The way forward for assessing environmental risks. Some proposals.
By Maud Abdelli, Lead Greening Financial Regulation Initiative, WWF, Adrian von Jagow, Institute for Ecological Economics, and Chiara Colesanti Senni, Centre for Environmental Policy
The extensive coverage around the latest IPCC report put it bluntly: catastrophic climate change is inevitable if current emissions are not mitigated within the next seven years. And yet, climate change is only one facet of the ongoing environmental crisis. The IPBES (the IPCC’s equivalent on Biodiversity and Ecosystem Services), in its latest report, warned that nature is now declining faster than ever. Species go extinct at around 100 to 1000 times the “normal rate”, driven by climate change, land degradation and unsustainable resource use. These impacts on nature create risks for societies, economic activity and financial stability. Indeed, there are strong linkages between climate change and other environmental risks: they are two sides of the same coin.
Nature loss is a financial stability issue
Financial assets and the economic activity they underwrite depend upon the ecosystem services provided by the environment. At the same time, investments can be linked to impacts on the environment and thus promote or hinder the transition to a more sustainable economy. Recent research, culminating in a new report commissioned by the NGFS (a network of central banks and financial regulators) and its research partner, INSPIRE, has highlighted as much. Accounting for these risks and impacts, the report finds, falls within the mandates of central banks and financial supervisors. The 114 NGFS member institutions confirmed this in a rare statement published shortly after the report. The collaborative effort of the working group that authored the report has allowed several important issues to be addressed in a short period of time and lays the foundation for expanding the work on climate-related financial risks to a broader set of environmental risks. However, concrete measures for further integrating environmental risks are still lacking.
Urgency of nature degradation requires rapid actions
Building on the powerful network of the NGFS and the work already done on climate-related risks will be an important advantage that should help save precious time. Lessons learned from the work on climate risks can inform the methodologies needed to account for broader environmental risks. Of course, as in the climate case, taking a precautionary approach on environmental financial risks would justify supervisory action even in the absence of fully-fledged methodologies.
To that end, the knowledge embedded in the recent NGFS-INSPIRE report should be rapidly translated into frameworks that central banks and financial supervisors can integrate in their activities. Although nature-related data is partially available, there is still some work needed to synthesize decision-relevant information for investors and their supervisors. Concrete, empirical illustrations can showcase possible frameworks of analysis. They would allow central banks and financial supervisors to start acting while additional data is becoming available. First broad-stroke analyses of the financial system’s exposure to (and its impact on) nature have been put forward for France, the Netherlands and Malaysia, among others. These studies already made important contributions, e.g. highlighting that a large part of environmental risks of a company are likely to be located in supply chains.
Addressing methodological challenges step by step
Future iterations of such methodologies should prioritize companies with supply chains that are more likely to entail environmental risks and initially focus on single ecosystem services. Zooming in on one ecosystem at a time, e.g. water resources or forestry, would allow to exploit existing information on the state of ecosystems while limiting the overall complexity. Starting with sectors characterized by risky supply chains would concentrate efforts on the most exposed parts of the economy while establishing a general framework applicable to other sectors too.
First insights into the magnitude of financial dependencies on ecosystems should encourage financial supervisors and central banks to consider broader environmental risks. These include both risks from climate change and the degradation of ecosystem services. The fact that much remains to be done on data and methodologies related to climate-related risks should not inhibit financial market actors from assessing these broader environmental risks. Members of the European Central Bank’s Executive Board have already recognized “the need to further incorporate climate considerations into its policy framework”. From here it is just a small step to acknowledge the wider implications of environmental degradation.
This article features in Green Central Banking