23 Pension Protection Fund Climate Change Report 2021/22 METRICS AND TARGETS CONTINUED Forward-looking scenario analysis We are keen to look ahead and assess how our portfolios might be a昀昀ected in the future by climate change. To do this, we deploy a number of tools to quantify the risk posed to our Physical VaR investments and the quality of action being taken by companies. On the We have seen improvements in the following pages we pro昀椀le two tools whose application we have advanced We not only examine MSCI Climate VaR tool regarding over the past year: the MSCI Climate Value-at-Risk (CVaR) tool and the Transition physical risks and we have been Pathway Initiative (TPI) tool. We also assess what proportion of our portfolios our portfolio in terms considering these in our assessments. comprises issuers setting science-based targets for their climate action, as part The location database used by the of our e昀昀orts to start measuring our alignment. of extreme risks, but tool now maps to approximately also opportunities 270,000 locations, including an 1. MSCI Climate Value-at-Risk expansion of the global power plant that will thrive in a database. In terms of hazards, the As an asset owner, it is important for • Policy VaR tool has undergone a number of us to stress-test our portfolio and see The highest Climate VaR under Net Zero world. updates over the last year and now how its value might be impacted in a a disorderly transition is mainly covers 10 hazards across acute and chronic types17 range of scenarios and circumstances. explained by the abrupt need . To explore the impact of climate in for a higher and faster reduction our portfolio we extensively analyse in emissions. Companies would Please note one aggregate metric: Climate Value- be required to achieve a bigger Recent updates in aspects of at-Risk (‘Climate VaR’ or ‘CVaR’). emission reduction and pay a the MSCI Climate Value-at-Risk Climate VaR comprises ‘Transition VaR’ higher assumed carbon price, physical risks methodology mean (comprising Policy VaR and Technology face higher electricity costs, and it is potentially challenging to Opportunities) and ‘Physical VaR’, which absorb higher costs from value make like-for-like, year-on-year we extrapolate in our analysis. chain totalling in a higher Policy comparisons for our di昀昀erent VaR. (Conversely a failed transition asset portfolios. We look forward Transition VaR results in low Climate VaR because to showing more reliable year- We analyse Climate VaR for each of it assumes no/minimal policy action on-year progress on CVaR in our portfolios under 昀椀ve transition is taken so companies would not be future reports. scenarios, led by our Paris Disorderly, required to decarbonise as much. Paris Orderly and Failed Transition Plus they would not be forced to identi昀椀ed scenarios. For the 昀椀rst two, move into renewable energy as we decided to further split these out quickly or at all.) into a 1.5°C and a 2°C scenario after • Technology opportunities recognising that there are signi昀椀cant We not only examine our portfolio di昀昀erences in the impact even between in terms of extreme risks, but also 1.5°C and 2°C. The highest CVaR (worst) opportunities that will thrive in a is predicted to be materialised under Net Zero world. The higher policy a Paris Disorderly transition (‘1.5°C risk that our portfolio faces in a disorderly’ and ‘2°C disorderly’). The disorderly world is o昀昀set to some lowest Climate VaR (best) is predicated extent by a higher and positive under an Paris Orderly (‘1.5°C orderly’ contribution from technology and ‘2°C orderly’) or Failed Transition opportunities. Principally, the VaR (‘3°C hot house’). model assumes that, as the world moves into a Net Zero world, 17 There are now 昀椀ve acute risks and 昀椀ve companies with low-carbon chronic risks incorporated. Acute hazards patents will achieve an excellent = catastrophic events such as coastal performance as the demand for 昀氀ooding, tropical cyclones, 昀氀uvial 昀氀ooding, renewable energy/low-carbon river low 昀氀ow, wild昀椀re. Chronic hazards = technologies increases. extreme heat, extreme cold, precipitation, extreme snowfall, extreme wind.