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David Lunsford

David Lunsford

Executive Director, MSCI Research

Thomas Verbraken

Thomas Verbraken

Executive Director, MSCI Research

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Stress Testing Climate-Change Scenarios


  • Regulatory initiatives around climate-related financial disclosures are accelerating globally.
  • Climate-change risk could come from a transition to a low-carbon, greener economy, as well as from more frequent and severe extreme weather events.
  • For example, under a 1.5°C scenario, the “average” European energy company could lose 67% of its enterprise value due to policy changes, whereas it could gain around 18% because of revenues generated from innovations in low-carbon technology.

The Biden administration’s focus on climate change may greatly increase regulatory requirements for climate-risk reporting,1 and climate-change stress tests could be an important part of these regulatory disclosures. But apart from helping investors meet regulatory requirements, these could bring more transparency about companies’ and their investors’ exposures to climate-change risks and opportunities, accounting for a range of potential outcomes.


Accelerating Regulatory Demands for Climate Disclosure

The Task Force on Climate-related Financial Disclosures (TCFD), established in 2015 by the Financial Stability Board, jump-started the discussion on climate-related disclosure requirements. The TCFD received very strong support for the recommendations for climate-risk disclosures it published in June 2017.2 The Banque de France, Bank of England and Dutch National Bank took a leadership role shortly afterward, proposing to integrate TCFD-inspired disclosure guidelines into their existing supervisory roles. These efforts eventually formed the basis for the Network for Greening the Financial System (NGFS). By now, the NGFS has more than 80 member institutions. Notably, the U.S. Federal Reserve joined the initiative in December 2020.

It is no coincidence that central banks are focusing on stress testing and scenario analysis as tools to provide transparency about the economic impacts of climate change. First, there is large uncertainty about future pathways for climate change and its economic impact. Second, the economic impact is complex, and there are multiple dimensions such as transition risk — the cost or benefit from a transition to a greener economy — and physical risk — the impact of more, or less, frequently occurring extreme weather events. Finally, there is no real precedent, so we cannot learn much from historical experience. As a result, investors may wish to assess a range of climate-change scenarios and their potential impact on companies and portfolios.


A Stress Test of Transition and Physical Risks

For this blog post, we have analyzed how companies in the MSCI Europe Index could be impacted by climate change. Our methodology included both transition and physical risks and opportunities. First, we turned our attention to transition risk for two climate-stabilization goals: the 1.5°C and 3°C temperature-rise scenarios.3 While MSCI Climate Value-at-Risk metrics can be calculated at a security level, the exhibit below shows the impact to the enterprise value for the “average” company in each Global Industry Classification Standard (GICS®) industry group, whereby companies are equally weighted.4

Carbon-intensive companies in energy, transportation, utilities and materials were most severely impacted by policy risk — with the average energy company losing 67% in enterprise value under a 1.5°C scenario.5 This was partially offset by revenue opportunities from a low-carbon transition, or technology opportunity, which could be as high as 41% for the average utilities company. Companies in other industry groups, such as automobiles and components, also possess the potential for a climate upside, as they hold low-carbon technological innovations that could be used to green the economy into the future. Of course, one should keep in mind that averages hide a wide range of differences between companies. Under a 3°C transition scenario, the risk level was significantly smaller because companies would need to make less effort to reduce emissions, with both policy risk and technology opportunity being less pronounced.


Transition Risk Clustered Among Carbon-Intensive Companies


Impact of the transition-risk scenarios on the enterprise value of companies in the MSCI Europe Index. The impact on the “average” company in each industry group is shown, whereby companies are equally weighted. Based on data as of Dec. 22, 2020. Source: MSCI ESG Research.

Next, we looked at the impact of physical risk to the enterprise value of the same set of industry groups, for two scenarios: an average and an aggressive scenario.6 The magnitude of the impact is generally smaller than for transition risk; e.g., the average European energy company loses 18% in the aggressive physical-risk scenario, while it loses 49% in the 1.5°C scenario for transition risk.

However, the physical risk is predominantly on the downside, with little upside, as the exhibit below shows. The impact is more spread out over the industry groups, because the main driver of physical-risk exposure is the location of companies’ facilities.

Still, we see a larger impact on energy companies — as capital-intensive industries are more vulnerable to extreme weather events — and to food & staples retailing companies — because extreme weather could impact food productivity. Although physical risks could be reduced by a transition to a greener economy, extreme weather events may become more frequent and some of this risk might materialize regardless of the climate-change mitigation efforts undertaken.


Physical Risk Is Spread More Widely Among Industry Groups


Impact of the physical-risk scenarios on the enterprise value of companies in the MSCI Europe Index. The impact on the “average” company in each industry group is shown, whereby companies are equally weighted. Based on data as of Dec. 22, 2020. Source: MSCI ESG Research


As regulatory pressures mount, portfolio stress testing sheds new light on the potential impact of climate change on investment outcomes. Our analysis shows how exposed different industry groups are to climate change and the huge potential variation between industry groups. For investors, this may be critical information as they construct and monitor their portfolios.


The authors thank Monika Szikszai for her contributions to this blog post.


1Bloom Raskin, S. "US climate finance is approaching a leapfrog moment " Financial Times, Jan. 11, 2021.

2“2020 Status Report.” Task Force on Climate-related Financial Disclosures, Oct. 29, 2020.

3The MSCI Climate Value-at-Risk Model integrates a range of different transition scenarios, which are differentiated by, among others, temperature targets and transition “pathways” to achieve such temperature-rise targets. In this example, we evaluate the policy impacts from a 1.5°C and 3°C scenario. To calculate the costs associated with reaching emission-reduction requirements, MSCI uses technology- and policy-based price estimates available from integrated assessment models. The overall share of future low-carbon revenues attributable to a company is based on a weighted average of two inputs: its estimated current market share of low-carbon revenues and its modeled share of low-carbon patents. To understand the impact to today’s enterprise value, these projected costs and benefits are discounted, whereby the discount rates are aligned with the weighted average cost of capital of companies and the sectors in which they operate.

4GICS is the global industry classification standard jointly developed by MSCI and Standard & Poor’s. In this blog post, we show the impact to the overall enterprise value (equity + debt), but it is also possible to assess the impact at security level — i.e., the impact to the company’s stock and bond prices. Furthermore, as we looked at total enterprise value, we averaged using equal weights within each industry group.

5This estimate is based on the energy companies in the MSCI Europe Index, whereby the impact to the enterprise value (equity + debt) is averaged using equal weights.

6Using the past 40 years of observed weather patterns to set a historical baseline, MSCI ESG Research brings both acute and chronic climate developments into perspective for the coming 15 years. A probabilistic modeling framework is used to determine the probability distribution of the annual cost from weather extremes for company assets at any given location. This approach allows us to not only determine the average cost from climate change, but also explore the possibility of much more severe outcomes. The scenarios used in this analysis are derived from the average and the 95th percentile of the cost distribution (“aggressive”), the latter exploring the severe downside risk within the distribution tail.



Further Reading

What Biden’s Climate Plan Means for US Utilities

2021 ESG Trends to Watch

Water Funds’ Exposure to Sustainable Water Solutions

Climate risk in private real estate portfolios: What’s the exposure?

Managing Climate Risk in Investment Portfolios

Climate Solutions