May 29, 2025 • 33 mins
Extreme weather has always meant extreme risks for businesses and investors. Yet climate change has varied the calculus, and many businesses are facing new, potentially existential risks as the world and the energy transition heat up. As such, central banks and financial supervisors have begun conducting climate risk stress tests, to ensure these institutions are capable of mitigating the potential impacts of a changing climate. But what do these tests entail, which markets have been the most proactive in conducting them, and what exactly is “climate risk” anyway? On today’s show, Tom Rowlands-Rees is joined by Tifenn Brandily, BloombergNEF’s head of transition risk and alignment, and special guest Edo Schets, Bloomberg’s head of climate, nature and regulatory financial solutions, to discuss findings from the note “Climate Risk Stress Test Review”.
Complementary BNEF research on the trends driving the transitions to a lower-carbon economy can be found at BNEF<GO> on the Bloomberg Terminal or on bnef.com
Links to research notes from this episode:
Climate Risk Stress Test Review - https://www.bnef.com/insights/35901
TRACT - https://www.bnef.com/insights/34869
Worksheet Sample Library for Physical Risk - WSL PHYSICALRISK<GO>
Worksheet Sample Library for Water - WSL WATER<GO>
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
This is Tom ronnins Reese, and you're listening to Switched
on the podcast brought to you by B and EF.
With climate change in extreme weather events becoming more prevalent,
central banks and financial supervisors are facing new risks alongside
those existing from geopolitics and volatile capital markets. To counter
this climate threat, some central banks have been creating and
conducting climate risk stress tests in order to make sure
(00:21):
financial institutions are capable of riding out potential impacts on
businesses and investments. But what do these climate risk stress
tests entail? What are the approaches that different central banks take,
and which markets are taking this climate threat seriously. Today,
I'm joined by Tiff and Brandley Bloomberg, NIF's head of
Transition Risk and Alignment, who draws from findings from his
note Climate Risk Stress Test Review, which B and EF
(00:42):
clients can find at B and EF go on the
Bloomberg Terminal or on BNF dot com. On our website,
B and EF clients can also find our Transition Risk
Model TRACKED, which assesses around eighty thousand companies and is
now integrated into Bloomberg's MARS climate stress testing solution. Also
on today's show, we are joined by a special guest,
at Osh, the head of Climate, Nature and Regulatory Financial
(01:02):
Solutions at Bloomberg, where he and his team provide data
and analytics that help investors incorporate climate and nature related
risks in investment decisions and comply with sustainable disclosure requirements.
Prior to Bloomberg, Edo was a manager of the Climate
Scenarios team at the Bank of England, where he led
the development of the NNGFS scenarios, and while working at
the Dutch National Bank, he was part of the first
ever climate stress test conducted by a central bank. Examples
(01:25):
of his team's work be found on the terminal at
WSL Physical Risk or WSL Water. All right, let's get
talking about climate risk stress tests with Tiffin and Edo. Tiffin,
(01:45):
welcome to the podcast today, please to be here. Tom
and Ado welcome on board as well. Thanks Tom, so.
I know that you both come into this question of
climate stress testing from quite different angles and have had
different experiences in the space. So my first question was,
you know, to talk about maybe the history of climate
stress testing. But before we even do that, for those
(02:08):
of us and I include myself in this that are
not really familiar with this concept, can you explain what
a climate risk stress test is or even just what
is a stress test?
Speaker 2 (02:18):
So stress test is a way for financial supervisor to
assess the resiliency of the financial system, and this means
assessing regulated entities, so these can be banks, insurances, even investors,
and looking at different scenarios to know whether these institutions
are impacted and whether they are resilient to different type
(02:39):
of shocks. A new type of shocks that has emerged
in the last ten years is shocks coming from climate risk.
So this can be the transition risk, so the risk
arising from climate policies, shifting consumer preferences, or technology disruption,
and also physical risks, so this is sort of your
classic natural disasters or the chronic risk rising temperatures, overall
(03:02):
sea level rise and so on.
Speaker 3 (03:03):
Yeah, from my kind of perspective, stress testing became quite
popular as a regulatory tool after the two thousand eight
financial crisis. The Basal Committee for Banking Supervision set up
principles for stress testing which had nothing to do with climate,
mind you, but but more generally, and one of the
principles that they highlighted was that stress tests look to
analyze scenarios that are severe but plausible. So it's explicitly
(03:26):
not about you know, business as usual risk management, but
really thinking to more extreme cases that could occur, such
as the two thousand and eight financial crisis, and make
sure we're better prepared for such events in the future.
Speaker 1 (03:38):
Got it. So I mean when we say financial supervisors,
do we mean people like the regulators, the government and
central banks.
Speaker 2 (03:45):
And also you can have let's say the SEC in
the US, so Securities Exchange Commission, which is basically supervising
and looking at equity markets. So it is a range
of institution agencies that all looking at financial risk.
Speaker 1 (04:01):
Essentially, Let's say a central bank is running a stress test,
it's not just looking at its own sort of commitments
in relation to the risks that you highlighted. So I
think you said transition risk, then weather events and then
chronic climate risk were the three main categories. It's not
(04:21):
just looking at those in relation to the Bank of England,
for example, be looking at the whole UK financial system
when it's doing that stress test. Is that do I
understand it correctly? Yeah?
Speaker 3 (04:32):
That's exactly right. So within the Bank of England, actually
it's the prad Prudential Regulation Authority which is responsible for
just that prudential regulation and in essence is at the
perfect wordsworld. Actually it seeks to ensure the financial stability
of the UK financial system.
Speaker 1 (04:50):
So Ado, you have got some experience actually in being
involved in the financial institutions that have been running some
of these stress tests, how do you go about? I mean,
what does that look like? And is it difficult or easy?
Did you have to kind of invent your own version
of it with each institution?
Speaker 3 (05:07):
I suppose it's come along way over the years, And
I'll just flag up front that you know, I don't
work at these institutions anymore, so I can't represent the institutions.
But from my experience working on climate stress testing, when
we started out the first stress test that I was
a part of, we didn't really have a president of
climate stress testing and we didn't know what it looked like,
(05:29):
so we had to more or less invent the wheel.
What we did have, though, is a decent conceptual understanding
of what we were trying to do. There was already
in academic literature kind of separating out climate transition risks
from climate physical risks as different risk channels to look
at and some insight onto what those risk transmission channels
(05:50):
could look like. So what we really needed to then
do is think about how could we model these risk
transmission channels in a scenario setup that's going to be
relevant for financial institutions. But yeah, as you can imagine
with anything new, we did run into a number of
challenges along the way trying to do that.
Speaker 1 (06:07):
And what sort of challenges were those?
Speaker 3 (06:10):
Well, for for example, you know, if suppose a risk
transmission channel is a carbon price increasing. This is one
channel that that was quite often used in a lot
of climate stress test where we say, okay, suppose the
carbon price goes up. How would that impact the exposures
of financial institutions. Well, then you need to start thinking
about what are the GHD emissions of those financial institutions,
(06:32):
How could thoseg emissions be the gg emissions of the
companies that financial institutions are invested in, And how could
a carbon price impact the cost structure of these companies,
and how could that ultimately affect things like the credit
worthiness of the companies. That's going to have a bearing
on the financial institutions stability and safety and soundness. So
(06:52):
you have to think backwards, and then you realize that
at that time especially, there wasn't very good data on
things like GHD emissions, and there wasn't really a president
of how do you model the impact of a common price?
How does that play too on the cost structure of
that company? Could they pass it to to upstream suppliers
downstream consumers. So there were a lot of new questions
we uncovered in the process, and a lot of the
(07:14):
stress tests that have happened over the year, have you know,
as part of their objectives, have had capacity building to
just try and understand these questions better and kind of
learn ways of answering them.
Speaker 1 (07:26):
And how often are stress tests you know necessary? I mean, Tiffan,
I had a quick peek at your climate stress test
review No, and I was quite struck by the chart
on the front of that piece of research which showed,
you know, what's looked to me like a wave of
stress tests happening in late twenty tens, early twenty twenties
(07:47):
that then sort of tails off. Is that just because
a phase of stress tests amongst certain central banks has
been complete or is you know, I'm presuming this isn't
because they were in fashion now they've gone out of fashion.
It's just they've been done for now. Am I reading
it right?
Speaker 2 (08:03):
Yes? So my Curley Sunny Park and I looked at
forty three different climat risk stress tests that have been
published since twenty seventeen. So if you look at the
history of stress tests, you know, going back to twenty
fifteen twenty seventeen, this is when we see the first
academic studies. The first one was from Stefano Battiston and
he really set the conceptual framework for stress testing. The
(08:26):
Dutch Central Bank DNB was the first one to publish
twenty seventeen twenty eighteen a transition risk and then a
physical risk stress test. And it's no surprise that DNB
actually published the first physical risk stress test because the
Netherlands has a lot of exposure to physical risk from
sea level rise. Twenty nineteen is also a very important
(08:47):
date for stress testing because this is when the NNGFS
so the Network for Greening the Financial System, which is
an alliance of central banks and financial regulators. This is
when the MNGFS launched its open source scenarios that really
created the blueprint for a lot of central banks around
the world to build their own stress test upon and
(09:07):
so you know, in twenty twenty one, twenty twenty two,
our stress test review shows that, you know, there's almost
thirty exercises that have been published. Some of them are
sort of first of a kind or one off, and
some others have a frequency of you know, a year
two year. What we see is a lot of central
banks integrating climate stress testing into their own standard risk review.
(09:31):
It's not necessarily a part yet of what we call
the capital requirements. So usually, you know, a stress test,
one of the main goals would be to derive a
number that would quantify the amount of money that an
institution has to set aside to face a certain shock.
So climatory stress testing is not currently leading to capital
adequacy requirements, but central banks are mainly trying to push
(09:55):
to raise awareness around this new source of risk and
also build cap city within their regulated entities in terms
of the modeling, making sure that banks hire different teams
that are able to look at these questions.
Speaker 1 (10:08):
So you've introduced this idea of an MGFS there, what
does that stand for? And yeah, can you just give
us a little bit more detail about how it operates
and what's under the hood.
Speaker 2 (10:17):
There So the NNGFS is the Network for Greening the
Financial System. This is an alliance of regulators that are
looking to incorporate climate in the supervisory scope. So the
NNGFS counts more than one hundred and forty members. You
have central banks, you have financial regulators. Development banks also
are part of the NGFs, and so there are different
(10:39):
working groups that are working across a range of topics.
The main topic that stood out and the main work
that stood out out of the NGFs is the NGNGFS scenarios.
So these are climate scenarios that look across physical risk
and transition risk. The long term scenarios are looking out
to twenty one hundred on a five year basis. And
when you think of you know, the nngfsnios. This is
(11:02):
quite different actually from the scenarios that BNF can publish
or the International Energy Agency can publish. The NNGFS scenarios
are not normative, so they don't tell you what you
should do in order to achieve a certain climate outcome,
like a net zero emissions pathway. The nngfsnios are really
here to explore different plausible futures and they're interested in
(11:22):
sort of exploring those extremes as well, you sort of
extreme a physical risk and extreme transition risk, and what
happens if the transition is delayed for a long time
and then all of a sudden, you know, in the
twenty thirties, you have a policy shock that imposes a
very strangent pathway to the economy to decarbonize very fast.
There are six to seven scenarios depending on the phase
(11:43):
of the nngfsnios you're looking at, and these are really
here to explore this world of risk from a physical
and transition standpoint.
Speaker 1 (11:51):
So could you just I think you mentioned that there's
the scenarios that it looks at. There's sort of three
main ones. You just explain what those are.
Speaker 2 (11:59):
Yeah, So they are three categories. You have the orderly
transition category, you have disorderly transition category, and then you
have the hothouse world. So elderly transition this is a
relatively smooth transition pathway where the economy starts decarbonizing basically
from next year onwards at a steady pace. And this
(12:20):
transition sort of limits the amount of physical risk that
there will be later on in the scenario. So we
decalbonize fast. We don't accumulate as much greenhouse gases into
the atmosphere, and so natural disaster are a little less
frequent than they would have otherwise been. Disorderly transition is
looking at what I already describe. So this is assuming
(12:40):
that the transition does not happen in the short and
mid term, but then by a certain date you start
seeing more climate policies coming and disrupting part of the economy.
So you can think of for example, bands internal combustion
engine cars being implemented pretty heavily across the world and
so disrupting one part of the economy. And then the
hot house world is a very high intensity, physical risk
(13:04):
world where we do not decarbonize fast enough and so
we continue accumulating a lot of emissions in the atmosphere,
and this leads to very frequent and high amplitude and
natural disasters and the physical risk impacts.
Speaker 1 (13:17):
So ado, I mean you've had some experience of applying
these scenarios in the stress test that you've been involved
in developing. Is it ay standard? How they are applied
across different institutions stress tests? Well, they were.
Speaker 3 (13:30):
Actually maybe it's a great point, they were actually developed
to serve as a baseline for primarily regulators central banks
to frame stress tests around. So the idea was, let's
develop a set of common scenarios that can then be
refined to meet the specific context of the regulator, the
specific risk they want to prope and maybe any specific
(13:50):
local jurisdictional features that they would want to incorporate. So
they're very much as starting point, and in fact the
Bank of England's climate be annual exploratory scenario or the
stresses that they ran in the UK. The scenarios that
were used actually deviated from the ng festerinaris in a
few places, even though the anti festerinaris were used as
the baseline, if you will, But then certain tweaks were made,
(14:13):
for example, around physical risks. There was an understanding that
the NNGFS scenarios, due to modeling constraints that are that
are well restrewed across climate modelers, there was a risk
that the scenarios didn't capture the fullest extent of physical
risks that may actually occur. So the Bank of england
took steps to mpop some of the physical risks in
(14:34):
their exercise, essentially to get to that severe but still
plausible a level of stress that you want to analyze.
Speaker 1 (14:41):
So where in the world have we been seeing some
of these stress tests happening across the world?
Speaker 2 (14:46):
Emia apak amor, but we have to say you really
let the charge in terms of developing the framework. And
actually the NNGFS as Secretariat was hosted i believe by
ban de France and Bank of England, and so DNB
also has played a role. Out of the forty three
stress test that Sanny and I reviewed, we found that
(15:08):
more than forty percent of them have been conducted across Europe.
So Europe really played a role in that first wave
of stress tests, so between twenty twenty one and twenty
twenty two, and then we saw this spread across the world.
So APAC really took the lead towards the end of
twenty twenty two and twenty twenty three with a lot
of new stress tests that were published on the back
(15:30):
of the NNGFS scenarios. Overall, we found that between sixty
and seventy percent of transition risk and physical risk stress
test were conducted on the back of the NNGFS scenarios.
Another source of climate scenario data is the IPCC, and
you have also different ways of capturing the risk. You know,
different models, but NNGFS has really been the blueprint for
(15:52):
a lot of countries to develop their own stress test.
Speaker 1 (15:55):
So it's not the only show in town, but it's
the main one in this domain. Absolutely, so is the EU.
I mean you mentioned that this kind of started in
the EU, but you know we're now seeing in other regions.
Is the EU still playing a leading role in this runt?
Speaker 2 (16:10):
I would say yes. And last year the EU published
a new type of stress tests which incorporated the FEIT
for fifty five policy package or the U in a
very granular way. So this is sort of the decarbonization
policy package across the U, and this stress test really
looked at the risk across all the banks, the insurers
(16:31):
and dig very deep into some of the implications across
sectors of these policies. So this is sort of the
you trying to anticipate some of the risks coming from
sector level climate policies. And I think this is also
this sets a very interesting precedent for other stress testers
to look at, not just running the analysis in a
(16:53):
very generic way, but running those stress tests in a
specific policy orientated way.
Speaker 1 (17:00):
So that's the role that EU is playing, and obviously
you're both sitting in Europe, but I'm here in the US,
and you just turn on ANYTV channel and you can
see that it is a very different environment politically here
than it was, say a year ago, and then particularly
in relation to questions around climate. So has that had
an impact at all on stress tests in the US
(17:22):
or plans around stress tests?
Speaker 2 (17:24):
So the US published in twenty twenty four a pilot
stress test that included six large banks, so that's you know, Goldman, Sachs, JP, Morgan,
and other banks. And this stress test was actually very interesting.
So on the physical risk side, it looked at the
impact of hurricanes in the northeast of the US, looking
at you know, hundreds of thousands of residential and commercial loans.
(17:46):
And on the transitionersk side, it looked at, you know,
the impact of transition risk and potticas on real estate,
for example. So I thought was this was a very
promising episode. But actually right before the Trump administration came
into office, So in Jazz Neurary twenty twenty five, the
Federal Reserve actually exited the NGFs And so this is
sort of a reaction potentially to the current politics and
(18:09):
the current environment in US politics. But nevertheless, physical is
are very important today in the US. So you're seeing
heightened natural disasters. There's a wild fire season now in California.
You have zones across the US that have become unensurable
from a residential and commercial real estate standpoint. And so
while the US is sort of backing away from stress
(18:32):
testing potentially for a while, there are actual effects that
are being felt across the economy.
Speaker 3 (18:38):
I might add to two additional developments that I could
shed some light here. So while the Central banks were
developing climate stress tests, there was another group called the
Task Course for Climate Related Financial Disclosures TCFD, which came
out with a set of recommendations in twenty seventeen. The
same year the first under My stress test was published,
and they set out recommendations for corporations to publish more
(19:03):
information on various particularly around their climate related risks and
how they were managing climate related risks. And these recommendations
actually included a recommendation to apply scenario analysis to identify
what those risks might be over the short, medium and
long term. And the TCFD recommendations have evolved the bit
since then. They have been formalized by the International Sustainability
(19:26):
Standards Board, the ISSB, who has actually merged with the
TCFD or vice versa, and has published a more formalized
set of reporting requirements which have been formally adopted by
jurisdictions across the world, which require companies, financials and non
financial companies to disclose on their climate related risks and
implicitly or explicitly, there's an askut in there, depending on
(19:48):
the jurisdiction that is, but there's an askut in there
to apply scenario analysis to identify those risks. So we've seen,
if you will, a kind of trend of private sector
scenario analysis in peril level to the more broader central
bank exercises. So that's been helping further establish climate stress
testing as a discipline across the world. Now, what we
(20:10):
did notice with the Trump administration coming in is that
the SEC which was set to mandate such a climate
disclosure rule in the US, has currently stopped their efforts
to get that rule across It was already being contested
in a number of US courts and in Canada the
regulator had a similar climate disclosure requirement that they were
about to bring into force. And they've actually pressed pause
(20:33):
on that in response to developments in the US. It
seems so we do see a bit of a setback
there as well. But a final thing I just quickly
want to mention is that during all of these years
of capacity building, my sense of the industry is that
there's been a growing intrinsic appreciation of the risks brought
forth by climate change, and as Tiffan pointed out, especially
(20:54):
the physical risks which are which are very visible in
some jurisdictions, and you know, with very real con sequences
that we can see today financial consequences as well as others.
And so even though the regulatory push in Americas may
subside somewhat, I think that might be compensated in part
by an innate push by institutions to manage these risks regardless.
Speaker 1 (21:16):
I mean an innate push by the climate itself. You
could say, just force financial institutions to think about this.
I mean, just on that, you know, the governmental level,
things have changed. At a federal level. One of the
things there's always been a narrative in the US is
whatever's happening at a federal level, you need to look
at what the states are doing, do we see any
activity at a state level in terms of climate stress
(21:36):
tests in the US.
Speaker 2 (21:37):
So on our side, we haven't captured any state level
stress tests. But it's important to note that across the
US some states now stepping up to put together structures
to support the insurance market. And so this is something
we see across a number of states where public money
is going to come to support locally some future homeowners
(22:00):
that are looking to insure their house and so, you know,
the collapse of the private insurance market is actually a
very good proxy for you know, how critical physical risks
are to homeowners today. So you know, physical risks are
becoming a real risk for households and companies, and so
this is critical to still have, you know, an insurance
market locally that can support those businesses. A collapse of
(22:24):
the insurance market is also a collapse of the financial
market locally. Climate risk is a manageable risk from a
financial standpoint. You know, if you think about the full economy,
banks have a diversified portfolio. It is true that locally
the market for insurance and the market for mortgages has
already collapsed and public money has to step in already.
Speaker 1 (22:45):
So we kind of got a picture of what's happened
in the EU and in the US. Is is there
a thing noteworthy going on elsewhere in the world.
Speaker 2 (22:52):
So absolutely, we're seeing a lot of activity also across
emerging markets, and sometimes we see you know, the World
Bank or the IMF really partnering with local supervisors to
publish this stress test. So notable examples of this include,
you know, in the Philippines twenty twenty two, we've seen
in analysis the impact of typhoons on the financial system,
(23:14):
specifically you know, gelt towards credit exposure. We've seen also,
you know, floods in Mexico being one of the main
targets of one analysis across Brazil this is mainly a
drought have pushed the financial supervisors to publish their own
stress test. In China, we've seen also the regulator publishing
transitionary stress test that was also in twenty twenty two.
(23:36):
So there's a lot of activities around the world and
this really speaks to the sort of broadhouse strategy the
NGFs has implemented, and going forward, we definitely expect a
lot of regulators across Africa also to publish their first
stress test using an MGFS blueprint mainly.
Speaker 1 (23:56):
So it seems like climate stress tests are becoming more
and more main stare dream and although the road to
get there on climate stress test has some bumps along it,
you know, and particularly what we're discussing in relation to
the US, they are getting along that road bit by bit,
and we have no reason to think that they're not
going to continue to become more and more mainstream as
(24:16):
a model. One question I have is what are their limits?
What can they do and more importantly, what can't they
do and what's the gap.
Speaker 2 (24:22):
So if you think about it, sixty to seventy percent
of stress tests have used the NNGFS scenarios, and so
this is definitely an incredible success of these scenarios. But
at the same time, this is a curse mainly because
now you don't necessarily have the diversity in modeling approaches
and climate scenio data across this, you know, the body
(24:43):
of stress test that we reviewed, and so the limitations
of the current literature are mainly the limitation of the nngfscenario.
And so one thing that I'll mentioned on the transition
mix side is really the use of shadow carbon prices.
So shadow CAB is a modeling artifact that the NNGFS
(25:03):
models are using essentially to capture the intensity of climate
policies overall. This is an approximation and basically says in
the modeling, essentially you have these carbon prices that are
applied to every single economic activity across the world and
are driving up the cost of carbon intensive activities and
(25:23):
sort of helping also climate solutions to come into the system. Now,
in reality, what we see in practice is only a
quarter of global emissions are subject to an actual carbon price,
and outside of the most carbon pricing schemes or taxes
are well below thirty dollars pert on. So this is
a level that's not necessarily extremely material for corporates, and
(25:47):
they're often applied to corporate activities or industrial activities. So
the central point in the transitional scynalysis of NGFs or
those carbon prices. But actually when you think about the
transition and the weight it manifests, you know, it might
be for example, the cost competitiveness of electric vehicles that
is driving market adoption, and in turn this means you know,
(26:09):
the sales of internal combustion engine costs are going down,
So this is a financially material risk for a number
of automakers, and it's not currently captured in the nngfscenios.
So what we've seen is up until phase five of
the ngfsscenios, the scenarios really looked at transition risk in
the power sector and also transition risk coming from you know,
(26:31):
higher carbon prices across the economy, but it didn't necessarily
assess the risk across you know, all the different sectors
you can think of transport, but also transition metals that
are going to play a key part in the transition
just on the on the physical risk side as well.
The NNGFS being a bit of a global baseline for scenarios,
it looks at physical risk very much through a macro
(26:54):
economic lens. It tells us something about the macroeconomic impacts
in a location in a country that is, you know,
the kind of jurisdiction where we'd measure GDP, so that
that's countries, what the impacts from physical risk may be
at the aggregate level. In practice, physical risk is something
that tends to be highly localized. An intense hurricane impacting
(27:16):
New York City could be very different from a financial
standpoint from that same hurricane impacting forward. In both cases,
we may, you know, there may be significant impacts, but
the types of institutions that are impact which companies, which
households differs quite a bit, and hence, you know, also
the level of insurance of those impacts may differ, and
ultimately what the impact of the financial institution is could
(27:38):
impact quite a bit. Similarly, physical risks, you know, so
there's this direct damage depending on the location where the
impact occurs. Damages can also kind of shocked to a
company's supply chain. So a company itself may not be
directly impacted by a physical risk, but if a critical supplier,
say Transition metals, is impacted by physical risk, and that
(27:58):
chokes the you know, the supply and the distribution of
those metals, that could impact downstream companies. So there's a
lot of complexity to physical risk, which requires an understanding
of the locations where companies operate and the supply chains
of those companies as well. Now, naturally, NDFS, you know,
being a global open source model, won't be able to
(28:19):
capture all of these specificities. So it's an important area
where financial firms, if they really want to have a
good grasp of the risk, likely will need additional sources
of data to supplement that analysis.
Speaker 1 (28:29):
As you mentioned that, I mean, one of the things
that was occurring to me is that having a central
bank conducts this exercise and all of the complexity involved,
that they're obviously never going to capture some of those
things you just mentioned. And I just wonder if that
is an issue. Whereas if the model was say, like
let's in said, say you are an electric vehicle manufacturer,
(28:52):
then I think that you reasonably could if you were
running a scenario exercise to identify risks, you reasonably could
be expected to capture, you know, the risks to your
supply chain. So does this system need a sort of
a bottom up complement to provide metrics that can feed
into the big picture model rather than putting the onus
(29:12):
on central banks to try and figure everything out themselves.
Speaker 3 (29:16):
You know, certainly there's an aspect of that, and I
think the TCFD very much try to answer that that question.
Speaker 1 (29:23):
When I spoke just to find the TCFT Sorry.
Speaker 3 (29:25):
Yeah, yeah, So when I spoke about climate related disclosure
requirements before reporting requirements, part of the idea there when
regulators ask companies to report on their climate risk is
precisely to fill this gap that central regulators may not
have all the information. So if companies themselves, who understand
their own business model better than anyone in their supply
chains and their operating locations, if they can analyze the
(29:47):
risk and report on that, that can then help other stakeholders,
including their investors and their lenders to assess the risks
on their part. So certainly that bottom up component is there,
and this is why we see a lot of push
for climate related reporting in Europe for example, and in
across asas specific with the ISSB standards that are being implemented.
Speaker 1 (30:09):
Sort Of just a thought and reflection as well, when
you know Tiff and just now you are talking about
shadow carbon prices and their strengths but also their limitations
sort of on a more macro level, I know that
climate in Europe is often sort of the main policy
lever is the EETs carbon market, and also in the
UK ETS and in Europe we're quite adept at thinking
(30:32):
of the problem in terms of carbon prices, and we
know that a lot of the climate stress tests momentum
came from Europe. Is there an issue that maybe the
NNGFS is a little bit too eurocentric in how it
thinks about the world, and that might be part of
the limitation. And you know that the shadow carbon price
issue is just an example of that.
Speaker 3 (30:52):
I'm not sure that death characterization would be would be
quite correct because the NNGFS scenarios are ultimately based on
academic models called integrated assessment models and global climate models,
which have been developed within Global academy. One of the
models underpinning the NFS scenarios is the GCAM model, which
(31:12):
is a model developed out of the University of Maryland.
And so these models come out of academia and those
are the basis for the scenarios themselves. And the tradition
in integrated assessment modeling in this particular strand of academic
literature is to use carbon prices as a metric for
policy intensity. Now, where you know where you might have
(31:34):
a debate is whether this metric is suitable for the
use in stress testing, as has been applied by many
central banks. And I think that's tiffense commons. You know,
strike a good court. They may not be as reliable
and in fact, in the stress test themselves, in some
of them you'll actually see acknowledgments by the central banks
about the limitations of using a carbon price because it
won't accurately reflect the true policy environment. It was very
(31:56):
much acknowledged as a shortcut that could help determine and
pockets of risk, and you know, I think some of
the subsequent analysis by Bloomberg and e F and others
has shown that this shortcut may actually miss significant drivers
of risk, like the automotive example that Tiffin mentioned.
Speaker 1 (32:13):
This has been a really fascinating conversation and there's so
much to chew on here. I think we could carry
on talking all day if we had the time. Tiffin
and Ado, thank you so much for coming and sharing
your insights on this, which is a really tough topic,
but I think one that can really move the needle.
So it's a really important conversation. So thank you both
for joining.
Speaker 3 (32:32):
Thank you, thank you for having us.
Speaker 1 (32:42):
Today's episode of Switched On was produced by Cam Gray
with production assistants from Kamala Shelling. Bloomberg ne EF is
a service provided by Bloomberg Finance LP and its affiliates.
This recording does not constitute, nor should it be construed
as investment and vice investment recommendations or a recommendation as
to an investment or other strategy.
Speaker 2 (33:01):
Bloomberg ANIAF should not be considered as information sufficient upon
which to base an investment decision.
Speaker 1 (33:06):
Neither Bloomberg Finance LP nor any of its affiliates makes
any representation or warranty as to the accuracy or completeness
of the information contained in this recording, and any liability
as a result of this recording is expressly disclaimed
This is Tom ronnins Reese, and you're listening to Switched
on the podcast brought to you by B and EF.
With climate change in extreme weather events becoming more prevalent,
central banks and financial supervisors are facing new risks alongside
those existing from geopolitics and volatile capital markets. To counter
this climate threat, some central banks have been creating and
conducting climate risk stress tests in order to make sure
(00:21):
financial institutions are capable of riding out potential impacts on
businesses and investments. But what do these climate risk stress
tests entail? What are the approaches that different central banks take,
and which markets are taking this climate threat seriously. Today,
I'm joined by Tiff and Brandley Bloomberg, NIF's head of
Transition Risk and Alignment, who draws from findings from his
note Climate Risk Stress Test Review, which B and EF
(00:42):
clients can find at B and EF go on the
Bloomberg Terminal or on BNF dot com. On our website,
B and EF clients can also find our Transition Risk
Model TRACKED, which assesses around eighty thousand companies and is
now integrated into Bloomberg's MARS climate stress testing solution. Also
on today's show, we are joined by a special guest,
at Osh, the head of Climate, Nature and Regulatory Financial
(01:02):
Solutions at Bloomberg, where he and his team provide data
and analytics that help investors incorporate climate and nature related
risks in investment decisions and comply with sustainable disclosure requirements.
Prior to Bloomberg, Edo was a manager of the Climate
Scenarios team at the Bank of England, where he led
the development of the NNGFS scenarios, and while working at
the Dutch National Bank, he was part of the first
ever climate stress test conducted by a central bank. Examples
(01:25):
of his team's work be found on the terminal at
WSL Physical Risk or WSL Water. All right, let's get
talking about climate risk stress tests with Tiffin and Edo. Tiffin,
(01:45):
welcome to the podcast today, please to be here. Tom
and Ado welcome on board as well. Thanks Tom, so.
I know that you both come into this question of
climate stress testing from quite different angles and have had
different experiences in the space. So my first question was,
you know, to talk about maybe the history of climate
stress testing. But before we even do that, for those
(02:08):
of us and I include myself in this that are
not really familiar with this concept, can you explain what
a climate risk stress test is or even just what
is a stress test?
Speaker 2 (02:18):
So stress test is a way for financial supervisor to
assess the resiliency of the financial system, and this means
assessing regulated entities, so these can be banks, insurances, even investors,
and looking at different scenarios to know whether these institutions
are impacted and whether they are resilient to different type
(02:39):
of shocks. A new type of shocks that has emerged
in the last ten years is shocks coming from climate risk.
So this can be the transition risk, so the risk
arising from climate policies, shifting consumer preferences, or technology disruption,
and also physical risks, so this is sort of your
classic natural disasters or the chronic risk rising temperatures, overall
(03:02):
sea level rise and so on.
Speaker 3 (03:03):
Yeah, from my kind of perspective, stress testing became quite
popular as a regulatory tool after the two thousand eight
financial crisis. The Basal Committee for Banking Supervision set up
principles for stress testing which had nothing to do with climate,
mind you, but but more generally, and one of the
principles that they highlighted was that stress tests look to
analyze scenarios that are severe but plausible. So it's explicitly
(03:26):
not about you know, business as usual risk management, but
really thinking to more extreme cases that could occur, such
as the two thousand and eight financial crisis, and make
sure we're better prepared for such events in the future.
Speaker 1 (03:38):
Got it. So I mean when we say financial supervisors,
do we mean people like the regulators, the government and
central banks.
Speaker 2 (03:45):
And also you can have let's say the SEC in
the US, so Securities Exchange Commission, which is basically supervising
and looking at equity markets. So it is a range
of institution agencies that all looking at financial risk.
Speaker 1 (04:01):
Essentially, Let's say a central bank is running a stress test,
it's not just looking at its own sort of commitments
in relation to the risks that you highlighted. So I
think you said transition risk, then weather events and then
chronic climate risk were the three main categories. It's not
(04:21):
just looking at those in relation to the Bank of England,
for example, be looking at the whole UK financial system
when it's doing that stress test. Is that do I
understand it correctly? Yeah?
Speaker 3 (04:32):
That's exactly right. So within the Bank of England, actually
it's the prad Prudential Regulation Authority which is responsible for
just that prudential regulation and in essence is at the
perfect wordsworld. Actually it seeks to ensure the financial stability
of the UK financial system.
Speaker 1 (04:50):
So Ado, you have got some experience actually in being
involved in the financial institutions that have been running some
of these stress tests, how do you go about? I mean,
what does that look like? And is it difficult or easy?
Did you have to kind of invent your own version
of it with each institution?
Speaker 3 (05:07):
I suppose it's come along way over the years, And
I'll just flag up front that you know, I don't
work at these institutions anymore, so I can't represent the institutions.
But from my experience working on climate stress testing, when
we started out the first stress test that I was
a part of, we didn't really have a president of
climate stress testing and we didn't know what it looked like,
(05:29):
so we had to more or less invent the wheel.
What we did have, though, is a decent conceptual understanding
of what we were trying to do. There was already
in academic literature kind of separating out climate transition risks
from climate physical risks as different risk channels to look
at and some insight onto what those risk transmission channels
(05:50):
could look like. So what we really needed to then
do is think about how could we model these risk
transmission channels in a scenario setup that's going to be
relevant for financial institutions. But yeah, as you can imagine
with anything new, we did run into a number of
challenges along the way trying to do that.
Speaker 1 (06:07):
And what sort of challenges were those?
Speaker 3 (06:10):
Well, for for example, you know, if suppose a risk
transmission channel is a carbon price increasing. This is one
channel that that was quite often used in a lot
of climate stress test where we say, okay, suppose the
carbon price goes up. How would that impact the exposures
of financial institutions. Well, then you need to start thinking
about what are the GHD emissions of those financial institutions,
(06:32):
How could thoseg emissions be the gg emissions of the
companies that financial institutions are invested in, And how could
a carbon price impact the cost structure of these companies,
and how could that ultimately affect things like the credit
worthiness of the companies. That's going to have a bearing
on the financial institutions stability and safety and soundness. So
(06:52):
you have to think backwards, and then you realize that
at that time especially, there wasn't very good data on
things like GHD emissions, and there wasn't really a president
of how do you model the impact of a common price?
How does that play too on the cost structure of
that company? Could they pass it to to upstream suppliers
downstream consumers. So there were a lot of new questions
we uncovered in the process, and a lot of the
(07:14):
stress tests that have happened over the year, have you know,
as part of their objectives, have had capacity building to
just try and understand these questions better and kind of
learn ways of answering them.
Speaker 1 (07:26):
And how often are stress tests you know necessary? I mean, Tiffan,
I had a quick peek at your climate stress test
review No, and I was quite struck by the chart
on the front of that piece of research which showed,
you know, what's looked to me like a wave of
stress tests happening in late twenty tens, early twenty twenties
(07:47):
that then sort of tails off. Is that just because
a phase of stress tests amongst certain central banks has
been complete or is you know, I'm presuming this isn't
because they were in fashion now they've gone out of fashion.
It's just they've been done for now. Am I reading
it right?
Speaker 2 (08:03):
Yes? So my Curley Sunny Park and I looked at
forty three different climat risk stress tests that have been
published since twenty seventeen. So if you look at the
history of stress tests, you know, going back to twenty
fifteen twenty seventeen, this is when we see the first
academic studies. The first one was from Stefano Battiston and
he really set the conceptual framework for stress testing. The
(08:26):
Dutch Central Bank DNB was the first one to publish
twenty seventeen twenty eighteen a transition risk and then a
physical risk stress test. And it's no surprise that DNB
actually published the first physical risk stress test because the
Netherlands has a lot of exposure to physical risk from
sea level rise. Twenty nineteen is also a very important
(08:47):
date for stress testing because this is when the NNGFS
so the Network for Greening the Financial System, which is
an alliance of central banks and financial regulators. This is
when the MNGFS launched its open source scenarios that really
created the blueprint for a lot of central banks around
the world to build their own stress test upon and
(09:07):
so you know, in twenty twenty one, twenty twenty two,
our stress test review shows that, you know, there's almost
thirty exercises that have been published. Some of them are
sort of first of a kind or one off, and
some others have a frequency of you know, a year
two year. What we see is a lot of central
banks integrating climate stress testing into their own standard risk review.
(09:31):
It's not necessarily a part yet of what we call
the capital requirements. So usually, you know, a stress test,
one of the main goals would be to derive a
number that would quantify the amount of money that an
institution has to set aside to face a certain shock.
So climatory stress testing is not currently leading to capital
adequacy requirements, but central banks are mainly trying to push
(09:55):
to raise awareness around this new source of risk and
also build cap city within their regulated entities in terms
of the modeling, making sure that banks hire different teams
that are able to look at these questions.
Speaker 1 (10:08):
So you've introduced this idea of an MGFS there, what
does that stand for? And yeah, can you just give
us a little bit more detail about how it operates
and what's under the hood.
Speaker 2 (10:17):
There So the NNGFS is the Network for Greening the
Financial System. This is an alliance of regulators that are
looking to incorporate climate in the supervisory scope. So the
NNGFS counts more than one hundred and forty members. You
have central banks, you have financial regulators. Development banks also
are part of the NGFs, and so there are different
(10:39):
working groups that are working across a range of topics.
The main topic that stood out and the main work
that stood out out of the NGFs is the NGNGFS scenarios.
So these are climate scenarios that look across physical risk
and transition risk. The long term scenarios are looking out
to twenty one hundred on a five year basis. And
when you think of you know, the nngfsnios. This is
(11:02):
quite different actually from the scenarios that BNF can publish
or the International Energy Agency can publish. The NNGFS scenarios
are not normative, so they don't tell you what you
should do in order to achieve a certain climate outcome,
like a net zero emissions pathway. The nngfsnios are really
here to explore different plausible futures and they're interested in
(11:22):
sort of exploring those extremes as well, you sort of
extreme a physical risk and extreme transition risk, and what
happens if the transition is delayed for a long time
and then all of a sudden, you know, in the
twenty thirties, you have a policy shock that imposes a
very strangent pathway to the economy to decarbonize very fast.
There are six to seven scenarios depending on the phase
(11:43):
of the nngfsnios you're looking at, and these are really
here to explore this world of risk from a physical
and transition standpoint.
Speaker 1 (11:51):
So could you just I think you mentioned that there's
the scenarios that it looks at. There's sort of three
main ones. You just explain what those are.
Speaker 2 (11:59):
Yeah, So they are three categories. You have the orderly
transition category, you have disorderly transition category, and then you
have the hothouse world. So elderly transition this is a
relatively smooth transition pathway where the economy starts decarbonizing basically
from next year onwards at a steady pace. And this
(12:20):
transition sort of limits the amount of physical risk that
there will be later on in the scenario. So we
decalbonize fast. We don't accumulate as much greenhouse gases into
the atmosphere, and so natural disaster are a little less
frequent than they would have otherwise been. Disorderly transition is
looking at what I already describe. So this is assuming
(12:40):
that the transition does not happen in the short and
mid term, but then by a certain date you start
seeing more climate policies coming and disrupting part of the economy.
So you can think of for example, bands internal combustion
engine cars being implemented pretty heavily across the world and
so disrupting one part of the economy. And then the
hot house world is a very high intensity, physical risk
(13:04):
world where we do not decarbonize fast enough and so
we continue accumulating a lot of emissions in the atmosphere,
and this leads to very frequent and high amplitude and
natural disasters and the physical risk impacts.
Speaker 1 (13:17):
So ado, I mean you've had some experience of applying
these scenarios in the stress test that you've been involved
in developing. Is it ay standard? How they are applied
across different institutions stress tests? Well, they were.
Speaker 3 (13:30):
Actually maybe it's a great point, they were actually developed
to serve as a baseline for primarily regulators central banks
to frame stress tests around. So the idea was, let's
develop a set of common scenarios that can then be
refined to meet the specific context of the regulator, the
specific risk they want to prope and maybe any specific
(13:50):
local jurisdictional features that they would want to incorporate. So
they're very much as starting point, and in fact the
Bank of England's climate be annual exploratory scenario or the
stresses that they ran in the UK. The scenarios that
were used actually deviated from the ng festerinaris in a
few places, even though the anti festerinaris were used as
the baseline, if you will, But then certain tweaks were made,
(14:13):
for example, around physical risks. There was an understanding that
the NNGFS scenarios, due to modeling constraints that are that
are well restrewed across climate modelers, there was a risk
that the scenarios didn't capture the fullest extent of physical
risks that may actually occur. So the Bank of england
took steps to mpop some of the physical risks in
(14:34):
their exercise, essentially to get to that severe but still
plausible a level of stress that you want to analyze.
Speaker 1 (14:41):
So where in the world have we been seeing some
of these stress tests happening across the world?
Speaker 2 (14:46):
Emia apak amor, but we have to say you really
let the charge in terms of developing the framework. And
actually the NNGFS as Secretariat was hosted i believe by
ban de France and Bank of England, and so DNB
also has played a role. Out of the forty three
stress test that Sanny and I reviewed, we found that
(15:08):
more than forty percent of them have been conducted across Europe.
So Europe really played a role in that first wave
of stress tests, so between twenty twenty one and twenty
twenty two, and then we saw this spread across the world.
So APAC really took the lead towards the end of
twenty twenty two and twenty twenty three with a lot
of new stress tests that were published on the back
(15:30):
of the NNGFS scenarios. Overall, we found that between sixty
and seventy percent of transition risk and physical risk stress
test were conducted on the back of the NNGFS scenarios.
Another source of climate scenario data is the IPCC, and
you have also different ways of capturing the risk. You know,
different models, but NNGFS has really been the blueprint for
(15:52):
a lot of countries to develop their own stress test.
Speaker 1 (15:55):
So it's not the only show in town, but it's
the main one in this domain. Absolutely, so is the EU.
I mean you mentioned that this kind of started in
the EU, but you know we're now seeing in other regions.
Is the EU still playing a leading role in this runt?
Speaker 2 (16:10):
I would say yes. And last year the EU published
a new type of stress tests which incorporated the FEIT
for fifty five policy package or the U in a
very granular way. So this is sort of the decarbonization
policy package across the U, and this stress test really
looked at the risk across all the banks, the insurers
(16:31):
and dig very deep into some of the implications across
sectors of these policies. So this is sort of the
you trying to anticipate some of the risks coming from
sector level climate policies. And I think this is also
this sets a very interesting precedent for other stress testers
to look at, not just running the analysis in a
(16:53):
very generic way, but running those stress tests in a
specific policy orientated way.
Speaker 1 (17:00):
So that's the role that EU is playing, and obviously
you're both sitting in Europe, but I'm here in the US,
and you just turn on ANYTV channel and you can
see that it is a very different environment politically here
than it was, say a year ago, and then particularly
in relation to questions around climate. So has that had
an impact at all on stress tests in the US
(17:22):
or plans around stress tests?
Speaker 2 (17:24):
So the US published in twenty twenty four a pilot
stress test that included six large banks, so that's you know, Goldman, Sachs, JP, Morgan,
and other banks. And this stress test was actually very interesting.
So on the physical risk side, it looked at the
impact of hurricanes in the northeast of the US, looking
at you know, hundreds of thousands of residential and commercial loans.
(17:46):
And on the transitionersk side, it looked at, you know,
the impact of transition risk and potticas on real estate,
for example. So I thought was this was a very
promising episode. But actually right before the Trump administration came
into office, So in Jazz Neurary twenty twenty five, the
Federal Reserve actually exited the NGFs And so this is
sort of a reaction potentially to the current politics and
(18:09):
the current environment in US politics. But nevertheless, physical is
are very important today in the US. So you're seeing
heightened natural disasters. There's a wild fire season now in California.
You have zones across the US that have become unensurable
from a residential and commercial real estate standpoint. And so
while the US is sort of backing away from stress
(18:32):
testing potentially for a while, there are actual effects that
are being felt across the economy.
Speaker 3 (18:38):
I might add to two additional developments that I could
shed some light here. So while the Central banks were
developing climate stress tests, there was another group called the
Task Course for Climate Related Financial Disclosures TCFD, which came
out with a set of recommendations in twenty seventeen. The
same year the first under My stress test was published,
and they set out recommendations for corporations to publish more
(19:03):
information on various particularly around their climate related risks and
how they were managing climate related risks. And these recommendations
actually included a recommendation to apply scenario analysis to identify
what those risks might be over the short, medium and
long term. And the TCFD recommendations have evolved the bit
since then. They have been formalized by the International Sustainability
(19:26):
Standards Board, the ISSB, who has actually merged with the
TCFD or vice versa, and has published a more formalized
set of reporting requirements which have been formally adopted by
jurisdictions across the world, which require companies, financials and non
financial companies to disclose on their climate related risks and
implicitly or explicitly, there's an askut in there, depending on
(19:48):
the jurisdiction that is, but there's an askut in there
to apply scenario analysis to identify those risks. So we've seen,
if you will, a kind of trend of private sector
scenario analysis in peril level to the more broader central
bank exercises. So that's been helping further establish climate stress
testing as a discipline across the world. Now, what we
(20:10):
did notice with the Trump administration coming in is that
the SEC which was set to mandate such a climate
disclosure rule in the US, has currently stopped their efforts
to get that rule across It was already being contested
in a number of US courts and in Canada the
regulator had a similar climate disclosure requirement that they were
about to bring into force. And they've actually pressed pause
(20:33):
on that in response to developments in the US. It
seems so we do see a bit of a setback
there as well. But a final thing I just quickly
want to mention is that during all of these years
of capacity building, my sense of the industry is that
there's been a growing intrinsic appreciation of the risks brought
forth by climate change, and as Tiffan pointed out, especially
(20:54):
the physical risks which are which are very visible in
some jurisdictions, and you know, with very real con sequences
that we can see today financial consequences as well as others.
And so even though the regulatory push in Americas may
subside somewhat, I think that might be compensated in part
by an innate push by institutions to manage these risks regardless.
Speaker 1 (21:16):
I mean an innate push by the climate itself. You
could say, just force financial institutions to think about this.
I mean, just on that, you know, the governmental level,
things have changed. At a federal level. One of the
things there's always been a narrative in the US is
whatever's happening at a federal level, you need to look
at what the states are doing, do we see any
activity at a state level in terms of climate stress
(21:36):
tests in the US.
Speaker 2 (21:37):
So on our side, we haven't captured any state level
stress tests. But it's important to note that across the
US some states now stepping up to put together structures
to support the insurance market. And so this is something
we see across a number of states where public money
is going to come to support locally some future homeowners
(22:00):
that are looking to insure their house and so, you know,
the collapse of the private insurance market is actually a
very good proxy for you know, how critical physical risks
are to homeowners today. So you know, physical risks are
becoming a real risk for households and companies, and so
this is critical to still have, you know, an insurance
market locally that can support those businesses. A collapse of
(22:24):
the insurance market is also a collapse of the financial
market locally. Climate risk is a manageable risk from a
financial standpoint. You know, if you think about the full economy,
banks have a diversified portfolio. It is true that locally
the market for insurance and the market for mortgages has
already collapsed and public money has to step in already.
Speaker 1 (22:45):
So we kind of got a picture of what's happened
in the EU and in the US. Is is there
a thing noteworthy going on elsewhere in the world.
Speaker 2 (22:52):
So absolutely, we're seeing a lot of activity also across
emerging markets, and sometimes we see you know, the World
Bank or the IMF really partnering with local supervisors to
publish this stress test. So notable examples of this include,
you know, in the Philippines twenty twenty two, we've seen
in analysis the impact of typhoons on the financial system,
(23:14):
specifically you know, gelt towards credit exposure. We've seen also,
you know, floods in Mexico being one of the main
targets of one analysis across Brazil this is mainly a
drought have pushed the financial supervisors to publish their own
stress test. In China, we've seen also the regulator publishing
transitionary stress test that was also in twenty twenty two.
(23:36):
So there's a lot of activities around the world and
this really speaks to the sort of broadhouse strategy the
NGFs has implemented, and going forward, we definitely expect a
lot of regulators across Africa also to publish their first
stress test using an MGFS blueprint mainly.
Speaker 1 (23:56):
So it seems like climate stress tests are becoming more
and more main stare dream and although the road to
get there on climate stress test has some bumps along it,
you know, and particularly what we're discussing in relation to
the US, they are getting along that road bit by bit,
and we have no reason to think that they're not
going to continue to become more and more mainstream as
(24:16):
a model. One question I have is what are their limits?
What can they do and more importantly, what can't they
do and what's the gap.
Speaker 2 (24:22):
So if you think about it, sixty to seventy percent
of stress tests have used the NNGFS scenarios, and so
this is definitely an incredible success of these scenarios. But
at the same time, this is a curse mainly because
now you don't necessarily have the diversity in modeling approaches
and climate scenio data across this, you know, the body
(24:43):
of stress test that we reviewed, and so the limitations
of the current literature are mainly the limitation of the nngfscenario.
And so one thing that I'll mentioned on the transition
mix side is really the use of shadow carbon prices.
So shadow CAB is a modeling artifact that the NNGFS
(25:03):
models are using essentially to capture the intensity of climate
policies overall. This is an approximation and basically says in
the modeling, essentially you have these carbon prices that are
applied to every single economic activity across the world and
are driving up the cost of carbon intensive activities and
(25:23):
sort of helping also climate solutions to come into the system. Now,
in reality, what we see in practice is only a
quarter of global emissions are subject to an actual carbon price,
and outside of the most carbon pricing schemes or taxes
are well below thirty dollars pert on. So this is
a level that's not necessarily extremely material for corporates, and
(25:47):
they're often applied to corporate activities or industrial activities. So
the central point in the transitional scynalysis of NGFs or
those carbon prices. But actually when you think about the
transition and the weight it manifests, you know, it might
be for example, the cost competitiveness of electric vehicles that
is driving market adoption, and in turn this means you know,
(26:09):
the sales of internal combustion engine costs are going down,
So this is a financially material risk for a number
of automakers, and it's not currently captured in the nngfscenios.
So what we've seen is up until phase five of
the ngfsscenios, the scenarios really looked at transition risk in
the power sector and also transition risk coming from you know,
(26:31):
higher carbon prices across the economy, but it didn't necessarily
assess the risk across you know, all the different sectors
you can think of transport, but also transition metals that
are going to play a key part in the transition
just on the on the physical risk side as well.
The NNGFS being a bit of a global baseline for scenarios,
it looks at physical risk very much through a macro
(26:54):
economic lens. It tells us something about the macroeconomic impacts
in a location in a country that is, you know,
the kind of jurisdiction where we'd measure GDP, so that
that's countries, what the impacts from physical risk may be
at the aggregate level. In practice, physical risk is something
that tends to be highly localized. An intense hurricane impacting
(27:16):
New York City could be very different from a financial
standpoint from that same hurricane impacting forward. In both cases,
we may, you know, there may be significant impacts, but
the types of institutions that are impact which companies, which
households differs quite a bit, and hence, you know, also
the level of insurance of those impacts may differ, and
ultimately what the impact of the financial institution is could
(27:38):
impact quite a bit. Similarly, physical risks, you know, so
there's this direct damage depending on the location where the
impact occurs. Damages can also kind of shocked to a
company's supply chain. So a company itself may not be
directly impacted by a physical risk, but if a critical supplier,
say Transition metals, is impacted by physical risk, and that
(27:58):
chokes the you know, the supply and the distribution of
those metals, that could impact downstream companies. So there's a
lot of complexity to physical risk, which requires an understanding
of the locations where companies operate and the supply chains
of those companies as well. Now, naturally, NDFS, you know,
being a global open source model, won't be able to
(28:19):
capture all of these specificities. So it's an important area
where financial firms, if they really want to have a
good grasp of the risk, likely will need additional sources
of data to supplement that analysis.
Speaker 1 (28:29):
As you mentioned that, I mean, one of the things
that was occurring to me is that having a central
bank conducts this exercise and all of the complexity involved,
that they're obviously never going to capture some of those
things you just mentioned. And I just wonder if that
is an issue. Whereas if the model was say, like
let's in said, say you are an electric vehicle manufacturer,
(28:52):
then I think that you reasonably could if you were
running a scenario exercise to identify risks, you reasonably could
be expected to capture, you know, the risks to your
supply chain. So does this system need a sort of
a bottom up complement to provide metrics that can feed
into the big picture model rather than putting the onus
(29:12):
on central banks to try and figure everything out themselves.
Speaker 3 (29:16):
You know, certainly there's an aspect of that, and I
think the TCFD very much try to answer that that question.
Speaker 1 (29:23):
When I spoke just to find the TCFT Sorry.
Speaker 3 (29:25):
Yeah, yeah, So when I spoke about climate related disclosure
requirements before reporting requirements, part of the idea there when
regulators ask companies to report on their climate risk is
precisely to fill this gap that central regulators may not
have all the information. So if companies themselves, who understand
their own business model better than anyone in their supply
chains and their operating locations, if they can analyze the
(29:47):
risk and report on that, that can then help other stakeholders,
including their investors and their lenders to assess the risks
on their part. So certainly that bottom up component is there,
and this is why we see a lot of push
for climate related reporting in Europe for example, and in
across asas specific with the ISSB standards that are being implemented.
Speaker 1 (30:09):
Sort Of just a thought and reflection as well, when
you know Tiff and just now you are talking about
shadow carbon prices and their strengths but also their limitations
sort of on a more macro level, I know that
climate in Europe is often sort of the main policy
lever is the EETs carbon market, and also in the
UK ETS and in Europe we're quite adept at thinking
(30:32):
of the problem in terms of carbon prices, and we
know that a lot of the climate stress tests momentum
came from Europe. Is there an issue that maybe the
NNGFS is a little bit too eurocentric in how it
thinks about the world, and that might be part of
the limitation. And you know that the shadow carbon price
issue is just an example of that.
Speaker 3 (30:52):
I'm not sure that death characterization would be would be
quite correct because the NNGFS scenarios are ultimately based on
academic models called integrated assessment models and global climate models,
which have been developed within Global academy. One of the
models underpinning the NFS scenarios is the GCAM model, which
(31:12):
is a model developed out of the University of Maryland.
And so these models come out of academia and those
are the basis for the scenarios themselves. And the tradition
in integrated assessment modeling in this particular strand of academic
literature is to use carbon prices as a metric for
policy intensity. Now, where you know where you might have
(31:34):
a debate is whether this metric is suitable for the
use in stress testing, as has been applied by many
central banks. And I think that's tiffense commons. You know,
strike a good court. They may not be as reliable
and in fact, in the stress test themselves, in some
of them you'll actually see acknowledgments by the central banks
about the limitations of using a carbon price because it
won't accurately reflect the true policy environment. It was very
(31:56):
much acknowledged as a shortcut that could help determine and
pockets of risk, and you know, I think some of
the subsequent analysis by Bloomberg and e F and others
has shown that this shortcut may actually miss significant drivers
of risk, like the automotive example that Tiffin mentioned.
Speaker 1 (32:13):
This has been a really fascinating conversation and there's so
much to chew on here. I think we could carry
on talking all day if we had the time. Tiffin
and Ado, thank you so much for coming and sharing
your insights on this, which is a really tough topic,
but I think one that can really move the needle.
So it's a really important conversation. So thank you both
for joining.
Speaker 3 (32:32):
Thank you, thank you for having us.
Speaker 1 (32:42):
Today's episode of Switched On was produced by Cam Gray
with production assistants from Kamala Shelling. Bloomberg ne EF is
a service provided by Bloomberg Finance LP and its affiliates.
This recording does not constitute, nor should it be construed
as investment and vice investment recommendations or a recommendation as
to an investment or other strategy.
Speaker 2 (33:01):
Bloomberg ANIAF should not be considered as information sufficient upon
which to base an investment decision.
Speaker 1 (33:06):
Neither Bloomberg Finance LP nor any of its affiliates makes
any representation or warranty as to the accuracy or completeness
of the information contained in this recording, and any liability
as a result of this recording is expressly disclaimed
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