Climate Scenario Analysis Under ISSB: A Step-by-Step Guide

Climate Scenario Analysis Under ISSB: A Step-by-Step Guide

Climate scenario analysis is near the top of the list of topics where sustainability teams say, "we know we have to do it, but we don't know where to start." The International Sustainability Standards Board's (ISSB) climate standard, IFRS S2, makes this analysis mandatory — but in a far more flexible way than most teams assume. This guide explains what scenario analysis is, who it applies to, and how to run it step by step in practice.

What Is Climate Scenario Analysis, and Who Does It Apply To?

Climate scenario analysis is not about predicting the future; it is about testing how resilient your organization is across different plausible climate futures. For example, in a transition scenario where warming is held to 1.5 °C, carbon prices and regulatory pressure rise; in a scenario where warming reaches 3 °C, physical risks (flooding, drought, extreme heat) come to the fore. The goal is to understand whether your strategy holds up under both kinds of future.

IFRS S2 requires organizations to assess and disclose their climate resilience using climate-related scenario analysis (IFRS S2, para. 22). The standard is effective for annual periods beginning on or after 1 January 2024 and is applied alongside IFRS S1 (ISSB, 2023). IFRS S2 builds on the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and turns them into a mandatory reporting framework (TCFD, 2017). The key distinction to internalize: scenario analysis is a stress test, not a forecast. It does not try to say which future will happen; it surfaces where your strategy becomes fragile across several clearly divergent futures.

The Proportionality Principle: "Commensurate with Your Circumstances"

What makes scenario analysis intimidating for many teams is equating it with the complex quantitative modeling done by large financial institutions. IFRS S2 does not expect that. The standard requires the analysis to be performed using an approach that is commensurate with the organization's circumstances (IFRS S2, para. 22; Application Guidance B1-B18). This proportionality rests on three factors:

• Your exposure: How exposed are you to climate risk? A high-carbon or climate-sensitive sector warrants deeper analysis.
• Your skills and resources: The data, capabilities, and tools you already have.
• Information available without undue cost or effort: You work with the data you can reasonably obtain at the reporting date.

A few examples make proportionality real. For a low-carbon services firm with offices concentrated in one region, a qualitative narrative is enough: "Under a disorderly transition, our energy costs and office rents come under pressure; acute flood risk could affect a single data center." The same depth would be inadequate for an energy-intensive cement producer with coastal assets — that company is expected to model carbon-price sensitivity and temperature/flood projections at least semi-quantitatively. For banks and insurers, where both exposure and capacity are high, portfolio-level quantitative modeling effectively becomes the norm. What matters is explaining your approach and why you chose it; proportionality directs effort to the right place, it does not excuse avoiding the work.

The NGFS Scenario Families: What Each One Tests

The Network for Greening the Financial System (NGFS) publishes reference scenarios developed by central banks and supervisors and made freely available (NGFS, 2023). They fall into four families, each striking a different balance between transition and physical risk:

The power of this framework is that choosing at least one scenario from opposite ends tests your resilience against genuinely contrasting pressures: an orderly transition scenario foregrounds transition risk (carbon price, regulation, technology shift), while a hot house scenario foregrounds physical risk (flood, drought, extreme heat). IEA scenarios (e.g., Net Zero Emissions by 2050, Announced Pledges, Stated Policies) model the energy-transition side in more detail and are commonly used alongside NGFS as a complement (IEA, 2023).

Defining Time Horizons

IFRS S2 asks you to define short, medium, and long term yourself; it does not impose fixed year counts (IFRS S2, para. 10). The right definition is not abstract calendar bands but your real decision cycles:

• Short term should align with your budgeting and operational planning cycle (typically 1–3 years).
• Medium term should match your strategy and capital allocation cycle (typically 3–10 years); this is where most investment decisions are made.
• Long term should reach the economic life of your longest-lived assets. If a plant, refinery, or power station will operate for 20–40 years, physical risks only become visible over that horizon.

Practical rule: set your time horizon by your longest-lived asset and your most distant capital commitment. If an expansion investment made today will still be on your balance sheet in the 2050s, you cannot see stranded-asset risk unless your analysis extends that far.

Step by Step: How to Run Scenario Analysis

1. Define the purpose and scope. Clarify why you are doing the analysis: to test strategic resilience, prioritize risks, inform investment decisions. Determine which business lines, geographies, and time horizons (short / medium / long term) it will cover.

2. Select scenarios. Use at least two, preferably divergent, scenarios. IFRS S2 encourages considering a scenario aligned with the latest international climate agreement (for example, 1.5 °C / "well below 2 °C"). A typical set drawn from the NGFS and IEA libraries: an orderly transition scenario, a disorderly / delayed transition scenario, and a high-warming ("hot house") scenario.

3. Identify exposures. Map which risks and opportunities come to the fore in each scenario. Transition risks (carbon price, regulation, technology, market demand) tend to dominate low-warming scenarios; physical risks (acute events and chronic shifts) dominate high-warming scenarios.

4. Assess impacts. Evaluate the effect of the identified exposures on your business model, value chain, and financial position. This can begin as a qualitative narrative ("under scenario X, our raw material costs come under pressure") and progress to quantitative estimates (revenue, cost, asset impairment) as capacity grows.

5. Document and disclose. Record the scenarios, assumptions, time horizons, and method you used. IFRS S2 requires disclosure of how and when the resilience assessment was carried out. Documentation is critical both for assurance and as the basis for next year's analysis.

Important: Scenario analysis is not a one-off project but a recurring process. You are expected to build a qualitative baseline in year one and deepen it in subsequent years. Progress, not perfection, is the bar.

Worked Example: A Mid-Size Manufacturer

This example is purely illustrative and does not represent a real company. Consider "EgeMetal," a mid-size manufacturer with a single plant on Türkiye's Aegean coast that exports metal components to the EU. The team selects two contrasting scenarios and looks at the medium (10-year) and long (25-year) horizons.

Orderly transition scenario (~1.5 °C). Here transition risks dominate. Carbon prices rise predictably; the EU Carbon Border Adjustment Mechanism (CBAM) imposes an embedded-emissions cost on the metal they export. Electricity prices climb in the short term but supply is stable. Customers begin demanding lower-carbon components — both a risk and an opportunity. EgeMetal's outcome: cost pressure is manageable, but unless it greens its power supply and produces primary emissions data, it could lose competitiveness under CBAM. Physical risk stays limited in this scenario.

Hot house scenario (~3 °C+). The picture inverts: transition pressure is weak (policy stays loose), but physical risks come to the fore. The single plant's near-coastal location is exposed to acute flood risk from rising sea levels and intensifying storm surge. On the chronic side, higher temperatures raise cooling costs and reduce worker productivity on extreme-heat days. In the supply chain, raw-material suppliers exposed to drought and flood disruptions could interrupt deliveries. EgeMetal's outcome: dependence on a single location is the biggest vulnerability in this scenario.

Resilience conclusion. Read together, the two scenarios point the strategy clearly: prioritize primary emissions data and renewable power procurement in the short term (against transition risk), and flood defenses for the plant plus a geographic-diversification assessment in the medium term (against physical risk). No single scenario would have delivered both lessons — that is precisely the value of contrasting scenarios.

How Scenario Outputs Land in the Four IFRS S2 Pillars

IFRS S2 inherits TCFD's four content pillars. Scenario analysis is not an isolated exercise; its outputs distribute across all four:

• Governance: How scenario findings are reported to the board and relevant committees; who oversees the resilience assessment.
• Strategy: This is the primary home — the resilience assessment itself, the identified risks/opportunities, and their effect on the business model and financial planning (IFRS S2, para. 22).
• Risk management: How the risks surfaced by the scenarios are identified, assessed, and prioritized, and how they integrate into the enterprise risk management process.
• Metrics and targets: Indicators derived from the scenarios — carbon-price sensitivity, stranded-asset share, exposed revenue — and their link to transition-plan targets.

Common Pitfalls

• Confusing scenarios with forecasts. Scenarios are not probability estimates; in the spirit of a "stress test," they are plausible but challenging futures. "Which scenario is most likely?" is the wrong question.
• Using a single scenario. Analysis based on one future does not test resilience. At least two contrasting scenarios are needed — ideally one transition-weighted (orderly/disorderly) and one physical-weighted (hot house).
• Looking only at physical or only at transition risk. Both must be assessed; which dominates depends on the scenario. A common manufacturer trap is to look for physical risk only at its own site, not across the supply chain.
• Analysis disconnected from strategy. Scenario analysis that is shelved as a compliance document creates no value; its outputs must connect to strategy, capital allocation, and risk management.
• Over-engineering. A low-exposure organization attempting a complex quantitative model in year one runs against the proportionality principle and wastes resources.
• Misaligning the time horizon with asset life. A 10-year analysis hides the stranded-asset risk of a plant that will operate for 30 years.
• Not documenting scenario parameters. If you don't record which NGFS/IEA scenario, which version, and which carbon-price/temperature pathway you used, the analysis cannot be repeated year on year.
• Skipping documentation. If assumptions and method are not recorded, neither assurance nor year-on-year consistency is possible.

Choosing Data and Reference Scenarios

A widespread misconception is that scenario analysis requires building a model from scratch; in fact, credible, publicly available datasets supply the backbone of the analysis for free. NGFS publishes carbon-price, GDP, energy-mix, and temperature projections for all scenario families through an online scenario explorer (NGFS, 2023). The IEA's World Energy Outlook scenarios provide energy-transition trajectories by sector (IEA, 2023). On the physical-risk side, the IPCC's Shared Socioeconomic Pathways (SSPs) and regional climate projections are the starting point (IPCC, 2021).

The practical approach: rather than inventing your own assumptions, select a recognized reference scenario, record which version you used, and apply only that scenario's parameters to your own exposure (plant locations, energy mix, export markets). This both lowers cost and gives you a defensible basis under assurance.

Transition Reliefs and Timeline

The ISSB grants certain transition reliefs in the first year of application. In the first reporting period, organizations may focus only on climate-related disclosures (IFRS S2) and, where they lack the capacity for quantitative scenario analysis, may use a qualitative approach (ISSB, 2023). This keeps the standard accessible from the outset; but the reliefs are temporary, and more robust analysis is expected over time.

On timing, the critical point is that IFRS S2 is being adopted across jurisdictions as a global baseline. Many countries, including Türkiye, have designed their own sustainability reporting standards to align with IFRS S1/S2; scenario analysis capability is therefore becoming necessary not only for the ISSB but for local obligations as well.

Action Checklist

• Map your climate exposure (sector, geography, plant location, value chain) through a preliminary assessment and set a proportionate depth (qualitative / semi-quantitative / quantitative).
• Tie your time horizons to real business cycles: short = budget, medium = capital allocation, long = longest-lived asset.
• Select at least two contrasting scenarios (e.g., one NGFS orderly transition + one hot house); ensure at least one aligns with an international climate goal (e.g., 1.5 °C).
• Record the source, version, and key parameters (carbon-price curve, temperature pathway) of the reference scenario you use.
• Identify transition and physical risks separately for each scenario, across both your own operations and your value chain.
• Build a qualitative resilience narrative in year one and reach an explicit resilience conclusion; write a road map for quantitative deepening.
• Place scenario outputs into the four IFRS S2 pillars (governance, strategy, risk management, metrics and targets); report findings to the board.
• Set a recurrence schedule to update the analysis annually.

Done at the right scale, climate scenario analysis is not a compliance burden but a strategic decision tool: it lets you see in advance which futures leave your business fragile. Thanks to IFRS S2's proportionality principle, even a small team can start with a qualitative baseline today and build on it each year.

To see how IFRS S2 resilience disclosures and scenario assumptions are managed in an auditable form, request a demo from Azalt.

References

1. ISSB, "IFRS S2 Climate-related Disclosures," IFRS Foundation, 2023.
2. ISSB, "IFRS S2," paragraph 10 (time horizons) and paragraph 22 with the accompanying Application Guidance (B1-B18) on climate resilience and scenario analysis, IFRS Foundation, 2023.
3. ISSB, "IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information," IFRS Foundation, 2023.
4. TCFD, "Recommendations of the Task Force on Climate-related Financial Disclosures," 2017.
5. ISSB, "Transition Reliefs for First-Time Application of IFRS S1 and S2," IFRS Foundation, 2023.
6. NGFS, "NGFS Climate Scenarios for Central Banks and Supervisors (Phase IV)," Network for Greening the Financial System, 2023.
7. IEA, "World Energy Outlook 2023" (NZE, APS, and STEPS scenarios), International Energy Agency, 2023.
8. IPCC, "Climate Change 2021: The Physical Science Basis (AR6, WGI)" — Shared Socioeconomic Pathways (SSPs), 2021.