This research piece was co-authored by Wong De Rui, Senior Vice President, Sustainability Office at GIC, and Thomas Nielsen, Partner at Planetrics, McKinsey Sustainability.

The authors would like to thank Shang Thong Chie and Trang Chu Minh from GIC and Ethan McCormac and Ahmed Ali from Planetrics for their contributions to this work.

Executive Summary

  • Investors are increasingly exposed to climate change. According to the International Energy Agency (IEA), the goal of limiting global warming to 1.5°C will require the transformation of economies around the world 1. Investors are likely to be affected by these changes as the transition to a low-carbon economy further shapes companies, markets, and the global economy 2.
  • However, the pace and path of future climate policy and technological change are uncertain. Traditional risk and return models that are solely based on historical data make it challenging to explore new climate-related risks. Quantifying climate risks can be further complicated by significant uncertainty around the pace and stringency of policy and technological innovation.
  • To address these uncertainties, GIC employs both top-down and bottom-up approaches for stress-testing investment portfolios against a multitude of potential future pathways. Top-down approaches assess risk at a macroeconomic level. In a previous report 3, GIC mapped out the climate impact on macro indicators such as gross domestic product (GDP) growth or inflation, as well as financial asset returns.
  • Climate risks, however, are concentrated across and within sectors, depending on factors such as emissions intensity and market characteristics. Companies might be impacted differently even within the same emissions-intensive sector. A granular, bottom-up modelling approach can help investors quantify climate impacts on firms across and within sectors.

This paper, co-authored with Planetrics, part of McKinsey Sustainability, explores a bottom-up climate scenario analysis methodology to support investors in assessing the transition impacts on individual companies and their portfolios:

  • Sections 1 and 2 introduce climate scenario analysis as a tool to help investors explore low-carbon transition scenarios.
  • Section 3 details a bottom-up climate scenario analysis approach to assess company-level financial impacts.
  • Section 4 presents results for an illustrative global equity portfolio. It highlights pockets of potential climate-related risks and opportunities across and within sectors, as well as the impact of whether companies might achieve their publicly announced climate targets.
  • Section 5 concludes with a brief discussion of potential investment applications.

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