Accountants must understand “nuances” of climate-related scenario planning

The increasing use of scenario planning by businesses to identify climate-related risks and opportunities means that accountants must evolve their knowledge to assist organisations more effectively with investment decisions.

“It’s very important that accountants start dealing with these nuances,” said Davide Puglielli, head of scenario planning at energy manufacturer Enel, speaking at a panel discussion held by the Institute for Chartered Accountants in England and Wales this week.

“Companies might be wrong to some extent, but then there’s the role of people who need to assess whether those decisions were reasonable or not.”

According to the Task Force on Climate-Related Financial Disclosures (TCFD), the importance of forward-looking assessments of climate-related risk has led scenario analysis, a method for developing strategic plans, to become a key financial tool for businesses in recent times.

According to the TCFD, the use of scenario analysis is critical for “assessing potential business implications of climate-related risks and opportunities” and “informing stakeholders about how the organisation is positioning itself in light of these risks and opportunities”.

However, the panel’s central argument was that the lack of understanding of scenario analysis among advisers is a concern.

It is a concern shared by Christoph McGlade, head of the energy supply unit at the International Energy Agency, who noted the disparity in understanding of how to use scenario analysis that exists between businesses and accountants.

“Many in the financial and accounting communities are coming to this from a very different perspective,” he said.

“They need to get ahead of it, do that homework and develop an understanding of the scenarios, and then find out the best way forward to make them as useful as possible.”

McGlade went on to elaborate on the balance that needs to be struck when using these methods, arguing that many businesses simply rely on two extreme scenarios (the most and least likely), and that many use hundreds, resulting in confusing and imprecise forecasting.

“We need to find a happy medium between these two extremes,” he added.

Looking ahead

The panel finished by speculating on what could be done to develop scenario analysis practice, first drawing attention to a TCFD-authored paper published in October 2020.

The paper offers an overview on how companies can understand, develop, implement and demonstrate the effectiveness of scenario planning methods, outlining various taxonomies, definitions and rationales.

“If I had to say where to start, that would be one key resource to me,” said Puglielli.

Tristan Stanley, climate change principal at BHP, also highlighted the importance of such resources, but went on to stress the need for regulatory intervention. This would catalyse evolution among businesses and advisors when it comes to understanding risk metrics, he argued.

“Having a more common understanding of scenarios allows us to build some of these metrics that allow for comparisons between companies. Ultimately that needs to be picked up by regulatory bodies.”