Scenario Analysis – Understanding This Requirement of AASB S2
Of all the requirements introduced under Australian Accounting Standards Board Standard S2 (AASB S2), scenario analysis is often the one that generates the most uncertainty. Companies approaching it for the first time often find the concept straightforward in principle but genuinely difficult to execute in practice. This article explains what the requirement actually asks for, how to approach it, and what a credible first attempt looks like for a company starting the work now.
What the Standard Actually Requires
The scenario analysis requirement sits in Paragraph 22 and Appendix B (paragraphs B2 to B18) of AASB S2. The standard requires entities to use climate-related scenario analysis to assess their climate resilience, using an approach that is commensurate with their circumstances. The phrase ‘commensurate with circumstances’ is important as it signals that the standard does not expect the same level of analytical sophistication from every organisation.
At a minimum, AASB S2 requires the use of at least two climate scenarios: one aligned with limiting global warming to 1.5°C (consistent with the Paris Agreement), and one where warming well exceeds 2°C, to test resilience under higher physical risk conditions. The intent is to ensure that both a relatively orderly transition to a low-carbon economy and a higher-warming, higher-disruption future are formally considered.
It is also worth noting that scenario analysis under AASB S2 carries a three-year modified liability period from 1 January 2025. This means that for the first three years, enforcement actions related to scenario analysis disclosures are limited to regulator-initiated actions only. This provision exists because the standard recognises that scenario analysis is a developing practice, and it reduces the immediate legal exposure for companies working through a genuine first attempt.
Different Terms to Understand – Scenario Analysis, Stress Testing and Sensitivity Analysis
A common source of confusion in early AASB S2 reports is the interchangeable use of three different types of analysis that serve distinct purposes.
Scenario analysis (as required by AASB S2) is an exploratory exercise. It asks: how resilient is our overall business strategy under different plausible climate futures? It is forward-looking, qualitative or quantitative, and designed to inform strategic decision-making rather than produce a single financial figure.
Stress testing is a narrower exercise. It asks: what is the financial impact on our assets or operations if a specific climate condition occurs — for example, a 4°C warming scenario affecting a physical asset? It produces a financial impact estimate but does not address strategic resilience.
Sensitivity analysis asks: how does a specific variable (such as operating costs) change if a single input (such as a carbon price) shifts? Again, useful, but not the same as assessing whether the overall business strategy holds up across different climate futures.
Many first-year reporters have conducted stress tests or sensitivity analyses and labelled them as scenario analysis. Those exercises have value, but they do not satisfy what AASB S2 is asking for in terms of strategic resilience assessment. This distinction matters because regulators and investors are increasingly aware of it.
Which Scenarios to Use
AASB S2 does not prescribe specific scenarios but directs entities toward recognised, reputable reference scenarios. In practice, the most commonly used among Group 1 reporters in Australia have been those from the Intergovernmental Panel on Climate Change (IPCC) and the Network for Greening the Financial System (NGFS), as noted in PwC Australia’s March 2026 review of early reports.
The IPCC’s Shared Socioeconomic Pathway (SSP) scenarios are widely used. SSP1-1.9 models a below-1.5°C world with strong policy action, rapid decarbonisation and low physical risk. SSP5-8.5 models a fossil fuel-intensive future with warming above 4°C, high physical risk and limited policy intervention. These two scenarios together span the range required by AASB S2.
The NGFS scenarios, developed specifically for financial institutions and supervisors, organise climate futures into three families: orderly (early, coordinated policy action), disorderly (delayed or fragmented action) and hot house world (limited policy ambition, severe physical risk). The NGFS “Net Zero 2050” pathway aligns with the 1.5°C requirement, while “Current Policies” represents the high-warming end. NGFS scenarios are freely available through the NGFS Scenarios Portal and are accompanied by macro-financial and sectoral data that can support quantitative analysis.
The International Energy Agency (IEA) Net Zero Emissions by 2050 pathway is also referenced by some Australian reporters, particularly those in the energy and resources sectors.
The choice of scenarios should be explained and justified in the disclosure, including the key assumptions, policy environments, technological trends and sectoral drivers considered. That documentation is itself a meaningful part of meeting the standard’s requirements.
Physical Risk and Transition Risk
Scenario analysis under AASB S2 requires consideration of both physical risks and transition risks, as these play out differently across the two scenarios chosen.
Physical risks are the direct consequences of climate change on the physical world: extreme weather events, flooding, rising temperatures, water stress, sea level rise and supply chain disruptions arising from those conditions. A low-warming scenario carries relatively lower physical risk because emissions are reduced more rapidly. A high-warming scenario carries significantly higher physical risk over the medium and long term.
Transition risks arise from the process of shifting to a lower-carbon economy: changes in regulation and policy (such as carbon pricing), shifts in technology (such as the displacement of fossil fuel energy by renewables), and changes in market conditions and consumer preferences. Transition risks are typically higher under a low-warming scenario, because a more rapid and ambitious policy response is required to achieve it.
The interaction between these two risk types across the two scenarios is part of what makes scenario analysis useful as a strategic exercise as it forces an organisation to consider trade-offs that do not appear when risks are assessed in isolation.
How to Approach It in Practice
For a Group 2 or Group 3 company starting this work now, a reasonable and defensible first approach involves the following steps.
The first step is governance and scoping. Establish a cross-functional working group involving risk, sustainability, finance and strategy functions, with oversight by the board or executive committee. Clarify the purpose of the exercise: which risks and opportunities is the analysis trying to understand, across which time horizons (short, medium and long term as defined by the organisation), and at what level of geographic and operational detail?
The second step is scenario selection. Select at least two reference scenarios from the IPCC or NGFS, one representing a low-warming pathway and one representing a high-warming pathway. Document why each was chosen, including the key assumptions about policy settings, technology and the economy that underpin them.
The third step is risk and opportunity identification. For each scenario, identify the most material physical and transition risks and opportunities relevant to the organisation’s sector, geography and business model. A manufacturing company with facilities in northern Australia will have different priority risks from a financial services firm or a retail business. The NGFS and IPCC scenario data, alongside sector-specific guidance from the Australian Prudential Regulation Authority (APRA) and ASIC’s Regulatory Guide 280, can help identify what is most relevant.
The fourth step is impact assessment. For each material risk or opportunity identified, assess how it would affect the organisation’s strategy, business model, financial position, revenue, costs and capital allocation under each scenario. In a first-year report, this assessment can be qualitative which may include describing the nature, direction and likely magnitude of impacts rather than producing precise financial estimates. What matters is that the analysis is substantive and documented, not that it achieves a level of quantitative precision that the available data does not yet support.
The fifth step is documentation and disclosure. Document the methodology, the scenarios used, the time horizons applied, the key assumptions made, and the conclusions reached. AASB S2’s Appendix B provides detailed guidance on what this documentation should cover. Connecting the scenario analysis outputs to the broader strategy and risk management disclosures in the report, rather than leaving them as a standalone section and will strengthen the overall disclosure.
What Early Group 1 Reports Show
PwC Australia’s March 2026 review of the first cohort of AASB S2 reports found that most Group 1 entities converged around the IPCC and NGFS reference scenarios, with a majority using SSP1-1.9 to satisfy the 1.5°C requirement. However, time horizons differed significantly across reporters, and few clearly connected scenario analysis outputs to financial impacts or strategic responses. The variability in approach reflects the current level of maturity in the market where an emerging baseline is forming, but leading practice has not yet been established.
For Group 2 and Group 3 reporters, the challenge is that the standard is clear about what it requires, even if practice has not yet converged on how to meet it. The opportunity is that Group 2 and 3 companies can learn directly from what Group 1 reporters have done, identify where the gaps are, and build a more considered approach from the outset.
Our View
The most common issue we observe in early AASB S2 reports is that scenario analysis is being treated as a disclosure exercise rather than a strategic one. Companies are selecting recognised reference scenarios, documenting them, and describing risks at a high level but few are connecting those scenarios to specific financial impacts on their business. There is a gap between describing a risk and quantifying what it means for revenue, costs, assets or capital allocation.
A credible first attempt does not need to be a sophisticated quantitative modelling exercise. A well-reasoned qualitative analysis with clear documentation of methodology, scenario selection rationale, and time horizons can be an appropriate starting point, provided the organisation is also building toward greater quantitative depth in subsequent years. The three-year modified liability period exists precisely because the standard recognises where the market currently is.
The trajectory that good scenario analysis is heading toward is one where it is genuinely integrated into strategic planning rather than sitting as a separate sustainability workstream. That means boards and management teams using scenario outputs to make actual decisions about capital allocation, asset management and business model adaptation. It also means greater sector-specific depth over time, as the scenarios most relevant to a mining company operating in northern Australia are quite different from those relevant to a financial services firm or a food manufacturer. That is a multi-year journey for most Australian companies, and honesty about where an organisation currently sits on that maturity curve is more useful than overstating readiness.
Sources
- Australian Accounting Standards Board (AASB), AASB S2 Climate-related Disclosures, Paragraph 22 and Appendix B (paragraphs B2-B18), September 2024, aasb.gov.au
- BDO Australia, Clarifying Climate-related Scenario Analysis: A Guide to AASB S2 Compliance, December 2025, bdo.com.au
- PwC Australia, AASB S2 Unpacked: How Did Australia’s Group 1 Climate Reporting Fare?, March 2026, pwc.com.au
- Anthesis Group, What Is Climate Scenario Analysis? Tools, Examples, and How to Get Started, November 2025, anthesisgroup.com
- RSM Australia, Episode 7: Climate Risk and Scenario Analysis — Preparing for AASB S2, September 2025, rsm.global
- Network for Greening the Financial System (NGFS), NGFS Scenarios Portal, ngfs.net
- Intergovernmental Panel on Climate Change (IPCC), Sixth Assessment Report (AR6), Shared Socioeconomic Pathways, ipcc.ch
- ASIC, Regulatory Guide 280 Sustainability Reporting, March 2025, asic.gov.au
- AASB, S2 Scenario Analysis Workshops, March 2026, aasb.gov.au
Anabranch ESG Advisory provides independent advice on ESG strategy, climate disclosure, and sustainability reporting. The information in this article is general in nature and does not constitute legal or financial advice.
