Climate Science, Risks, and Regulations
This domain tests whether you can convert physical climate science into financially usable risk statements and place them inside the disclosure architecture now converging on the ISSB baseline.
The physical basis you are expected to know
IPCC AR6 puts the remaining carbon budget from 2020 at roughly 500 GtCO2 for a 50% chance of holding 1.5°C, and about 1,350 GtCO2 for 2°C. Warming scales with cumulative emissions, so a credible pathway is a finite budget, not a slope. The SSP pathways (SSP1-1.9 through SSP5-8.5) are the emissions trajectories; RCPs are the older concentration pathways still used in hazard modelling. NGFS converts these into transition scenarios: Net Zero 2050, Divergent Net Zero, Delayed Transition, Below 2°C, Nationally Determined Contributions, Current Policies and Fragmented World.
Risk taxonomy
Physical risk is acute (flood, wildfire, cyclone) or chronic (heat, sea-level rise, shifting precipitation). Transition risk is policy and legal, technology, market or reputational. Liability risk is the litigation tail linking the two. IFRS S2 requires disclosure across governance, strategy, risk management, and metrics and targets, with industry metrics drawn from SASB.
Regulation
IFRS S1 and S2 (June 2023) are the global baseline. EU CSRD/ESRS E1 adds double materiality; SFDR classifies funds under Articles 6, 8 and 9. The EU Taxonomy applies three tests - substantial contribution, do no significant harm, minimum safeguards - with separate transitional and enabling categories. CBAM moves the EU carbon price onto imports of cement, steel, aluminium, fertiliser, hydrogen and electricity.
Worked example
A European utility is modelled to 2040. Run two NGFS scenarios with divergent carbon prices, Net Zero 2050 and Current Policies, through the same model. The carbon path hits merchant generation margins; chronic heat changes hydrology and therefore hydro output; acute flood risk changes the physical asset register and insurance cost. Report the scenario-weighted expected value, not a base case with a sensitivity band - the exam rewards showing the transmission channel from scenario to cash flow line item.
Traps that cost marks
Treating EU Taxonomy-eligible revenue as aligned revenue; assuming ISSB and CSRD disclosure are interchangeable; running one scenario and calling it stress testing; using a linear glidepath to 2050 rather than a cumulative budget; confusing Scope 1 operational control with equity share boundaries; citing an RCP as if it were an emissions scenario.