:I■ Durable Net Zero

© 2021 Intergovernmental Panel on Climate Change Climate Change 2021 The Physical Science Basis. Working Group I
Contribution to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change.

Chapter 8 Net Zero ■ 179

events. This in turn implies that halting anthropogenic
climate change requires us to reach a balance between
the greenhouse gases entering the atmosphere and those
removed via sinks (e.g., via geological storage or carbon
capture in biomass) (see Figure 8.1). Stabilizing global tem­
peratures at any given level therefore requires total global
emissions of greenhouse gases to reach net zero, meaning
that all global GHG emissions are balanced by correspond­
ing GHG removals (IPCC, 2021).
8. 1.2 Net zero and the 1.5 °C target
This insight forms the core of the 2015 Paris Agreement,
in which countries committed themselves to halting
human-induced climate change by reaching "global peak­
ing of greenhouse gas emissions as soon as possible" and
achieving "a balance between anthropogenic emissions by
sources of greenhouse gases." Importantly, the Paris Agree­
ment further specifies the level at which this stabilization
should occur. In Article 2.1 of the Paris Agreement, negotia­
tors agreed to "hold the increase in global average tem­
°
perature to well below 2 C above pre-industrial levels" and
° °
pursue "efforts to limit the temperature increase to 1.5 C."
BOX 8.1: THE DIFFERENCE BETWEEN 1.5 ° AND 2 ° CELSIUS
°
The 2018 IPCC Special Report on 1.5 C (SR 1.5) starkly
outlined the severity of the implications of an additional
°
0.5 C of warming. For example, the 2018 report had the
following conclusions:
• The estimated share of the global population exposed to
severe heat at least once every five years rises from 14%
° °
under a 1.5 C scenario, to 37% under 2 c of warming.
°
• Although 1 .5 C of warming would still likely lead to
70-90% reduction in average coral cover, it would pre­
vent the total loss of coral reefs projected with warm­
°
ing of 2 C.
• The probability of extreme drought and water stress,
particularly in the Mediterranean region and southern
°
Africa, are substantially higher under a 2 C scenario,
°
compared with 1.5 C.
• An additional 10 million people are estimated to be at
° limiting global warming to 1.5 C would substantially
risk of flooding under a 2 C scenario, compared to a
°
scenario where warming is limited to 1.5 C by 2100.
180 ■ Sustainability and Climate Risk Exam
This target reflected a political consensus regarding a com­
mon aspiration, rather than a scientific assessment of what
level of global warming would be "acceptable." Neverthe­
less, the Paris Agreement was groundbreaking insofar as it
marked the first document in which governments around
the world were able to achieve international agreement on
a common level of ambition for limiting global warming.
°
However, already at the time of signing, the 2 C target
faced criticism. Many climate advocacy groups and even
some country delegations argued that the risks incurred
°
with 2 C of warming above pre-industrial levels were unac­
ceptable, and that political decision-makers should raise
their ambitions. The IPCC was therefore asked to prepare
a special report that investigated the difference between a
° °
2 C and a 1.5 C warming scenario, as well as the possible
°
pathways for reaching the 1.5 C target. The resulting "Spe­
°
cial Report on the impacts on global warming of 1.5 C,"
published in 2018, provided evidence that the likely effects
°
from an extra 0.5 C of warming would be substantial (IPCC,
2018) (see Box 8.1 ).
On the one hand, these findings have led a ratcheting up
of global ambitions, with the 1.5 C target becoming the
°
• At 2 C of global warming, it is likely that temperature
°
increases of more than 2 C would occur over most
land regions in terms of extreme temperatures (up to
° °
4 C-6 C depending on region and considered extreme
index). Regional increases in temperature extremes can
be robustly limited if global warming is constrained to
° ° °
1.5 C, with regional warmings of up to 3 C-4.5 C.
Many of these conclusions have more recently been
echoed in the 2022 IPCC Report on Impacts, Adaptation
and Vulnerability, which focused on both the projected
risks and already observed impacts of climate change.
Its findings re-emphasize that an increase of global
°
surface temperature by 1.5 C would cause unavoidable
increases in various climate hazards and present multiple
risks to humans and ecosystems. It further outlines the
various ways in which the impacts of climate change are
already being felt today. The report also underlines that
°
reduce the projected loss and damages compared to
higher warming scenarios.
de-facto standard against which climate advocates and oth­
ers assess climate ambitions. This ambition was codified in
the 2021 Glasgow Climate Pact, which "recognizes that the
impacts of climate change will be much lower at the tempera­
° °
ture increase of 1.5 C compared with 2 C and resolves to pur­
°
sue best efforts to limit the temperature increase to 1.5 C."
At the same time, the 2018 report and subsequent analy­
°
ses by the IPCC sharply underline that reaching the 1.5 C
target is a major challenge that requires a sharp reversal in
emission trends (see Chapter 1.3). In its most recent report,
°
the IPCC estimates that to limit global warming to 1.5 C,
global net emissions would need to peak before 2025,
decline by 43% by the 2030s, and reach net zero in the
early 2050s (IPCC, 2022).
8.2 The Spread of Net-Zero Targets
T his 2050 target has become a global rallying cry for cli­
mate commitments from governments and non-state actors.
By June 2022, 128 countries representing 83% of global
emissions and 91% of global GDP made net-zero commit­
ments of some description (Net Zero Tracker, 2022).
Among non-state actors, the UN Race to Zero campaign
plays a crucial role. The initiative was launched in the run-up
to COP26, with the intention of mobilizing "real economy"
actors, including regions, cities, businesses, and financial
institutions, to commit to reducing their carbon emissions
to net zero by 2050. It operates as a coordinating umbrella
framework of partner initiatives, which usually have either a
sectoral focus or represent coalitions of particular types of
entities (e.g., cities; see Table 8.1).
To join the Race to Zero, these initiatives have to demon­
strate that they require their members to meet a set of
globally defined procedural criteria, including a pledge to
reach net zero by 2050 at the latest. On top of these global
criteria, individual initiatives will often ask for more-detailed
commitments from their members, which help translate
global climate ambitions to sector-specific actions. Since its

1fflMl=l1
KEY ALLIANCES IN THE RACE TO ZERO
Name Actors Description
PUBLIC SECTOR ALLIANCES

Cities Race to Zero Cities Coalition of cities that have publicly joined the Race to Zero and
committed to achieving net-zero emissions by 2050.

Under 2° Coalition Governments Coalition of states, regions, provinces and other subnational
governments committed to achieving net zero emissions by
2050 at the latest.

FINANCIAL SECTOR ALLIANCES

Glasgow Financial Alliance
for Net Zero (GFANZ)
Financial sector A global coalition of over 550 financial institutions which covers
various subsector alliances. Although many of its member firms
and alliances are part of Race to Zero, GFANZ announced in
2022 that it would not require member firms to sign up to the
Race to Zero Campaign.

UN Environment Financial sector Initiative that provides guidance to advance market practice to
Programme Finance Initia­ over 450 financial-sector institutions (including banks, insurers,
tive (UNEP Fl) investors) with the goal of ensuring that financial systems sup­
port both people and planet.

Commercial banks
Net Zero Banking Alliance Banks An alliance of global banks that have committed to reaching net
(member of GFANZ) zero by 2050.

(continued)

Chapter 8 Net Zero ■ 181

Name
Asset managers
Net Zero Asset Managers
Initiative (member of GFANZ)
Asset owners
Paris Aligned Investment lni-
tiative (member of GFANZ)
Net Zero Asset Owner Alli-
ance (member of GFANZ)
Insurers
Net Zero Insurance Alliance
(member of GFANZ)
Other financial services
Net Zero Financial Service
Provider Alliance (member of
GFANZ)
Net Zero Investment Con­
sultants Initiatives (member
of GFANZ)
REAL ECONOMY (NON-SECTOR SPECIFIC)
Business ambition for 1.5 °C
The Climate Pledge
Certified B Corporation
SME Climate Hub
Business Declares
182 ■ Sustainability and Climate Risk Exam
Actors Description
Asset managers An initiative designed to mobilize climate ambition among inter­
national asset managers. All members have committed to reach­
ing net zero by 2050 and are using the forum to develop and
share best-practices.
Asset owners A collaborative, investor-led forum of 118 institutional investors
representing USO 34 trillion in assets that are seeking to align
their operations with the goals of the Paris Agreement.
Asset owners A coalition of 7 4 pension funds and insurers that are collaborat­
ing to Paris-align their investment activities.
Insurers A group of 30 leading insurers that have committed to aligning
their insuring and reinsurance underwriting portfolio with the
°
1.5 C target enshrined in the Paris Agreement.
Financial service An alliance of investment advisors, auditors, rating agencies,
providers index providers, ESG research and data providers, and exchanges.
All members have committed to aligning their activities to achieve
net-zero greenhouse gas emissions by 2050 or sooner.
Investment A coalition that sets actions that investment consultants will take
consultants in the context of their legal and fiduciary duties, as well as specific
client mandates, to support reaching the global net-zero target
by 2050 or sooner.
Corporates Led by the Science-Based Targets Initiative in partnership with
the UN Global Compact and the We Mean Business Coalition, it
seeks to encourage private businesses to develop science-based
°
emissions-reduction targets in line with the 1.5 C target.
Corporates A campaign co-founded by Global Optimism and Amazon which
seeks to call businesses and other organizations to action on cli-
mate. Its signatories have pledged to reach net zero by 2040.
Corporates A Certified B Corp is a corporation that has been certified by B
Lab, which is a non-profit company. B Corporations are compa-
nies that meet high standards of social and environmental per-
formance, accountability, and transparency.
Small and medium- A hub that provides the tools, resources, and frameworks that
sized companies allow businesses with fewer than 500 employees to commit to
reaching net zero by 2050 or sooner.
Corporates Non-profit organization that seeks to raise awareness for climate
emergency in the private sector, accelerate private-sector action,
and amplify the voices in the business community that are calling
for regulatory action.
Name Actors Description
CBN Expert Community Corporates Community of organizations that have pledged to achieve
net- zero emissions via CBN Expert, a firm that supports compa-
nies seeking to calculate, measure, and track their carbon footprint.

Planet Mark Corporates Sustainability certification scheme through which organizations

can certify their net-zero pledge.

REAL ECONOMY (SECTOR SPECIFIC) I

Tech Zero Tech sector Collection of technology companies that have committed to
measure and disclose Scope 1, 2, and 3 emissions and set ambi-
tious net-zero targets.

Pledge to Net Zero
Environmental A pledge through which organizations from the environmental
sector sector are committing to reduce their own emissions in line
°
with Science Based Targets' 1.5 C climate change scenario, and
actively contribute to the conversations on how targets can be
achieved (e.g., by publishing thought pieces).

Race to Zero for Universities Higher education Collaboration by UNEP, the alliance for sustainability leadership
& Colleges in education (EAUC), and second nature, which are mobilizing uni-
versities and colleges to commit to Paris-align their operations.

Fashion Industry for Climate Fashion industry Pledge by stakeholders in the fashion industry to drive the fash-
Action ion industry to net-zero Greenhouse Gas emissions no later than
°
2050 in line with keeping global warming below 1.5 C.

Healthcare Without Harm Healthcare sector Alliance that focuses on mobilizing the healthcare industry to
move toward a net-zero future.

CASE STUDY: COMMITMENTS OF THE NET-ZERO INSURANCE ALLIANCE

The UN convened Net-Zero Insurance Alliance (NZIA)
is a leading net-zero initiative for insurers and currently
brings together 30 companies that jointly represent
15% of the world premium volume. By joining the NZIA,
companies automatically become members of both
the Glasgow Financial Alliance for Net Zero (GFANZ)
and the UN Race to Zero. However, to join the NZIA,
companies have to sign a statement of commitment
that is tailored to the insurance market and goes
beyond the minimum criteria established by UN Race to
Zero. For example, all members have to commit to the
following:
• Transitioning all operational and attributable GHG
emissions from insurance and reinsurance underwriting
portfolios to net-zero emissions by 2050.
• The Alliance requires members to set and disclose
Establishing intermediate, science-based targets every
five years, based on one or more scientific metrics
that build on recognized methodologies, which will be
defined via an NZIA target-setting protocol.
• Supporting the implementation of corporate disclo­
sure frameworks relevant to the net-zero transition
and the insurance industry.
• Engaging with clients and potential clients on their
decarbonization strategies and net-zero pathways.
• Developing and offering insurance and reinsurance
products, solutions, and arrangements for low­
emission and zero-emission technologies and nature­
based solutions that are key to the net-zero transition.
In addition, the Alliance launched its first Target-Setting
Protocol in January 2023 which allows insurance and
reinsurance companies to set science-based targets for
their insurance and reinsurance underwriting portfolios.
targets by 3pt July 2023.
Source: © United Nations Environment Programme
Finance Initiative.

Chapter 8 Net Zero ■ 183

launch, over 8300 companies have joined the Race to Zero
via one of the member alliances and submitted their respec­
tive commitments.
In parallel to that process, there are myriad public- and
private-sector players that have published pledges
CASE STUDY: THE MEANING OF NET ZERO AND HOW TO GET IT RIGHT
Fankhauser et al. (2022) usefully summarized the debate
and derived seven attributes that net-zero targets need
to fulfil to provide a meaningful framework for action.
These are the following:
1. Front-loaded emission reductions: Given that global
temperature change is determined by cumulative
emissions, and not emissions in any given year, it
matters when emissions are reduced. To increase the
chances of meeting the Paris targets, entities must
reduce emissions as soon as possible.
2. Comprehensive approach to emission reductions:
Reaching net zero requires tackling all emissions. For
governments, this means pushing forward decarbon­
izations in hard-to-abate sectors. For private corpo­
rations, this implies pursuing best efforts to reduce
emissions across Scopes 1, 2, and 3, and engaging
with all stakeholders along the value chain whose
actions are required to achieve these targets.
3. Cautious use of carbon dioxide removal: Theoreti­
cally, net zero could be reached by combining high
residual emissions with significant CO2 removal. In
practice, however, there are unresolved issues for
most forms of removals, which make it important to
prioritize deep emissions reductions
4. Effective regulation of carbon offsets: Given that
some organizations will be unable to reach net zero
purely by adapting their own operations, we will
continue to require a mechanism to balance global
sources and sinks (e.g., carbon markets). It is critical
that these mechanisms underlie governance struc­
tures that meaningfully address the concerns out­
lined in Box 8.3 and allow for monitoring, reporting,
and verification of removed carbon.
184 ■ Sustainability and Climate Risk Exam
independently of the Race to Zero framework and its core
criteria. As of November 2022, an estimated 40% of the
world's largest corporations had submitted a net-zero
pledge (Net Zero Tracker (2022). However, not all targets
are created equal. Individual commitments differ widely
among important dimensions such as the target year
5. Equitable transition to net zero: Deciding how the
costs of the transition are shared across different
actors creates challenging equity considerations. The
Paris Agreement calls on countries to set their own
ambitions in line with the principle of "common but
differentiated responsibilities and respective capaci­
ties," emphasizing that developing countries will
need more time and financial and technological sup­
port to transition. Effective net-zero target setting
must take such considerations of fairness into account
and recognize that some actors will need to decar­
bonize at different speeds, to help ensure that the
transition does not exacerbate existing inequalities.
6. Alignment with broader socio-ecological objec­
tives: There are complex interlinkages among
climate change and other critical socio-ecological
challenges such as ocean acidification, the erosion
of biosphere integrity, economic inequality, or the
marginalization of indigenous communities (Steffen
et al., 2015). A narrow focus on mitigation may over­
look negative repercussions in other dimensions. For
example, there are cases where commercial refores­
tation projects rely on large-scale monocultures to
generate offsets, which have negative implications
for local populations, ecosystem resilience and ulti­
mately, reliable carbon storage.
7. Pursuit of economic opportunities: It is becom-
ing increasingly apparent that there are also eco­
nomic opportunities that arise through the net-zero
transition.
8. Effective net-zero planning should consider where
such opportunities are likely to arise, and address
what steps need to be taken so these can be realized.
by which entities intend to achieve net zero, the scope
of emissions included by the pledge, and the extent to
which organizations have presented a robust and credible
implementation plan. At the national level, countries have
pledged to move at different speeds. Whereas Sweden
has pledged to reach carbon neutrality by 2045, China
aims to achieve that goal by 2060, and India aims for 2070
(UNFCCC, 2023).
They also exhibit different degrees of legal commitment
to their targets. In the UK and Germany, the national net­
zero targets have been embedded in law. However, this
is only the case for roughly 18% of global country-level
commitments (Net Zero Tracker, 2023). In around 43% of
cases, including the US, the pledges have been published
via non-legally binding policy documents such as a coun­
try's National Determined Contribution (i.e., the climate
action plans submitted to the UNFCCC under the Paris
Agreement; see Chapter 4). Around 20% of countries have
pledged to reach net zero only via public statements made
by key officials.
The landscape of non-state actor pledges is similarly
varied. Although some corporations have put forward
rigorous commitments with clear strategies and interim
targets for moving toward net zero, others have done
little more than publicly declare their intent to decarbon­
ize. Some pledges only cover carbon emissions, whereas
others also include commitments to reduce all green­
house gas emissions, including methane. Furthermore,
there are immense differences regarding the scope of
activities covered by reduction targets. For example, the
net-zero target published by Apple explicitly includes
Scope 1, 2, and 3 emissions, whereas the pledge submit­
ted by Tata Consultancy Services covers only Scopes 1
and 2 (Net Zero Tracker, 2023). Some organizations are
very transparent about the extent to which they are rely­
ing on carbon offsets to reach their targets, while others
remain opaque.
This variety presents a challenge for those seeking to navi­
gate the transition over the coming years. There is a clear
need to develop tools and frameworks that allow us to dis­
tinguish between credible net-zero commitments that are
being effectively implemented in good faith and those that
are unlikely to be met or have been made cynically without
any intention to deliver.
8.3 The Implications of Net Zero for
Different Actors
8.3. 1 Countries
Following international emission accounting standards,
country-level emissions are usually assigned on a territorial,
or production-based accounting method. Essentially, this
means that a country's emissions are those which directly
arise within its geographic boundaries. A national net-zero
target based on this form of territorial GHG accounting
implies that a country will strive to significantly reduce all
domestic greenhouse gas emissions, and directly remove
any net flows from remaining sources via carbon sinks.
This approach is controversial. Critics argue that by
placing emphasis on the country where emissions are
produced, too little attention is being paid to the con­
sumption patterns that drive emission-intensive production
elsewhere. An alternative approach would be instead to
rely on consumption-based accounting methods, which
measure the cumulative emissions that arise from the pro­
duction of all goods and services consumed in that country,
regardless of where this production took place. The differ­
ence in the resulting emission estimates can be large
(see Table 8.2).
This has important distributional implications. Gener-
ally speaking, high-income countries have much higher
consumption-based than production-based emis-
sions (SEI, 2017). The opposite is true for many low-
and middle-income states, which may have domestic
emissions-intensive industries that cater predominantly
to foreign demand. Many have therefore argued that
production-based emissions accounting places a dispro­
portionate share of the transition burden on developing
countries and allows developed economies to shirk from
addressing the emissions intensity of domestic consump­
tion. Despite these concerns, production-based account­
ing has become the internationally dominant standard for
attributing emissions at the country level.
Although conceptually simple, achieving net zero at the
national level in practice requires a sophisticated system­
level understanding of how different elements of the
economy and the energy system work together. In any
given country, there will always be multiple pathways to this
Chapter 8 Net Zero ■ 185
iffl�tl:fj Production- vs. consumption-based 8.3.2 Sub-national governments
emissions estimates
Despite the growing importance of sub-national climate poli­
2021 cies (see Chapter 4), there is no globally recognized standard
Production- 2020
for accounting emissions at the sub-national level. T herefore,
based Consumption-
for cities and regions seeking to decarbonize, a first chal­
emissions, based emissions,
Country per-capita (t) per-capita(t) lenge lies in building greenhouse gas inventories, deriving
baseline emissions, and determining the scope of their target.
United States 14.86 15.47
A widely recognized best-practice standard is the Protocol
Singapore 5.47 24.24 for Community-Scale Greenhouse Gas Emissions Inventories,
Germany 8.09 9.23 published by the Greenhouse Gas Protocol (GHG Protocol,
2021). As in the categorizations used to determine corporate
South Africa 7.34 5.14
emissions, they build on a distinction among Scope 1, 2, and 3
China 8.05 7.04
emissions.
EU (27) 6.28 7.21
Based on this distinction, the GHG Protocol has developed
Switzerland 4.02 12.36 two different greenhouse gas reporting standards for cit­
ies and regions - BASIC and BASIC+ - which differ in
Source: https://doi. org/10. 5194/essd-14-1917-2022
© Author(s) 2022. This work is distributed under the Creative the complexity of data required and the breadth of emis­
Commons Attribution 4.0 License. sions covered. BASIC level emissions inventories cover
scope 1 and 2 emissions from stationary energy and trans­
target, each with different distributional implications. How port, as well as scope 1 and 3 emissions from waste (see
policy makers evaluate these options and decide what path­ the example of Mexico City in Figure 8.3). BASIC+ level
way to pursue will depend as much on the economic and inventories are significantly more comprehensive and cover
technological means available as on political factors such sources such as scope 3 emissions from transboundary
asvoter preferences, the influence of interest groups, and transport and scope 1 emissions from agriculture, forestry,
the political will of key leaders. and land use. That cities and regions around the world

CASE STUDY: A NET-ZERO SCENARIO FOR GERMANY

Integrated assessment models and scenario analyses are • Incrementally introducing hydrogen from the late
useful tools to help conceptualize what reaching country­
2020s.
level net-zero emissions will require in practice. For
• Tackling residential emissions by expanding district
example, in 2021, a group of German think tanks and
researchers published a study that outlines how Germany heating networks, rolling out heat pumps, and install­
could achieve the target of reducing net territorial ing energy efficiency measures.
emissions by 65% by 2030 and reach net zero by 2045.
• Reducing transport emissions by increasing the share
According to their analysis, major near-term emissions
of electric vehicles and encouraging a modal shift
reductions in the period up to 2030, could arise from the
toward public and soft transport (biking and walking).
following:
• Decreasing agricultural emissions by reducing fertil­
• Increased electrification across all sectors, coupled
izer use, shifting production toward crops with lower
with a rapid decarbonization of the power sector
nitrogen requirements, reducing livestock numbers,
achieved by:
and expanding organic farming practices.
• Phasing out coal;
Completing the low-carbon transition by 2045 would
• Rapidly expanding the share of renewables; and then require tackling remaining sources of emissions

186 ■ Sustainability and Climate Risk Exam

 in hard-to-abate sectors. Important steps to achieving Following their estimations, it would be possible by 2045
those targets include the following: to reduce total greenhouse gas emissions from Germany
by 95%. This would leave a remaining 5% of residual
• emissions, predominantly from some industrial production
Continued electrification and a further expansion of
processes, waste, and agriculture, which would need to
renewable electricity production.
be offset via carbon removal to reach net zero.
• Scaling up the production and use of green hydrogen.
The measures outlined imply significant changes in
• Replacing fossil fuels in energy intensive industries practically all areas of the German economy. This
(e.g., steel and chemicals) with a combination of bio­ modeling exercise illustrates that reaching a national net­
zero target is simultaneously feasible and enormously
mass and carbon capture and storage.
challenging. It also highlights that our ability to reach net
• Fully phasing out internal combustion engines, both zero will depend on whether current assumptions about
in passenger and freight transport. future technological advancements (e.g., on carbon
capture and green hydrogen) will materialize.

Measures for the climate-neutral 2045 scenario (CN2045)

(Greenhouse gas emissions in Mt CO2e)

Energy sector Industry

Waste
Negative emissions
BECCS, DACCS, and green
polymers offset
for residual emissions

____Ii_■ -
jdtivi
emissions••

----; 7
2018 2030 �=20�4-5__..,.2---,--
2050
H2 • Hydrogen
• This includes electricity generated from renewably generated hydrogen.
•• This figure mere ly extrapolates the trend after 2045, further emissions reductions are possible.

Prognos, Oko-lnst tut, Wuppertal Institut (2021 ); Towards a climate-neutral Germany by 2045. How Germany can reach its climate targets before 2050. E)(ecutive Summary conducted for
Stiftung Klimaneutralitat, Agor., Energiewende and Agora Verkehrswende.

blH'ikJ:f.j Prognos, Oko-lnstitut, Wuppertal lnstitut (2021)

Prognos, Oko-lnstitut, Wuppertal lnstitut (2021): Towards a climate-neutral Germany
by 2045. How Germany can reach its climate targets before 2050. Executive
Summary conducted for Stiftung Klimaneutralitat by Agora Energiewende and
Agora Verkehrswende. Reprinted with permission of Agora Energy.

are applying different standards matters, as the emissions seeking to reach their targets will face similar challenges
inventories define the goalposts of what it means to reach regarding the need to decarbonize urban transport systems
"net zero". In general terms, however, cities and regions and reduce emissions from buildings.

Chapter 8 Net Zero ■ 187

iffl�tl:f1 Protocol for Community-Scale Greenhouse Gas Emissions Inventories

Scope Definition
Scope 1 GHG emissions from sources located within the city boundary (equivalent to territorial emissions).

Scope 2 GHG emissions that occur as a consequence of the use of grid-supplied electricity, heat, steam, and/
or cooling within the city boundary.

Scope 3 All other GHG emissions that occur outside the city boundary as a result activities taking place within
the city boundary.

From Global Protocol for Community-Scale Greenhouse Gas Inventories, copyright © WR/. Reprinted with permission.

Emissions (in tCO2e) by scope: Mexico City 2018

Inventory type: BASIC

I city a. I I sector a. I I subsector a. I Values

Scope 1 Scope 2 Scope 3
Mexico City 22,341,795 5,869,816 4,317,690
Stationary 5,366,801 5,543,494 0
Residential buildings 1,456,549 1,315,704 0
Commercial and institutional building and facilities 626,520 1,767,121 0
Manufacturino industries and construction 3,230,691 2,441,017 0
Energy industries 20,901 19,355 0
Agriculture, forestry and fishing activities 32,087 297 0
Non-specified sources 0 0 0
Fugitive emissions from mining, processinq, storage and transportation of coal 0 0 0
Fuqitive emissions from oil and natural qas systems 53 0 0
Transport 16,817,395 326,322 0
On-road transportation 16,335,139 9,140 0
Railways 12,585 317,182 0
Waterborne navigation 0 0 0
Aviation 451,776 0 0
Off-road transportation 17,895 0 0
Waste 157,599 0 4,317,690
Solid waste disposal 42,923 0 3,799,830
Bioloqical treatment of waste 1,724 0 99,196
Incineration and open burning 7,542 0 0
Wastewater treatment and discharqe 105,410 0 418,664
This map displays BASIC GPC emissions (stationary energy, transport and waste) per subsector by scope. You can choose to display total or per
capita emissions in the filter above.

1£.!jij#J-ii Emissions (in tCO2e) by Scope: Mexico City 2018

8.3.3 Private sector
Non-Financial Sectors
How the net-zero transition will affect firms in the real
economy differs across sectors. For firms in energy-inten­
sive industries whose climate impact is largely driven by
Scope 1 emissions, the core challenge will be to develop
alternatives to current production processes. This requires
investing in technological innovation and developing
solutions that are less emissions intensive and can be
deployed at scale.
early, as well as to scale climate solutions that will replace
these assets. For example, steel producers can only reach
net zero if they find energy carriers to replace the fossil
fuels they traditionally use to generate the large amounts
of heat required to produce steel. Although first trials using
hydrogen produced from renewable energies have been
successful, significant investment in research and infrastruc­
ture is needed before the sector can transition to fossil-free
production at scale. In other sectors, firms' individual Scope
1 emissions will make up a much smaller share of their
overall climate footprint. This is the case, for example, for

Indeed, many high-emitting sectors may require increased many supermarket chains, whose own emissions are typically

investment to decarbonize and retire high-emitting assets miniscule when compared to the emissions arising across

188 ■ Sustainability and Climate Risk Exam

the value chain of their products, which covers everything
from agricultural production to packaging and logistics.
In these sectors, the challenge lies in understanding the
Scope 3 emissions embedded in products and engaging
with partners across the value chain to minimize these,
as well as customers' and consumers' use and disposal of
products.
Financial Sector
The net-zero transition poses a unique set of challenges to
actors in the financial sector. In most cases, the main climate
impact of financial institutions arises not from their own
operations, but from the activities they enable through their
investments and other services. Although there are little
regulations to date, a series of industry-led alliances and
voluntary standards have emerged to help financial institu­
tions establish the climate impact of their portfolios, and
develop strategies for reducing their financed emissions
over time (see Box 8.2).
Some of the tools and methodologies (e.g., Implied Tem­
perature Ratings [ITRs], sectoral pathways) used by financial
services to support their net-zero strategies and targets are
BOX 8.2: SBTl'S GUIDANCE FOR THE FINANCIAL SECTOR
One important voluntary standard for financial-sector
net-zero targets was developed by the Science-Based
Targets initiative (SBTi). Its framework, which was
published in February 2022, provides guidance on the
conditions under which a financial-sector target can be
deemed science-based and Paris-aligned. In general
terms, the SBTi outlines three different approaches that
financial firms can take to set a science-based target:
• Sectoral decarbonization approach: The first
approach is to define emissions-based physical inten­
sity targets for investments and loans in a defined list
of emission-intensive sectors, including cement, steel,
pulp and paper, and buildings.
• SBTi portfolio coverage approach: A second
approach that financial institutions can take is to work
toward ensuring that increasing proportions of invest­
ees in their portfolios who have committed to their
own respective science-based target. The SBTi argues
in different maturities of development and differ in their
underlying assumptions and models. Understanding the
assumptions, the models used, and the limitations is a key
step in using them with respect to targets, transition plans,
and frameworks.
Reaching the net-zero targets will require countries,
regions, and companies to develop a vision for what role
they play in a decarbonized economy. Publicly committing
to a target is only the first step. Meaningful action requires
entities to develop credible and ambitious pathways that
illustrate how these targets can be reached.
8.4 Transition Plans
Transition plans are currently gaining increasing attention as
important tools with which private-sector actors can opera­
tionalize climate action and allow others to verify the cred­
ibility of their commitments. The Transition Plan Taskforce
defines transition plans as "integral to an entity's overall
strategy, setting out its plan to contribtue to and prepare
for a rapid global transition towards a low GHG-emissions
economy" (TPT, 2022).
that financial institutions should strive to reach a port­
folio coverage of 100% by 2040 to stay in line with
the Paris Agreement.
• The temperature rating approach: A third possible
approach to target setting is to assess the current
temperature rating of a financial portfolio, and work
to align it with ambitious long-term temperature tar­
gets by engaging with portfolio companies.
Importantly, the SBTi recommends that to achieve
effective emission reductions, financial institutions should
engage with investees and encourage them, including
through financing transition, to implement ambitious
targets. Adjusting portfolio holdings and divesting from
companies with low ambition are solely recommended as
complementary strategies, where engagement does not
lead to the desired improvements.
Source: SBTi, 2022
Chapter 8 Net Zero ■ 189
In essence, they are strategy documents that outline targets
and actions that will facilitate the transition of an organiza­
tion to a net-zero-carbon economy and allow it to measure
and report on progress.
Net-zero transition plans are a relatively new idea. In Octo­
ber 2021 , the TCFD first published high-level guidance
that outlined the core components required for a transition
plan to be effective (TCFD, 2021). Since 2021, however,
they have gained increasing prominence. In 2022, the
Glasgow Financial Alliance for Net Zero set out detailed
recommendations for financial institution transition plans,
and outlined what investors expect to see in transition
plans of their investee companies. Some institutional
investors, such as the British pension fund Railpen, are
already outlining expectations regarding transition plans
in their voting policies (Railpen, 2023). At COP27, the UN
High-Level Expert Group on the Net-Zero Emissions Com­
mitments of Non-State Entities, appointed by Antonio
Guterres set out detailed recommendations for how the
integrity of net-zero targets can be ensured. They argue
that creating transition plans are essential tools to deliver
on ambition (UN HLEG, 2023).
Transition plans are also emerging on the regulatory
agenda. In the UK, the government has already committed
to making transition plans mandatory across the economy.
Recognizing a current guidance gap, the government also
appointed the Transition Plan Taskforce (TPT) to develop
a gold standard for robust private sector transition plans.
The TPT launched a draft disclosure framework for consul­
tation at COP27 (see Figure 8.4) Other jurisdictions such
as the EU, are also deliberating new disclosure expecta­
tions which would require companies to publish transition
plans. Key international forums such as the FSB and NGFS
have indicated that they will undertake work on transition
plans in 2023.
Transition plans provide an opportunity for organiza­
tions to demonstrate how their net-zero targets are

The TPT Disclosure Framework

PRINCIPLES Ambition Accountability

VI
Z VI
-
zw
zU
:3�
0..0..

VI

w 2. Implementation 3. Engagement Strategy 4. Metrics & Targets

1. Foundation 5. Governance
::i: Strategy
�w
4.1 Governance, business
1.1 Objectives and 2.1 Business planning and 3.1 Engagement with 5.1 Board oversight and
and operational metrics
priorities operations value chain reporting
and targets

1.2 Business model 3.2 Engagement with 4.2 Financial metrics 5.2 Roles, responsibility
2.2 Products and services
implications industry and targets and accountability

3.3 Engagement with

4.3 GHG emissions metrics
2.3 Policies and conditions government, public sector 5.3 Culture
and targets
and c1v1I society

5.4 Incentives and

2.4 Financial planning 4.4 Carbon credits
renumeration

5.5 Skills, competencies

2.5 Sensitivity analysis
and training

Wl'iiJ-,H The TPT Disclosure Framework (TPT,2022)

190 ■ Sustainability and Climate Risk Exam

BOX 8.3: THE CHALLENGE OF CARBON OFFSETTING
In theory, it is possible to substitute some GHG
emissions by sequestering carbon or other greenhouse
gases elsewhere. This is the idea that underlies modern
carbon markets, which allow entities to balance
emissions with so-called carbon credits. Although
simple in theory, there is significant ambiguity about
what activities should be eligible for generating carbon
credits, and how it can be ensured that these are socially
and environmentally robust.
For example, there are ongoing discussions about
whether carbon credits should be generated only from
removal projects (i.e., activities that directly sequester
carbon or other greenhouse gases), or whether activi­
ties that avoid emissions that would have occurred in a
business-as-usual scenario should also be eligible (e.g.,
renewable energy projects). Experience with carbon mar­
kets has shown that there is a reason to be concerned
regarding the environmental integrity of sold credits.
According to a study commissioned by the European
Union, around 85% of the projects sold under the Clean
Development Mechanism were non-additional, mean­
ing that the reduction of carbon emissions would have
occurred without the financing through the sale of car­
bon credits. In addition, carbon-credit projects often
face challenges with leakage (i.e., displacing rather than
avoiding emissions), permanence (i.e., long-term stor­
age of carbon), and the accurate measurement of the
amounts of carbon stored.
These factors create challenges for companies seeking to
use offsets to reach net-zero targets. In September 2021,
a team of Microsoft staff and researchers published the
lessons they learned from Microsoft's efforts to pay for
carbon removal (Joppa et al. 2021). One of their key find­
ings was that there is a need for clear standards and defi­
nitions. The company received almost 200 proposals for
projects, which jointly offered 154 megatonnes of CO2
(MtCO2) in carbon credits. Out of these, however, only 2
MtCO2 met their conditions for high-quality CO2 removal.
CASE STUDY: TRANSITION PLANS FOR KELLOGG COMPANY
Using science-based targets and adopting an ambi­
tious transition plan, Kellogg Company was able to
significantly reduce transition risk, particularly policy
and reputation risks.
Starting in 2015, Kellogg Company (Kellogg's), a global
food manufacturer, set out to reduce its transition risks by
In light of these challenges, various certification bodies
have developed standards and verification procedures
to assess the quality of carbon-credit projects (e.g., the
Gold Standard or VERRA). These set out integrity criteria
that any verified project needs to achieve, including
the creation of co-benefits (e.g., through biodiversity or
climate resilience benefits) and the active involvement
of local populations and indigenous communities in the
management of projects. However, these standards are
not being applied universally, and it is still often difficult
to assess the quality of individually purchased credits.
It is important, therefore, that organizations tread care­
fully when relying on offsets to reach decarbonization tar­
gets. The Oxford Principles for Net Zero Aligned Carbon
Offsetting (2020) set out a useful list of high-level prin­
ciples to which organizations should adhere to develop
an environmentally sound approach to using offsets.
These principles are the following:
1. Cut emissions, use high-quality offsets, and regularly
revise offsetting strategy as best practice evolves.
2. Shift to carbon removal offsetting.
3. Shift to long-lived carbon storage.
4. Support the development of net zero aligned
offsetting.
The Science-Based Targets initiative similarly stresses
the need to prioritize deep emissions reductions. The
initiative does not validate carbon reduction pledges
where firms use carbon credits to measure progress
on their own net-zero targets. Instead, the SBTi only
validates targets that exclusively rely on credits to
neutralize residual emissions or to finance additional
climate mitigation beyond the entities' reduction targets.
Even here, the SBTi only recognizes carbon credits from
carbon removal projects and does not allow for the use
of credits generated through emissions avoidance.
decreasing Scope 1, 2 and 3 emissions and setting ambitious
long-term targets it can be held accountable for. To achieve
this, it partnered with Science Based Targets initiative (SBTi).
The company aimed to reduce Scopes 1 and 2 emissions by
15% per ton of food produced by 2020, and 20% of Scope 3
emissions by 2030. In addition, it defined long term targets
Chapter 8 Net Zero ■ 191
 of reducing 65% of absolute Scopes 1 & 2 emissions and
50% of Scope 3 by 2050.
To tackle these quantifiable targets, Kellogg implemented
company-internal measures to reduce its own carbon
footprint, while engaging with suppliers to learn about their
emissions and advance the company's Scope 3 goals. Using
these insights, Kellogg designed 35 global prog rams to
help farmers decrease their footprint.
T his process did not only require significant invest­
ments in carbon reduction investments, but also tackling
company's internal culture and promoting employees
towards more long-term thinking. Also, Kellogg believes
living up to each of these attributes. They further allow
investors, governments, and other stakeholders to hold
entities accountable to their own targets and assess
whether these are taking meaningful steps or using
vague pledges to distract from inaction. Finally, transi­
tion plans can play an important role in communicating
how companies are measuring, managing, and reduc­
ing transition risks. A transition plan should therefore
always allude to the four key transition risks outlined
in chapter 3 (policy and legal, technology, market, and
reputation risk). For example, developing a transition
plan can help an organization prepare for anticipated
regulatory changes (policy and legal risk); identify which
technologies will be key in the climate transition, and
develop strategies for harnessing them (technology
risk); assess how demand and supply changes will affect
prices of resources used (market risk); and grasp how
climate awareness could change how an organization is
perceived by the public (reputation risk).
In summary, writing a transition plan forces decision makers
to rethink how their business model fits into a decarbon­
ized economy and take appropriate action. Remember that
"no decision" is a decision for the status quo. The following
case study on Kellogg Company highlights how moving
along a predefined transition plan can help a company man­
age and reduce transition risk.
192 ■ Sustainability and Climate Risk Exam
that over the long-term, setting ambitious targets and
sticking to a transition plan is cost-effective and there­
fore a "win-win".
As a result, Kellogg has significantly improved its repu­
tation amongst retailers, which is crucial for on-going
operational business. T he initiatives have also enhanced
the company's relationship with the government as Kel­
logg is being perceived as a front-runner in emissions
reporting and as a corporation that is working towards
taking responsibility for the planet.
Adapted from Science Based Targets Case Study: Kel­
logg Company (SBTi, 2022).
8.5 Interim Targets and Pathways
Detailed net-zero pathways and interim targets are the
most important way of ensuring that net-zero targets are
credible and attainable. This section discusses how these
methods are used by countries as well as corporations
to control their transition and increase the credibility of
pledges.
For countries, Climate Action Tracker has defined ten key ele­
ments of good practice national net-zero target setting (see
Table 8.4). These are jointly used to assess whether a national
commitment is robust in terms of scope, architecture as well
as transparency. One of these key quality criteria is compre­
hensive planning underpinned by scientifically robust path­
ways and clear interim targets. Firstly, this planning is needed
to show that countries have a clear sense of how their tar­
gets can be realized, and an action plan to achieve them.
Secondly, interim targets are critical because the timing of
emissions reductions matters. As discussed in Chapter 1, the
total level of radiative forcing is determined by the cumula­
tive stock of greenhouse gasses in our atmosphere. Pathways
which delay emissions reductions have a much higher cumu­
lative effect on radiative forcing than those which achieve
early and deep emissions reductions over the next five years.
Long-term targets are therefore only credible if they are sup­
ported by interim targets with clear action plans.
lffl�ttl=ti
Ten key elements of national net-zero target setting

Scope Target year

Emissions coverage International aviation and Reductions or removals outside

shipping of own borders

Architecture Legal status Separate reduction & removal Review process

targets

Transparency Carbon dioxide removal Comprehensive planning Clarity on fairness of target

Adapted from Climate Action Tracker's evaluation methodology for national net-zero targets (2021). Reprinted by
Permission from Climate Action Tracker.

Net zero commitments as% of Forbes Global List

45.0% ---------------------------------
40.0%
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
Net zero commitment Interim Target Achieved Achieved (externally
(self declared) validated)

lif.jij#J-!-i
At the moment, however, many national commitments that there is currently no country with a credible and
do not fulfil these quality criteria. Governments' Nation­ attainable pathway to reach net-zero emissions by 2050
ally Determined Contributions (NDCs) illustrate this issue. (Climate Action Tracker, 2023).
Many NDCs do not outline clear and attainable short­
It is similarly important that we develop the tools to
term targets and milestones. The targets that are set,
ensure the credibility of private sector targets. Figure 8.5
are often not underpinned by robust plans. For example,
illustrates how many companies from the Forbes Global
many governments are currently failing to keep pace with
2,000 list have, as of February 2023, committed to a net­
their 2030 interim emissions targets. This undermines
zero target, and in which fashion they report this (Net
the credibility of governments and lessens our chance
Zero Tracker, 2023). While around 40% of the companies
°
of staying within the 1.5 ° or 2 C pathways. T his is com­
have committed to net zero, less than 30% have set
monly referred to as the Credibility Gap (e.g., Climate
interim targets. This indicates that some of the already
Action Tracker, 2021). To overcome this, it is essential
low numbers of pledges might be unsubstantiated and
that governments present comprehensive emission reduc­
therefore not particularly credible. A review conducted by
tion pathways with adequate interim targets. While some
Hale et al. (2022) concluded that of the companies that
countries, such as New Zealand and China, have recently
published a target, only around 26% met a set of minimal
updated their NDCs to reflect more ambitious interim
robustness criteria.
targets and reduce the credibility gap, analysis shows

Chapter 8 Net Zero ■ 193

 CASE STUDY: INTERIM TARGET SETTING IN PRACTICE:
Using interim targets, L'Oreal successfully moves
along the 1.5 °C pathway to net zero in 2050.
L'Oreal Groupe (L'Oreal), the French personal care
company, has set out to achieve net zero by 2050, in
alignment with the 1.5 °C scenario. This effort started
in 2005, when the company aimed to reduce 60% of
emissions at plants and distribution centers by 2020. To
achieve this, it used a strategy based on three pillars:
(1) Reduce energy requirements across facilities, (2)
increased use of renewable energy, and (3) achieve
targets without carbon offsetting projects.
The company exceeded the initial target by 18% and
now builds on these accomplishments. L'Oreal aims to
achieve carbon neutrality at administrative, industrial,
and research sites by 2025. By 2030, the beauty product
specialist will reduce Scopes 1 and 2 emissions per
product by 50% and emissions resulting from the use
of products by 25%, compared to 2016 values. Further
initiatives include a reduction of per product emissions
linked to transport by 50% and an absolute decrease of
50% direct emissions from L'Oreal's strategic suppliers.
Why then, have so few of the large companies committed to
net zero, and even fewer defined pathways for their targets?
Besides lacking regulatory pressure, part of the answer prob­
ably lies in the complexity of understanding what net zero
implies for their operations, and the challenge of developing
a realistic pathway towards that target. This is not helped
by the complex landscape of GHG accounting standards,
disclosure frameworks and recommendations. Important
tools that can help organizations unpack these complexities
are sectoral transition pathways. T hese are being developed
by various organizations such as Industry Tracker, a research
organization that helps develop decarbonization pathways
for hard-to-abate sectors, or the Transition Pathway Initia­
tive, a global initiative formed by asset owners that provides
sectoral benchmarks against which company ambitions can
be assessed. Such organizations aim to provide coherent
data on transition pathways of companies to asset manag­
ers and owners. As part of this process, they independently
define benchmarks for sectoral transition pathways based
on key metrics and target dates. These pathways define tra­
jectories for how a sector can transition towards a net-zero
future. While mainly intended for financial institutions, such
194 ■ Sustainability and Climate Risk Exam
Climate positive by 2030: Symrise supports ambitious
goals with interim targets
Symrise AG (Symrise), a German producer of flavours
and fragrances with over €3 bn. in turnover, aims to be
climate positive by 2030. Even though this target lies less
than 10 years in the future, Symrise set an interim target
of reducing greenhouse gas emissions by 60% in relation
to value added by 2025, compared to 2016.
To accomplish these ambitious feats, the company
focuses on energy efficiency at production sites.
Beyond Scopes 1 and 2 emissions, Symrise involves its
key suppliers in the climate strategy and encourages
them to commit to targets themselves. By now almost
90% of its suppliers have started emissions reduction
initiatives. To increase transparency, every year the
firm releases a thorough sustainability report based
on SASB (Sustainability Accounting Standards Board)
standards.
Adapted from CDP: Running Hot, Accelerating Europe's
Path to Paris (2021).
documents often contain useful external benchmarks that
can help company executives from any sector define firm­
level interim targets and allow external stakeholders to com­
pare a company's ambition to industry peers.
To define transition plans that are granular enough to sup­
port ambitious net-zero pledges, companies should con­
sider a few key points. Firstly, they should take advantage
of above-mentioned, industry-specific benchmarks and
consider joining the Race to Zero initiatives in their sector,
which can often provide a baseline for more companyspe­
cific measures and targets. Secondly, it should be ensured
that any defined transition plan does not collide with exist­
ing or anticipated local net-zero policies. T hirdly, companies
must determine specific short- and medium-term interim
targets. Case studies of L'Oreal and Symrise show how
interim targets are used in practice to steadily inch closer
towards net zero.
To ensure that the goals defined by companies amount to
more than just greenwashing, further measures should be
considered. For example, consulting key stakeholders for
their opinions and publicly disclosing both targets as well as
progress over time increases accountability for the actions
taken by a company. Initiatives like the previously men­
tioned Science Based Targets can further help by verifying
that the targets set are science-based and realistic.
8.6 Use of Metrics
So far, this chapter has examined why the transition to net
zero is crucial and what actions governments and organiza­
tions can take to define a credible transition path to net
zero. This section briefly examines the metrics that can be
used to track progress towards net zero, for both non-finan­
cial and financial institutions.
8.6. 1 Cross-industry principles & metrics
T he Task Force on Climate-related Financial Disclosures
(TCFD), an initiative by the Financial Stability Board (FSB),
recommends disclosing climate-related metrics to cover
three broader topics (2017):
a. Disclose metrics used to assess climate-related risks
and opportunities in line with the strategy and risk
management process.
b. Disclose Scopes 1 and 2 and, if appropriate, Scope 3
emissions and related risks.
c. Describe the targets used to manage climate-related
risks and opportunities and performance against
targets.
In addition, the TCFD recommends that organizations
clearly disclose metrics used to assess progress against
their decarbonization targets, including related operational
and financial performance metrics, metrics aligned with
the cross-industry, climate-related metric categories, and
industry-specific or organization-specific metrics (TCFD,
2021).The disclosure of these metrics allows investors and
other stakeholders to assess how an organization monitors
and tackles its climate-related risks.
More recently, the guidance developed by GFANZ and the
UK Transition Plan Taskforce points to the need for metrics
and targets that allow companies to meaningfully track
their progress in relation to climate-related targets. These
include GHG emissions reduction targets, but also other
operational or financial metrics which are used as key per­
formance indicators (KPls) of progress (GFANZ 2022).
If the wider business sector or economy discloses the same
metrics, stakeholders are provided a basis on which to com­
pare across organizations. To improve the quality of reported
metrics and provide a better understanding of progress,
organizations are urged to provide historical data to allow
for trend analyses. The metrics disclosed should be closely
related to the targets set to enable a review on the progress
made. Organizations should note that metrics lose credibility
if the reporting entity fails to provide details on methodol­
ogy, including any estimates used. Organizations gain cred­
ibility if the metrics they use can be third-party assured.
While Table 8.5 provides some examples of metrics that
can be used for reporting and target setting, Table 8.5.1
provides examples of climate-related targets. While some
industries are prone to similar physical and transition
risks, there is no single set of metrics that captures the
cross-section of climate-risks for all organizations. Some
metrics can be used to enable a base comparability, such
as absolute Scopes 1 and 2 emissions, or the percentage
of electricity used that was generated with renewable
methods. Generally, however, it is essential for target set­
ters to analyze the business they are in and define metrics
that appropriately cover the topics defined above. Some
metrics take significant efforts to calculate or estimate.
Therefore, organizations are encouraged to first harvest
low-hanging fruits while defining processes to automate
and standardize the calculation of some more complex
quantitative measures.
The usage of carbon-related metrics can go beyond report­
ing. Metrics are often also used for project selection pur­
poses. One can use metrics to describe the carbon intensity
of projects such as factories and office buildings: Decisions
can be made based on metric thresholds or relative to
rivalling projects. A second approach uses internal carbon
pricing to account for emissions in net present value (NPV)
calculations, which punishes carbon-intensive projects.
8.6.2 Metrics for financial institutions
There are many tools for financial institutions to analyze
whether their investments are sustainable. Most promi­
nently, and thoroughly discussed in Chapter 5, are ESG rat­
ings and data, which report on companies' environmental,
social, and governance footprints and efforts.
Chapter 8 Net Zero ■ 195
iffl�rJ=l-1
Cross-Industry, Climate-Related Metrics Categories, and Example Metrics

Metric category Example metrics

GHG emissions • Absolute Scope 1, 2, and 3 emissions

• Financed emissions by asset class
• Emissions per MWh of electricity produced

Transition risks • Concentration of credit-exposure to carbon-related assets

• Percent of revenue from coal mining

Physical risks • Proportion of real assets exposed to 1 :200 climate-related hazards

• Revenue associated with water withdrawn and consumed in regions with high base-
line water stress

Climate-related opportunities • Number of zero-emission vehicles and hybrid vehicles sold

• Revenues from products or services that support the transition to a low-carbon
economy

Capital deployment • Percentage of revenue invested in R&D of low-carbon products

• Investment in climate adaptation measures (e.g., flood defenses, location changes)

Internal carbon prices • Internal carbon price (e.g., a company internal tax on emissions that is invested into
sustainability projects)
• Shadow carbon price (an estimated cost of carbon used for project selection
purposes)

Remuneration • Weighting of climate goals on scorecards for Executive Directors

• Portion of employee's bonus linked to climate-related metrics

Adapted from TCFD, Guidance on Metrics, Targets and Transition Plans (2021)

However, typical ESG ratings lack the depth needed to assess
whether a company is on a net zero path by 2050, or whether
it is ahead or behind a benchmark schedule. To answer these
questions, portfolio alignment tools are needed. In 2022,
GFANZ published a report on the use of portfolio alignment
tools for financial institutions (GFANZ 2022). In that report,
they distinguish between four broad categories of alignment
metrics, which are currently being used:
1. Binary target measurement: provides insight on the per­
centage of portfolio companies with science-validated
1.5 degrees-aligned reduction targets.
2. Maturity scale alignment metrics: groups portfolio
companies into alignment categories (e.g. aligned,
aligning, and not aligned).
3. Benchmark divergence: evaluates the distance from a
net-zero aligned pathway.
4. Implied temperature rise (ITR): translates the distance
form a measured pathway into a projection of likely
end-of-century global warming outcomes.
T he quality of reporting based on these portfolio alignment
tools is always subject to the scientific robustness of the spec­
ifications and choices made in the modelling of these scores.
For the binary measurement, for example, an asset manager
and owner should carefully consider what is classifiable as
a net-zero target. Does a public announcement suffice, or
must the target be mentioned in the counter-party's financial
disclosure? Benchmark divergence and ITRs provide many
more parameter choices that could significantly alter results.
It is essential, for example, to determine appropriate bench­
mark net-zero paths. To ensure credibility, it is crucial that any
underlying assumptions are transparently communicated.
Financial institutions should also consider using portfolio
alignment tools to set sector-specific targets. For example,

196 ■ Sustainability and Climate Risk Exam

CASE STUDY ON USE OF CARBON-RELATED METRICS: BASF SE
BASF follows the recommendations from TCFD and
reports its emissions in accordance with the Green­
house Gas Protocol as well as the sector-specific
standard for the chemical industry. The result is a
comprehensive, transparent, and comparable report
on climate risk and sustainability.
progress made as well as historical data to allow for trend
analyses, as suggested by the TCFD. Further, the figure
depicts the five key initiatives to reduce emissions. This
chart alone provides more insights on transitions risks and
net-zero targets than are available from most of the larg­
est companies in the world.

The German company BASF is the largest chemical
producer in the world and has committed to achieving
net-zero Scopes 1 and 2 emissions by 2050 and has set
an interim target of a 25% reduction to the base year
2018 until 2030. Figure 1 depicts these commitments, the
The next figure depicts BASF's value chain and the emis­
sions caused along it, measured in million metric tons CO2
equivalent. To calculate the carbon footprint of products
the company produces, it implemented a new method of
calculating emissions for over 45,000 different products. To

Schematic overview: development of the BASF Group's greenhouse gas emissions (Scope 1 and 2)

Million metric tons of CO2 equivalents

MM l•
20.1
20.8 20.2
MN

N;�;�gt:!��e
gas emissions

1990 2018 2030 2050 2018 2019 2020 2021 2030

liid'iiJ.it·1
Reprinted with permission from BASF. (2022). BASF Report 2021. https://report.basf.com/2021/enl_assets/
downloads/entire-basf-ar21.pdf

Scope 3 emissions along the BASF value chain in 2021'

Million metric tons of CO2 equivalents
BASF Customers Disposal
Production (including generation Emissions from the use Incineration with energy
of steam and electricity) of end products (C 11) recovery, landfilling (C 12)

DII
I I I

21
I I I
Suppliers Transport Other
Purchased products, services and Transport of products, (C 3b, 3c, 5,
capital goods (C 1, 2, 3a) employees' commuting and 8, 13, 15)
business travel (C 4, 6, 7, 9)

a According to Greenhouse Gas Protocol; Scope 1, 2 and 3; categories within Scope 3 are shown in parentheses. Scope 3 emissions in category 10 ("Processing of sold
products") are not reported according to the standard for the chemical sector. Only direct use phase emissions are reported in the customer category (Scope 3.11 ). For
more information on our Scope 3 emissions reporting, see basf.com/corporate_carbon_footprint

lifWIZJ.d
Reprinted with permission from BASF from BASF Report 2021.

Chapter 8 Net Zero ■ 197

 decrease these emissions, BASF shares its results with sup­
pliers and engages in cooperation to reduce the footprint
caused by raw-material gathering and transport before the
materials arrive at BASF production sites.
To estimate the carbon footprint of activities to the
right of BASF in its value chain, the chemical producer
places its products into the four categories Accelerator,
Performer, Transitioner, and Challenged (see Figure 8.7).
This also enables the company to set such targets as, for
example, the phasing out of products in the Challenged
category until 2023. As a chemical company, many Scope 3
emissions reductions on the customer side can be reduced
with technological advancements, such as the development
Classification of assessed portfolio according to the Sustainable Solution Steering method
Accelerator
Substantial sustainability contribution
in the value chain
Meets basic sustainability standards
on the market
Transitioner
Specific sustainability issues which are
being actively addressed
Challenged
Significant sustainability concern identified and
action plan in development or implementation
Reprinted with permission from BASF from BASF Report 2021.
No tool is perfect, and each of the four described herein
have both strengths and weaknesses. Binary measure­
ment is simplest to use, based on easily attainable data,
and broadly applicable to any asset class. It's limited,
however, in that it offers no insight into the degree of net­
zero alignment/misalignment; and meaningfully aggregat­
ing results to the portfolio level can be a challenge.
Maturity scale alignment metrics provide a more holis­
tic understanding of the trajectory that portfolio compa­
nies are on. The pitfall of these metrics is that there is no
commonly used approach for categorizing companies,
making it difficult to compare across entities or assess
the robustness of individual assessments.
Benchmark divergence, to its credit, generates a mea­
surement of degree of alignment/misalignment, allows
Adapted from Portfolio Alignment Team, Measuring Portfolio Alignment- Technical Considerations (2021)
198 ■ Sustainability and Climate Risk Exam
of products that have increased durability and improved
recycling capabilities. BASF has also reduced its products'
footprint by introducing renewable, plant-based products.
These excerpts from the BASF Report 2021 show how orga­
nizations can successfully use metrics to define and report
on targets, to address key stakeholder needs and expecta­
tions. Besides metrics, it is worth mentioning that BASF also
reports qualitatively, meaning it aims to predict regulatory
change and discusses the findings and risks indicated by the
data. It is only when data is interpreted soundly and care­
fully, that relevant takeaways can be made.
Reprinted with permission from BASF from BASF
Report 2021.
Accelerator sales
2021: €24,103 million
2020: €16,740 million
2021: €39,033 million
Assessed 2020: €30,519 million
portfolio
€71,041 million Transitioner sales
2021: €7,879 million -
2020: €6,799 million -
Challenged sales
2021: €26 million
2020: €72 million
evaluation of progress toward net zero, and allows for
results to be aggregated meaningfully to the portfolio
level. It poses challenges, however, in that it is com­
plex and requires climate-scenario expertise to use, is
based on potentially difficult-to-obtain data (such as
company-level emissions projections and benchmarks),
and delivers technical output that can be challenging to
interpret.
Implied temperature rise (ITR) offers all the advantages of
benchmark divergence plus the added benefits of a mea­
sure of the consequence of alignment/misalignment and
easily understood output. As with benchmark divergence,
it poses challenges in that it is complex and requires
climate-scenario expertise to use and is based on poten­
tially difficult-to-obtain data and/or extensive assumptions.
 CASE STUDY: LYXOR PUBLICLY DISCLOSES IMPLIED TEMPERATURE
RATINGS
Using implied temperature rises to assess net zero­ Of course, reporting this metric a/so caters to the
alignment of ETFs increasingly climate-conscious investor base. To ensure
that the reported data is credible, Lyxor provides a
In January 2021, Lyxor Asset Management (Lyxor), a
detailed methodology for the /TR calculation, including
renowned fund manager and subsidiary of Amundi,
data sources and shortcomings. To be specific, Lyxor
started to disclose implied temperature ratings for
uses a popular framework provided by Science Based
over 150 of the ETFs in its product portfolio. As a
Targets (SBTi), which makes their approach comparable
large fund manager, Lyxor understands that the liquid­
and verifiable.
ity it allocates, and investors it steers, have significant
impacts on the corporations it invests in. As such, it is The asset manager uses many different climate-related
crucial to use funds to actively support the transition to metrics to assess its investments, including ESG ratings.
a low carbon economy. In comparing ESG data with /TR metrics, the company
found interesting differences. The most important thing
From the several ratings and data that Lyxor con­
to consider is that ESG ratings largely focus on the status
sidered disclosing publicly, it opted for the implied
quo and current business activities, while ITRs focus on
temperature rating for two main reasons. Firstly, the
the net-zero transition path of companies. As a result, a
company believes that the /TR metric is becoming a
gas-extracting company might have terrible absolute ESG
key metric in portfolio allocation and disclosure for
ratings but an /TR of <1.5 °C. Potential investors should
financial institutions. Secondly, the indicator is straight­
be aware of this when comparing funds and assets.
forward and easy to understand for investors, which
simplifies their investment allocation process. Information taken from the official Lyxor website (2022).

asset managers can use benchmark divergence to assess the EU Sustainable Finance Taxonomy) can also help to
whether industry-specific sub-portfolios are aligned with net­ categorize investments in terms of their contributions to
zero pathways (see ING's Upstream Oil & Gas finance reduc­ high emissions or decarbonizing activities. While most tax­
tion pathway for ING against IEA's SDS scenario in Figure 8.8). onomies provide less detail than portfolio alignment tools,

This granularity helps prevent approaches which decarbon­ they have recently gained traction because they are simple

ize the portfolio, but do not decarbonize the economy to use, understand and are increasingly being included in
or reduce climate risk. Indeed, when addressing portfolio regulatory frameworks. One exemplary taxonomy for fossil
decarbonization it is crucial to focus on sectors with the fuel producers is provided by the UK Climate Financial Risk
most (including Scope 3) impact. Use of taxonomies (e.g., Forum in Table 8.6.

1mnt1=1-1
Sustainable finance taxonomy for fossil fuel producers

Financing activities that could Financing activities that could stabilize Financing activities that could reduce
increase emissions and devi­ or prevent further emissions (neutral or emissions and transition the portfolio/
ate away from alignment incremental effect on alignment) company (positive effect on alignment)

• New exploration and
production
• Expansion of current explo­
ration and production
• Making operations more efficient and • Carbon removal technologies (e.g.,
reducing emissions (e.g., CCS, fugitive CCS, BECCS)
and flaring prevention) • Alternative fuel/energy finance to
• Decommissioning "high carbon" displace fossil fuel assets
assets
• Alternative fuel/energy finance as
additional assets

From Climate Financial Risk Forum Guide 2021 on Scenario Analysis with permission Oct 2021. Reprinted by permission from
CL/MATE FINANCIAL RISK FORUM.

Chapter 8 Net Zero ■ 199

 Power Generation
Global and OECD De carbonisation Pathways
ING vs. pathway
-29.6% I Upstream Oil & Gas
Absolute Financing Trend Reduction Pathway
ING vs. NZE2050
-3.6% I
i 600
500
- SOS Global
i >
5,0CX
4,000
\,98 6 -2% 8%
- SDSOECD 3)��:::::;·:::::.::::·······
- N ZE2050 Global 1
g
3,000 ' -12% 19%...•
-24%

.·
•··· SOS Trajectory

• • • • NZE2050 Trajectory
- Market (Global) ti 2,000 -36% · ·•....
•
u
8 1,000 -53% .. ... - ING Portfolio
°' 100 - ING Portfolio
-69%
• ING Target
• ING Target
'l,�O ...... Con vergence Pathway

Residential Real Estate

European Union Decarbonisation Pathway
ING vs. pathway
-2.1% I Cement
Global Decarbonisation Pathway
ING vs. pathway
+1.3%

-
,,o�
40
........ -- - B2DSEU
� 08
- B2OS Scenario

j :: ---------------
- ING Portfolio (NUDE/PL) - Market
o
u
20
• ING Target - ING Portfolio
a, 10 · ··· Convergence Pathway 2030 0 0.2
• ING Tar get
u
0 · · · · Convergence Pathway 2050 0.0 · · · · Convergence Pathway

'l, ''%,-f
'
'l,o'l, 1,
0
-f'"" 'l,�
o
'l,�" 1,0"
0
-f''' '\-
o
'l,O
,t, ""
o
1 ,,s,"
%, fJ
<-, "'
""
o 0

6Pl1iki·&>
Figure taken from 2022-ING-Climate-Report, Page no: 55. https://www.ing.com/Newsroom/News/lNG­
publishes-climate-report.htm. Reprinted by permission from ING Group.

8. 7 Reporting Important frameworks include those provided by the Task­

force on Climate-related Financial Disclosure (TCFD), the
A final crucial parameter that determines the credibility of framework of the Sustainability Accounting Standards Board
net-zero targets is how organizations disclose their target (SASB), the International Sustainability Standards Board (ISSB)
and accompanying plan to external stakeholders. Over the and the Global Reporting Initiative (GRI) (see Table 8.7
past years, many independent bodies have begun to rede­ for more detail). In the realm of climate risk disclosures, the
fine the scope of financial disclosure by introducing various TCFD has emerged in recent years as the leading force and
sustainability-related standards. baseline setter. As of 2022, over 4000 organizations from

1mnt1=1J
Key disclosure and reporting standard setters

Organization Description

TCFD Initiative launched in 2015 by the Financial Stability Board, which developed recommendations for
how companies can report on climate-related risks and opportunities. Their recommendations have
since been integrated into the regulatory reporting requirements across several jurisdictions.

SASB Non-profit standard setter which launched in 2011 to develop accounting standards for sustain­
ability issues. They have set sector-specific ESG reporting standards across 77 industries. Their work
was consolidated first into the Value Reporting Foundation in 2021, and then into the International
Sustainability Standards Board in 2022.

ISSB A new standard-setting body established in 2021, which sits under the IFRS Foundation. The ISSB
aims to deliver a global reporting standard for sustainability-related financial information.

GRI An initiative focused on developing standards for impact reporting. Their work goes beyond that of
the ISSB, SASB and TCFD by focusing on how companies can report their external impacts on issues
such as climate change, human rights and corruptions, rather than focusing on the disclosure of
financially material ESG issues.

200 ■ Sustainability and Climate Risk Exam

100+ countries with a joint market capitalization of USD 27
trillion., publicly supported the TCFD. Eight jurisdictions,
namely Brazil, the EU, Hong Kong, Japan, New Zealand, Sin­
gapore, Switzerland, and the UK have even made announce­
ments to make TCFD-aligned reporting mandatory, with
more jurisdictions to follow (TCFD, 2021). For example, in
March 2022 the US Securities and Exchange Commission
(SEC) has published a proposal to make climate-related
reporting mandatory for its registrants. The proposed
rules were largely built on the TCFD's recommendations.
Specifically on the issue of net-zero transitions, disclosure
standards are only beginning to emerge now. At the end
of 2021, the TCFD first included high-level guidance on
transition plans in its recommendations. In line with this,
and emerging out of COP26, the GFANZ as well as the UK's
Sustainability Disclosure Requirements (SDR) have also com­
mitted to encouraging and introducing transition plan dis­
closure requirements for members and companies. Indeed,
in 2021, the UK Chancellor has announced that preparing
and publishing transition plans will become mandatory
across the economy (Gov.uk, 2021). This adds a new level
of requirements to existing disclosure recommendations,
as companies are for the first time being explicitly asked
to publish a roadmap towards a decarbonized future. The
efforts in the UK are supported by a high-level Transition
Plan Taskforce (TPT), which is developing recommendations
on gold standard transition plans. Its recommendations are
expected to be finalized by early 2024, after which the gov­
ernment will develop its rules. The Corporate Sustainability
Reporting Directive (CSRD) aims to make all large compa­
nies in the EU more publicly accountable by obliging them
to regularly disclose information on their societal and envi­
ronmental impact. This would end greenwashing, strengthen
the EU's social market economy, and lay the groundwork for
sustainability reporting standards at global level.
It is still unclear whether other jurisdictions will take a similar
approach. As discussed in Section 8.2, most parts of the
world are still far from making net-zero commitments, not to
mention codifying them in law and requiring their disclosure.
Given the current complexity of the sustainability disclosure
landscape, there are ongoing efforts to align requirements
internationally. A key initiative is the IFRS' International
Sustainability Standards Board (ISSB). In March 2022, the
ISSB published initial exposure drafts of its general sustain­
ability and climate-related corporate disclosures, which
seek to align with recommendations provided by the CDSB,
the SASB and the TCFD (amongst others). These drafts
contain initial guidance on what elements of their transition
strategies companies should disclose as part of their cli­
materelated disclosures.
A key controversy in the development of net-zero disclosure
standards is the question of whether such standards should
consider double materiality. In 2019, this term was coined
by the EU, and is now gaining much traction. Materiality is a
concept coming from financial disclosure, which encourages
corporations to report on all activities, opportunities and
risks which could be material to the company's value, turn­
over, income, or other key performance indicators. Double
materiality adds to this concept with the notion that com­
panies must also disclose activities which could be material
to society and the environment. This concept now builds
much of foundation of the EU's taxonomy and CSRD disclo­
sure standards. The ISSB, on the other hand, has excluded
double materiality from the scope of its requirements.
To summarize, there are a few essential organizations to
keep in mind for the future of net-zero financial disclosure.
First is the TCFD, which often acts as a baseline-setter of
ideas and recommendations. Second is the ISSB, who are
aiming to create comprehensive and lasting carbon-related
financial disclosure standards. Lastly, one should also keep
in mind national regulatory bodies, who are increasingly
looking to include net-zero disclosure requirements (e.g.,
via transition plans) in their jurisdictional policies.
8.8 Conclusion
This chapter started with an introduction to net zero by
explaining the science behind the concept and the dif­
° °
ference between the 1.5 and 2 C targets. It highlighted
the urgency with which countries, sub-national govern­
ments, and the private sector must strive towards net zero
to achieve the goals set out in the Paris Agreement. It
then briefly discussed the landscape of initiatives within
these three sectors and emphasized that while an increas­
ing number of actors are publishing net-zero goals, the
underlying ambitions vary widely. To make net-zero targets
more credible and allow us to hold entities accountable for
their progress, organizations need to develop and disclose
transition plans. The chapter outlined key characteristics
of meaningful transition plans and argued that they are an
Chapter 8 Net Zero ■ 201
important tool which allow decision makers to manage and
reduce transition risks. One way of increasing credibility
of a net-zero pledge is to disclose a transition plan that
defines interim targets that are attainable and allow stake­
holders such as employees, shareholders, and customers to
understand and track the goals defined by an organization.
To track progress along a transition plan, metrics such as
emissions data can be used. For financial companies specifi­
cally, portfolio alignment tools such as implied temperature
ratings that analyze the net-zero progress of counterparties
were discussed. Finally, the chapter provided an overview
of the regulatory landscape governing net-zero disclosures
and identified the TCFD and ISSB as key leaders in this
emerging area.
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204 ■ Sustainability and Climate Risk Exam

The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.
QUESTIONS
8.1 Which of the following was a key finding of the 2018
°
IPCC Special Report on 1.5 C?
A. The difference in the global impacts on human
societies and the natural world are not likely to be
° °
starkly different between a 1.5 C and a 2 C warm­
ing scenario.
°
B. Under a 2 C scenario, the share of global popula­
tion exposed to severe heat is likely to be signifi­
°
cantly higher than under a 1.5 C scenario.
C. The estimated share of species that would lose
over half their habitat range and face a significant
risk of extinction would likely be the same under a
° °
2 c and a 1.5 C warming scenario.
D. The probability of extreme drought and water
°
stress is likely to be lower under a 2 C scenario,
compared with a scenario where the world man­
ages to limit global average temperature increases
°
to 1.5 C.
8.2 In national net-zero pledges, countries largely commit
to which of the following:
A. Reducing all emissions generated via the produc­
tion of goods and services consumed in their
territory.
B. Reducing all emissions that are directly produced
within their territory.
C. Balancing all emissions that are directly produced
within their territory with GHG removal via sinks.
D. Balancing all emissions generated via the produc­
tion of goods and services consumed in their terri­
tory with GHG removal via sinks.
8.3 Which of these approaches are currently outlined by
the Science-Based Targets initiative as science-based
ways for financial institutions to develop a decarbon­
ization target?
A. Setting a pledge to reduce only Scopes 1 and 2
emissions, such as direct operational emissions and
those arising from electricity, energy use, heating
and cooling.
B. Defining targets to reduce the physical
intensity of investments and loans in a set of
emissions-intensive sectors.
C. Increasing investments in companies operating
in "green" sectors, such as renewable energy,
hydrogen production, and electric vehicles.
D. Divesting from emissions-intensive industries.
8.4 Which among the following is not a typical challenge
posed by carbon-credit projects?
A. Displacement of emissions vs. avoiding emissions.
B. Long-term storage of carbon.
C. Accurate measurement of the amounts of carbon
stored.
D. Carbon reduction pledges of organizations vs.
availability of carbon credits.
8.5 Which of the following financing activities poses the
greatest threat to stabilizing or preventing further
emissions?
A. Making operations more efficient.
B. Decommissioning high carbon assets.
C. New exploration and production.
D. Sourcing raw materials from local suppliers.
8.6 Which of the following objectives is needed to provide
a meaningful framework to achieve net-zero targets?
A. Understanding the emission pathways of competi­
tors in the same industry.
B. Pursuing best efforts to reduce Scope 1 and 2
emissions.
C. Engaging with stakeholders that have a
well-publicized net-zero commitment.
D. Understanding economic opportunities that arise
through the net-zero transition.
Chapter 8 Net Zero ■ 205
The following questions are intended to help candidates understand the material. These are not actual SCR exam questions.

ANSWERS
8.1 B 8.4 D

8.2 C 8.5 C

8.3 B 8.6 D

206 ■ Sustainability and Climate Risk Exam

Glossary
Attention Deflection When organizations or companies conceal
unsustainable practices with incomplete disclosures or misleading
statements.
Avoid Refers to renewable energy projects, or similar initiatives
that do not add greenhouse gases to the atmosphere.
Bid-Ask Spreads The difference between what a buyer is willing
to pay and the selling price of an asset.
Biomass Energy A form of renewable energy created by
combusting plant-based material.
Cap-and-Trade Schemes A form of carbon pricing in which a
government caps emissions, but emissions permits can be traded
between participants.
Carbon Capture, Utilization, and Storage (CCUS) A process
by which fossil fuels are burned and carbon dioxide is captured
and used in a range of applications, such as being incorporated in
cement or plastic, or stored underground.
Carbon Intensity The level of GHG emissions normalized by the
market value of the portfolio.
Carbon Leakage When carbon-intensive companies relocate to
areas with weaker climate policies.
Carbon Pricing Refers principally to two types of policies­
carbon taxes and emissions-trading schemes (often known as
cap-and-trade schemes).
Carbon Taxes A form of carbon pricing in which a government
sets a price per ton of CO2.
Changes in Insurance Premiums A metric to determine the
amount of money an individual or business must pay for an insur­
ance policy.
Climate The long-term patterns or statistics of the weather.
Climate Action A set of actions and policies to address climate
change risk. Necessary to address sustainable development,
climate action and risks are broader than ESG, impacting all aspects
of society.
Climate Change The long-term differences in the statistics of
weather patterns measured over multi-decadal periods.
Climate Finance Financial flows related to adaptation and/or
mitigation climate change projects.
Climate Risk The financial risks linked to climate change.
Climate Risk Management A form of risk management that can
help identify, analyze, mitigate, and manage the impacts of climate
change.
Climate Scenario Analysis A planning tool that firms use to
develop narratives to sketch out potential future states of the world
as climate change advances.
Climate Stress Tests Simulations that are used to assess how a
firm responds to climate-induced physical and transitional risk.
207
Climate Tipping Point A low probability, high impact event in Double Materiality A concept that encourages companies to
which the climate system undergoes a large and rapid shift to an disclose all activities, opportunities, and risks that may be material
entirely new climate state. to the company, society, and the environment.

CO2 Emissions Standards A set of European Union regulations Economic Sustainability An aspect of sustainability that pro­
to reduce the quantity of CO2 emissions from cars and vans. motes accessibility of economic prosperity around the world.

Commercial (Climate) Data Providers Entities that provide Ecosystem Services Benefits that humans derive from ecosys­
detailed climate-related data for transition and physical risk sce­ tems, including provisioning, supporting, regulating, and culural
nario analysis. services.

Company-Level Scores A measurement of a company's physical Emission Trajectories A projection of the level of GHG that an
climate risk exposure. entity emits, based on current and proposed practices and policies.

Company-Level Risks Microeconomic risks that impact the func­ Enterprise Risk Management (ERM) Comprehensive approaches
tion of an individual firm, including operational, credit, liquidity, to managing risk across and within an organization.
and underwriting risks.
Environmental Criteria Criteria that assess how a company
Consumption-Based A GHG accounting method which measures impacts environmental factors such as water use and GHG
the cumulative emissions which arise from the production of all emissions.
goods and services consumed in that country, regardless of where
Environmental Sustainability An aspect of sustainability that
production took place.
involves maintaining and balancing ecological and biological
Corporate Alignment A process in which companies develop systems.
approaches to reach a common goal.
ESG A set of criteria investors use to gauge companies and
Corporate Carbon Footprints Carbon emissions data of a firm's sometimes other entities such as governments on environmental,
Scope 1, 2, and 3 emissions, as defined by the GHG Protocol. social, and governance performance.

Corporate Greenhouse Gas Emissions The combination of a ESG Criteria The standards investors use to assess ESG perfor­
firm's Scope 1, 2, and 3 emissions, as defined by the GHG Protocol. mance of companies and governments.

Corporate Social Responsibilty (CSR) When companies under­ ESG Integration Involves using and collecting data on material
take social or environmental activities in an attempt to benefit ESG issues, integrating it into investing or lending decisions, and
wider society. engaging with investee companies.

Corporate Strategy High-level decisions on an organization's EU Taxonomy A European Union framework that sets perfor­
priorities and mission. mance thresholds for economic activities, by sector and subsector,
to determine which investments are environmentally sustainable.
Credit Risk A measure of creditworthiness, or ability a borrower
has to pay back a loan. European Economic Area European countries that participate in
the European Union's single market.
Culture Defined by COSO as the "attitudes, behaviors and
understanding about risk[ ... ] that influence the decisions of man­ EV Purchase Subsidies Government-funded subsidies that pro­
agement and personnel and reflect the mission, vision and core mote purchasing electric vehicles.
values of the organization"
Exposure A measure of whether assets or firms in a vulnerable
Decoupling When organizations or companies do not fulfill place or setting could be adversely affected by climate hazards or
stakeholder expectations of sustainability claims. drivers.

Development Financial Institutions (DFls) Institutions that Extreme Event Attribution Science A branch of climate change
finance projects in developing countries. science that quantifies the contribution of climate change to
extreme events.
Direct Emissions Emissions from sources that are owned or con­
trolled by the reporting company. Feed-in Tariffs A form of carbon pricing which sets a guaranteed
price per unit of electricity generated at which producers can sell
Disorderly Transition A delayed and less organized economic
their electricity for a fixed period of time.
transition to net zero CO2.

208 ■ Glossary
Financial Performance A traditional metric to gauge company
performance.
Financial Stability A set of conditions in which economic pro­
cesses operate as expected.
Financial Supervision A toolkit of strategies and regulations to
ensure the stability of financial institutions.
Fuel Efficiency Standards Regulations that set a target average
consumption of fuel in motor vehicles (often indicated as mpg,
I/km, g CO2/km).
Geothermal Energy A form of renewable energy generated by
heat in the Earth's crust.
(Global) Reference Scenarios A set of agreed-upon and widely
used projections of future emissions with accompanying socioeco­
nomic narratives and estimates, which are a crucial input for climate
scenario analysis.
Global Reporting Initiative An organization that provides widely
accepted sustainability reporting standards.
Global Warming Though often used interchangeably with climate
change, specifically refers to the increase in temperature caused by
increased greenhouse gases.
Global Warming Potential (GWP) A measure of a gas's abilty to
trap heat relative to carbon dioxide. For example, methane's GWP
of 28 means that it can trap 28 times more heat than carbon dioxide.
Governance Issues that pertain to company leadership, compen­
sation, and risk management strategy.
Green Bonds Bonds whose proceeds are earmarked for environ­
mental projects that can, but are not required to, include climate­
related goals.
Green Car Loans Loans that are dedicated to financing environ­
mentally friendly cars, such as electric vehicles.
Green or ESG Indices Stock market indices that include compa­
nies according to various sustainability performance standards.
Green Finance Sustainable finance focused on environment-related
risks and opportunities-often, but not necessarily, climate change.
Green Labels A standardized recognition/confirmation/certificate
that a financial product, project, or organization has a measur-
able positive contribution to the environment, climate change,
renewable energy, or other types of recognized green/sustainable
activities.
Green Loans Loans whose proceeds are used for environmental
and climate-related projects.
Green Mortgages Mortgages for energy-efficient homes.
(Green) Taxonomies Frameworks that are used to define what
products are considered sustainable.
Greencrowding A form of greenwashing in which an organization
depends on the sheer volume of other companies in its sector to
obscure its sustainability record.
Greenhouse Gases Gases, such as carbon dioxide and methane,
that trap heat energy emitted by the Sun and Earth.
Greenhushing A form of greenwashing in which an organization
undereports sustainability successes to avoid investor or public
scrutiny.
Greenlabelling A form of greenwashing in which an organization
misleads on sustainability claims.
Greenlighting A form of greenwashing in which an organization
focuses on only one small or specific sustainability success.
Greenrinsing A form of greenwashing in which an organization
regularly changes its ESG targets before completion.
Greenshifting A form of greenwashing in which an organization
shifts blame for unsustainable practices to consumers.
Greenwashing Practices that include companies not fulfilling
green claims made to consumers or deflecting attention away from
unsustainable practices.
Greenwishing Well-intended efforts that may not make a signifi­
cant difference toward sustainable outcomes.
Growth An increase in utilization.
Hazards Events with the potential to cause harm and enhance risk.
Hothouse World A lack of action in pursuing net CO2, leading to
enhanced physical risks.
Hydroelectric Energy A form of renewable energy generated
when water running through a damn spins turbines.
Impact and Dependency Mapping A tool that describes impacts
and dependencies in terms of stock and flow in relation to various
types of capital.
Indirect Emissions Emissions that are a consequence of the
activities of the reporting company, but occur at sources owned or
controlled by another company.
Integrated Assessment Models (IAMs) Broad-spectrum models
designed to allow analysis of how societal and economic choices
affect each other and the natural world, including the causes of
climate change.
Intergovernmental Panel on Climate Change (IPCC) The UN
entity that is responsible for assessing and reporting on climate
change and its impacts.
Glossary ■ 209
International Climate Policy Binding and nonbinding multina­
tional agreements that primarily focus on reducing greenhouse gas
emissions.
International Energy Agency (IEA) An international organiza­
tion that collects data, conducts analyses, and produces reports on
energy use across the global energy system.
International Financial Institutions (IFls) Banks that are estab­
lished and managed by two or more countries.
Key Performance Indicators (KPls) A quantified measure of
advancement toward a predetermined goal.
Kyoto Protocol Established in 1997, a legally binding treaty
in which high-income countries agreed to reduce emissions by
5% from 1990 levels by 2008-2012.
Leakage Refers to displacing rather than avoiding emissions.
Liability Risk When firms suffer financial consequences after
being held legally responsible.
Life Cycle Assessment An assessment of the environmental
impacts of a product through its entire life cycle, from production,
to use, to disposal.
Liquidity Risk Potential loss due to an institution's inability to
meet its obligations or losing access to liquidity.
Loan-to-Deposit Ratios A ratio to compare a bank's total loans to
the bank's total deposits.
Loss Given Default (LGD) The amount a lender loses when a
borrower is unable to pay back a loan.
Macroprudential Supervision The oversight of the broader finan­
cial system for financial soundness.
Materiality/Material The relative significance of an issue to an
organization's finances and business operations.
Materiality Assessment The process of assessing the relative
importance of various climate risk and sustainability risk drivers.
Measurement Refers to the challenge of accurately assessing the
amount of stored carbon.
Measuring and Defining (risk) The process of identifying and
analyzing threats (and opportunities) to an organization.
Microprudential Supervision The oversight of specific financial
institutions (usually banks and insurers) for financial soundness.
Multifaceted (risk) Risks with a variety of features and elements.
Multilateral Development Banks (MDBs) Multinational institu­
tions that support financial growth in developing countries.
Nationally Determined Contributions (NDCs) National plans to
reduce greenhouse gas emissions in alignment with international goals.
210 ■ Glossary
Natural Capital The stock of the world's natural resources, which
include living and geological resources.
Natural Capital Protocol A framework that allows organizations
to assess their impact and dependencies on natural capital.
Natural Climate Solutions Practices and technologies that
equester carbon from the atmosphere by conserving, restoring, or
managing natural systems.
Nature-Based Solution "Nature based solutions are defined as
actions to protect, manage, or restore ecosystems that also address
societal and human challenges."
Net Zero Reaching a balance between the greenhouse gases
entering the atmosphere and those removed via sinks.
Net-Zero Scenario A climate scenario that models the pathways
and outcomes of reaching a balance between greenhouse gas
emissions and elimination.
Network for Greening the Financial System (NGFS) An initia­
tive that joins central banks and regulators to work on climate inte­
gration, and helping to spread best practices.
Nuclear Energy A dispatchable form of energy produced by
nuclear reactions.
Operational Risk The risk inherent in doing business that reflects
potential losses from inadequate or failed internal processes, sys­
tems, human error, or outside events.
Orbital Variations Driver of climate shifts that are caused by
changes in the shape of Earth's orbit around the Sun.
Orderly Transition A focus on a swift economic transition to net
zero CO2.
Output of the Sun Driver of climate shifts that result from fluctua­
tions in the Sun's brightness.
Paris Agreement A nonbinding multinational 2015 agreement
that set an emissions target to limit warming to 1.S-2°C. The agree­
ment depends upon mutual accountability from member nations
to adhere to the emissions reduction plans that each country
establishes.
Permanence Refers to the capacity for long-term storage of
carbon.
Physical Climate Models Computer simulations that model the
functioning and operation of the Earth's climate system, and are
now used for scenario analysis.
Physical Risk Risks that arise from the physical climate (and
weather) impacts that result from the changing climate.
Portfolio Alignment Tools A set of tools financial institutions can
use to analyze and set investment sustainabilty targets.
Portfolio (Climate) Risk Management Using scenario analysis to
assess portfolio-level exposures, and gauge how exposures may
vary in different climate outcomes.
Portfolio Selection Using scenario analysis to inform decisions
about investment strategies.
Probability of Default (PD) The likelihood that a borrower will be
unable to pay back a loan.
Production-Based A GHG accounting method in which a
country's emissions are those which directly arise within its geo­
graphical boundaries.
Removal Refers to activities that directly sequester carbon or
other greenhouse gases.
Renewable Portfolio standards (RPSs) An umbrella term for a
range of quota-based regulations that aim to increase the supply of
renewable electricity by requiring commercial electricity producers
to source a specific portion of supply from renewable energy
sources, such as wind or solar power.
Representative Concentration Pathways (RCPs) Adopted
by the IPCC, RCPs are scenarios that model the level of radia­
tive forcing that is caused by a given level of greenhouse gas
concentrations.
Resilience Planning Using scenario analysis to mitigate opera­
tional risk and improve preparedness.
Review and Revision Additional checks and balances on the ERM
framework to reassess risks when considering susbstantial changes
to a firm's business context.
Risk Assessment Evaluating gathered data on the actual scope of
identified risks.
Risk Governance The process of managing risk properly within
an institution, by utilizing structures and staff to diffuse knowledge
and monitor risks.
Risk Identification Examining the transmission channels of cli­
mate risk drivers into financial risk.
Risk Management A structured approach to monitoring, measur­
ing, and managing exposures to reduce the potential impacts of
uncertain occurrences.
Risk Prioritization Ranking risks in order of importance (can
include likelihood of occurrence, adaptability and complexity, or
severity).
Risk Responses COSO ERM Framework counts five possibilities:
acceptance, avoidance, pursuit, reduction, and sharing.
Scenario Analysis The use of narratives to sketch out potential
future states of the world.
(Scenaro Analysis) Analytical Tools A wide range of models and
scenarios to understand and respond to the challenges of climate
change, including physical risks and transition risks.
(Scenario Analysis) Outputs The results of climate scenario
modeling, which can include, but not limited to, revenues or costs
to asset valuations and impacts on productivity.
(Scenario Analysis) Parameters A set of assumptions that can
range from macroeconomic variables (e.g., GDP growth) to energy
demand and mix to policies.
SDG Bond Bonds that are linked to UN Sustainable Development
Goals.
Sector-Specific Decarbonization Pathways A set of approaches
designed to demonstrate how various sectors can reduce their
greenhouse gas emissions in accordance with Paris Agreement goals.
Sector-Specific Policies Policies (including, but not limited to
renewable portfolio standards and fuel efficiency standards) that
are tailored to reduce the emissions from unique industries.
Shared Socioeconomic Pathways (SSPs) A set of scenarios that
show how the climate is influenced by social and economic factors
(including but not limited to population, economic growth, educa­
tion, and level of globalization).
Social Bonds Bonds with earmarked proceeds for projects that
will bring social benefits.
Social Metrics Metrics that measure how a company manages
employees and relationships with suppliers and communities.
Social Sustainability An aspect of sustainability that focuses on
securing a minium standard of basic human necessities and rights.
Solar Energy A form of renewable energy that uses solar panels
to gather light and heat from the Sun's rays.
Standardize The process of ensuring definitions and standards
are consistent.
Stranded Assets Environmentally unsustainable or otherwise
climate-affected assetscan suffer from unanticipated or premature
write-offs due to either physical or transition risk.
Strategy and Stakeholder Communication The process of dis­
closing a firm's climate-related opportunities and risks.
Stress Testing A set of simulations that are used to assess a firm's
stability and how the firm responds to threats.
Supply Chain Risk Risks that arise from disruptions from
suppliers.
Sustainability Humankind meeting its economic needs without
overburdening the environment or weakening societies.
Glossary ■ 211
Sustainability Accounting Standards Board (SASB) An organiza­
tion that provides standards for reporting material sustainability
issues.
Sustainability Bonds A combination of green and social bonds,
meant to simultaneously address both environmental and social
objectives.
Sustainability and Climate Investment Policies A broad range
of policies established by multinational institutions (e.g. The World
Bank) to guide sustainable finance.
(Sustainability) Coalitions Private sector-focused groups that
develop best practices on a range of sustainability issues.
(Sustainability) Frameworks A set of metrics to guide and pro­
mote the disclosure of financially material sustainability information
by companies to their investors.
Sustainability-Linked Bonds (SLB) Bonds whose coupons are
linked to the issuer firm's achievement of pre-agreed sustainability
targets.
Sustainability-Linked Loans (SLL) Loans whose interest rates are
linked to a company's achievement of certain sustainability targets.
Sustainability Performance Targets (SPTs) Measureable
advancement of KPls in accordance with a timeline set by the issu­
ers of an instrument.
Sustainable Credit Cards Credit cards that donate a percentage
of purchases to environmental charities.
Sustainable Development Country-level economic development
that does not overexploit natural resources or overburden society.
Sustainable Development Goals An international initiative the
UN started in 2015 that advances the UN 2030 Agenda for Sustain­
able Development.
Sustainable Finance Any kind of financial activity that takes sus­
tainability into account, across asset classes, products, and services.
Sustainable Funds Funds that consist of sustainable instruments
and funds with shares in sustainable companies.
Sustainably-Linked Instruments that are linked to sustainability
targets.
SWOT Analysis A form of risk assessment that focuses on identi­
fying strengths, weaknesses, opportunities, and threats.
Systemic (risk) Risk of a breakdown or collapse of an entire sys­
tem (rather than failure of individual parts).
Tax Incentives A policy option that can significantly increase
renewable energy competitiveness and deployment.
212 ■ Glossary
Tectonic Processes Driver of climate shifts that occur as a result
of continental drift.
Temperature Scores A shorthand way of understanding what
level of warming a company's plans are aligned with.
T ime Horizons A predetermined point in the future that marks an
important threshold.
Transition Risk Risks that arise from the economic transforma­
tion and any dislocation needed to drastically reduce, and even­
tually eliminate, net greenhouse gas emissions to reach net-zero
emissions.
Triple Bottom Line An assessment of corporate sustainability that
equally weights social and environmental perform with financial
peformance.
Unforced Variability Driver of climate shifts that naturally occur
over a period of a few weeks to years, but cannot fully account for
recent climate change.
United Nations Framework Convention on Climate Change
(UNFCC) A multinational UN treaty, signed in 1992, to address
the risks of human-induced climate change.
Use of Proceeds A brief statement summarizing how investments
are used.
Value at Risk (VaR) A metric for quantifying(or measuring) the
potential loss/the level of financial risk in a firm, a portfolio, or a
given investment.
Vulnerability Degree to which assets (or firms) could suffer losses
due to exposure to climate change impacts.
Weather The exact state of the atmosphere at a particular loca­
tion and time.
Weighted Average Carbon Intensity A portfolio's exposure to
carbon-intensive companies.
Wind Energy A form of intermittent renewable energy that relies
on wind turbines to harvest kinetic energy from wind.
World Business Council for Sustainable Development An inter­
national organization that conducts research on corporate social
responsibility and shares research with members. It developed the
Greenhouse Gas Protocol along with the World Resources Institute.
World Energy Outlook The IEA's annual report; a comprehensive
assessment of global energy use.
World Resources Institute Ecosystem Services Review A frame­
work that allows organizations to assess their impact and depen­
dencies on ecosystem services.
INDEX

A BECCS. See Bioenergy with carbon capture and sequestration

(BECCS)
"Abiotic" resources, 40
Benchmark divergence, 198
Adaptation, 18 Bid-ask spreads, 131
maladaptation, 18-19
Biden Administration, 23
Adaption, 60-61
Binary "green" assessment, 88
Aerosols, 8-9
Binary measurement, 198
Affordable energy, 37
Biodiversity, and climate change, 92-93
African Development Bank (AfDB), 85 Bioenergy, 62
Agricultural infrastructure, 14
Bioenergy with carbon capture and sequestration (BECCS),
Agricultural nitrogen pollution, 40 22
Agroforestry,23 Biomass energy, 21
Albedo effect, 16
52
Anthropogenic climate change,
Asian Development Bank (ADB), 85
C
Asset bubbles, 88 Cap-and-trade schemes, 80
Assets, 54-55 Carbon capture, 21
management, 199 Carbon capture, utilization, and storage (CCUS), 21
Attention deflection, 42 Carbon countercyclical capital buffer, 92
Attribution of warming Carbon dioxide (CO2), 7-8
greenhouse gases, 11 emissions standards, 82

orbital variations,11 removal, 22, 191

output of sun, 10-11 trap heat, 7 5

statement on, 11-12 Carbon intensity,19, 140

tectonic processes, 10 Carbon offsets, 191, 194

unforced variability, 11 Carbon pricing, 80

Automotive, 165 Carbon-related metrics, 195, 197-198

Carbon sequestration (CCS), 21
Carbon storage, 22
B Carbon taxes, 80
Banks methodology, 165 CCS. See Carbon sequestration (CCS)
Battery energy storage systems (BESS), 21 Cement, 165

213
Central bank-led supervision, 89-91 types
Clean development mechanism (CDM), 78 physical risk, 53, 55-61
Climate action, 36 stranded assets, 54-55
Climate Action Tracker, 192 stranded human capital and just transition,
Climate Biennial Exploratory Scenario, 155 66-67
Climate change transition risk, 53, 61-66
causes Climate risk measurement/management, 123-147
attribution of modern warming, 10-11 data and analysis, 135-141
energy balance, 6--7 company-level transition risk data, 136-138
greenhouse effect, 7 corporate alignment, 136
human activity, 7-10 corporate carbon footprints, 136
description, 2 market participants, 138
future warming (see Warming) physical risks, company-level, 138-139
impacts portfolio-level analysis, 140-141
agricultural infrastructure, 14 products and services, 136
Albedo effect, 16 temperature scores, 137
cold-season temperatures, 14 enterprise risk management, 141-147
distribution of ecosystems, 14 corporate strategy, 142-144
extreme events, 16--17 culture, 142
human society and natural ecosystems, 17 investors and lenders, 146
modern, 14-17 materiality assessment, 143
polar amplification, 16 review and revision, 146
positive feedbacks, 16 risk assessment, 144
precipitation, 14-15 risk governance, 142
sea level and ocean acidification, 15 risk identification, 144
temperature, 14 risk prioritization, 144
observations risk responses, 146
global annual average temperature, 3, 4 scenario analysis, 144
global average surface temperature, 5, 6 time horizons, 144
high-quality weather, 4 kinds of risks, 124
before humans, 5, 6 macro climate risk
independent scientific groups, 4 climate impacts, 132
thermometers, 4 climate Minsky moment, 133
warming, 4 credit risk, 133
policy responses, 17-24 financial counterparties, 132
Climate, definition, 2 insurance risks, 133
Climate finance, 101 liquidity risk, 133
Climate groupings, 94 market risk, 133-135
Climate impact, 9-10 operational risk, 132-133
Climate integration, central bank-led supervision, 89-91 potential threat, 133
Climate models, and scenario analysis, 152-172 sovereign risk, 135
Climate policies, 75-78 systemic risk and financial stability, 132-135
ClimatePREDICT, 167 micro and macro level, 126-128
Climate risk, 33-34 micro (company-level) climate risks
definition, 52 credit risk, 129-131
finance, economy and key sectors, 67 liquidity risk, firm-specific, 131
introduction, 52-53 operational risk, 128-129
measurement/management (see Climate risk measurement/ underwriting risk, 131-132
management) transversal risk, 147

214 ■ Index
Climate scenario analysis, 153
D
Climate tipping point, 17
DAC. See Direct air capture (DAC)
Climate transition risk, 132
Data granularity, 59-60
Climate value at risk (CVaR), 134
DDPP. See Deep decarbonization pathways project (DDPP)
Coalitions, 45-48
Decarbonization, 66
Cold-season temperatures, 14
Decoupling, 42
Commercial data providers, 164
Deep decarbonization pathways project (DDPP), 161
Common Ground Taxonomy, 89
Delta Blue Carbon Project, 45
Community-Scale Greenhouse Gas Emissions Inventories,
Development Financial Institutions (DFls), 85
186, 188
Direct air capture (DAC), 22, 62
Comprehensive approach to emission reductions, 184
Direct emissions, 83, 84
Computer simulations, 11-13, 16
Double materiality, 201
Concentrated solar power (CSP), 64
Dynamic integrated climate economy (DICE) model, 76
Consumer pressure, 64-65
Consumption-based accounting methods, 185
Corals, 5 E
Corporate alignment, 136 Economic sustainability, 32
Corporate carbon footprints, 136 Economy, 66
Corporate social responsibility (CSR), 33, 41 Ecosystems, 14, 17
and greenwashing, 42-43 Ecosystem services, 39-40
Corporate strategy, 142 Electricity generation, 67-69
Corporate sustainability reporting, 41-42 El Nino/Southern Oscillation (ENSO), 11
Corporate Sustainability Reporting Directive (CSRD), Emission reductions, 191
201 Emissions scenarios, 24
Corporate use cases Energy balance, 6-7
operational risk and resilience planning, 168 Energy storage, 20
strategy and stakeholder communication, 168 Energy system, 19-22
Corporate Value Chain Standard, 83 Engagement, 33, 42
Counterparty climate risk assessment, 145 Enterprise risk management (ERM), 141
COVID-19 pandemic, 165, 170 Environmental criteria, 34
IEA, 158 Environmental impact, 41
recovery fund, 88 Environmental, social and governance (ESG)
sustainability bonds, 106, 107 and climate integration, 110-114
T CFD reporting, 116 data and scores, 110
Credibility gap, 193 investment decisions and portfolio analysis, 110-113
Credit risk, 129 shareholder engagement, 112, 114
macro climate risk, 133 policies, 33
micro (company-level) climate risks, sustainability and climate risk, 33-34
129-131 Environmental sustainability, 32, 33
Cross-industry principles & metrics, 195 Equitable transition to net zero, 184
CSR. See Corporate social responsibility (CSR) ESG. See Environmental, social and governance (ESG)
Culture, 142 European Development Finance Institutions (EDFI) association,
Culture, and governance, 75-95 85
collective action problems, 78 European Economic Area (EEA), 40
COP meetings, 79 European Investment Bank (EIB), 85
global COVID-19 pandemic, 88 E.U. Taxonomy, 87, 116-118
joint implementation, 78 EV purchase subsidies, 82
Paris Agreement, 79 Ex-ante investment integration, 170
Cumulative CO2 emissions, 76-77 Exposure, 54

Index ■ 215
Extreme-event attribution science, 16 Greenhushing, 43
Extreme weather events, 16-17 Greenlabelling, 43
Green labels, 109
Greenlighting, 42
Green loans, 106
Feed-in tariffs, 82
Green mortgages, 110
Finance, 67
Green or ESG indices, 109
Finance & investment
Greenrinsing, 43
ex-ante investment integration, 170
Greenshifting, 42
portfolio analysis and stress testing, 168-171
Green/sustainable finance
Financial performance, 41
ESG and climate integration, 110-114
Firm's strategy, 53
data and scores, 110
Forest conservation, 23
investment decisions and portfolio analysis, 110-113
Fossil fuels, 165
shareholder engagement, 112, 114
combustion, 8
markets and instruments, 101-118
sustainable finance taxonomy, 199
green bonds, 104-106
Frameworks, sustainability risk, 45-48
green labels, 109
Front-loaded emission reductions, 184
green loans, 106
Fuel efficiency standards, 82
institutional or retail, 108

G private and public entities, 104

social, and sustainable bonds, 104-106
GCM. See Global climate model (GCM) sustainability-linked bonds, 104, 106-108
Geoengineering, 22-23 sustainability-linked loans, 104, 106-108
Geothermal, 21 use of proceeds, 104
Glasgow Climate Pact, 179 products and instruments, 104-110
Glasgow Financial Alliance for Net Zero, 190 taxonomies, 115-117
Global Assessment Report on Biodiversity and Ecosystem Services, economic activity, 116-117
IPBES, 93 financial products, 116
Global climate model (GCM), 12 regulators and exchanges, 116
Global emissions, 78 trends and flows, 101-104
Global precipitation change, 57 Green taxonomies, 89
Global reference scenario and financial regulation, 87-89
International Energy Agency (IEA), 158-162 Greenwashing, 91
IPCC scenarios (RCPs and SSPs), 156-159 and CSR, 42-43
net zero, 155-156 Greenwishing, 43
Global Reporting Initiative (GRI), 47, 200 GWP. See Global warming potential (GWP)
Global Resilience Index Initiative (GRII), 137
Global warming, 2-3
Global warming potential (GWP), 8 H
Governance, 34, 53, 75-95 Halocarbons, 8
Grassland restoration and management, 23 Hazards, 54-59
Green bonds, 104-106 Holocene, 5
Green car loans, 109 Human activity
Greencrowding, 42 carbon dioxide, 7-8
Green finance, 101 greenhouse gases and aerosols, 8-9
Green funds, 108-109 on climate impact, 9-10
Greenhouse effect, 7 radiative forcing, 10
Greenhouse gases (GHG), 8-9, 11, 179-180 Human society, 17
emission accounting at corporate level, 83-85 Hydroelectric energy, 20

216 ■ Index
 Legal liability risk,60
Legal risks, 60, 63-64
IAMs. See Integrated assessment models (IAMs)
Levelized cost of electricity (LCOE), 64
Ice ages,5
LGIM. See Legal and general investment management (LGIM)
cycles, 11
Liability risk,60
Ice cores,5
Life cycle assessments (LCA), 43
IEA. See International Energy Agency (IEA)
Liquidity risk
IFis. See International financial institutions (IFls)
macro climate risk,133
Impact and dependency mapping, 143
micro (company-level) climate risks,firm-specific, 131
Impact assessment,43
Little Ice Age, 5
Implied temperature rise (ITR),198, 199
Loan-to-deposit ratios,131
Indirect emissions,83, 84
Lobbying,88
ING's 2021 Climate Report, 200
Loss given default (LGD),129
Institutional Investors Group on Climate Change (IIGCC), 91
Lyxor Asset Management (Lyxor),199
Insurance premiums, changes in, 131
Insurance risks,133
Integrated Assessment Modeling Consortium, 12
M
Integrated assessment models (IAMs),157,163 Macroprudential supervision,89,90

Inter-American Development Bank (IADB),85 Maladaptation,18-19

lnterglacials, 5 Market risk, 62,65-66,133-135

Intergovernmental Panel on Climate Change (IPCC), 4-5, 9-12,35, Material financial effects, 42

52,153, 155 Materiality, 42

in 1988,76 assessment, 143

Interim targets and pathways, net zero,192-195 Maturity scale alignment metrics,198

International Bank for Reconstruction and Development (IBRD),85 MDBs. See Multilateral development banks (MDBs)

International Climate Agreements, 78-79 MDGs. See Millennium Development Goals (MDGs)

International Energy Agency (IEA),158-162 Metrics, 53

International Finance Corporation (IFC),85 for financial institutions,195-199

International financial institutions (IFls),85 and targets,195

International Labor Organization,60 use of,195-200

International sustainability and climate policies,75-85 Microprudential supervision,89, 90

International Sustainability Standards Board (ISSB), 47-48, 200 Millennium Development Goals (MDGs), 35

Inventory analysis,43 Millennium Ecosystem Assessment (MA),39

IPCC. See Intergovernmental Panel on Climate Change (IPCC) Minsky moment,133

Isotopes,8 Mitigation, 19-22

targets, 23-24

J Mitigation Goal Standard, 83

Multifaceted risk,60
Just transition,66-67
Multilateral development banks (MDBs), 85

K N
Keeling curve,7
Nationally determined contributions (NDCs),23, 79, 193
Key performance indicators (KPls),42, 106
and national climate policies,79-82
KPls. See Key performance indicators (KPls)
National net-zero target setting, 193
Kyoto Protocol,78
Natural capital,40
Natural Capital Protocol,40
L Natural climate solutions,22-23
Land degradation,93 Natural ecosystems,17
Legal and general investment management (LGIM),164, 172 Nature-based solutions,38, 39

Index ■ 217
NOC. See Nationally determined contributions (NDCs) Paris Alignment Capital Transition Assessment (PACTA), 165
Network for greening the financial system (NGFS),89, 161 Partnership for Carbon Accounting Financials,48
Net zero, 179-202 Physical climate models, 162,166-167
alignment with broader socio-ecological objectives,184 Physical risk,53, 55
community-scale greenhouse gas emissions inventories, acute and chronic hazards,56-59
186,188 changing climate,53
country-level emissions,185-186 data granularity,59-60
durable,179 distributional consequences,55
economic opportunities, 184 electricity generation, 69
equitable transition,184 emissions trajectories, 162,166,170
in global climate architecture,179 exposure, 54
implications of,185-189 opportunities, resilience and adaption,60-61
interim targets and pathways, 192-195 real estate,67-69
metrics,195-199 scenario analysis, 165-167
private sector, 188-189 supply chain,legal and systemic risks,60
reporting, 200-201 very long-horizon portfolio, 167
SBTl's guidance for the financial sector,189 vulnerability, 54
scenario for Germany, 186-187 Plastic pollution, 93
scientific discussions,179 Polar amplification, 16
spread of,181-185 Policy and Action Standard,83
sub-national governments, 186-188 Policy enforcement, sustainable investment and disclosure,91
temperature increase to 1.5°C,180-181 Policy options, ecosystem services,40
transition plans, 189-192 Policy responses
Net-Zero Insurance Alliance (NZIA),183 adaptation,18-19
Net zero scenario, 155-156, 159 geoengineering,22-23
NGFS. See Network for greening the financial system (NGFS) mitigation, 19-22
Non-state and subnational actor (NSA) climate commitments,83 mitigation targets, 23-24
Nordhaus's dynamic integrated climate economy (DICE) model, Policy risk,63-64
76 Portfolio alignment tools, 196
Nuclear energy,20 Portfolio analysis,and stress testing,168-171
Potsdam Institute for Climate Impact Research (PIK),162
0 Power, 165
Precipitation, 14-15
Ocean acidification, 15
Principles for Responsible Investment (PRI),45
Ocean sediment cores,5
Private sector,net zero
Operating Principles for Impact Management (OPIM), 86
financial sectors,189
Operational risk
non-financial sectors, 188-189
macro climate risk,132-133
Private-sector sustainability
micro (company-level) climate risks, 128-129
frameworks and coalitions,45-48
Opportunities
investors, 45
physical risk,60-61
sustainability risk, 47-48
transition risk,61-66
Probability of default (PD),129
Orbital variations, 11
Production-based accounting method, 185
Outputs,162
Production-vs. consumption-based emissions estimates,2020,
Ozone (03),8
2021,185,186

p Product Standard,83
Project Protocol,83
Parameters/assumptions,162 Provisioning services,40
Paris Agreement,83, 179 Public policy,green finance adoption,86-87

218 ■ Index
R SSP3, 12
SSP5, 12
Race to Zero campaign, 181-183
Shareholder activism, 114
RCPs. See Representative concentration pathways (RCPs)
Small modular reactors (SM Rs), 20
Real estate, 67-69
Social bonds, 105
Reference scenarios, 153
Social impact, 41
Reforestation, 23
Social metrics, 34
Renewable portfolio standards (RPSs), 81
Social sustainability, 32
Reporting, net zero, 200-201
Soil carbon sequestration, 23
Representative concentration pathways (RCPs),
Solar energy, 20
156, 170
Solar radiation management, 16, 22
Reputational risk, 45, 64-65
Sovereign risk, 135
Resilience, 60-61
Speleothems, 5
planning, 168
SSPS vs. RCP-SSP, 158
Risk assessment, 144
Stakeholder communication, 168
Risk governance, 142
Stalactites, 5
Risk identification, 144
Stalagmites, 5
Risk management, 53, 60, 124
Standard Value at Risk, 134
Risk prioritization, 144
Steel, 165
Risk responses, 146
Stranded assets, 54-55
Roundtable for Sustainable Palm Oil (RSPO), 45
Stranded human capital, and just transition, 66-67
RPSs. See Renewable portfolio standards (RPSs)
Stratosphere, 8
Stress testing, 89, 90, 154-155, 168-171
Subnational climate policies, 82-83
SASB. See Sustainability Accounting Standards Board (SASB) Sub-optimal targeting, 88
Scenario analysis, 144, 153, 154 Sulfate aerosols, 9
asset management, 172 Sun's output, 10-11
BHP, 169 Supply chain risk, 60
global reference, 155-162 Supporting services, 40
introduction, 152-155 Sustainability
outputs, 162 climate policy (see Sustainability and climate policy)
parameters, 162 at corporations and financial institutions, 40-45
physical climate effects, 166 definition, 32
physical risk, 165-167 Delta Blue Carbon Project, 45
TCFD recommendations, 154, 168 ESG and climate risk, 33-34
transition risk, 162-165 introduction, 32-33
use cases private-sector frameworks and coalitions, 45-48
corporate, 168 products and systems, 43
finance and investment, 168-171 source of risk, 44-45
SDG bond, 106 Sustainability Accounting Standards Board (SASB), 47, 48, 200
SDGs. See Sustainable Development Goals (SDGs) Sustainability and climate policy. See also Culture, and governance
SDS. See Sustainable Development Scenario (SDS) broader societal implications, 93-95
Sea level, 15 cap-and-trade schemes, 80
Sector decarbonization pathways, 163 carbon pricing, 80
Sector-specific decarbonization pathways, 153 climate risk
Securities and Exchange Commission (SEC), 201 and financial policy, 85-89
Shared socioeconomic pathways (SSPs), 12-14, 156, 170 and financial supervision, 89-91
SSP1, 12 EV purchase subsidies, 82
SSP2, 12 feed-in tariffs offer, 82

Index ■ 219
Sustainability and climate policy (continued) Technology risks, 64
financial supervision Tectonic processes,10
capital management,91 Temperature,2,14
Central Bank-led supervision,89-91 Temperature scores,137
EU Taxonomy, 87 Territorial-based accounting method, 185
macroprudential supervision,89,90 Time horizons, 144
microprudential supervision,89,90 Transition plans,net zero,189-192
frameworks, 91-92 Transition Plan Taskforce (TPT),189,190
fuel efficiency standards, 82 Transition risks,53,55,195
global warming,75 analysis,162-165
greenwashing,91 carbon prices/cap-and-trade,63
investment policies,75 economic transformation, 53
nature,biodiversity and climate change,92-93 electricity generation,67-68
private financial sector,86 exposure,54
private-sector sustainability,91-92 HSBC,169,171
roots stretching,75 market risk,65-66
sustainable investment and disclosure,91 non-financial corporations/financial institutions,153,154,162
types of policies, 80 and opportunities
Sustainability bonds,106 business-as-usual scenarios, 61
Sustainability-linked bonds (SLB),104,106-108 cap-and-trade scheme,62
Sustainability-linked instruments,104 DAC, 62
Sustainability-linked loans (SLL),104,106-108 policy and legal risks,63-64
Sustainability risk,47-48 reputational risks and consumer pressure,64-65
Sustainable credit cards,110 technology risks,64
Sustainable development,34 real estate,67-69
Sustainable Development Goals (SDGs) scenario analysis,162-165
corporations,41-42,44 vulnerability,54,60
ecosystem services & natural capital,39-40 Tree rings, 5
leading up to 2030 agenda,35-36 "Triple bottom line," 41
materiality and alignment,42
targets and cross-cutting solutions,37-39 u
and their targets,36-37
Unforced variability,11
United Nations,34,36
United Nations Framework Convention on Climate Change
Sustainable Development Scenario (SDS),158
(UNFCCC), 35, 53, 75
Sustainable finance,101
UN Race to Zero campaign,181-183
Sustainable finance taxonomy for fossil fuel producers, 199
Use of proceeds, 104
SWOT analysis,142
Systemic risk,60
V
T Value at Risk (VaR),134
Vulnerability, 54,60
Targets, 53
Task Force on Climate-related Financial Disclosures (TCFD), 53,92,
153,154,162,200
w
framework and recommendations, 53 Warming

Taskforce on Nature-related Financial Disclosures (TNFD), 92,93 attribution,10-11

Taxonomy,116 distribution,4

T CFD. See Taskforce on Climate-Related Financial Disclosures SSPs, 12-14

(TCFD) Warning systems,18

220 ■ Index
Water quality trading, 40 World Business Council for Sustainable Development (WBCSD), 45,
Water vapor, 7, 9-10 83
Water vapor feedback, 10 World Energy Outlook, 159
WBCSD. See World Business Council for Sustainable Development World Meteorological Organization (WMO), 78
(WBCSD) World Resources Institute (WRI), 83
Weather, 2 World Resources Institute Ecosystem Services Review, 40
Weighted average carbon intensity, 140 Worst-case scenario, 156
Wetland restoration, 23
Wildfire predictions, 58
Wind energy, 20 z
WMO. See World Meteorological Organization (WMO) Zero-emission economy, 21

Index ■ 221