A Climate Scenario Taxonomy for the Financial Sector

Abstract:

The financial sector faces an urgent need for accurate and comprehensive climate scenarios. Accurate pricing of risk is essential if there is to be a smooth shift in the flow of a capital to accommodate both transition and adaptation. The current suite of available scenarios falls short in providing the necessary breadth, transparency and detail.

Our proposed climate scenario taxonomy offers a valuable tool for enhancing the transparency, reliability, and applicability of climate scenarios in the financial sector. By addressing the existing gaps in understanding and documentation, this taxonomy can contribute to more effective risk management and sustainable financial practices.

Climate economics is a complex multidisciplinary topic. We must improve the flow and comprehensibility of knowledge from the academic to the financial services sector if financial decision makers are to accurately price and manage these risks. This paper introduces a three-dimensional, six-level taxonomy designed to help address this need. The taxonomy categorises climate scenarios based on their narrative, macro-modelling, and micro-expansion elements, while also identifying geographical and sectoral variations. By understanding the assumptions and calibration choices at each stage of scenario construction, both scenario builders and financial end-users can better evaluate and utilise scenario pathways.