14 Pension Protection Fund Climate Change Report 2022/23 STRATEGY AND RISK MANAGEMENT CONTINUED How we assess the risks and opportunities Progress on Climate scenario analysis Our climate transition scenarios Our external data provider, MSCI, has updated its overall Climate Value At Risk When stress-testing the Climate Value at Risk (Climate VaR) of our (VaR) models by incorporating a number of improvements. This does mean portfolios, we take into account a number of climate transition scenarios that we cannot directly compare this year’s results with last year’s due to the that align with those developed by the Network for Greening the Financial signi昀椀cant number of enhancements: System (NGFS): • Improvements in physical risk analysis: Physical risk analysis has been Our scenario category Equivalent NGFS scenario expanded. Speci昀椀cally, MSCI now includes two new datasets, Regional Company Exposure to Physical Hazards and Regional Physical Hazard 1.5 degrees orderly Net Zero 2050 (1.5°C) Metrics, which aligns with TCFD recommendations. 1.5 degrees disorderly Divergent Net Zero (1.5°C) • Reduction in the Transition Climate VaR time horizon from 2100 to 2050: This is a welcome change given the global focus on achieving Net Zero 2 degrees orderly Below 2°C 2 degrees disorderly Delayed transition by 2050. • Re昀椀nement of assumptions for the Technology Opportunity model: Hot house world Current policies Calculations of low-carbon revenues for each company have been enhanced and the projected electricity generation fuel mix now re昀氀ects each climate transition scenario. (Previously, the projected electricity generation fuel mix NGFS scenarios framework was based on IEA data that was aligned with a speci昀椀c temperature but was not scenario speci昀椀c, i.e. ignored whether the transition would be orderly gh or disorderly.) i H Disorderly Too little, too late The chart below shows the impact of the worst transition risk scenario and the worst physical risk impact on each of our Liquids portfolios. For all three portfolios, it is the same scenarios that are the most disruptive i.e., 1.5 degrees disorderly/Divergent Net Zero combined with aggressive physical risk impacts. The Credit and UK Credit portfolios are found to demonstrate more resilience Divergent to both physical and transition risks than the Equities portfolio, based on the Net Zero VaR outputs. (1.5ºC) See our detailed Climate VaR results in the Metrics & Targets section. Delayed Climate VaR quick overview relative to our portfolios Enhancements to external manager ESG reporting transition s There have been no signi昀椀cant changes to our quarterly ESG reporting template k is 30% for our Liquids managers which is now very comprehensive and has led to an r n improvement in the quality of reporting, especially on climate risks. We continue o iti 25% $2.98bn to look to improve the depth and comparability of ESG reporting among our ns external managers, with progress on the reporting of alternative assets: a r T R Net Zero a • Real Estate: Our annual reporting template seeks to encourage V 20% 2050 (1.5ºC) l a $1.77bn standardisation and requires managers to include energy ratings and c i s y performance certi昀椀cates. h P 15% e • Farmland and Timberland: We started asking for additional data in 2020 to Below 2ºC v i s $4.62bn enable more accurate and standardised alignment and carbon sequestration NDCs es10% gr assessments, although this is still a work in progress while managers use Current Ag di昀昀erent sequestration methodologies. policies 5% • Private Markets: The eFront ESG Outreach Project has expanded coverage this year to include all Private Markets. One caveat is that the current 0% questionnaire does not di昀昀erentiate between companies and real assets, w Orderly Hot house world 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% which we raised with the Outreach team. Lo Highest Transition VaR Low Physical risks High Equities Credit UK Credit