27 Pension Protection Fund Climate Change Report 2022/23 METRICS AND TARGETS CONTINUED 1 Climate Value-at-Risk 2022 results by asset class Physical risk In Credit, Physical VaR is primarily The 1.5°C Disorderly scenario continues to present the greatest CVaR for all three of our analysed asset classes. Note: Due to model enhancements by our data Physical risk within Equities is driven accounted for by Extreme Heat provider, the 1.5°C Orderly scenario now presents a worse outcome than the 2°C Disorderly scenario. This is because MSCI has changed the way they calculate mostly by Extreme Heat (17 per cent (7 per cent of the 12 per cent). In terms costs, which is one of the main inputs for Climate VaR. of the 25 per cent of Physical VaR). of sector, Food & Staples Retailing, This is mainly due to Banks – the most Transportation and Utilities have the exposed sector – then Energy and highest exposure; and in terms of Equities We hope our actions to assess and Equities Climate VaR Telecommunications Services. China, regional exposure, the US and China The impact from a 1.5°C Disorderly manage all our assets’ alignment with US, and Japan are the most exposed have the highest exposure. scenario is most signi昀椀cant for Paris targets (see page 13) will further k 25% 25.1% regions to physical risk within the In UK Credit, physical risk is mostly s help to improve this resilience in the i Equities, with a Transition VaR of r Equities book. 20% coming from Coastal Flooding (15 future. For example, Energy is the most at over 16 per cent. The Physical VaR e per cent of the 19 per cent). Capital u for the aggressive physical risks exposed sector within Equities under l 15% 16.5% a Biggest contributing sectors Goods is the most exposed sector; v Transition VaR. As mentioned, 72 per scenario is 25 per cent. Whilst the e 12.5% to physical risks by portfolio Netherlands and United Kingdom Transition VaR is lower than last year cent of the Energy sector emissions at10% m are the most exposed countries. are associated with companies in our li 9.1% (which was 38 per cent), it suggests c l 5% a our Equities portfolio is still not Climate Watchlist. t o 1.7% 3.8% very resilient to scenarios factoring T 0 Banks Note in delayed but forceful action to 3ºC 2ºC 2ºC 1.5ºC 1.5ºC The UK Credit book has some keep global warming within Paris Certain information ©2023 MSCI ESG hot house orderly disorderly orderly disorderly physical risk exposure to other Agreement levels. Research LLC. Reproduced by permission; countries besides the UK. This no further distribution. Transition risk Aggressive physical risk Equities: is because it includes non-UK Ph VaR companies that issue Sterling debt 25% or companies that might have Credit Transportation is the most exposed Global Credit Climate VaR Telecoms Energy assets located elsewhere than UK. sector under Transition VaR across Services For another year, our global Credit 12% If MSCI does not have data for the portfolios registered a lower CVaR, all 昀椀ve scenarios. This is due to k 11.1% underlying credit issuer, we may s the sector being highly exposed to i than our Equities ranging from 12 to r 10% use data from the ultimate parent transition risks around electri昀椀cation at 16 per cent under our 昀椀ve scenarios to approximate the risk, which e 8% u Food & when aggregating both Transition and a move away from fossil fuel l may not be a UK name. a v Staples energy sources. 6% and Physical VaR. Whilst the Physical e Retailing VaR is higher than last year, due to the at 5.2% Technology opportunities m 4% li methodology changes undertaken c Although a 1.5°C Disorderly scenario l 3.4% a by MSCI, the Transition VaR is lower t 2% 2.6% Credit is expected to have the highest – and o 0.8% for both 2°C and 1.5°C disorderly T 0 1.1% Ph VaR hence worst – Climate VaR for all asset scenarios than last year. 3ºC 2ºC 2ºC 1.5ºC 1.5ºC 11% classes we analyse, it is also expected Certain information ©2023 MSCI ESG hot house orderly disorderly orderly disorderly Trans- Utilities to generate the most exposure of all Research LLC. Reproduced by permission; portation scenarios to Technology Opportunities. no further distribution. Transition risk Aggressive physical risk Technology, Buildings and Health have the highest future low-carbon UK Credit However, there is considerable UK Credit Climate VaR technology potential. MSCI’s Even taking into account the exposure in this portfolio to Utilities Capital modelling suggests that the sector methodology changes year-on- companies that have set science- 25% Goods best positioned for low carbon k opportunities is Heavy Manufacturing s based targets. Our expectation is that i year, we have seen Transition VaR r 20% 19.1% in the Equities portfolio, Technology if these companies start delivering on at increase for the UK Credit book. This e UK Credit and semiconductors manufacturing u is likely to be driven by the increased their goals, then the transition risk they l 15% a in the Credit portfolio and Rail and v Ph VaR are exposed to will decline. exposure to Utilities. e 19% Utilities in the UK Credit portfolio. at10% Food & m 10.1% li Staples Utilities 1 The Climate VaR of a company, in any given c l 5% 7.4% Retailing scenario, is simply the present value of the a t 1.6% 5.2% o costs impacts in that scenario divided by T 0 0.8% the current enterprise market value of the 3ºC 2ºC 2ºC 1.5ºC 1.5ºC company. The enterprise market value is Certain information ©2023 MSCI ESG hot house orderly disorderly orderly disorderly computed as the sum of the market values Research LLC. Reproduced by permission; Certain information ©2023 MSCI ESG of a company’s equity and debt. The book no further distribution. Transition risk Aggressive physical risk Research LLC. Reproduced by permission; value of debt is used to proxy the market no further distribution. value of debt at the company level.