SCR 2024 - Book

®
@GARP
SCR I Sustainability and Climate Risk
2024
®
CERTIFICATE
Sustainability and
Climate Risk Exam
@Pearson
Copyright© 2024, 2023, 2022 by the Global Association of Risk Professionals.
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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: Integrating climate factors into a business strategy requires
the company to ensure that all its major functional areas
In a very short time, sustainability and climate risk have trained personnel to test climate strategies' resiliency
management issues have started to up-end economies and and effectiveness.
drive financial institutions, companies, and governments to
Climate risk is complex for institutions, investors, analysts,
develop strategies to prepare for climate change.
and the global regulatory community. Data is still a chal
Assessing climate risks and developing scenario analyses lenge. Related analytics can be misleading, or so uncertain
of the physical adjustments, transitions costs, and financial as to affect transactional due diligence, risk exposure calcu
implications that will accompany climate change requires lations, or even reporting requirements.
a broad-based understanding of science and an analysis of
GARP's Sustainability and Climate Risk (SCR®) certificate
related risks. This is especially true as global economies and
program considers these issues and more. The program's
institutions move from carbon-based economies to those
curriculum is dynamic, fact-based, and unbiased. Its
driven by sustainable energy sources.
coverage is directly informed by senior climate risk-related
Real economy and energy firms have focused intensely on practitioners from around the globe who participate
the physical and transition consequences of climate change as members of the SCR Advisory Committee, in addi-
to assets, supply chain, and operations, among other areas. tion to GARP's own senior SCR certification program
Financial institutions are focusing heavily on the costs of professionals.
transition, evolving policy, regulations, financing, credit, and
This year, to remain current, the SCR's content expanded to
global macroeconomic outlooks.
build on its basic climate risk-related theories and concepts.
Building strategies to prepare for climate change neces Its curriculum has been enhanced to include geoengineer
sitates recognizing and understanding the broad number of ing techniques, natural climate risk-mitigation strategies,
threats and opportunities it presents. Understanding how recent examples of greenwashing, clarifications around
related risks interconnect presents numerous and unique evolving sustainability standards, net-zero transition plan
challenges. ning, and updated case studies.
vi ■ Preface
Simply being a bit ahead of peer organizations in We wish you the very best in your pursuit of the SCR
addressing climate risk issues is no longer an acceptable certificate and in achieving your individual or company
goal for firms. Integrating climate issues and concepts into related sustainability and climate risk-related achievements.
a firm's risk appetite and overall risk profile must now be a
priority.
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 SCR eBook. The official eBook for the SCR Exam includes
ness of sustainability and climate risk and join a growing required readings across the eight chapters of the curricu
community of Sustainability & Climate Risk (SCR) certificate lum. Each chapter begins with a set of learning objectives
holders. to guide candidates through key concepts of the chapter.
Review questions at the end of each chapter provide can
The SCR Exam is practice oriented. Exam questions reflect
didates with regular knowledge checks. A Glossary of key
the theory presented in program materials and true-to-life
terms and an abbreviations list appear at the end of the
work experience. Exam candidates must not only under
book. NOTE: The abbreviations list is available for reference
stand sustainability and climate-risk concepts, but should
during the SCR Exam.
also be able to apply these concepts in real-life settings.
The program curriculum covers skills and knowledge areas Required Online Readings. In addition to information
necessary to understand today's rapidly evolving climate contained in the 2024 SCR book, the SCR Exam covers a
risk landscape. The SCR Exam is comprehensive, testing selection of online material from leading academics and
candidates on a number of sought-after sustainability and practitioners. These online readings are a required part of
climate-risk standards and practices. the SCR curriculum and may be reflected in the SCR Exam
questions.
In an effort to offer optimized learning tools for SCR Exam
candidates, GARP created study materials to increase the SCR Practice Exam. This SO-question multiple-choice exam
likelihood of a successful Exam outcome. Access to the fol includes sample questions similar to questions covered on
lowing Study Materials is complimentary for all candidates the SCR Exam. These questions broadly reflect material
registered to take the SCR Exam in 2024: assigned for 2024 and represent a multiple-choice question
style the SCR Advisory Committee considers appropriate.
SCR Study Guide and Learning Objectives. This guide
Explanations are included for correct and incorrect answer
includes a complete list of chapter topics, required online
choices.
readings, and key learning objectives.
viii Preparing for the 2023 SCR Exam

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
Director
UK Centre for Greening Finance and Investment Director
Krister Koskelo
Researcher, DPhil candidate Krister Koskelo
Oxford Sustainable Finance Programme Researcher, DPhil candidate
University of Oxford Oxford Sustainable Finance Programme

Chapter 3: Climate Change Risk Ira Poensgen

Research Assistant
Ben Caldecott, PhD
Oxford Sustainable Finance Programme
Director, Oxford Sustainable Finance Programme and
Lombard Odier Associate Professor of Sustainable Finance
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
Director
Director 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
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 • Know the primary greenhouse gases and aerosols, their
weather and climate. sources, and relative contribution (e.g. global warming
potential, atmospheric lifetime) to climate change.
• Know the general trends of modern climate change,
such as observed surface temperature, sea ice • Explain non-human and human mechanisms that
coverage, etc. 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 1.12 Geoengineering
considerations of climate change adaptation,
1.13 Mitigation Targets
including maladaptation.
• Understand how energy sources can contribute to or

mitigate climate change. Identify and discuss mitiga INTRODUCTION TO THE PROBLEM
tion opportunities, strategies, technologies, and
associated challenges. Weather refers to the exact state of the atmosphere at a
particular location and time. So, if you tell someone that the
• Understand the opportunities and drawbacks of
° °
current temperature outside is 55 F/13 C, you're talking about
implementing geoengineering techniques to combat
the weather. Climate refers to the long-term patterns or statis
climate change.
tics of the weather. If you hear that the average daily high tem
° °
• Explain carbon budgets and emissions trajectories perature for your city in August is 84 F/29 C, that's climate.
to stay within mitigation targets. Know key numeric
A simple analogy to explain the difference between
global emissions limits, commitments, and scenario
weather and climate involves tossing a six-sided die. The
paths.
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
Climate change is one of the most important issues of
tures appear on three sides of the die and cold tempera
our generation and future generations. Choosing how
tures appear on the other three, then you can infer that hot
to respond requires both a knowledge of the science
and cold temperatures are equally likely.
as well as an understanding of our policy options. This
chapter will give a brief summary of these two aspects When we talk about climate, temperature is the most
of the climate problem. 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
Chapter Outline weather, the climate is typically estimated from the statistics
1.1 Modern Climate Change of the weather over a period of several decades, typically
30 years or more.
1.2 Climate Change before Humans
Climate change describes the long-term differences in the
1.3 Energy Balance
statistics of weather measured over multi-decadal periods.
1.4 The Greenhouse Effect For example, if the average temperature of a city during
1.5 How Humans Are Changing the Climate the period 1990-2020 is warmer than the average tempera
ture during the period 1900-1930, then we can say that the
1.6 Attribution of Modern Warming
climate changed between these periods. If we go back to
1.7 Summary Statement on Attribution of Modern our weather dice analogy, climate change means that the
Warming dice are changing. As the climate warms, for example, we
would find that hot temperatures now appear on 4 of the
1.8 Shared Socioeconomic Pathways
6 sides of the temperature die. Note that cold temperatures
1.9 Impacts of Modern Climate Change can still occur in a warmer climate-but not as often.
1.10 Policy Responses
Climate change is sometimes referred to as global warming.
1.11 Mitigation In its most literal sense, someone might think global
2 ■ Sustainability and Climate Risk Exam

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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1860 1880 1900 1920 1940 1960 1980 2000 2020 1980 1985 1990 1995 2000 2005 2010 2015 2020
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(e) Ocean heat content (f) Sea level
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1960 1970 1980 1990 2000 2010 2020 1995 2000 2005 2010 2015 2020
lif!(ijlJd• 0
(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 several of the groups publicly released the code and data
used to generate their estimates of warming in order to
CHANGE be transparent with the data and the analyses that were
done. This allows anyone to be an independent reviewer
1.1 Modern Climate Change of the data and analyses, and yet there have not been any
While we have a greater number of high-quality weather legitimate issues in the data or analyses found.
observations in the last several decades, we have an adequate Nevertheless, any sample of data (the temperature obser
observational history of the last 150 years covering enough vations at observational sites) from the true population
of the planet that we can measure climate change over that (the true temperature change everywhere over all time)
period. Figure 1.1a shows change in global average tempera may contain biases or other data issues that the scientific
ture since the late-nineteenth century, estimated from thermom community has not yet recognized. For this reason, scientists
eters distributed across the planet. The surface thermometer look for a comprehensive analysis with multiple indepen
°
record shows that the Earth has warmed by 1.2 C over this time dent confirmations of important scientific conclusions. As
(calculated as the difference between the 1850-1900 average described below, there are many data sets that confirm the
and the 2013-2022 average). As of early 2023, the warmest year warming seen in the surface thermometer record.
in the record was 2016 followed by 2020, 2019, 2017, and 2022.
The trend in the global-average temperatures measured
Figure 1.2 shows how the warming in Figure 1.1a is distributed by instruments onboard satellites during the period of
across the planet. The warming is not uniform-land warmed overlap (Figure 1.1b) agrees well with the trend in the
more than the ocean and the northern hemisphere warmed surface temperature record (Figure 1.1 a). We can also look
more than the tropics or the southern hemisphere. This is at indirect evidence of warming, that is, the effects that
important because about 85% of the world's population lives warming would cause our planet to experience. Figures 1.1c
on land in the northern hemisphere, meaning that they have and 1.1 d show that ice on the planet is disappearing
experienced more warming over the past 150 years than the something we would expect in a warming climate.
global average warming seen in Figure 1.1a.
About 93% of the heat trapped by greenhouse gases goes
The data in Figures 1.1 a and 1.2 have been independently into heating the oceans, so we can also look to see if energy,
verified. Several independent scientific groups have gener or heat, is accumulating in the oceans (IPCC, 2013). Figure 1.1e
ated their own surface temperature record (for example, shows the heat content of the top 2 km/1.25 miles of the ocean,
NASA, NOAA, and the UK Hadley Center) from the raw sta and it shows that the oceans are gaining energy. Finally, Figure
tion data, and these all show similar warming. In addition, 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
temperature change melting of grounded ice (melting of floating ice does not raise
,·J.· 4.0
sea level). When it melts and the water runs into the ocean,
3.0 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
2.0 planet, and we expect that to drive an increase in sea level. Sec
1.5 °C ond, water expands when it warms. Figure 1.1e shows that the
oceans are indeed heating, and the resulting thermal expansion
1.0 should also raise sea level. These two processes have contrib
uted about equally to sea level rise over the past century.
0.5
Putting all of this evidence together, recent reports from the
0.0
Intergovernmental Panel on Climate Change (IPCC) have
@jijUjf.j The distribution of modern warming described the confidence in the warming of the climate
(in °C). Warming is calculated as the difference system since the early twentieth century as unequivocal,
between the 1850-1900 average and the meaning beyond doubt. This arises because the conclusion
2009-2018 period. is supported by many independent data sets and statistical

analyses, and there is no single error or confounding factor • Ocean sediment cores: Analyzing the composition of the
that would generate a false warming trend in all of them. As mud at the bottom of the ocean provides information
a result of this consistency, there is virtually no chance that about the climate covering the past tens of millions of
enough of these data sets could be wrong by far enough, years.
and all in the same direction, that the overall conclusion
Analyzing these data show that the Earth has experienced
that the climate is currently warming is wrong.
large climate fluctuations over its history. Figure 1.3a shows the
temperature over the past 70 million years. About 50 million
1.2 Climate Change before Humans years ago, the Earth was much warmer than it is today-so
much so, in fact, that there was no permanent ice on the
To put today's warming into context, it is useful to consider
planet. Since then, the climate has generally been cooling.
the Earth's entire climate history. The measurements
described in the previous section go back at most 170 Figure 1.3b shows the last 410,000 years, and it shows that
years, so a different strategy is required to look further back the planet has been cycling between cold periods, known
in time without the same types of observational systems as ice ages, and interglacials (warmer periods). These
(i.e., thermometers). What we need are long-lived, geological, cycles take approximately 100,000 years to complete.
chemical, or biological systems that have the climate The last ice age reached its coldest point about 20,000
imprinted on them. Then, we can make measurements today years ago, and it ended about 10,000 years ago, and,
that provide evidence what the climate was like in the past. since then, we have enjoyed a rather pleasant interglacial
For example, scientists can extract climate information from period.
tree rings. Tree growth follows an annual cycle, which is Figure 1.3c shows the last 11,000 years, since the end of the
imprinted in the rings in their trunks. As trees grow rapidly in last ice age, a period known as the Holocene. This estimate
the spring, they produce light-colored wood; as their growth shows that temperatures peaked about 7,000 years ago and
slows in the autumn, they produce dark wood. Because trees then started a slow, long-term decline that bottomed out in
grow more and produce wider rings in relatively warm and a period 200 to 300 years ago, known as the Little Ice Age.
wet years, the width of each ring yields information about After that, the Earth began warming, and in the late 201Os,
temperature and precipitation around that tree in that year. °
it was about 1 C warmer than the Little Ice Age-roughly
Scientists today can measure the size of the rings of a tree and comparable to peak temperatures of the mid-Holocene.
then estimate the local climate around the tree for each year
These estimates of the Earth's past climate allow us to
during which the tree was alive. Trees can live for centuries,
reach several important conclusions about the modern
and by combining the record from modern trees with trees
warming we are presently experiencing. First, the global
that were cut down centuries ago and, for example, used in
average temperature difference between an ice age and an
timber of old buildings, we can extend the tree-ring record to ° °
interglacial is about 6 C, so the 1 C warming the Earth has
give us climate information going back about a millennium.
experienced since the nineteenth century is not an insignifi
There are many different proxies that cover different cant amount of warming. In addition, human society, made
regions and different time frames. For example: up of mega-cities and trillions of dollars of infrastructure
• Tree rings: These measurements can reveal climate on a global scale, has only been around since the indus-
variations in regions where trees grow and experience trial revolution (around 1800) and, since that time, society
seasons for the last millennium. has experienced a small range of global temperatures. As
• Corals: Analysis of the skeletons of these sea creatures can our climate continues to warm, we will soon be departing
yield climate conditions in the ocean over millions of years. from conditions under which human society developed and
• Speleothems (e.g., stalactites and stalagmites): These cave thrived. More troubling, the warming we are experiencing is
structures can yield estimates of the climate in the region very rapid. For example, the warming over the past century
°
around the cave over the past few hundred thousand years. (approximately 1 C in about a century) is around 16 times
• Ice cores: Measuring the chemical composition of ice faster than the average rate of warming coming out of the
°
(mainly in Greenland and Antarctica) yields estimates of last ice age (roughly 6 C in 10,000 years corresponds to an
°
the climate over the past million years or so. average warming of 0.06 C/century).

(a)
I- Temperature
5.0 �--'=============='--- 300
(b)
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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 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
1.3 Energy Balance
elements of the climate system, meaning that net solar
The source of energy for the Earth's climate is sunlight, energy absorbed by Earth is 238 W/m 2. In the 1820s,
which is mainly visible radiation and provides about Joseph Fourier recognized that this meant that the

Earth had to also be radiating an equal amount of Water vapor is the most important greenhouse gas in the
energy back to space. This radiation back to space is in atmosphere-meaning it traps the most heat-and carbon
the form of infrared radiation, but for this analysis con dioxide is the next largest contributor. The amount of water
sider it heat. vapor in the atmosphere is highly variable, ranging from a
few percent in warm tropical marine regions to a fraction
The amount of energy radiated by an object is determined
of a percent in cold polar regions. Carbon dioxide's strong
by the temperature of the object-as the object heats up, it
contribution occurs despite the fact that it made up only
radiates more energy. This means that the amount of heat
0.0417% of our atmosphere in 2022. This is an awkwardly
radiated by the Earth to space is determined by the temper
small number, so the concentration is usually written as 417
ature of the planet. Therefore, for a given amount of energy
parts per million (ppm), meaning that, in every million mol
from the Sun, there is a temperature of the planet that will
ecules of air, about 417 molecules are CO2.
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
1.5 How Humans Are Changing the
be equal to the energy the Earth radiates back to space, and Climate
this determines the temperature of the climate system. 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
1.4 The Greenhouse Effect ing that greenhouse gases in our atmosphere are increasing
It turns out that the temperature of the planet is not the as a result of human activity.
only thing that determines the amount of energy the Earth
radiates to space. The composition of the atmosphere also 1.5. 1 Carbon Dioxide
matters-in particular, the amount of greenhouse gases in We have been directly monitoring the abundance of carbon
the atmosphere. Greenhouse gases are a part of the atmo dioxide in the atmosphere since the middle of the twentieth
sphere that absorbs infrared radiation (or radiant heat). century. The measurements are plotted in Figure 1.4, which is
In the 1820s, Joseph Fourier recognized that these gases often referred to as the Keeling Curve after Charles D. Keeling,
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
400
mean when they talk about a greenhouse effect.
As the mass of greenhouse gases in our atmosphere 380

E
Q.
increases, the atmosphere traps more heat, leading to higher
temperatures. This possibility was first recognized by scien N 360
0
tists more than a century ago, first by the Swedish chemist
Svante Arrhenius in 1896 and again, with more supporting 340
evidence by the British engineer Guy Callendar, in 1938.
320
Merely having an atmosphere does not produce a greenhouse
effect; the atmosphere needs to have the right composition to 1960 1970 1980 1990 2000 2010 2020
absorb infrared radiation. The majority of Earth's atmosphere W:i•ikJii The record of annual average atmospheric
consists of molecular nitrogen (N2}, oxygen (02), and the inert carbon dioxide since the middle of the twentieth
gas argon (Ar). These simple molecules do not interact with century. Data measured at Mauna Loa, Hawaii by
infrared radiation and therefore generate no greenhouse Dr. Pieter Tans, NOAA/GML and Dr. Ralph Keeling,
effect to warm the surface. Rather, the greenhouse effect is Scripps Institution of Oceanography. Data downloaded
caused mainly by minor constituents in the atmosphere: water from the NOAA Earth System Research Laboratory/
vapor (H 2 0), carbon dioxide (CO2), and other components like Global Monitoring Division (www.esrl.noaa.gov/gmd/
methane that we will learn about later. ccgg/trends/data.html, retrieved 2020-11-29).

the scientist who initiated the measurements in 1957. The mea 280 ppm in the atmosphere. By the early 2020s, humans
surements clearly show a long-term upward trend. As we have increased atmospheric carbon dioxide by about 50%.
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.
1.5.2 Other Greenhouse Gases and Aerosols
This increase in carbon dioxide is primarily due to the com
The next most important greenhouse gas is methane (CH4),
bustion of fossil fuels. This conclusion is confirmed from
which has increased from 0.8 ppm before the industrial
multiple sources of data. If we look at carbon dioxide con
revolution to about 1.9 ppm in 2020. This might seem like
centration in our atmosphere over the last few centuries
a small increase, particularly compared to the 130-ppm
(not shown), we see that carbon dioxide began increasing
increase in carbon dioxide, but methane is a far more
at the beginning of the nineteenth century, at the same
powerful greenhouse gas on a permolecule basis-each
time the world economy began generating energy from
kilogram of methane traps as much heat as 28 kilograms
fossil-fuel combustion (IPCC, 2007).
of carbon dioxide. This heat-trapping power relative to
Scientists have observed that, for the past 50 years, the carbon dioxide is known as the global warming potential
increase in carbon dioxide in the atmosphere each year (GWP}, and its value has important policy implications. For
averages 44% of what humans released into the atmo example, methane's GWP of 28 means that it is 28x bet
sphere in that year (Global Carbon Project, 2020). Of the ter for the climate to reduce emissions of one tonne of
56% that is removed, about half is absorbed into the ocean methane than it is to reduce one tonne of carbon dioxide.
and leads to ocean acidification, which we will discuss later
Human activities are also increasing the atmospheric abun
in this chapter. The other half is absorbed by the land bio
dance of other powerful greenhouse gases, such as nitrous
sphere through enhanced plant growth.
oxide (N20) and an entire class of molecules called halo
The fact that the increase in atmospheric carbon dioxide each carbons. These gases are found at very low concentrations
year is (on average) slightly less than half of what humans in our atmosphere-parts per billion-but they have large
emit is one of the key pieces of evidence that the increase in GWPs (Table 1.1), so that even small increases can trap a
atmospheric carbon dioxide is due to human activities. If the significant amount of heat in our climate system.
increase were due to some non-human process, it seems
Finally, there is ozone (03), a molecule with multiple effects
unlikely that it would track human emissions so closely.
on the atmosphere. It is well known for its ability to absorb
The chemical composition of atmospheric carbon dioxide ultraviolet radiation, which is harmful to human health and
also shows that the increase in Figure 1.4 is due to natural ecosystems. However, ozone is also a powerful
fossil-fuel combustion. The analysis is based on isotopes greenhouse gas that contributes to trapping heat in the
of carbon. All carbon atoms have six protons, but carbon atmosphere. While humans do not directly emit ozone into
atoms can have different numbers of neutrons, which are the atmosphere, they do emit the precursors that lead to
called isotopes. The most abundant isotope is carbon-12, the formation of ozone, such as hydrocarbons and nitrogen
containing six neutrons to go with the six protons, but less oxides. Over the past few decades, the increase in these
abundant isotopes include carbon-13, with seven neutrons; precursors has led to an increase in ozone in the lower
and carbon-14, which has eight neutrons. atmosphere, which contributes to the trapping of heat. It is
The potential sources of carbon dioxide (e.g., volcanoes, fos important to distinguish this type of ozone from the ozone
sil fuels, etc.) release carbon dioxide with different amounts of found in the stratosphere. In the 1970s and 1980s, it was
these various isotopes. Chemical analysis of the atmosphere discovered that humans were destroying ozone in the strato
shows that the carbon dioxide being dumped into the atmo sphere, but this is a different phenomenon from the increase
sphere over the past half century has an isotopic composition in lower atmospheric ozone that is warming the climate.
that is consistent with carbon dioxide from fossil fuels.
Another way that humans are changing the climate is through
By looking at air bubbles trapped in glacial ice, we can mea emissions of aerosols or their precursors. Aerosols are par
sure chemical composition of atmospheric carbon dioxide ticles so small that the buoyant forces can be similar to the
back through time. These measurements tell us that, in the force of gravity and therefore remain suspended in the
late 1700s, before the industrial revolution, there was about 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 1.5.3 Summarizing Human Impact on The
tion back to space, so their net effect is to cool the climate. Climate
They also can affect cloud formation and make clouds more
In the past 250 years, the Earth has experienced signifi
reflective, which is an additional cooling mechanism.
cant anthropogenic changes to radiative forcing, which
As a result of human activities over the past two centuries, quantifies the difference between the incoming energy
the abundance of these aerosols has increased, and this (sunlight) absorbed by the Earth and the outgoing energy
has generated a cooling effect that partially offsets the (infrared radiation) emitted by the Earth back to space.
warming effect of the increase in greenhouse gases. As Carbon dioxide and other greenhouse gases have caused
an example of how humans generate aerosols, when fos- a combined positive (heating) change to radiative forcing,
sil fuels containing sulfur impurities are burned, the sulfur whereas aerosols have caused a negative (cooling) change
is released into the atmosphere with the other products of to radiative forcing. The net human contribution, including
combustion. Once in the atmosphere, the sulfur gases react several other small forcings, is positive, which is illustrated
with other atmospheric constituents to form small liquid in Figure 1.5.
droplets known as sulfate aerosols. Other types of aerosols
You might be wondering why water vapor does not appear
produced by humans include black carbon aerosols, such as
in Figure 1.5, particularly because it was stated that it was
soot, which is produced by such things as the incomplete
our climate system's most important greenhouse gas. The
combustion of a smoldering fire or two-stroke gasoline
main source of water vapor in the atmosphere is evaporation
engines. Mineral dust is produced by agricultural activities
from the oceans, and it is primarily removed from the atmo
(e.g., harvesting, plowing, overgrazing), changes in surface
sphere when it falls out as rain or snow. Because the amount
water features (e.g., drying out of lakes such as the Aral Sea
of water vapor in the atmosphere is regulated by evapora
in Central Asia and Owens Lake in the Western US), and
tion and condensation, it is fundamentally set by the Earth's
industrial practices (e.g., cement production).

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

the output of the Sun since the late 1970s, and there is no revolution, nor observations supporting unforced vari
long-term trend that could explain the very rapid warming ability as causing this observed warming. Second, obser
over that period. Prior to that time, it was more difficult vations of the past millennium show nothing similar to
to determine what the Sun was doing because there were the rate and magnitude of warming of the twentieth cen
no satellite measurements. Instead, the Sun's output for tury. Third, computer simulations of the climate do not
this period must be inferred indirectly from other measure support this as a cause. Thus, scientists are very skeptical
ments, such as the number of sunspots, which people have that unforced variability is playing anything other than a
counted for many hundreds of years, or from chemical minor role in modern warming.
proxies such as the carbon-14 content of plant materiaI. • Greenhouse gases: The evidence supporting the cause
Such estimates suggest that the Sun has changed little of the warming being the increase in greenhouse gases
over the past few hundred years. Thus, we can eliminate over the last two centuries is immense. First, the laws of
this as a cause of modern global warming. physics tell us that adding carbon dioxide, or any other
• Orbital variations: The amount of solar energy reaching gas that absorbs infrared radiation, to the atmosphere
the Earth is determined not only by the energy emit- should warm the planet by affecting the planet's energy
ted by the Sun but also by the Earth-Sun distance. If, balance. Second, it is a fact that humans are adding
for example, the Earth moved closer to the Sun, then carbon dioxide to the atmosphere. Just based on that,
the solar energy hitting the Earth would increase even you could have predicted the warming of the climate
if the thermal properties of the Sun did not change. In that we are observing. The timing of warming, begin
fact, the Earth's orbit does change in three ways: First, ning in the nineteenth century, after the industrial revo
the shape of the orbit changes, with the orbit cycling lution, and the magnitude of the warming, also match
between more elliptical and less elliptical over a period scientific theory. Finally, the geologic record shows
of 100,000 years. Second, the tilt of the Earth, today that changes in climate are frequently associated with
° °
about 23.5 ° , cycles from 22.3 to 24.5 over a period of changes in greenhouse gases. For example, carbon
about 41,000 years. Third, the date of closest approach dioxide changes during ice-age cycles (Figure 1.3b) are
of the Earth to the Sun, presently occurring in Janu- thought to play a key role in amplifying the size of the
ary, cycles through the calendar over a period of about climate variations, although the exact mechanism that
23,000 years. These variations are responsible for the ice alter the concentration of atmospheric carbon dioxide
ages (Figure 1.3b) but could not be the cause of modern during ice-age cycles is an active area of research.
warming because the orbit does not change much over
a century.
• Unforced variability: The previous suspects are all 1. 7 Summary Statement on Attribution
examples of climate change forced by planetary energy of Modern Warming
imbalances. However, the Earth's climate system is so
Given the evidence supporting the hypothesis that green
complex that it can also vary without an imposed energy
house gases are responsible for the modern warming and
imbalance driving it. Such changes, which are caused
the lack of support for any competing theory, there is wide
by complex internal physics of the climate system, are
spread agreement in the scientific community on the reality
often referred to as unforced variability. The best-known
of anthropogenic (human) influence on the climate system.
example of unforced variability in our climate is the El
The Sixth Assessment Report (AR6) of the Intergovern
Nino/Southern Oscillation (referred to by scientists by its
mental Panel on Climate Change, published in 2021, came
initials, ENSO). El Nino events, which make up the warm
to the following conclusion:
phase of ENSO, occur every few years and last a year
or so, and alternate with cooler La Nina events. Could It is unequivocal that human influence has warmed
the modern warming be due to unforced variability? It is the atmosphere, ocean, and land. Widespread
very unlikely for three reasons: First, there is no theory and rapid changes in the atmosphere, ocean,
that explains the observed warming since the industrial cryosphere, and biosphere have occurred.

Thus, it is beyond doubt that humans are warming the cli atmospheric concentrations of carbon dioxide can be
mate system. However, that statement does not tell you calculated (Figure 1.6c) and, from this, the amount of
how large this human influence is. Thus, the report follows climate change under each scenario can be estimated by
up by saying: inputting atmospheric carbon dioxide into a computer
simulation, known as a global climate model, sometimes
The likely range of total human-caused global surface tem
referred to by its initials as a GCM (Figure 1.6d).
perature increase from 1850-1900 to 2010-2019 is 0.8°C to
1.3°C, with a best estimate of 1.07°C. The different scenarios describe very different worlds:
Since the observed warming over this period is about • SSP1 is a sustainable world where the world's econo
1.1°C, this means that the best estimate is that humans mies gradually shift towards a more environmentally
are responsible for 100% of the observed warming of the friendly path. Because of strenuous efforts to adopt
climate system. Note the use of the word likely here. The renewable energy, emissions are currently peaking
IPCC uses a set of carefully defined terms to express confi and expected to decline throughout the rest of the
dence. In the parlance of the IPCC, likely denotes a confi century. In fact, SSP1's emissions go negative around
dence of 66%. 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
FUTURE WARMING temperature increases of 2° C/3.6°F above the pre
industrial climate.
1.8 Shared Socioeconomic Pathways • SSP2 is a world that follows the trends of our world today,
leading to generally declining emissions over the twenty
In order to predict future climate change, we must first first century due to widespread adoption of renewable
project how much greenhouse gas society will emit in energy (although slower than in SSP1). Economic growth
the future. Because of the difficulty of making a single, is similar to SSP1. The carbon dioxide emissions associ
confident projection of the future, a group known as the ated with this scenario lead to temperature increases of
Integrated Assessment Modeling Consortium has devel 3°C/5.4°F above the pre-industrial climate.
oped a set of alternative pathways that they believe span
• SSP3 is a world where economic inequality gets
the range of different futures the world may experience
worse, leading to increasing conflict between regions.
over the next century or two. These are based on five
Because of this, economic growth is slow and adop
different narratives of the future, which are referred to as
tion of new energy technology is also slow, leaving
Shared Socioeconomic Pathways, usually abbreviated SSPs.
the world almost entirely dependent on fossil fuels.
The SSPs are labeled SSP1, SSP2, SSP3, SSP4, and SSP5, The combination of these leads to carbon dioxide
and each represents a different way the world may evolve emissions increasing throughout the century, reaching
in the future. It is worth noting that the numbers 1-5 in the around double today's values in 2100. Temperature
name of each scenario indicate a continuum of potential increases in this world are 4.5° C/8°F above the pre
climate outcomes, with SSP1 representing the most industrial climate.
optimistic and SSP5 the most pessimistic. Further-more, • SSP5 is a world similar in many ways to SSP1, but it is
SSP4 is rarely used in the climate literature, and we will not
one that emphasizes economic growth rather than sus
consider it further in this chapter.
tainability. As a result, economic growth in this world
One can think of these different scenarios as mainly is very high and fossil fuels power a significant fraction
differing in the amount of economic growth and the of this growth. This leads to carbon dioxide emissions
amount of climate-safe energy that is being deployed increasing throughout the century, reaching more than
(Figure 1.6a), which leads to different amounts of carbon triple today's values in the late-twenty-first century.
dioxide emitted into the atmosphere each year (Figure Temperature increases in this world are 5.5° C/10°F
1.66). Given these emissions scenarios, the resulting above the pre-industrial climate.

GDP vs. renewable energy
(a) (b) Emissions
0
100 ------------------
SSP1
-*----------------------------- 120
SSP5
�
0
*
N
100
.!: 80 -----------------ssp2-----------------------------
rn a,
:-' 80
*
0
� 60 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 5s_p_5 - a,
0..
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0
·.;;
0 40 - � 40
...,C
� 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
a,
L
0..
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0
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600 a,
0..
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

decisions we make in the next decade or two could radically climate, we will have to build coast defenses or relocate
alter our climate trajectory and which SSP scenario turns out cities in response to higher seas, and we will have to
most accurate. Because many people alive today might live enhance our infrastructure to handle more intense storms.
well into the second half of the century, the resulting climate
Not every single change in every region will be negative.
impacts would affect us, not just future generations.
Warmer cold-season temperatures might have benefits:
While the SSPs are the most commonly used scenarios today, less cold-weather mortality, benefits to agriculture of fewer
you may still see references to an earlier set of scenarios, freezing events that can destroy some crops. Plant growth
known as the Representative Concentration Pathways, abbre may well be enhanced in some regions. But there are also
viated RCPs. As their name suggests, these are a set of con negative effects of warmer winters, such as less wintertime
centration pathways, but without corresponding economic insect mortality, leading to increased agricultural damage
drivers. The more advanced SSPs were designed to span the from pests, or less wintertime precipitation falling as snow,
same range of future climates as the RCPs and for each RCP reducing snowpack and meltwater and stressing freshwater
scenario, there is a roughly similar SSP scenario (this is dis supplies during the spring and summer.
cussed in Chapter 7).
1. 9. 1 Temperature
1. 9 Impacts of Modern Climate Change One of the most certain predictions of climate science
is that the long-term trajectory of the climate is towards
A few degrees of global-average warming over the next
warmer temperatures. However, the warming will not be
century would have significant impacts to life on Earth.
uniform across the globe. In a continuation of the observed
Although local temperatures can vary considerably over time,
patterns seen in Figure 1.2, we expect continents to warm
the global average temperature of the Earth is very stable,
more than oceans and to have more warming in the north
with random variations of just a few tenths of a degree per
ern hemisphere than in the southern hemisphere. Given
year. Moreover, seemingly small changes like those in the dif
that most people live on land of the northern hemisphere,
ferent SPP scenarios in global average temperature are asso
this means that the average temperature increase expe
ciated with massive shifts in the Earth's climate. For example,
rienced by humans will be larger than the global average
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 Higher temperatures will have many negative impacts for
Europe and, because so much water was tied up in glaciers, society. Temperature extremes can be fatal-for example,
sea level was approximately 100 m (330 ft) lower than it is a 2003 heat wave in Europe caused tens of thousands
today. The net effect of these changes was a completely dif of excess deaths. Higher temperatures also reduce the
ferent distribution of ecosystems. productivity of people who work outside. In some regions,
temperatures are getting high enough that people cannot
Thus, warming of a few degrees Celsius over the coming
work outside in the middle of the day in summer. Higher
century (Figure 1.6d), would be comparable to the warming
temperatures, especially when combined with precipitation
since the last ice age and implies enormous changes in our
changes, can reduce agricultural yields. Higher tempera
environment. This would be challenging for human progress
tures also require people to run the air conditioners more,
because humans are adapted to our present climate. We
and this costs money.
have built trillions of dollars of infrastructure in places where
it makes sense in today's climate. We invest in agricultural
1. 9.2 Precipitation
infrastructure in regions that today are good for farming.
We build cities at today's sea level. We construct storm Precipitation is another key aspect of climate. As the sur
water infrastructure to handle storms that occur today. If face temperature increases, there is an increase in the rate
the climate changes, these assumptions will no longer make of evaporation at the surface. Because precipitation must
sense. We will have to rebuild agricul-tural infrastructure in balance evaporation, precipitation must therefore also
new regions where agriculture makes sense in a changed increase. More quantitatively, total global precipitation is

projected to increase by about 3% for every degree Celsius amount of water in the ocean and, therefore, sea level. Mea
of global average warming (Jeevanjee, 2018). surements (e.g., Figure 1.1f) confirm that sea levels are already
rising as temperatures have gone up, and we can be confident
Although total rainfall is expected to increase, the increase
that the seas will continue to rise into the next century.
will not be distributed evenly. Scientists expect regions that
get a lot of rain today to get more as the climate warms, The IPCC's Sixth Assessment Report (AR6) contains predic
while dry regions will become drier, a pattern referred to as tions that sea level will rise 44 to 76 cm (17 to 30 inches)
"wet gets wetter, dry gets drier." above today's levels by 2100 under the most likely emis
sions scenario (SSP2). Even though such a sea level rise may
In addition to changes in the pattern of precipitation, it is
not seem significant, the impacts could be very serious. In
likely that a higher fraction of total rainfall will come during the
Florida, for example, a sea level rise in the middle of the
heaviest downpours, which continues a trend observed over
projected range would flood 9% of Florida's current land
the last few decades. This will tend to increase the occurrence
area at high tide. This includes virtually all of the Florida
of flood events. The increase in the fraction of heavy events
Keys as well as 70% of Miami-Dade County. It also includes
also tends to increase the time between rain events, which,
important infrastructure, such as two nuclear reactors, three
combined with warmer temperatures, will increase the rate at
prisons, and sixty-eight hospitals (Stanton, 2007). And this
which water is lost from soils by evaporation and increase the
is just Florida. Multiply these impacts to account for all the
occurrence of drought. Thus, we get the surprising result that
places on the planet where people live near sea level, and
both wet and dry extremes will grow more likely in the future:
you can get a feel for how big a problem this is going to be.
When it rains, it's more likely to flood, and when it's not rain
ing, it's more likely to create drought conditions. Because ice melts slowly, the amount predicted for this
century is just a fraction of how much sea level rise we are
There will also be shifts in the form of precipitation. Less
committed to. Based on observations of previous changes
wintertime precipitation will fall as snow and more will fall as
in climate, it has been estimated that sea level rises a few
rain. This is more important than it might sound: When snow
meters for every degree of warming (Garbe, 2020). This
falls in winter, the water does not run off until the snow melts
means that a few degrees of warming this century could
in spring. Rain, on the other hand, runs off immediately and
commit us to many meters of sea level rise. It may take mil
therefore changing the form of precipitation will change the
lennia for sea level to fully respond to the warming of the
timing of runoff. This will increase the availability of water
twenty-first century, or it could happen more rapidly in a
in winter and spring and decreasing it in summer. Places
tipping point scenario (see Section 1.9.5).
that rely on a particular timing of runoff, such as how the
U.S. Pacific Northwest relies on summertime runoff during Ocean acidification is another consequence of emissions
their dry summers, will be impacted. Impacts would include of carbon dioxide to the atmosphere. As discussed earlier,
reduced freshwater and hydroelectric power availability as about a quarter of carbon dioxide emitted to the atmosphere
well as reduced recreational opportunities. by human activities ends up in the oceans where, in the liquid
environment of the ocean, carbon dioxide is converted into
Changes in precipitation will have negative impacts for
carbonic acid. The net result is that as humans continue to
society. As with all other aspects of the climate, societies
emit carbon dioxide to the atmosphere, the oceans absorb
adapt in important ways to the amount and timing of rain
more and more, and the oceans will become more acidic.
fall. Changes will require construction of costly new infra
structure to protect against flood events in some regions and This can have important impacts on ocean ecosystems. For
droughts in others. It may also be politically destabilizing as it example, decreasing the ocean's pH makes it harder for cal
exacerbates political tensions over access to water. cifying species (e.g., corals, molluscs, crustaceans) to build
and maintain their shells and skeletons. These species will
1. 9.3 Sea Level & Ocean Acidification find it more and more difficult to extract carbonate from the
Sea level rise is a direct impact of climate change with the water for use in their shells or skeletons. Eventually, ocean
main future driver being the melting of grounded ice. The chemistry will increase to the point where it is fatal for these
melt water eventually reaches the ocean, increasing the total species.

1. 9.4 The Albedo Effect, Polar Amplification, Until recently, it was difficult to quantitatively determine the
and Positive Feedbacks extent to which climate change played a role in an extreme
event. In response to this need, a new branch of climate
Similar to the "water vapor feedback" process discussed
science known as extreme-event attribution science has
earlier, a decline in sea and land ice can amplify warming
begun to give us the capability to quantify the contribution
beyond the release of GHGs. Ice is more reflective-it has
of climate change to extreme events.
a higher albedo-than the darker ocean or land. Thus,
previously ice-covered areas absorb more solar radiation, Extreme-event attribution analyses use three different
heating up the atmosphere, which in turn, melts more ice, sources of information. The first technique uses statistical
exposing more dark areas and reducing the Earth's overall analysis of historical climate. The observations can be sta
albedo-the albedo effect. tistically analyzed to determine the likelihood that an ob
served extreme event occurring today could have occurred
This is the primary reason the Artie is warming faster than
prior to human-induced warming. By itself, however, this
other areas of Earth. Other polar and geographic charac
type of analysis usually can't tell you whether an observed
teristics (e.g., more land and less ocean in the Arctic than the
phenomena was caused by global warming or by some
Antarctic) compound this effect. This polar amplification leads
thing else because correlation does not prove causality.
to average Arctic temperature change 3-4 times that of the
rest of the Northern Hemisphere. The impacts of this amplifi Thus, the second technique focuses on our understand
cation are manifold (faster melting of the Greenland ice sheet, ing of the physics of the phenomenon. In a warmer world
leading to sea level rise; melting permafrost releases GHGs it should be obvious why we expect to get more frequent
such as methane; and alteration of the northern hemisphere heatwaves. The clarity of the connection adds to our confi
jet stream, affecting weather patterns across the globe). dence that climate change is a factor in the occurrence of
heat waves. For other things, like the frequency of occur
Water vapor feedback, polar amplification, and any other
rence of tornadoes, we do not have a good understanding
self-reinforcing warming phenomena are "positive feed
of how this will change as the climate warms. This lowers
backs." A feedback loop either speeds up or slows down
our confidence that tornado outbreaks are affected by
a change in a system. As discussed, a positive feedback
global warming.
accelerates a change, in this case, warming. A negative
feedback-such as a condition in which cloud cover acceler Finally, we use computer simulations (i.e., GCMs) of the cli
ated, increasing albedo-would slow down warming. How mate to evaluate frequency and intensity of extreme events.
ever, negative feedback loops play less of a significant role The simulations can be run with and without the increase in
in modern climate change than positive feedback loops. greenhouse gases, and the impact of climate change can
Feedback loops can play an important role in climate tip be quantitatively estimated. If we find that a heatwave with
ping points, discussed below. characteristics of the observed event rarely or never occurs
in the simulated world without climate change, but does in
1. 9.5 Extreme Events a world with simulated climate change, then it increases our
confidence that climate change was a factor in the event.
While we've previously been focused on average conditions,
many of the biggest impacts of climate change come from These attribution studies are now carried out for most
the changes in frequency and intensity of extreme weather extreme weather events around the world. As just one
events. However, when it comes to extreme events, climate example, it has been estimated that climate change
change is only one of the contributors as extreme weather increased the rainfall from Hurricane Harvey by about 15%
events are random in time. For example, extreme heat (Van Oldenburgh et al., 2017). The American Meteorologi
waves are magnified when added on top of the long-term cal Society puts out an annual review of extreme events
warming. Another example is how strong coastal storms can and their connection to climate change, and they find that
combine with sea level rise to generate extreme sea level most extreme events have been affected by climate change
events. (AMETSOC). Thus, it would be correct to say the data and

analysis shows that climate change is already making many • thawing of permafrost and methane hydrates, which
extreme weather events more extreme. would release huge amounts of greenhouse gases into
the atmosphere, leading to additional warming and an
1. 9.6 Impacts on Human Society and Natural acceleration of climate change; and
Ecosystems • a shift in the timing and magnitude of the Indian mon
As our climate changes, human systems will respond to soon, changing seasonal rainfall that billions of people
these changes; this is discussed in the next section. But rely on.
many of the impacts of climate change will be on natural
It is difficult to assess the probability of a tipping point
systems that humans do not manage, and those impacts
occurring. Climate models do not reliably predict the
will be much more difficult to mitigate. These natural
occurrence of an abrupt climate change, and many experts
ecosystems provide enormous benefits to human society.
view the probability to be low, although not zero, over the
For example, mangrove forests that grow in shallow salt
coming century. If an abrupt change did occur, though, it
water coastal regions provide protection for coastal areas
could be a catastrophe for both human and natural systems
from erosion, storm surge (especially during hurricanes),
because the rate of change is so high for these kinds of
and tsunamis. Pollination by bees is a key part of the
events. This is why these kinds of events pose such a chal
growth cycle of many societally and economically beneficial
lenge for risk management.
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
POLICY RESPONSES
will be shifted onto society. In China, for example, a decline
of wild bees has forced farmers to hire people to go from
Our responses to climate change can be broadly split
flower to flower and hand-pollinate the flowers using tiny
into three categories: adaptation, mitigation, and
brushes.
geoengineering. Adaptation means responding to
One concern for both natural and human systems is that the negative impacts of climate change. If climate
the climate will not warm linearly as greenhouse gases are change causes sea level to rise, an adaptive response
added to it linearly. Rather, we will add enough green to this impact would be to build seawalls or relocate
house gas that the climate system will undergo a large and communities away from the encroaching sea. Mitigation
rapid shift to an entirely new climate state-this is colloqui refers to policies that avoid or minimize climate change
ally known as a climate tipping point. An example of an in the first place, thereby preventing impacts such as sea
abrupt change occurred roughly 12,000 years ago, as the level rise from occurring. This is accomplished by reduc
Earth was emerging from the depths of the last ice age, ing emissions of greenhouse gases, primarily through
when temperatures in the Northern Hemisphere plunged policies that encourage the transition from fossil fuels
several degrees in a few decades due to a disruption in the to energy sources that do not emit greenhouse gases.
ocean currents. Geoengineering refers to active manipulation of the
climate system. Under this approach, our society could
Research on potential abrupt changes has revealed several
continue adding greenhouse gases to the atmosphere,
possible places in our climate system where abrupt changes
but we would intentionally change some other aspect of
could occur. These include:
the climate system in order to cancel the warming effects
• similar to that described above, another shutdown of the of the greenhouse gases. For example, we could engineer
Gulf Stream that leads to rapid, widespread changes in a decrease in the amount of solar energy absorbed by
climate; the Earth. If done correctly, this could stabilize the climate
• a rapid disintegration of the West Antarctic or Greenland despite continuing emissions of greenhouse gases. In the
ice sheets, which could raise sea level by several meters rest of this chapter, we explore each of these options in
in a century or less; detail.

1.10 Adaptation around the levee, a reduction in flooding there will push
water-and flooding-downstream. This can lead to levee
Any climate change that is not avoided must be adapted wars in which communities building higher levees force
to. Because the climate is presently changing and, even other communities to raise their levees, reducing flood
under the most optimistic scenario, will continue to change impacts to their area but pushing flooding into other
for decades, adaptation must be part of our response areas.
to climate change. Adaptation is primarily a response to
physical climate risk, which will be detailed in subsequent
chapters.
1. 10. 1 Maladaptation
The previous example shows how an action that decreases
Adaptation actions can physically manifest in human-built
climate vulnerability for one community can increase
infrastructure or enhancement of ecosystem services and
exposure to risk for another. This is maladaptation, an
functions, such as protection of mangrove forests to quell
intended adaptation action that actually increases climate
storm surges or expanding forested areas to improve
vulnerability. Maladaptations can increase vulnerability
water quality. Beyond physical enhancements, human
immediately or sometime in the future. The negative
communication, processes, regulations, etc ... can be
effects of maladaptations can include not just an increase in
adaptive, such as better extreme event warning systems or
vulnerability but also an increase of greenhouse gases or an
more climate-informed zoning regulations. Individuals can
imposition of disproportional burdens on the most vulner
adapt without any direction from the government, if they
able populations.
have sufficient resources. For example, when the climate
changes in agricultural areas, farmers will need to change Maladaptations can increase vulnerability immediately or
their farming practices to avoid bankruptcy. They can sometime in the future. The negative effects of maladapta
change farming practices by switching to drought-resistant tions can include not just an increase in vulnerability,
plant species, add infrastructure to irrigate their fields more but an increase of greenhouse gases or an imposition
effectively, or take any number of similar actions to adjust of disproportional burdens on the most vulnerable
to the realities of a new climate. populations.
However, leaving adaptation up the individual has the Insurance policies can lead to maladaptation. Home or
significant disadvantage that some of the most effective building insurance policies, a seemingly adaptive risk
adaptive responses take enormous resources or require management practice, can lead to rebuilding in areas at
large-scale societal coordination. For example, consider increasing risk from climate impacts or provide a false sense
the complexities in building a seawall. Effective sea walls of security. Building sea walls or other coastal defense
cover an entire community and therefore require consen structures can sometimes lead to increased erosion and
sus from that community on whether to make that signifi damage to neighboring areas, thus creating new vulner
cant investment, and how to best make that investment. abilities and negatively impacting ecosystems. Planting
Because of this, many of the possible adaptive responses trees is often seen as a way to address climate change but
require a significant role be played by the government-in planting non-native or monoculture tree species can have
both organizing decisions about large-scale infrastructure unintended consequences such as reduced biodiversity,
and in providing resources. This requirement for significant increased vulnerability to pests and diseases, and potential
resources has profound implications for equity and justice disruptions to local water cycles.
of adaptation. Because not everyone has those resources,
Another issue with adaptation is that the ability of societ
policies that rely extensively on adaptation policies run the
ies to adapt to climate change varies. Financially stable
risk of exacerbating existing inequalities.
and well-governed countries like the United States and
It is also worth noting that one person's adaptation can transgovernmental organizations like the European
modify impacts elsewhere. A good example of this is Union will be able to adapt far more effectively than less
building a levee on a river. While that may reduce flooding financially stable places without strong public institutions.

This creates a tension in the climate debate-the societies 1.11 Mitigation
most responsible for climate change, who historically
emitted the most carbon dioxide into the atmosphere, are Mitigation refers to actions that reduce emissions of carbon
also the richest countries. Because of their wealth, they dioxide and other greenhouse gases, thereby preventing
are also most capable of dealing with the impacts. Those the climate from changing.
who will be most negatively affected are also the poorest
countries, who have contributed the least to the climate
1. 11. 1 Emissions from the Current Energy
System
problem.
In our present energy system, most energy comes
In addition to direct aid, governments can also imple
from combusting fossil fuels. The amount of carbon
ment regulations and financial incentives to encourage
dioxide produced per unit of energy generated is known
citizens to adapt to a changing climate. Regulations
as the carbon intensity. The highest carbon intensity
promoting water conservation, for example, would help
fuel is coal, followed by oil, and lastly natural gas
communities adapt to decreased freshwater availability
(see Table 1.2).
caused by climate change. Governments can also reform
existing policy that encourage us to be poorly adapted GHGs can be measured in grams or kilograms per million
to the present (or future) climate and that increase our British thermal unit (MMBtu) and organizations typically
vulnerability (maladaptation) to climate change, such as report total emissions in metric tons (tonnes). T here
setting the price of flood insurance too low (as happens in are 1,000 kilograms in a tonne. So, an organization that
the United States). used 30,000 MMBtus of propane in a year would report
1,890 tonnes CO2 = 30,000 MMBtus x (63 kg C02/MMBtu
Finally, governments can facilitate adaptation by providing
+ 1,000 kg/tonne).
reliable information about climate change. Telling peo-
ple that the parcel of land they're considering building a Beyond accurately reporting organizational GHG emissions,
house on has a higher likelihood of flooding in the next few understanding carbon intensities/emissions factors plays an
decades may convince them to build elsewhere, saving soci important role in energy policy discussions. Natural gas has
ety the costs of rebuilding the house. T he government can been heralded as a cleaner fossil fuel than coal and "coal-to
also provide technical assistance about possible responses gas switching" as a "bridge" to help countries transition to
to climate change-that is, helping a farmer figure out what more clean-energy. However, methane leakage, the escape
farming practices she needs to change in order to be better of methane during extraction or transport of natural gas, has
adapted to a drier climate. 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

1.11.2 Moving Toward a Cleaner Energy water running through a dam spins turbines and generates
System electricity. It is the most widespread dispatchable renew
able energy source in the world today, providing 16%
Solving climate change requires our society replace fossil
of the world's electricity in 2018 (IEA). Despite the many
fuels with climate-safe energy sources that do not release
advantages of this energy source, it seems unlikely that this
carbon dioxide into the atmosphere. Solar energy is the
power source can be greatly expanded. Many of the world's
renewable energy source with the most potential. To satisfy
big rivers are already dammed, and new dams often cause
all human energy needs would require roughly 1 million
local environmental and social problems that generate sig
km 2 to be covered with solar energy collectors. This would
nificant local political opposition.
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 Another significant source of climate safe and dispatch-
a large area, it is comparable to the total area covered by able energy sources is nuclear energy. Nuclear energy is a
cities, so there is no reason to believe that it is impossible mature technology that generated about 10% of the world's
for humans to construct this area of solar panels, distributed electricity in 2018, so there is no question about its techni
around the world. cal feasibility (Our World in Data). Nuclear power plants are
expensive to build, and this is one of the primary reasons
Wind is another important and prolific climate-safe energy
that few new nuclear power plants have been built in the
source. Today's electricity-generating wind turbines can
United States in the last few decades. Opposition to new
individually generate as much as 10 MW of power. Consid
nuclear power plants also arises because of the environ
ering the intermittency of wind, we could satisfy humani
mental risks of that power. One particularly frightening risk
ty's energy requirement with a few million wind turbines.
is of release of nuclear radiation from an accident (such as
It should be noted that putting up wind turbines does not
occurred in Chernobyl and Fukushima) or from intentional
preclude using the land simultaneously for other activities,
release due to terrorism.
such as agriculture. In addition, wind turbines can be put
offshore with an additional benefit that offshore wind typi Another issue is nuclear waste, which is highly radioactive
cally blows more consistently, so intermittency is less of an and must be safely isolated for thousands of years.
issue than for land-based wind. Accidental or intentional release could cause massive
harm to humans and the environment. Additionally, there
Wind and solar energy have been growing rapidly over the
is a risk of proliferation, as the nuclear fuel cycle might
past decade and are emerging as important contributors to
enable diversion of materials for building a nuclear bomb,
our energy supply. The price of these energy sources has
potentially putting weapons in the hands of terrorists or
declined rapidly over the years, and they are competitive or
rogue nations.Advances in reactor design, particularly
even cheaper than conventional fossil-fuel energy in many
small modular reactors (SMRs), hold the promise to solve
places. There is no question that this trend will continue and
some of these problems. SMRs are physically small, so they
wind and solar will become a bigger part of our energy mix.
occupy fraction of the area of a conventional nuclear power
The primary issue with wind and solar is intermittency-the
reactor. Their modular design would allow much of the
Sun shines only during the daytime and when not obscured
plant to be manufactured in a factory and transported to
by clouds, and the wind speed varies with meteorological
the final site. These offer savings in cost and construction
conditions.
time, two of the main impediments to building nuclear
But people want power when they want it, so a grid con power reactors today. SMRs are simpler than traditional
taining a significant amount of wind and solar must be nuclear power plants and are expected to have safer
balanced with dispatchable carbon-safe energy sources. modes of failure. And less frequent refuel cycles may
Dispatchable sources are able to generate energy regard ease proliferation concerns. Thus, many of the technical
less of weather conditions, so the power is always available problems with nuclear energy can be addressed. Whether
and can be modulated to counteract the intermittency of this makes nuclear energy more politically palatable
wind and solar. Hydroelectric power is generated when remains to be determined.

Another potentially important source of dispatchable power to shift energy produced at the peak of solar power, around
is geothermal, in which water, pumped underground, local noon, to the peak of demand, in the late afternoon/
heated by the Earth, and brought back to the surface, early evening. This would play a key role in smoothing out
is used to turn a turbine and generate power. While fre the intermittency of solar energy. The cost of batteries is
quently used in places with active volcanism, like Iceland, it coming down quickly and such short-term storage is already
can be used more widely than it currently is today. a component of some grids, such as in California. Longer
term storage (days to weeks) would potentially displace the
Other sources of dispatchable power are more problematic.
need for dispatchable power. At this point, however, long
Biomass energy refers to the process of growing plants
term storage at sufficient scale is not feasible. Research
and then burning them to yield energy. Because the carbon
on new technologies now occurring means that this may
dioxide released from burning biomass was absorbed from
become possible in the future.
the atmosphere during the growth of the plant, there is no
net increase in carbon dioxide in the atmosphere. While Batteries require elements like cobalt, which come from
people have been utilizing biomass energy for nearly all of politically volatile regions like central Africa. In some cases,
human existence, there remain important issues with this the mining is done for low pay and in dangerous conditions,
as a large-scale energy source. For example, a global-scale making ethical issues in the supply chain prominent.
bioenergy source will require enormous amounts of land. Recently, Chinese mining companies have moved
This can be problematic because we already farm most pro aggressively to gain control of strategically important
ductive land, so additional land typically comes from clear mines, potentially adding political uncertainty. Clearly, the
ing forest, which causes a host of other local environmental supply chain is a risk for future production of batteries. One
impacts, such as loss of native biodiversity and ecosys- way to mitigate that risk is to recycle the batteries. This is
tem degradation. These issues need to be assessed and possible, but not widely done currently. However, given
addressed before we embark on an expansion of this potential supply-chain issues, efforts to recycle batteries will
energy source. inevitably increase.
A final option to generate dispatchable power without Ultimately, to reach a zero-emission economy, as many
emitting carbon dioxide to the atmosphere is known as economic activities as possible must be electrified. This will
carbon capture, utilization, and storage, often shortened to greatly increase consumption of electricity compared to a
carbon capture, carbon sequestration, or by its abbrevia scenario where we continue to rely on fossil fuels. That in
tion, CCUS. CCUS refers to a process by which fossil fuels turn will require enhancements in infrastructure, such as
are burned in such a way that the carbon dioxide generated enhanced transmission lines. An enhanced transmission
is not vented to the atmosphere. Rather, the carbon diox system will also help reduce the impact of intermittency of
ide is captured and used in a range of applications, such as solar and wind energy by allowing the transfer of energy
being incorporated in cement or plastic. from regions with excess renewable energy to regions
where demand exceeds supply.
The carbon can also be stored. The most promising place to
store the carbon dioxide is to inject it deep underground in Some important economic processes may be difficult to
depleted oil and gas fields, coal beds that cannot be mined, electrify, including international airline flights and long
or deep saline formations. Such storage is technically fea distance trucking. For these, hydrogen energy might play
sible and has been demonstrated to work in preliminary a role due to its large energy per unit mass. The hydrogen
tests. Overall, it is presently unclear if CCUS is economically must be produced in a way that does not produce green
feasible at the scale necessary to allow fossil-fuel sources to house gases, such as from electrolysis of water powered
continue to be an important source of energy without the by renewable energy. Hydrogen could also be used in
carbon emissions. place of batteries for storage-it could be produced when
there is excess renewable power and then converted back
Battery energy storage systems (BESS) may also play a role
to electricity when more power is needed. A downside
in two ways. Short-term storage (a few hours) can be used

of hydrogen is that it is difficult to store, and it carries a planet. This is the same mechanism by which volcanoes cool
significant explosion risk, as passengers of the Hindenburg the planet. Thus, the physics supporting these suggestions
found out. This means that any widespread adoption of is robust, and we have high confidence that if schemes like
hydrogen would require significant investment in new this were carried out at a sufficiently large scale, the planet
hydrogen infrastructure. would experience cooling.
The clean-energy transition must be carefully managed. There are, however, important disadvantages with these
A reliable and climate-safe energy system will contain a approaches. To begin with, such schemes may have serious
mix of power sources: wind and solar will produce a lot of side effects. We expect, for example, that solar radiation
power, but it also must contain dispatchable power that management will change precipitation patterns, poten
will pick up the load when wind and solar are not able tially causing droughts in some regions or floods in others.
to generate sufficient energy. One of the biggest risks is In addition, solar radiation management is a governance
that our existing fossil fuel energy sources are shut down nightmare, potentially leading to misunderstanding around
too soon, before climate-safe energy sources are able to causes and effects, and subsequently instigating politically
provide the 24-hour-per-day reliable power that everyone destabilizing conflicts.
expects. Maintaining reliable power may require keeping A second category of geoengineering is known as carbon
open economically non-competitive fossil fuel plants dioxide removal. This is an effort to implement processes
until the gird can be robustly maintained by climate-safe that rapidly remove carbon dioxide from the atmosphere.
energy. Planting trees is an example. As the trees grow, they pull
The transition must also be managed in a way that ensures carbon dioxide out of the air and sequester it in wood. The
that it is economically and politically feasible. This includes problem with trees as a carbon storage device is that they
ensuring that the transition is equitable and that access to are not permanent. You can plant a forest and, as the trees
clean energy is available to all, regardless of income level grow, carbon is indeed pulled out of the atmosphere. But
or location. Finally, it is critical to ensure that the transition that forest can burn down, thereby releasing all of the car
is done in a way that does not result in too many "stranded bon back into the atmosphere. Even in the best case, trees
assets," such as coal-fired power plants that may become typically only live a few centuries.
obsolete due to the shift to clean energy. 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
1.12 Geoengineering
removes carbon dioxide from the exhaust gas of a power
A final category of solution to the climate change prob plant, whereas air capture removes carbon from the free
lem is known as geoengineering, which refers to actively atmosphere. A related approach is referred to as bioenergy
manipulating the climate system in order to prevent the with carbon capture and sequestration, more commonly
climate from changing despite continuing greenhouse gas referred to by its initials, BECCS. In this process, plants are
emissions. Geoengineering efforts can be roughly divided grown, which removes carbon from the atmosphere. The
into two categories. plants are then burned to produce power, and the carbon
dioxide produced is captured and sequestered.
The first category is known as solar radiation management,
and these efforts attempt to engineer a reduction in the A final category is what are referred to as natural climate
amount of solar energy absorbed by the Earth. The most solutions. These are practices and technologies that can
frequently discussed way to do this is to inject sulfur into help sequester carbon from the atmosphere and reduce
the stratosphere. Once in the stratosphere, this gas reacts emissions, thereby reducing the impacts of climate change.
with ambient water vapor to form droplets that reflect These solutions often involve the conservation, restoration,
sunlight back to space, thereby increasing the reflection and management of natural systems, such as forests, grass
of incoming solar energy back to space and cooling the lands, and wetlands, which can absorb and store carbon

°
dioxide. To the extent that they eliminate emissions, there is "well below 2 C above pre-industrial levels" while "pursu
°
some ambiguity about whether these belong in mitigation ing efforts to limit the temperature increase to 1.5 C above
or geoengineering. Some examples of natural climate solu pre-industrial levels." As part of the Paris Agreement pro
tions include: cess, each country has submitted a nationally determined
contribution (NDC), a promise of global emissions reduc
1. Forest conservation and reforestation: Forests absorb and
tions that the country intends to achieve.
store carbon dioxide from the atmosphere through the
process of photosynthesis. Protecting existing forests and The Biden Administration committed the United States to
planting new trees can help sequester carbon and reduce cutting overall greenhouse gas emissions by 50% below
emissions from deforestation and land use change. 2005 levels by 2030 and reaching net-zero emissions by
2050. In support of this, the US government has passed two
2. Agroforestry: This involves the integration of trees into
laws that support climate action: 2021 's Infrastructure Invest
agricultural landscapes, which can aid in sequester
ment and Jobs Act and 2022's Inflation Reduction Act. The
carbon.
Inflation Reduction Act is the more significant legislation,
3. Wetland restoration: Wetlands, such as marshes and
investing USD 319 billion in provisions related to climate
swamps, are important carbon sinks because they store
and clean energy. These investments take the form of direct
carbon in the soil and vegetation. Restoring wetlands
spending on infrastructure like electric vehicle charging, loan
can help increase their capacity to sequester carbon
guarantees for innovative clean energy programs, and incen
and provide other ecosystem benefits, such as improv
tives and tax breaks for clean energy projects. There are also
ing water quality and flood control.
provisions to incentivize the domestic manufacture of clean
4. Grassland restoration and management: Grasslands, energy components and critical minerals.
such as prairies and savannas, can also absorb and
The E.U. has committed to similar reductions-in 2030,
store carbon. Restoring and managing grasslands in
emissions should be 55% below 1990-level emissions,
a way that promotes carbon sequestration, such as
reaching net-zero emissions by 2050. China committed to
using cover crops and reduced tillage, can help reduce
leveling off its carbon emissions no later than 2030 and
greenhouse gas emissions.
reaching net zero by 2060.
5. Soil carbon sequestration: Soil contains a large amount
While these emissions reduction commitments are signifi
of carbon, and certain practices, such as conservation °
cant, they are not likely sufficient to limit warming to 2 C.
tillage, cover cropping, and the use of organic fertil
Rather, commitments under the Paris Agreement put us on
izers, can help increase the amount of carbon stored in °
track for 2.5-3 C of warming in 2100, with warming continu
the soil. This can help reduce emissions from the agri
ing into the twenty-second century and beyond (Climate
culture sector and improve soil health.
Action Tracker).
There are minimal technical barriers to carbon dioxide °
So, what do we have to do to keep warming below 2 C?
removal schemes, but the scale required is enormous
A useful way to think about this problem is in terms of a carbon
humans are adding more than 40 billion tonnes of CO2 into
budget. It turns out that the peak warming we eventually expe
the atmosphere every year. Carbon dioxide removal must
rience is determined by total cumulative emissions of carbon
be able to remove a significant fraction of this at a price low
dioxide since the industrial revolution began around the begin
enough to not disrupt the economy. No one knows if this
ning of the nineteenth century. The scientific community's best
can be achieved. °
estimate is that peak warming is 0.3-0.6 C for every trillion
tonnes of carbon dioxide emitted into the atmosphere.
1.13 Mitigation Targets Humans have already emitted about 2.2 trillion tonnes
The international climate agreement that the world is pres between the industrial revolution and the end of 2017, so
°
ently working under, the 2015 Paris Agreement, has the aim we can stay under 2 C warming if we limit future emissions
of holding the increase in global average temperatures to to around 1.5 trillion tonnes. This is a tight budget: With

present-day emissions exceeding 40 billion tonnes per year,
we will blow through our remaining budget by the 2050s.
40 --------------------------1 �:�:� 1·
°
To stay below 1.5 C is even more daunting. Our emissions 30
budget for that limit is 580 billion tonnes, meaning that we (/)
20
are on track to exceed our budget for stabilizing below this "iii
.!!!
temperature in the 2030s. 10 -----------: ----------
Figure 1.7 shows emissions trajectories consistent with keep 0
° °
ing the temperature of the planet below the 2 c and 1.5 C
thresholds. Because we have so little carbon budget remain -10
ing, emissions need to begin declining immediately. For the
° 2000 2020 2040 2060 2080 2100
1.5 C threshold, net emissions need to decline to 50% of
Year
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 bf;jliijiJ Emissions scenarios for 1.5 ° C and 2 °C.
today's value by the mid-2040s and reach zero in 2080.
Nevertheless, achieving either temperature target may be
For both scenarios, emissions continue to decline after
unattainable without the ability to generate large negative
they reach net zero and become negative. This means that
emissions.
humans are pulling more carbon dioxide out of the atmo
° °
sphere than they are releasing using approaches discussed There are other trajectories that achieve 1.5 C and 2 C.
in the geoengineering section above. These negative emis However, they all have a fundamental trade-off between the
sions imply the removal of potentially hundreds of billions speed of emissions reductions right now and negative emis
of tonnes of carbon dioxide from the atmosphere over a sions later this century. If a trajectory reduces emissions more
few decades. This is an enormous task, to put it mildly, slowly over the next decade or two, then we will need larger
and our ability to accomplish this is entirely speculative. negative emissions later.
SUMMARY humans care about, including the natural systems that we

rely on.
This chapter has provided a short introduction to climate Humans have a range of options in response. We can try to
science and policy. The scientific community is confident prevent the climate from changing (mitigation), adapt to
the Earth is warming, and humans are the main driver of the changing climate (adaptation), or try to engineer a more
this warming. It is possible that warming over the coming hospitable climate (geoengineering). Most of the discus
century will be a few degrees Celsius, an amount compa sion and conflict over climate policy is over efforts to miti
rable to the warming since the last ice age. According to gate climate change, which requires us to transition from
the IPCC, the exact amount will lead to vastly different fossil fuels to renewable energy.
outcomes in different places.
Under the Paris Agreement, the countries of the world have
This warming is already and will continue to bring agreed to a mitigation target of limiting warming to well
with it changes in many other aspects of the climate °
below 2 C above pre-industrial temperatures, with an aspi
system, including changes in the distribution and inten °
rational goal of limiting warming to 1.5 C. Achieving this will
sity of precipitation, increases in sea level, changes in be challenging and will require emissions reductions to accel
ocean chemistry, and many others. There is also a chance erate and reach net-zero sometime in the second half of this
the climate system will experience a tipping point, where century. It will also require negative emissions, where humans
the climate suddenly transitions into a new climate pull more carbon dioxide out of the atmosphere than they
regime. These changes will affect many of the things that °
emit, with much more necessary for the 1.5 C target.

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

°
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

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

Sustainability
After reviewing this chapter, you should be able to:
• Define and explain sustainability and its three • Define ecosystem services, subcomponents, and
different aspects. natural capital. Understand how organizations
depend upon and can impact ecosystem services.
• Define and explain Environmental Social Governance
(ESG), Corporate Responsibility, and Sustainable • Trace the evolution of sustainability in governments,
Development. Understand how different entities use corporations, and financial institutions.
these concepts to implement and report sustainability
and climate practices. • Know the different types of greenwashing. Describe
how organizations can greenwash and "greenwish"
• Explain the relationship and intersection among sus sustainability claims as well as actions to counteract
tainability, ESG, and/or climate change. these practices.
• Describe the key features of the United Nations • Describe the life-cycle assessment (LCA) process and
(UN) Sustainable Development Goals (SDGs) and how organizations use this tool to advance sustainability.
Millennium Development Goals (MDGs).
• Know the major sustainability reporting frameworks
• Discuss strategies for implementing and aligning with and initiatives, their objectives, and to whom they are
the SDGs and how the SDGs and sustainability can be targeted.
material to companies.
31
• Sustainability is a broad category; ESG, or measuring
This chapter discusses the broad topic of "sustain the environmental, social, and governance performance
ability," particularly as it relates to public policies, of firms, often by financial counterparties, sits within
corporate actions, and financial institutions. The broad sustainability.
examination of sustainability in a policy, corporate, • The UN's 2030 Agenda, particularly the Sustainable
and investment context is important background
Development Goals at the heart of it, have become an
before examining climate risk analysis (Chapters 3 and
important reference point and benchmark for both poli
6) and policy frameworks (Chapter 4) in greater detail.
cymakers and for the private sector.
This chapter starts by defining sustainability and differ
• Corporate sustainability practices have evolved
entiating it from the concept of ESG (environmental,
from being primarily motivated by corporate
social, and governance issues) and from climate risk.
social responsibility-that is, branding or moral
This chapter also discusses international goals on sus
considerations-to considerations of financial
tainability, notably the UN Sustainable Development
materiality.
Goals (SDGs). The chapter takes a broad approach,
• Frameworks and coalitions have been crucial in
touching on economic development, issues of social
justice and equity (e.g., human rights), and environ promoting sustainability practices among private
mental protection (e.g., biodiversity), and focusing pri sector actors.
marily on concepts and general framing in preparation

for later chapters that go into greater detail.
SUSTAINABILITY
2.1 Introduction to Sustainability
Chapter Outline
2. 1. 1. Definition
Sustainability is defined as humanity meeting its current
2.2 ESG, Sustainability, and Climate Risk needs without overburdening the natural environment or
future generations. Most definitions of sustainability place
2.3 Sustainable Development Goals (SDGs) and
the natural environment and its resources on equal foot
the 2030 Agenda
ing with social and justice concerns and with economic
2.4 Ecosystem Services and Natural Capital outcomes.
2.5 Sustainability at Corporations and Financial Institutions • Environmental sustainability means maintaining eco
2.6 Private-Sector Sustainability Frameworks and Coalitions 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
Key Learning Points by humans at a rate less than that at which they can be
• Sustainability refers to humankind meeting its economic replenished.
needs without overburdening the environment or weak • Social sustainability means that a minimum standard
ening societies. of basic necessities and human rights is afforded to all
• The modern concept of sustainability originated within people, who have sufficient resources to keep them
the context of sustainable development, that is, selves, their families, and their communities healthy and
country-level economic development performed in a way secure.
that does not overexploit natural resources or overbur • Economic sustainability means having economic
den society. But sustainability is now applied to govern systems that are accessible to everyone and that help
ments, corporations, and financial institutions alike, and to spread and generate prosperity globally. These three
to actions by individuals. elements, then, make up "sustainability" writ large.

2. 1.2 Historical Background as the Sustainable Development Goals, covered in Section
2.3. Essentially every organization involved in development,
There have been periodic concerns about the finite nature of
such as multilateral development banks, seeks to align its
natural resources stretching back at least to the eighteenth
work with sustainable development principles. Some con
and nineteenth centuries. These discussions about the value
sumers consider sustainability in making moral and ethical
of nature and the debates (and in some cases, political move
choices in regard to consumption: for instance, many peo
ments and even revolutions) around sharing wealth and well
ple have reduced or eliminated their use of meat and dairy
being more equitably for the benefit of wider society started
products for environmental reasons.
almost as soon as the industrial revolution (which brought
unprecedented economic growth and wealth) began. Corporations practice sustainability through their sustain
ability policies and strategies; through adherence to environ
However, the concept of sustainability as applicable to
mental, social, and governance norms (ESG); and through
today's public policy and corporate arenas traces its roots
corporate-level commitments, which range from commit
to actions in the 1970s and 1980s. In 1972, the first major
ments to eliminate the use of forced labor from a firm's sup
United Nations meeting on environmental issues took
ply chain to the alignment of a firm's business model with
place. That same year saw the publication of "The Limits
Paris Agreement-compliant emissions reductions goals. Inves
to Growth," a report commissioned by the Club of Rome
tors and financial institutions, for their part, practice sustain
that argued that there were limits to economic growth due
ability through the ESG policies they have in place relating
to resource constraints. However, neither of these signifi
to their investing and lending activities, sustainable finance
cantly shaped public policy, leading to the creation of the
product offerings (described in more detail in Chapter 5), and
Brundtland Commission a decade later. Unlike the Club
various commitments to align with sustainability goals.
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 2.2 Sustainability, ESG, and Climate
that meets the needs of the present without compromising Change
the ability of future generations to meet their own needs"
Discussions of sustainability can easily get bogged down in
(Brundtland, 1987). This has since become the most cited
definitional confusion or overlap. Sustainability is the broad
and widely accepted definition of sustainable development.
est category of all. As defined in Section 2.1, it includes
While the definition was grounded in the development actions or activities undertaken in such a way as to not
discourse of allowing the world's poorer countries to gain exhaust or exploit resources-human or natural-and to
access to better living standards, it later served as a basis allow for economic activity to continue into the future (see
for defining what sustainability means for other sorts of Figure 2.1). The three categories of environmental, social
entities. For example, from the 1990s, corporations widely and economic sustainability are broad in and of themselves.
pursued corporate social responsibility (CSR), whereby For example, environmental sustainability encompasses
companies undertake social or environmental activities for considerations such as addressing climate change, striving
the wider benefit of society (see Section 2.4). Around the for clean air and water, protecting oceans, conserving habi
same time as companies started widely practicing and com tats and nature, and preserving biodiversity.
municating about CSR, investors began pressing investee
The notion of ESG, meanwhile, with "E" referring to envi
companies to become more sustainable through share
ronment, "S" to social, and "G" to governance, began in
holder "engagement" (O'Rourke, 2003).
the financial industry and surrounding policy discussions
Today, sustainability is an important guiding principle for involving financial regulation and financial-sector sustain
governments, international organizations, individuals, cor ability. The term ESG was coined in a 2005 report by the
porations, and financial institutions alike. Governments UN Global Compact, which was endorsed by a coterie of
advocate the merits of sustainability and agree on interna investment firms, including ABN Amro, Goldman Sachs, and
tional sustainability goals through the United Nations, such 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.

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

Goal 1 No Poverty. End poverty in all its forms everywhere Goal 12 Responsible Consumption and Production.
Goal 2 Zero Hunger. End hunger, achieve food security and Ensure sustainable consumption and production patterns
improved nutrition and promote sustainable agriculture Goal 13 Climate Action. Take urgent action to combat
Goal 3 Good Health and Well-Being. Ensure healthy lives climate change and its impacts
and promote well-being for all at all ages Goal 14 Life Below Water. Conserve and sustain
Goal 4 Quality Education. Ensure inclusive and equitable ably use the oceans, seas, and marine resources for
quality education and promote lifelong learning opportu sustainable development
nities for all Goal 15 Life on Land. Protect, restore, and promote sus
Goal 5 Gender Equality. Achieve gender equality and tainable use of terrestrial ecosystems, sustainably man
empower all women and girls age forests, combat desertification, and halt and reverse
Goal 6 Clean Water and Sanitation. Ensure availability and land degradation and halt biodiversity loss
sustainable management of water and sanitation for all Goal 16 Peace, Justice and Strong Institutions. Pro
Goal 7 Affordable and Clean Energy. Ensure access to mote peaceful and inclusive societies for sustainable
affordable, reliable, sustainable, and modern energy for all development, provide access to justice for all and build
Goal 8 Decent Work and Economic Growth. Promote effective, accountable, and inclusive institutions at all
sustained, inclusive, and sustainable economic growth; levels
full and productive employment; and decent work for all Goal 17 Partnerships for the Goals. Strengthen the
Goal 9 Industry, Innovation and Infrastructure. Build means of implementation and revitalize the Global Part
resilient infrastructure, promote inclusive And sustainable nership for Sustainable Development
industrialization and foster innovation
Goal 10 Reduce Inequalities. Reduce inequality within Reprinted with permission of the United Nations Sustainable
and among countries Development Goals [https://www.un.org/ sustainablede
Goal 11 Sustainable Cities and Communities. Make cit velopmentl]. The content of this publication has not been
ies and human settlements inclusive, safe, resilient, and approved by the United Nations and does not reflect the
sustainable views of the United Nations or its officials or Member States.
public sector, multilateral institutions and civil society stake all children to primary and secondary education; access to
holders. The SDGs, on the other hand, are also increas early childhood care; access to technical, vocational, and
ingly being used by the private sector to define entity-level higher education; and eliminating gender disparities in
sustainability aims and monitor progress. education, as well as a more short-term goal (set for 2020)
of "substantially expanding" the number of scholarships
The 17 goals are also subdivided into 169 targets, which
available to developing countries. Goal 7, on affordable
provide specificity and enable accountability and the track
energy, has detailed targets on energy access, renewable
ing of progress. While the broad goals help bring about a
energy, and energy efficiency (see SDG Example of Targets).
wide span ambition of action, the breakdown of each large
lofty goal into smaller targets helps in concretizing their Even if these targets are not necessarily quantitative, their
implementation. This subsection will highlight examples specificity nonetheless is helpful in developing targeted
from a few of the goals. metrics and policies to better gauge progress.
While the original UN formulation is methodical goal by goal,

2.3.3 Implementing the SDGs: Targets and
many implementations of the SDGs further several goals at
Cross-Cutting Solutions once. Many private sector stakeholders have started enumer
Under Goal 4, which relates to education, the more detailed ating which SDGs their activities principally align with (see
targets include ensuring the free and equitable access of Section 2.4, including Shell case study). One example of a
EXAMPLE OF TARGE TS UNDER AN SDG: GOAL 7 (AFFORDABLE ENERGY)
7.1 By 2030, ensure universal access to affordable, 7.b By 2030, expand infrastructure and upgrade technology
reliable, and modern energy services for supplying modern and sustainable energy services
for all in developing countries, in particular least
7.2 By 2030, increase substantially the share of
developed countries, small island developing States,
renewable energy in the global energy mix
and land-locked developing countries, in accordance
7.3 By 2030, double the global rate of improvement in with their respective programmes of support
energy efficiency
7.a By 2030, enhance international cooperation to Reprinted with permission of the United Nations
facilitate access to clean energy research and Sustainable Development Goals [https://www. un.org/
technology, including renewable energy, energy sustainabledevelopmentl]. The content of this
efficiency and advanced and cleaner fossil-fuel publication has not been approved by the United
technology, and promote investment in energy Nations and does not reflect the views of the United
infrastructure and clean energy technology Nations or its officials or Member States.
CASE STUDY: NATURE-BASED SOLUTIONS TARGET ING A COMBINATION

OF SDGS 13, 14, AND 15
Nature-based solutions are defined as actions to protect, For nature-based climate solutions to be viable, the
manage, or restore ecosystems that a/so address societal World Wildlife Fund (WWF) argues they must
and human challenges. Some nature-based solutions
1) address climate change and increase ecosystem
are well suited to providing climate change mitigation
functionality;
and adaptation benefits. This case study examines how
2) be science-based;
actions to protect ecosystems such as forests, grass
3) be synergistic;
/ands, mangroves, and wetlands (SDGs 14 and 15) can
4) be designed and implemented with local stakeholders
a/so address human-caused climate change (SDG 13).
and indigenous peoples; and
Climate change is, after all, caused by excess human 5) be measurable and traceable.
generated carbon dioxide emissions, as well as emis In light of these conditions, it is easy to see why one
sions of other greenhouse gases. Plants absorb carbon wellknown nature-based climate solution-planting
dioxide from the air and use it in photosynthesis to trees-can fail unless done properly. From a carbon
produce chemical energy in the form of sugars and as sequestration perspective, planting one species of tree
building blocks for their structural tissues. The carbon in orderly, dense rows may seem optimal, but this does
is retained in plants indefinitely so long as the plants not produce a functional, biodiverse ecosystem, and
are alive, or in wood products, that is, lumber; but if thus fails condition 1. Many offsetting schemes involv
the plant material burns or decomposes, the carbon ing tree-planting only ensure that saplings are planted,
dioxide is re-released into the atmosphere. In terrestrial but they do not have mechanisms in place to ensure the
forests, microbes and fungi can absorb and sequester trees grow and stand for decades and centuries, rather
carbon dioxide in the soil. Wetlands, meanwhile, can than being felled or burned; this, then, fails condition
retain and absorb floodwaters, which can help limit their 5. Therefore, only tree-planting done in a way to ensure
impact on buildings or infrastructure. Mangrove forests biodiversity and ecosystems are supported, and tree
along tropical coasts can substantially attenuate storm growth is ensured and monitored for the long term,
surges and provide important habitats for fish and other would actually fulfill the criteria.
marine wildlife (see graphic). © 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 ).
• 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

Robert Owen, whose New Lanark Mills in Scotland included other stakeholders. This line of thinking is summed up in
social welfare programs and became a hopeful example the famous adage of Nobel Prize-winning economist Milton
for many social reformers. Similar communities existed in Friedman: "there is one and only one social responsibility
many parts of the United States. John Lewis & Partners, a of business-to use its resources and engage in activi-
British department store, is famous as an employee-owned ties designed to increase its profits" (Friedman, M.[1970,
mutual organization that has served social goals and dem September 13, 1970). The Social Responsibility of Business
onstrated commercial success. From its foundation in its is to Increase its Profits. New York Times Magazine.)
current form in 1920, its employees, called partners, have
In the 1980s and 1990s, however, the notion of the "triple
been co-owners of the business and have had a say in how
bottom line" was developed, placing environmental
it is run.
and social impact "bottom lines" on co-equal status
with the traditional bottom line-a company's financial
Until recently, the likes of John Lewis have been the excep
performance.
tion rather than the norm. Historically, the prevailing view
has been that businesses practice "pure" capitalism and The concept of corporate social responsibility (CSR)-that
that achievement of social, environmental, or other non a corporation also has a broader obligation to society
economic outcomes were the domain of governments or gained attention in corporate boardrooms. Although the
CASE STUDY: CORPORATE SUSTAINABILITY REPORTING-SHELL PLC.

As one of the first large firms to issue a modern-format ethical leadership to greater transparency. We must con
sustainability report, Anglo-Dutch oil & gas firm Shell tinue...to make a real contribution to people's lives. We
pie. makes an interesting case study for understand- can only do this by keeping our approach to sustainabil
ing how corporate responsibility and sustainability have ity at the heart of the way we do business." [*)
changed over two decades, and how these concerns are
On climate change: "We fully support the Paris Agree
communicated to outside stakeholders. The inaugural
ment's goal to keep the rise in global average tem
1997 report frames its content primarily through the lens
perature this century to well below two degrees Celsius
of values, arguing there does not need to be a "choice
above pre-industrial levels and to pursue efforts to limit
between profits and principles." Subsequent reports,
the temperature increase even further to 1.5 degrees
like in 2019, promote stronger action on global climate
Celsius."(*)
goals. Meanwhile, the most recent report at the time
of publication, covering the year 2022 and published in
Shell 2022 Sustainability Report: Excerpt
spring 2023, is much more focused on firm-level commit
ments to specified initiatives or international goals. For From the CEO Letter: "As we invest in the energy
example, the firm now has a climate target to become a needed today, our target to become a net-zero emis
net-zero emissions energy business by 2050. sions energy business by 2050 remains at the heart of
our strategy. We are making good progress. By the end
2019 Sustainability Report: "Delivering Energy of 2022, we had reduced carbon emissions from our
Responsibly" operations by 30% compared with 2016 on a net basis,
more than halfway towards our target of a 50% reduction
From the CEO Letter: "In 2019, demands for urgent
by 2030."
action on climate change grew ever louder.[ ...) Shell
shares this sense of urgency. We continue to take cli ...This report shows what we have achieved so far in our
mate action on many fronts[ ...] But we-and society as work to be a sustainable business. We aim to do this
a whole-need to do much more because change is not work responsibly, with discipline and at pace to make a
happening fast enough.[ ...] positive difference."(*)
This report shows much progress. But Shell must further Source: 2019 & 2022 Shell pie. sustainability reports.
step up efforts on all fronts, from climate change to [*the above quotes contain cautionary notes]
term was coined in the 1950s, its use was regularized in the for financial institutions analyzing corporate performance.
1990s, with many large multinational corporations launching It is now a lens used to screen companies and analyze
CSR initiatives. For example, Shell pie., a large Anglo-Dutch entire investment portfolios. As an example, MSCI, an
oil & gas firm, formed its internal Social Responsibility investment data company, offers an SDG Alignment Tool
Committee in 1997, and the firm started issuing stand that covers 8,600 companies in a way that measures a
alone sustainability reports in 1998-one of the first major "holistic overview of [a company's] net contribution to
global firms to do so. The first one was titled "Profits and the UN SDGs". In parallel, using SDG alignment allows
Principles-does there have to be a choice?" The firm has for an easy way to present outcomes and priorities to
issued annual sustainability reports ever since, with the con investors in a way that is cross-comparable between
tents evolving somewhat over the years (see case study on financial firms.
Shell pie).
During this period, investors started taking an interest in

2.5.2 Greenwashing and CSR
the sustainability of investee companies. Proponents of CSR is widely acknowledged as creating many opportunities
responsible investment point to early examples like the for greenwashing. According to Siano et al (2016), there are
Philadelphia Quakers, who in the mid-eighteenth century two main types of greenwashing identified in the literature:
banned investing in slave trading, and the decision by decoupling and attention deflection.
Sweden's Ansvar Aktie Fond in 1960 to leave out shares of
• Decoupling is when organisations claim to fulfill stake
companies with interests in apartheid South Africa, alco
holders' expectations for action on sustainability, without
hol, or gambling (Chow, 2010). These are two examples of
actually making any changes in what they do in practice.
divestment-that is, an exclusion from investments. The
Decoupling includes firms joining voluntary sustainability
notion of using shareholder pressure for "good" through
initiatives established by NGOs to gain credibility by
"engagement", "stewardship" and "monitoring" is a
association, the promotion of empty green claims and
more recent phenomenon, tracing to the notion of cor
policies when such commitments are unable to be imple
porate social responsibility in the 1990s and early 2000s.
mented, and the "sin of fibbing," which is making false
(O'Rourke, 2003).
claims and statements.
• Attention deflection is when organisations hide unsus

2.5. 1 Applying the SDGs in the Private Sector: tainable practices from stakeholder attention, prepare
SDG Materiality and Alignment selective and inaccurate disclosures, make incomplete
The SDGs have become a benchmark against which com comparisons with other products and services, and use
panies and investors measure outcomes. In particular, even vague and irrelevant statements. Attention deflection
if the SDGs themselves are concerned with non-financial also includes the deployment of misleading texts and/or
outcomes for society, the environment, and the wider imagery. At the extreme, companies can also undertake
economy, many of the SDGs do have material financial falsifications to gain accreditations.
effects on particular companies or industries-that is, Planet Tracker (2023) argue there are in fact a wider range
effects that can impact the financial bottom line. In rec of greenwashing categories. These include
ognition of this, individual companies have started includ
• Greencrowding, which involves hiding in a crowd to
ing references to SDGs in their sustainability and other
evade detection and relying on safety in numbers;
reporting. Consultancies promote their knowledge on
how SDGs can have material financial effects on corpora • Greenlighting occurs when companies spotlight small
tions and advise firms on how to integrate SDGs in their green features of their operations or products in their
operations. This can occur through the development of communications to distract from larger environmentally
appropriate key performance indicators (KPls). Data firms damaging activities being conducted elsewhere;
provide information on SDGs. Understanding SDG align • Greenshifting is when companies shift the blame for
ment has also become increasingly important and relevant environmental issues to the consumer;

• Greenlabelling, on the other hand, involves misleading 2.5.3 Developing Sustainable Products and
claims of sustainability; Greenrinsing occurs when com Systems: Towards a Circular Economy
panies regularly change their ESG targets before they
Companies often conduct life cycle assessments (LCA)
are achieved;
to substantiate green marketing claims. An LCA should
• Greenhushing refers to under-reporting or hiding sus
examine every stage of a product's life cycle, that is, the
tainability credentials by corporate management teams
extraction of its inputs, use, and disposal, basically, a
to avoid investor scrutiny.
"cradle-to-grave" assessment of a product's environmental
Greenwashing is therefore very serious and undermines impacts. There are four phases of an LCA, as laid out in
the efforts of companies who are actually acting on sustain ISO 14040:
ability. Arguably it is also a form of mis-selling, and this is
1. Goal and scope definition-determine why an LCA is
one of the reasons that advertising standards agencies and
necessary and to whom the results are relevant. Identify
other regulators, including financial regulators, are taking
the product and associated functions; define the prod
action on this issue. The UK's Financial Conduct Authority
uct's system boundary by identifying the processes that
proposed in 2022 a package of new measures including
contribute most to the product's environmental impact.
investment product sustainability labels and restrictions on
how terms like 'ESG', 'green' or 'sustainable' can be used. 2. Inventory analysis-gather data on the inputs, out
(FCA, 2022). A prominent recent greenwashing investiga puts, and energy use of the product.
tion launched by financial regulators targeted DWS, for 3. Impact assessment-characterize and categorize
merly Deutsche Bank's asset management arm. This was
product impacts.
instigated by BaFin, the German financial regulator, and the
4. Interpretation-evaluate completeness of the LCA;
US Security and Exchange Commission (SEC) in 2021.
develop conclusions and recommendations.
Although unintentional and intentional greenwashing is
Beyond substantiating green marketing claims, LCAs can
increasingly well-defined and regulated, the related con
help determine an organization's water, land, and energy
cept of "greenwishing" is perhaps even more widespread
use, and carbon footprints. LCAs can also help organiza
and probably more challenging to address.
tions identify efficiency improvements, enhance supply
Greenwishing are well-intended efforts to tackle sustainabil
chain purchase decisions, as well as compare the environ
ity challenges, which may not make enough of a difference
mental impacts of similar products within a company and
or encourage superficial changes when more structural ones
competitors.
are required. This can make consumers and companies think
they are doing their bit or making a significant difference to Full LCAs can be very expensive and time consuming and
sustainability challenges, when they aren't. Examples could are typically conducted for a few key products. There are
include, for example, buying an electric vehicle when the multiple software systems that help organizations conducts
grid electricity used to power the car comes from coal-fired LCAs. LCAs also focus primarily on environmental impacts,
power stations or buying soy milk for environmental reasons not social or governance issues. Thus, these other ESG
when the soya is sourced from suppliers causing deforesta issues must be considered when developing recommenda
tion in the Amazon. tions based off of LCAs.
Perhaps the only way to really address greenwishing is to LCAs are a building block of developing a more circular
enhance consumer and company understanding of the scale economy, in which economic growth is "de-linked" from
of sustainability challenges, as well as their understanding consumption of finite resources. Ultimately, waste and
of what actually makes a difference. But this creates poten pollution are reduced and eliminated by design from prod
tial risk, namely people and organizations feeling disem ucts and economies. LCAs provide the data and information
powered given the scale of sustainability challenges, and essential to show evidence of progress in advancing circular
then becoming disengaged. economies. Circular economy thinking can also advance the
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 Reputational risk, for example, can be a material risk. If all
and production patterns. corporations are expected to have a CSR policy, and then
some corporations either do not have one or are exposed
2.5.4 Moving Toward Sustainability as a (e.g., through investigative journalism or a non-governmen
Source of Risk tal organization) to not have abided by their own policy,
these companies can sustain real losses. Serious perceived
While sustainability issues were once seen as a supplementary
breaches of sustainability can lead to reduced demand for
add-on by many companies, they are now increasingly being
a firm's products and services, and increased scrutiny from
viewed as potentially material sources of corporate risks that
creditors or regulators.
can directly or indirectly cause financial impacts and losses.

CASE STUDY: DELTA BLUE CARBON: THE VALUE OF HOLISTIC
APPROACHES TO SUSTAINABILITY
It is crucial that private actors seeking to address sustain generating verified carbon credits and increasing carbon
ability risks develop approaches which recognize the deep sequestration. In addition, the project has led to habitat
interconnectivity between environmental, social, and eco restoration and improvements across key ecosystem ser
nomic sustainability. For example, companies looking to vices such as water quality improvement and increased
invest in carbon sequestration might be able to increase recreational opportunities. By strengthening physical resil
their impact by investing in well-designed nature-based ience, reducing dependence on costly infrastructure, and
solutions which can provide significant and cost-effective building sustainable supply chains, businesses can reduce
benefits beyond climate mitigation. For example, the their exposure to climate risks. Finally, it also creates eco
Delta Blue Carbon Project (Pollination, 2022) focused on nomic benefits by providing new revenue streams to local
wetland restoration in California has been successful in communities.It has been shown that
But there is increased recognition that sustainability issues can coalitions, which have helped develop best practices on
affect firms materially in ways beyond reputational risk. If a for sustainability issues (see Table 2.3).
estry or fishing firm overexploits resources through excessively
The World Business Council for Sustainable
wide-scale logging or fishing, forests or fish stocks could be
Development (WBCSD) was formed after the UN Rio
severely depleted. If a mining firm does not properly maintain
Summit in 1992, and it does research on corporate social
tailings dams (for storing liquid waste), they can burst, caus
responsibility and shares best practices on sustainability
ing floods that inflict severe damage. For example, in January
among its members.
2019, the Brumadinho dam in Brazil, owned by the mining
firm Vale, collapsed. The ensuing flood killed 270 people and The Principles for Responsible Investment (PRI) group,
polluted the downstream river's ecosystem, which prompted launched in 2006, has played a similar role to the WBCSD
an outcry from many of Vale's investors; the firm's share price for investors.
also crashed, falling by 24% on the first trading day following
By joining PRI, investors commit to
the incident. These sorts of incidents can lead firms to face
pressure on many fronts, such as from regulators, making it 1. incorporating ESG in investments and decisions;
more difficult or costly to secure permission to operate in the 2. being active owners;
future, or from skeptical investors putting heavier scrutiny on
3. seeking disclosure on ESG issues from investee firms;
companies' practices. Too many such destructive incidents can
even risk a business' "social license to operate."
4. promoting acceptance and implementation of the
Principles;
Many key sustainability risks that are financially material on
5. collaborating to implement the principles; and
reasonably short timescales are climate change-related.
Therefore, climate change forms a large portion of risk 6. reporting activities and progress toward implementing
based sustainability analyses (see Chapter 3). the Principles.
The PRI, as a very early coalition, has helped pave the

2.6 Private-Sector Sustainability way for later issue-specific coalitions ranging from
Coalitions and Frameworks groups like the Alliance to End Plastic Waste to com
modity specific organizations like the Roundtable for
2.6. 1 Private Sector Sustainability Coalitions
Sustainable Palm Oil (RSPO) to climate groupings such
In the sustainability space, a particularly important role as Climate Action 100+ (see further discussion on coali
has been played by corporate and investor groups and tions in Chapter 4).
1fflMY¥i
SUSTAINABILITY INITIATIVES AND COALITIONS
General/Corporate Initiatives
Name Members Description
World Business Council for Cross-sectoral An organization of over 200 global firms, formed in the wake of
Sustainable Development the 1992 Rio Summit. Members come from a range of industries,
(WBCSD) such as consumer goods (Nestle), chemicals (Dupont), or oil & gas
(BP). Firm CEOs act as council members.
Business for Social Cross-sectoral A network organization that helps develop resilient business
Responsibility (BSR) strategies and connects member companies with sustainable
business experts.
UN Global Compact (UNGC) 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.
Business Roundtable 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.
Financial-Sector Initiatives
Principles for Responsible Asset managers The six Principles for Responsible Investment are a voluntary and
Investment (PRI) and owners aspirational set of investment principles that offer a menu of possible
actions for incorporating ESG issues into investment practice.
Principles for Sustainable Insurers Launched in 2012, the four Principles for Sustainable Insurance
Insurance (PSI) are designed to guide better management of ESG issues and
strengthen the insurance industry's contribution to building a
resilient, inclusive, and sustainable society.
Principles for Responsible Global banks The six Principles for Responsible Banking provide the framework
Banking (PRB) 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.
Global Impact Investing Net- Asset owners, asset GIIN is a nonprofit organization dedicated to increasing the scale
work (GIIN) 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.
Natural Capital Finance Alli- Financial sector NCFA provide the knowledge and tools that help the financial
ance (NCFA) 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 Sustainability Accounting Standards Board (SASB). SASB
Risk was founded in 2011 to provide standards which enable
the disclosure of decision-useful information on financially
An important area where initiatives and frameworks have
material sustainability information by companies to their
been influential on sustainability is in homogenizing and
investors. SASB standards provide guidance across a broad
standardizing how companies disclose and report on
spectrum of sustainability issues, but break this down for
sustainability-related information. Broadly speaking, there
companies by singling out the most materially relevant
are two different types of reporting frameworks.
issues in each of 77 industries.
Global Reporting Initiative (GRI)
International Sustainability Standards Board
The first, are those which focus on providing a framework
In 2021, SASB was one of several reporting frameworks
through which companies can report on all sustainability
to be consolidated into the newly formed International
related impacts, regardless of whether these are financially
Sustainability Standards Board (ISSB). The ISSB, which was
material to investors or not. The most prominent framework
established under the International Financial Reporting
in this field was developed by the Global Reporting Initia
Standards Foundation, is currently developing new financial
tive (GRI) which, was launched in 1997 in the wake of the
reporting standards for the disclosure of a broad range of
Exxon Valdez oil spill. Today, the GRI provides widely used
sustainability risks, with first standards expected to be final
sustainability reporting standards through which companies
ized in 2023.
can report on their impact on a wide range of sustainability
issues such as climate change and human rights. In addition to these frameworks which cover a wide range
of sustainability topics, there are a multitude of more issue
Sustainability Accounting Standards Board (SASB)
specific reporting frameworks. For example, the Taskforce
In the second group, are those frameworks which allow on Climate-Related Financial Disclosures, have sought to
companies to specifically report on those sustainability provide holistic recommendations for disclosing all kinds
issues which are financially material to investors. For exam of climate risks, from physical risks caused by the physical
ple, this includes the reporting standards developed by the impacts of climate change to transition risks caused by the
CASE STUDY: ISSB S1 AND S2 DRAFT STANDARDS

In March 2022, just months after it was first launched, the on the issue of climate-related risks and opportunities. In
ISSB published exposure drafts of its first two standards: drafting the standard, the ISSB explicitly integrated the
• the [draft] IFRS S1 General Requirements for Disclo recommendations of the TCFD. It would require firms
sures of Sustainability-related Financial information, to disclose all material information on their governance,
and strategy, risk management, as well as the metrics and
targets used to monitor and assess climate-related risks
• the [draft] IFRS S2 Climate-related Disclosures.
and opportunities.
The S1 standard provides an overarching framework for
Both drafts have undergone public consultation period
the disclosure of all material sustainability-related finan
and are, as of February 2023, being redeliberated by the
cial information.
board. It is currently expected that the final standards
The S2 standard builds on top of this framework and sets will be issued in June 2023 and can then be picked up
out more granular disclosure requirements specifically and implemented by national legislators
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 Chow, S. Y. C. (2010). Cross-country Comparison of Share
work of the Partnership for Carbon Accounting Financials holder Engagement for Responsible Investment. University
is even more specialized, and provides guidance for how of Melbourne. Melbourne.
financial institutions can measure and report their financed
Friedman, M. (1970, September 13, 1970). The Social
emissions.
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

QUESTIONS
2.1 How is sustainability best defined? 2.4 What are nature-based solutions and how can they
A. Practices that avoid all use of natural resources, address climate change?
exclusively using recycling A. Nature-based solutions use modified versions of

natural processes to accomplish societal goals. For
B. Meeting current needs without overburdening the
instance, agricultural crops or trees for commercial
natural environment or future generations
forestry can be genetically modified to increase
C. Measures to reduce greenhouse gas emissions
their carbon dioxide absorption.
D. Compliance with requirements by SASB
B. Nature-based solutions use natural solutions to
2.2 How do sustainability and ESG fit together? help human society. For example, certain plants
A. Sustainability is a concept mainly used by the and insects in the Amazon rainforest have been
private sector, whereas ESG is mainly used by gov found to contain compounds that can help treat
ernments and the public sector to set policies and certain forms of cancer.
regulations. C. Nature-based solutions protect, manage, or

B. Sustainability is the broadest concept, encompass restore ecosystems while also addressing societal
ing public and private action; ESG is typically used challenges. For example, vegetation naturally
by the private sector to measure companies and absorbs carbon dioxide, so restoring and replant
screen investments. ing forests can help remove carbon from the
atmosphere.
C. Sustainability relates to compliance with SASB
recommendations, whereas ESG relates to compli 2.5 What role have private-sector coalitions played for
ance with GRI recommendations. sustainability?
D. ESG is limited to environmental and social action, A. Coalitions have encouraged the diversion and divi
whereas sustainability also encompasses other sion of sustainability reporting and frameworks
kinds of policies. over time.
2.3 What are the Sustainable Development Goals (SDGs)? B. Coalitions have provided frameworks for com
panies to report financially immaterial impacts to
A. A set of goals developed by the Business Round
investors.
table for businesses to implement sustainable
practices C. Coalitions typically have strict, legally binding con
ditions on sustainability to join, providing strong
B. A set of goals developed by the World Bank to
pressure for companies to conform to the relevant
govern financing directed to emerging markets
practices.
C. A set of goals developed by the Principles for
D. Coalitions can act as collective actors, pressuring
Responsible Investment (PRI) for investors to allo
companies to change their practices or policymak
cate assets in a sustainable manner
ers to tighten regulations.
D. A set of goals developed and agreed to by the UN
and its member countries to shape global policy
and private-sector action
ANSWERS
2.1 B 2.4 C
2.2 B 2.5 D
2.3 D

Climate Change
Risk
• Describe how climate risk can translate to financial • Define and provide examples of indirect risks.
risk.
• Discuss how physical and transition risks can provide
• Differentiate physical and transition risks. opportunities for companies and sectors.
• Understand how hazards/drivers, exposure, and vul • Identify the drivers of transition risk. Categorize
nerability interact to manifest physical and transition transition risks (e.g. technology, market) and provide
risks. examples.
• Define stranded assets and discuss how different sec • Discuss human capital as a stranded asset and the
tors may experience stranded asset risk. challenges associated with asset stranding and a just
transition.
• Define and differentiate acute and chronic hazards.
Provide examples. • Understand current industry trends for transition and
physical risk categories and strategies companies
• Discuss uncertainty, variability, and accuracy in hazard can take to reduce risk or manifest climate-related
model predictions (e.g. frequency, timeframes). opportunities.
Identify data challenges modeling direct physical risk.
51
• The economic transformation required to reach climate
This chapter provides a comprehensive introduction change targets, which is a source of transition risk, is
to the financial risks linked to climate change that huge and unprecedented in speed and scale.
throughout this text are referred to simply as climate
• Transition risks manifest not only through policies but
risk. It explains the two main subtypes of climate
also from technological change, reputational risk,
risk: physical risk (resulting from the physical weather
litigation risk, and market risk.
impacts of climate change) and transition risk (result
• Climate risk transmits into the economy through corpo
ing from the economic transformation to a net-zero
rate and financial balance sheets and consumer spend
carbon economy), delving into the causes and impli
ing patterns; however, the effects vary significantly by
cations of each type. Chapters 6 and 7 return to,
sector.
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). CLIMATE CHANGE RISK
3.1 Introduction to Climate Risk
Chapter Outline Climate-related financial risks, referred to throughout this
3.1 Introduction to Climate Risk text as simply climate risk, are the financial risks linked to
climate change. Climate risk can affect financial balance
3.2 Types of Climate Risk
sheets and lead to losses through standard channels such as
3.3 Physical Risks diminished asset valuations or increased loan defaults.
3.4 Transition Risks Anthropogenic climate change is a huge subject that
3.5 Stranded Human Capital and the Just Transition involves intense and multi-disciplinary scientific inquiry,
inspires passionate political and social movements, and
3.6 Transmission into Finance, the Economy, and Key Sectors
raises as many political, social, and moral questions as it
does economic and financial ones. Science shows that it is
Key Learning Points indisputable that human-caused emissions of carbon diox
ide (CO2) and other greenhouse gases, such as methane,
• Climate risk can be caused by the physical effects and
are warming and disrupting the climate. Some arguments
changing weather patterns that result from climate change-
persist over the most appropriate means and timeline
physical risk-or by efforts to reduce and eliminate the
for reducing and/or eliminating emissions to mitigate
greenhouse gas emissions that cause it-transition risk.
climate change. However, increasing numbers of govern
• Climate risk results from an interaction of hazards or driv
ments are converging on a goal of net-zero emissions by
ing factors with exposure and vulnerability.
2050. This is in line with recommendations by the Inter
• Environmentally unsustainable or otherwise climate governmental Panel on Climate Change (IPCC), and the
affected assets can suffer from unanticipated or prema goals of the Paris Agreement of 2015 to keep the aver
ture write-offs due to either physical or transition risk, °
age global temperature rise "well below 2 C above pre
thus becoming stranded assets. industrial levels" and to "pursue efforts to limit the rise
°
• T here is significant variability between hazards as to the to 1.5 C" (UNFCCC, 2015). One area where debates still
accuracy with which historic data and climate models can rage is over how best to address and adapt to the physi
provide precise estimates. Global average temperatures cal impacts of climate change, including what entities
are near certain to increase, but uncertainty persists on (companies, rich countries, etc.) should bear the main
precipitation patterns. the cost.
• Physical risks can have strong direct effects, but also Although the notion of climate risk is clearly linked to broader
indirect ones through supply chains, legal liability, or sys discussions around the phenomenon of climate change, and
temic and second-order effects. to international goals such as those of the Paris Agreement,

climate risk is a distinct subset of these discussions. Under report from 2017 (see below), but it has also produced
standing the risks resulting from climate change does not other documents and technical annexes before and since.
require absolute certainty from a climate model, or conclu This chapter largely follows TCFD categorizations, notably
sively assigning moral blame, but rather a focus on under with regard to the subtypes of transition risk.
standing how physical climate hazards or drivers of economic
Viewing climate through a risk lens means zeroing in specifi
low-carbon transition affect firms and financial outcomes.
cally on the ways in which climate change affects assets,
The source of the notion of climate risk is therefore some through hazards and drivers, exposures, and vulnerabilities
what distinct from wider climate discussions. While these (Sections 3.2-3.4); how they transmit into the real and
wider discussions are carried out through the United Nations financial economies affecting households, governments,
Framework Convention on Climate Change (UNFCCC) and companies, and the financial institutions that lend to and
periodic intergovernmental summits, such as the one that invest in them (Section 3.5); and, how different sectors are
resulted in the Paris Agreement, the notion and analysis of differentially affected.
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 3.2 Types of Climate Risk
(TCFD), formed in 2015 under the aegis of the G20 Finan
Climate risk is usually divided into two broad categories:
cial Stability Board. This international body is chaired by
physical risk and transition risk. Physical risks
Michael Bloomberg, an entrepreneur, and is composed
(see Section 3.3) arise from the physical climate (and
largely of private-sector representatives from both financial weather) impacts that result from the changing climate,
and non-financial corporations. The TCFD's outputs have whereas transition risks arise from the economic transforma
been particularly influential. It is best known for its final tion and any dislocation needed to drastically reduce, and
TCFD FRAMEWORK AND RECOMMENDATIONS: FINAL REPORT (2017)

The TCFD singles out physical and transition risk as the • designed to solicit decision-useful, forward-looking
main sources of climate risk. It splits physical risk in two
information on financial impacts; and
subtypes: acute and chronic. It splits transition risk into
four subtypes: policy and legal, technology, market, and • strongly focused on risks and opportunities related to
reputational. transition to lower-carbon economy.
TCFD recommendations state that firms should disclose According to the TCFD 2022 Status Report, over 3,800
on four key parameters, ranging from the concrete to organizations have become supporters of the TCFD
the abstract, so that firm shareholders and other stake Recommendations, including over 1,500 financial insti
holders are aware and fully informed of the progress the tutions responsible for assets of $217 trillion. Based on
firms have made in their preparedness to tackle climate the fiscal year 2021 reporting of over 1,400 companies,
change. These are metrics and targets, that is, the met 80% of companies disclosed in line with at least one
rics used by the firm in question to assess climate-related of the 11 recommended disclosures; however, only 4%
risks and opportunities; risk management, that is, what disclosed in line with all 11 recommended disclosures
processes the firm has in place to manage climate risks; and only around 40% disclosed in line with at least five.
the firm's strategy surrounding climate change; and the Europe remains the leading region for disclosure, and
governance structures the firm has in place to address reporting on climate-related risks and opportunities is
and take responsibility for climate issues, including at higher than any other recommended disclosure. Despite
board level. this, the resilience of companies' strategies under dif
Key features of the recommendations are that they are ferent climate-related scenarios continues to have the
intended to be lowest level of disclosure, while governance remains the
least disclosed recommendation.
• adoptable by all organizations;
Source: TCFD 2022 Status Report
• included in financial filings;
Chapter 3 Climate Change Risk ■ 53

eventually eliminate, net greenhouse gas emissions to reach At the corporate level, vulnerability can refer to the lack of
net-zero emissions-a goal that many countries have set preparation for such issues as climate change mitigation and
for themselves to reach by 2050. However, some countries adaptation planning, or it can apply to a lack of financial
have set slightly earlier goals (for example, Finland has set resilience, such as through insurance-based mechanisms.
a goal for 2035), and some countries have set slightly later
Overall, the interaction between hazards or drivers, expo
goals (for example, China has a goal for 2060), and there
sures, and vulnerability then produces the overall effect of
are other jurisdictions that have not yet made any net-zero
climate risk (see Figure 3.1 ).
commitments.
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

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

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

• Average temperature rise Increased incidence of the following:
• Sea level rise • Storms and hurricanes

• Changing precipitation patterns • 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 :,
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0 emission scenario
nd data prepared by Berkeley Earth and combined 0 "iii
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6 RCP2.6
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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

CESM1-BGC CCSM MPI-ESM-MR
MPI-ESM-LR NorESM1 GFEDv4s
0.0 0.5 1.0 2.0 5.0 10.0 20.0 50.0 100.0

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 To point out the shortcomings of, and disagreements
tion between climate events and local conditions, such between, models is not to say that they are not useful,
as flooding or wildfires. Large amounts of rainfall within merely that given some uncertainty in the models them
a short period of time make it more likely that a river will selves, calculating actual direct physical risk is a step more
overflow its banks, but the particular topography of a difficult (see next section).
specific river valley also affects how and where flooding
For acute physical hazards, it is not necessary to rely on
will occur (not to mention the presence, or absence, of
models exclusively. The increased incidence of acute haz
human-built flood defenses). Droughts make it more likely
ards is already visible in the natural catastrophe data from
for fires to start, but wildfires need vegetation to burn,
the past several decades of (see graph, below), and this
meaning models must take both climate and land cover
trend is expected to continue.
into account-and, ideally, human land-use patterns as
well. The interaction of these multiple factors makes it par Moreover, a relatively new offshoot of climate science, attri
ticularly difficult for models to accurately predict wildfire bution science, is now able to show how specific events are
locations. One study to validate models, which compared (partially or almost completely) caused by climate change.
five different model-predicted wildfire areas (panels 1-5 According to research of this type, the devastating Australian
of Example 2, above) to measurements of the actual area wildfires of 2019-2020, for example, were made at least 30%
burnt from satellite data (see the panel labeled GFEDv4S more likely by climate change, and the huge Thai floods of
above), showed that many models overestimated the burn 2011 would likely not have occurred without climate change.
ing potential in North and South America while underesti The July 2019 heatwave over France and the Netherlands
mating it in Africa. would have been extremely unlikely to occur without human

900
800
700
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300
ll ,� ;t l�
200
100 I I -
0 II IJ a ll ll ll I I II � I I � � ll 1 I �� I � Iii! 11
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ra;:m.•j••1t•¥E'!!■'.wM
influence on climate. Similarly, the Siberian heatwave of 2020, Getting precise enough data on these hazards is not neces
°
when temperatures reached a record 38 C in Verkhoyansk, sarily straightforward either. Some is available open source
far above the Arctic Circle, would have been almost impos or free from academic institutions or international organiza
sible without human-caused climate change.The floods in tions or non-governmental organizations such as the World
Germany in 2021 and the 2022 drought in the US are also Resources Institute; other climate data can be bought from
considered to have been exacerbated by human activity. specialist consultancies, some of which also offer their own
ready-made ways to evaluate exposure and vulnerability.
3.3.2 Direct Physical Risks and Data For some hazards, such as flooding, which depends on
Granularity hyper-local topography, resolution matters tremendously: for
instance, JBA Consulting, an industry leader in its field, sells
Understanding direct physical risks as they apply to a spe
flood map data at a Sm X Sm resolution. Much of the other
cific asset or company, or even country, is not straightfor
climate data that is downscaled from global climate models
ward. Beyond the differences between the different global
appears at a much rougher resolution, such as 100 km x 100
climate models' estimates for various hazards (see above),
km, and even still suffers from lack of robustness over shorter
readjusting these climate models to derive regional or local
timescales, as discussed in Section 3.3.1.
estimates leads to less precision.
Moreover, climate hazards do not, alone, cause climate risks With climate data in hand, mapping exposures is not exces
to become apparent. Firstly, certain types of physical risks sively difficult, and it only requires precise location data to
require an interaction between climate events and local cross-compare with climate hazards. Investors in, owners
conditions, as discussed above in Section 3.3.1 with regards of, or lenders to specific physical assets, such as a particu
to wildfires. Droughts make it more likely for fires to start, lar warehouse or wind farm, should already know where
but wildfires need vegetation to burn. Secondly, and per the asset is located. And although a firm should know the
haps more importantly, as discussed above in Section 3.2, location of its own production and office facilities, inves
physical risks occur only when there are also exposure and tors in, or lenders to a firm may not currently know precise
vulnerability. geolocations.

Vulnerability, however, is an area where there is still very little For instance, a company could be sued for not adequately
visibility or data because it ultimately refers to facility-level preparing for physical risks. One such example currently
preparedness: Two nearby factories in the same flood-prone making its way through US courts is Conservation Law
area might be affected differently if only one has flood walls, Foundation v. Shell, an ex-ante claim by the Conservation
basement pumps, or worker contingency plans. A firm plan Law Foundation, a non-governmental organization, filed in
ning a large greenfield capital expenditure, such as a new 2017 against Shell, the multinational oil and gas firm, claim
factory, will be able to hire consultancies that specialize in ing it had failed to satisfactorily prepare its Providence Fuel
climate engineering to evaluate the present state of adap Terminal for sea level rises and the increased frequency
tive infrastructure, such as floodwalls or the cost of building and intensity of severe weather events ("Conservation Law
them. But a large firm may not have detailed information on Foundation, Inc. v. Shell Oil Products US").
all of its own legacy assets, let alone on interdependencies
A third, more nebulous, category are the indirect physi
through its supply chains (see also next section). And other
cal risks that can be considered systemic in their propa
counterparties with stakes in a firm's continued well-being,
gation effects and their multifaceted nature. A good
such as banks, institutional investors, auditors, or credit rat
example is the nascent literature from both academia
ing agencies, may have even more limited data access.
and policymakers quantifying the effects of heat stress on
worker productivity. The International Labor Organiza-
3.3.3 Indirect Risks: Supply Chain, Legal, and tion, for instance, estimates that by 2030, when the global
°
Systemic Risks temperature is expected to have risen by 1.3 C, the share
of total working hours lost will be 2.2%, or the equiva-
Physical risks do not only affect assets and the companies
lent of 80m full-time jobs (up from 1.4% and 35m jobs as
that own them, through exposure to hazards, but there are
recently as 1995). In monetary terms, it estimates this loss
several other ways in which climate-related physical risks
at USD 2.4 trillion in purchasing power parity terms (com
can affect assets and firms.
pared to USD 280 billion in 1995, meaning a net loss of
Perhaps the most straightforward of these is supply chain over USD 2.1 trillion in 35 years of climate change alone).
risk. Of course, this risk is partly a matter of classification. Two It further warns that these are likely to be underestimates,
identical firms, one that is vertically integrated and another as they are based on the assumption of limiting warming to
°
that has outsourced production to suppliers, may both be 1.5 C by 2100, which looks extremely unlikely (ILO, 2019).
subject to the same physical risks in the production process
only for the first, this would be counted as affecting the firm 3.3.4 Opportunities, Resilience, and Adaption
itself, and for the second, it would count as a supply chain
While many climate risk management discussions seek to
risk. Nonetheless, all firms rely to an extent on suppliers.
balance risks with opportunities, when discussing physical
Other severe indirect impacts with financial implications
risk specifically, the argument is harder to make. Physi-
include the infrastructure (roads, railways, airports) needed
cal risks, at least for private-sector counterparties, tend to
to transport things in and out of factories and the housing of
bring more downside than upside. Occurrences such as hur
employees. For example, if a plant is well protected from a
ricanes, wildfires, or floods can bring huge losses through
flood but workers have to deal with their own homes being
facility destruction and business interruption. Paying large
under water, or if the roads to and from our plant are not
amounts to adapt and fortify facilities against physical risks,
usable, a company might not able to operate.
such as through building firebreaks, floodwalls, or better air
A second important kind of indirect risk is legal liability conditioning systems, does not produce a profit or revenue
risk, where firms suffer financial consequences after being stream per se, but rather simply avoids large losses that
held legally liable. Liability risk can exist for both physical would have otherwise happened. For corporations, insur
and transition risks (see Section 3.4.1 on transition-related ance availability is crucial to mitigate financial losses, and
liability); for physical risk issues, liability usually comes into thus insurers' willingness to pull out of coverage in cases
play with regard to the duties and responsibilities of cor of particularly severe exposure to physical climate risks, as
porate management or a company's board of directors. 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,
140 +---�---�--�--�---�---
Data: SSP database (IIASA)/GCP/Riahi et al. 2017/Rogelj et al. 2018
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2040
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1980 2000 2020 2060 2080 2100
Change.
"Explainer: How 'Shared Socioeconomic Pathways'
Source:
explore future climate change" (April 2018) Chart produced
liH'i#♦i:i
for Carbon Brief by Glen Peters and Robbie Andrews from the
Global Carbon Project,https://www.carbonbrief.org/explainer
how-shared-socioeconomic-pathways-explore-future-climate
change/. Reprinted by permission from Carbon Brief.
bf?i1ik♦iJ
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target-slipping-out-of-reach/. Reprinted by permission from
Carbon Brief.
blWii♦i·>
°
most models and scenarios for reaching a 1.5 C equilib tax and, despite hitting record levels in the EU on 2023, the
rium, including ones used by the IPCC, assume very large price of carbon is not anywhere close to high enough on its
amounts of net-negative global emissions (see Figures 3.7 own to reduce emissions sufficiently to reach internationally
and 3.10). Natural ways to remove carbon from the atmo agreed-upon targets.
sphere, such as planting more trees, can only address a
Therefore, more recently, there has been a recognition that
small fraction of these needs: To reach the scales assumed
the means through which emissions (the drivers of transmis
in these models would require massive and extremely rapid
sion risk) will actually be reduced will be both more varied
rollout of technologies and practices such as directly captur
and less neat than simply imposing a high carbon tax that
ing CO2 from the air (known as direct air capture, or DAC),
would seem an optimal solution in economic models, but
or bioenergy with carbon capture and storage-growing
that has so far struggled to gain ground in light of political
plants, which absorb CO2 from the air, then burning them
realities. This section follows TCFD-outlined best practices
to generate electricity, but capturing the CO2 from combus
in describing transition risk drivers as including policy and
tion and burying it, thus resulting in net removal.
legal risks (encompassing factors ranging from mandatory
shutdowns to legal liability); technology risks (e.g., cheaper
Seeing the pace and change required to meet any of these
renewables making fossil fuel-based power generation less
climate goals, it is easy to imagine that these would be
economical by comparison); reputational risks (e.g., from
pursued mainly, or even exclusively, through government
bottom-up consumer pressures for sustainable products);
policies, and therefore that policies would be the primary
and other risks, such as market risks.
or even only source of transition risk. For decades, both
policy developers and academic economists have discussed This section concludes with a discussion of the various
the optimal way to reduce (and eventually eliminate) green opportunities presented by the transition. More so than
house gas emissions, and these discussions have revolved with physical risk, where the main focus is on avoiding or
around centralized policy options such as imposing a price reducing the potential for losses, the converse of transition
per ton of carbon dioxide emitted through a carbon tax or risk can be found in a myriad of economic and investment
limiting quantity through a cap-and-trade scheme-both opportunities presented by the speedy, wholesale transfor
of which have been implemented in various jurisdictions mation of the economic structure that much of the world
worldwide. However, currently, there is not a global carbon has committed to undertake.

3.4. 1 Policy and Legal Risks that can result in risk to companies. A relatively straight
forward one is a tactic increasingly adopted by activist
The sources of policy and legal risk in causing climate transi
and advocacy organizations-filing suit in court against
tion risk are varied. As already described, the classic policy
carbon-intensive projects on the grounds that these proj
solutions for achieving emissions reductions have tended
ects breach existing environmental rules or commitments
to be either carbon taxes, setting a price on emissions, or
and should not have been approved. A prominent example
cap-and-trade schemes, which set a limit on quantity. But
of this is the suit filed by ClientEarth, a climate litigation
other important policies can also lead to transition risks.
NGO, against Enea, a Polish utility, alleging failure to con
One important example is that of energy efficiency, such as
sider the material climate-transition risks of its project to
energy requirements for residential buildings or emissions
build a large €1.2 billion coal-fired power plant, Ostrd�ka
requirements for new automobiles-which can be set at
C ("ClientEarth v. Enea," 2019). (In this particular case, the
either the level of individual vehicles or at the fleet level.
Poznan District Court did find in ClientEarth's favor in 2019,
Another source of policy risk is government-mandated
but they did so on a technicality, meaning the judge did
closures, ranging from cancellations of previously agreed
not need to formally determine whether Enea had failed to
fossil-fuel infrastructure projects, such as natural gas pipe
consider climate risks.)
lines and mandatory shutdown dates for certain types of
high-emitting facilities, such as coal-fired power plants.
A much broader strand of legal risk comes from nascent
Other examples include energy-efficiency regulations and
efforts to directly pin legal liability on firms for their propor
limits on pollution.
tional contribution to the physical impacts of climate change
Legal risks, when a firm is held liable, can result in various through their emissions. A landmark case in this regard that
consequences ranging from fines or penalties to class action is slowly making its way through German courts is Lliuya v.
damages or changes in valuation. In relation to transition RWE, where a Peruvian farmer alleges that the emissions of
risk, there are at least two potential strands of litigation RWE, a German utility, partially caused the glaciers around
EXAMPLES OF TRANSITION RISK FROM SOURCES OTHER THAN CARBON

PRICES OR CAP-AND-TRADE:
• April 2019: Fiat Chrysler Automobiles (FCA), an summer 2020, will thus only have a maximum of 18
Italian-American automobile manufacturing group years to run, though the owner, Uniper, may consider
(now part of Stellantis after a 2021 merger with closing it earlier.)
Groupe PSA of France), was forced to pay Tesla, an • January 2021: In his first day in office, the new US
all-electric American car manufacturer, hundreds president, Joe Biden, cancelled the permit for the
of millions of euros to avoid fines for breaking E.U. planned Keystone XL oil pipeline to cross from
standards on average fleet emissions. T hrough the Canada into the United States, thus terminating the
payment, Tesla's car output was counted as part of project. T hough there were also other reasons that
FCA's fleet for regulatory purposes, thus lowering the led to such a large political movement against the
average fleet emissions. project, including opposition from Native Americans
• July 2020: Germany passed a law mandating the and from local ranchers, the pipeline, which would
closure of all coal-fired power plants by 2038 at the have carried emissions-intensive Albertan oil that
latest and providing compensation to owners. Many was derived from tar sands (a process in which the
of these plants will be shutting before the end of their sand has to be heated and processed to release oil),
operational lifetime, which can be 30-50 years, thus was also seen as incompatible with making progress
becoming stranded. (For instance, Germany's last toward climate change mitigation.
new coal power station, Datteln 4, commissioned in Sources: Energy Central; Reuters; FT; New Yorker.

a particular lake to melt due to their historic emissions, Other technologies, such as lithium-ion batteries, are on
which increased flood risk. This line of argument relies on similarly steep learning curves, becoming ever cheaper.
the contention that RWE can be held proportionally liable Batteries, in turn, can be used not only for utility-scale
on the basis of its pro-rata contribution to all human emis energy storage, further strengthening the usability of wind
sions, which is estimated at 0.47% of historic CO 2 emissions and solar energy for electricity that would otherwise be
(Luciano Lliuya v. RWE AG). While still at an early stage, if intermittent, but also for other sectors.
this case succeeds, legal liability risk may be a much larger
The continued cheapening of, and improvement of,
concern and source of risk for firms than it is currently.
battery technology makes it conceivable that the trans
portation sector will be the next to be hit by technology
3.4.2 Technology Risks risks and potential asset stranding. According to Bloom
As much as changing technology is seen as a benefit, it can bergNEF, electric vehicles will hit price parity with inter-
also serve as an important driver of transition risk for older nal combustion engine (ICE) vehicles once battery pack
assets and laggard firms reliant on outdated technology prices (the single most expensive component of EVs) reach
that becomes less economical, or even obsolete. USD 100/kWh. Based on current trends, the threshold of
USD 100 is expected to be reached around 2023. After this
Perhaps the most powerful example of these technology
point, EVs will be as affordable as, and after, even cheaper
risks so far involves the technological development of
than, combustion engine vehicles-even without subsidies
renewable energy. In the past decades, wind turbines and
or further policy incentives, meaning there will be a strong
solar photovoltaic (PV) panels have fallen so steeply in price
economic incentive to switch and that existing ICE fleets
that they are now cost-competitive with, or even cheaper
may end up becoming stranded assets.
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
Reputational Risks and Consumer Pressure
Case Study in Section 3.6). Figure 5.8 depicts the impres Reputational risks and bottom-up or lateral pressures from
sive 68% drop in the global weighted average levelized cost consumers, clients, suppliers, or employees can be an
of electricity (LCOE) of concentrated solar power (CSP) from important source of transition risk. The classic type of repu
2010 to 2020, delineating its principal components. 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

by its association with industries that are seen as unsavory can be seen to exist also in other sectors. For instance,
(see Goldman Sachs example). Apple's commitment to carbon neutrality in its supply chain
and products by 2030 has led it to demand sustainable
This concept is related to the more abstract notion of the
raw materials, resulting, for instance, in its purchase of the
"social license to operate," whereby firms' business mod
world's first zero-carbon aluminum from an Alcoa-Rio Tinto
els must satisfy a minimum requirement of acceptability
joint venture. In a similar vein, commodity markets that
and cannot be so noxious as to be considered immoral or
have previously been fairly homogeneous have seen a trend
unconscionable by wider society. While it is difficult to sin
toward separate labeling and marketing due to upward
gle out a particular firm or sector that completely went out
pressure. A good example is the separate labeling and cer
of business due to this alone, some sectors, such as tobacco
tification of "green steel," in comparison to normal steel,
or certain weapon manufacturers, have at times come
which allows end users to differentiate between steel made
close-certainly close enough for this to impact their share
in more environmentally friendly ways (such as through
prices and access to capital markets. Some of the highest
the use of hydrogen) rather than the typical method that
emission, climate-unfriendly industries, such as coal and tar
involves burning large amounts of coal.
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

3.4.4 Market and Other Transition Risks
from consumers and stakeholders can also be an important Other notable sources of transition risks include the notion
driver of change-for flexible firms, greater opportuni- of market risk, which in relating to climate transition risk
ties, and for firms that are inflexible or slow to respond, encompasses a broad range of potential supply, demand,
transition risk. In consumer products sectors, as consumers and pricing effects.
become more aware of the climate impact of their pur
The most straightforward kinds of market transition risks
chases, agile firms will respond by increasing the selection
relate to the shifting demands from high-emissions products
and availability of sustainable products, whereas staid firms
to low-carbon products and commodities. As industries and
will be left behind. Consumer influence is most obvious
equipment transition to using cleaner fuels or become elec
in household goods or food products (for example, the
trified, the demand for coal will fall, potentially completely;
increasing recognition of the high climate footprint of meat
oil and gas demand will also likely reduce significantly,
and dairy products, which is driving part of the demand for
though oil has non-combustion uses such as in petrochemi
plant-based meat and dairy alternatives).
cals. This will then filter through to sectors such as coal
But using a broader definition of "consumer" to encompass mining or bulk coal shipping. Likewise, shifts and spikes in
all sorts of client-supplier relationships, this type of pressure demand for low-carbon commodities, or commodities that
EXAMPLE: REPUTATIONAL RISK RELATED TO CLIMATE-CASE:

GOLDMAN SACHS
Goldman Sachs is arguably the most renowned and The bank has many mechanisms in place which seek to
prestigious Wall Street investment bank; hence, the pre-empt and mitigate climate-related reputational risk.
firm takes issues of reputational risk seriously and The bank's board of directors places "significant focus"
singles them out in its TCFD reporting. It says that on issues of reputational risk in its considerations. The
"involvement in certain industries associated with cli bank also has a firm-wide Reputational Risk Committee,
mate change" may pose reputational risk to the firm. which provides oversight over transactions that include
Specifically, it says it may lead to "reduced client and some climate-related dealings that may attract height
employee loyalty, investor divestment and impacts to ened reputational risk.
client activity." Source: Goldman Sachs 2019 TCFD Report.

are needed for low-carbon infrastructure, may cause market forests (e.g., logging concessions), transport (e.g., ports),
disruptions. For example, there have been periodic con the built environment (e.g., offices), and agriculture (e.g.,
cerns around the availability of lithium, crucial for lithiumion land-use change).
batteries, and copper, used widely in electric vehicles and
The faster the pace of decarbonization, the greater the
other electric equipment.
chance of stranded assets in different sectors and the
Another kind of market transition risk that is already larger the likely economic, social, and political conse
manifesting itself is through shareholder perceptions or quences that might need to be managed. This could desta
pressures in public markets. A large portion of the value bilize low carbon transitions and prevent the realization
ascribed to oil & gas firms, for instance, has historically of climate objectives. The mere threat of stranded assets
been due to their proven reserves. Oil majors have been could result in groups potentially affected actively or pas
forced to write off assets; in June 2020, for instance, sively, frustrating or destabilizing low carbon transitions.
oil-major BP cut the value of its assets by a full USD These groups could include the owners of assets potentially
17 .5 billion, and Shell pie. by USD 22 billion. impacted, the businesses operating assets, communities
hosting assets, and policymakers reliant on tax revenues
generated from assets.
3.5 Stranded Human Capital and the These issues are already being felt acutely in different parts
Just Transition of the world. In 2016, China announced a USD15 billion
compensation fund for unemployed iron and steel work-
Assets that can become stranded are not just limited to
ers and coal miners (Wood Mackenzie 2016). The structural
physical or tangible assets. Intangible assets, such as intel
challenges facing coal mining communities in Germany and
lectual property, social networks, and company reputa
Poland have also become a significant issue for national and
tion can also become stranded, and so can the skills and
provincial governments in each country, having a significant
expertise held by workers and professionals. This strand
influence on burden sharing negotiations within the Euro
ing can be caused by exactly the same drivers that result
pean Union (Krukowska 2016).
in stranded tangible assets. This is important as the size
of intangibles relative to tangibles has grown over time, This is a particularly salient issue for developing countries
with intangible assets, particularly in advanced economies who have a right to development and access to affordable
becoming an ever-larger share of total enterprise value. energy (Swilling and Annecke 2010) while at the same time
Intangible assets for S&P 500 companies, for example, hit facing the consequences of global warming and dwindling
a record value of USD 21 trillion in 2018: intangible assets levels of cheap oil, productive soils, metals, clean water sup
account for around 90% of total assets. plies, and forest products? How do they address widening
inequalities in income as well as the need to rebuild ecosys
There is also growing interest in and concern for a "just
tem services and natural resources. The book considers the
transition," where those that could suffer most from asset
theme of a just transition, which reconciles the sustainable
stranding, for example communities and individuals depen
use of natural resources with a pervasive commitment to
dent on industries most likely to experience asset stranding,
sufficiency, where overconsumers are satisfied with less so
are supported, including, for example, through retraining
that underconsumers can secure enough. The reallocation
provided by companies and governments.
of resources and compensation for those individuals and
Distributional challenges associated with asset stranding communities affected by climate change and related poli
can create political economy frictions within countries and cies could help facilitate a just transition (Caldecott et al.
across countries. Net-zero carbon transitions, particularly for 2016; Newell and Mulvaney 2013). This might be more
countries endowed with natural resources, imply stranded likely to occur in developed countries, where citizens tend
assets in carbon-intensive sectors. In the energy sector, to be able to demand higher relocation costs and stron-
stranded assets could occur upstream (e.g., reserves), mid ger unions demand higher settlements for loss of earnings
stream (e.g., transmission), or downstream (e.g., genera (Funk 2014). Rosemberg (2010) suggests that job losses are
tion). But other sectors could be affected too, for example, not a direct result of national climate policies, but rather are

caused by a lack of social policies and by the anticipation of an effect throughout the financial system and the broader
and investments in alternative mitigation measures. Thus, economy and key sectors. Ultimately, climate risk becomes
providing adequate support for sectors that are losing out relevant to risk managers when climate change's physical
in a low-carbon future and generating new employment impacts, or government policies meant to reduce emissions,
opportunities in low-carbon sectors are critical to ensuring a have an effect on balance sheets and portfolios of firms
just transition (Jagger, Foxon, and Gouldson 2013) 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
3.6 Transmission into Finance, the
these through two sectoral examples: that of physical risk in
Economy, and Key Sectors
real estate (with an accompanying short section on transi
Climate risks matter not only for the assets or firms directly tion risk) and that of transition risk in electricity generation
affected but also because they can propagate and have (with a section on physical risk as well.)
CA SE STUDY 1: REAL ESTATE

Physical risks and real estate despite this level of SLR not expected to be reached until
2100 at the earliest (Bernstein et al., 2019). Keenan and
Real estate is a sector particularly affected by physical
Bradt show that local lenders pass on proportionally more
climate risk, as buildings obviously have fixed locations,
SLR risk to secondary markets than large national banks,
and if those locations are in vulnerable, exposed areas
indicating that they have better access to local soft informa
they will be subject to climate risk. Wildfire and flood risk
tion on SLR risk (Keenan & Bradt, 2020). And Ouazad and
are particularly acute for real estate. In a potentially wider
Kahn show that catastrophes prompt mortgage originators
warning sign, in certain particularly wildfire-ravaged parts
in the United States to increase the share of mortgages
of Australia and California in 2019-2020, local insurers just below the conforming limits of mortgages eligible for
paused or refused to continue selling residential property securitization by the government-sponsored enterprises
insurance. Due to the desirability of living near the coast, Freddie Mac and Fannie Mae, thus passing on SLR risk to
and the typical location of cities along rivers for historic
wider markets (Ouazad, 2019) (see diagram below).
reasons, flood risk is another very widespread and poten
tially severe risk in the real estate sector. One analysis in
Transition risks and real estate
2019 found that 19% of retail spaces and 16% of offices in
Europe are exposed to floods and/or sea level rise, with Though transition risks are not quite as acute as physical
even higher proportions in more severely affected cities, risks for real estate, they do still exist. The main route
such as 23% in Glasgow (Four Twenty Seven, 2019). through which transition risks affect real estate is through
the energy use of buildings, particularly heating. After
But perhaps the most precisely documented physical risk
all, the only direct emissions from most residential or
transmission mechanism is that of the coastal flooding risk
commercial non-industrial buildings are from heating,
in the United States, from both sea level rise (a chronic
which often still relies on natural gas or sometimes oil in
physical hazard) and the risk from an increased frequency
rural areas. Electricity use can also be seen to contrib
of storms and hurricanes (an acute hazard) transmitting into
ute to transition risk in areas where the electricity grid
the property market and thence to banks, insurers, asset
is itself still highly reliant on fossil fuel-based sources of
managers, and owners and the wider financial system. In
electricity, such as coal or natural gas.
this particular transmission chain, empirical evidence from
academic literature gives fairly precise estimates of the Many jurisdictions have updated building codes to
magnitude of these effects. An analysis by Bernstein and require new builds to conform to higher energy
associates in 2019 showed that US properties exposed to efficiency standards and be heated with renewable
sea level rise (SLR) sell for 7% less on average than equiva sources of energy. While these are sometimes grand
lent unexposed properties matched on key characteristics; fathered in for older buildings, this is not always the
those exposed at 1 ft (30cm) of SLR sell at a 14.7% dis case, and the UK's incoming Minimum Energy Effi
count, whereas those exposed at 6 ft (2m) still sell at 4.4% cient Standard (MEES) shows how buildings can cause

transition risk. The UK uses a system where all properties This could lead to transition risk for UK lenders if land
are given an Energy Performance Certificate (EPC) rat lords' credit position deteriorates from lost rental income
ing for energy efficiency on a scale from A to G, with due to their properties having become ineligible (if
G being the worst. As of 2018, the average EPC for they do not make energy-efficiency improvements), or
rented property was an E. Under the MEES rule, from through the market value of Fand G properties falling.
April 2018, properties rated For G were not allowed to The Bank of England has conducted analysis showing
be rented out on new leases, with the rule extending to that the energy-efficiency rating of a property is a predic
existing leases from 2023, with fines for non-compliance. 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

The most straightforward way in which climate risks Physical risks and electricity generation
affect the electric utilities sector is through transition
Even if the exposure of fossil-fuel power generation to
risk. A good example is that of coal-fired power plants,
transition risk is more obvious than the connection to
which have been an obvious focus of attention because
physical risk, the electricity generation sector can be
burning coal for electricity is one of the most emissions
significantly affected by physical climate risk, as well. Two
intensive processes; the CO2 emissions per MWh of
American examples from recent years serve to highlight
electricity output are twice as high as even those from
this: California-based Pacific Gas & Electric (PG&E) and
natural gas power plants (with 1.0 metric ton of CO2
the related wildfires in 2018 and the Texas-based power
from coal per MWh versus 0.4 metric tons per MWh from
plants and an extreme cold snap in 2021.
gas, based on 2019 US data).
Across the western US, climate change-induced
Coal-fired power plants can be affected directly increases in summer temperatures and the intensifica
through transition policy risk, where mandated shut tion of droughts have been a very significant contribu
downs, such as Germany's phased shutdowns by tor to wildfires, with climate change responsible for
2038, means coal plants close before the end of their doubling the cumulative forest fire area since 1984. In
operational lifetimes and become stranded assets (see 2018, in a dry and warm spell, poorly maintained equip
Section 3.4.1). ment from PG&E, California's main power utility, ignited
fires, including the campfire that killed 84 people and
But coal power generation can be affected equally by
destroyed the town of Paradise. The firm has been held
technology transition risk in the form of cost competition
liable in court and had to declare what has been termed
from renewable technologies. From a global levelized
the "first climate-change bankruptcy."
cost of electricity (LCOE) as high as USD 347 per MWh
for solar PV as recently as 2009, USD 190 for offshore In January 2021, an extreme cold spell caused by a devia
wind, and USD 111 for onshore wind, the LCOE for all tion in the jet stream led to unseasonably cold temperatures
three had dropped to USD 39, 78, and 44 for solar PV, in Texas, which froze electricity-generation infrastructure
offshore, and onshore wind, respectively, as of 2020, ranging from natural gas plants and nuclear plants to
according to data from research firm BloombergNEF. wind turbines, none of which had been "winterized." This
Without taking any sort of subsidies or tax credits into led to rolling blackouts across the state and several peo
account, wind and solar are now the cheapest forms of ple freezing to death. While the lack of preparedness had
new-build electricity generation for two-thirds of the as much to do with the extreme deregulation of the Texas
global population, and the economic incentive is strong grid, which is separate from the rest of the United States,
for them to displace fossil-fuel generation even without as with direct climate risk, the incident serves to highlight
further policy action. the need to prepare for more extremes going forward.
REFERENCES Caldecott, B., Kruitwagen, L., Dericks, G., Tulloch, D. J., Kok,
I., & Mitchell, J. (2016). Stranded Assets and T hermal Coal:
Bernstein, A., Gustafson, M. T., & Lewis, R. (2019, An analysis of environment-related risk exposure. Stranded
2019/11/01/). Disaster on the horizon: The price effect Assets Programme, SSEE, University of Oxford, 1-188.
of sea level rise. Journal of Financial Economics, 134(2),
ClientEarth v. Enea, (Regional Court in Poznan 2019).
253-272. https://doi.org/https://doi.org/10.1016/j.
jfineco.2019.03.013 Conservation Law Foundation, Inc. v. Shell Oil Products US,
(United States District Court for the District of Rhode Island).
Caldecott, B. H., Nicholas; McSharry, Patrick. (2013).
Stranded Assets in Agriculture: Protecting Value from Fiedler, T., Pitman, A. J., Mackenzie, K., Wood, N., Jakob,
Environment-Related Risks (Smith School of Enterprise C., & Perkins-Kirkpatrick, S. E. (2021, 2021/02/01). Busi
and the Environment Working Papers, Issue. https://www. ness risk and the emergence of climate analytics. Nature
smithschool.ox.ac.uk/publications/reports/stranded-assets Climate Change, 11(2), 87-94. https://doi.org/10.1038/
agriculture-report-fina I.pdf s41558-020-00984-6

Four Twenty Seven. (2019). Real Estate Climate Risks How Krukowska, E. (2016). Poland T ies Climate-Deal Ratification
Will Europe be Impacted? http://427mt.com/wp-content/ to EU Concessions on Coal. Bloomberg.
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Luciano Lliuya v. RWE AG, Case No. 2 0 285/15 (Essen
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Newell, P., & Mulvaney, D. (2013). The political economy of
ILO. (2019). Working on a warmer planet: The impact of the "just transition." The Geographical Journal.
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Ouazad, A. K., Matt. (2019). Mortgage Finance and Climate
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ing of 1.5 °C above pre-industrial levels and related global Rosemberg, Anabella. (2010). Building a Just Transition: The
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Jagger, N., Foxon, T., & Gouldson, A. (2013). Skills con Swilling, M., & Annecke, E. (2010). Forthcoming. Just Transi
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org/10.1007/s 10584-020-02734-1 Four-points-about-China-coal-sector-overcapacity

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

ANSWERS
3.1 C 3.5 A
3.2 B 3.6 B
3.3 C 3.7 A
3.4 B

Sustainability and
Climate Policy,
Culture, and
Governance
• 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 Key Learning Points
into supervision practices.
• There have been various attempts to agree on inter
• Identify methods used to enforce sustainable invest national climate policy globally. These efforts have
ment and disclosure policies. been complicated by disagreements over the optimal
amount of emissions reductions, the inherent difficul
• Describe the trends in private-sector climate frame
ties of collective action, and the fact that countries that
works and identify important climate groupings.
have sharply increased their share of emissions in the
• Understand climate-related risk and nature-related past two decades (e.g., China, India) are different from
risk. those responsible for accumulated historical emissions
(e.g., US, EU, Russia, Japan) and those expected to drive
• Explain the broader societal and cultural impacts of
future emissions unless they adopt green growth models
climate change and policies.
(e.g., Saudi Arabia, Indonesia, Brazil), raising "fairness"
questions around the potential trade-off between emis
sions and economic development.
This chapter examines the wider policy and cultural
• The first global agreement on climate established the
context in which the move toward sustainability
and climate risk integration in the private sector United Nations Framework Convention on Climate
has occurred. It starts by describing international Change (UNFCCC) in 1992 at the Rio Summit.
sustainability and climate policy frameworks to • The first global compact on emissions reductions, the
date and the challenges inherent in attempts to Kyoto Protocol of 1997, took the form of a legally bind
reduce emissions through global agreements. It ing treaty, according to which high-income countries
then describes how sustainability and climate have agreed to reduce emissions by 5% from 1990 levels by
become part of various policy frameworks, both 2008-2012.
public-sector and private-sector-oriented, rang- • The subsequent Paris Agreement of 2015 took a differ
ing from promotion to supervision and regulation. °
ent direction, agreeing on a 1.5-2 C reduction aspiration
Finally, consideration is given to potential implica and inviting all countries to submit (non-binding) plans to
tions, both at the micro and macro level, of how get there, relying on the mechanism of peer pressure.
policies and other transition drivers may impact
• At the national level, carbon pricing is a widely used
society and corporate culture.
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
Chapter Outline exclusive).
4.1 Introduction to Sustainability and Climate Policy, • However, carbon pricing is not the only policy option
Culture, and Governance to achieve emissions reductions; countries have also
4.2 International Sustainability and Climate Policies used sector-specific policies, such as feed-in tariffs and
quota requirements for renewable power generation,
4.3 Climate Risk and Financial Policy
and fuel efficiency and CO2 emissions standards for
4.4 Climate Risk and Financial Supervision automobiles.
4.5 Private-Sector Sustainability and Climate Risk • In the investment space, societal and cultural trends and
Frameworks sustainability and climate investment policies, led by
governments, international financial institutions, and pri
4.6 Nature, Biodiversity, and Climate Change
vate investor coalitions, are helping to frame the private
4.7 Broader Societal Implications and Conclusions sector's transition to a sustainable, green economy and

promote the growth of green finance and sustainability 4.2 International Sustainability and
oriented products.
Climate Policies
• One of the most impactful policy areas where climate
There have been various attempts since the 1990s to agree
change has been integrated is that of financial super
on international climate policies, mainly regarding emissions
vision: Many central banks now expect financial
reductions, at a global level. The first global agreement on
institutions to integrate climate into governance, risk
climate change was the formation of the United Nations
management, and disclosure, and to undergo climate
Framework Convention on Climate Change (UNFCCC)
stress tests to assess the resiliency of the financial sys
in 1992; the first accord on emissions reductions was the
tem to climate shocks.
Kyoto Protocol of 1997; and, the latest and most success
• Financial policy also supports the growth of sustainable
ful, so far, climate change mitigation agreement is the
finance through auditing self-described sustainable prod
Paris Agreement of 2015. Understanding why global cli
ucts, and in some jurisdictions, through top-down regula
mate policy has proved to be so difficult and slow-moving
tory taxonomies defining what products are considered
requires an understanding of the background situation,
sustainable.
open questions, and the different ways that agreements
have attempted to resolve them (these are reviewed and
SUSTAINABILITY AND CLIMATE described in this section). In addition, sustainability and

climate-related issues have gained prominence in other
POLI CY, CULTURE, AND areas, including private-sector practices, financial policy,
GOVERNANCE and regulation (these are reviewed in subsequent sections).

and Climate Policy, Culture, and 4.2. 1 Backdrop of Climate Policies
Governance The scientific evidence that human greenhouse gas emis
sions are warming the planet's climate has roots stretching
To understand the private sector's approaches to sustain back decades, and it became the consensus in the 1970s
ability, climate change, and climate risk requires an under and 1980s. In fact, it was not long after the initial discovery
standing of the broader policy and cultural framework in of the greenhouse effect in the mid-nineteenth century
which these issues are gaining prominence. This chapter is the fact that gases such as carbon dioxide (CO 2) trap heat
intended to contextualize and frame the private-sector tran in the atmosphere-that Svante Arrhenius, a Swedish sci
sition to a sustainable, green economy. First, it describes entist, proposed in 1896 that fossil-fuel combustion, and
international sustainability and climate policies and the con the resulting increase in atmospheric CO 2 concentrations,
siderations that have led them to be relatively slow-moving. would result in global warming. Scientists such as Gilbert
Then, it examines the increasing importance of sustain Plass and observers such as Guy Callendar continued to
ability and climate policy considerations, from investment work on collecting evidence that CO2 was warming the
policies to supervision and regulation of the private sector, Earth, although at the time many other scientists thought
notably the private financial sector. The chapter also looks the oceans' ability to absorb excess CO2 was vast, or that
at private-sector-oriented governance and coordination natural variability mattered more than human influence on
frameworks on sustainability and climate change, building climate. Indeed, global average temperatures were not
on the coalitions discussed in Chapter 2. meaningfully rising in the 1940s, 1950s, or 1960s (in fact,
However, just as importantly, policies and private-sector the slight cooling trend observed in the 1950s and 1960s
practices are evolving within a greater context of societal can retrospectively be attributed to aerosols, a type of
and cultural shifts on sustainability and climate, including chemical pollution that decreased after clean air legislation
market expectations. Therefore, the chapter concludes with in major economies). But in the 1980s, global mean annual
a look at these and their implications. temperatures started to rise significantly, and scientific
Chapter 4 Sustainability and Climate Policy, Culture, and Governance ■ 75

consensus around the strong human influence on climate somewhat lower levels of warming can lead to severe physi
solidified, leading to the formation of the Intergovernmen cal impacts and potentially to catastrophic "tipping points,"
tal Panel on Climate Change (IPCC) in 1988, a UN-convened leading to an international consensus around a goal of limit
organization of scientists, and soon thereafter to the ing warming to 2°C. A subsequent revisitation by academics
United Nations Framework Convention on Climate Change of the DICE model found that even it suggested an opti
(UNFCCC), a UN body dedicated to climate change. mum around 2°C once the carbon cycle and energy balance
models within it were better calibrated, and climate dam
But the understanding and wide recognition of the fact that
age estimates were updated (Hansel et al., 2020).
human-caused emissions were warming and disrupting the
global climate prompted more questions, for example con Another important open question revolves around the allo
cerning the optimal level of emissions reductions, over the cation of (moral) responsibility, the relationship between a
allocation of (moral) responsibility and the potential trade country's wealth and historical emissions and the potential
off between emissions and economic development, and trade-off between emissions and economic development.
regarding how to overcome collective action problems. What matters to the warming and disruption of the Earth's
climate is the stock of carbon dioxide and other green
One important debate played out both within academia
house gases in the atmosphere-the higher the concentra
and among policymakers over the optimal level of emis
tion, the greater the impacts. Obviously, annual emissions
sions reductions. Economists such as William Nordhaus
keep adding to this stock. One could therefore argue that
developed models to assess the costs and benefits of
those responsible for the greatest share of new emissions
mitigating climate change through emissions reductions
are the ones who must cut back the most, especially as
versus the physical impacts of climate change. The original
solutions (both technical and nature-based) to remove CO2
formulation of Nordhaus's dynamic integrated climate
from the atmosphere are in their infancy and do not yet
economy (DICE) model from the early 1990s suggested that
exist at scale. However, looking backward, one can equally
warming of 3.5°C would be optimal in terms of not unduly
argue that it is the countries responsible for the great-
hampering economic growth while still mitigating the worst
est share of cumulative emissions (i.e., the total stock},
climate impacts. Climate scientists have tended to be more
that are most responsible for climate change. Countries
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 atmosphere-and it is the total stock, not the annual
tries that are currently the largest emitters and those that
flow, that affects the changes in climate.
have cumulatively contributed most to rising emissions.
In terms of current annual emissions, China's by far out
Cumulative CO2 Emissions (1751-2017) by Country
pace any other country's, and India's are also growing
rapidly. Of current (as of 2019) emissions at regional lev An examination of cumulative emissions finds that, while
els, Asia accounts for half (50%}, with North America at China does still account for a substantial share-one
17%, and Europe at 15%. eighth and growing-Europe and North America come
out ahead. The United States alone is responsible for a
However, because industrialization driven by coal, oil,
quarter of global cumulative emissions, and the former
and other fossil fuels started far earlier in Europe and
28 countries of the European Union-including the
in North America than in Asia, these countries account
United Kingdom, France, Germany, Italy, and others-for
for a far larger share of cumulative emissions. In many
nearly as much, just over a fifth. North America accounts
ways, cumulative emissions matter more because for 29% of global emissions through 2017, the exact same
cumulative emissions reflect the stock of CO2 in the 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

that have sharply increased their share of emissions in the Subsequent summits of the UNFCCC were called "confer
past two decades (e.g., China, India) are different from ences of the parties," or COP for short, with the number of
those responsible for accumulated historical emissions the meeting attached: the first follow-up meeting, COP1,
(e.g., US, EU, Russia, Japan) and those expected to drive took place in Berlin in 1995.
future emissions unless they adopt green growth models
COP3 in Kyoto in 1997 produced the first major interna
(e.g., Saudi Arabia, Indonesia, Brazil) (see Box 4.1). This has
tional accord on emissions reductions. The Kyoto Protocol,
set up a tension in international negotiations ever since,
which took the form of a legally binding treaty, required
and it is complicated by the "fairness" questions around
high-income "Annex 1" countries to attain 5% emissions
the potential trade-off between emissions and economic
reductions compared to 1990 levels by 2008-2012, with
development.
several mechanisms built in that attempted to promote flex
A final important issue that forms an indelible part of the ibility and technology transfer between countries. The first
backdrop of international climate policy is the inherent of these, emissions-trading, was meant to allow Annex 1
collective action problem as such as moral hazard, informa countries that had made deeper emissions cuts to sell sur
tion asymmetry or short-termism. Global emissions, and plus emissions allowances to other Annex 1 countries. The
attempts to reduce them, constitute a classic collective second of these, "joint implementation," was also meant
action problem, that is, a problem caused by disincentives to be between Annex 1 countries, where one country could
that tend to discourage joint action by individual entities undertake a project involving technology transfer in a fellow
(in this case, mainly countries, but also individuals or com Annex 1 country. The third, the "clean development mecha
panies) in pursuit of a common goal, or where the result is nism" (CDM), attempted to provide a way for emissions
a public good that benefits everyone. The Earth's climate is cuts to also be spread to developing economies. Under the
a global public good, and a healthier, less disrupted climate CDM, an Annex 1 country could get credit for conducting
benefits everyone on Earth. However, any country reduc an emissions reduction project in a non-Annex 1 country
ing its greenhouse gas emissions is paying the full cost of (Napoli, 2012).
those emissions cuts in the short term, while only receiving
Immediately after its adoption, the Kyoto Protocol was
a fraction of the benefits of a better climate, realized over
viewed as a resounding success and an optimistic sign for
the long term. Thus, countries are easily disincentivized
the future. However, in retrospect, it is widely viewed as
from implementing painful emissions cuts and tempted to
having been a failure, as it did not achieve even the mod
freeride off the emissions cuts of others.
est emissions targets it had embedded within it. Some of
its failings were technical, such as the fact that the planned
4.2.2 Brief History of International Climate
emissions-trading scheme was never properly implemented.
Agreements, from Kyoto to Paris
But many of its failings were deeper and more structural.
The origins of international climate summits can be traced One of the core principles of the Kyoto Protocol was the
back to 1979, when the first World Climate Summit, orga notion of "common but differentiated responsibilities,"
nized by the World Meteorological Organization (WMO), which acknowledged that developed and developing
framed climate change as an issue to be addressed by countries have different levels of responsibility in address
global politics. In 1988, the WMO was also the co-creator of ing climate change. This principle led to differentiating
the Intergovernmental Panel on Climate Change (IPCC), the between Annex 1 (developed) and non-Annex 1 (develop
scientific body that was to become ever more influential in ing) countries in terms of emissions reduction obligations.
subsequent years and decades. However, developing countries were not subject to any kind
However, the history of concerted global political action on of emissions reduction obligations and many experienced
climate starts with United Nations involvement. The 1992 skyrocketing rates of emissions growth during this time.
Earth Summit in Rio de Janeiro, Brazil, introduced several This made even Annex 1 countries less committed to the
new UN initiatives and bodies, including the United Nations Protocol. Indeed, the United States ended up never ratify
Framework Convention on Climate Change (UNFCCC). ing the Protocol for this reason. Additionally, other reason

for the Protocol's failure include the late ratification of The voluntary nature of NDCs and the lack of strong
the agreement by several countries, issues with the Clean enforcement mechanisms may limit the effectiveness of
Development Mechanisms (CDM) and Joint Implementa the Paris Agreement in driving ambitious climate action.
tion (JI) projects that did not adequately prevent double While the first round of "ratcheting" seems to be work
counting of emissions reductions, and concerns about the ing as intended, with many 2020 NDCs being much more
additionality of these projects - whether the GHG reduction ambitious and countries committing to a (domestic) goal
were real and would not have occurred without the projects of achieving net-zero emissions by 2050, there are still con
(Napoli, 2012). cerns about the adequacy and enforcement of these com
mitments. The voluntary nature of NDCs and the lack of
Expectations were high that negotiations at COP15 in
strong enforcement mechanisms may limit the effectiveness
Copenhagen in 2009 would produce an improved, binding
of the Paris Agreement in driving ambitious climate action
treaty for the post-Kyoto space, as Kyoto was set to expire
in 2012. Inversely to the situation with Kyoto, the Copen In any case, it is already possible to say that the success
hagen summit's acrimonious end, with no agreement on Paris has brought so far is in its different structure and
a new binding treaty, was widely seen by commentators approach from Kyoto. Instead of relying on legal obligations
and the media as an abject failure. Nonetheless, some of (which are difficult to enforce for any international treaty,
the ideas first introduced at Copenhagen ended up laying unlike domestic contracts that can be enforced by judicial
the groundwork for subsequent climate policy. For one systems and appropriate penalties), the Paris Agreement
example, the meeting in Copenhagen was the first COP to makes use of the powerful tools of inclusion and peer pres
establish the aspirational goal that global warming be kept sure. Everyone must submit an NDC, and countries ramp
°
to below 2 C. Another example is that in the absence of a up ambitions when others do. As an example, a first version
binding treaty, the Copenhagen accord invited countries of of Japan's 2020 NDC was not significantly different from its
all kinds, high-income and low-income, to submit domestic 2015 NDC, but after South Korea adopted a goal of net
mitigation strategies to the UNFCCC. zero emissions by 2050, Japan did too.
In 2015, COP21 in Paris built on some of these new In addition, the framework around the Paris Agreement
ideas first tentatively floated in Copenhagen. The Paris explicitly recognized for the first time that many kinds of
Agreement is based not on legally binding emissions stakeholders, ranging from subnational actors such as cit
reductions targets but on a commonly agreed aspiration to ies and regions to private-sector businesses and financial
°
keep global temperature rise "well below 2 C above pre institutions, could help to contribute to climate goals. The
industrial levels" and to "pursuing efforts" to limit the rise UN High-Level Champions have been instrumental in foster
°
to 1.5 C, combined with national efforts by each individual ing collaboration and engagement among these diverse
party in this direction (UNFCCC, 2015). These national stakeholders. One notable example is the "Race to Zero"
plans, now called Nationally Determined Contributions campaign, which the High-Level Champions have been pro
(NDCs), are to be submitted to the UNFCCC, and moting to mobilize businesses, cities, regions, and investors
periodically re-evaluated. However, one of the shortcom to commit to achieving net-zero carbon emissions by 2050.
ings of the Paris Agreement is that the combined NDCs This ambitious campaign demonstrates how the Champions
submitted by countries are insufficient to achieve the goal can encourage a wide range of actors to take action and
°
of limiting global temperature rise to well below 2 C. For share best practices that contribute to the global climate
instance, the International Energy Agency (IEA) estimated goals (see section 4.2.4 and Section 4.5).
°
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
4.2.3 National Climate Policies
"ratchet" mechanism, where countries are expected to Achieving NDCs requires having a domestic climate
tighten their NDCs every five years, and these are to be policy. This section briefly reviews the principal types of
evaluated at COP meetings. climate change mitigation (i.e., greenhouse gas emissions

reduction) policies at the national level that countries have Japan's carbon tax is at the lower end, less than USD10
in place. Overall, policies can be economy-wide-typically per ton, whereas Sweden's is currently the world's highest,
a form of carbon pricing-or sector-specific. This section at around USD125 per ton. In addition to (or instead of)
reviews carbon pricing and then describes climate change carbon taxes, many countries have opted for cap-and-trade
mitigation policies in two of the most emissions-intensive schemes. In these, the total amount of emissions is capped
sectors: power generation and transportation. (and the cap gradually lowered), but emissions permits can
be traded between participants. While this limit on quantity
Carbon pricing refers principally to two types of policies does end up imposing a price as well, a trading scheme is
carbon taxes and emissions-trading schemes, better known often considered more flexible.
as cap-and-trade schemes. Carbon taxes, which impose a
In general, carbon taxes and emissions-trading schemes
price per ton of CO2 emitted, have typically been favored
both have benefits and drawbacks. Carbon taxes raise reve
by economists. They are a classic way of internalizing an
nue for the government, which can then be spent on further
externality by forcing emitters to pay for the social cost of
mitigating or adapting to climate change. Additionally, car
their carbon emissions, and a tax in such an instance is the
bon taxes have practical advantages over emissions-trading
classic prescription from economic theory. The World Bank
schemes. They are generally easier to administer, provide
plays a significant role in monitoring and supporting carbon
greater price certainty, and can promote investment by
pricing initiatives worldwide, including carbon taxes and
providing a stable price signal. Moreover, carbon taxes have
emissions trading systems, through its "State and Trends of
the potential to generate significant revenues and can cover
Carbon Pricing" report. According to the 2021 report, there
broader emissions sources. However, in at least some coun
are currently 64 carbon pricing instruments in place, which
tries, levels of tax are frequently tweaked, which can be det
cover about 20.1% of global greenhouse gas emissions.
rimental to investors or businesses that need certainty over
However, in many of these, the price ends up being below
multiple years to make investment decisions.
the USD100 per ton assumed to be needed to have a sig
nificant effect. Additionally, these initiatives have generated Emissions trading schemes set caps on total emissions for
approximately USD 53 billion in government revenues, specific industries or sectors, allocating each company
an 8% increase compared to 2019. Carbon taxes can be permits based on their allowed greenhouse gas emissions.
implemented at different stages of the production and con Companies can sell, buy, or trade permits according to their
sumption process: upstream, midstream, or downstream. needs and reduction strategies. Selling credits incentivizes
Upstream taxes target the production or importation of green technology investments, while banking unused per
fossil fuels, midstream taxes are applied at the processing mits provides flexibility and smooths market fluctuations.
or distribution stage, and downstream taxes are imposed However, trading schemes can cause volatile carbon pric
on end-users or consumers. Each approach has its benefits ing, and exogenous shocks like financial crises can lead to
and drawbacks. Upstream taxes are usually more straight permit oversupply, decreasing incentives to reduce emis
forward to administer and have broader coverage, while sions. Borrowing permits from future allocations manages
downstream taxes offer more direct incentives for consum short-term emissions or price fluctuations but may pose
ers to reduce their carbon emissions. Midstream taxes fall in risks if companies become overly reliant on future permits
between, balancing coverage and incentives. One concern and neglect emission reduction investments.
with carbon pricing is the potential for carbon leakage, Various mechanisms enhance the functioning of emis
which occurs when carbon-intensive industries relocate to sions trading schemes and address potential challenges.
jurisdictions with less stringent climate policies, leading to a Price floors and ceilings help reduce market volatility and
shift in emissions rather than an overall reduction. This can ensure permit prices remain within a desirable range, miti
undermine the effectiveness of carbon pricing policies and gating the effects of volatile carbon pricing. Monitoring
may negatively impact the competitiveness of businesses and enforcement ensure system integrity, with penalties
in countries with stricter regulations. Currently, carbon for non-compliance maintaining the scheme's effective
taxes exist in many jurisdictions, though they vary in scope: ness. Offset projects allow companies to invest in external

emissions-reducing projects, earning additional permits or Electricity Standard on the federal level in the United
offsetting emissions. Market stability reserves help man States. Feed-in tariffs offer a guaranteed price per unit of
age permit supply, maintaining effective permit prices and electricity generated at which producers can sell their elec
addressing oversupply issues. Finally, international coop tricity for a fixed period of time (usually between 15 and 25
eration links emissions trading schemes across countries or years). Sometimes these tariffs are simply set by policymak
regions, creating a larger, more liquid market for efficient ers; in other cases, they are determined through a market
resource allocation and increased cost-effectiveness in based process, such as the UK's "contract for difference"
achieving global emissions reduction targets. approach. Tax incentives have a significant impact on the
Other policies have also had significant effects in reducing deployment of renewable energy by reducing project costs
emissions in specific sectors. Perhaps the sector where spe and improving their economic competitiveness compared
to conventional energy sources. In addition to cost reduc
cific policies have had the largest impact so far is in power
generation. Renewable Portfolio Standards (RPSs) are tions, tax incentives can provide, if designed well, market
stability and predictability, enabling investors and project
an umbrella term for a range of quota-based regulations
that aim to increase the supply of renewable electricity by developers to make long-term investment decisions. The
requiring commercial power producers to source a specific Inflation Reduction Act in the United States incorporates
over 20 new or modified tax incentives, along with tens of
portion of supply from renewable energy sources, such as
billions of dollars in grant and loan programs. The Act aims
wind or solar power.
to stimulate investment in and deployment of new clean
RPSs have been deployed in 173 countries, including
energy technology, thereby accelerating our transition to a
the Renewable Obligation in the UK and the Renewable
clean energy economy.
CASE STUDY: JUST ENERTY TRANSITION PARTNERSHIPS

Just Energy Transition Partnerships (JETPs) are a series of a total of USD 8.5 billion. South Africa has since published
formal collaborations among governments, private sector its Implementation Plan, setting out priority investments
entities, and civil society organizations that aim to promote required for a transition to a low-carbon and climate resil
renewable energy, increase energy efficiency, and improve ient economy. A key area of focus lies on accelerating the
energy access in underserved communities. The partnerships decarbonization of the South African electricity grid by
aim to ensure that vulnerable communities and workers are scaling up renewables and ensuring the early retirement
not left behind in the shift away from fossil fuels and that the of South Africa's large coal generation fleet.
benefits of a clean energy economy are shared more fairly.
The Indonesia JETP was launched a year later at the G20
JETPs aim to signal to the international community that a leaders' summit in Bali, with USD 20 billion in committed
subset of affluent nations are committed to supporting a finance from the public and private sector. The proj-
climate transition in developing countries and emerging ect has integrated critical aspects of the IEA Net-Zero
economies. This can unlock financing to retire carbon Roadmap, which includes the analysis showcasing that
intensive assets, re-skill fossil fuel workers, and promote Indonesia could achieve peak emissions in its electricity
local economic development. sector by 2030 to realize net-zero emissions by approxi
mately 2050. Vietnam also announced in December
South Africa and Indonesia were the first nations to
2022 a JETP that aims to mobilise $15.5 billion of public
formally launch JETPs, with support from donor govern
and private finance to support its ambitious Net Zero
ments in the form of grants, guarantees, and conces
2050 goal.
sional finance. They each prioritize the swift increase of
renewable power, reducing reliance on fossil fuels, and India and Senegal are currently negotiating to establish
investing in transition-aligned jobs. similar JETPs with donor governments in the develop
ment world.
The South Africa JETP was announced at COP26, when
France, Germany, the UK, the US and the EU committed Sources: ODI (2022), IEA (2022)

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.

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

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

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

to be financially selfsufficient but with a mandate to sup in addressing both climate change and debt. An example
port socioeconomic development, as opposed to simply from 2021 includes the Italian government's $30 million
maximize profits), they became some of the earliest orga debt-for-nature swap with the Democratic Republic of
nizations to devise explicit sustainability, ESG, and climate Congo, which supports REDD+ programs to combat defor
investment policies. estation and promote sustainable land use practices while
providing debt relief.
Long before Mark Carney, the governor of the Bank of
England, helped popularize the types of climate risk to a Finally, there are innovative insurance policies and proj
broader financial audience in 2015, institutions like the IFC ects, such as the Global Shield for climate risks, which be
were writing detailed reports about climate risk. For exam an important building block of climate investment poli-
ple, back in 2007, the EIB issued the world's first "Climate cies. Global Shield is a climate risk insurance program that
awareness bond" dedicated to climate-related issues, which was announced jointly by the Vulnerable Twenty (V20) and
helped launch the global market in green bonds (see Chap Group of Seven (G7) member states at COP27. The aim
ter 5). And, as early as 2010, IFC was discussing filling the of the initiative to provide financial protection against the
financing gap on climate change, boasting about its USD 1 increasing risks of losses and damages from climate change,
billion in investments in climate-related projects in 2009 and particularly amongst poor and vulnerable peoples. The
its ability to leverage greater funding through attracting instrument aims to both incentivize adaptation measures
private co-financing. Similarly, a 2011 IFC report examined and improve preparedness for climate disasters, and pro
in detail the effects of climate on traditional risk categories, vide swift financial protection when climate damages do
such as credit risk, strategy risk, operational risk, and legal occur. Initiatives such as this can help address a range of
risk, covering both physical and transition risk examples risks, including climate risks, and build resilience against the
(though not yet using that terminology) (IFC, 2011 ). More impacts of climate change.
recently, starting in 2019, IFC has partnered with the private
DFls and private financial institutions can play a key role in
sector to develop the Operating Principles for Impact Man
developing and scaling up these insurance products, pro
agement (OPIM), which draw on emerging best practices
viding the necessary financial and technical resources to cre
to assess the impact of management systems of funds and
ate market incentives and encourage investment in climate
institutions, including their impact on environmental and
risk and pandemic insurance programs. For example, DFls
climate-related aspects.
can provide financing and technical assistance for paramet
And, in a signal of the increasing momentum behind sus ric insurance programs that protect against weather-related
tainability and climate investment policies, private finan- risks, while private financial institutions can help develop
cial institutions are replicating parts of the multilateral insurance products that cover infrastructure damage caused
and bilateral DFI model. For example, the USD100 billion by climate change.
J.P. Morgan Development Financial Institution was launched
in 2020 to spur additional capital toward financing the 4.3.2 Public Policy to Promote Adoption of
UN Sustainable Development Goals (SDGs) in emerging Green Finance
economies. Another strand of public policy relating to finance is that
which assumes the role of promoting the presence and
DFls, private financial institutions, and governments have
activity of the private financial sector. In recent years, as cli
the opportunity to collaborate and mobilize climate finance.
mate change has become a more prominent issue, financial
Debt-for-climate swaps represent one potential approach,
sector promotion and policymaking around financial centers
where creditor countries or organizations forgive or reduce
have started to incorporate green elements.
the debt of developing countries in return for commit
ments to lower greenhouse gas emissions and adapt to Much of this work has involved setting up various
climate impacts. By facilitating the deployment of funds sorts of green finance "hubs" or taskforces, in some
towards climate-friendly initiatives and building interna cases with dedicated institutions. In Japan, the Japan
tional partnerships, these swaps can serve as a crucial tool Financial Services Agency and two Japanese ministries

CASE STUDY: SOVEREIGN SUSTAINABILITY-LINKED BOND S
Sovereign sustainability-linked bonds (SLBs) are a novel and nature targets in September 2022. The bond's inter
debt instrument issued by governments for financing est rate is tied to Uruguay's performance in meeting
their deficits or refinancing existing debt. Uniquely, two key performance indicators: reducing greenhouse
these bonds are linked to the sustainability targets of gas intensity and preserving the native forest area. The
the issuing government, with the bond's interest rate coupon will step up or down based on whether Uruguay
directly tied to the government's progress in meeting its meets its targets, with equal-sized coupon step-up and
sustainability goals. The sustainability target reflects the step-down provisions. The bond is significant as it intro
government's commitment to environmental, social, and duces nature preservation and restoration targets, a first
governance (ESG). Failure to achieve these goals results for sovereign SLBs. Sustainalytics rated both metrics
in an increased interest rate, thus making it expensive for as strong, with the native forest increase target being
the government to borrow. SLBs are a recent addition to judged as highly ambitious. Uruguay's SLB is the sec
the financial market and have only been issued by a few ond after Chile's issuance in March 2022, which focused
governments to date. on reducing greenhouse gas emissions and increasing
renewable energy sources.
Uruguay published a framework for a sovereign sustain
ability-linked bond with innovative coupon structures Sources: BIS (2022) and Sustainalytics (2022)
have set up the TCFD Consortium of Japan to facili 4.3.3 Green Taxonomies and Financial
tate dialogue between investors and companies on Regulation
climate risk disclosure. In Hong Kong, the territory's
Another strand of emerging public policy and regulatory
financial regulator and quasi-central bank, the Hong
responses to climate change and environmental challenges
Kong Monetary Authority, has launched the Centre
is green taxonomies.
for Green Finance to spread best practices and help
to green Hong Kong's financial services industry. In Until recently, policymakers and regulators had not felt
Singapore, through its Green Finance Action Plan, the the need to create lists of economic activities considered
Monetary Authority of Singapore has proposed guide "green." Such green lists or "taxonomies" are now being
lines on environmental risk management for banks, created in a number of jurisdictions, including ASEAN,
asset managers, and insurers. In 2019, the UK set up a Canada, China, the EU, Malaysia, and the UK.
Green Finance Institute, backed by the government but The furthest along in this regard is the European Union.
staffed by bankers, to convene and lead sectoral coali The EU Taxonomy, first published in draft format in March
tions of experts to broaden and promote the growth of 2020, sets performance thresholds (referred to as "techni
a green finance ecosystem. Luxembourg has a body with cal screening criteria") for economic activities, by sector
a similar mission, the Luxembourg Sustainable Finance and subsector. To c ount as "sustainable," activities must (a)
Initiative. make a substantive contribution to one of six environmental
Some of these networks are themselves transnational. objectives, (b) do no significant harm to the other five, and
Financial Centres for Sustainability (FC4S), founded in 2017, (c) meet minimum safeguards (e.g., the OECD Guidelines
is a network to promote sustainability among 30 financial on Multinational Enterprises and the UN Guiding Principles
centers, with public entities promoting their respective cit on Business and Human Rights).
ies serving as the FC4S members. Green taxonomies are intended to inform policy, regulatory,
The FC4S has a permanent secretariat, which provides and market decisions. For example, they are often accom
research on emerging issues, guidance on best practices, panied by requirements to disclose the quantity of green
and project development and support services to its economic activities in investment products. This can then
members. result in green labels for such products to help guide retail

investors. Green taxonomies are also being used to guide potentially undermining the credibility of the EU green
fiscal policy by helping to determine, for example, in what taxonomy.
categories the EU's €750bn COVID-19 recovery fund can • Asset bubbles. Over time, a green taxonomy could arti
be spent on. Over time, green taxonomies may play a key ficially inflate the value of assets labeled green, poten
role in determining what companies can access green subsi tially creating financial stability risks.
dies or incentives from governments, and possibly what tax
• Sub-optimal targeting. Incentives based on a green
or other incentives investors could receive based on their
taxonomy could benefit not only investors in new green
investments in green companies and assets.
assets but also owners of green assets already created,
Proponents argue that green taxonomies facilitate com which were already considered to be profitable at the
parability across investments, and that they reduce the time of investment.
burden associated with determining whether an invest • Decreased quality. Green taxonomies might lead to a
ment is green. Also, green taxonomies can help to tackle
situation where institutions focus primarily on obtain-
greenwashing by making it clearer what is green and what
ing the label, rather than thoroughly evaluating the
green holdings exist in investment products. To this effect,
underlying economic activities and cash flows associated
do-no-significant-harm provisions, including in the EU tax
with the investment. This could result in a superficial
onomy, are meant to ensure that green activities make a
approach to sustainable investing, with the label taking
positive contribution to environmental outcomes and do
precedence over genuine assessment and due diligence.
not harm other environmental and social objectives in the
In view of this potential drawbacks, green taxonomies may
process. And, because green taxonomies are intended to
end up being used for public policy and related fiscal deci
be common frameworks for determining which activities
sions, such as how to allocate subsidies, but may not play
can be defined as environmentally sustainable, in theory this
a central role in efforts to tackle greenwashing in financial
could help to improve our understanding of the impact of
markets. Also, there are nascent efforts underway to create
company activities on the environment, thereby helping to
brown or transition taxonomies, which might be easier to
green portfolios and loan books. However, while this feels
design and implement.
intuitively appealing, it is in fact extremely challenging to
assess every type of economic activity, determine whether Transition taxonomies categorize all economic activities
it is green or not, and then apply that consistently to every based on their level of alignment with climate goals, recog
company (see Caldecott 2019). nizing "brown" activities that contribute to climate change,
"green" activities that facilitate the transition to a low
Potential drawbacks arising from the use of green taxono
carbon economy, and "transition" activities that possess
mies include the following:
the potential to become greener by embracing low-carbon
• Binary "green" assessment. In some contexts, there technologies and practices (NGFS, 2022). Investors and
may be "shades of green," for example depending on policymakers utilize both green and transition taxonomies
local and national contexts, as well as on the timing of to identify green activities and incorporate environmental,
the assessment. For taxonomy purposes, a green port social, and governance (ESG) factors into their invest-
folio where green is "deep green" may be indistinguish ment decisions. The critical difference between the two
able from a green portfolio where green is "light green." frameworks is that green taxonomies focus solely on green
• Lobbying. The administrative process required to activities, while transition taxonomies evaluate all activities
develop a green taxonomy may be open to lobbying based on their contribution to the transition to a sustainable
and political influence. For example, following lobbying economy. The European Union and Singapore GFIT taxono
by some EU member countries and industry associa mies also acknowledge transitional activities, which should
tions, the new technical rules on green finance issued by outperform others in their industry, not hinder the develop
the European Commission in December 2021 classified ment of alternatives, and not perpetuate existing practices.
certain natural gas power plants as green investments, For both green and transition taxonomies, establishing

industry thresholds to distinguish better performers from Central banks and financial supervisors have moved to
those with less potential to reduce emissions is crucial. integrate climate change both into microprudential
supervision, the oversight of specific financial institutions
Finally, although there are efforts underway to create a
(usually banks and insurers) for financial soundness, and
universal green taxonomy across multiple jurisdictions,
macroprudential supervision, which examines the stability
including the Common Ground Taxonomy between the
of the broader financial system (some have even moved to
EU and China, this is likely a long way off. A report com
incorporate climate issues into traditional monetary policy,
missioned to explore ways for merging green taxonomies
though this practice is still limited).
in the EU and China found significant structural differ
ences, and given that deciding what is green inevitably In regard to microprudential supervision, various central
is a political decision, different countries are likely to banks and supervisors have amassed, and continue to build
have different views. However, the more modest goal of up, internal capacity for climate risk integration. T he BoE is
enabling comparability across different taxonomies, espe a forerunner in this space, having laid out its expectations
cially in relation to how thresholds are set, is likely to be regarding governance, risk management, scenario analysis,
easier to achieve. and disclosure in 2019 (see Case Study). But similar super
visory expectations have been laid out by the European
4.4 Climate Risk and Financial Central Bank (European Central Bank, 2020), the Monetary
Supervision Authority of Singapore (Monetary Authority of Singapore,

2020), and the Australian Prudential Regulation Authority
While investment policies are important, perhaps the most (Australian Prudential Regulation Authority, 2020), among
significant way in which climate risk has become embedded others.
in financial policy is in its role in supervision and oversight,
General trends on climate integration in regard to gov
especially by central banks tasked with overseeing the sta
ernance and risk management cut across jurisdictions. In
bility of both individual institutions and the financial system
governance, the supervisory expectation is that financial
as a whole.
institutions have structures in place to ensure climate risks
are actively managed at the highest level by senior manag
4.4. 1 Climate Integration into Central Bank-led
ers and boards of directors. In risk management, firms are
Supervision
often asked to use some combination of scenario analysis
In just five years, from 2015 to 2020, central banks largely and stress testing. In disclosure, the recommendations of
incorporated climate change into their supervision prac the TCFD are increasingly seen as best practice by regula
tices. In this, they followed the lead of the Bank of England tors and policymakers. In the UK and New Zealand, TCFD
(BoE), the UK central bank and financial regulator, which aligned reporting has been made mandatory, and other
in 2014 was widely recognized as the first central bank to counties are likely to follow suit. In relation to sustainability
begin working on these issues. and climate-related risks, regulators have indicated their
An important subsequent initiative bringing together intention to incorporate the forthcoming ISSB standards
central banks and regulators to work on climate integra into their mandatory disclosure frameworks (refer to Chap
tion, and helping to spread best practices, has been the ter 2 for more details).
Network for Greening the Financial System (NGFS). It Where the potential impacts of climate risks are assessed
promotes collaboration and the sharing of expertise on to be material, supervisors may then expect or require firms
climate risk among supervisory institutions. It was founded to demonstrate how they will mitigate these risks. In gen
by three European central banks-those of the UK, France, eral, climate-related prudential policies do differ somewhat
and the Netherlands-but the network now counts over across countries, due to the different mandate scope of
120 members from all continents. relevant institutions and systematic differences in the use of

CASE STUDY: BANK OF ENGLAND
The Bank of England (BoE), the UK central bank and executives to be held responsible. It also expects
financial regulator, now integrates climate-related risk in boards to be involved in assessing climate risk. On
all three of its main policy responsibilities- micropru- risk management, the BoE requires banks and insur
dential policy, macroprudential policy, and monetary ers, under their own capital adequacy and solvency
assessments, to include "all material exposures" relat
policy, which are described in this case study.
ing to the financial risks from climate change. As for
scenario analysis, the Bank expects firms to conduct
Background of Climate Integration it to "inform ... strategic planning". Finally, on disclo
The BoE's shift toward climate started with a 2015 sure, the Bank expects firms to consider implement
speech called "Tragedy of the Horizon," by its then ing disclosures on climate risk beyond mandatory
governor Mark Carney. The speech recognized and laid requirements, suggesting TCFD recommendations as a
out how climate change affects financial stability. Carney guideline.
argued that while most climate damage is expected far
enough in the future to be beyond typical investment Macroprudential Measures
horizons, escaping financial scrutiny, climate change
For macroprudential policy, which looks at system-wide
would eventually cause systemic risks to the whole finan
risks, stress tests have become one of the most important
cial sector (hence the "tragedy" of the horizon). He spe
regulatory tools since the Global Financial Crisis of 2008.
cifically discussed physical, transition, and litigation risk.
From 2021, the Bank is launching a dedicated climate
Once it was accepted that climate change could cause risk stress test, the Biennial Exploratory Scenario (BES).
material risks to the financial system and that it therefore The BES will be based on scenario analysis (see Ch 7
belonged within the Bank's supervisory scope, it started for more details on scenarios) and make use of an early
to be incorporated into the Bank's expectations and pro policy action scenario, a late policy action scenario, and a
cesses. Some time later, in March 2021, the mandate of no additional policy scenario. The BES also specifies the
the Bank was explicitly modified by the UK government variables to be used, and the ways and details in which
to include environmental goals: specifically, that the Bank participating institutions are expected to conduct model
should support the greening of the country's economy ing. The BES follows on from a first successful stress test
and help the country reach net-zero emissions by 2050. incorporating climate considerations, namely the BoE's
insurance stress test in 2019.
Microprudential Measures
Monetary Measures
The BoE has expectations regarding, and monitors firms'
progress on, adopting a strategic approach to climate Climate has so far been less integrated into monetary
change, which was first laid out in early 2019. While policy than into other areas of the Bank's operations. The
allowing for some flexibility in line with the UK tradition Bank has previously reported on the climate risk expo
of principles-based regulation, there are four key pillars sures of the assets it owns for monetary policy purposes
to the BoE requirements: governance, risk management, (e.g., the corporate bond portfolio used for quantitative
scenario analysis, and disclosure. easing). With the new mandate, the Bank is expected to
adjust how it purchases corporate bonds.
Regarding governance, the BoE requires firms to
allocate responsibility for climate-related risks to a Sources: Bank of England 2015; Bank of England 2019;
designated executive under UK rules that allow senior PRA 2019; FT 2021
prudential tools. However, bodies like the NGFS are helping

were already widely adopted by regulators in the wake
to spread best practices.
of the Global financial crisis of 2008, and they are now
Stress tests are another micro- and macroprudential being adapted to examine the potential impact of cli
tool at the disposal of central banks. Such tests, which mate change. The Dutch, French, and UK central banks,
model the reaction of an individual financial institution as well as the European Central Bank, are all currently
or the whole financial system to a hypothetical shock, developing climate stress tests with differing degrees of

granularity, distinct climate and policy scenarios, time management firms to better realize and implement existing
horizons, and feedback loops. requirements that disclosures must be "fair, clear, and not
misleading."
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
4.5 Private-Sector Sustainability and
during periods of carbon-intensive credit. Another is large Climate Risk Frameworks
exposure limits that would limit banks' (over)exposure to Regarding climate change, a particularly important role has
carbon-intensive assets that are considered to be at high been played by corporate and investor groupings, which
risk of stranding. Some central banks, while not yet adopt have helped spread best practices. In this regard, the trend
ing large exposure limits as a requirement for supervised has been very similar to what occurred with broader sustain
financial institutions, have done so for the management ability groupings and frameworks such as the UN Global
of their own portfolio (for example, Sweden's Riksbank's Compact or the Principles for Responsible Investment,
exclusion of sub-sovereign issuers with a "large climate covered in Chapter 2. One of the key early groupings in
footprint" from its capital management, such as the bonds this space was the Institutional Investors Group on Climate
of the Canadian province of Alberta, which produces very Change (IIGCC), which was launched in 2001 and now
emissions-intensive crude oil derived from tar sands). encompasses over 300 members (mostly pension funds and
asset managers) in 22 countries and represents over USD
4.4.2 Policy Enforcement of Sustainable 40 trillion in assets under management.
Investment and Disclosure
With private-sector-led frameworks, there has generally
Another type of policy enforcement of sustainability has been a trend toward greater size. This manifests not only
to do not with financial stability, but it derives from the in groups themselves gaining members and becoming
regulatory tradition of consumer protection, specifically larger, but also in ever larger groups of groups and umbrella
combating mis-selling or misleadingly advertising products initiatives. The Investor Agenda, for example, consists of
to consumers. the IIGCC and six other groups working with investors.
One way in which this is implemented is through audits to The IIGCC also helped to co-found Climate Action 100+,
determine if funds or products marketing themselves as an investor coalition with 575 members that represents
sustainable are in fact living up to their promise. The Finan over USD 54 trillion in assets under management target-
cial Conduct Authority (FCA), the UK financial regulator ing the world's 100 most heavily emitting publicly listed
for conduct and financial consumer protection, found in a companies, with the goal of pressuring them to reduce
2019 review in that the sustainable label was applied to a emissions and conform to climate targets. Climate Action
"very wide range" of financial products, some of which did 100+ has managed to push for substantial change in quite
not appear to have "materially different exposures" when a short amount of time, including getting Glencore, a com
compared to products not marketed as sustainable. This modities and mining firm, to agree to cap coal production,
raised the specter of greenwashing, that is, marketing that and Shell pie., an oil & gas firm, to link executive compen
portrays products or activities as producing positive envi sation to environmental targets. Other important group
ronmental outcomes, when this is not actually the case. ings include the Net Zero Asset Owners' Alliance, and its
counterpart for asset managers (see Table 4.2 for more
A further step, beyond checks, is to have mandatory dis
examples).
closure or marketing requirements. The European Union's
securities regulator conducted a consultation in 2020 In some cases (as alluded to in Section 4.2.4) there has been
about the appropriate marketing of sustainable funds, an increasing trend toward combining public and private
with a view to drawing up guidelines and rules. The FCA, efforts. The Chilean and UK high-level climate champions
too, has developed a set of principles intended for fund founded the Race to Net Zero in 2020. Similar to America's

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

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

norms have changed, as have societal and cultural In the corporate and financial space, remarkable examples
ones. Where previously politicians and policymakers of this include Climate Action 100+ and the various net-zero
may have been wary of implementing strong climate groupings of financial firms. Climate Action 100+ was a
policies, now it is as often as not other stakeholders private-sector, investor-led initiative to pressure the world's
that push them, or each other, to be more ambitious. most polluting publicly listed firms to do more on climate
The mechanism of peer pressure, cleverly built as it change. Even though many of the jurisdictions in which
was into the Paris Agreement, also operates beyond its these firms (e.g., large oil & gas majors or steel manufactur
direct scope. ers) operate were not seriously restricting their emissions,
1fflntllfJ
CLIMATE GROUPINGS
General/Corporate Groupings
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
Institutional Investors Asset The organization aims to support and enable the investment
Group for Climate Change managers community in driving significant and real progress by 2030
(IIGCC) 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 Asset managers Similar to, and founded on, the model of, the asset owner alli-
Initiative 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.

the firms' investors stepped in to demand that they limit 2019 to protest slow global progress on combating climate
emissions for reasons of corporate strategy, moral responsi change, and these protests significantly raised the profile
bility, and long-term viability and profitability. Asset owners of climate change as a political issue. Extinction Rebellion,
and asset managers in the various net-zero groupings have a climate-focused civil disobedience movement in the UK,
been able to position themselves as forerunners, placing sought to disrupt society to highlight the crucial impact of
competitors who have not made such commitments on the climate change, and many of its targets were banks per
back foot. Even back-end, structural aspects of the financial ceived to not be moving quickly enough on climate change
system, such as financial infrastructure, are starting to shift. or continuing to fund fossil fuels.
Many exchanges, for example, require sustainability and cli
Going forward, it is likely that that the bottom-up popular,
mate disclosures to list shares or bonds.
societal, and consumer pressure, combined with lateral
T hese changes are mirrored by changes in the broader soci pressure from some stakeholders (e.g., by large investors
ety. With the rise in popularity of Greta T hunberg, a young on large corporations) will continue to spur ever tighter and
Swedish climate activist, millions took to the streets in more ambitious policy frameworks.
REFERENCES documents/200309-sustainablefinance-teg-fi na I-report

taxonomy_en.pdf
Australian Prudential Regulation Authority. (2020).Under Climate Risk and Financial Institutions: Chal
IFC. (2011).
standing and managing the financial risks of climate change. lenges and Opportunities. Retrieved from Washington, DC:
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files/2020-02/Understanding%20and%20managing%20 7-9fd7-9185625dc1fe/lFCClimate_RiskandFls_FullReport.
the%20financial%20risks%20of%20climate%20change.pdf pdf?MOD=AJPERES&CACHEID=ROOTWORKSPACE-a23f1
European Central Bank. (2020). Guide on climate- 841-294d-4477-9fd7-9185625dc1fe-jqeAwCp
related and environmental risks: Supervisory expec- Kuramochi, T., Roelfsema, M., Hsu, A., Lui, S., Weinfurter,
tations relating to risk management and disclosure. A., Chan, S., . . . Hahne, N. (2020). Beyond national climate
Retrieved from https://www.bankingsupervision.europa. action: the impact of region, city, and business commit
eu/ legalframework/publiccons/pdf/climate-related_risks/ ments on global greenhouse gas emissions. Climate Policy,
ssm.202005_draft_guide_on_climate-related_and_environ 20(3), 275-291. doi:10.1080/14693062.2020.1740150
mental_risks.en.pdf
Proposed
Monetary Authority of Singapore. (2020).
Hansel, M. C., Drupp, M. A., Johansson, D. J. A., Nesje, F., Guidelines on Environmental Risk Management (Banks).
Azar, C., Freeman, M. C., ... Sterner, T. (2020). Climate eco (P003-2020). Retrieved from https://www.mas.gov. sg/-/
nomics support for the UN climate targets. Nature Climate media/MAS/News-and-Publications/ConsultationPa
Change, 10(8), 781-789. doi:10.1038/s41558-020-0833-x pers/2020/Consultation-Paper-on-Proposed-Guidelineson
High-Level Expert Group on Sustainable Finance. Environmental-Risk-Management-for-Banks.pdf
(2020).Taxonomy: Final report of the Techni- Napoli, C. (2012). Understanding Kyoto's Failure. The SAIS
cal Expert Group on Sustainable Finance. Retrieved review of international affairs, 32(2), 183-196. doi: 10.1353/
from https:// ec.europa.eu/info/sites/info/files/ sais.2012.0033
business_economy_euro/banking_and_finance/

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

ANSWERS
4.1 C 4.5 B
4.2 B 4.6 A
4.3 C 4.7 D
4.4 A

Green and
Sustainable
Finance: Markets
and Instruments
• 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. • Describe sustainable funds, green funds, and other
sustainable finance products.
Explain the core components of the Green Bond
Principles. • Understand the integration of ESG and climate issues
into investment and lending decisions.
• Explain green loans and their markets.
99
Understand how shareholders impact sustainability Key Learning Points
strategy of a company.
• Sustainable finance refers to any kind of financial product
Describe the existing and emerging approaches to or service that takes sustainability into account. Green
defining sustainable and green finance. finance is specifically environmental financing, and climate
finance is climate-related financing.
• Explain the trends in ESG disclosure requirements for
• Sustainable finance and climate finance have both seen
companies.
significant growth in recent years. The single larg-
• Identify regulatory trends in sustainable and green est actor providing financial flows for climate projects
finance. are public-sector development banks. The growth in
membership and total size of climate- and sustainability
related private-sector coalitions highlights their
importance.
This chapter focuses on financial-market develop
• Green bonds are bonds whose proceeds are ear
ments relating to sustainability issues and climate
related risks and opportunities. The chapter begins marked for environmental projects. They combine
by explaining what constitutes "green" and "sustain several innovations: They are separately labeled, their
able" finance and covers trends and investment flows. proceeds are ring-fenced, and the (planned) use of
It then includes a detailed examination of specific sus proceeds is reported both to prospective bondholders
tainable and green finance instruments and products, ex ante and to current bondholders once projects are
such as green bonds, green loans, and sustainability implemented.
linked bonds and loans. The chapter considers the • Other sustainable financial instruments include social
integration of environmental, social, and governance bonds, where proceeds are earmarked for social ben
(ESG) issues into investing, both through analysis and efit; sustainability bonds with dual environmental
through investor engagement. The chapter finishes and social benefits; green loans, which are similar to
with existing and emerging taxonomies and regula green bonds but are loans; and sustainability-linked
tory definitions, building on the policy material cov bonds and loans, where the bond coupon or loan
ered in Chapter 4. interest rate is tied to the achievement of sustainability
targets.
• The market for sustainable funds is large and growing
Chapter Outline and consists of both funds composed of sustainable
instruments (e.g., green bond funds) and funds with
5.1 Introduction to Green and Sustainable Finance
shares in sustainable companies.
5.2 Trends and Flows in Sustainable and Climate Finance • Many financial institutions practice ESG integration,
5.3 Sustainable and Green Financial Products and which involves using and collecting data on material ESG
Instruments issues, integrating it into investing and lending decisions,
and engaging with investee companies.
5.4 ESG and Climate Integration in Investing
• As the market has matured, there is greater regulatory
5.5 Existing and Emerging Definitions and Taxonomies
involvement and a move to standardize definitions
5.6 Conclusions and Prospects across borders.

GREEN AND SUSTAINABLE There is also increasing consensus on how to integrate envi
ronmental, social, and governance factors into lending and
FINANCE: MARKETS investing practices, specifically scores and metrics for port
AND INST RUMENTS folio analysis. Further, sustainability is an area where the use
of specific, defined, and labeled sustainable financial instru
5.1 Introduction to Green ments, such as green bonds, has become more popular.
and Sustainable Finance In general, the trend toward sustainable finance transac
The awareness of sustainability has moved from develop tions, products, and offerings has been carried out by main
ment and international public discourse into private-sector stream banks, insurers, asset managers, asset owners, stock
corporations, including financial-market participants. Build exchanges, ratings agencies, and other parts of the financial
ing on the examination of sustainability and corporate social system, sometimes through a dedicated sustainability divi
responsibility in Chapter 2, this chapter looks specifically sion. There has also been a rise in smaller, specialist pure
at the application of sustainability, especially in regard to play green or ESG financial firms.
environmental and climate issues and finance. Sustainable
finance refers to any kind of financial activity that takes
5.2 Trends and Flows in Sustainable
sustainability into account, across asset classes (includ-
and Climate Finance
ing equity, debt-both bonds and loans-and other asset
classes such as commodities or derivatives) and across dif This section reviews trends in assets and flows in sustain
ferent products and services, ranging from corporate loans able finance. According to a very broad definition of sus
to mutual funds with shares of sustainable firms, offered to tainable finance used by the Global Sustainable Investing
retail investors. Green finance refers to sustainable finance Alliance (GSIA), sustainably invested global assets under
focused on environment-related risks and opportunities management stood at USD 35.3 trillion in 2020. Assets
often, but not necessarily, climate change. Other topics grew by 15% in just the two years from 2018. Of the major
falling under the "green" categorization can include waste markets covered by the survey-namely the United States,
management, water usage, conservation of natural habitats, E.U., Canada, Australia, and Japan-Japan saw the greatest
and mitigating biodiversity loss. Climate finance refers growth in this period, with sustainable assets tripling every
exclusively to financial flows relating to climate change, year on average. The survey also indicates that a large pro
whether mitigation or adaptation. The term has been asso portion of all professionally managed assets are now man
ciated more with the use of public funds via development aged sustainably: around half in Canada and Europe, and a
assistance to fund mitigation and adaptation activities in quarter in the United States.
developing countries.
Note, however, that the GSIA definition includes negative/
Sustainable finance, both in its broadest sense and relating exclusionary screening (where the shares of certain types of
to its subtypes like green or climate finance, has been rap companies such as weapons manufacturers are left out of port
idly growing in popularity. Its growth can be measured in all folios) as a type of sustainable investing, accounting for around
sorts of ways, from assets under management invested in half of the total. The second and third largest categories in the
sustainable ways to the proliferation of specific sustainable GSIA survey-ESG integration and shareholder engagement
financial instruments. will be the focus in the remainder of this chapter.
Given the increasing awareness of sustainability, there has A similar trend can be seen in the field of climate finance.
been a temptation and tendency on the part of financial A common way to measure trends in this market is to track all
firms to label their offerings or their practices "sustainable" the financial flows that are used for climate change-related
without a harmonization of definitions. Industry standards projects and investments, regardless of their source-whether
and oversight has evolved both through self-policing from in the public or private sector or in financial or non-financial
industry associations and as a result of regulatory action. firms. Here, the comprehensive datasets compiled by the
Chapter 5 Green and Sustainable Finance: Markets and Instruments ■ 101

UNDERSTANDING CLIMATE FIN ANCE FLOWS BY SOURCE , INSTRUMENT,
AND SECTOR
The comprehensive accounting assembled bi-annually are not far behind, with commercial banks accounting
by the Climate Policy Initiative, an NGO, is widely seen for a somewhat smaller proportion. Financing is fairly
as a gold standard in tracking climate finance flows from evenly split between debt and equity. The vast majority
public and private sources, ranging from governments to of financing is related to climate change mitigation, not
public and private financial institutions to corporations adaptation, with large portions flowing into renewable
and households. In general, climate finance has more energy generation (e.g., wind and solar) and low-carbon
than doubled from 2012 to 2021, from USD 360 billion transport (such as electric vehicles).
to an estimated USD 850 billion per year (see graph).
Interestingly, for all the discussions of cross-border
It is more insightful to examine the comprehensive break investments and financial flows, the CPl's tallies show
down by source, instrument, and targeted sector than it the large majority of financing is domestic, with 76% of
is to only look at the simple amount. (See graphic). 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 the Net Zero Asset Owner Coalition, a group of investors
(see Figure 5.1), and similarly show the rapid growth in this dedicated to aligning their entire portfolios with the goal
space in recent years. of net-zero emissions by 2050, grew from 12 members
representing USD 2.4 trillion in assets to 84 members with
Yet another way to gauge the surge in sustainable and cli
11 trillion (see Table 5.1).
mate investing is to look at the proliferation and growth of
investor groupings and coalitions dedicated to sustainability Finally, one can also see this growth when looking at the
and climate issues, as covered in Chapter 4. For example, evolution in the market of sustainable finance instruments
in under two years from September 2019 to spring 2021, and financial products.

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,
::r
Ill
Others&
cross-sedoral $48
.,
ID
Project-level
(/1 market rate debt Land Use $1§_
$236
G)
(I)
(I)
:I
QI
a..
:I
V,
C: Energy systems
!!I.
Ill
$336
:I Mitigation
Ill
$586
!'2:
(I)
financing
(debt portion)
!! $112
:I
Ill
:I
n
(I)
s: Balance sheet
financing Transport
..,
Ill
;,;
(equity portion)
$156
$169
(I)
r+
C/1
Ill
a..
:I
Reprinted with permission of Climate Policy Initiative.
:I
C/1
..,
r+ dH'ik¥fJ
3
(I)
:I
r+
C/1
■
�
0
w
1ffltjrj.j■
GROWTH IN SIZE OF SELECT CLIMATE GROUPINGS
Founding Members 2020/1 Members

Name Founding Year Number Assets (USD) Number Assets (USD)
Principles for Responsible 2006 63 $6.5tn 5319 (2022) $121 tn (2022)
Investment
Taskforce on Climate-Related 2017 100+ $25tn 3960+ (2022) $220tn (2022)

Financial Disclosures
Climate Action 100+ 2017 225 $26.3tn 700+ (2022) $68tn (2022)
Net Zero Asset Owners 2019 12 $2.4tn 84 (2023) $11tn (2023)

Alliance
5.3 Sustainable and Green Financial and the (planned) use of their proceeds is reported both to
prospective bondholders ex ante and to current bondhold
Products and Instruments
ers once projects are implemented. In this way, they differ
This section reviews sustainable financial instruments and from typical corporate or government bonds, which func
products. These come in various forms, and different instru tion as general-purpose borrowings, where the issuer can
ments involve different sorts of counterparties. Green or then use the proceeds as needed.
sustainability loans, like typical corporate loans, tend to
be an agreement between a small number of banks and a Green bonds were pioneered by multilateral development
borrowing company. Green and other sustainability bonds banks. In 2007, the European Investment Bank issued a
are used by all kinds of private and public entities to raise "climate awareness bond," and in 2008, the World Bank used
funds; as with other kinds of bonds, their issuance is under the term "green bond" to describe debt issuance. Since
written by banks, and they are traded on secondary mar these early developments, the use of these instruments has
kets. For institutional or retail end investors, sustainable or increased exponentially. The EIB's initial USD 800 million
green fund products are available. These may consist of sus green bond issuance has grown to USD 270 billion in 2020.
tainable instruments (a bond fund made up of green bonds) One of the challenges in this market is that green bond issu
or of other assets (e.g., shares of sustainable companies). ances are, so far, largely self-defined and self-policed by the
market under broad, industry-led principles and definitions
In general terms, sustainable financial products come in three
such as the Green Bond Principles from the International
broad varieties. For some, the use of proceeds is earmarked
Capital Market Association (ICMA). However, regulators are
and ring-fenced for sustainable use (e.g., green bonds). For
also moving toward setting definitions, as exemplified by the
sustainability-linked instruments, the financial instrument
E.U. green bond standard (see Section 5.4).
itself is linked to sustainability targets, such as through an
interest rate penalty or reward on achievement of a specified As issuance has grown, the issuer base of green bonds has
target. For still other products, sustainability acts as selection diversified and the market has matured. From its origins
criteria for inclusion (e.g., in a sustainable equity fund) or for within public-sector development banks, green bond issu
targeted engagement with the management of a company. 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
5.3. 1 Green, Social, and Sustainable Bonds around green bonds. As with traditional bonds, investment
Green bonds are bonds whose proceeds are earmarked for banks handle the underwriting of issuance. In addition to
environmental projects. They combine several innovations: seeking credit ratings, it has become established industry
They are separately labeled, their proceeds are ring-fenced, practice for green bond issuers to seek a rating or "second

ICMA GREEN BOND PRINCIPLES-EXCERPTS
The[Green Bond Principles] have four core components: - Complementary information on processes by which
1. Use of Proceeds the issuer identifies and manages perceived social
2. Process for Project Evaluation and Selection and environmental risks associated with the relevant
project(s).[. . .]
3. Management of Proceeds
3. Management of Proceeds: The net proceeds of the
4. Reporting
Green Bond[. . .]should be credited to a sub-account,
moved to a sub-portfolio or otherwise tracked by the
1. Use of Proceeds The cornerstone of a Green Bond
issuer in an appropriate manner, and attested to by the
is the utilization of the proceeds of the bond for Green
issuer in a formal internal process linked to[. . .]lending
Projects, which should be appropriately described in
and investment operations for Green Projects. [. . .]
the legal documentation for the security. All designated
Green Projects should provide clear environmental 4. Reporting: Issuers should make, and keep, readily
benefits, which will be assessed and, where feasible, available up to date information on the use of proceeds
quantified by the issuer.[ ...] to be renewed annually until full allocation, and on
a timely basis in case of material developments. The
Eligible Green Project categories, listed in no specific
annual report should include a list of the projects to
order, include, but are not limited to:
which Green Bond proceeds have been allocated, as well
• renewable energy as a brief description of the projects and the amounts
• energy efficiency allocated, and their expected impact.[ . . .]
• pollution prevention and control Green Bond Frameworks: Issuers should explain
the alignment of their Green Bond or Green Bond
• environmentally sustainable management of living
programme with the four core components of the
natural resources and land use GBP[ ...]in a Green Bond Framework or in their legal
• terrestrial and aquatic biodiversity conservation documentation. Such Green Bond Framework and/or
legal documentation should be available in a readily
• clean transportation
accessible format to investors.[ ...]
• sustainable water and wastewater management
External Review: It is recommended that issuers appoint
• climate change adaptation (an) external review provider(s) to assess through a pre
issuance external review the alignment of their Green Bond
• circular economy adapted products, production
or Green Bond programme and/or Framework with the
technologies and processes four core components of the GBP[ ...]as defined above.
• green buildings 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
2. Process for Project Evaluation and Selection: The issuer nal tracking and the allocation of funds from the Green
of a Green Bond should clearly communicate to investors: Bond proceeds to eligible Green Projects. [ ...]
- the environmental sustainability objectives of the eli
Source: Green Bond Principles Voluntary Process
gible Green Projects; Guidelines for Issuing Green Bonds June 2021 (with
- the process[. . .]determin[ing]how projects fit within June 2022 Appendix). Reprinted by permission from
the eligible Green Projects categories; International Capital Market Association.
opinion" on the environmental credentials of green bonds evolved. Social bonds are bonds with earmarked proceeds
from organizations such as CICERO, a Norwegian research for projects that will bring social benefits. As with green
organization, or Sustainalytics, a consultancy. Although bonds, the impetus initially came from a public-sector
green bonds were the first labeled sustainable bond and financial institution, in this case Spain's lnstituto de Credito,
make up the largest portion of sustainable bond issuance, which issued the first social bond in 2015 to finance small
in recent years, other types of sustainable bonds have and medium enterprises in disadvantaged parts of Spain.

Social bonds also have spread to the private sector. NPL ratio stood at 1.83% (Choi, 2020). However, effects vary
January 2021, alone, saw issuance from firms like German significantly between large, state-owned banks, where the
regional bank, Landesbank Baden-Wurttemberg, for financ green loan ratio is negatively associated with credit risk, and
ing affordable basic infrastructure and access to essential smaller city/regional level commercial banks, where increases
services, and British firm Motability Operations Group for in the proportion of green loans has been found to be asso
operating a wheelchair-accessible vehicles initiative. ciated with greater credit risk (Zhou, 2020). In other words,
it seems that large Chinese banks' green loans tend to be
Sustainability bonds are a combination of the two, in that
"safer" than the rest of their loan book, whereas for small
they are meant to simultaneously address both environmen
Chinese banks, green loans tend to be riskier.
tal and social objectives. The issuance of social and sustain
ability bonds increased dramatically in 2020, partly due to Globally, green loan underwriting grew from around USD
the global COVID-19 pandemic, and continued to grow 30 billion in 2015 to around USD 90 billion in 2019. Green
rapidly in 2021 and 2022. Another variety of labeled bonds loans have been highly concentrated in the power sector,
is the SDG bond, linked to UN Sustainable Development with 47% lent to renewable energy projects and another
Goals. As covered in Chapter 2, the SDGs cover social, 23% to the power generation sector as of October 2020
environmental, and economic goals. (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
5.3.2 Green Loans ing. Indeed, on a global scale (but especially in Europe),
Green loans are loans that have been made for envi green loans have been overshadowed by the even quicker
ronmental and climate-related projects. In international growth of sustainability-linked loans, whose total volume in
markets, under the definition set out by the Loan Market 2019 already exceeded that of green loans despite a later
Association in the Green Loan Principles, green loans are start (see next section).
expected to ring-fence and borrowers are expected to
report on the use of their proceeds. In specific jurisdictions, 5.3.3 Sustainability-Linked Bonds and Loans
green loans are sometimes governed by slightly different,
An important innovation among labeled sustainable instru
national rules, most notably in China.
ments has been to introduce dynamism through linking
China, in its domestic market, is a notable and early adopter financing to sustainability targets as an incentive, rather
of green loans. The adoption of these loans stemmed from than simply ring-fencing certain funds for use in green or
the government's 2007 Green Credit Policy rather than sustainable projects. In sustainability-linked bonds (SLB),
from a private-sector initiative. This policy requires banks the coupon paid by the issuer is linked to the issuer firm's
to offer green credit for environmental protection, emission achievement of pre-agreed sustainability targets. Similarly,
reduction, and energy conservation projects, and restricts for sustainability-linked loans (SLL), the interest rate on
loans to high-polluting and -emitting industries, and to ones the loan is linked to a company's achievement of certain
suffering overcapacity. The policy aims both to reduce envi sustainability benchmarks. In contrast with green bonds and
ronmental harm and to reduce exposure to climate-related especially green loans, sustainability-linked instruments are
financial risks from heavily polluting industries, thus improv rapidly being adopted by a variety of sectors, tied to a vari
ing financial stability (Cui et al., 2018). ety of targets (see highlighted examples). These targets are
often called key performance indicators (KPls).
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, Sustainability-linked bond issuance and loan volume have
representing a cumulative total of over RMB 10.6 trillion grown significantly in a very short period of time. Despite
(USD 1.5 trillion). The vast majority of Chinese green loans the fact that the Sustainability-Linked Loan Principles,
went to clean transport (45%) and clean energy (29%) in which set guidelines for the market, only launched in 2019,
2019. Generally, green loans in China have performed better that year already witnessed more in SLL volume (around
than conventional loans, with the non-performing loan (NPL) USD 90 billion) than the green loan market, a more mature
ratio for green loans at 0.42% in 2018, while the overall credit labeled loan category. The Sustainability-Linked Bond

GROWTH OF SUSTAINABLE BONDS BEYOND GREEN
Green bond issuance has grown significantly in a when the world was hit with the COVID-19 pandemic
short amount of time, reaching over $500bn for the and many institutions wanted to raise money to help
first time in 2021. Social and sustainability bonds address its impacts, saw a particularly large upsurge
have likewise grown quickly in issuance, although in social and sustainability bond issuance compared to
with a later start and from a lower baseline. In 2020, previous years.
1000
■ Green ■ Social ■ Sustainability
Vl
C
800
600
SLB ■ Transition
.Q
co
0
V)
400
::,
200
0 iiiii
<2015 2016 2017 2018 2019 2020 2021
© Climate Bonds Initiative, 2022.
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SUSTAINABILITY-LINKED BONDS AND LOANS: SELECT EXAMPLES

DSM (EUR 1 billion loan, 2018): In a very early deal Volution (GBP 150 million loan, 2020): Volution, a
for the sustainability-linked loan market, DSM, a Dutch British ventilation systems manufacturer, was due to
health, nutrition, and materials company, took out refinance an existing GBP 120 million loan facility. After
a EUR 1 billion revolving credit facility with a group conversations on integrating sustainability with its advisor
of 15 banks linked to its greenhouse gas (GHG) Rothschilds and its banking syndicate, it agreed a GBP
emissions. Specifically, the interest rate was linked 150 million sustainability-linked revolving credit facility.
to three indicators KPls: cumulative GHG efficiency It is tied to two KPls: the percentage of sales revenue
improvements, changes in the Energy Efficiency Index from low-carbon products and the percentage of plastic
(EEi), and the proportion of the firm's electricity sourced processed in its owned factories from recycled sources.
from renewable resources.
Schneider Electric (EUR 650 million bond issue, 2020):
Chanel (EUR 600 million [2 x 300 million] bond issue, Schneider Electric, a French electrical equipment company,
2020): Chanel, the famous French fashion company, issued a EUR 650 million bond issue tied to three KPls:
issued a sustainability-linked bond in 2020 in two parts. GHG emissions, gender diversity in its workforce, and
The first EUR 300 million tranche was tied to cutting training underprivileged people. Specifically, the firm set
its corporate GHG emissions in half by 2030 and a 2025 target of 800 megatons of saved and avoided CO2
reducing supply chain emissions by 10%. The coupon emissions; targets of reaching a workforce of 50% women,
on the bond of 1 % will be supplemented by a penalty including 40% in front-line management and 30% among
of 0.75% should the emissions targets not be met. The senior executives; and training one million people in
second EUR 300 million tranche is tied to transitioning energy management. Should its performance fall short, it
the firm to 100% renewable energy use by 2025. The has committed to pay its bondholders a penalty of 0.5% of
base coupon is 0.5% and, in case of non-fulfillment, the the nominal value of the (coupon-free) bonds.
coupon increases to 1.0%.
Sources: DSM; Raconteur; Rothschild; Schneider Electric.

Principles are even more recent, launching in 2020. Both have some specific elements, notably in relation to the strin
are industry-led sets of guidelines, with the loan guidance gency requirements for KPls and sustainability performance
developed by three loan-market umbrella organizations: targets (see Sustainability-Linked Loan Principles box).
the Loan Market Association (LMA), the Loan Syndication
and Trading Association (LSTA), and the Asia Pacific Loan
5.3.4 Sustainable and Green Funds
Market Association (APLMA). The bond guidance was An additional category of sustainable finance products are
developed by ICMA, the same body that published the sustainable and green funds, which are primarily targeted
Green Bond Principles. The SLL and SLB principles are also at institutional or retail investors. A large number of invest
being further coordinated so that the sustainability-linked ment vehicles, both actively or passively managed, such
market aligns better across bonds and loans. While they are as mutual funds, exchange-traded funds, or other types of
based on the Green Bond Principles to an extent, they also funds, market themselves on their sustainable credentials.
SUSTAINABILITY-LINKED LOAN PRINCIPLES-EXCERPTS

"Sustainability linked loans are any types of loan instru The SLBP have five core components:
ments and/or contingent facilities (such as bonding lines, 1. Selection of Key Performance Indicators (KPls)
guarantee lines or letters of credit) which incentivise the
borrower's achievement of ambitious, predetermined 2. Calibration of Sustainability Performance Targets (SPTs)
sustainability performance objectives. The borrower's 3. Bond characteristics
sustainability performance is measured using sustainabil
ity performance targets (SPTs)[. . . ] measuring improve 4. Reporting
ments in the borrower's sustainability profile.
5. Verification[. . .]
The use of proceeds in relation to a sustainability-linked
loan is not a determinant in its categorisation and, in The KPls should be
most instances, sustainability-linked loans will be used • relevant, core and material to the issuer's overall busi
for general corporate purposes. Instead of determining ness, and of high strategic significance to the issuer's
specific uses of proceeds, sustainability linked loans look current and/ or future operations;
to improve the borrower's sustainability profile by align
ing loan terms to the borrower's performance against the • measurable or quantifiable on a consistent method
relevant predetermined SPTs. ological basis;
The SLLP set out a framework[. . .] based around the fol • externally verifiable; and
lowing four core components: • able to be benchmarked, i.e. as much as possible
1. Relationship to Borrower's Overall Sustainability using an external reference or definitions to facilitate
Strategy the assessment of the SPT's level of ambition. [. . .]
2. Target Setting-Measuring the Sustainability of the The SPTs should be ambitious, i.e.:
Borrower • represent a material improvement in the respective
3. Reporting KPls and be beyond a "Business as Usual" trajectory;
4. Review" • where possible be compared to a benchmark or an

external reference;
Sustainability-Linked Bond Principles-Excerpts • be consistent with the issuers' overall strategic
"Sustainability-Linked Bonds ("SLBs") are any type of sustainability I ESG strategy; and
bond instrument for which the financial and/or structural • be determined on a predefined timeline
characteristics can vary depending on whether the issuer
achieves predefined Sustainability/ ESG objectives. In that Sources: SLLP 2020 and Sustainability-Linked Bond
sense, issuers are thereby committing explicitly (including Principles Voluntary Process Guidelines June 2023.
in the bond documentation) to future improvements in Reprinted by permission from International Capital
sustainability outcome(s) within a predefined timeline. [. . . ] 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.

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

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

EXAMPLES: ESG INTEGRATION IN PRACTICE
Neuberger Berman (asset manager)-ESG Integration Columbia Threadneedle (asset manager)-ESG
for Japanese investments: Integration through use of in-house scores:
The American asset manager uses two pillars to inte In 2017, Columbia Threadneedle decided to build a solu
grate ESG into its investment process, the first focusing tion for itself to cut through the tangle of different com
on material environmental and social issues, and the mercially available ESG ratings. Drawing on its own 130
second on governance. The firm uses the Sustainability financial analysts and research staff, it developed a pro
Accounting Standards Board (SASB) framework to iden prietary ratings system intended to provide useful invest
tify the factors that are likely to affect companies, indus ment signals. The ratings are based partly on proven
tries, and sectors. The lead portfolio manager or analyst academic models that have demonstrated their reliability
for a company evaluates the firm in detail, including its as strong indicators of companies' financial stewardship.
supply chains, through the use of company disclosure This model is then paired with a second model focused
documents and meetings with firm executives. Neuberger on the financial materiality of ESG factors, which makes
Berman then blends this data, which it sources itself, use of SASB standards to help define materiality. Colum
with ESG ratings from third-party providers. Neuberger bia's model is on a rating scale of 1-5. The asset manager
Berman uses its own scoring model to put together these applies these ratings to approximately 6000 companies.
data points and determine the weighting of a particular
Sources: SASB (2020), SASB (2019).
firm in its portfolio.
a substantial proportion of the shareholders of any publicly enough to show up in third-party data (Barko, 2017; Dyck
listed company, and therefore Climate Action members are et al., 2019).
able to exert much more pressure on management than any
Often, engagement is paired with the threat of divestment,
individual investor could.
which is the ultimate penalty, if all engagement efforts are
There is strong evidence of the power and results achieved unsuccessful. This is also the case for the LGIM approach.
by shareholder engagement in the academic literature. But this threat obviously requires market power and flexibil
One review found that companies comply with shareholder ity to be effective, meaning it can only be credibly made by
engagement requests at success rates ranging from 18% larger asset managers or hedge funds. Passively managed
to 60% (Kolbel et al., 2019). Shareholder proposals have funds, by definition, follow an index and therefore cannot
also been linked to subsequent increases in the ESG rat divest by their own choice. They shift the fund composition
ings of the firms targeted for engagement, meaning that only if the underlying index composition is changed, or if
the results of shareholder engagement can be significant the tracker index of a fund changed.
CASE STUDY: ENGINE NO.1 AND SHAREHOLDER ACTIVISM

In 2021, the hedge fund Engine No. 1 made headlines reforms. They a/so proposed four new independent
around the world by challenging the leadership of directors as candidates for the company's board. Over
Exxon for its lack of climate action. In December 2020, the next six months, they were successful in convincing
the impact-focused investment fund had invested major investors, including Vanguard and BlackRock, to
around USO 40 million dollars in Exxon shares. The support this campaign, which ultimately led to three
group then began to publicly argue that Exxon's new directors being appointed to at the next Share
hesitancy on climate was creating risks that ultimately holder meeting in May 2021. This is a prominent exam
threatened shareholder value. They wrote a letter to ple of how investors are beginning to use their power
the board of directors, criticizing the firm's history in to pressure companies into stepping up their efforts to
supporting climate denialism and asking for widespread tackle climate change.

C ASE STUDY: LEGAL & GENERAL INVESTMENT MANAGEMENT
AND CLIMAT E CHANGE
Legal & General Investment Management is a large, UK against their management and divested from them
based asset manager with over GBP 1 trillion in assets within some of their funds-as it did, for instance, with
under management. In 2016, LGIM launched its Climate oil & gas major ExxonMobil in 2019.
Impact Pledge, a program of targeted engagement with
In recent years, LGIM has made significant progress
about 80 companies and with the aim to speed up the
towards achieving economy-wide net-zero emissions.
economic transition to a low- or zero-carbon economy.
In 2019, it renewed and expanded its original pledge
This original pledge focused on the largest companies by increasing the number of companies and sectors
in sectors crucial to energy transition (energy, transport, covered, adopting a new engagement approach, and
financials) and deforestation and land use change (food updating its scoring methodology.
retail). Companies were assessed and ranked on a wide
In an upgrade to its engagement practices, LGIM
range of indicators-from governance structures to
divided its investee companies into two groups-a broad
business targets and lobbying activities-to gain a well
group of 500 firms to which LGIM will send a letter, and
rounded view of their exposure to climate risks and the
a targeted group of 50 companies it considers "pivotal"
available opportunities, and to produce a Climate Impact
to the transition and that will receive more involved and
Pledge score. The firm then published these scores and
frequent engagement.
used them to "name and shame" firms. When compa
nies failed to demonstrate sufficient action, LGIM voted Source: Legal & General Climate Impact Report, 2020.
5.5 Existing and Emerging Definitions information. Naming and marketing rules will restrict the use
of certain sustainability-related terms unless the product has
and Taxonomies
a sustainable investment label, and distributors must ensure
Amid the proliferation of sustainable finance and invest product-level information is available to consumers. The FCA
ments, the need for harmonized definitions has grown. has proposed a general anti-greenwashing rule for all regu
So far, much of this has been satisfied through bottom-up lated firms, emphasizing the need for sustainability-related
approaches from market participants coming together claims to be clear, fair, and not misleading. The industry
through industry associations that agree to voluntary guide feedback from the consultation will continue into 2023.
lines and frameworks. However, there is also growing regu
The new guidance also restricts how some sustainability
latory involvement in this area.
related terminology can be utilized in marketing for prod
Regulatory involvement has come in many different forms and ucts that don't qualify for sustainable labels. The aim is to
depends to some extent on the regulatory frameworks and avoid misleading marketing of products and to increase
traditions in different jurisdictions (as covered in Chapter 4). transparency and consumer confidence in investments. It
places a significant emphasis on the importance of investors
Common-law jurisdictions, such as the UK and its former
to properly substantiate their sustainability claims, rather
colonies, typically rely more on evaluating situations as they
than the regulator itself trying to define every permissible
come up, whereas civil-law jurisdictions tend to specify laws
type of sustainability claim, recognizing that this is a rapidly
and rules in advance. The UK Financial Conduct Authority
evolving area of practice.
(FCA) has taken a case-law approach with its proposals to
clamp down on greenwashing. The FCA aims to enhance In the E.U., regulators are focused on specifying green
consumer trust in sustainable investments by introduc- bond definitions, sustainable fund marketing parameters,
ing sustainable investment labels and consumer-facing and the limits of sustainable economic activities in advance.
disclosures, pre-contractual and ongoing sustainability Indirect regulatory action has also played a role. For instance,
related performance information, and a sustainability entity in jurisdictions where central banks practice monetary easing
report for institutional investors and those seeking more through large-scale bond purchases (i.e., quantitative easing),

the eligibility requirements for these purchases can end up companies and limited liability partnerships to report on
significantly affecting market practices and the growth of climate risk in line with TCFD recommendations. China's
nascent sustainable instruments. securities regulator has introduced rules to mandate all
listed firms to disclose ESG risks. In Canada, listed firms are
5.5. 1 Defining Financial Products required to report some ESG parameters around diversity,
and all companies receiving extraordinary government sup
Many of the labeled financial products covered in this chap
port in the COVID-19 pandemic are required, in return, to
ter were invented or standardized in a bottom-up way, by
start TCFD reporting.
financial market participants. Green bonds abide by the
Green Bond Principles, with extra confidence coming from In other cases, disclosure requirements have come through
the second-opinion providers that vouch for their green exchanges themselves. Exchanges can serve as important
credentials, such as Sustainalytics, CICERO, or the Climate gatekeepers, because they are the only venues where com
Bonds Initiative. panies can be publicly listed. The Shanghai and Shenzhen
stock exchanges require ESG disclosure from the firms
The trend has been similar with social and sustainability
listed on them; one of Shanghai's requirements to conduct
bonds and sustainability-linked bonds and loans. In general,
an initial public offering (IPO) is to provide annual sustain
Green loans have been similar in most countries, though
ability reporting. At least 25 stock exchanges worldwide
their use in certain jurisdictions, such as China, is mainly due
from Buenos Aires and Lagos to Lisbon and Manila-have
to domestic regulatory pressure.
similar rules requiring firms to disclose ESG to be listed on
There has been a limited trend in regulatory involvement their exchanges.
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
5.5.3 Regulatory Trends: Defining
undertaken in autumn 2020. As of 2022, negotiations
Sustainability by Economic Activity
remain ongoing. Indirect regulator recognition has also An increasing amount of regulatory activity in relation to
helped. Regulatory initiatives have encouraged the sustainable finance involves neither financial products or
growth of green finance, such as through the Network for disclosures, but rather the underlying economic activity
Greening the Financial System (NGFS). The recognition being financed.
by the European Central Bank in November 2020 that
There has historically been some divergence on these
sustainability-linked bonds are acceptable as collateral
issues between jurisdictions, notably between China and
has also helped grow that market.
OECD countries. For a long time, China has allowed "clean
coal" and other types of "clean utilization of fossil fuels"
5.5.2 Disclosure Requirements: Regulators to be financed by green bonds, whereas prevailing market
and Exchanges led standards in the West have not allowed fossil-fuel
One important trend that has grown in recent years is that financing of any kind. However, in a sign of growing moves
of increased disclosure requirements for companies, usually toward harmonization, China announced a proposal in
through regulatory action. 2020 to exclude clean fossil fuels from a revised standard,
thus bringing it in line with other countries and market-
In the E.U., a directive on disclosure of non-financial infor
led rules.
mation requires certain large firms and firms of public
interest to disclose ESG-related matters. The directive Regulators have also been moving to pin down the
was expanded in 2021, with all firms with more than 500 definitions of sustainable activities in ever greater detail.
employees that are doing business in the E.U. required The furthest along in this regard is the European Union.
to disclose. In the UK, listed firms have been required to The E.U. Taxonomy, first published in draft format in
report on greenhouse gas emissions and diversity since March 2020, sets performance thresholds (referred to as
2006. Starting in 2022, the country is requiring all listed "technical screening criteria") for economic activities, by

sector and subsector. The taxonomy is agnostic to financial aim to develop a jointly recognized classification system for
instruments or means of funding. Any investment or lend signifying which businesses are considered sustainable. The
ing for a recognized activity, whether through a loan, a first consultation version was published at the end of 2021,
green bond, or project financing, counts as sustainable. with an updated version published in June of 2022.
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 5.6 Conclusions and Prospects
substantive contribution to at least one of six environmen
The field of sustainable finance has grown tremendously
tal objectives: climate change mitigation, climate change
within the financial sector, evolving from a niche area of
adaptation, the sustainable use and protection of water
finance dominated by project finance funded by public bod
and marine resources, the transition to a circular economy,
ies, to a sizeable market segment of private finance. The
pollution prevention and control, and the protection and
financial sector has brought its innovation capacities to bear
restoration of biodiversity and ecosystems. They must also
and come up with many kinds of novel financial instruments
explicitly do no harm to any of the other five objectives and
that earmark funding for sustainable projects. Many of
must meet a series of minimum safeguards.
these have sprung up organically, with standards and guide
Other countries are also developing taxonomies, including lines born from industry associations. Integrating ESG into
the UK, Canada, and the ASEAN countries of Southeast the fabric of operations occurs at an increasing number of
Asia. Given the E.U.'s role as the first major jurisdiction to financial firms. How-ever, as the ESG market grows further,
finalize its taxonomy, it may well end up providing a model there is also a trend toward more regulatory involvement as
or template for many of these others. The UK process, for well as cross-border harmonization of definitions.
example, is explicitly "tak[ing] the scientific metrics in the
The portion of all financial activities that incorporates sus
E.U. taxonomy as its basis."
tainability is expected to continue rising amid increased
In parallel, the magnitude of global cross-border invest stakeholder, government, and peer pressure, and as sustain
ment flows creates an incentive to harmonize definitions on ability becomes a societal norm. However, for sustainable
sustainable economic activities, just as there has been on finance to develop further it likely will require further action
the definitions of sustainable investment products. In April not only on harmonization and regulatory oversight but also
2021, for instance, China and the E.U. announced plans for on more fundamental measures such as ways to measure
joint technical work on harmonizing taxonomies, with the non-financial impact in cross-comparable ways.
E.U. TAXONOMY: SELECT EXAMPLE CRITERIA

The technical criteria of the E.U. taxonomy set out in [The eligibility of the activity/factory requires the
detail, by sector and subsector, what activities count following:]
as sustainable. This box highlights some illustrative
(A) Cement clinker: Specific emissions (calculated accord
examples.
ing to the methodology used for EUETS benchmarks)
Cement manufacturing: associated to the clinker production processes are lower
than the value of the related EU-ETS benchmark. As of
The manufacturing of cement is associated with significant February 2020, the EU-ETS benchmark value for cement
CO2 emissions. Minimising process emissions through clinker manufacturing is: 0.766 tCO2e/t of clinker
energy efficiency improvements and switch to alternative
fuels, promoting the reduction of the clinker-to-cement (B) Cement: Specific emissions associated to the clinker
ratio and the use of alternative clinkers and binders can and cement production processes are lower than: 0.498
contribute to the mitigation objective. tCO2e/t of cement or alternative binder

Passenger rail transport (interurban): • For activities which go beyond 2050, it must be tech-
[These must] demonstrate substantial GHG emission nically feasible to reach net-zero emissions
reduction by:
Anaerobic digestion of sewage sludge:
• Increasing the number of low- and zero emission
Net GHG emission reduction from sewage sludge treat
fleets, and improving fleet efficiency, and
ment through the capture and utilization of the gener
• Improving efficiency of the overall transport/mobility ated biogas in various forms and applications, often
system displacing fossil fuels.
Anaerobic digestion of sewage sludge treatment is eli
Zero direct emissions trains are eligible. Other trains are
gible provided that (cumulative):
eligible if direct emissions (TTW) are below 50g CO2e
• methane leakage from relevant facilities (e.g. for
emissions per passenger kilometre (gCO2e/pkm) until
2025 (noneligible thereafter). biogas production and storage, energy generation,
digestate storage) is controlled by a monitoring plan;
Cogeneration of Heat/Cool and Power from
Concentrated Solar Technology: • the produced biogas is used directly for the gen
Any cogeneration technology can be included in the tax eration of electricity and/or heat, or upgraded to
onomy if it can be demonstrated [. . .] that the life cycle biomethane for injection in the natural gas grid, or
impacts for producing 1 kWh of heat/cool and power are used as vehicle fuel (e.g. as bioCNG) or as feed
below the declining threshold. stock in chemical industry (e.g. for production of H2
Declining threshold: The Cogeneration Threshold is the com and NH 3).
bined heat/cool and power threshold of 100 gCO2e/ kWh.
• This threshold will be reduced every 5 years in line Source: Taxonomy: Final report of the Technical Expert
with a net-zero CO2e in 2050 trajectory Group on Sustainable Finance. Copyright © 2020. This
work is licensed under a Creative Commons Attribution
• The threshold must be met at the point in time when
4.0 International License.
taxonomy approval is sought for the first time
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Banking in China-Emerging Trends (CPI Discussion Brief,
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Barko, T. C., M.; Rennebog, L. (2017). Shareholder Engage Cui, Y., Geobey, S., Weber, 0., & Lin, H. (2018). The Impact
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papers.cfm?abstract_id = 2977219 Dyck, A., Lins, K. V., Roth, L., & Wagner, H. F. (2019,
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IMLA. (2020). Green mortgages. http://www.imla.org.uk/ & Club, S. (2020). Banking on Climate Change: Fossil Fuel
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mental Network, Oil Change International, Reclaim Finance,

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

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

ANSWERS
5.1 C 5.5 A
5.2 D 5.6 C
5.3 B 5.7 B
5.4 D

Climate Risk
Measurement and
Management
• Explain how climate risk manifests as financial risk • Understand transmission channels of climate risk,
through micro and macro economic transmission and how related systemic risks potentially threaten
channels. financial stability.
• Describe how climate risk affects company-level • Describe CVaR and its uses.
risks including operational, credit, liquidity, and
underwriting risks, and whether these risk types pose • Describe the data types, analytical tools, and their
macro-level risks. sources to measure transition and physical risks at the
company-level.
• Understand the associated risk metrics for and com
ponents of each risk type. • Understand how to measure transition and physical
risks at the portfolio level.
Examine the effects of climate risk on micro
(company-level) risks such as operational, credit, • Examine how climate risk drivers can be incorporated
liquidity, and insurance. into existing enterprise risk management (ERM)

frameworks.
• Discuss how ERM frameworks are used in practice

using case studies and examples.
123
• Climate risk can also constitute a systemic risk and a
This chapter describes how climate risk, both physi potential threat to financial stability through its impacts
cal and transition risk, is measured and managed, ((as on entire sectors and swathes of the economy.
described in Chapter 3). After an introduction, this • Corporate greenhouse gas emissions are classified by
chapter covers in detail how climate risk transmits
scope. The classifications are as follows: Scope 1 (direct
into more traditional risk categories at the company
emissions), Scope 2 (emissions from energy inputted)
level, including operational risk, credit risk, liquidity
and Scope 3 (indirect emissions from supply chains and
risk, and underwriting risk. It then covers how climate
products).
risk can be a systemic risk with potential threat to
• Understanding transition risks requires data beyond
financial stability, transmitting either through one of
current emissions, notably on emission trajectories, as
the previously mentioned channels or through mar
well as data on a number of drivers ranging from policy
ket dislocations (market risk) or effects on countries
and technological changes to consumer preferences and
(sovereign risk).
market sentiment.
The chapter goes on to describe available data and • Physical risks can be analyzed at the asset level, or, for
analytical tools for measuring both physical and transi
ease of use, through company-level scores. Asset
tion risks, building on material from Chapter 3. Finally,
level analysis is more thorough but also more difficult;
this chapter examines how climate risk can be, and
scores are easier to use and integrate but can some
is being integrated into existing enterprise risk man
times suffer from methodological opacity or lack of
agement (ERM) processes, ranging from governance
cross-comparability between providers.
structures and strategy setting to risk evaluation and
• Climate risk can be integrated into enterprise risk man
disclosure. The material in this chapter sets the stage
agement in all its facets. This includes risk governance,
for Chapter 7, which builds on these topics by looking
strategy, risk assessment, review, and disclosure.
specifically at the application of scenario analysis to
climate risk management.
CLIMATE RISK MEASUREMENT

Chapter Outline AND MANAGEMENT
6.1 Introduction to Climate Risk Measurement and
Management 6.1 Introduction to Climate Risk
6.2 Introducing Climate Risk Transmission: Micro and Measurement and Management
Macro Level
Risk management is a structured approach to monitoring,
6.3 Micro (Company-Level) Climate Risks measuring, and managing exposures to reduce the potential
6.4 Macro Climate Risk: Systemic Risk and Financial Stability impacts of uncertain occurrences. It has long been practiced
by non-financial corporations and financial institutions alike.
6.5 Climate Risk Measurement: Data and Analysis
As with other kinds of risks, climate risk management, when
6.6 Climate Risk within Enterprise Risk Management (ERM)
practiced proactively, can help mitigate the impacts of climate
6.7 Conclusions change, both from physical impacts and transition impacts, on
a financial institution's portfolio or corporation's operations.
Key Learning Points
To understand and manage climate risk, it is helpful to
• Measuring and defining climate risk is a prerequisite for examine how climate risk affects various types of financial
being able to manage it-even more acutely so than for risk, such as operational, market, insurance, liquidity, and
many other kinds of risks. credit risk. This is not only because risk managers are more
• Climate risk affects many company-level risks, including familiar with these "traditional" categories of risk, but rather
operational, credit, liquidity, and underwriting risks. because climate change transmits through these various

types of risk. Understanding these transmission channels greater variety of data. Understanding transition risk not
is therefore crucial for understanding the risks created by only requires solid data on the amount of greenhouse gas
climate change. For analytical clarity, this chapter starts by emissions attributable to a particular company or asset
looking at company-level "micro" climate risk transmission but also an understanding of the evolving climate policy
(Section 6.2) and then goes on to discuss climate change as landscape, technological changes, and evolving consumer
a macro phenomenon, with the potential to be a source of and broader societal preferences, as well as market senti
systemic risk and a threat to financial stability (Section 6.3). ment. Understanding physical risk requires forward-looking
climate models and historical weather data, as well as
The old cliche that "You can only manage what you can
information on physical geography, adaptive infrastructure,
measure" is just as true for climate risk as it is for other
market responses, cross-correlations, and distributions (see
types of risk. However, compared to other types of risk,
schematic for an example, and Section 6.4 for details).
accurately measuring climate risks often requires a much
EXAMPLE: DATA FOR UNDERSTANDING PHYSICAL RISK TRANSMISSION

INTO FINANCIAL PORTFOLIOS
This visual shows the generalized transmission chain of In jurisdictions where mortgages tend to be retained
physical risk into financial assets, as presented for the US on bank balance sheets, banks need access to this
mortgage market in Chapter 3. It highlights the different information to track their risk exposure and conduct
types of data and information needed to account for, risk management. In jurisdictions such as the United
measure and manage climate risk in a financial context. States, where mortgages tend to be securitized and sold
Weather and climate data and models are needed to onwards in financial markets, this adds an additional
understand the physical hazards; topographical maps and layer of complexity. Ultimately, end investors need
geolocation data are required to understand exposure; access to climate risk exposure data to be able to
and data on flood defenses and other adaptive measures adequately gauge the riskiness of their holdings.
are important for ingunderstanding vulnerability.
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 and households can be impacted by property damage,
business interruption, loss of income, changes in demand,
Transmission: Micro and Macro Level
and declines in asset valuation through asset stranding. The
Climate risk drivers can transmit to financial risk through macroeconomy can be affected by shifts in prices, changes
a number of risk types, ranging from operational risk and in productivity, socioeconomic changes, or labor-market fric
credit risk to market risk. This section contextualizes the clas tions. All of these can then cause financial risks to manifest.
sification of these risks before the transmission channels are
However, the micro- and macroeconomic split, with finan
covered in much more detail in Section 6.3 and Section 6.4.
cial risk relegated to a separate category, de-emphasizes
Many classification schemes of climate risk transmission the impacts on the broader financial system, as well as any
channels come from central banks (and umbrella organiza feedback effects between it and the economy.
tions made up of them, such as the Basel Committee on
This chapter's focus is on corporations with less empha
Banking Supervision or the Network for Greening the Finan
sis on households or on the macroeconomy. Section 6.3
cial System). Given these institutions' focus on the health
focuses on company-specific risks, whereas Section 6.4
of the macroeconomy, including maintaining price stability
combines macroeconomic risks with systemic risks and
and employment, their schemes distinguish between micro
those that potentially threaten financial stability. The
economic, macroeconomic, and financial consequences and
following section focuses on six main risk categories,
drivers (see Figure 6.2).
some primarily at the company- or macro-level and others
The NGFS schematic clearly shows how both transition affecting markets. The summary table below highlights
and physical climate risks can cause microeconomic and these risks, which are then analyzed in greater detail in
macroeconomic effects. At the micro level, individual firms 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
1fflMl·I•
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?
Operational risk • Proportion of facilities Physical risk leading to more frequent, LIMITED-The likelihood of
in risky areas more severe extreme weather can risks occurring increases when
cause property damage and business a sector exhibits high geo-
• Level of company
interruption, both to a business' own graphic concentration.
preparedness facilities and to supply chains. Heat can
also affect worker productivity.
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- SIGNIFICANT-If a number
insurance risk premiums ance premiums for corporations, of insurers withdraw or refuse
or, in more severe cases, for certain coverage, this might leave
• Availability of insurance
facilities in extremely vulnerable firms completely without cov-
areas to become uninsurable, with no erage, potentially amplifying
insurance available. 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)

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] Physical and transition risk can SIGNIFICANT-Climate risk
carbon intensity become more widely incorporated is expected to produce sector
in asset prices, both through abrupt and market-wide repricing of
• [Climate] Value at Risk
repricing as well as more gradu- many, if not most assets and
• Portfolio risk scores ally. Large-scale shifts in input and commodities, causing disloca-
product markets affect non-financial tion and potential systemic
corporations. Shifts in asset prices risk.
increase the risk of financial institu-
tions' portfolios.
Sovereign risk • Proportion of budget Physical risk can cause countries that MIXED-Many countries
revenues from fossil are particularly vulnerable, such as have diversified economies
fuels Bangladesh, to have higher costs of and geographies, but some
damage and lower GDP growth, ham- countries are heavily exposed
• Vulnerability to physical pering long-term ability to repay debt. to physical or transition risk
climate risks and are likely to be severely
Transition risk can heavily affect
affected.
countries reliant on fossil-fuel produc-
tion for a substantial proportion of
GDP and of government tax revenue.
6.3 Micro (Company-Level) Climate in vulnerable locations and various measures of company
preparedness against external risks Climate models com
Risks
bined with detailed data can allow at least some degree of
An important way in which climate risk manifests as anticipation on what physical facilities will be affected by
financial risk is through its effects on microeconomic these external risks.
company-level risks such as operational, credit, liquidity,
One of the strongest effects of climate risk on operational
and insurance risk, each of which are examined in turn
risk is through its effect on external risk. Acute climate
in this section. (Some of these channels can also pose a
change hazards, such as wildfires or floods or chronic cli
systemic risk, which is discussed in Section 6.4 along with
mate hazards, such as sea level rise, can damage or destroy
other transmission channels).
the factories, supply lines, or warehouses needed by a cor
poration or the offices, data centers, or bank branches of a
6.3. 1 Operational Risk financial institution.
Operational risk is the risk inherent in doing business, and To the extent that climate risk transmits into systems risk, it
it reflects potential losses from inadequate or failed internal does so in ways similar to external risk. For example, physi
processes, systems, human error, or outside events such as cal climate hazards such as floods or fireswild can destroy
extreme weather or terrorist attacks. These various causes data centers, causing systems risk to a both financial and
of operational risk can be classified into external risk (from non-financial corporations.
outside events), systems risk; people risk (from human
Climate risk can manifest through people risk in a few differ
error); internal process risk, as well as legal, strategic, and
ent ways. Inadequate staff training or management's lack of
reputational risks.
attention toward physical and transition climate effects can
Since operational risk is multifacted, it can be more difficult lead to these issues being ignored or underplayed within
to measure, but metrics include the proportion of facilities an institution's operations, potentially leading to losses.

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

Impact of climate
½
transition risk
Distribution of asset Climate-adjusted PD

value of a borrower
�
Original PD
Reprinted with permission of the United Nations Environment Programme.
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and requires high degrees of customization (ed assessment to transition risk, if a company's high emissions factory is hit
(UNEP Finance Initiative, 2018). In general, climate risk is with a regulatory shutdown mandate or a higher carbon tax.
expected to shift the entire PD risk distribution of a bor
The oil & gas sector is a good example of a sector that
rower (see Figure 6.4, labeled for transition risk but appli
has been hit by the stranded asset transmission channel.
cable for all types of climate risk).
Historically, much of the value of such firms has been
One important transmission channel from climate to credit in their reserves and the expectation of their consistent
risk runs through operational risk. A company whose fac or growing revenues. The fact that many of these firms'
tories, warehouses, or supply chains are particularly vulner assets may become stranded because oil demand is
able to extreme weather impacts (physical risk) or to abrupt expected to fall means that these firms may become less
policy changes (transition risk) will have greater business creditworthy than they would in the absence of climate
interruption, resulting in a loss of revenues and profits. Fur change. (Of course, there are still differences within the
thermore, it weakens the company's ability to repay loans sector-for instance, oil companies with very low extrac
compared to a similar company that is not exposed, thus tion costs on their reserves will tend to have a smaller
translating into increased PD and credit risk for a lender. proportion of stranded assets than companies with
Project finance tied to a vulnerable asset, such as a ware assets that are more expensive to extract.)
house at risk of flooding, would be subject to even higher A final, related channel is that of pricing effects-both
PD and LGD than the exposure of an entire company own through markets for inputs (raw materials) and outputs
ing a mix of vulnerable and non-vulnerable assets. (products). If climate risk causes a company's raw materials
to become more expensive, or makes its products less valu
Another important channel operates through valuation
able, this, too, can increase its credit risk. Pricing effects can
effects; that is, asset stranding (as covered in Chapter 3). If
also work the other way and reduce a company's credit risk.
a company's core assets fall in value or even become worth
For instance, companies in the mining sector that extract
less, this significantly affects the financial health of the firm.
minerals important for mass electrification, such as copper
With less valuable assets, a company's liabilities suddenly
for wiring or lithium for lithium-ion batteries, can benefit
weigh a lot heavier on its balance sheets and make it more
from higher prices of these commodities, make greater rev
likely that the company will default on future debts and that
enues and profits, and become more creditworthy than they
LGD will be greater,not to mention that the company will
would have been without climate change.
also hasve less collateral to use to secure funding. The asset
stranding can be due to physical risk, such as a warehouse Policy considerations regarding the rise of credit risk due
in a flood prone area with a much lower resale value, or due to climate risk are being increasingly incorporated by major

credit ratings agencies, which serve as important arbiters of dislocations are a more meaningful source of risk through
credit risk for financial markets. In January 2021, S&P, one their macro effects, their impacts on financial stability ands
of the three major rating agencies, revised its entire out well as the potential for "Minsky moments,", all of which
look on the oil & gas industry due to "significant challenges are discussed in Section 6.4).
and uncertainties engendered by the energy transition,
For an individual non-financial company, liquidity risk only
including market declines due to growth of renewables,"
manifests as a consequence of climate risk under specific
and shortly afterwards &P downgraded oil companies by
circumstances. An acute climate-related event, such as a
one notch: Exxonmobil and Chevron to AA- from AA and
major hurricane devastating a firm's operations and under
ConocoPhillips to A- from A. (S&P Global Ratings, 2021).
lining its lack of preparedness, or a fine imposed by authori
The rise of sustainability-linked bonds and loans, as dis ties for non-compliance with carbon emissions regulations,
cussed in Chapter 5, can also be seen as an example of the leads investors and lenders to reassess their view of a firm's
financial industry internalizing the linkage between credit viability so suddenly and abruptly that the firm has trouble
risk and sustainability performance. Offering a lower rate accessing liquidity. However, under most circumstances
on a loan or lowering the coupon on a bond that an issuer and given the gradual pace of climate change, it is more
must pay in return for meeting sustainability targets, as likely that climate risk filters through to companies more
these instruments do, implies that poor performance raises gradually through increased credit risk rather than abruptly
credit risk. through liquidity risk. Increased investor awareness of risks,
and increasing manifestation of climate risk, leads to higher
6.3.3 Firm-Specific Liquidity Risk credit risk and thus higher cost of capital for a firm.
Liquidity risk is about losing access to liquidity-the abil-

ity to quickly and easily convert assets into cash. For banks, 6.3.4 Underwriting Risk
liquidity risk means something very specific, as banks' busi
Although underwriting risk only directly affects the insur
ness models are based on liquidity transformation: Banks
ance sector, it is still important to single it out as a type of
take on short-term deposits and underwrite long-term loans.
risk affected by climate risk, especially physical climate risk,
Key metrics for liquidity risk include loan-to-deposit ratios as many other corporations and financial institutions rely on
(specifically for banks) and bid-ask spreads (specifically for insurance coverage as a crucial part of their risk-mitigation
markets; also see Section 6.4.3). strategies.
Banks are particularly affected by climate risk since liquidity Key metrics to gauge underwriting risk from a corporation's
is of critical importance. Climate risk drivers can prompt perspective are changes in insurance premiums and the
depositors to draw down deposits and debtors to draw availability of insurance. The insurance industry itself uses a
down credit lines at the same time, dramatically increasing variety of metrics and models to arrive at estimates of the
loan-to-deposit ratios. riskiness of the entities it insures, many of which are propri
etary and not the focus here.
Some empirical evidence suggests that this occurs due to
physical climate risks, specifically in the wake of natural Insurance works best when a large pool of participants
disasters, as households and corporations withdraw depos (motorists, corporations, homeowners, etc.) all have a small,
its and draw on credit lines to finance cash-flow needs for and close-to-equal, chance of being struck by misfortune,
recovery. This combination puts pressure on banks' liquidity and when these accidents or other losses follow predictable
and can lead to crystallized liquidity risks (Basel Commit patterns discernible from historical data. Climate risk, partic
tee on Banking Supervision, 2021). This phenomenon could ularly those related to physical impacts, present a challenge
potentially affect other types of financial firms as well. For as they can become highly concentrated. This concentration
instance, if abrupt climate-related drivers prompt inves can result in underwriting damages to facilities and proper
tors to liquidate their fund holdings at the same time as ties in affected areas that are no longer economically viable.
climate drivers are causing market dislocations, this could Examples include buildings in low-lying coastal areas subject
cause some asset managers to suffer liquidity risk. (Market to sea level rise and coastal flooding or buildings in wooded

areas that are becoming drier and hotter due to climate through which insurance takes on (at least part of) the finan
change and thus more prone to wildfire, such as in California cial risks of a firm being sued.
and parts of Australia. In areas such as these, climate risk
Underwriting risk increases can also affect other types of
is very concentrated geographically, and it is intensified as
risk. In many cases, such as home or commercial property
climate change progresses, with events that were previously
mortgages, lending banks require insurance coverage as a
rare, such as 1-in-100-year events, becoming much more
condition of issuing a mortgage. If a company can no longer
common. To provide just one example, the severe heatwave
obtain insurance coverage for physical damage, business
in France and the Netherlands in 2019 was estimated as a
interruption, or directors' liability, it cannot use insurance as
1-in-50-year event in the current climate, but it would be a
one of its resilience and buffer mechanisms, which further
1-in-1000-year event (or even less frequent) in the absence
increases operational risk. This, in turn, increases its credit
of climate change (Vautard, 2019). With further warming,
risk from the perspective of a lender.
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.
6.4 Macro Climate Risk: Systemic Risk
and Financial Stability
For the insurer to break evenover shorter return periods
would require very high premiums; for instance, a ten-year Because climate change, both through its physical impacts
return period (i.e., a 10% chance of annual occurrence) of a and policy and societal effects to mitigate emissions and
total destruction event in a specific location would require an achieve a zero-carbon transition, is such a broad phenome
insurance premium of at least 10% of the value of the insured non, it can be a source of systemic risk and potentially pose
property. This level of occurrence is not outlandish for many a risk to financial stability. Generally, the risk types cov
physical risks. One study found that for an extreme rain ered in Section 6.3 can have systemic effects if they occur
event in Texas equivalent in size to Hurricane Harvey (which widely enough, and affect entire sectors or swathes of the
flooded Houston in 2017), the annual probability of occur economy-each of these is covered briefly in turn (Sections
rence was 1% from 1981 to 2000; 6% by 2017, when Harvey 6.4.1-6.4.4). But there are also other categories of risk that
occurred; and 18% by 2081 to 2100 under a worst-case cli operate primarily at the systemic and/or macroeconomic
mate scenario (Emanuel, 2017). An 18% probability of annual level, such as market risk and sovereign risk.
occurrence is the same as a return period of just 5.5 years.
Of course, larger insurers with diversified exposures can and

6.4. 1 Operational Risk
do cross-subsidize to an extent, but smaller, regional insur If physical climate impacts cause operational risk to manifest
ers without geographical diversity do not have that luxury. across a range of companies, this can have ripple effects
(Insurers can sometimes offload a portion of their risk to across supply chains and through to markets, customers,
reinsurers, but these firms are also becoming warier of tak and financial counterparties. For operational risk to have
ing on additional climate risk.) There are already some anec this wide of an effect typically requires a particular set of
dotal examples of smaller insurers that have gauged the circumstances, such as geographic concentration and pinch
underwriting risk to be too high and have refused renewals points in supply chains. The climate change-exacerbated
to homeowners in areas of California hard-hit by climate Thai floods of 2011, which significantly affected global
exacerbated wildfires. Most types of insurance available to semiconductor production and had ripple effects across
individuals or corporations are on one-year renewal cycles, supply chains, are a good example of the macro effects of
so insurers can pull coverage with relatively short notice. operational risk. But they only had a macro effect because
so many intermediate components for global semiconduc
Climate transition risk, too, can affect underwriting risk. The
tor manufacturers specifically came from Thailand.
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
6.4.2 Credit Risk
industries, which could then transmit into insurance through Increased counterparty credit risk that results from climate
general liability or "directors and officers" (D&O) policies change can directly transmit into the financial sector and

pose a potential threat to financial stability if it occurs broadly market-wide liquidity crunch like the shock of the global
enough. Many climate risk drivers that lead to increased financial crisis of 2008, if not greater.
credit risk at an individual firm can also affect entire sec-
However, it is worth noting that large-scale dislocations and
tors. In sectors such as utilities (for those still reliant on fossil
repricings resulting from climate risk are expected to be a
power plants) or oil & gas, sector-wide asset stranding is
problem even if they do not occur suddenly enough to con
expected to occur or has already occurred, which increases
stitute a Minsky moment and a liquidity shock. These kinds
credit risk. Changing demand and cost structures resulting
of market changes are classified under market risk rather
from climate-related pressures can impact companies' rev
than liquidity risk (see Section 6.4.5).
enues and profits, as can physical climate impacts leading to
business interruption, both of which can lead to widespread
6.4.4 Insurance Risk
increases in credit risk. For financial institutions heavily
exposed to these sectors, this can pose a risk to the financial Insurance risks, particularly the specter of uninsurability, in
institution's soundness. If exposures run across the financial cases where the insurers deem climate risks to be too great
sector, increased credit risk at the company level can become to underwrite, can have systemic effects. Even if insurers
a threat to financial stability. 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.
6.4.3 Liquidity Risk If large numbers of insurers significantly increase premiums
As examined above, banks are also particularly affected by or completely withdraw their coverage of certain climate
climate risk impacts on liquidity. Given the wide reach and related risks, this might leave households and firms with
potential severity of climate impacts, it is possible for liquid out coverage, potentially amplifying the resulting risks to
ity risk to be a source of systemic risk to the banking sector finanancial stability (FSB, 2020).
and to therefore threaten financial stability. If enough house
holds, corporations, and financial firms sharply increase their 6.4.5 Market Risk
demand for precautionary liquidity after a severe natural At the systemic level, climate risk translates into market risk
disaster, this can be at a systemic enough scale to neces through repricing and dislocation effects as well as through
sitate intervention by the central bank. A good example of asset stranding. The repricing effect is an important channel
the potential for this kind of course of events comes from through which physical or transition risks that are antici
the aftermath of the large Japanese earthquake in March pated but not yet realized can more quickly and tangibly
2011-admittedly not a climate-related natural disaster, but have an impact on asset prices, whether they are physical
comparable to one. After the shock, the Bank of Japan (BoJ) assets such as housing or financial assets such as shares and
had to offer record amounts of liquidity to Japanese banks bonds. The research by Bernstein and co-authors cited in
to ensure stability in the markets: On the first business day Chapter 3 shows how sea level rise and coastal flooding risk
after the earthquake, the BoJ offered funds totaling transmits into, and is reflected in, US coastal property prices
21.8 trillion yen, nearly three times the maximum daily today, with discounts ranging from 14.7% for properties
liquidity during the 2007-2009 financial crisis (Basel Com exposed at 1 ft (0.3m) of sea level rise to 4% for properties
mittee on Banking Supervision, 2021). exposed at 6 ft (1.8m) (Bernstein et al., 2019).
Another potential concerning source of systemic liquidity risk Of more concern to most market actors, however, are quicker,
would be a "climate Minsky moment." A Minsky moment, in more abrupt pricing shocks and increased volatility. These are
general, is a sudden, major collapse of asset values. In 2016, reflected in key metrics such as Value at Risk (VaR), or the
Mark Carney, then Governor of the Bank of England, warned climate version thereof, climate VaR (see CVaR box). Other
of the potential for a climate Minsky moment in the case of a metrics are useful for individual institutions to gauge their
wholesale, abrupt and broad-based re-evaluation of climate own exposure to climate-related market risk, such as the
risks by markets, causing massive repricing of assets and a weighted average carbon intensity of a portfolio, which is a
pro-cyclical crystallization of losses (Carney, 2016). If severe proxy for transition risk exposure, or portfolio-level physical
enough, such a climate Minsky moment could provoke a risk scores (see also next section, Section 6.5).

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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DECISIONS FOR A BETTER WORLD."
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Climate risk drivers, both physical and transition risk, can composition of their economies, capacity to create adaptive
reveal new information about future conditions, precipitat policies and responses to climate change, debt accessibil-
ing downward price shocks and increases in market volatil ity and affordability, and specific policy decisions. Moody's,
ity in traded assets. It is also possible that climate risk could one of the top three largest credit ratings agencies, came up
lead to a (partial) breakdown of typical correlation pattern with a physical risk methodology for sovereigns as early as
between assets, reducing the effectiveness of hedges and 2016 and found that India, Pakistan, Vietnam, Cambodia, and
challenging banks' abilities to actively manage their risks. much of Central America and sub-Saharan Africa were the
The empirical evidence, while mixed, suggests that climate most vulnerable. Academic research from Buhr et al. (2018)
risk is not yet priced into many asset classes (Basel Commit has demonstrated empirically that countries with higher
tee on Banking Supervision, 2021). exposure to physical climate vulnerability do face a higher
cost of capital, by up to 1.17 percentage points (Buhr, 2018).
As and when climate risk drivers become priced in, it is
likely that there will be less potential for unexpected price As for transition risk effects on sovereigns, discussions are
movements or volatility. Climate risk incorporation into mostly still centered on countries' reliance on fossil fuel
asset prices might also reduce risks to financial stability. and other carbon-intensive exports. For instance, as tighter
That said, it may also end up serving to illustrate that risks climate policies, new technologies and preference changes
are concentrated in certain parts of the financial system, reduce the demand for fossil fuels, this may turn states
which could in fact increase the threat to financial stability, heavily reliant on fossil fuel exports into "stranded nations"
particularly if it triggers amplifying behaviors among finan (by analogy to stranded assets). If this occurs, fossil-fuel
cial institutions (FSB, 2020). reserves become commercially unattractive to extract and
a substantial share of national wealth may permanently
It is also important to note that even if abrupt repricing has
lose its value, leading to a massive drop in sovereign cred
been relatively infrequent so far, this is partly due to the
itworthiness and a corresponding increase in sovereign risk
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.
look at the medium-term impact of climate on countries'
Many experts expect much more severe repricing and
GDP per capita, GDP growth, and debt ratios, and thereby
market risk in the years ahead as climate policy tightens.
their sovereign credit ratings, predicted that 63 nations will
For instance, the Principles for Responsible Investment has
experience a drop in credit rating by 2030 without emis
a project called the "Inevitable Policy Response," which
sions reductions (Klusak, 2021 ).
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,
6.5 Climate Risk Measurement: Data
could have important implications for financial markets and and Analysis
trigger repricing on much larger scale. (Note that deeper Accurately gauging transition and physical risks requires
analysis of different outcomes necessitates scenario-based multiple types of data as well as appropriate analytical tools
analysis, which will be covered in Chapter 7.) to understand their application to the user's needs (see also
Chapter 7). Transition risk requires, first and foremost, accu
6.4.6 Sovereign Risk rate asset-level and company-level data on greenhouse gas
The transmission of climate risk into sovereign risk is exam emissions but also data on policy landscapes, technological
ined here separately due to the unique considerations changes, and consumer preferences to capture the various
involved. On physical risk, evaluating a country starts, as drivers of transition risk as laid out in Chapter 3. Physical
with a company, with geographical exposures, such as the risk requires data on current and future physical hazards,
presence or proportion of low-lying coastal areas vulnerable derived from a combination of historical data and climate
to sea level rise and coastal flooding. But understanding models, topographical data and locational data of assets,
entire countries also means examining the size and sectoral and information on vulnerability and adaptive capacity.

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

100 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0- 0 0 0
• • •
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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

there are opt-in initiatives, such as the Science-Based strategy is aligned with, and thus are covered in greater
Targets that companies can sign up to as well as exter detail in Chapter 7.
nal parties, such as the Transition Pathway Initiative,
Combined with new approaches to more accurately measure
that seek to gauge firms' plans. Various methodologies
carbon footprints without relying on self-disclosure, the use
have been developed for temperature scores that give
of asset-level data on specific factories or power plants ulti
a shorthand way of understanding what level of warm
mately provides a lot more granular information on which to
ing a company's plans are aligned with. Most of these,
base investment or lending decisions (see Schematic graphic).
however, examine which climate scenario a company's
CASE STUDY: GLOBAL RESILIENCE INDEX INITIATIVE (GRII)

Accessing data, metrics, and projects on risks can be to more accurately measure risks to communities, infra
incredibly challenging and costly for individual firm. The structure, and ecosystems. At COP27, the initiative
Global Resilience Index Initiative (GRII), a new public launched the GRII Viewer, a demonstrator which provides
private initiative, is developing a tool which is intended to global data on hazards, vulnerability, and exposure under
fill that gap. Announced at COP26, the initiative aims to different climate scenarios. It is currently expected that
develop an open, standardized set of climate metrics and the GRII will finalize this tool over the course of the year
data which allows individuals, entities, and governments and launch a full version at COP28.
SCHEMATIC: DISCLOSURE VS A SSET-LEVEL DATA ON CARBON

FOOTPRINTS
Old Model New Model
Power plant C
ABC Electric Power Inc. (Wind farm)
C o po ate-le el
v
disclosure
O PTION1: r r
of emissions
- ABC Electric Power Inc_
_
� � �
� - - _ _ _ _ _ _ _ - - _ _ - -
OPTION 2: Corporate-level
estimate of emissions Corporate-le el disclosure of
\ o Plant-level
v
climate alignment and
\ emissions
phyical/transition risk plans
\ o Plant-level
\ data
\
INVESTMENT/ LENDING INVESTMENT/ LENDING
DECISION DECISION
@jij#J-IJ

This schematic shows how much more granular the new from open source datasets. Meanwhile, corporations
model of data collection and decision-making is than are increasingly expected to disclose not just emissions
the old one for an example firm, ABC Electric Power but also on alignment and plans for addressing both
Inc. Historically, ABC's shareholders, bondholders, and transition and physical climate risks. Thus, investors and
bank lenders would have had to rely either on ABC's lenders can start to make more detailed decisions, such
own disclosures of emissions or on estimates from as relating to project finance of specific plants or at the
data firms. Increasingly, however, asset-level data is corporate level, based on much more sophisticated and
becoming available at the facility level (in this case at granularized datasets.
the power plant level) through data firms, including
Source: Author.
through earth observation and satellite data as well as
More sophisticated transition risk analysis typically requires the Some physical climate risk tools that are one notch above
use of climate scenarios, which is covered in Chapter 7. But for simple raw data (e.g., combining climate hazard data with
the purpose of this chapter, the last important point to men topographical or vegetation data) are available for free
tion regarding transition risk is that even data on both emis from governmental or non-profit organizations. Examples
sions and emissions trajectories are not enough without an include the dataset from Climate Central on projected sea
understanding of the drivers of transition risk such as policies, level rise, which combines sea level estimates with local
changing technologies, shifts in consumer preferences, and topography; the World Resources lnstitute's (WRI) data on
market sentiment (as discussed in Chapter 3). There are inter water stress; and the Max Planck lnstitute's index on wildfire
national agencies, such as the International Energy Agency vulnerability, which combines drought and precipitation
(IEA) or International Renewable Energy Agency (IRENA); estimates with vegetation cover.
specialist consultancies, such as Bloomberg New Energy
That being said, many physical risk indicators have been
Finance or Rystad Energy; and large data firms, such as S&P
developed by, and are sold by, specialist for-profit consultan
Global, that offer quantitative and qualitative data on policies
cies. One recent survey identified eight firms or organizations
and new technologies, such as data on pricing of solar mod
that provide investors with physical climate risk analysis tools
ules or lithium-ion batteries. Some types of data are quite dif
of some kind: Acclimatise, Moody's, WRI, Four Twenty Seven
ficult to come by and valuable to market participants, which
(since acquired by Moody's, the credit rating agency), Car
means purchasing information can be quite expensive.
bone 4, Carbon Delta (since acquired by MSCI, a data firm),
Mercer, and a collaboration between Ecolab, Trucost, and
6.5.2 Company-Level Physical Risk Data Microsoft (ClimlNVEST, 2019). Since the survey, Trucost, a divi
sion of S&P Global, the ratings and data firm, has also started
The basic data for gauging physical hazards is provided by
selling physical risk data on firms. McKinsey & Co, the global
global climate models developed by climate scientists for
management consultancy, acquired Vivid Economics and
the periodic reports of the IPCC; an example is the Coupled
Planetrics, two other firms that have also worked with inves
Model lntercomparison Project, versions 5 or 6 (CMIPS
tors on physical risks. Other consultancies beyond these, such
and CMIP6). Only some corporations and financial coun
as XDI or South Pole Group, have been hired by investors on
terparties have the ability and desire to bring the specialist
an ad hoc customized basis on issues of physical climate risk,
knowledge in-house to make direct use of these models.
but they do not provide scores or analysis for broad use.
Moreover, for them to be relevant and usable for firms or
investors, the output of the different models must be rec Company or asset-level physical risk data and scores are argu
onciled and downscaled to give regional or local estimates. ably the most easily interpretable approach to physical risk
Then, it needs to be combined with exposure and vulner analysis in a way that is accessible to lenders, investors, and
ability data (see Schematic: Reaching Physical Risk Esti other stakeholders. Although some of the free datasets offer
mates). The use of climate models to run different scenarios a high level of geographic precision, the output is fairly unre
is covered in Chapter 7 as part of scenario analysis. fined (e.g., whether a given location is above or below the

SCHEMATIC: REACHING PHYSICAL RISK ESTIMATES
Detailed exposure
mapping
C
0
Global climate model .....
:i
0
V)
Physical
risks
o Data on
hazards
o Downscaled
models
Wl'iki·!:1
To reach an understanding of physical risks, global must be mapped geographically and combined with
climate models must be downscaled, both in spatial and information on vulnerability and resilience to arrive at
temporal resolution, as they are usually designed for an estimate of physical risks.
global use on multi-decadal timescales; then, exposures
2050 coastal flooding line). A real estate tool such as Moody's, to Ford or Microsoft without the need to delve deeply into
by contrast, allows real estate investors to easily gain a sense the climate models themselves or figuring out exactly where
of the exposure of their assets by overlaying the location VW or Ford have their factories or Microsoft its data cen
of buildings with the tool, which uses normalized numerical ters. The scores are normalized on a 0-100 scale, and they
scales to give a sense of the relative severity of extreme pre are available both by hazard type, and as an overall score.
cipitation, hurricane-force winds, sea level rise, water stress,
These "heavily digested" scores do have their downsides,
and heat stress for a given geographical location or address.
however. The proprietary methods and datasets that they
Company-level scores, as sold by Four Twenty Seven, derive from remain a "black box" to the investors who pur
Carbone 4, and Trucost, take this approach a step further. chase the scores, which is why some investors have opted to
The competing offerings all combine the proprietary meth work with "raw" data themselves or construct in-house scores.
odologies of downscaling and normalizing climate model Many of these scores also attempt to capture several hazards
data with detailed facility-level location information of firms, in one score, meaning that the weighting and averaging meth
mainly of those that are publicly listed. By combining data odology can matter as much to the end result as the underly
on climate hazards with the location of companies' factories ing raw climate data. Due to the inclusion of different hazards,
and warehouses and an estimate of vulnerability, the physi different ways of measuring, and different methodologies,
cal climate risk scores can tell investors about the relative scores from competing providers, or compiled internally by
physical risk of investing in, say, Volkswagen as compared different financial firms, are not necessarily comparable.

6.5.3 Portfolio-Level Analysis (Transition of an invested amount or of corporate revenues, rather
and Physical) than simply total absolute emissions. Two common met
rics are carbon intensity (expressed in tons CO 2e/USD
Portfolio-level analysis, as opposed to asset- or firm-level
mil. revenue) and weighted average carbon intensity
analysis, is the type of analysis of most relevance to a finan
(expressed in tons CO2e/USD mil. revenue). Other meth
cial counterparty, such as a lender or an investor. Under
odologies pin a temperature or "warming potential"
standing both transition and physical risk at the portfolio
on an entire portfolio. More risk-based approaches to
level can be somewhat different than just understanding the
transition risk include stress testing (for example, model
impact of these risks on a particular firm.
ing how a portfolio reacts to a transition shock such as
On transition risks, many portfolio-level approaches start a sudden rise in carbon tax). However, most stress test
with numbers that are proportional to an amount, either 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 typhoons, sea /eve/ rise, water stress and wildfires, as
portfolio /eve/ is to look at the best- and worst-in-class well as a view of market and supply chain risk based on a
of an index, which the below figure from Moody's ESG company's industry.
Solutions demonstrates. It shows the physical climate risk,
However, in a space that has changed and matured
based on the physical risk exposure of the companies'
quickly, most physical climate risk analyses currently use
underlying assets to floods, heat stress, hurricanes &
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."

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

ERM is not considered to simply be a function or a depart many companies to institute climate risk-governance
ment, but consists of "culture, capabilities and practices that structures and to allocate responsibility to specified senior
organizations integrate with strategy-setting." Neither is ERM executives. Firms often disclose these arrangements and,
simply about compiling a list of risks, having internal controls, indeed, promote them as differentiating factors of their
or using checklists; rather, COSO argues, it is a holistic modus respective firms.
operandi across an entire firm (COSO, 2017).
Culture can seem more difficult to pin down; nevertheless,
This section is generally structured in line with the COSO it is just as important to risk management and climate risk
categories, as they are well suited to examining climate risk. management, as are specific governance arrangements.
However, other important frameworks are also incorpo A corporation's culture has been defined by COSO as the
rated, notably regulatory ones. The TCFD, in particular, has "attitudes, behaviors and understanding about risk[ ...] that
been a key initiator of framing climate change as a source influence the decisions of management and personnel and
of risk (as described in Chapter 3), by promoting disclosure reflect the mission, vision and core values of the organiza
to investors and other stakeholders and pushing scenario tion" (COSO and WBCSD, 2018). For climate change and
analysis as a methodological tool (see Chapter 7). Another sustainability to be reflected in a company's culture, its mis
prominent example of a regulatory initiative taking action sion and core values should address climate risk drivers: the
is the Network for Greening the Financial System (NGFS), tone from senior leadership should convey expectations on
a consortium of central banks and supervisors. At a country climate, and employee behaviors and initiatives that are in
level, some countries have national-level bodies, such as line with strategic corporate priorities should be welcomed
the Climate Financial Risk Forum (CFRF) in the UK, where and encouraged (COSO and WBCSD, 2018).
the country's two main financial regulators bring together
industry representatives to share their experiences in managing 6.6.2 Strategy and Setting Objectives, Goals,
climate-related risks and opportunities. The CFRF has helped and Targets
categorize and frame the management of climate risk, and this
Corporate strategy, that is, high-level decisions on an
section also partly draws on CFRF categorizations.
organization's priorities and mission, is an important com
ponent of a holistic ERM approach in general, as well as of
6.6. 1 Risk Governance and Culture
any enterprise's response to climate risk drivers in particular.
Managing climate risk properly within an institution, as with An important prerequisite for strategic decisions is strategic
managing any other sort of risk, starts with having struc landscape evaluation; this is especially the case in regard to
tures and staff in place to monitor these risks. Successful climate issues . Understanding the full business context on
risk governance starts at the highest level, with the board climate risk requires understanding the external environment
and senior executives. Effective risk governance can ensure and megatrends, such as the expected physical, societal,
understanding and diffusion of knowledge as well as genu and macroeconomic impacts of climate change. But it also
ine accountability at all levels of an institution, and it can requires understanding how the inputs, business activities,
help increase the resilience of a firm. and outputs of that particular company are affected by cli
mate change.
Best practice governance arrangements tend to involve
multiple layers of employees and internal processes. For COSO and the World Business Council for Sustainable
instance, client-facing staff, responsible for new transac Development (WBCSD) have recommended starting with
tions, or portfolio managers, who make allocation deci megatrend analysis and then delving deeper through the use
sions, can be tasked with making initial judgments on the of tools such as SWOT analysis, impact mapping, and mate
environmental and climate risks of the transactions they are riality assessment. A SWOT analysis (strengths, weaknesses,
considering (see ING case study). Climate risk can also be opportunities, threats) uses a two-by-two matrix to compare
built into legal and compliance processes. This kind of inte the (internal) strengths and weaknesses, (external) opportuni
gration can supplement and complement formalized inter ties, and threats an organization is facing, and it is commonly
nal risk management procedures and oversight. The TCFD used for strategic planning (see ING Case Study). In impact
recommendations on governance have helped prompt 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 (GCTP) and its Global Credit Committee-Transaction
forerunners in holistically and deeply integrating climate Approval (GCC-TA), both of which include the CRO,
change risk into its risk-governance structures. The CFO, and Head of Wholesale Banking.
current level of integration is described in detail in its
Seen horizontally, the bank describes its risk and control
annual report and its Climate Risk Report. Like many
structure as a "three lines of defense" model. Here, front
continental European banks, the bank has a two-tiered
office staff, including relationship managers and deal
board structure. At the supervisory board level, the
principals who actually negotiate transactions, form the
risk committee is tasked with oversight of climate risks,
"first line of defense" and are tasked with identifying
whereas at management board level, the Chief Risk
potential environmental risks. Local and regional risk
Officer has this responsibility.
committees at the bank, as well as regional risk managers,
From a credit risk angle, climate risk is within the remit constitute the "second line of defense," and regular
of the bank's Global Credit & Trading Policy Committee 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

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 Risk identification starts with examining the transmission
change, and emphasized by the TCFD, are time horizons channels of climate risk drivers into financial risk (Sections
and outcome variance by scenario, which can be addressed 6.2-6.4) and then identifying which of these are the most
through scenario analysis. Climate-related risks and oppor relevant for a particular organization. Not all climate risks
tunities vary significantly over the short-, medium-, and long present an enterprise-level risk to all companies, and it is
term, and organizational strategy-setting and ERM processes part of risk managers' remit to translate external trends into
to address climate change need to examine different time identifiable risks and assess the impact and severity on the
horizons separately. Climate outcomes also significantly vary organization in question. Beyond simply "listing" pertinent
based on emissions trajectories, for which scenario analysis risks, risk identification involves articulating the potential
can help corporate preparedness (see Chapter 7). impact on business operations and strategy.
Finally, strategy is also about setting goals and targets. On Risk assessment involves gathering data on the actual
climate change, a lot of corporate goal setting revolves around scope of these risks. Investors and banks can use company
climate change mitigation and emissions commitments, level data, including scores on physical and transition risk
including alignment with net zero emissions (for example, as exposure, and they can also conduct portfolio-level analysis
the members of the Net Zero Asset Owners Coalition have to determine whether they have excess overall risk at the
done}, or even commitments to being carbon negative (e.g., portfolio level-or if they would have such a level in an
Microsoft has pledged to remove all carbon dioxide attribut unfavorable climate scenario (as described in Section 6.5, as
able to its historical operations from the atmosphere by 2050). well as in Chapter 3 and in Chapter 7 on scenario analysis).
T hese goals may be driven by a range of motivations, and they A financial institution will tend to do this sort of analysis at a
seek various different risk objectives, such as corporate social counterparty level (see McKinsey case study on banking).
responsibility and keeping up with peers and societal norms
Non-financial companies looking inward at their own
(avoidance of reputational risk) or protection from asset valu
operations will be able to source some data from external
ation through pre-emptive corporate transition (avoidance of
providers or from publicly available sources, such as maps
stranded asset and market risk). But, once these targets are in
of projected sea level rise that can be compared against
place, they also then help to shape future business decisions.
facility and asset locations. But internal risk assessment for
a company will also require assessing the vulnerability and
6.6.3 Performance: Tracking and adaptive capacity of these facilities.
Measuring Risks Risk prioritization is especially important in an ERM con
According to the COSO ERM framework, tracking text, as any large enterprise will be exposed to a multitude
performance for ESG and climate risks consists of three of risks, and it is important to rank these in order of impor
sub-components: risk identification, risk assessment and tance. Ranking methods include ranking by likelihood
prioritization, and the implementation of risk responses. of occurrence, adaptability and complexity, or severity.

Various ranking methods can be adopted for this purpose, morale or land use. Another way of prioritizing risks is to
such as ranking by the likelihood of occurrence, adaptabil filter by the risks that the company can actually control.
ity, complexity, or severity. One way of ranking by severity As an example of such an approach, Solvay, a French
is to assess the potential outcomes of each risk, where chemicals firm, has, in the past, rated risks both on impact
risks impacting core business fundamentals, such as prof and on level of control, focusing on those risks with the
its, revenues, and asset values, are deemed more severe severest impact but over which it has the most control to
than those affecting ancillary outcomes such as employee 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 emissions intensity and reliance on fossil fuels on the
banking group that has embedded climate risk into transition risk side and exposure to physical hazards on
its counterparty risk evaluation process. The process the physical risk side. The model was especially helpful
allows the bank to assess climate risk for 2,500 for differentiating climate risk exposure between
counterparties on an annual basis. For the sake of counterparties within the same sector. As an example,
straightforwardness, the bank opted for a scorecard within the utilities portfolio, electricity providers and
system that starts with the counterparty's industry and multi-utilities scored more poorly than did regulated
geographical footprint, with adjustments for the firm's 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

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

to transition toward a more climate-ready and a zero-emis enterprise risk management frameworks. However, impor
sions future. This is why the entire TCFD framework is predi tantly, climate is a transversal risk, which affects nearly all
cated on disclosure. (Many of the case studies highlighted in "traditional" categories of risk in some way at the company
this book, especially in this chapter and in Chapters 3 and 7, specific level, and it also poses a potential threat to financial
are drawn specifically from companies' TCFD reports, which stability, constituting a source of systemic risk at the macro
would not exist without this push for disclosure and subse level. T hus, any holistic approach to risk management must
quently, helps to spread knowledge and expertise.) 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
6. 7 Conclusions
risk. Ultimately, however, many of the best risk assessment
This chapter shows that climate risk measurement and man methods rely quite heavily on scenario analysis, which will be
agement is possible and can be integrated into standard examined and explored in the next chapter (see Chapter 7).
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press.spglobal.com/2021-01-26-S-P-Global-Ratings-Takes
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Multiple-Rating-Actions-On-Major-Oil-And-Gas-Companies
r160926h.pdf
To-Factor-In-Greater-1 ndustry-Risks
ClimlNVEST. (2019). Physical climate risk: Investor needs
UNEP Finance Initiative. (2018). Extending Our Horizons:
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handle.net/11250/2589503
mate. Outputs of a working group of 16 banks piloting the
COSO. (2017). Enterprise Risk Management: Integrating TCFD Recommendations. PART 1: Transition-related risks &
with Strategy and Performance https://www.coso.org/ opportunities. https://www.oliverwyman.com/content/dam/
Documents/2017-COSO-ERM-lntegrating-with-Strategy oliver-wyman/v2/pubIications/2018/apri 1/EXTENDING-OUR
and-Performance-Executive-Summary.pdf HORIZON S-AW.pdf
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Applying enterprise risk management to environmental, K.; Vogel, M. M.; Seneviratne, S. I.; Soubeyroux, J-M.; Schnei
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National Academy of Sciences, 114(48), 12681. https://doi. weatherattribution.org/wp-content/uploads/ July2019heat
org/10.1073/pnas.1716222114 wave.pdf

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

ANSWERS
6.1 B 6.4 B
6.2 D 6.5 D
6.3 C

Climate Models
and Scenario
Analysis
• Define climate scenario analysis and explain how • Describe how scenarios and models are used in
organizations use scenario analysis. scenario analysis to assess transition risk.
• Explain the definition and purpose of global net-zero • Explain how scenario analysis is used for assessing
scenarios including carbon removal processes. physical risk.
• Understand IPCC scenarios and associated repre • Examine how all types of corporations (financial and
sentative concentration pathways (RCPs) and shared non-financial) use climate scenario analysis.
socioeconomic pathways (SSPs).
• Describe how financial firms use climate scenario
• Describe IEA scenarios and other key global reference analysis for investment processes and climate risk
scenarios. exposure management.
Understand the key choices that organizations need • Explain different aspects of climate scenario analysis
to consider for scenario development and analysis. using case studies.
151
pathways (RCPs) and accompanying shared socioeco
This chapter describes how climate change risk nomic platforms (SSPs) that allow for more societal and
can be modeled and analyzed through the use of economic nuance, as well as policy changes, to be incor
scenarios, which can help companies and financial porated into RCPs.
institutions to prepare for various possible physical • Other important providers of reference scenarios are
and transition climate-related outcomes. The chapter
the International Energy Agency (IEA), Greenpeace,
begins with an introduction to scenario analysis as
IRENA, and the NGFS.
a general planning tool for companies. The chapter
• Scenario analysis, while often starting with these refer
then reviews various reference scenarios used by
ence scenarios, requires a number of decisions to be
climate scientists, policymakers, and corporations.
taken. Firstly, various parameters/assumptions must be
Then the chapter examines climate scenario analysis
set, analytical tools chosen, and outputs analyzed and
as applied to physical and transition risk, building on
interpreted.
the material in Chapter 3. The chapter ends with a
• Transition risk scenario analysis can make use of inte
detailed look at use cases of scenario analysis both in
corporations and in a financial context. grated assessment models (IAMs), economic models
that also include representations of societal and environ
mental phenomena and sector-specific decarbonization
pathways.
Chapter Outline • Physical risk scenario analysis uses physical climate
7.1 Introduction to Scenario Analysis models, but it also benefits from resilience planning. The
physical impacts of climate change are projected to be
7.2 Global Reference Scenarios
relatively similar between now and 2050 under any plau
7.3 Scenario Parameters and Applications to Physical and sible emissions trajectory, which is why short-term sce
Transition Risk nario planning is more about preparedness than variation
7.4 Scenario Analysis Use Cases: Corporate between trajectories.

• Corporations, financial and non-financial, use scenario
7.5 Scenario Analysis Use Cases: Financial & Investment
analysis for strategy and stakeholder communication
7.6 Conclusions to investors and regulators. Scenario analysis is also used
for resilience planning.
Key Learning Points • Financial firms, in addition, use scenario analysis for
portfolio risk management and stress testing as well
• Scenario analysis refers to the use of narratives to
as pre-emptively in portfolio selection. The Securi
sketch out potential future states of the world. While it
ties Exchange Commission (SEC) has been proposing
originated in academic research in the 1950s, it was soon
climate resilience disclosures for public companies.
applied by some large corporations, and it is now widely
used to analyze climate risk.
• Global reference scenarios have been proposed or
CLIMATE MODELS AND SCENARIO
adopted by various NGO's including projections of
future emissions, sometimes with socioeconomic narra
ANALYSIS
tives attached, which are a crucial input for climate sce
nario analysis.
7.1 Introduction to Scenario Analysis
• The most widely-used reference scenarios are from This chapter examines how climate models and sce
the IPCC, including representative concentration nario analysis can be a useful tool for both non-financial

corporations and financial institutions to respond to the and financial institutions. Climate scenario analysis is used
challenges of climate change, including risks related to both to bolster corporate preparedness in the face of physical
physical impacts of climate change (physical risks) and the and transition-related climate impacts to communicate
zero-carbon economic transition (transition risks). that preparedness to investors and other stakeholders and
to guide strategy and investment decisions at all types of
Scenarios, as well as models (for which scenarios are used
firms. It is also starting to be integrated into asset allocation
as inputs), are critical tools for climate risk management.
and investment decisions at some financial firms.
Scenario analysis is flexible enough to draw together nearly
all the relevant issues, risks, and their interrelationships in The recommendations of the Taskforce on Climate-Related
one approach, and it can yield results applicable for many Financial Disclosures (TCFD) are an important starting
purposes, ranging from reporting to shareholders or stake point for understanding the role of scenario analysis. The
holders and setting internal company strategy to making TCFD recommends scenario analysis as a way to "enhance
investment decisions. critical strategic thinking" and challenge conventional
Scenario analysis, in its broadest sense, is the practice wisdom regarding the future using plausible, distinctive,
of planning through describing and sketching the future consistent, relevant, and challenging scenarios (see box).
using plausible narrative stories ("scenarios"). The concept The TCFD essentially recommends flexible, corporate
originated in academic research in the 1950s and is often specific, forward-looking analysis that is not dissimilar to the
credited to Herman Kahn, an American researcher, though approach pioneered at Shell in the 1960s.
similar concepts were developed around the same time in

However, this type of high-level, strategic scenario analy-
France. Scenario analysis spread quickly beyond academic
sis is not the only use of the approach when it comes to
circles to corporations, such as General Electric, DHL, and
climate. Indeed, while each organization and firm does
Shell pie., the Anglo-Dutch oil & gas firm.
face a different blend of climate-related risks and oppor
Indeed, corporations in general, and Shell in particular, tunities, and it can make sense to customize scenarios for
played an outsize role in developing and maturing the firm-specific use, analysis of climate change is often done
technique. Shell's "futures" team, which took shape in the using a set of standard, cross-comparable scenarios. These
1960s, sent its first oil-price forecasts to executives in the reference scenarios are a set of agreed-upon projections
early 1970s. The founders of the team shied away from of global emissions trajectories, with accompanying socio
attempting to assign probabilities, but they prioritized economic narratives and estimates for physical impacts (as
plausible scenarios, even ones that seemed improbable. calculated by climate models). Sometimes, these scenarios
The approach quickly proved its value to the firm by help include sector-specific pathways. The most widely used, and
ing it to be prepared for the kind of scenario that played widely agreed upon, reference scenarios are those created
out in the oil crisis of 1973. The point of the team, however, directly by the Intergovernmental Panel on Climate Change
was not to predict the future accurately; its value was in (IPCC), although scenarios from the International Energy
ensuring a firm-wide approach to preparedness, which has Agency, an international organization, and from various
continued ever since (Wilkinson, 2013). This sort of scenario non-profit and academic sources are also widely used. The
planning has, in more recent decades, been applied to a use of such common reference scenarios allows for cross
wide variety of challenges, such as ensuring that the end comparability, both across firm types and across different
of apartheid occurred peacefully in South Africa, PepsiCo's use cases. Furthermore, combinations of scenarios are often
changes in demand in response to changing consumer food used in tandem to help cover gaps in coverage for a par
and beverage preferences, and climate change. ticular time frame, sector, or regional geography of interest.
In recent years, climate scenario analysis, that is, the use Scenario analysis for climate change varies quite signifi
of climate scenarios for analysis and decision-making, has cantly between the two main types of climate risk, namely
become a preferred tool of both non-financial corporations transition and physical risk (Section 7 .3). For transition risk,
Chapter 7 Climate Models and Scenario Analysis ■ 153

TCFD RECOMMENDATIONS ON SCENARIO ANALYSIS-EXCERPTS
"What is a Scenario Analysis? should be clearly differentiated in structure and in
• message.[ ... ]
Scenario analysis is a tool to enhance critical strategic
thinking. Consistent: Each scenario should have strong internal
• A key feature of scenarios is that scenarios should logic. The goal of scenario analysis is to explore the way
challenge conventional wisdom about the future. that factors interact[ ...]
• In a world of uncertainty, scenarios are intended to Relevant: Each scenario, and the set of scenarios taken
explore alternatives that may significantly alter the as a whole, should contribute specific insights into the
basis for "business-as-usual" assumptions. future that relate to strategic and/or financial implica
tions of climate-related risks and opportunities.
Scenario Characteristics
Challenging: Scenarios should challenge conventional
Plausible: The events in the scenario should be pos wisdom and simplistic assumptions about the future[ ...]
sible and the narrative credible (i.e., the descriptions[... ] [and] business-as-usual assumptions.
should be believable).
Source: Reprinted with permission of the Task Force on
Distinctive: Each scenario should focus on a Climate-Related Financial Disclosures.
different combination of the key factors. Scenarios
non-financial corporations or financial institutions typically or financial institutions between continued flat or rising
examine whether their facilities, strategies, and portfolios emissions ("business as usual") as compared to hitting goals
align with one of the global projected emissions trajecto such as net-zero emissions by 2050, which requires drastic
ries. Or else, they examine the potential effects of climate cuts by 2030.
policy tightening (e.g., a higher carbon tax) on their opera
tions and plans. For physical risk, emissions trajectories, Finally, the use cases of scenario analysis are varied and
when "plugged in" to a physical climate model, allow for ever broadening. Besides its use in high-level strategy set
producing estimates of temperature rise, precipitation, ting and corporate disclosure, as recommended by the
weather extremes, and other phenomena. But, due to the TCFD, scenario analysis is being integrated in concrete
lag in the global climate system, the physical outcomes ways by non-financial firms and financial ones alike. For
of climate change are practically the same for the next non-financial firms, climate scenario analysis can allow for
few decades (until about 2050) regardless of emissions. concrete preparedness actions to be taken with regard to
Therefore, to improve firms' preparedness and resilience, specific facilities (offices, factories, etc.), and it can be used
for physical risk specifically, scenario analysis is more for capital expenditure investment decisions. For financial
about using the sorts of physical climate impacts that are firms, climate scenario analysis can be useful to gauge
°
already occurring and expected to continue. For physical portfolio alignment with goals such as the well-below 2 C
risk, emissions trajectories only make a difference on very goal of the Paris agreement, to pre-empt or shape new
long timescales, whereas for transition risk, emissions tra investment decisions by portfolio managers, or to provide a
jectories make a very significant difference even on short top-down "stress test" approach where a portfolio is tested
timescales. There is an enormous difference for companies under certain assumptions and conditions.

From being simply a "nice to have" tool or one recom removals, or offsets ("sinks") on an ongoing basis. To stabilize
mended as best practice, scenario analysis is increasingly the climate at any given temperature, whether it is the Paris
being implemented by, and even mandated by, regulators. Agreement's objective of holding the increase in the global
°
Stress tests, which model the reaction of both a financial average temperature to well below 2 C, or alternative efforts
° ° °
system as a whole and an individual institutions' balance to limit temperature rises to 2.5 C, 3 C, or 4 C, we need to
sheets to a hypothetical shock, rely on scenario analysis by achieve net-zero carbon emissions in order to stabilize the
their very premise (see also Chapter 5). Stress tests were stock of carbon in the atmosphere (IPCC, 2018).
widely adopted by regulators in the wake of the global
This means reducing carbon emissions to zero in every
financial crisis of 2008 and are now increasingly being re
sector we can while also extracting and sequestering carbon
purposed to examine climate change risk. The Bank of
from the atmosphere using biological, chemical, and indus
England (BoE), the Banque de France, and the Nederland
trial processes at incredibly large scales (McGlashan, Shah,
sche Bank (the Dutch central bank), as well as the European
Caldecott, & Workman, 2012). We need the capacity to
Central Bank are at various stages of implementing climate
capture and sequester carbon because some sectors, such
stress tests with differing degrees of granularity, distinct
as agriculture, will have residual emissions that are nearly
climate and policy scenarios, time horizons, and feedback
impossible to stop. There are also sectors like aviation
loops. Starting in 2021, the BoE's climate stress test, called
where we do not yet have viable zero carbon alternatives.
the Climate Biennial Exploratory Scenario (CBES), will be
run every other year. The May 2022 report found that, while 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 timeframe, end up at net zero. Figure 7 .1 below shows
°
to be done to fully understand climate risks, and a lack different pathways for stabilizing temperatures at 1.5 C or
°
of available emissions data is a big issue. The US admin 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.

transition results in higher temperatures. In contrast, scenar agreed-upon, projected, plausible emissions pathways
ios where action begins immediately and emissions decline through 2100. These pathways represent different emis
quickly, usually with emissions halving by 2030 and net zero sions projections under basic, plausible economic and social
° °
being achieved mid-century end up keeping a 1.5 C or 2 c assumptions, while staying within physical constraints.
outcome "alive."
The RCPs were constructed by back-calculating the
All scenarios use some carbon removals to achieve the amount of emissions that would result in a given amount
"net" in net zero. Some scenarios ambitiously assume new of radiative forcing-the difference between incoming
technologies will be quickly deployed at sufficient scale to energy emitted by the Sun and outgoing energy emitted by
scrub carbon from the atmosphere, others use less gener Earth (as covered in Chapter 1)-that would then result in a
ous assumptions about the deployment of carbon removal given amount of warming. Because of this, the RCP names
technologies. These assumptions are key to determining are based on the amount of radiative forcing measured in
whether net zero can be achieved and this is not without watts/meter squared (W/m2), and they do not correspond
controversy as different carbon removals options result neatly with the anticipated amount of warming in degrees
in different trade-offs and have costs that will need to be Celsius.
absorbed by society.
Note that because different physical climate models yield
somewhat varying predictions based on the same emissions
trajectory, the amount of warming corresponding to any
7.2.2 IPCC Scenarios (RCPs and SSPs) given RCP is only approximate, not absolute. For RCP 2.6,
°
The concentration of greenhouse gases in the atmosphere the pathway often used as shorthand for "below 2 C," the
is key to the Earth's climate, yet the concentration is being 2023 IPCC report) found that there is only a 67% probability
swiftly altered by human activity. Because of this fact, that the global temperature increase does remain below
°
modeling and predicting the future trajectories of the 2 C (IPCC, 2023).
greenhouse gases in the atmosphere is arguably the single
The table below lists the RCPs; the corresponding approxi
most important factor to understand-more so than hav
mate, global average temperature rise by 2100; and the
ing the physical parameters of a climate simulation model
shorthand, if used. The most widely used models tend to
exactly correct. Indeed, given accurate emissions trajectory
be RCP 2.6 and RCP 8.5. RCP 2.6 is used as a shorthand
data, even simple climate models can perform quite well in °
for reaching Paris goals (of limiting warming to below 2 C)
predicting global warming. (See Section 7.3 for more infor
by drastically cutting emissions. RCP 8.5, sometimes called
mation on models.)
"business as usual," and sometimes, confusingly enough,
Because of this, there has understandably long been a used as a "worst-case scenario," is a scenario that assumes
focus among climate scientists in the IPCC to, if not defini continued rising emissions, leading to much higher levels
tively predict the single future path of emissions, at least of warming. RCPs, while originating with the IPCC, can now
lay out plausible, agreed-upon scenarios. These climate be found in everything from financial regulatory reports to
scenarios would then provide a common starting point for commercially available climate risk tools meant for corpo
modelers. The first iteration of such scenarios was devised rations. As of the 2023 IPCC report, the RCPs have been
in the 1990s, with assumptions about population growth, updated to include socioeconomic factors more explicitly.
economic growth, and emissions. From these begin-
For analytical clarity, the RCPs did not originally include a
nings among scientists, these kinds of scenarios have now
socioeconomic "narrative" but only emissions trajectories
become a crucial reference point for policymakers, corpo
calculated using certain assumptions about energy use.
rate managers, and investors alike.
Instead, shared socioeconomic pathways (SSPs) (as cov
Current IPCC usage and modeling is based on a combina ered in Chapter 1) have been developed subsequently to
tion of representative concentration pathways (RCPs) be used in conjunction with the RCPs. SSPs are intended
and Shared Socioeconomic Pathways (SSPs), which are to provide plausible scenarios for how the world evolves

1fflMYI■
PRE-2021 RCPS
Corresponding Rise in Global

Pathway Name Average Temperature by 2100 Emissions Trend to 2100
°
RCP 1.9 ~1.5 C very strongly declining
°
RCP 2.6 ~2.0 C strongly declining
°
RCP 4.5 ~2.4 C slowly declining
°
RCP 6.0 ~2.8 C stabilizing
°
RCP 8.5 ~4.3 C rising
in areas such as population, economic growth, education, climate modelers now use a combination of SSPs and RCPs.
level of globalization, level of urbanization, and the rate of When examined purely through the output of emissions
technological development. pathways, the outputs look fairly similar (see graph), but
the SSPs nonetheless add value in significant other ways.
The five SSP scenarios range from better to worse climate
For example, SSPs may be useful for transition and liability
change outcomes. SSP-1 sketches out a scenario of signifi
risk assessment, and for evaluating opportunities. In gen
cant focus on sustainability; SSP-2 is a "business as usual"
eral, because they allow many ways to achieve the same
scenario; SSP-3 involves regional rivalry between countries;
(or similar) emissions outcomes, they provide more flexibil
SSP-4 has a high degree of inequality; and SSP-5 posits
ity for models and scenarios.
fossil-fuel development.
The SSP base scenarios deliberately do not include climate Having the SSPs alongside, but separate from, RCPs allows
policies. The reasoning is that the SSPs can be combined the two to be mixed and matched. This permits the explo
with different RCPs to explore the climate policy options ration of climate policy options and their impact on energy
and assumptions that are necessary to limit global warm use, land use, emissions, and economic activity in a matrix
ing to a particular target level. Specifically, shared climate type format. To compare matrix rows is to compare differ
policy assumptions capture key policy attributes such as the ent levels of climate policy stringency (as rows are different
goals, instruments, and obstacles of mitigation and adapta RCPs); to compare matrix columns is to compare different
tion measures, and they introduce an important additional baseline socioeconomic situations, but the same level of
dimension to the scenario matrix architecture. climate policy stringency (different SSPs) (see Figure 7.3).
For instance, RCP2.6 and RCP1.9 are both possible to However, not all RCPs are achievable under all SSPs-a
achieve under the baseline SSP1 assumptions, but with high-mitigation scenario is not feasible under the SSP3
tighter climate mitigation policies in the latter. RCP2.6 is a "regional rivalry" assumptions. The models that can assess
plausible emissions pathway under both SSP1 and SSP2, the combination of social, economic, energy, emissions, and
but the underlying socioeconomic drivers and outcomes climate factors are called integrated assessment models.
are different.
As important as the IPCC's RCPs and SSPs are as a refer
Because the SSPs took longer to elaborate than the RCPs, ence point, the IPCC is not the only organization to have
they were not included in the 2014 or 2018 IPCC reports, put out scenarios. Several other organizations' projections
but they are included from 2021 onwards. So instead of are also used widely by governments, companies, and finan
sketching an emissions pathway that is merely RCP2.6, cial institutions.

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 2020 2040 2060 2080 2100
dwlZ!ll'-1
When compared side by side, the pure RCP emissions much larger expected negative emissions at the end of
trajectories previously used by the IPCC (dotted lines) the century than in the original scenario. The SSP sce
and the combined SSP-RCP trajectories that will be used narios are also useful in adding flexibility because they
from 2021 onwards (solid lines) do not look radically allow for multiple ways to achieve the same (or similar)
different. But there are some notable differences. For emissions outcomes.
instance, the mix of CO2 and non-CO2 (e.g., methane)
emissions are different even between trajectories that "Explainer: How 'Shared Socioeconomic Pathways'
result in the same amount of end-of-century radiative explore future climate change" (April 2018) Chart
forcing. Also, the old RCPs started in 2007, and the new produced for Carbon Brief by Glen Peters and Robbie
pathways start in 2014. The 2°C-compliant SSP1-RCP2.6 Andrews from the Global Carbon Project, https:/lwww.
has a higher starting point than the old RCP2.6, reflect carbonbrief.org/explainer-how-shared-socioeconomic
ing higher emissions in the 2007-2014 period and a pathways-explore-future-climate-change/. Reprinted by
slower initial decline, both of which are made up for by Permission from Carbon Brief.
7.2.3 IEA and Other Reference Scenarios The IEA has also modeled net-zero emissions by 2050 sce
narios. After years of being criticized for consistent underes
There are a limited number of global, macroeconomic cli
timation of the potential for renewables and expecting the
mate scenarios and predicted emissions trajectories from
persistence of fossil fuels, the IEA's report on net-zero of May
organizations beyond the IPCC that are used widely enough
2021, its most comprehensive up to that point, laid out a much
to be considered reference scenarios.
more ambitious path to the achievement of net-zero (see box).
Most important among these are the scenarios developed The IEA has occasionally modeled other scenarios as well, such
by the International Energy Agency (IEA). The IEA's two as a delayed economic recovery scenario in 2020 in response
core scenarios are the 1) Stated Policies Scenario, which to the global COVID-19 pandemic, and the impacts of Russia's
reflects existing policy frameworks and announced policy invasion of Ukraine on Global Energy markets.
intentions, and 2) the Sustainable Development Scenario
(SDS), which combines climate and social targets and limits Besides the IEA, there are a handful of other energy
°
warming to 2 C in line with Paris targets. transition and climate scenarios in wide use, such as the

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

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

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

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

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

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

THE PACTA FOR BANKS METHODOLOGY
2 Degrees Investing Initiative, an NGO, has developed a Cement. Alignment results are given at the level of each
methodology called the Paris Alignment Capital Transi sector (and technology level within those sectors).
tion Assessment (PACTA) tool, which has seen consider
For power, fossil fuels, and the automotive sector, there
able uptake both among investors, with its equities and
are viable and clear low- or zero-carbon technologies
bonds version, and among banks, with the PACTA ver
available, so in these sectors, PACTA uses two metrics to
sion on corporate loans, or PACTA for Banks.
measure alignment:
PACTA for Banks starts with a bank's financial exposure
to physical assets (such as steel or power plants) in the 1. Production Volume Trajectory-this measures the
real economy. The methodology then compares eco alignment of a loan book and/or client's production
nomic units of output (e.g., tons of steel, MWh of elec volume per technology/fuel against trends pre
tricity) to different climate change scenarios, allowing scribed in climate change scenarios.
the bank to know which climate pathway its clients are
on. Because the analysis uses economic units of output, 2. Technology/Fuel Mix-this metric shows the sectoral
it is able to make forward-looking projections and assess technology/fuel mix of a loan book and/or client
counterparties against both a "business as usual" and a (e.g., what percentage of automobile production
"Paris aligned" scenario. a bank finances that is related to electric vehicles,
The PACTA output metrics look to control two key cli internal combustion engines, etc.) and how this mix
mate issues: should evolve to be considered aligned with vari
1. The absolute production output, and limits, of high ous climate change scenarios. This identifies the
carbon technologies. For example, fossil-fuel pro required shift to low-carbon technologies.
duction in aggregate must ultimately decrease to

For sectors without clear decarbonization pathways as
achieve the goals set out in the Paris Agreement. yet, such as steel and cement, the methodology instead
2. Identifying the production shift from high-carbon uses the measure of emissions intensity. PACTA can com
pare the sector-specific emissions intensity of a particular
to low-carbon production (and the technologies)
bank's loan book with emissions intensity aligned with
needed to be compatible with a Paris-aligned world. climate scenarios.
PACTA for Banks currently covers five climate-critical Source: PACTA for Banks.
sectors: Power, Fossil Fuels, Automotive, Steel, and
methodology that provides an illustrative example is PACTA, disorderly and delayed but quick transition; and "Islands,"
developed by 2 Degrees Investing Initiative, which has seen with a late and slow transition. Perhaps unsurprisingly, both
°
significant uptake among large global banks (see box). "Sky 1.5" and its predecessor, the 2 C compatible "Sky,"
assume a much larger continuing role for oil & gas through
A final, ambitious approach to transition risk scenario analy
2100 than do scenarios drawn up by neutral bodies such as
sis is to build fully original emissions trajectories. Building
the IPCC or IEA, showing how companies' businesses and
bottom-up global models of energy demand and emissions,
interests potentially shape projections.
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.
7.3.3 Use of Scenario Analysis for Physical Risk
Shell, for instance, constructs and periodically updates its Use of scenario analysis for physical risks is significantly
own climate and energy scenarios. The latest iteration in different from transition risk scenario planning in multiple
the wake of the 2020 COVID-19 pandemic includes three ways. One difference is that, to the extent emissions trajec
°
scenarios, "Sky 1.5," which is 1.5 C compatible; "Waves," a tories matter, physical climate models are required as a first

step to translate trajectories into physical impacts. However, to last decades. And by 2100, the differences in physical
a second important difference is that, because the climate risks between RCPs are very significant (see case study on
system responds on a lag, physical impacts until about 2050 Ortec Finance).
are largely "baked in" by current emissions, so emissions
Another important difference that makes physical risk
trajectories do not matter on the timescale of the next few
scenario planning very distinct from transition risk is that
decades, which is what the majority of policymakers, firms,
physical risk always starts at the facility level. Physical
and investors limit themselves to (Four Twenty Seven, 2019).
impacts affect specific processes and sites-a flooded fac
Finally, because of this, a completely different sort of sce
tory, a wildfire-ravaged warehouse, an overheated office
nario analysis is sometimes more useful for physical risk
building-and then these effects cumulate upward through
one not driven by global or sector emissions trajectories but
ownership supply and investment chains. Thus, as far as
an exercise in operational preparedness based on plausible
facilities are concerned, both non-financial firms and finan
future events.
cial ones are forced to consider physical risk as an opera
Physical climate models were originally developed to help tional risk. For transition risk, industrial firms can principally
scientists understand the functioning and operation of the examine their own facilities or compare performance to
Earth's climate system. Now, they are an important tool for sector benchmarks, and even financial firms can use emis
scenario analysis on physical risk. sions data for just a few key emissions-intensive sectors
The relationship between physical climate models and to get an estimate of portfolio alignment. Meanwhile, for
emissions scenarios goes in both directions. On the one physical risk, all sectors and a wide range of assets and
hand, physical climate models are used to calibrate emis facilities are potentially affected.
sions scenarios to make sure that the amount of radiative As discussed in Chapters 3 and 6, examining facility-level
forcing resulting from the posited emissions correspond physical risk requires having detailed data on hazards, expo
roughly to certain temperature targets for global average sure, and vulnerability, including adaptive capacity, which
temperature rise. But on the other hand, these emissions many firms choose to source from commercial data pro
trajectories can then be re-inputted into models to gain an viders such as Four Twenty Seven, Carbone 4, or Trucost,
estimate of various hazards. whereas others evaluate these in-house.
The growing sophistication of newer climate models allows
Finally, and importantly, the combination of the lower
them to present forecasts with greater granularity, including
importance of emissions scenarios for physical risk in the
at the regional level, and for a greater range of phenomena,
shorter term (through 2050) and of physical risk's opera
ranging from heat waves to precipitation patterns. This
tional nature means that the type of scenario analysis that
does come with the caveat, as discussed in Chapter 3, that
tends to be conducted for physical risk is, in fact, much
physical climate models can disagree on the particulars of
closer to the original tradition of scenario analysis as pio
many hazards when it comes to future trends. For instance,
neered by Herman Kahn or Shell. That is to say, plausible
essentially all major models predict that precipitation pat
scenarios of physical impacts can be drawn up that can then
terns will change going forward due to climate change, but
help prepare for impacts. For this sort of planning, physical
there are disagreements among these models as to the
climate models can help to an extent in pinpointing vul
magnitude and particular regions affected.
nerable areas. But they cannot predict incidence precisely
Both because of the lag in the Earth's climate system and enough to be of use for forward planning, especially not for
because of the way the physical models are designed, acute physical hazards (e.g., when a flood will hit). There
these models give the best accuracy on decadal timescales. fore, using scenarios that are based on historically plausible
Emissions trajectories do make a significant difference in circumstances, especially of the types of hazards that are
predicting physical impacts in the second half of the twenty expected to increase in frequency and severity with climate
first century, which can matter for very long-term planning, change, can provide an excellent way to build preparedness
such as for physical infrastructure that is generally expected 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 York City metropolitan area, losses from hydrological
called ClimatePREDICT specializing in projecting extreme (flooding) events are predicted to be USO1.2 trillion in
weather risk on decadal timescales. Specifically, the model 2030 under a "Paris" scenario and USO 1.3 trillion under
forecasts the increase in frequency as we// as the financial a "failed" scenario. The difference between the two is
impact of climate-related extreme weather risk to physical somewhat greater in 2050, but the two scenarios are still
assets and economic growth. It does this year-by-year and much closer to each other than a counterfactual, hypo
across various peril classes, covering over 120 countries. thetical baseline with no climate change (see bar chart).
In a case study, Ortec modeled losses from extreme However, when the outlook is extended to the end of
weather events linked to climate change under a 4 °C "failed the century, differences between scenarios diverge
transition" pathway and a 2 °C "Paris compliant" pathway. markedly. In New York by 2100, annual flood losses in a
"failed transition" 4 °C scenario are expected to be triple
On a timescale of the coming decades, the difference in
those in a "Paris compliant" scenario.
losses is not that great between scenarios. For the New
Projected flood damages in NYC metro area
$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·
·�C 5 'fi5 5
-·
C
Q)
u u
Q)
�-
Ill Ill
>,
..0 4 .•·
>,
..0 4
Ill Ill
Q) Q)
Ill Ill
Ill
3 Ill
_Q
3
"' :::,
C
C
2 C
C
2
<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
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.

BHP BILLITON SCENARIO ANALYSIS-EXCERPTS
Scenario analysis approach • Lower Carbon View tracks to approximately 2.5 °C tem
BHP develops planning cases to inform our strategic perature increase by 2100 and accelerates decarboniza
choices and the timing of their execution, and to under tion trends and policies, particularly in easier-to-abate
pin our rigorous annual corporate planning process. sectors such as power generation and light duty vehicles
These planning cases consist of plausible commodity
• Climate Crisis scenario has strong growth with limited cli
specific forecast ranges (high, mid, and low cases) that
are developed through in-depth, rigorous bottom-up mate action for a decade and a half, followed by a climate
analysis. [... ] crisis which precipitates an extremely steep decarbon
Scenarios do not constitute definitive outcomes for us. ization trajectory, societal turmoil, and low GDP growth
Scenario analysis relies on assumptions that may or may • 1.5°C scenario, which aligns with the goals of the
not be, or prove to be, correct.
Paris Agreement and requires steep global annual
Scenarios: emissions reductions, sustained for decades
• Central Energy View reflects existing policy trends and
° Source: From Climate Change Report 2020 by BHP.
commitments, and tracks to approximately 3 C tem
Adapted from BHP.
perature increase above pre-industrial levels by 2100
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 Often, the results are then published and used as a way for
ing climate stress tests, an increasing number of financial institutions to communicate their soundness and solid ERM
institutions, especially banks, are choosing to voluntarily practices to their own investors and other stakeholders. This
conduct stress tests internally and not just when mandated is exactly what HSBC, a large global bank, has done with a
by a regulator. transition risk stress test on its loan portfolio (see Figure 7.10).

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

CASE STUDIES: INTEGRATION OF SCENARIO ANALYSIS INTO ASSE T
M ANAGEMENT
Abrdn (formerly AberdeenStandard) Legal & General Investment Management (LGIM)
In 2021, Abrdn, a UK asset manager, set out how it In October 2020, LGIM and Baringa Partners, a specialist
intends to integrate its in-house climate scenario work in climate and physical risk analysis, announced the co
into its investment activities: development of a bespoke climate risk framework, Desti
nation@Risk. This framework is intended to allow
"In the coming months [as of Feb 2021), we will fully inte
grate our climate-scenario framework and insights into • LG/M to quantify physical and transitional risks of
our business strategy[... ] This will include the following: climate change within its investment portfolios using
a. Integrating the results into active stock selection by these proprietary climate scenarios.
asking critical climate-related research questions that are •
informed by our scenario analysis.[...]This in turn will the degree of alignment at the company level to
allow us to construct portfolios that are resilient to differ coincide with Paris goals-preliminary data and initial
ent plausible climate pathways. analysis of a sample set of 2,000 companies done for
b. Embedding scenario analysis into our approach to the launch announcement showed that the majority
stewardship. Where material climate risks are identi were not aligned to Paris.
fied, we will engage with companies to understand what • these scenarios and measures of alignment to be fully
actions they are taking to mitigate them and encourage
integrated into all LG/M's investment activities glob
firms to undertake their own analysis.[...]
ally through a "climate dashboard."
c. Fully integrating climate risk and opportunity into our
strategic asset-allocation framework[...] Source: Climate Scenario Analysis: A Rigorous
Framework for Managing Climate Financial Risks and
d. Developing a wide range of innovative climate-change
Opportunities, Feb. 2021.
(including net zero) solutions for our clients."
scenarios matter only for very long-term planning because analysis, as well as increase the data necessary, to create
the significant physical differences between emissions sce consistent scenarios required to understand the impacts of
narios only really manifest after 2050, in the second half of climate change in a cohesive way.
the century. Instead, the use of scenario planning for cor While corporations of all kinds can and do use climate
porate contingency planning can be more fruitful. We must scenario analysis to decide on strategy, communicate with
also be cognizant that there is not broad alignment nor stakeholders, and increase preparedness, financial firms in
the data fidelity necessary for consistent scenario analysis particular can also benefit from the use of scenario analysis
across companies and organizations. Over time, all stake for portfolio stress testing and as an input for investment
holders will need to continue to advance and refine the decision-making.
REFERENCES The Physical Science Basis. Contribution of Working Group

I to the Fifth Assessment Report of the Intergovernmental
Collins, M., Knutti, R., Arblaster, J., Dufresne, J.-L., Fichefet, Panel on Climate Change. Cambridge University Press.
T., Friedlingstein, P., Gao, X., Gutowski, W. J., Johns, T., Four Twenty Seven. (2019). Demystifying Climate Scenario
Krinner, G., Shongwe, M., Tebaldi, C., Weaver, A. J., & Analysis for Financial Stakeholders. http://427mt.com/wp
Wehner, M. (2013). Long-term Climate Change: Projections, content/uploads/2019/12/Demystifying-Scenario-Analysis_
Commitments and Irreversibility. In T. F. Stocker, D. Qin, 427_2019.pdf
G.K. Plattern, M. Tignor, S. K. Allen, J. Boschung, A. Nauels, Wilkinson, A. K., Roland. (May 2013). Living in the Futures.
Y. Xia, V. Bex, & P. M. Midgley (Eds.), Climate Change 2013: Harvard Business Review.

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.

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

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

Net Zero
• Explain the concept of net zero and how it relates to private-sector actors can use to verify the credibility
global climate goals. of net-zero commitments.
• Discuss the types of key alliances in the UN Race to • Describe how net-zero pathways and interim targets
Zero. are key to achieving credible and attainable net-zero
targets across sectors.
• Describe the attributes of net-zero targets, and the
challenges of navigating the net-zero transition. • Identify cross-industry principles and metrics and dis
cuss how climate-related metrics are used in reporting
• Explain the key attributes of national and subnational and project selection.
net-zero target strategies and emissions reduction
approaches. • Understand metrics used for net-zero portfolio align
ment, considering strengths and weaknesses.
• Describe the factors that affect different sectors' abili
ties to achieve net zero. • Describe the net-zero disclosure landscape and key
stakeholders.
• Describe how organizations use transition plans
to pursue net-zero carbon emissions and the tools.
177
Key Learning Points
T his chapter provides an overview of the concept of
net zero and its implications for different players in the • To stabilize global temperatures, it is necessary to reach
economy. It begins with an introduction to the scien a balance between global sources and sinks of green
tific background behind net zero and its link to global house gases (i.e., global greenhouse gas emissions must
climate ambitions enshrined in the Paris Agreement. reach net zero). To have a chance of limiting global aver
°
It further provides an overview of the key global initia age temperature increases to 1.5 C, the IPCC estimates
tives that are mobilizing entities across the world to that global emissions need to halve by 2030 and reach
make bottom-up commitments and pushing them to net zero by 2050.
begin the journey of reducing the climate impact of • Although we are currently witnessing a wave of coun
their own organization. T he chapter then outlines the tries, sub-national governments, and companies submit
various elements required to ensure the credibility of ting bottom-up net-zero pledges in support of this goal,
these targets. It explains the crucial role that transition these differ greatly in their ambition and credibility. For
plans can play in demonstrating that an organization example, some pledges will only apply to carbon emis
is integrating decarbonization ambitions into its core sions, whereas others cover emissions of all greenhouse
strategy, and emphasizes the importance of interim tar gases, such as methane. Some pledges include only
gets and pathways and the transparent use of metrics Scope 1 and 2 emissions, whereas others cover all
to measure progress. It ends with a discussion of the 3 Scopes.
emerging landscape of net-zero disclosure standards.
• What reaching a net-zero target implies depends on the
type of organization submitting the pledge. National
Chapter Outline pledges generally cover all emissions produced within
8.1 Introduction to Net Zero its geographical boundaries. Reaching these targets will
require reducing all domestic greenhouse gas emissions
8.1.1 The science behind Net Zero
and directly removing any remaining net domestic flows
°
8.1.2 Net zero and the 1.5 C target via carbon sinks. In contrast, there is no single globally
recognized standard for setting the scope of net-zero
8.2 The Spread of Net-Zero Targets
pledges for sub-national communities or corporations.
8.3 The Implications of Net Zero for Different Actors It remains to be seen whether the work by the UN High
8.3.1 Countries Level Expert Group for net-zero Emissions Commitments

of Non-State Entities, or the voluntary framework pro
8.3.2 Sub-national governments
vided by the Science-Based Target Initiative will evolve
8.3.3 Private sector to become a globally recognized standard.
8.4 Transition Plans • Transition plans can be an important tool to add credibility
to net-zero pledges. In such plans, entities have a chance
8.5 Interim Targets and Pathways
to demonstrate how their climate pledge aligns with their
8.6 Use of Metrics broader organizational strategy, and that they have a mean
8.6.1 Cross-industry principles & metrics ingful action plan to back up their commitments.
• Net-zero targets are not enough to ensure a timely transi

8.6.2 Metrics for financial institutions
tion. To overcome the credibility gap and help decision
8.7 Reporting makers manage transition risks, target setters must define
8.8 Conclusion credible net-zero pathways with attainable interim targets.

• Carbon-related metrics are used to track an entity's outlining the scientific basis of the concept and explaining
progress along its net-zero pathway, select projects, and how it relates to the global climate goals enshrined in the
compare an entity to its peers. Along with metrics, enti Paris Agreement and the Glasgow Climate Pact. The chap
ties must consider stakeholder needs and public disclo ter further clarifies what net-zero pledges mean in practice
sure of the progress made. for different players in the field, and the role that transition
• Portfolio alignment tools, although varied in their com 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. 8. 1. 1 The science behind Net Zero
Recent consolidation of standard setters and initiatives The concept of net-zero emissions originally emerged in
seem to leave two key leaders, the TCFD and ISSB, at scientific discussions on the link between anthropogenic
the forefront, while new government-backed initiatives emissions and global temperature changes (Hale et al.,
try to incorporate some of these standards into law. 2022). It has long been understood that there is a near
linear relationship between cumulative net emissions of
NET ZERO 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
8.1 Introduction to Net Zero
in the global concentration of greenhouse gases in the
This chapter is designed to introduce the concept of net atmosphere lead to further warming which translates into
zero and its role in global climate architecture. It begins by 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 This target reflected a political consensus regarding a com
climate change requires us to reach a balance between mon aspiration, rather than a scientific assessment of what
the greenhouse gases entering the atmosphere and those level of global warming would be "acceptable." Neverthe
removed via sinks (e.g., via geological storage or carbon less, the Paris Agreement was groundbreaking insofar as it
capture in biomass) (see Figure 8.1). Stabilizing global tem marked the first document in which governments around
peratures at any given level therefore requires total global the world were able to achieve international agreement on
emissions of greenhouse gases to reach net zero, meaning a common level of ambition for limiting global warming.
that all global GHG emissions are balanced by correspond °
However, already at the time of signing, the 2 C target
ing GHG removals (IPCC, 2021).
faced criticism. Many climate advocacy groups and even
some country delegations argued that the risks incurred
8. 1.2 Net zero and the 1.5 °C target °
with 2 C of warming above pre-industrial levels were unac
ceptable, and that political decision-makers should raise
This insight forms the core of the 2015 Paris Agreement,
their ambitions. The IPCC was therefore asked to prepare
in which countries committed themselves to halting
a special report that investigated the difference between a
human-induced climate change by reaching "global peak ° °
2 C and a 1.5 C warming scenario, as well as the possible
ing of greenhouse gas emissions as soon as possible" and °
pathways for reaching the 1.5 C target. The resulting "Spe
achieving "a balance between anthropogenic emissions by °
cial Report on the impacts on global warming of 1.5 C,"
sources of greenhouse gases." Importantly, the Paris Agree
published in 2018, provided evidence that the likely effects
ment further specifies the level at which this stabilization °
from an extra 0.5 C of warming would be substantial (IPCC,
should occur. In Article 2.1 of the Paris Agreement, negotia
2018) (see Box 8.1 ).
tors agreed to "hold the increase in global average tem
°
perature to well below 2 C above pre-industrial levels" and On the one hand, these findings have led a ratcheting up
° °
pursue "efforts to limit the temperature increase to 1.5 C." of global ambitions, with the 1.5 C target becoming the
BOX 8.1: THE DIFFERENCE BETWEEN 1.5 ° AND 2 ° CELSIUS

°
The 2018 IPCC Special Report on 1.5 C (SR 1.5) starkly °
• At 2 C of global warming, it is likely that temperature
outlined the severity of the implications of an additional °
°
increases of more than 2 C would occur over most
0.5 C of warming. For example, the 2018 report had the
land regions in terms of extreme temperatures (up to
following conclusions:
° °
4 C-6 C depending on region and considered extreme
• The estimated share of the global population exposed to index). Regional increases in temperature extremes can
severe heat at least once every five years rises from 14% be robustly limited if global warming is constrained to
° °
under a 1.5 C scenario, to 37% under 2 c of warming. ° ° °
1.5 C, with regional warmings of up to 3 C-4.5 C.
°
• Although 1 .5 C of warming would still likely lead to
Many of these conclusions have more recently been
70-90% reduction in average coral cover, it would pre
echoed in the 2022 IPCC Report on Impacts, Adaptation
vent the total loss of coral reefs projected with warm and Vulnerability, which focused on both the projected
°
ing of 2 C. risks and already observed impacts of climate change.
Its findings re-emphasize that an increase of global
• The probability of extreme drought and water stress, °
surface temperature by 1.5 C would cause unavoidable
particularly in the Mediterranean region and southern
increases in various climate hazards and present multiple
°
Africa, are substantially higher under a 2 C scenario, risks to humans and ecosystems. It further outlines the
°
compared with 1.5 C. various ways in which the impacts of climate change are
already being felt today. The report also underlines that
• 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
reduce the projected loss and damages compared to
°
scenario where warming is limited to 1.5 C by 2100. higher warming scenarios.

de-facto standard against which climate advocates and oth By June 2022, 128 countries representing 83% of global
ers assess climate ambitions. This ambition was codified in emissions and 91% of global GDP made net-zero commit
the 2021 Glasgow Climate Pact, which "recognizes that the ments of some description (Net Zero Tracker, 2022).
impacts of climate change will be much lower at the tempera
Among non-state actors, the UN Race to Zero campaign
° °
ture increase of 1.5 C compared with 2 C and resolves to pur
plays a crucial role. The initiative was launched in the run-up
°
sue best efforts to limit the temperature increase to 1.5 C."
to COP26, with the intention of mobilizing "real economy"
At the same time, the 2018 report and subsequent analy actors, including regions, cities, businesses, and financial
°
ses by the IPCC sharply underline that reaching the 1.5 C institutions, to commit to reducing their carbon emissions
target is a major challenge that requires a sharp reversal in to net zero by 2050. It operates as a coordinating umbrella
emission trends (see Chapter 1.3). In its most recent report, framework of partner initiatives, which usually have either a
°
the IPCC estimates that to limit global warming to 1.5 C, sectoral focus or represent coalitions of particular types of
global net emissions would need to peak before 2025, entities (e.g., cities; see Table 8.1).
decline by 43% by the 2030s, and reach net zero in the
To join the Race to Zero, these initiatives have to demon
early 2050s (IPCC, 2022).
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
8.2 The Spread of Net-Zero Targets criteria, individual initiatives will often ask for more-detailed
T his 2050 target has become a global rallying cry for cli commitments from their members, which help translate
mate commitments from governments and non-state actors. 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 Financial sector A global coalition of over 550 financial institutions which covers
for Net Zero (GFANZ) 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)

Asset managers
Net Zero Asset Managers Asset managers An initiative designed to mobilize climate ambition among inter
Initiative (member of GFANZ) 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
Paris Aligned Investment lni- Asset owners A collaborative, investor-led forum of 118 institutional investors
tiative (member of GFANZ) representing USO 34 trillion in assets that are seeking to align
their operations with the goals of the Paris Agreement.
Net Zero Asset Owner Alli- Asset owners A coalition of 7 4 pension funds and insurers that are collaborat
ance (member of GFANZ) ing to Paris-align their investment activities.
Insurers
Net Zero Insurance Alliance Insurers A group of 30 leading insurers that have committed to aligning
(member of GFANZ) their insuring and reinsurance underwriting portfolio with the
°
1.5 C target enshrined in the Paris Agreement.
Other financial services
Net Zero Financial Service Financial service An alliance of investment advisors, auditors, rating agencies,
Provider Alliance (member of providers index providers, ESG research and data providers, and exchanges.
GFANZ) All members have committed to aligning their activities to achieve
net-zero greenhouse gas emissions by 2050 or sooner.
Net Zero Investment Con Investment A coalition that sets actions that investment consultants will take
sultants Initiatives (member consultants in the context of their legal and fiduciary duties, as well as specific
of GFANZ) client mandates, to support reaching the global net-zero target
by 2050 or sooner.
REAL ECONOMY (NON-SECTOR SPECIFIC)

Business ambition for 1.5 °C 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.
The Climate Pledge 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.
Certified B Corporation 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.
SME Climate Hub 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.
Business Declares 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.

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

launch, over 8300 companies have joined the Race to Zero independently of the Race to Zero framework and its core
via one of the member alliances and submitted their respec criteria. As of November 2022, an estimated 40% of the
tive commitments. world's largest corporations had submitted a net-zero
pledge (Net Zero Tracker (2022). However, not all targets
In parallel to that process, there are myriad public- and are created equal. Individual commitments differ widely
private-sector players that have published pledges among important dimensions such as the target year
CASE STUDY: THE MEANING OF NET ZERO AND HOW TO GET IT RIGHT
Fankhauser et al. (2022) usefully summarized the debate 5. Equitable transition to net zero: Deciding how the
and derived seven attributes that net-zero targets need
costs of the transition are shared across different
to fulfil to provide a meaningful framework for action.
actors creates challenging equity considerations. The
These are the following:
Paris Agreement calls on countries to set their own
1. Front-loaded emission reductions: Given that global ambitions in line with the principle of "common but
temperature change is determined by cumulative differentiated responsibilities and respective capaci
emissions, and not emissions in any given year, it ties," emphasizing that developing countries will
matters when emissions are reduced. To increase the need more time and financial and technological sup
chances of meeting the Paris targets, entities must port to transition. Effective net-zero target setting
reduce emissions as soon as possible. must take such considerations of fairness into account
2. Comprehensive approach to emission reductions: and recognize that some actors will need to decar
Reaching net zero requires tackling all emissions. For bonize at different speeds, to help ensure that the
governments, this means pushing forward decarbon transition does not exacerbate existing inequalities.
izations in hard-to-abate sectors. For private corpo 6. Alignment with broader socio-ecological objec
rations, this implies pursuing best efforts to reduce tives: There are complex interlinkages among
emissions across Scopes 1, 2, and 3, and engaging climate change and other critical socio-ecological
with all stakeholders along the value chain whose challenges such as ocean acidification, the erosion
actions are required to achieve these targets. of biosphere integrity, economic inequality, or the
3. Cautious use of carbon dioxide removal: Theoreti marginalization of indigenous communities (Steffen
cally, net zero could be reached by combining high et al., 2015). A narrow focus on mitigation may over
residual emissions with significant CO2 removal. In look negative repercussions in other dimensions. For
practice, however, there are unresolved issues for example, there are cases where commercial refores
most forms of removals, which make it important to tation projects rely on large-scale monocultures to
prioritize deep emissions reductions generate offsets, which have negative implications
for local populations, ecosystem resilience and ulti
4. Effective regulation of carbon offsets: Given that
mately, reliable carbon storage.
some organizations will be unable to reach net zero
purely by adapting their own operations, we will 7. Pursuit of economic opportunities: It is becom-
continue to require a mechanism to balance global ing increasingly apparent that there are also eco
sources and sinks (e.g., carbon markets). It is critical nomic opportunities that arise through the net-zero
that these mechanisms underlie governance struc transition.
tures that meaningfully address the concerns out 8. Effective net-zero planning should consider where
lined in Box 8.3 and allow for monitoring, reporting, such opportunities are likely to arise, and address
and verification of removed carbon. what steps need to be taken so these can be realized.

by which entities intend to achieve net zero, the scope 8.3 The Implications of Net Zero for
of emissions included by the pledge, and the extent to
Different Actors
which organizations have presented a robust and credible
implementation plan. At the national level, countries have 8.3. 1 Countries
pledged to move at different speeds. Whereas Sweden Following international emission accounting standards,
has pledged to reach carbon neutrality by 2045, China country-level emissions are usually assigned on a territorial,
aims to achieve that goal by 2060, and India aims for 2070 or production-based accounting method. Essentially, this
(UNFCCC, 2023). means that a country's emissions are those which directly
They also exhibit different degrees of legal commitment arise within its geographic boundaries. A national net-zero
to their targets. In the UK and Germany, the national net target based on this form of territorial GHG accounting
zero targets have been embedded in law. However, this implies that a country will strive to significantly reduce all
is only the case for roughly 18% of global country-level domestic greenhouse gas emissions, and directly remove
commitments (Net Zero Tracker, 2023). In around 43% of any net flows from remaining sources via carbon sinks.
cases, including the US, the pledges have been published This approach is controversial. Critics argue that by
via non-legally binding policy documents such as a coun placing emphasis on the country where emissions are
try's National Determined Contribution (i.e., the climate produced, too little attention is being paid to the con
action plans submitted to the UNFCCC under the Paris sumption patterns that drive emission-intensive production
Agreement; see Chapter 4). Around 20% of countries have elsewhere. An alternative approach would be instead to
pledged to reach net zero only via public statements made rely on consumption-based accounting methods, which
by key officials. measure the cumulative emissions that arise from the pro
The landscape of non-state actor pledges is similarly duction of all goods and services consumed in that country,
varied. Although some corporations have put forward regardless of where this production took place. The differ
rigorous commitments with clear strategies and interim ence in the resulting emission estimates can be large
targets for moving toward net zero, others have done (see Table 8.2).
little more than publicly declare their intent to decarbon This has important distributional implications. Gener-
ize. Some pledges only cover carbon emissions, whereas ally speaking, high-income countries have much higher
others also include commitments to reduce all green consumption-based than production-based emis-
house gas emissions, including methane. Furthermore, sions (SEI, 2017). The opposite is true for many low-
there are immense differences regarding the scope of and middle-income states, which may have domestic
activities covered by reduction targets. For example, the emissions-intensive industries that cater predominantly
net-zero target published by Apple explicitly includes to foreign demand. Many have therefore argued that
Scope 1, 2, and 3 emissions, whereas the pledge submit production-based emissions accounting places a dispro
ted by Tata Consultancy Services covers only Scopes 1 portionate share of the transition burden on developing
and 2 (Net Zero Tracker, 2023). Some organizations are countries and allows developed economies to shirk from
very transparent about the extent to which they are rely addressing the emissions intensity of domestic consump
ing on carbon offsets to reach their targets, while others tion. Despite these concerns, production-based account
remain opaque. ing has become the internationally dominant standard for
This variety presents a challenge for those seeking to navi attributing emissions at the country level.
gate the transition over the coming years. There is a clear Although conceptually simple, achieving net zero at the
need to develop tools and frameworks that allow us to dis national level in practice requires a sophisticated system
tinguish between credible net-zero commitments that are level understanding of how different elements of the
being effectively implemented in good faith and those that economy and the energy system work together. In any
are unlikely to be met or have been made cynically without given country, there will always be multiple pathways to this
any intention to deliver.

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

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.

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

the value chain of their products, which covers everything in different maturities of development and differ in their
from agricultural production to packaging and logistics. underlying assumptions and models. Understanding the
In these sectors, the challenge lies in understanding the assumptions, the models used, and the limitations is a key
Scope 3 emissions embedded in products and engaging step in using them with respect to targets, transition plans,
with partners across the value chain to minimize these, and frameworks.
as well as customers' and consumers' use and disposal of
Reaching the net-zero targets will require countries,
products.
regions, and companies to develop a vision for what role
they play in a decarbonized economy. Publicly committing
Financial Sector
to a target is only the first step. Meaningful action requires
The net-zero transition poses a unique set of challenges to entities to develop credible and ambitious pathways that
actors in the financial sector. In most cases, the main climate illustrate how these targets can be reached.
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 8.4 Transition Plans
regulations to date, a series of industry-led alliances and
Transition plans are currently gaining increasing attention as
voluntary standards have emerged to help financial institu
important tools with which private-sector actors can opera
tions establish the climate impact of their portfolios, and
tionalize climate action and allow others to verify the cred
develop strategies for reducing their financed emissions
ibility of their commitments. The Transition Plan Taskforce
over time (see Box 8.2).
defines transition plans as "integral to an entity's overall
Some of the tools and methodologies (e.g., Implied Tem strategy, setting out its plan to contribtue to and prepare
perature Ratings [ITRs], sectoral pathways) used by financial for a rapid global transition towards a low GHG-emissions
services to support their net-zero strategies and targets are economy" (TPT, 2022).
BOX 8.2: SBTl'S GUIDANCE FOR THE FINANCIAL SECTOR

One important voluntary standard for financial-sector that financial institutions should strive to reach a port
net-zero targets was developed by the Science-Based folio coverage of 100% by 2040 to stay in line with
Targets initiative (SBTi). Its framework, which was
the Paris Agreement.
published in February 2022, provides guidance on the
conditions under which a financial-sector target can be • The temperature rating approach: A third possible
deemed science-based and Paris-aligned. In general approach to target setting is to assess the current
terms, the SBTi outlines three different approaches that temperature rating of a financial portfolio, and work
financial firms can take to set a science-based target:
to align it with ambitious long-term temperature tar
• Sectoral decarbonization approach: The first gets by engaging with portfolio companies.
approach is to define emissions-based physical inten Importantly, the SBTi recommends that to achieve
sity targets for investments and loans in a defined list effective emission reductions, financial institutions should
of emission-intensive sectors, including cement, steel, engage with investees and encourage them, including
pulp and paper, and buildings. through financing transition, to implement ambitious
targets. Adjusting portfolio holdings and divesting from
• SBTi portfolio coverage approach: A second companies with low ambition are solely recommended as
approach that financial institutions can take is to work complementary strategies, where engagement does not
toward ensuring that increasing proportions of invest lead to the desired improvements.
ees in their portfolios who have committed to their Source: SBTi, 2022
own respective science-based target. The SBTi argues

In essence, they are strategy documents that outline targets integrity of net-zero targets can be ensured. They argue
and actions that will facilitate the transition of an organiza that creating transition plans are essential tools to deliver
tion to a net-zero-carbon economy and allow it to measure on ambition (UN HLEG, 2023).
and report on progress.
Transition plans are also emerging on the regulatory
Net-zero transition plans are a relatively new idea. In Octo agenda. In the UK, the government has already committed
ber 2021 , the TCFD first published high-level guidance to making transition plans mandatory across the economy.
that outlined the core components required for a transition Recognizing a current guidance gap, the government also
plan to be effective (TCFD, 2021). Since 2021, however, appointed the Transition Plan Taskforce (TPT) to develop
they have gained increasing prominence. In 2022, the a gold standard for robust private sector transition plans.
Glasgow Financial Alliance for Net Zero set out detailed The TPT launched a draft disclosure framework for consul
recommendations for financial institution transition plans, tation at COP27 (see Figure 8.4) Other jurisdictions such
and outlined what investors expect to see in transition as the EU, are also deliberating new disclosure expecta
plans of their investee companies. Some institutional tions which would require companies to publish transition
investors, such as the British pension fund Railpen, are plans. Key international forums such as the FSB and NGFS
already outlining expectations regarding transition plans have indicated that they will undertake work on transition
in their voting policies (Railpen, 2023). At COP27, the UN plans in 2023.
High-Level Expert Group on the Net-Zero Emissions Com
Transition plans provide an opportunity for organiza
mitments of Non-State Entities, appointed by Antonio
tions to demonstrate how their net-zero targets are
Guterres set out detailed recommendations for how the
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)

BOX 8.3: THE CHALLENGE OF CARBON OFFSETTING
In theory, it is possible to substitute some GHG In light of these challenges, various certification bodies
emissions by sequestering carbon or other greenhouse have developed standards and verification procedures
gases elsewhere. This is the idea that underlies modern to assess the quality of carbon-credit projects (e.g., the
carbon markets, which allow entities to balance Gold Standard or VERRA). These set out integrity criteria
emissions with so-called carbon credits. Although that any verified project needs to achieve, including
simple in theory, there is significant ambiguity about the creation of co-benefits (e.g., through biodiversity or
what activities should be eligible for generating carbon climate resilience benefits) and the active involvement
credits, and how it can be ensured that these are socially of local populations and indigenous communities in the
and environmentally robust. management of projects. However, these standards are
not being applied universally, and it is still often difficult
For example, there are ongoing discussions about
to assess the quality of individually purchased credits.
whether carbon credits should be generated only from
removal projects (i.e., activities that directly sequester It is important, therefore, that organizations tread care
carbon or other greenhouse gases), or whether activi fully when relying on offsets to reach decarbonization tar
ties that avoid emissions that would have occurred in a gets. The Oxford Principles for Net Zero Aligned Carbon
business-as-usual scenario should also be eligible (e.g., Offsetting (2020) set out a useful list of high-level prin
renewable energy projects). Experience with carbon mar ciples to which organizations should adhere to develop
kets has shown that there is a reason to be concerned an environmentally sound approach to using offsets.
regarding the environmental integrity of sold credits. These principles are the following:
According to a study commissioned by the European
Union, around 85% of the projects sold under the Clean 1. Cut emissions, use high-quality offsets, and regularly
Development Mechanism were non-additional, mean revise offsetting strategy as best practice evolves.
ing that the reduction of carbon emissions would have
2. Shift to carbon removal offsetting.
occurred without the financing through the sale of car
bon credits. In addition, carbon-credit projects often 3. Shift to long-lived carbon storage.
face challenges with leakage (i.e., displacing rather than
avoiding emissions), permanence (i.e., long-term stor 4. Support the development of net zero aligned
age of carbon), and the accurate measurement of the offsetting.
amounts of carbon stored.
The Science-Based Targets initiative similarly stresses
These factors create challenges for companies seeking to the need to prioritize deep emissions reductions. The
use offsets to reach net-zero targets. In September 2021, initiative does not validate carbon reduction pledges
a team of Microsoft staff and researchers published the where firms use carbon credits to measure progress
lessons they learned from Microsoft's efforts to pay for on their own net-zero targets. Instead, the SBTi only
carbon removal (Joppa et al. 2021). One of their key find validates targets that exclusively rely on credits to
ings was that there is a need for clear standards and defi neutralize residual emissions or to finance additional
nitions. The company received almost 200 proposals for climate mitigation beyond the entities' reduction targets.
projects, which jointly offered 154 megatonnes of CO2 Even here, the SBTi only recognizes carbon credits from
(MtCO2) in carbon credits. Out of these, however, only 2 carbon removal projects and does not allow for the use
MtCO2 met their conditions for high-quality CO2 removal. of credits generated through emissions avoidance.
CASE STUDY: TRANSITION PLANS FOR KELLOGG COMPANY

Using science-based targets and adopting an ambi decreasing Scope 1, 2 and 3 emissions and setting ambitious
tious transition plan, Kellogg Company was able to long-term targets it can be held accountable for. To achieve
significantly reduce transition risk, particularly policy this, it partnered with Science Based Targets initiative (SBTi).
and reputation risks.
The company aimed to reduce Scopes 1 and 2 emissions by
Starting in 2015, Kellogg Company (Kellogg's), a global 15% per ton of food produced by 2020, and 20% of Scope 3
food manufacturer, set out to reduce its transition risks by emissions by 2030. In addition, it defined long term targets

of reducing 65% of absolute Scopes 1 & 2 emissions and that over the long-term, setting ambitious targets and
50% of Scope 3 by 2050. sticking to a transition plan is cost-effective and there
fore a "win-win".
To tackle these quantifiable targets, Kellogg implemented
company-internal measures to reduce its own carbon As a result, Kellogg has significantly improved its repu
footprint, while engaging with suppliers to learn about their tation amongst retailers, which is crucial for on-going
emissions and advance the company's Scope 3 goals. Using operational business. T he initiatives have also enhanced
these insights, Kellogg designed 35 global prog rams to the company's relationship with the government as Kel
help farmers decrease their footprint. logg is being perceived as a front-runner in emissions
reporting and as a corporation that is working towards
T his process did not only require significant invest
taking responsibility for the planet.
ments in carbon reduction investments, but also tackling
company's internal culture and promoting employees Adapted from Science Based Targets Case Study: Kel
towards more long-term thinking. Also, Kellogg believes logg Company (SBTi, 2022).
living up to each of these attributes. They further allow 8.5 Interim Targets and Pathways
investors, governments, and other stakeholders to hold
entities accountable to their own targets and assess Detailed net-zero pathways and interim targets are the
whether these are taking meaningful steps or using most important way of ensuring that net-zero targets are
vague pledges to distract from inaction. Finally, transi credible and attainable. This section discusses how these
tion plans can play an important role in communicating methods are used by countries as well as corporations
how companies are measuring, managing, and reduc to control their transition and increase the credibility of
ing transition risks. A transition plan should therefore pledges.
always allude to the four key transition risks outlined For countries, Climate Action Tracker has defined ten key ele
in chapter 3 (policy and legal, technology, market, and ments of good practice national net-zero target setting (see
reputation risk). For example, developing a transition Table 8.4). These are jointly used to assess whether a national
plan can help an organization prepare for anticipated commitment is robust in terms of scope, architecture as well
regulatory changes (policy and legal risk); identify which as transparency. One of these key quality criteria is compre
technologies will be key in the climate transition, and hensive planning underpinned by scientifically robust path
develop strategies for harnessing them (technology ways and clear interim targets. Firstly, this planning is needed
risk); assess how demand and supply changes will affect to show that countries have a clear sense of how their tar
prices of resources used (market risk); and grasp how gets can be realized, and an action plan to achieve them.
climate awareness could change how an organization is Secondly, interim targets are critical because the timing of
perceived by the public (reputation risk). emissions reductions matters. As discussed in Chapter 1, the
In summary, writing a transition plan forces decision makers total level of radiative forcing is determined by the cumula
to rethink how their business model fits into a decarbon tive stock of greenhouse gasses in our atmosphere. Pathways
ized economy and take appropriate action. Remember that which delay emissions reductions have a much higher cumu
"no decision" is a decision for the status quo. The following lative effect on radiative forcing than those which achieve
case study on Kellogg Company highlights how moving early and deep emissions reductions over the next five years.
along a predefined transition plan can help a company man Long-term targets are therefore only credible if they are sup
age and reduce transition risk. 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

CASE STUDY: INTERIM TARGET SETTING IN PRACTICE:
Using interim targets, L'Oreal successfully moves Climate positive by 2030: Symrise supports ambitious
along the 1.5 °C pathway to net zero in 2050. goals with interim targets
L'Oreal Groupe (L'Oreal), the French personal care Symrise AG (Symrise), a German producer of flavours
company, has set out to achieve net zero by 2050, in and fragrances with over €3 bn. in turnover, aims to be
alignment with the 1.5 °C scenario. This effort started climate positive by 2030. Even though this target lies less
in 2005, when the company aimed to reduce 60% of than 10 years in the future, Symrise set an interim target
emissions at plants and distribution centers by 2020. To of reducing greenhouse gas emissions by 60% in relation
achieve this, it used a strategy based on three pillars: to value added by 2025, compared to 2016.
(1) Reduce energy requirements across facilities, (2)
To accomplish these ambitious feats, the company
increased use of renewable energy, and (3) achieve
focuses on energy efficiency at production sites.
targets without carbon offsetting projects.
Beyond Scopes 1 and 2 emissions, Symrise involves its
The company exceeded the initial target by 18% and key suppliers in the climate strategy and encourages
now builds on these accomplishments. L'Oreal aims to them to commit to targets themselves. By now almost
achieve carbon neutrality at administrative, industrial, 90% of its suppliers have started emissions reduction
and research sites by 2025. By 2030, the beauty product initiatives. To increase transparency, every year the
specialist will reduce Scopes 1 and 2 emissions per firm releases a thorough sustainability report based
product by 50% and emissions resulting from the use on SASB (Sustainability Accounting Standards Board)
of products by 25%, compared to 2016 values. Further standards.
initiatives include a reduction of per product emissions
linked to transport by 50% and an absolute decrease of Adapted from CDP: Running Hot, Accelerating Europe's
50% direct emissions from L'Oreal's strategic suppliers. Path to Paris (2021).
Why then, have so few of the large companies committed to documents often contain useful external benchmarks that
net zero, and even fewer defined pathways for their targets? can help company executives from any sector define firm
Besides lacking regulatory pressure, part of the answer prob level interim targets and allow external stakeholders to com
ably lies in the complexity of understanding what net zero pare a company's ambition to industry peers.
implies for their operations, and the challenge of developing
To define transition plans that are granular enough to sup
a realistic pathway towards that target. This is not helped
port ambitious net-zero pledges, companies should con
by the complex landscape of GHG accounting standards,
sider a few key points. Firstly, they should take advantage
disclosure frameworks and recommendations. Important
of above-mentioned, industry-specific benchmarks and
tools that can help organizations unpack these complexities
consider joining the Race to Zero initiatives in their sector,
are sectoral transition pathways. T hese are being developed
which can often provide a baseline for more companyspe
by various organizations such as Industry Tracker, a research
cific measures and targets. Secondly, it should be ensured
organization that helps develop decarbonization pathways
that any defined transition plan does not collide with exist
for hard-to-abate sectors, or the Transition Pathway Initia
ing or anticipated local net-zero policies. T hirdly, companies
tive, a global initiative formed by asset owners that provides
must determine specific short- and medium-term interim
sectoral benchmarks against which company ambitions can
targets. Case studies of L'Oreal and Symrise show how
be assessed. Such organizations aim to provide coherent
interim targets are used in practice to steadily inch closer
data on transition pathways of companies to asset manag
towards net zero.
ers and owners. As part of this process, they independently
To ensure that the goals defined by companies amount to
define benchmarks for sectoral transition pathways based
more than just greenwashing, further measures should be
on key metrics and target dates. These pathways define tra
considered. For example, consulting key stakeholders for
jectories for how a sector can transition towards a net-zero
their opinions and publicly disclosing both targets as well as
future. While mainly intended for financial institutions, such

progress over time increases accountability for the actions If the wider business sector or economy discloses the same
taken by a company. Initiatives like the previously men metrics, stakeholders are provided a basis on which to com
tioned Science Based Targets can further help by verifying pare across organizations. To improve the quality of reported
that the targets set are science-based and realistic. metrics and provide a better understanding of progress,
organizations are urged to provide historical data to allow
8.6 Use of Metrics for trend analyses. The metrics disclosed should be closely
related to the targets set to enable a review on the progress
So far, this chapter has examined why the transition to net
made. Organizations should note that metrics lose credibility
zero is crucial and what actions governments and organiza
if the reporting entity fails to provide details on methodol
tions can take to define a credible transition path to net
ogy, including any estimates used. Organizations gain cred
zero. This section briefly examines the metrics that can be
ibility if the metrics they use can be third-party assured.
used to track progress towards net zero, for both non-finan
cial and financial institutions. While Table 8.5 provides some examples of metrics that
can be used for reporting and target setting, Table 8.5.1
8.6. 1 Cross-industry principles & metrics provides examples of climate-related targets. While some
industries are prone to similar physical and transition
T he Task Force on Climate-related Financial Disclosures
risks, there is no single set of metrics that captures the
(TCFD), an initiative by the Financial Stability Board (FSB),
cross-section of climate-risks for all organizations. Some
recommends disclosing climate-related metrics to cover
metrics can be used to enable a base comparability, such
three broader topics (2017):
as absolute Scopes 1 and 2 emissions, or the percentage
a. Disclose metrics used to assess climate-related risks of electricity used that was generated with renewable
and opportunities in line with the strategy and risk methods. Generally, however, it is essential for target set
management process. ters to analyze the business they are in and define metrics
b. Disclose Scopes 1 and 2 and, if appropriate, Scope 3 that appropriately cover the topics defined above. Some
emissions and related risks. metrics take significant efforts to calculate or estimate.
Therefore, organizations are encouraged to first harvest
c. Describe the targets used to manage climate-related
low-hanging fruits while defining processes to automate
risks and opportunities and performance against
and standardize the calculation of some more complex
targets.
quantitative measures.
In addition, the TCFD recommends that organizations
The usage of carbon-related metrics can go beyond report
clearly disclose metrics used to assess progress against
ing. Metrics are often also used for project selection pur
their decarbonization targets, including related operational
poses. One can use metrics to describe the carbon intensity
and financial performance metrics, metrics aligned with
of projects such as factories and office buildings: Decisions
the cross-industry, climate-related metric categories, and
can be made based on metric thresholds or relative to
industry-specific or organization-specific metrics (TCFD,
rivalling projects. A second approach uses internal carbon
2021).The disclosure of these metrics allows investors and
pricing to account for emissions in net present value (NPV)
other stakeholders to assess how an organization monitors
calculations, which punishes carbon-intensive projects.
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
8.6.2 Metrics for financial institutions
and targets that allow companies to meaningfully track There are many tools for financial institutions to analyze
their progress in relation to climate-related targets. These whether their investments are sustainable. Most promi
include GHG emissions reduction targets, but also other nently, and thoroughly discussed in Chapter 5, are ESG rat
operational or financial metrics which are used as key per ings and data, which report on companies' environmental,
formance indicators (KPls) of progress (GFANZ 2022). social, and governance footprints and efforts.

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

CASE STUDY ON USE OF CARBON-RELATED METRICS: BASF SE
BASF follows the recommendations from TCFD and progress made as well as historical data to allow for trend
reports its emissions in accordance with the Green analyses, as suggested by the TCFD. Further, the figure
house Gas Protocol as well as the sector-specific depicts the five key initiatives to reduce emissions. This
standard for the chemical industry. The result is a chart alone provides more insights on transitions risks and
comprehensive, transparent, and comparable report net-zero targets than are available from most of the larg
on climate risk and sustainability. est companies in the world.
The German company BASF is the largest chemical The next figure depicts BASF's value chain and the emis
producer in the world and has committed to achieving sions caused along it, measured in million metric tons CO2
net-zero Scopes 1 and 2 emissions by 2050 and has set equivalent. To calculate the carbon footprint of products
an interim target of a 25% reduction to the base year the company produces, it implemented a new method of
2018 until 2030. Figure 1 depicts these commitments, the 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.

decrease these emissions, BASF shares its results with sup of products that have increased durability and improved
pliers and engages in cooperation to reduce the footprint recycling capabilities. BASF has also reduced its products'
caused by raw-material gathering and transport before the footprint by introducing renewable, plant-based products.
materials arrive at BASF production sites.
These excerpts from the BASF Report 2021 show how orga
To estimate the carbon footprint of activities to the nizations can successfully use metrics to define and report
right of BASF in its value chain, the chemical producer on targets, to address key stakeholder needs and expecta
places its products into the four categories Accelerator, tions. Besides metrics, it is worth mentioning that BASF also
Performer, Transitioner, and Challenged (see Figure 8.7). reports qualitatively, meaning it aims to predict regulatory
This also enables the company to set such targets as, for change and discusses the findings and risks indicated by the
example, the phasing out of products in the Challenged data. It is only when data is interpreted soundly and care
category until 2023. As a chemical company, many Scope 3 fully, that relevant takeaways can be made.
emissions reductions on the customer side can be reduced
Reprinted with permission from BASF from BASF
with technological advancements, such as the development
Report 2021.
Classification of assessed portfolio according to the Sustainable Solution Steering method

Accelerator Accelerator sales
Substantial sustainability contribution 2021: €24,103 million
in the value chain 2020: €16,740 million
Meets basic sustainability standards 2021: €39,033 million

on the market Assessed 2020: €30,519 million
portfolio
Transitioner €71,041 million Transitioner sales
Specific sustainability issues which are 2021: €7,879 million -
being actively addressed 2020: €6,799 million -
Challenged Challenged sales

Significant sustainability concern identified and 2021: €26 million
action plan in development or implementation 2020: €72 million
Reprinted with permission from BASF from BASF Report 2021.
No tool is perfect, and each of the four described herein evaluation of progress toward net zero, and allows for
have both strengths and weaknesses. Binary measure results to be aggregated meaningfully to the portfolio
ment is simplest to use, based on easily attainable data, level. It poses challenges, however, in that it is com
and broadly applicable to any asset class. It's limited, plex and requires climate-scenario expertise to use, is
however, in that it offers no insight into the degree of net based on potentially difficult-to-obtain data (such as
zero alignment/misalignment; and meaningfully aggregat company-level emissions projections and benchmarks),
ing results to the portfolio level can be a challenge. and delivers technical output that can be challenging to
interpret.
Maturity scale alignment metrics provide a more holis
tic understanding of the trajectory that portfolio compa Implied temperature rise (ITR) offers all the advantages of
nies are on. The pitfall of these metrics is that there is no benchmark divergence plus the added benefits of a mea
commonly used approach for categorizing companies, sure of the consequence of alignment/misalignment and
making it difficult to compare across entities or assess easily understood output. As with benchmark divergence,
the robustness of individual assessments. it poses challenges in that it is complex and requires
climate-scenario expertise to use and is based on poten
Benchmark divergence, to its credit, generates a mea
tially difficult-to-obtain data and/or extensive assumptions.
surement of degree of alignment/misalignment, allows
Adapted from Portfolio Alignment Team, Measuring Portfolio Alignment- Technical Considerations (2021)

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 • Making operations more efficient and • Carbon removal technologies (e.g.,
production reducing emissions (e.g., CCS, fugitive CCS, BECCS)
• Expansion of current explo and flaring prevention) • Alternative fuel/energy finance to
ration and production • 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.

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
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.·
•··· 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
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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.

100+ countries with a joint market capitalization of USD 27 seek to align with recommendations provided by the CDSB,
trillion., publicly supported the TCFD. Eight jurisdictions, the SASB and the TCFD (amongst others). These drafts
namely Brazil, the EU, Hong Kong, Japan, New Zealand, Sin contain initial guidance on what elements of their transition
gapore, Switzerland, and the UK have even made announce strategies companies should disclose as part of their cli
ments to make TCFD-aligned reporting mandatory, with materelated disclosures.
more jurisdictions to follow (TCFD, 2021). For example, in
A key controversy in the development of net-zero disclosure
March 2022 the US Securities and Exchange Commission
standards is the question of whether such standards should
(SEC) has published a proposal to make climate-related
consider double materiality. In 2019, this term was coined
reporting mandatory for its registrants. The proposed
by the EU, and is now gaining much traction. Materiality is a
rules were largely built on the TCFD's recommendations.
concept coming from financial disclosure, which encourages
Specifically on the issue of net-zero transitions, disclosure
corporations to report on all activities, opportunities and
standards are only beginning to emerge now. At the end
risks which could be material to the company's value, turn
of 2021, the TCFD first included high-level guidance on
over, income, or other key performance indicators. Double
transition plans in its recommendations. In line with this,
materiality adds to this concept with the notion that com
and emerging out of COP26, the GFANZ as well as the UK's
panies must also disclose activities which could be material
Sustainability Disclosure Requirements (SDR) have also com
to society and the environment. This concept now builds
mitted to encouraging and introducing transition plan dis
much of foundation of the EU's taxonomy and CSRD disclo
closure requirements for members and companies. Indeed,
sure standards. The ISSB, on the other hand, has excluded
in 2021, the UK Chancellor has announced that preparing
double materiality from the scope of its requirements.
and publishing transition plans will become mandatory
across the economy (Gov.uk, 2021). This adds a new level To summarize, there are a few essential organizations to
of requirements to existing disclosure recommendations, keep in mind for the future of net-zero financial disclosure.
as companies are for the first time being explicitly asked First is the TCFD, which often acts as a baseline-setter of
to publish a roadmap towards a decarbonized future. The ideas and recommendations. Second is the ISSB, who are
efforts in the UK are supported by a high-level Transition aiming to create comprehensive and lasting carbon-related
Plan Taskforce (TPT), which is developing recommendations financial disclosure standards. Lastly, one should also keep
on gold standard transition plans. Its recommendations are in mind national regulatory bodies, who are increasingly
expected to be finalized by early 2024, after which the gov looking to include net-zero disclosure requirements (e.g.,
ernment will develop its rules. The Corporate Sustainability via transition plans) in their jurisdictional policies.
Reporting Directive (CSRD) aims to make all large compa

nies in the EU more publicly accountable by obliging them 8.8 Conclusion
to regularly disclose information on their societal and envi
ronmental impact. This would end greenwashing, strengthen This chapter started with an introduction to net zero by
the EU's social market economy, and lay the groundwork for explaining the science behind the concept and the dif
° °
sustainability reporting standards at global level. ference between the 1.5 and 2 C targets. It highlighted
the urgency with which countries, sub-national govern
It is still unclear whether other jurisdictions will take a similar
ments, and the private sector must strive towards net zero
approach. As discussed in Section 8.2, most parts of the
to achieve the goals set out in the Paris Agreement. It
world are still far from making net-zero commitments, not to
then briefly discussed the landscape of initiatives within
mention codifying them in law and requiring their disclosure.
these three sectors and emphasized that while an increas
Given the current complexity of the sustainability disclosure ing number of actors are publishing net-zero goals, the
landscape, there are ongoing efforts to align requirements underlying ambitions vary widely. To make net-zero targets
internationally. A key initiative is the IFRS' International more credible and allow us to hold entities accountable for
Sustainability Standards Board (ISSB). In March 2022, the their progress, organizations need to develop and disclose
ISSB published initial exposure drafts of its general sustain transition plans. The chapter outlined key characteristics
ability and climate-related corporate disclosures, which of meaningful transition plans and argued that they are an

important tool which allow decision makers to manage and Running_hot_-_accelerating_Europe's_path_to_Paris.
reduce transition risks. One way of increasing credibility pdf?1615190423
of a net-zero pledge is to disclose a transition plan that
Fankhauser, S., Smith, S. M., Allen, M., Axelsson, K., Hale,
defines interim targets that are attainable and allow stake
T., Hepburn, C., Kendall, J. M., Khosla, R., Lezaun, J.,
holders such as employees, shareholders, and customers to
Mitchell-Larson, E., Obersteiner, M., Rajamani, L., Rickaby,
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R., Seddon, N., & Wetzer, T. (2022). The meaning of net
To track progress along a transition plan, metrics such as
zero and how to get it right. Nature Climate Change, 12(1),
emissions data can be used. For financial companies specifi
15-21. https://doi.org/10.1038/s41558-021-01245-w
cally, portfolio alignment tools such as implied temperature
ratings that analyze the net-zero progress of counterparties Fong, W. K., Sotos, M., Doust, M., Schultz, S., Marques, A.,
were discussed. Finally, the chapter provided an overview & Deng-Beck, C. (2021). Global Protocol for Community
of the regulatory landscape governing net-zero disclosures Scale Greenhouse Gas Inventories.
and identified the TCFD and ISSB as key leaders in this GFANZ (2022) Financial institution Net-zero Transition Plans.
emerging area. Fundamentals, Recommendations, and Guidance.
GFANZ (2022) Expectations for Real-economy Transition

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

ANSWERS
8.1 B 8.4 D
8.2 C 8.5 C
8.3 B 8.6 D

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

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®

Pearson Education, Inc., 221 River Street, Hoboken, NJ 07030

Printed in the United States of America

@Pearson ISBN 10: 0-13-829183-7

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

viii Preparing for the 2023 SCR Exam

GARP Learning Platform. The platform is accessible via

Preparing for the 2023 SCR Exam ■ ix

Steven Bullock Robert Litterman

Ben Carr Charmian Love

John T. Colas Michael Marano

Beth Gould Creller Jo Paisley

Sandro Diez-Amigo Julie Pullen

x ■ SCR® Advisory Committee

Michael Sheren Michael Wilkins

SCR® Advisory Committee ■ xi

Chapter 1: Foundations of Climate Director

Chapter 2: Sustainability Chapter 4: Sustainability and Climate

University of Oxford Oxford Sustainable Finance Programme

Chapter 3: Climate Change Risk Ira Poensgen

Krister Koskelo Krister Koskelo

Chapter 6: Climate Risk Measurement Chapter 8: Net Zero

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

Joerg Osterloh, CFA Chapter 8: Net Zero

Chapter 4: Sustainability and Climate

• Understand how energy sources can contribute to or

2 ■ Sustainability and Climate Risk Exam

(a) Surface thermometer (b) Satellite temperature

i-=: -0.6 ..........-�-��-�-�-�-�-�-�

(c) Arctic sea extent (d) Glacier ice

(e) Ocean heat content (f) Sea level

0 ----------------- --- --------------------------·

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

4 ■ Sustainability and Climate Risk Exam

For example, scientists can extract climate information from period.

Chapter 1 Foundations of Climate Change: What Is Climate Change? ■ 5

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

0.4 -------- ------ -- ----- ----------------------

6 ■ Sustainability and Climate Risk Exam

This is the most important rule of the Earth's climate: energy

As the mass of greenhouse gases in our atmosphere 380

Chapter 1 Foundations of Climate Change: What Is Climate Change? ■ 7

8 ■ Sustainability and Climate Risk Exam

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%

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

Because water vapor's abundance in the atmosphere

1s climate change is to amplify changes caused by things

1.6 Attribution of Modern Warming

10 ■ Sustainability and Climate Risk Exam

Chapter 1 Foundations of Climate Change: What Is Climate Change? ■ 11

12 ■ Sustainability and Climate Risk Exam

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

0.. 900 2-4

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

14 ■ Sustainability and Climate Risk Exam

Chapter 1 Foundations of Climate Change: What Is Climate Change? ■ 15

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

Spencer, R. W., Christy, J. R. & Braswell, W. D. UAH Ver

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

• Attention deflection is when organisations hide unsus

Within SASB's five main dimensions of sustainability

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