A “radical and urgent” shift is needed in the climate scenarios used to address climate change, the Universities Superannuation Scheme (USS) and University of Exeter have said, warning that current scenarios have significant limitations.

The report from the duo, No Time To Lose – New Scenario Narratives for Action on Climate Change, suggested that current climate scenarios often understate both the economic damage of climate change and the potential benefits of action, restricting their usefulness for investment decision-making.

The research explained that whilst global warming is not a major uncertainty over the next few years, the tools investors and others are using to assess the financial risks faced are inadequate.

In particular, it found that current scenarios do not pay enough attention to shorter term geopolitical risks and volatility in financial markets, using multi-decade horizons and smooth transitions that are not realistic representations of how economic and financial markets are likely to behave over the next five-10 years.

It also suggested that the current analysis is failing to capture key aspects of the real world, including acute physical risk, politics and policy, unemployment, tipping points, path dependency and complex feedback loops.

And, given evidence that emissions will need to be halved by 2030 to reach net zero by 2050, the USS and University of Exeter argued that investors must pay close attention to shorter term risks and challenges even when assessing the long-term financial impacts.

"It is time for a paradigm shift in climate scenario analysis," the report stated.

"This paradigm shift towards shorter horizons and business applications requires scenarios that focus less on the climate itself and more on the vicissitudes of politics, markets and extreme weather events."

In line with this, the report outlined four new climate scenarios that look at shorter term and more realistic horizons to inform investment decision making, developed with input from leading experts.

The new scenarios range from optimistic, with politics and economics working in harmony to drive rapid decarbonisation, to pessimistic, where a toxic political climate compounded by dysfunctional markets frustrates progress.

In particular, the new scenarios look to switch focus away from global average temperature pathways and towards the complex interplay between physical factors such as extreme weather events and human factors such as disruptions in geopolitics, economics, financial markets, and technology.

Whilst the report was initially produced to inform USS decision-making, the scheme said that, by making the report public, it hoped to stimulate a broad-ranging debate among practitioners, policy makers and academic experts about developing this practical approach to climate scenario analysis with a view to embedding it into transition planning and all forms of financial decision-making.

In addition to this, the USS confirmed that it intends to develop a long-term investment outlook informed by the scenarios and draw out investment implications for capital markets expectations, top-down portfolio construction and country/sector preferences.

Commenting on the report, USS Investment Management (USSIM) chief executive officer, Simon Pilcher, stated: "We hope this work represents the beginning of a much-needed shift in climate-related strategic decision making both within the investment industry and potentially beyond, which is a cause for cautious optimism.

USSIM head of investment strategy and advice, Mirko Cardinale, also highlighted the work as an "important milestone" for the development of a new approach to climate scenario analysis.

“We aim to lead in the development of this new approach that is less focused on precise estimation and more on understanding how real-world dynamics could play out in a complex world where climate risks cannot be looked at in isolation from political, economic, and technological factors," he stated.

“Moving forward, we intend to develop a long-term investment outlook informed by the scenarios and draw out investment implications for capital markets expectations, top-down portfolio construction, and country/sector preferences.”

Adding to this, University of Exeter visiting fellow and lead author on the report, Mark Cliffe, said “Many organisations, not least in the investment community, are committed to playing their part in halving global greenhouse emissions by the end of the decade.

"It is disturbing that only in the most optimistic of our four scenarios does this look to be plausible. We have no time to lose.”

This was echoed by GARP Risk Institute president and contributor to the report, Jo Paisley, who stated: “We are already witnessing devastating physical impacts from a warming planet, which are only going to intensify over coming decades.

“Add transition risks to the mix, and the resulting risk landscape will be increasingly difficult to navigate. But given the significant uncertainties, we urgently need to consider a variety of scenario narratives. As this timely and thought-provoking paper makes clear, there is no time to lose.”

The report from USS and University of Exeter is not the first to raise concerns around the current climate analysis underpinning investment decisions, as research previously found that "flawed" climate analysis could be placing pension savers at risk.

The Pensions Regulator (TPR) has since said that it “recognises and shares” concerns that some climate scenarios may show impacts that seem at odds with established science, highlighting this as a 'timely opportunity to take stock'.

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