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