Clarifying climate-related scenario analysis: A guide to AASB S2 compliance

AASB S2 Climate-related Disclosures (AASB S2) requires the use of climate-related scenario analysis to assess an entity’s climate resilience. In practice, the term “scenario analysis” is often used interchangeably with stress testing and sensitivity analysis, leading to confusion about what is actually required to inform the climate resilience disclosures for AASB S2.

In this article we are referring to two different types of scenario analysis, namely:

• Scenario analysis to assess climate resilience; and
• Scenario analysis to identify and assess climate risks (e.g. stress testing and sensitivity analysis).

AASB S2 is closely aligned with IFRS S2, “which incorporates and builds on the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD)” (Basis for Conclusions accompanying AASB S2, paragraph BC5). As a result, TCFD guidance is considered a reliable and relevant reference for meeting the scenario analysis and other requirements under both IFRS S2 and AASB S2.

In particular, the TCFD Guidance on Scenario Analysis for Non-Financial Companies, specifically referenced in AASB S2 (Footnote in paragraph B1), provides relevant information on how organisations can develop and apply climate scenarios to assess climate resilience. This guidance is especially useful for clarifying common misconceptions and supporting consistent disclosures.

While scenario analysis to assess climate resilience and scenario analysis to assess and identify climate risks (e.g. stress testing and sensitivity analysis) can both involve the use of climate scenarios, they serve distinct purposes and have different methodologies.

This article aims to clarify these differences by:

• Defining scenario analysis to assess climate resilience as intended by AASB S2 and TCFD guidance, with a focus on its exploratory nature and role in assessing climate resilience.
• Differentiating scenario analysis to assess climate resilience from scenario analysis to identify and assess climate risks (e.g. stress testing and sensitivity analysis), highlighting the distinct methodologies and objectives of each.
• Examining inconsistencies between market practices and regulatory expectations, particularly where terminology is used interchangeably or inaccurately.

By clearing up these concepts, we hope to support organisations in developing more robust, transparent, and compliant climate-related disclosures as required by AASB S2.

Scenario analysis to assess climate resilience

Scenario analysis to assess climate resilience, is a forward-looking tool used to explore how different climate futures could impact an organisation’s strategy and operations. It involves developing and analysing multiple plausible scenarios, typically based on varying levels of global warming and policy responses, to assess the resilience of a business model under uncertain climate conditions. Importantly, TCFD recommends an exploratory approach to scenario analysis.

Figure C1: Exploratory Scenarios

As illustrated below, exploratory scenario analysis involves considering multiple plausible futures. This approach helps organisations assess how resilient their strategies are under different climate conditions.

Exploratory scenarios

Different pathways leading to different plausible futures.

Source: 2020-TCFD_Guidance-Scenario-Analysis-Guidance.pdf

The goal is not to predict the future, but to explore how a range of possible futures could affect the organisation. Each scenario should include both physical risks (such as extreme weather or rising sea levels) and transition risks (such as policy changes, market shifts, or technological disruption), even though the balance of these risks may differ across scenarios. The analysis of this information is used to inform the climate resilience disclosures of AASB S2.

The Corporations Act 2001 requires the development of at least two scenarios:

• A low warming scenario (i.e. 1.5°C), representing strong global climate action.
• A high warming scenario (i.e. 2.5°C or higher), representing limited or delayed action.

These scenarios help organisations identify vulnerabilities, test strategic responses, and improve transparency for investors and stakeholders regarding climate.

Scenario analysis to identify and assess climate risks (e.g. stress testing and sensitivity analysis)

Stress testing

Stress testing is a technique used to examine how an organisation (usually those in the financial sector) might perform under extreme or adverse conditions. In the context of climate risk, this often involves applying a worst-case scenario, such as a high warming pathway (e.g. SSP5-8.5, >4°C), to assess the potential impact of severe physical risks like heatwaves, floods, or sea level rise.

• Purpose: To test vulnerability under extreme conditions.
• Approach: Typically quantitative, focusing on risk exposure and financial impact.
• Use case: Common in risk management and financial modelling, especially for physical risks.

Sensitivity analysis

Sensitivity analysis, sometimes called “what-if” analysis, explores how changes in key assumptions, such as warming levels, carbon prices, or policy timelines, affect outcomes. It helps organisations understand which variables have the greatest influence on risk or performance.

• Purpose: To understand how outcomes vary with changes in assumptions.
• Approach: Flexible and exploratory, often used to test transition risks.
• Use case: Useful for identifying critical thresholds or tipping points in strategy or financial planning.

Why the distinction matters

Scenario analysis to identify and assess climate risks (e.g. stress testing and sensitivity analysis) can use climate scenarios, but they are not the same as the exploratory approach to scenario analysis to assess climate resilience. Stress tests are specifically referred to in the TCFD guidance, noting this is another special type of scenario, not an exploratory approach, that may be used to understand the implications of climate change. While these methods are useful for understanding specific risks or testing assumptions, they don’t assess how well an entity’s strategy and business model hold up across a range of possible climate futures.

In many voluntary disclosures, stress testing and sensitivity analysis are often labelled as “scenario analysis.” However, consideration should be given to the purpose of the scenario analysis. This is a common practice, but it can cause confusion, especially for regulators and investors who are looking for insights into strategic resilience, not just risk exposure or financial impact.

Common misuse in practice

A common example of confusion in climate disclosures is when an organisation reports the financial impact of a 4°C warming scenario on its physical assets. This is a stress test, a useful exercise, but not the same as an exploratory approach to scenario analysis (i.e. scenario analysis to assess climate resilience). Similarly, modelling how changes in carbon pricing affect operating costs is a sensitivity analysis, not a scenario analysis to assess climate resilience.

This matters because organisations must go further to inform the climate resilience disclosures in AASB S2. They are expected to use exploratory scenario analysis to test the resilience of their business model and strategy under at least two distinct climate scenarios, including a low warming (1.5°C) and a high warming (2.5°C or higher) future, as required by the Corporations Act. This approach considers both transition and physical risks in each scenario and helps organisations prepare for a range of outcomes.

Clear and consistent terminology use is essential to ensuring that disclosures are meaningful, comparable, and aligned with regulatory expectations.

How can we help

BDO’s sustainability reporting team has expertise in climate scenario analysis and disclosure frameworks. We support clients in navigating regulatory requirements, developing robust scenario narratives, and aligning their climate strategies with best practices. If your organisation is preparing for AASB S2 or seeking to strengthen its climate-related disclosures, our team is here to help.