MODELLING THE FINANCIAL IMPACT OF CLIMATE CHANGE: PATHWAYS TO THE END OF THE CENTURY - NOCA
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Modelling the financial impact of climate change: pathways to the end of the century The impact on financial institutions and the choices ahead 30th October 2020 Copyright © Baringa Partners LLP 2020. All rights reserved. This document is subject to contract and contains confidential and proprietary information. Baringa Confidential
Introductions
The Team and our journey today
Roelof Coertze The Challenge
Climate Risk Lead
Coertze & Consultants Drivers for change
How are the regulators responding?
James Belmont The regulatory timeline
Climate Risk Lead
Baringa Global Scenarios
Our Climate Change Scenario Model
Tim Schrauwers
Climate Change Lead, Insurance, Asset What is a good response to the PRA
Management & Retirement
Baringa requirements?
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The challenge we face is great…
… and our window to address climate change is shrinking
Global Impact Risk Impact
1oC warming so far
3oC projected further warming this century
10% reduction in crop yields for every 1oC of warming
4x increase in wildfires for every 1oC of warming
117 basis points: Increase in average cost of debt in
developing countries with every 1oC of warming
23% per capita earnings reduction by 2100 due to climate
change
200 million climate migrants by 2050
Known Risk Factors Timing
Copyright © Baringa Partners LLP 2020. All rights reserved. This document is subject to contract and contains confidential and proprietary information. Source: Global Carbon Project (2017) with Bank graphic 3
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Global drivers of change for financial services
Institutions are rapidly incorporating climate change into their decisions in response to
regulatory and investor pressures – which will impact pricing and availability of finance
to corporates
Insurers, asset managers, pension schemes
Recognition that climate change is a
source of major financial risk Global Governments & Regulators
Changing institutional investor
mandates, with increasing incidence Recognition of climate change as a
of activist shareholder motions at source of major systemic risk
AGMs Increasing government policy
interventions in the real economy
to stimulate the transition,
General Public impacting business models
Regulatory requirements for
Customers, media and activists:
insurers and pension schemes to
Changing values impacting manage the risks to financial
customers’ decision-making stability in many countries
Increasing reputational importance of Network for Greening the Financial
positive engagement with climate System (NGFS) supports Global
change and negative press coordination of regulators
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How are the regulators responding?
Globally, regulators increasingly see climate change as a major risk to financial stability. The
New York Fed1 says “it is appropriate, even critical, for supervisors to focus on this particular
risk”
Task Force on Climate-related Financial Network for Greening the Financial System
Bank of England
Disclosures (TCFD) (NGFS)
Context: First regulator to set mandatory climate risk Part of the Financial Stability Board of the G20 A global consortium of central banks and
management requirements Voluntary disclosure regime designed to improve supervisors
information available to investors Develops best practice in climate risk
management in the financial sector
Scope: SS3/19 (Enhancing banks’ and insurers’ Any organisation that signs up As of September 18th 2020, the NGFS consists
approaches to managing the financial risks from September 2020 - 1,440 organizations, of 72 members and 13 observers.
climate change): All UK banks and insurers representing a market capitalization of over Covering over two-thirds of globally systemic
(including subs of non-UK parents) $12.6 trillion (over half FS) banks and insurers
Upcoming Biennial Exploratory Scenario (BES):
Largest UK banks and insurers (via stress testing
submissions)
Requirements: SS3/19: Use scenario testing, including a scenario with Individual central banks anticipated to
̶Governance transition risk implement regulatory regimes similar to the
̶ Risk management Disclosure of: Bank of England
̶ Scenario analysis ̶ Governance
̶ Disclosure ̶ Strategy
Incorporated into the Senior Manager Regime. ̶ Risk Management Members of note
BES: Delivery of climate risk scenario results ̶ Metrics and targets
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The regulatory requirements that will need to be met
The BoE emphasises the need to building capability in order to achieve full
implementation by end 2021. Climate risk analysis capability requires significant
focus to deliver these timelines End 2021
July 2020 ⚫BoE expects implementation
Regulatory Timeline
⚫BoE PRA SS3/19 Q3/Q4 (TBC) to be complete
Oct 2020 End 2020 Q2/Q3 (TBC)
deadline published ⚫BES submissions
⚫FCA Climate related ⚫Policy ⚫BES initiates
(Dear CEO letter) 2022
disclosures (TCFD) Statement in Postponed to “at large banks and
⚫FCA TCFD compliance for issuers
consultation closes force least mid-2021” insurers
May 2020 June 2020
⚫ECB launch ⚫NGFS Guide to Sept 2020 2021 2021 (TBC) 2022-24
consultation Scenario Analysis ⚫ECB guide ⚫ECB enters supervisory ⚫EBA expected final ⚫EBA expected update on incorporating ESG risks
implemented dialogue with banks draft ITS and RTS
Q2 2020 Q3 2020 Q4 2020 Q1 2021 Q2 2021 Q3 2021 Q4 2021 2022 2023 2024
Assess Governance Update Governance
Governance Impact Structures End 2021: PRA SS3/19
Implementation Complete
Typical Activities Required
Understand Risk Appetite
Priority assessments & near-term
& Risk Management
risks
Framework Impact Phased approach to
Risk Management development and
integration
Define & Build MI
Requirements Definition & Qualitative Choose and refine ICAAP / Initial Build
Analysis scenarios ORSA Complete Model
Scenario Based
Run
analysis
Test, refine and share Embed
Understand public Refine risk Embed into Annual
Disclosures commitments statements Reporting Reporting
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Global Scenarios
Scenarios are complex and illustrate what the world could look like and reflect a point of
view. They are usually very detailed and cover a wide range of economic activity.
Source Narrative Key Theme Ranking Warming (°C)
Themes
Baringa Exploring the costs/opportunities of climate change on companies across all sectors to
2-4 Physical
Partners inform investors’ climate risk profiles
Macro-economics
Systemic risks from climate change for guiding development of climate risk capability in
NGFS 1.5 - 3.5
the financial sector Consumer
Policy
IPCC RCPs Physical risks and societal impacts of climate change, underpinned by a set of socio-economic pathways. 1.5 - 4
Technology
IEA WEO /
US EIA IEO
Policy impacts on energy system evolution, climate change & progress towards Sustainable Development Goals 1.5 - 4
Company
Financials
IEA ETP Guidance to governments on priorities for low-regret technological development to achieve a low carbon future. 1.5 - 4
Chatham
House
The role of consumers in reducing climate change through circular economy, reducing meat consumption, etc. 2
IRENA Priorities for advancing the role of renewables and bioenergy in pursuit of climate change mitigation goals. 1.5 - 4
Energy Transition
Commission
Climate transition impacts for hard to abate sectors (trucking, shipping, heavy industry) 1.5 - 4
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Our Climate Change Scenario Model
An integrated model for translating transition and physical risks into instrument-level
financial impacts which can be applied across Financial institutions
Baringa’s Climate Change Scenario Model Uses
Commercial
direction
Transition Scenario Development Portfolio
Scenario Pathway Impacts modelling &
reporting
Temperature
Change Company
Strategic
reporting
Instrument
Emissions
Client reporting
Physical Risk
Instrument / asset
level results
Baringa are the leading energy, environment and climate change advisors, with over 20 years of
To understand our model in
experience in this topic. We are currently advising 5 of the 7 BES banks on the design and
implementation of climate risk and temperature alignment. more detail please click here
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Financial impacts vary widely across companies, given
differences in their individual profiles…
Spread driven by Impacts on annual free cash flow by 2030
differences in: 35%
30%
– Business model
25%
(eg oil vs gas,
upstream vs 20%
downstream) 15%
10%
– Current
financial state 5%
0%
– Physical
30% - 40%
>100%
10% - 20%
20% - 30%
40% - 50%
50% - 60%
60% - 70%
70% - 80%
80% - 90%
0% - 10%
90% - 100%
footprint
2030
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Baringa Confidential…with more significant impacts at longer horizons
Significant further Impacts on annual free cash flow by 2050
deterioration 35%
30%
Still a very wide
25%
spread
20%
Many companies 15%
changing their
business models & 10%
strategies – not 5%
factored into these
0%
results
30% - 40%
>100%
10% - 20%
20% - 30%
40% - 50%
50% - 60%
60% - 70%
70% - 80%
80% - 90%
0% - 10%
90% - 100%
2030 2050
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Baringa Confidential2030 impacts are skewed heavily towards companies
producing a lot of gas
Wide dispersion Relative impacts on annual free cash flow vs production mix
Exclusively gas 100% 100%
Current production mix
companies see oil gas
double the impact 0%
seen for Relative impact on free cash flow
exclusively oil -20%
companies
-40%
-60%
-80%
-100%
2030
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Baringa ConfidentialTransition in the next decade impacts gas more than oil…
Gas scenario Gas Demand Oil Demand Oil scenario
drivers 2.0 2.0 drivers
Gas demand index
Oil demand index
1.5 1.5
Power Transition of
generation 1.0 1.0 the transport
transition to 0.5 0.5 sector less
renewables 2020 2030 2040 2050 2020 2030 2040 2050 mature
impacting BAU Orderly 2 BAU Orderly 2
demand Dependency
on secondary
Consequent Gas Price Oil Price products (eg
1.5 1.5
Gas price index
impact on plastics and
Oil price index
price fertilisers)
1.0 1.0
0.5 0.5
2020 2030 2040 2050 2020 2030 2040 2050
BAU Orderly 2 BAU Orderly 2
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Baringa Confidential…but from 2030 onwards, decarbonisation of transport
accelerates, impacting oil more significantly
Gas scenario Gas Demand Oil Demand Oil scenario
drivers 2.0 2.0 drivers
Gas demand index
Oil demand index
1.5 1.5
Continued Transition for
transition for 1.0 1.0 cars rapidly
power 0.5 0.5 picks up
generation 2020 2030 2040 2050 2020 2030 2040 2050
BAU Orderly 2 BAU Orderly 2 Transition also
Transition of for heavy
building transport (eg
heating also Gas Price Oil Price trucks, ships,
1.5 1.5
Gas price index
increasingly planes) – but
Oil price index
material slower
1.0 1.0
0.5 0.5
2020 2030 2040 2050 2020 2030 2040 2050
BAU Orderly 2 BAU Orderly 2
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Baringa ConfidentialBy 2050 the “oily” companies have largely caught up with
the “gasy” companies
Upstream Impacts on annual free cash flow vs production mix
companies
impacted by the 100% 100%
Current production mix
“double whammy” oil gas
of price and 0%
demand changes Change in free cash flow
-20%
Low-margin
businesses -40%
particularly
-60%
impacted
-80%
Physical footprint
also more material -100%
in the later years
2030 2050
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Baringa ConfidentialWhat is a good response to the PRA requirements?
The PRA expects firms to embed climate risk management within their existing processes.
This will require not just scenario modelling, but also changes to governance, capabilities
and culture
Baringa’s Climate Change Strategy & Risk Management Framework
Woven into the fabric of firms’ existing risk management
frameworks and strategy formation processes
Engaged internal stakeholders across both first and second MONITOR STRATEGY
lines Reporting Firm strategy
alignment
Decision-
A thorough, thoughtful approach to both transition and making
physical risks
RESPOND IDENTIFY
Appropriately reflected in BAU decision-making Policies Risk
identification
Supported by short- and long-term scenario analysis, Controls Risk
taxonomy
based upon rich narratives that bring the risks and
opportunities to life ASSESS APPETITE
Measure
Qualitative and
A funded, resourced plan Aggregate quantitative
Scenario Cross-risk
Clearly-defined delivery ownership
models type
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Baringa ConfidentialThis document: (a) is proprietary to Baringa Partners LLP (“Baringa”) and should not be re-used for commercial purposes without Baringa's consent; (b) shall not form part of any
contract nor constitute acceptance or an offer capable of acceptance; (c) excludes all conditions and warranties whether express or implied by statute, law or otherwise; (d)
places no responsibility or liability on Baringa or its group companies for any inaccuracy, incompleteness or error herein; and (e) the reliance upon its' content shall be at user's
own risk and responsibility. If any of these terms is invalid or unenforceable, the continuation in full force and effect of the remainder will not be prejudiced. Copyright © Baringa
Partners LLP 2020. All rights reserved.
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