26 Pension Protection Fund Climate Change Report 2022/23 METRICS AND TARGETS CONTINUED Forward-looking scenario analysis Within our analysis, we have selected the ‘Aggressive’ physical risk scenario To manage our exposure to climate-related We not only examine throughout, against which to assess the resilience of our portfolios, so we risks e昀昀ectively, we also deploy a number our portfolio in terms can see the largest potential impact of forward-looking tools to assess how our of extreme risks, but on our investments. However, we acknowledge that portfolios might be a昀昀ected by climate also opportunities there are limitations with the currently that will thrive in a available climate scenarios and value- change in the future. These are covered in at-risk methodologies, that could be turn over the next four sub-sections. Net Zero world. under-representing the risk. Recent studies have highlighted, in particular, the lack of integration in the models 1. MSCI Climate Value-at-Risk between transition and physical risks Physical VaR and not factoring in tipping points or As an asset owner, it is important to • Policy VaR feedback loops. We would intuitively stress-test our portfolio and see how its The highest Climate VaR under The location database used by the expect to see a higher Physical VaR in value might be impacted in a range of a disorderly transition is mainly MSCI Climate VaR tool now maps the scenarios where there is less of a scenarios and circumstances. To explore explained by the abrupt need to approximately 270,000 locations, transition or a delayed transition. the impact of climate in our portfolio for a higher and faster reduction including an expansion of the global we extensively analyse one aggregate in emissions. Companies would power plant database. The tool covers 昀椀ve acute risks and 昀椀ve chronic Note metric: Climate Value-at-Risk (‘Climate be required to achieve a bigger risks. Acute hazards are catastrophic Our external data provider MSCI VaR’ or ‘CVaR’). Climate VaR comprises emission reduction and pay a events such as coastal 昀氀ooding, introduced two new datasets ‘Transition VaR’ (comprising Policy VaR higher assumed carbon price, tropical cyclones, 昀氀uvial 昀氀ooding, (Regional Company Exposure to and Technology Opportunities) and face higher electricity costs, and low river 昀氀ow, and wild昀椀re. Chronic Physical Hazards and Regional ‘Physical VaR’, which we extrapolate in absorb higher costs from their value hazards are extreme heat, extreme Physical Hazard Metrics) to our analysis. chain, totalling in a higher Policy cold, precipitation, extreme snowfall, improve accuracy and better align VaR. (Conversely a failed transition and extreme wind. with TCFD recommendations. As detailed on page 14, MSCI has results in low Climate VaR because updated its CVaR models by introducing it assumes no/minimal policy action This enhancement makes year- several enhancements to improve is taken so companies would not be on-year comparisons of Physical accuracy and re昀氀ect more realistic required to decarbonise as much. VaR less meaningful. and plausible scenarios. The updated Plus they would not be forced to models re昀氀ect more ampli昀椀ed results move into renewable energy as than the previous model did, especially quickly or at all.) for a 1.5°C Orderly scenario. However, • Technology opportunities this means that year-on-year analysis As well as assessing risks, we look is no longer directly comparable. ahead to see how opportunities Transition VaR that will thrive in a Net Zero world When stress-testing the Climate VaR of might bene昀椀t our portfolio. The VaR our portfolios, we look at 昀椀ve potential model principally assumes that, climate transition scenarios that align as the world moves towards Net with those developed by the Network for Zero, companies with low-carbon Greening the Financial System (NGFS), technology patents, for example, as described earlier. We choose to split are expected to see positive out orderly and disorderly scenarios performance as the demand for into a 1.5°C and a 2°C scenario to renewable energy/low-carbon acknowledge the signi昀椀cant di昀昀erences technologies increases. in these two temperature outcomes.