The Network for Greening the Financial System (NGFS) published an amended, third set of climate scenarios on 6 September 2022. The key updates include incorporation of countries’ commitments to reach net-zero emissions, increased sectoral granularity and improved representation of physical risk, including acute risks.
The NGFS’s climate scenarios have served as a benchmark for regulatory climate stress-tests across jurisdictions (ACPR CPE 2020, Bank of England CBES 2021, ECB CST 2022) and firms’ internal climate scenarios. The third set is expected to further improve the industry’s understanding and management of climate-related financial risks.
The set of six climate scenarios categorised into orderly, disorderly, and hot house scenario groups has been updated for population and GDP pathways using the IMF World Economic Outlook October 2021. That outlook included the consequences of COVID-19 pandemic but did not consider the recent economic and climate action implications of Russia’s aggression against Ukraine. The scenarios have been updated considering the latest trends in renewable energy and mitigation technologies as well.
Hot house world scenarios, i.e., the Nationally Determined Contributions and Current Policies scenarios, have been more visibly updated for the overall level of policy ambition with regards to global temperature change, increased variation in countries’ commitments, with some countries accelerating efforts to curb greenhouse gas emissions and others not progressing significantly, and increased carbon dioxide removal from low to low-medium.
Modelling has been improved for both chronic and acute physical risks. Indeed, a new damage function methodology is applied to estimate the GDP impacts from global mean temperature rises, and a novel approach is used to approximate changes in damages to GDP related to more frequent and severe weather events. Lastly, increased granularity for transport and industry sectors has been embedded within existing integrated assessment models, and further work has been initiated to increase sectoral granularity in the next NGFS climate scenarios release.
The key messages conveyed by previous NGFS scenario results remain.
Limited climate action, as assumed under hot house world scenarios, will have significant impacts on the economy by the end of the century due to materialisation of both chronic and acute physical climate risks. Global mean temperatures will rise in all scenarios, exceeding 3°C in Current Policies and, in consequence, negatively affecting health, labour productivity, agriculture, ecosystems, sea-levels, and changing the frequency and severity of severe weather events.
On the other hand, combating climate change via increased climate action will lead to multiple transition risks. Transitioning away from fossil fuels and carbon-intensive production and consumption, as assumed under orderly and disorderly scenarios, will require significant shifts towards emissions-neutral alternatives in all sectors, leading to sectoral disruptions and changes in real financial asset valuations. Significant investments in green energy will need to occur to achieve net zero and permanently change the energy mix before temperature rises beyond safe ranges. Carbon dioxide removal would need to be applied on a larger scale to smooth out the transition to low carbon economy. Carbon prices are expected to rise under both groups of scenarios to reflect the more stringent policies to reduce GHG emissions. This, in consequence, will impact energy costs in the short-term and feed through to temporary increases in inflation and unemployment. Inflationary pressures are expected to impact long-term interest rates.
GDP figures will be affected under all climate scenarios, either because of materialisation of transition or physical risks. However, in the long-term, the orderly scenarios are the least detrimental to global GDP as global economy gradually transitions to low-carbon, sustainable economy, and avoids the more severe consequences of physical changes to climate.
Along with the updated scenarios, NGFS shared two accompanying documents - a technical analytical document on the Climate Scenarios Sensitivity Analysis to Macroeconomic Policy Assumptions and a guidance note Practical Lessons for the Development of Climate Scenarios with Extreme Weather Events from Emerging Markets and Developing Economies. The first document assesses the sensitivity of the climate scenario results to assumptions related to fiscal and monetary policy, while the second provides regulators with a practical framework for assessing physical climate risks from extreme weather events. All three documents are expected to feed into regulatory exercises, while they remain exploratory or not mandatory for the banking, and the wider financial industry. However, the banking industry is advised to incorporate the results and methodological considerations of the third release of NGFS scenarios into their climate-related and environmental risk management frameworks and internal scenarios.
NGFS Climate Scenarios for central banks and supervisors | Banque de France
NGFS Climate Scenarios for central banks and supervisors (September 2022)