10th December 2020
In part 1 – Our changing climate - we looked at how the regulatory landscape on climate change is altering the concept of risk for financial institutions and touched on the complex nature of physical and transition risks. Today, we continue to understand this complexity with a look into a key issue for climate change projections, uncertainty and what this means for financial institutions.
The significance of the Governor of the Bank of England’s speech announcing the June 2020 launch of the Climate Biennial Exploratory Scenarios (BES) cannot be understated. It was a clear instruction that the regulators expect the UK’s biggest banks and building societies to step beyond traditional risk types and horizons and test their resilience to climate-related financial risks. Andrew Bailey’s speech has been hastily followed up another call to arms, this time from Charlotte Gerken in a speech last week at the InsuranceERM event. The BofE’s Director for Insurance used an ancient Greek proverb, to explain two opposing views on the management of risk: the fox and the hedgehog. This analogy was used to describe the management of financial risk, however, it can equally be applied to the way we will need to identify, manage and minimise the impact of climate change. The proverb is simple, the fox is cunning and has many ways to solve a problem whereas the hedgehog knows only one way to outsmart the fox. The fox may plan meticulously to capture the hedgehog, for it to be foiled by the hedgehog’s quick reactions and single ability to curl up into a tight, spiky ball.
In dealing with challenges of our changing climate, we need both the fox’s cunning and the hedgehog’s steadfastness. As a society, more like the hedgehog who recognises danger, we must quickly realise the problem ahead of us. However, more like the fox, we must also accept that there is not one single solution to manage and prevent the worst impacts climate change.
The reason we need so many solutions is because the future of our climate is highly, highly uncertain. We have known unknowns and unknown unknowns. There are numerous emissions scenarios, decided by the actions we put in place now and over the coming decades. Inevitably the scenarios predicting subsequent warming, sea level rise and macro/micro-scale climate change will vary dozens if not hundreds of times in the next 50 years.
Early, UK-wide action will have a positive effect on our resilience as a society to weather the negative effects of climate change in the long-term. However, it is highly unlikely to solve the global problem of reducing emissions enough to slow and eventually reverse climate change. While we must reduce our own emissions, lead by example and transition to low-carbon technology and energies, opportunities exist to model scenarios for a changing climate on a national and regional scale and develop ways to interact with and query those projections, test our resilience and manage the risks.
The saying ‘prior preparation prevents **** poor performance’ has never been so true in the context of an ever-changing climate. We must model numerous emission and climate change scenarios, monitor, and review them against the results of climate actions taken in the UK and across the world. Ultimately, this will mean that while it is essential that banks, insurers and UK PLC are stress-tested against the impacts of climate change now, it is essential that the models used in the 2021 BES are embedded into ongoing operations and day-to-day decision-making. The physical and transitional risks will only become greater and more complex as time goes on.
Physical risks, like subsidence, erosion, and flood are intrinsically linked to different emissions and climate change scenarios. New projections by the Met Office reveal warming is accelerating. In a worst-case scenario this decade, more rapid warming may lead to more energy in the atmosphere and increase the number of winter storm events. This in turn can lead to increased erosion rates, particularly in places such as Hampshire, Surrey and Kent, where large numbers of (high value) properties are at risk. Combining climate change and ground risk models enables us to predict dozens and eventually hundreds of scenarios for erosion rates, soil moisture deficit, slope instability under different emissions scenarios. Importantly, as modelling techniques enable greater granularity, projections across smaller time-slices becomes possible, for example projecting conditions in the winter of 2036 or summer of 2038 rather than the 2030s. This level of modelling, combined with data on property, asset and location, will enable high-resolution risk assessment to be accessed at any time, for any place.
So which scenario is it? To answer the title of this blog, right now, it is all of them. The future is uncertain and like climate models, the future of ground risk in the UK (and around the world) cannot be realistically constrained to one or two scenarios. With so much uncertainty in climate actions, here and globally, most, or a combination of all scenarios may occur. Consequently, we must work to model and make available several scenarios for emissions, climate change and ground risk, to support decision-makers now and as part of their business as usual. We must make like the hedgehog, act quickly and realise the danger and make like a fox, preparing and planning for as many scenarios as possible.
In November 2020, Terrafirma introduced the National Ground Risk Model (NGRM): Climate™, the next generation in ground risk assessment. The NGRM: Climate™ provides financial firms undertaking the Biennial Exploratory Scenarios (BES) on climate-related financial risks with an expertly modelled dataset to understand how ground risk can impact their balance sheet under a changing climate. Combining geological, soils, mining, coastal erosion, landslide and climate data with UKCP18 emissions scenarios provides granular insight into ground risk distribution and severity at property, land parcel or asset level.