The Network for Greening the Financial System (NGFS), launched at the Paris One Planet Summit on 12 December 2017, is a group of 18 Central Banks and Supervisors and 5 international organizations willing, on a voluntary basis, to contribute to the analysis and management of climate and environment-related risks in the financial sector, and to mobilize mainstream finance to support the transition toward a sustainable economy. Its purpose is to define and promote the implementation of best practices within and outside of the Membership of the NGFS and to develop analytical work on green finance. Its work is built on a range of national and international initiatives responding to the financial risks and opportunities stemming from climate – and environment – related changes, such as the Task Force on Climate-related Financial Disclosures (TCFD) and the G20 Green/Sustainable Finance Study Group as well as broader international activity such as the Paris Agreement and Sustainable Development Goals (SDGs).
The key messages from the first phase of NGFS work as reflected in this progress report are outlined below:
1. NGFS Members acknowledge that climate-related risks are a source of financial risk. It is therefore within the mandates of Central Banks and Supervisors to ensure the financial system is resilient to these risks. As set out in the academic literature, climate change will affect the global economy and so the financial system that supports it. The financial risks it presents are in consequence system-wide and potentially irreversible if not addressed. Exact pathways may be uncertain but it is foreseeable that financial risks will crystallize in some form through either the physical or transition channel, or some combination of them both. And while the financial risks may be realized in full over extended time horizon, the risks call for action in the short-term to reduce impact in the long-term. Some NGFS members have extended this analysis to broader environmental risks finding that these are a source of financial risk as well.
2. Against this backdrop, authorities and financial institutions need to develop some new analytical and supervisory approaches, including those based on forward looking scenario analysis and stress tests. Action is required now to reduce future financial risk although historical data is not sufficient to estimate this impact. The nature of the risk factors requires an enhanced approach, one that is forward looking and takes a long-term perspective. There may also be benefit of using data driven stories based on future potential scenarios as well as traditional analytics and quantitative risk modelling.
3. Central Banks and Supervisors, as well as financial institutions, are beginning to deepen their understanding of these risks and the need for an improved approach. The stock-taking exercise conducted within NGFS Members shows that Supervisors are starting to actively assess the prudential risks and begin to set supervisory expectations to enhance financial risk management of supervised firms. A growing number of financial institutions have also conducted their own climate and environment-related analysis.
4. The tools and methodologies, however, are still at an early stage and there are a number of analytical challenges. For example, the quality and availability of data is limited, taxonomies and definitions are still developing and there is a need to build intellectual capacity in translating the science into decision-useful financial risk assessment information. More work is also needed to assess whether a financial risk differential exists between “green” (low-carbon) and “brown” (carbon and pollution-intensive) assets.
5. Some Central Banks are also starting to play their part in scaling up green finance by accounting for climate and environment-related factors in their investment strategies for instance. A few Central Banks, regulators and local authorities have introduced incentives for banks to increase green lending and for issuers to issue green bonds.
In the coming months, the NGFS will carry on its work on the following deliverables which will feature in its first comprehensive report to be published by April 2019:
• Narrowing down the complexity of risk analysis, e.g. through the development of a small number of high level scenarios, in line with TCFD recommendations on the use of scenario analysis as a helpful tool for assessing future risks and opportunities.
• Analyzing the outcomes of the stock-take of supervisory and macro-prudential approaches to enhance firms’ financial risk management, assess systemic risks and support disclosure.
• Taking forward further analysis of potential risk differential between “green” and “brown” assets, identifying gaps where further work needs to be carried out and appropriate Central Bank and Supervisory responses.
• Doing further work to identify some specific areas for Central Banks and Supervisors to “lead by example” and integrate climate-related criteria in a growing number of their operations.
Download the full report here: NGFS_first progress report_20181011.pdf