MSCI

Sustainability
Institute

How can I use

climate scenarios?
A practical guide

December 2024
How can I use climate scenarios?
A practical guide

Contents

Foreword 3 Authors
Executive summary 4

Introduction 5 James Edwards

Executive Director
Criticisms and challenges 6 MSCI Research

A typology of climate scenarios 7

Fully narrative scenarios 9

Nathan Faigle
Quantified narrative scenarios 10
Senior Associate
Model-driven scenarios 11 MSCI Research
Probabilistic scenarios 12

A holistic approach 13
Using scenario types by level of analysis 15 Wenmin Li
Considerations by use case 16 Climate Risk Associate
United Nations Environment Programme Finance Initiative
Conclusion 19

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Sustainability
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How can I use climate scenarios?
A practical guide

Foreword
The growing impacts of climate tool for understanding the economic, financial At this critical time, when aligning financial
and societal consequences of climate change. strategies with the realities of climate change is
change and the global shift toward a
With the financial community facing increasingly so important, the insights in this report provide
low-carbon economy require complex climate challenges, the insights that valuable support to investors and fiduciaries as
investors, risk professionals and scenario analysis offers are now more essential they fulfill their responsibilities. This work will
policymakers to turn long-term risks than ever. also help mobilize the necessary capital to drive
the energy transition.
into today’s actionable strategies.
The decisions we make now about clean energy
investments, corporate strategies and I would like to thank our colleagues at the MSCI
Climate scenario analysis plays a key role in this
government policies will have long-lasting Sustainability Institute for their leadership in
process by offering structured frameworks to
effects on the global economy. This paper advancing this important conversation. Their
explore a range of possible futures. These
clarifies how climate scenarios can be applied in work helps prepare us for the significant
scenarios help us understand how changes in
practice, providing straightforward guidance. By challenges ahead and guides us toward a more
climate policy, technological advances and the
organizing these scenarios based on their climate-resilient future.
physical risks of a warming planet could affect
complexity and offering a roadmap for
financial markets and actors.
integrating them into investment decision-
making, the paper can help stakeholders make
This report provides a clear overview of the
informed choices.
various types of climate scenarios used by
finance practitioners. Each type is an important

David Carlin
Former Head of Risk
United Nations Environment Programme Finance Initiative

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Sustainability
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How can I use climate scenarios?
A practical guide

Executive summary
Investors and other capital markets Second, the report sets forth a series of suggestions to
guide the use of scenario analysis by practitioners. The
participants increasingly rely on climate
suggestions span a progression of four levels according to
scenario analysis to quantify the potential scope, quantification of risks, refinement and integration of
impacts on their investments of a warming scenarios into decision-making.
world and the transition to a low-carbon
Finally, the report considers the use of climate scenarios in
economy. specific applications. They include internal stress testing for
both prudential supervision and regulation and uses of
The ability to ponder a range of hypotheticals can help scenario analysis to fulfill mandatory or voluntary disclosure
investors assess the possible influence on portfolios of obligations. They also include stress testing for investment
national climate policies, technological developments or activities such as portfolio construction and asset allocation,
climate-driven tipping points that cannot be discerned from risk management and stewardship.
historical data. Climate scenarios also can help investors
understand courses of action that lead to these futures and The report recognizes that practitioners have a variety of
evaluate potential risks and opportunities. experience and expertise in the use of scenario analysis.
They confront challenges in analyzing climate scenarios
While investors routinely use climate scenario analysis, that range from building acceptance of scenario analysis
even experienced practitioners can struggle with within their institutions to deepening its use in the
implementing it. Challenges include choosing from an array investment process. It also recognizes that practitioners
of possible scenarios to weighing the uncertainty inherent can incorporate climate scenarios of progressively greater
in making assumptions about the future. complexity into their process.

This report aims to help investors make the most of climate The report espouses a holistic approach to climate scenario
scenario analysis in practice. It does so in three ways. analysis designed to improve financial decision-making and
infuse planning with resilience. It expresses our view that by
The report classifies climate scenarios based on their wielding complementary scenarios and integrating scenario
complexity and characteristics. It details four types of analysis seamlessly into existing workflows, practitioners
scenarios, examining strengths and weaknesses of each as can sharpen management of climate risks and capitalize on
well as the analysis that investors can reasonably expect opportunities.
them to augment.

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How can I use climate scenarios?
A practical guide

Introduction
Financial professionals have long used scenario Use cases also increasingly extend to business Figure 1: Estimated company devaluation in three different climate scenarios (maximum depreciation)
analysis to estimate potential change in asset values functions, including:
given possible changes in economic or market
conditions. Climate scenarios plausibly describe how • Investment activities: Investors are seeking to
Nationally Determined
the future may develop based on a set of assumptions maximize risk-adjusted returns based on
Contributions (NDC) Below 2⁰C Net Zero 2050
about key driving forces and relationships.1 anticipated climate risks and opportunities. This 0.0%
can include high-level activities such as strategic
Climate scenario analysis represents a developing area asset allocation and asset-liability management, as
well as portfolio construction and security -10.0%
of practice in which investors, risk professionals,
managers, and policymakers translate scenarios selection.
developed by climate scientists into models that • Risk management: Risk teams are tasked with -20.0%
examine how future pathways might affect their quantifying and managing risk arising from climate
investments. We have found in practice that different change, from the overall enterprise down to the -30.0%
use cases within the investment process require security level.
tailored approaches to address users’ specific needs.
These use cases include: • Client advisory: Advisory teams are advising -40.0%
clients on strategies designed to mitigate climate
• Reporting obligations: Whether voluntarily or by risks, identify opportunities and inform investment
decision-making. -50.0%
mandate, institutions are disclosing information on
climate risk management and performance to Climate scenario analysis begins with the assumption of
regulators, investors and the public. hypothetical future events that define each scenario.
-60.0%

• Stress testing: Institutions are being asked by Consideration of discrete future outcomes is necessary European energy company A Chinese utility company B American financial firm C
stakeholders, regulators and prudential supervisors because our global climate future will be greatly
to estimate the potential impacts of climate on influenced by distinct, bifurcating events, including
portfolio values, profitability and operations. action (or inaction) by governments, technological
shifts and potential climate-related tipping points. Source: MSCI ESG Research. Maximum devaluation forecasts are taken from MSCI Climate Value-at-Risk output and
reflect enterprise value. Scenarios developed by the Network for Greening the Financial System. Companies are
Figure 1 shows sample output of scenario analysis. publicly listed firms with names anonymized .
Here that analysis shows the estimated maximum
1. “Glossary,” Scenarios Portal, Network for Greening the devaluation of several companies based on three
Financial System scenarios for the low-carbon transition.

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How can I use climate scenarios?
A practical guide

Criticisms and challenges

Climate scenario analysis pushes the limits of expertise Against this backdrop, even experienced practitioners This paper aims to facilitate the use of scenario analysis by • Showing how practitioners can use different
in financial modeling. The field remains immature, have found it challenging to implement climate scenario showing how practitioners can wield it to their advantage. types of scenarios across use cases and at each
whether measured in know-how or acceptance among analysis. Key barriers this report aims to address include: We do that by: level of implementation within financial institutions,
investment-industry practitioners. as shown in Figure 2.
• Classifying climate scenarios by type, from simple
• A lack of guidance: The field suffers from an to highly complex. We discuss the strengths,
absence of guidance when it comes to best • Detailing how practitioners can use climate
At the same time, practitioners are being asked to weaknesses and compatible scenario analysis
practices or instruction for how to make the most scenarios in combination, with the aim of helping
develop models designed to meet the biggest questions associated with each type.
of scenario analysis in specific organizations. them make the most of the exercise.
of our climate future. Practitioners must also present the
current generation of results in a way that shows the Practitioners don’t need specific expertise in
value of climate scenario analysis to a wider audience mathematical modeling to derive value from
and invites further investment in its development. considering a range of what-ifs about the future.
Figure 2: Progressive levels of scenario analysis
Even rudimentary analysis can hold value.

Against these difficulties, a divergence of approaches to • Range of scenarios: Practitioners may tend to
Level 1 Level 2 Level 3 Level 4
scenario analysis has formed. Some practitioners overlook the value that considering complementary
champion qualitative scenarios, while others embrace scenarios can provide, whether in the substance of Scope Quantify Refine Integrate
quantitative modeling. Others omit climate-related output for decision-making or the ability to Identify and rank risk Create initial estimates of the Hone the actionability and Fully embed analysis into
factors they believe to be too speculative for decision- communicate the learnings to a wider audience. pathways and hot spots magnitude of financial impacts credibility of analysis decision-making

making. At the same time, some critics of climate

• The role of uncertainty: Climate scenarios by
scenario analysis say that practitioners are luring definition entail uncertainty. Yet communicating Source: MSCI Sustainability Institute
themselves into complacence by failing to consider uncertainty in the results of scenario analysis can
climate-related risks that may be all too real. be a challenge even for practitioners who execute
scenario analysis effectively.
We advocate for an approach to climate scenario
• Customization and flexibility: Though many
analysis that considers the benefits of both qualitative
nongovernmental organizations have developed
and quantitative scenarios and its ability to supply
climate scenarios for the financial industry,
insight. As we see it, a collection of imperfect forecasts
practitioners may find that off-the-shelf scenarios
beats a blind future, provided practitioners recognize the
fail to address the specifics of their strategies. At
uncertainty. the same time, such scenarios can be difficult to
customize.

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Sustainability
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How can I use climate scenarios?
A practical guide

A typology of climate scenarios

Although institutions are often familiar with traditional
macroeconomic scenario analysis, climate scenario
analysis diverges from this field in several key
respects. 2

Differing methods and a lack of consensus on what

Scenarios ARE:
constitutes best practice add to the challenge of
analyzing (and quantifying) the impacts of plausible Descriptions of potential futures
future pathways. The figure below shows a high-level
Significantly different views of the future
checklist of the defining characteristics for any climate
scenario. A movie of evolving dynamics over time

Specific decision-focused views of the future

In the following section we classify viable scenario types
based on their complexity. Table 1 (overleaf) proposes a To be shaped by practitioner’s insight and
typology of climate scenarios and summarizes the perceptions
strengths and limitations of each. Practitioners should
consider the list a menu of techniques that can be
combined to form an analytical program that addresses
their needs and not a catalog of mutually exclusive
approaches.

2. See the section on use cases for further discussion of these

differences. Scenarios ARE NOT:
Predictions of the most likely outcome

All variations on the same base case

Snapshots of endpoints

Generalized views of feared or desired futures

To be taken only from outside sources

Source: Adapted from Carlin (2023)

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Sustainability
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How can I use climate scenarios?
A practical guide

Table 1: Typology of climate scenarios (in ascending order of complexity) Strength Limitation Neutral

Scenario type Compatible scenario analysis Attributes of analysis Flexibility Treatment of uncertainty Time, cost and expertise required Ease of communication

Fully narrative: Professionals in traditional risk and

investment roles have the expertise
• Scenario construction and
analysis are subjective and
• Easily adjustable • Can only opine on
uncertainty in a qualitative,
• Time cost is relatively low • Output, being qualitative, is easily
consumable by a range of
A written narrative of a potential climate future is to translate a suitably defined written susceptible to bias/groupthink • Can capture risks that are very written manner • Construction requires only high-level audiences
developed. narrative into informed qualitative difficult to quantify climate knowledge
assessments of climate-driven risk • Lack of numeric output may be
and opportunity for each scenario. • Analysis requires only financial limiting for communication and
subject matter expert knowledge actionability

Quantified narrative: Suitable quantitative data produced

for each scenario may be fed into
• Scenario construction is
subjective and susceptible to
• Scenarios can be created or
adjusted relatively easily to fit
• Does not opine on
uncertainty directly
• Construction does not require
complex quantitative models
• Rationale behind scenario output
can be presented narratively,
traditional risk and investment bias/groupthink new or alternate potential lowering barriers to
A narrative of a potential climate future is models/analyses, forecasting futures understanding drivers.
• Flexibility allows for low- • Credibly quantifying a narrative
translated to quantitative data (macro forecasts, outcomes respective to each climate • Analysis is made more objective cost sensitivity analysis to typical requires a higher level of
asset class returns, regional physical damages) scenario. through quantitative scenario output subject matter expertise • Numerical output makes the
through an informed expert-driven approach.
output definition of the scenario less
• Analysis using quantitative scenario prone to interpretation.
output requires traditional quant
skills.

Model-driven: Suitable quantitative data produced

for each scenario may be fed into
• Mathematical relationship
between scenario definition and
• Constructing new scenarios is
costly and requires special
• Does not opine on
uncertainty directly
• Creating new scenarios is costly and
requires highly specific technical
• Understanding drivers of scenario
analysis output can be hindered
traditional risk and investment output increases objectivity and technical expertise, restricting expertise, but typical users will take by “black box” nature of
A scenario definition regarding the future models/analyses, forecasting transparency the ability to easily adjust or scenarios as given from scenarios
• Lack of flexibility restricts
economic environment (policy, technology, outcomes respective to each climate augment scenario sets. standardized sources such as NGFS
ability to perform
socioeconomics) are fed into a linked economic- scenario. and IEA.
• Output is still a function of meaningful sensitivity • Since scenarios typically come
environment model such as an integrated
necessarily subjective analysis on underlying from standard sources,
assessment model (IAM) to estimate required
assumptions underlying modelling assumptions understanding of their
scenario output.
modelling assumptions may be built up over
time

Probabilistic: Suitable quantitative distributional

data produced may be fed into
• Mathematical relationships
increase objectivity and
• Constructing new scenarios is
costly and requires special
• Directly models uncertainty
in outcomes as a function
• Probabilistic models are
computationally expensive and
• A distribution of outcomes may
be more interpretable for some
traditional risk/ investment models transparency technical expertise of scenario definition require a high level of technical audiences than point estimates
One or multiple climate-driven forecasts are and analyses, offering estimates of expertise across individual scenarios
combined with estimates of probability, variance, both expected and tail outcomes. • Assumptions on top of model- • Lack of research on how • Still may be difficult to test
and covariance to form conditional or full
driven approach needed to deal climate affects distributions sensitivity to modelling • Probabilistic output may be
distributions of potential climate futures.
with uncertainty may limit assumptions to “no assumptions harder to interpret for other
change from history” audiences

Source: MSCI Sustainability Institute

MSCI
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How can I use climate scenarios?
A practical guide
What the market thinks:
A climate risk survey

Fully narrative scenarios Climate scenarios have helped financial markets supervisors and
practitioners better understand a range of climate-related risks.

Fully narrative scenarios are written qualitative Figure 3: Examples of fully narrative scenarios But such scenarios have not been able to tell investment professionals in
narratives that can range from relatively simple and particular what they say they most want to know to shape their strategies:
open-ended descriptions of a prospective future to what their peers across the industry and around the world expect when it
detailed depictions of highly specific potential Scenario: Boom and Bust (BB)
Policy steps up after fossil fuel surge bursts comes to changes in policy, advances in technology, and patterns of
outcomes. climate-driven extremes of weather.
A Ukraine peace deal and easing of global geopolitical tension triggers an initial
These scenarios support analysis designed to quantify surge in economic growth which leads to overheating in major economies and The MSCI Sustainability Institute and our firm’s Climate Risk Center are
higher fossil fuel prices. Policy is tightened in response, which leads to a bust,
possible outcomes for an enterprise, portfolio or asset forcing governments to step in to provide support. A just green transition is driven constructing a climate scenario that reflects how investors and other
based on plausible hypothetical pathways. Note that a by pro-active policies to ease private sector frictions and support the emerging capital-markets participants expect that the risks of a changing climate and
fully narrative scenario can contain quantitative world. the transition to a net-zero economy could impact their investments.
elements; fully narrative here refers to the specification
of the scenario itself. It finds agreement among global investors that the risks of severe weather
Scenario: Meltdown (M) events will escalate and that global action to date is insufficient to stave off
The strengths of fully narrative scenarios begin with Policy failures compound weak growth the costliest warming.
their relatively low cost and ability to be customized.
Climate policy is the casualty of mounting geopolitical tension and protracted
They can be created and analyzed by practitioners The scenario is informed by a survey that asked more than 350 senior
recession. A Republican victory in the US elections is followed by Ukraine being
without specific technical skills or the need for partitioned. Tension with China undermines global decarbonisation efforts and investors and risk managers across banks, insurers and investment
technological progress. Extreme weather events are badly handled, triggering institutions for their views on the trajectory of climate policy, the pace of
computationally expensive workflows. Fully narrative
famines, mass migration and political instability.
scenarios are also easy to communicate and the energy transition and the impacts of climate-related hazards.
understand; they forgo black-box features or
We supplemented the survey with panel discussions and interviews of
complicated specifications that can characterize
Scenario: Roaring 20s (R20) more than 30 experts from across finance, policy and academia to test and
quantitative modeling. Fully narrative scenarios also can
Policy and markets align validate how the survey responses inform a climate scenario that reflects
be created without the need to either specify a model or
market expectations.
calculate outputs and can explore phenomena (such as Proactive climate policies and dynamic markets create powerful positive feedback
climate-related tipping points) that are difficult to loops. More extreme weather events focus minds and create a sense of global
solidarity around a recognition of humanity's mounting debt to nature. Constructive We’ve mapped the market’s expectations to climate scenarios in use
quantify at much less cost.
competition between nations accelerates technological progress and deployment. already, such as those developed by the Network for Greening the
Financial System (NGFS), a network of central banks and supervisors, and
Limitations are that fully narrative scenarios can be
find that the market expects a climate future that resembles pessimistic
perceived as subjective and vulnerable to bias, blind
scenarios in a “Hot house world” or “Too little, too late” scenario rather than
spots and groupthink. Scenario: Green Phoenix (GP)
Market-driven, while policy lags
a world with an early and orderly transition.

Climate action is initially upended by stagflation, the geo-political fallout of a

stalemate in Ukraine and badly-handled weather shocks. Popular anger builds and
civil society gradually emboldens more enlightened businesses and local
governments to step up and roll out mature green technologies, but progress is Read our Climate Risk Outlook Study
patchy and erratic.

MSCI Source: “No Time to Lose: New Scenario Narratives for Action on Climate Change,”
Sustainability University of Exeter and Universities Superannuation Scheme, 2023

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How can I use climate scenarios?
A practical guide

Quantified narrative scenarios

Quantified narrative scenarios build upon fully Figure 4 illustrates construction of a quantified Figure 4: Stylized examples of quantified narrative scenarios
narrative scenarios by adding quantitative output narrative scenario, driven in this case by the scenario
from experts to each part of the narrative. This means authors’ concern that standard model-driven physical
that for each part of the narrative (such as macro damage functions (the quadratic function in the figure) Damage functions vs temperature anomaly

Damages as percent of GDP

variables, sector growth, energy mixes or regional failed to capture fully the effects of physical climate 100% Logistic 4 degrees
physical damage), a group of experts will attach data change on economic growth. The authors speculate
to the narrative based on their experience and that economic activity might completely shut down at 80% Logistic 5 degrees
knowledge, without explicitly using models to create different levels of temperature increase (anomalies of 60% Logistic 6 degrees
output. 3⁰C, 4⁰C and 5⁰C, respectively) and posited simple Quadratic
40%
damage functions compatible with this assumption (the
Disasters/GDP
Unlike fully narrative scenarios, quantified narrative logistic functions in the figure). As shown in the tables 20%
scenarios can be used in downstream applications that beneath the chart, an assumed damage function can
0%
require numeric inputs such as risk or macro-financial be employed on top of modeled or assumed warming
0 1 2 3 4 5
models. Such scenarios are also relatively easy to paths to create a future path of GDP loss due to
Global Warming Temperature Anomaly w.r.t. 1900
communicate and understand because they retain the physical risk.
narrative nature of qualitative scenarios despite their
quantitative component. Because of how they are constructed, quantified
narrative scenarios share many of the same limitations 2025 2030 2035 2040 2045 2050
Compared with model-driven quantitative scenarios as fully narrative scenarios, including the risk of bias,
Scenario 1: Current Policies
(described below), quantified narrative scenarios have groupthink or blind spots due to the subjectivity
Temperature anomaly w.r.t. 1900 +1.39 +1.52 +1.62 +1.74 +1.86 +2.00
the advantage of relatively easy customization and associated with their output.
Physical damage as percent of GDP
sensitivity testing. Quantified narrative scenarios are (logistic 5-degree function)
1.7% 2.4% 3.1% 4.1% 5.5% 7.6%
also flexible, which means they can be adapted to In addition, the numerical output of quantified narrative
address potential futures that an institution thinks hold scenarios can create a false sense of precision, hence
the most relevance while still providing outputs needed practitioners who use such scenarios should Scenario 2: Net Zero 2050
Temperature anomaly w.r.t. 1900 +1.40 +1.51 +1.60 +1.68 +1.70 +1.71
for quantitative analysis, all at low cost. Such scenarios communicate clearly the subjectivity inherent in their
also can complement model-driven scenarios by creation. It helps if users of these scenarios think Physical damage as percent of GDP
1.8% 2.4 % 2.9% 3.6% 3.7% 3.8%
(logistic 5-degree function)
adjusting specific outputs to test either the effects of conservatively, including considering how their
forecast results or underlying assumptions. construction may create uncertainty in output, and
benchmarking the results of analysis using such
scenarios against model-driven quantitative scenarios, Source: “The Emperor’s New Climate Scenarios,” Institute and Faculty of Actuaries and the University of Exeter, July 4,
where possible. 2023, based on MSCI Sustainability Institute calculations. Temperature anomaly path adapted from the Network for
Greening the Financial System

MSCI
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How can I use climate scenarios?
A practical guide

Model-driven scenarios
Model-driven scenarios are scenarios in which the Modeling may be driven by adding shocks to traditional Figure 5: Simplified view of an IAM model
output is constructed through an underlying model or macroeconomic models (although this approach has its
suite of models. Given the complexity of potential limitations), through integrated energy-climate models,
climate phenomena, such models are typically and via full-system models or so-called Integrated Narratives of the shared socio-economic pathways
complicated both in specification and computational Assessment Models (IAMs) that integrate all known Macroeconomics

burden. systems (atmospheric, economic, energy and land use, • Growth and energy demand • International trade
• Capital accumulation and investment • Consumption and welfare impact
for example) with feedback loops.

Examples of model-driven climate scenarios

Energy system Land use
Publisher Representative scenarios • Agriculture and forestry
• Primary energy resources
• Energy conversion • Bioenergy supply
International Energy Agency • Net Zero Emissions by 2050 (NZE) • Greenhouse gases emissions
• Energy demand
• Stated Policies Scenario (STEPS) • Carbon sequestration
• Emissions & sequestration
• Announced Pledges Scenario (APS)

Network for Greening the Financial System (NGFS) • Delayed Transition Climate system Water & other environmental
• Net Zero 2050
• Greenhouse gases concentration • Water demands
• Below 2°C
• Radiative forcing • Health impacts
• Low Demand
• Global temperature change • Other environmental impacts
• Fragmented World
• Nationally Determined Contributions
• Current policies
Economic outcomes GHG emissions Sectoral energy pathways Land use
Intergovernmental Panel on Climate Change • Shared Socioeconomic Pathways (SSPs)
• Representative Concentration Pathways (RCPs)

Source: NGFS, 2023

Source: MSCI Sustainability Institute.

Model-driven scenarios include many of the scenarios At the same time, model-driven scenarios also have This scenario envisions a gradual tightening of Model-driven scenarios depend heavily on
used by investment practitioners. Such scenarios downsides. The scenario definition chosen to drive climate policies globally that constrain the rise in assumptions both within their specifications and for
include those from NGFS and the International Energy them is (of necessity) limited by the modeling average global temperatures to 2⁰C above chosen parameters. Varying the assumptions can
Agency (IEA). Such scenarios use quantitative models specification, hence the primitive “story” underlying preindustrial levels. But that stylized scenario change the outputs significantly. Changing the IAM
to generate a full suite of economic and climate such scenarios is often much more generalized than for assumes myriad individual policies and geopolitical used for a scenario defined by the NGFS, for
outputs that are driven by the scenario definition and a narrative-based scenario. Consider, for example, the relationships that may bear upon investors’ example, will change the economic and climate
that address climate policy, technological change and “Below 2⁰C” scenario developed by the Network for assessments in the short and medium term. Hence, outputs significantly for the same set of data.
future socioeconomic trends by design. Greening the Financial System (NGFS).3 practitioners may benefit from supplementing such
scenarios with a quantified or fully narrative scenario Finally, model-driven scenarios come with
that allows them to consider the drivers of a below- complexity. Because models such as IAMs typically
3. “NGFS Long-Term Scenarios for Central Banks and Supervisors,” 2⁰C scenario in greater detail. take time and specific expertise to run, it can be a
Network for Greening the Financial System,” November 2024. challenge to create custom outputs and or to employ
MSCI sensitivity testing, even for assumptions that are
Sustainability relatively easy to adjust.
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How can I use climate scenarios?
A practical guide

Probabilistic scenarios
Probabilistic scenarios (also called stochastic Figure 6: Comparing temperatures with damages
scenarios) incorporate the probability of events such
as the rise in average global temperatures or specific
a b
climate-related physical risks (Figure 6). Investors use
∆T(°C) Global mean temperature anomaly Damages
such scenarios most widely for quantifying physical
10 Risk Premium
risk with scenarios that build on modeling of natural
–13% +16%
catastrophes developed by the insurance and real $32Tr
RCP8.5
estate industries (see discussion of use cases below). 40%

The strengths and weaknesses of probabilistic scenarios 8 421 486 563

magnify those of model-driven scenarios. Probabilistic
scenarios allow for mathematical analysis of both
–23% +36%
expected outcomes and the uncertainty around them $15Tr
that includes both variance and tail analysis. The 19%
6
inclusion of uncertainty facilitates their use in risk-
management workflows, where they can inform thinking
102 131 179
about optimal behavior. RCP6.0

4 –26% +47%
At the same time, probabilistic scenarios are complex $9Tr
and costly to build and use and require additional RCP4.5 11%
assumptions to inform their output. Models to
understand how climate shocks will affect variance and
51 69 101
covariance of climate effects are immature even where 2
they exist; practitioners must often assume that baseline RCP2.6
variance/covariance processes are unaffected and that –30% +52%
$3Tr
climate effects influence only the mean of shocks. This
4%
can produce a false sense of precision and hide model
errors.
0
2050 2100 2150 2200 21 30 45
Year Trillion USD

Source: “Temperature Variability Implies Greater Economic Damages from Climate Change,” Raphael Calel
et al., Nature Communications, Oct. 6, 2020. Graph (a), solid black line, represents deterministic
temperature model. Graph (b), deterministic damages, are the solid lines in the distribution.

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How can I use climate scenarios?
A practical guide

A holistic approach
Although uses of climate scenarios analysis vary, Level 1 – Scope Figure 7: Levels of scenario analysis
they share a common goal, which is to improve
decision-making by projecting and comparing a range Identify and rank risk pathways and hot spots for the
of financial outcomes across plausible hypothetical institution across different potential climate futures. Level 1 Level 2 Level 3 Level 4

futures. While each use case presents unique

Level 2 – Quantify
Scope Quantify Refine Integrate
circumstances that require variation in analysis and Goals of Identify and rank risk Create initial estimates of the Hone the actionability and Fully embed analysis into
output, we believe that high-level best practice Produce first estimates of the potential magnitudes of analysis level pathways and hot spots magnitude of financial impacts credibility of analysis decision-making

across uses of scenario analysis in reporting, stress financial outcomes, with the focus of analysis guided by
testing, investing (as well as lending and scoping.
underwriting), risk management and client Fully narrative Fully narrative Fully narrative Fully narrative
engagement includes more similarities than Level 3 – Refine
differences.
Enhance analysis with a focus on providing
stakeholders with the most useful and credible output Model-driven Model-driven Model-driven
Practitioners new to climate scenario analysis confront for decision making. Communicating underlying Suggested
a threshold question of how to stage the OR
modeling pathways and uncertainty of forecasts is key scenario type
implementation of scenario analysis in their institutions to building acceptance. Quantified Quantified Quantified
while building expertise and gaining credibility and narrative narrative narrative
acceptance across the wider organization. Level 4 – Integrate
Practitioners with more experience using such Probabilistic Probabilistic
Fully embed scenario analysis output into existing
scenarios confront a question of how to further the
systems and decision-making. For most institutions this for specific risk and for specific risk and
current use of climate scenario analysis within the investment use cases investment use cases
is a long-term and aspirational goal.
decision-making process. We characterize best
practice as comprising the following progressive levels: A detailed discussion of best practices for each use
case and level goes beyond the scope of this report. Source: MSCI Sustainability Institute.
Instead, we provide suggestions of high-level
frameworks for complementary scenario analysis
across the four categories (Figure 7). Our suggestions
for optimizing the use of different types of scenarios
are similar across applications. We start with a general
summary of suggested approaches by analysis level
and follow with use-case specific commentary.

MSCI
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How can I use climate scenarios? Level 1 Level 2 Level 3 Level 4
A practical guide Scope Quantify Refine Integrate

Using scenario types by level of analysis

Level 1: Scope Level 2: Quantify
The first level of scenario analysis starts with simply Practitioners should aim to analyze as wide a set of For many institutions and use cases, scoping is merely
identifying the most material risk pathways for its potential futures and pathways as possible, and to a preliminary step, with quantitative output a necessity
operations and investments.4 Depending on the focus on the ease of communicating results across the to drive any change in decision-making. Level 2 seeks
institution, pathways may include lower investment organization, with the aim of building support for future to help stakeholders quantify the magnitude of risks.
returns, credit risk, market risk, actuarial risk, financing implementation. Although the magnitude of each risk
issues, direct damage to physical assets, supply chain need only be roughly estimated, practitioners are likely We suggest that practitioners quantify financial
problems or a fall in demand for its products or to have only limited resources at this level of outcomes using either model-driven or quantified
services. implementation. narrative scenarios. In choosing between the two,
practitioners might consider the relative ease of
A goal at this level is to describe some level of detail of These requirements are particularly suited for fully implementation based on their specific use case.
the risk within each pathway. Suppose, for example, narrative scenarios, which we suggest as the sole Regardless of which quantitative scenario you choose,
that possible adverse outcomes include lower risk- scenario type for this level. Subject experts in each using a fully narrative scenario in parallel with it can
adjusted returns. The investor could heat-map potential risk pathway may be given a written narrative help highlight areas of uncertainty in the quantified
exposure across sectors, regions and asset classes to for multiple scenarios, and then asked to provide output.
visualize hot spots for this risk. written forecasts including the analysis described
above. Results are then collated to provide summary
results to present across the organization.

4. Many organizations are already well past this stage, but it can be
useful for practitioners to revisit this level of analysis periodically to
confirm whether their underlying analysis remains up to date..

MSCI
Sustainability
Institute 14
How can I use climate scenarios? Level 1 Level 2 Level 3 Level 4
A practical guide Scope Quantify Refine Integrate

Using scenario types by level of analysis

Level 3: Refine Figure 8: Example of a complementary framework for analysis levels 3 and 4

We define Level 3 scenario analysis as gaining Step 3: Comprehensive analysis. At the completion of
acceptance organization-wide as stakeholders see the the first two steps, a practitioner now has output from Step 1: Employ model- Step 2: Augment baseline scenario analysis through
implemented analysis as both credible and actionable. multiple scenarios of different types, several of which driven scenarios for different scenario types, both with similar scenario
baseline scenario analysis definitions and additional futures
Practitioners who aim to meet this bar may benefit are comparative forecasts of the same potential future.
from using multiple, complementary scenarios. To contextualize these forecasts, the practitioner must
first know what is driving the differences in output for
Model-driven Quantified narrative Fully narrative
To achieve this, we suggest employing fully narrative, the linked scenarios, a process we label reconciliation scenarios scenarios scenarios
quantified narrative and model-driven scenarios, along analysis. Reconciliation analysis entails a clear
with probabilistic scenarios for some use cases. Figure statement of the different assumptions, approaches Net Zero 2050 with higher
Compare Compare Implementation of an
9 illustrates one such approach that reflects the and expectations that drive differences in forecasts NGFS Net Zero frictional transition costs aggressive global policy of
between linked scenarios. 2050 leading to prolonged carbon taxes, subsidies,
following levels of analysis. recession and regulation

Step 1: Baseline scenarios. In this example, model- Although reconciliation analysis can become quite
driven scenarios serve as the core of the exercise, technical (and hence may not be conducive to sharing Current Policies with high An unraveling of the
Compare
which typically will be the case for traditionally widely with internal stakeholders), it can inform NGFS Current physical damages from property insurance market
practitioners as they perform the final exercise of Policies indirect stresses and due to increasing physical
quantitative use cases in stress testing, investing and tipping points damages
risk management. Here, the practitioner analyzes three comprehensively analyzing the range of scenario
NGFS scenarios that range from a net-zero and high outcomes. That step, which concludes scenario
transition risk to high physical risk. In practice, analysis, entails discussing the implications of the
Compare
alternative regulatory scenarios and internally modeled analysis, including the range of potential outcomes, the NGFS Delayed Short Horizon Extreme Short Horizon Extreme
most severe outcomes and the plausible likelihood of Transition Physical Event Physical Event
scenarios might be employed.
each of them.

Step 2: Augmentative scenarios. The inclusion of

quantified narrative and fully narrative scenarios fills Level 4: Integrate
gaps driven by the limitations of model-driven
scenarios. When linked directly to model-driven The highest level of climate scenario analysis builds on Step 3: Analyze full
scenarios or to each other (comparison scenarios), Level 3 with enhancements to output and modeling. It range of outputs, with Reconciliation analysis
such scenarios can serve as an alternative includes honing climate scenarios in collaboration with an intermediate step of
stakeholders across the organization with the goal of reconciling differences
specification to the modeled approach. The links will,
integrating the scenarios fully into investment between comparative
ideally, allow the practitioner to examine effects that scenario sets
the modeled approach may omit or that are workflows. Comprehensive analysis of range of potential outcomes
characterized by high levels of uncertainty.

Source: MSCI Sustainability Institute.

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How can I use climate scenarios?
A practical guide

Considerations by use case

Uses of climate stress testing

Use Objective Key challenge Commonly used by

Internal stress testing To understand how climate change and the To include drivers of climate-related risk and Financial institutions, including banks and
energy transition may affect the value of consider differences in impacts across sectors insurers
portfolios, profitability and operations and regions
enterprise-wide

Regulatory stress testing To satisfy a regulatory or supervisory mandate Whether to augment with internal stress testing Financial institutions, including banks and
insurers

Climate and sustainability reporting To communicate exposure to climate-related Whether to use quantitative scenarios as a Companies and investors
risk complement to a fully narrative approach

Investment activities To inform investment decisions Driving actionable insight from the volume of Asset owners and managers
information

Risk management To assess climate-related risk both enterprise- Lack of probabilities due to uncertainty in Financial institutions, including asset managers,
wide and for specific investments climate scenarios banks and insurers

Stewardship and engagement To assess the climate-related risks of To analyze corporate scenarios using the same Asset owners and managers
companies’ business models data that investors use

Source: MSCI Sustainability Institute.

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How can I use climate scenarios?
A practical guide

Considerations by use case

Internal stress testing exercises Regulatory stress-testing exercises
For many institutions, an internal climate stress test This history has produced internal climate stress tests The workflow for a regulatory stress test resembles According to the ISSB, the entity’s circumstances
represents the first use of climate scenario analysis that depend heavily on model-driven scenarios. Such that of an internal stress test, with the difference consist of both its exposure to climate-related risks
within the organization. models, however, risk the omission of drivers of that a financial supervisor or regulator has and opportunities and the skills, capabilities and
climate-related risk and important sector and sub- prescribed the exercise and its parameters. resources available to the entity for the climate-
Such exercises are typically driven by requests from regional differences in analyzing the effects of a related scenario analysis.
management, investors and other key stakeholders warming world. The result is frameworks that Regulators have so far held off in pushing institutions
who aim to understand how climate change and the exacerbate the limits of modeled quantitative climate to implement multiple types of climate scenarios and The standard may, in practice, result in practitioners
low-carbon transition may affect the value of scenarios discussed in the previous section. associated analysis. In the meantime, practitioners relying on fully narrative scenarios to assess their
portfolios, profitability and operations. Given the can implement complementary internal stress tests institutional exposure to climate risk. At the same
comprehensiveness of the exercise needed to The example Level 3 framework in Figure 8 represents as described above to augment regulatory stress- time, practitioners should be mindful of the limitations
understand such effects, internal stress testing can an ideal for internal stress-testing exercises. testing requirements. of fully narrative scenario analysis and use
serve as a starting point for implementing climate Capabilities may be ramped up through Levels 1 and 2, quantitative scenario output where feasible. The use
scenario analysis for the applications discussed below. but institutions generally would need complementary Climate and sustainability reporting of quantitative scenarios as a complement to a fully
scenario analysis to understand risk at the enterprise narrative approach can help practitioners
Banks, insurers and other financial institutions are level. Investors and other capital markets participants communicate the results of the analysis to
familiar with the concept of internal stress testing, confront an increasingly demanding series of stakeholders, both inside and outside their
which supervisors in the U.S. and elsewhere mandated voluntary and mandatory climate and sustainability organization, because of the objectivity and
following the 2008 financial crisis. Many of these reporting obligations. comparability of numerical output.
institutions have aimed to fit climate scenario analysis
into the same macroeconomic stress-testing The climate disclosure standard developed by the Even an institution with limited technical capability
frameworks. International Sustainability Standards Board (ISSB), might consider obtaining complementary scenario
for example, represents a global baseline for both analysis from outside sources. For more highly
mandatory and voluntary disclosure.5 The standard exposed institutions, the framework in Figure 8 can
directs companies and investors to use climate- serve as a model for scenario analysis that backs
related scenario analysis based on an approach climate disclosure.
commensurate with the entity’s circumstances.

5. “IFRS Sustainability Disclosure Standard, Climate-related

Disclosures,” IFRS S2, International Sustainability Standards Board,
June 2023.

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How can I use climate scenarios?
A practical guide

Considerations by use case

Investment activities Risk management Stewardship and engagement
Investment teams in institutional front offices have a Complementary frameworks also allow a better Risk management activities cover a broad range The results of climate scenario analysis can be a
long history of using scenario analysis for strategic understanding of the range of possible outcomes, of use cases, from assessments of enterprise- useful resource in corporate engagement.
asset allocation, portfolio construction and security which can help centralized functions to more level risk to market- and credit-risk analysis of Investors can use such information to educate
selection. Fundamental analysts in particular use confidently create and pass output to analysts that individual securities. As the scope of analysis corporate managers on the risks of business
scenario analysis to set a base case, upside case and presents relevant upside, downside and base cases for narrows to the entity level, practitioners’ models and influence plans by management to
downside case for a specific investment, as well as to individual assets and portfolios. Investment teams can
considerations will tend to resemble scenario mitigate them.
deepen insight into a range of possible investment be given pilot examples in which quantitative outputs
analysis in investment activities.
outcomes. are shown side-by-side against standard fundamental
Investors may choose to present such information
analysis performed by analysts. This comparison more
One key risk management use case with a high with an emphasis on clarity. Optimally, such data
At the same time, investment teams have tended to clearly shows the levers that a quantitative climate
model does and does not capture, showing how level of climate exposure is calculating solvency will match the financial analysis performed by
resist the use of climate scenario analysis, contending
investors can use such models within the investment capital for property insurance. Such analysis analysts with the investor's institution. Hence the
that standard climate scenarios focus on too long a
process. evolved long ago into fully stochastic modeling discussion in the investment use case applies
horizon to inform investment decisions, do not capture
short-term climate effects that drive returns over the
techniques designed to help risk managers here as well. Quantitative scenario analysis may
investable horizons and lack granularity sufficient to Often, quantitative investors seek to have a more understand the tail losses associated with low- not form the most granular portion of output
capture the particulars of their investments. mathematical forecast of the distribution around an probability physical events, buoyed by the large shown to corporate managers, but it provides an
expected return. As noted, the current state of climate amount of data on historical events and losses. important objective benchmark.
This dichotomy suggests a need to recalibrate the use modeling means practitioners likely will have to use
of climate scenario analysis within investment firms, assumptions about baseline variance and covariance Climate hazard forecasting models (called
with a focus on boosting the relevance of scenarios, to build distributions around a scenario’s deterministic General Circulation Models) can create
presenting them in the language of portfolio managers climate shocks. probabilistic scenarios that are well-positioned to
and making the limitations of outputs clear. integrate with existing physical event modeling
Practitioners might also consider pulling together the frameworks.6 Risk managers can also adapt
Complementary climate scenario frameworks offer output of individual scenarios to form a single these models where possible to understand
improvement on each of these fronts. Compared with distribution representing all potential outcomes. The physical risk to real estate, corporate and
typical model-driven scenarios, fully narrative and efficacy of doing so, however, remains the subject of
government-backed assets.
quantified narrative scenarios can be more quickly and debate within the field of climate scenario analysis. As
flexibly adjusted to help understand the impact of such, practitioners who do so should familiarize
continually evolving short-term risks. They should be themselves fully with the limitations of such output.
used in this capacity to augment more-rigid model- 6. General Circulation Models are numerical models for simulating
driven scenarios. the response by the climate to growing concentrations of
greenhouse gas. See “What Is a GCM?” Data Distribution Center,
Intergovernmental Panel on Climate Change.

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How can I use climate scenarios?
A practical guide

Conclusion
Scenario analysis can sharpen the
robustness and relevance of climate risk
assessments. By instituting frameworks
that leverage fully narrative, quantified
narrative, model-driven and, in some
cases, probabilistic scenarios, institutions
can address the limitations of each
approach and deepen their understanding
of potential climate impacts. The holistic
approach suggested here can improve
decision-making and add resilience to
financial planning.

Investment practitioners may find value in a range

of approaches, including starting with simpler
methods and progressively incorporating more-
complex scenarios. Regardless of how they
approach the task, scenario analysis, if integrated
into investment workflows, can enhance
practitioners’ ability to manage climate risks and
capitalize on opportunities.

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How can I use climate scenarios?
A practical guide

About
MSCI Sustainability Institute

The MSCI Sustainability Institute is on a mission support scholarship and advance knowledge that
to drive progress by capital markets to create helps practitioners, academics and policymakers
sustainable value and tackle global challenges fine-tune their approaches for maximum
such as climate change. Our mission mirrors our effectiveness.
belief that capital markets can help to build a
better future for all of us. For more information and to engage with us, visit
msci-institute.com.
We aim to foster alignment of data, analysis,
policy, and practice. We do this by drawing upon
MSCI’s experience and expertise in the
investment industry to curate data and analysis,

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How can I use climate scenarios?
A practical guide

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Sustainability
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