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Climate change Plotting our course to Net Zero
Speech given by
Sarah Breeden, Executive Sponsor Climate Change and Executive Director,
UK Deposit Takers Supervision
University of Edinburgh and Environmental Association for Universities and Colleges
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Webinar
18 May 2021
I am hugely grateful to Ryan Barrett for his assistance in preparing these remarks; to Chris Faint,
Zane Jamal, Theresa Löber and Edo Schets for their comments; and to all those involved in the
NGFS work on climate scenarios.
Introduction
Good afternoon everybody. Thank you for the kind introduction Peter and to the University of
Edinburgh and the Environmental Association for Universities and Colleges for hosting this event.
Making sustainability a core part of education is essential for inspiring the leaders of tomorrow and
initiating the research and innovation that is needed for the momentous task ahead of us. I am
honoured to be here today.
Over the past year, we have seen scientists and academics, universities, pharmaceutical companies
and governments work together at unprecedented speed in a race to develop Covid-19 vaccines. A
task that was seen as nigh on impossible back in March 2020 has been achieved through urgency,
innovation, and collective action.
We must bring that same urgency to tackling climate change. Yet the race to achieve net-zero
emissions ('net zero') by 2050 is a multi-decade marathon, where the starting gun has already fired,
and getting to the finish line will require a sprint start, with a reduction in global emissions of a half by
2030 [figure 1 in the Appendix].1
- both what we know and what we don't
What I would like to talk about today is how we get there
know - and the important role of climate scenario analysis in helping us plot the best course.
Governments will of course play a central role in laying the track, removing hurdles and setting the
pace as we move to net zero. Over 110 countries, including the UK, have now moved to enshrine net
zero emission targets in policy or law and are working on detailed plans of what these look like in
practice.2
But climate change and climate policy will affect everyone - businesses from all sectors of the
economy, public bodies like the Bank of England, households and individuals. And so we all have a
stretch of the race to run. Some will perform strongly, others may struggle, and some, particularly in
less developed countries, might need a helping hand. But let's be in no doubt. We need everyone to
finish.
Role of the financial sector
Let me first say a few words about financial institutions given the unique role they play in this race.
As corporates, these firms have some direct emissions but they are not significant. Their success in
reaching net zero will instead be driven by their ability to reduce the emissions of the businesses and
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households they lend to, insure or invest in their so-called "financed emissions".
One perhaps obvious way for them to deliver such rapid reductions is to immediately divest
exposures to companies with high emissions and instead invest in companies with low emissions.
Financed emissions would fall sharply.
However, while individual investors can divest, the financial system as a whole cannot. And with a
fixed budget of emissions to reach net zero, if the real economy transition is simply delayed, the
sharper and riskier it will be. In this way, seemingly rational individual actions can make our collective
future problems bigger.
Instead we need those with high emissions today to make the biggest effort to reduce emissions
tomorrow. And we need the financial sector to steward them through that transition, as well as to help
to build greater resilience to physical risks.
This can be done through the provision of finance and risk management solutions that support firms in
making changes to business models and operations to align with the transition. And through support
of investment in new green companies and technologies that help pull the transition forward. If
managed smoothly, this represents a great opportunity.
As a supervisor and central banker, however, I worry about outcomes where this smooth transition
does not occur. Either because temperatures continue to rise as the transition is eluded; or because
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we face a disorderly transition - a so-called climate Minsky moment as a significant number of
otherwise productive assets have to be abandoned; or as asset prices adjust whilst risk and return are
repriced.
To avoid such outcomes, financial firms need to manage these risks not as they materialise but
instead by looking ahead over much longer time horizons than they are used to. And, as our
supervisory expectations of banks and insurers make clear, they need to act strategically and
pre-emptively, taking different decisions today, well before the consequences of inaction become
clear.3
Climate scenario analysis
Climate scenario analysis provides us with the toolkit for doing just that. To look forwards not
backwards, with a horizon of decades not years. In recognition of the uncertainty we face about what
might happen to our planet and our economy, some scenarios show the most efficient pathway to net
zero, while others highlight the risks of fragmented policies or insufficient action. They can all help
guide actions today.
Plotting the transmission channels of climate risks into economic and financial risks is a fiendishly
complicated task [figure 2].
The channels from climate to financial risk are numerous, with significant interdependencies. The
data and methodologies to translate climate outcomes into macroeconomic and financial risks are
incomplete and inadequate. And of course the future path of the climate risks themselves is subject
to huge uncertainty. But given the urgency of our challenge, we cannot let uncertainties and
complexities lead to inertia and inaction.
Scenarios are generally comprised of three key components:
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Transition models that set out how energy production and land-use can adjust to lower
emissions and meet a given carbon budget or temperature target;
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Physical models that set out projections for how living conditions and extreme weather
would shift given a pathway for emissions; and
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Economic models that quantify the potential impacts from both transition and physical risk
on the economy.
This is unfamiliar territory for most central banks, businesses and the financial sector. It is however
territory we all need to get familiar with if we are to find the right climate path.
Our desire to improve our understanding and capability to measure and monitor these risks inspired
us to launch a project to co-design climate scenarios together with world leading climate scientists
and 60 other central banks and supervisors that are part of the macrofinancial workstream of the
Network for Greening the Financial System or NGFS.4
It has been a truly interdisciplinary effort. We have had to integrate a suite of models across each of
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the areas physical, transition, economic, financial to deliver insights [figure 3]. The scenarios the
NGFS have produced pull together, for the first time, both transition risks and physical risks, and their
economic and financial consequences, in a coherent way. As a result, they are decision-useful,
reflecting the totality of risks we will face.
A guiding principle has been to try to shine a light on some of the uncertainties that exist. We have
focused on multiple scenarios and multiple models to highlight the range of potential outcomes. Since
modelling these impacts is subject to significant uncertainty and extensive academic debate, our work
is open source and we seek your expertise and challenge.
The first iteration of these scenarios, published in June 2020, drew from the existing work on
mitigation pathways, climate change and adaptation that supported the Intergovernmental Panel on
Climate Chance (IPCC) Special Report on Global Warming of 1.5°C.5 The NGFS will next month
release an update, which will include bespoke scenarios, detailed macroeconomic modelling and a
new online portal that can be used to explore physical risks.
Insights from the design of the NGFS climate scenarios
would like to share some of the insights I've
I gleaned from this work.
we don't know, but this doesn't do justice to how much
First, we often talk about how much
work has been done.
We know that today three quarters of our emissions come from surface transport, heating our
buildings, manufacturing goods, the food we eat, and producing electricity [figure 4]. By 2050 these
emissions will have to be almost completely eliminated.
Any remaining emissions, mainly from aviation and animal methane, where there are currently no
viable alternatives, would need to be offset by increasing the lungs of the earth. For example, through
planting more trees, sequestering carbon in soils and biomass crops.
Although there are many differences across models, the key building blocks of the transition are pretty
clear [figure 5].
Eliminating emissions from fossil fuels will require an increase in the share of renewables in the
energy mix, greater electrification, improving energy efficiency, finding substitute fuels (like hydrogen
or synthetic fuels) for use in heavy industry and transport, and capturing and storing emissions where
it is most feasible or necessary to do so.
Eliminating emissions from land-use requires us urgently to prevent deforestation and implement
more sustainable agricultural processes related to tillage, crop cover, fertilizer use and animal-related
emissions.
A number of different types of policy measures can take us there. Carbon pricing - like the UK
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emissions trading scheme is one tool to provide clarity on the route ahead.6 Other tools include
changing business regulation (such as preventing the sale of internal combustion engines), fiscal
policies (such as changes in subsidies and taxes) and research funding to spur on private and public
sector research and development.
In aggregate, these policies will need to internalise the costs of emissions to drive the shift in activities
that I have just described.
Our preliminary NGFS analysis suggests that these policies will need to add up to an equivalent
global shadow carbon price of over $150 a tonne within a decade if we are to meet Paris goals and
reach net zero by 2050 [figure 6].7 Considering what that forward shadow carbon price should be is
an essential consideration when making any investment decision today.
Second, the cost to the economy in aggregate of getting to net zero need not be substantial.
Our experience of the transition so far has been that costs for nascent technologies tend to fall much
more quickly than we initially expect once they start to gain traction and momentum.
Many transition models, including those leveraged for the NGFS scenarios, have for example
underestimated how quickly the price of renewables has fallen in recent years. Well-designed policies
and new technologies also bring new jobs and can lead to higher growth.
Our latest economic modelling suggests that reaching net zero, if the transition is managed well,
might have a small or negligible effect on economic aggregates such as GDP, unemployment and
inflation [figure 7]. Indeed depending on what investment means for productivity, there is a chance the
transition could prove positive overall.
However, these costs depend crucially on whether the transition follows an orderly or disorderly path.
Emission reductions may not follow a straight line as shown in many scenarios. It takes time for
policy to work and policy adjustments will also be needed along the way.
There may be higher investment uncertainty. Markets will not allocate capital perfectly, and without
certainty about policy and technological outcomes, there may be bumps in the road as they absorb
news about our path.
In the NGFS we explicitly capture some of these transmission channels in our disorderly scenarios,
for example by modelling delays in policy action and policy fragmentation across countries and
sectors. They result in much higher impacts, particularly in countries with greater dependence on
fossil fuel consumption or exports.
This work underlines that central banks and supervisors, and the financial firms and system that we
oversee, need to be prepared for a range of outcomes. But it also underlines that early action brings
lower risks.
Third, the impacts from physical risks will be significant. Even where we manage to limit the rise
in global mean temperatures to 1.5 degrees, physical risks are likely to dominate the potential impacts
of transition. And if instead we continue on our current trajectory, losses just from the impact on
productivity could be as high as 13% of GDP.8
In addition, many of the leading studies, including those we used in the NGFS, start from past
correlations and so find it hard to put an accurate number on the type of low-probability, high impact
warming will be unprecedented, we don't
events that will become more common. As high levels of
yet fully understand the delicate balance between the climate, living conditions, ecosystems and the
economy - for example, the level at which ice melts might accelerate; or methane stores under
permafrost might be unlocked.
What is clear is that investment is needed now to help adapt to these inevitable changes. And that we
should recognise the gaps in our understanding of how large changes to our climate might affect our
economies.
Challenges in applying scenarios
While these key themes are clear, I know from our own experience, and from the firms we supervise,
that applying the scenarios in practice is not straightforward.
The models, data and analytical frameworks are new, and the transmission channels are complex
and subject to much uncertainty. The results can be sensitive to input assumptions and type of model
used.
This leads to a tendency to focus on a limited number of transmission channels and pockets of risk -
for example, focusing on the costs of emissions in the most carbon-intensive sectors and ignoring
other channels like changes to demand or costs of energy and materials. But these are important
channels too. We need to capture all potential dependencies and feedback loops.
There are obvious dangers too in relying on past data and historical correlations for what is an
unprecedented challenge. We need to re-examine existing models and consider whether climate
change will cause some of these relationships to shift. There are perhaps parallels to the financial
crisis where models provided false comfort. The most obvious case for this is in physical risk where
we know there are non-linearities that are not well captured.
All of these factors lead me to believe that financial firms and businesses are significantly
underestimating the potential impacts, and 'green swan' events are not just possible but likely until
capabilities, understanding and management of these risks are greatly improved.
I would offer a few pieces of advice to users of scenarios.
 get bogged down in a This can be unhelpful and
Don't spurious amount of precision.
unnecessary for decision-making. Sound qualitative assessments supported by some
quantitative analysis and reasonable assumptions can be even more insightful. That is why,
Bank's own
for the Climate Biennial Exploratory Scenario exercise which we formally launch
next month, we are putting emphasis on the qualitative questionnaire and an assessment of
business model changes, rather than the traditional capital-adequacy metrics.9
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Look at both physical and transition risks coherently as you undertake your analysis
and as you determine your strategic response. Some combination of these risks will
If you are assuming there is no price on carbon in your risk models, you're
materialise.
implicitly assuming a high degree of warming. If you do believe some policy action is
inevitable but don't price of carbon is, don't assume it is zero.
know what the shadow That is
equivalent to not knowing for sure how Bank rate will evolve but assuming it away when
discounting over 30 years.
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Given the sensitivity to core assumptions, there is considerable value in running
credible, independent, standardised scenarios. That will make your results more easily
comparable to others, even if you use in addition other scenarios and models that you find
more relevant to your business.
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Don't be afraid to share lessons learned, disclose key assumptions and limitations in
your analysis and where possible work together to improve understanding. Here it is
worth highlighting the excellent work being done by the Climate Financial Risk Forum in the
UK which brings together senior financial sector representatives to build capacity and share
best practice in managing climate-related risks and opportunities. The working group on
scenario analysis has produced some really useful guidance and tools that should be useful
both to financial firms and to businesses.10
Next steps
It is critical that financial firms recognise now that the race to net zero has started. Indeed many
have.11
In support of their ambitions, and consistent with our expectations, they need to run climate scenarios
as part of business as usual risk management and embed climate risk management within day-to-day
decision-making. Time is running out. Perfection tomorrow cannot be the enemy of progress today.
We also need experts from academia, think tanks and consultancies to fill in the blanks, helping turn
the high-level into ground-level decision-useful material. A lot of promising work is already happening
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including NGFS-led work to increase the sectoral granularity of risks and to quantify the impacts
from flooding and tropical cyclones. But more research is needed. I will highlight three areas in
particular:
 What are the implications of government policy design on the transition, particularly on jobs,
productivity, prices and different sectors of the economy?
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What will the impact of physical risks be on assets and on the economy taking into account
different possible transmission channels and non-linearities?
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What will the impact be on the financial sector, and constructively, how can the financial
system play a role in climate mitigation and adaptation?
Conclusion
Let me conclude.
Dealing with the climate crisis is an unprecedented challenge. Building the toolkit to help us do that is
similarly unprecedented. But climate scenarios can help us plot the best course to net zero and they
can highlight the dangers of straying from that path. The private and the public sector need to build
on our early progress, both by recognising what we do know and urgently filling in the gaps for things
we do not.
Through climate scenario analysis, we have seen much closer collaboration between different groups
of academics, other specialists, the financial sector and businesses. This has led to some fantastic
work and insights that can drive the action we need now. If we are to rise to the climate challenge, we
need to continue in this spirit and tackle some of these big outstanding questions together.
In the race to net zero everyone needs to participate, and there are no silver medals. Do join the
team.
APPENDIX
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Figure 1 The Race to Net Zero emissions by 2050
Source: Bank graphic based on NGFS data
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Figure 2 Transmission channels from climate risks to financial risks
Source: NGFS Climate Scenarios for central banks and supervisors
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Figure 3 NGFS suite of models
Source: NGFS Climate Scenarios for central banks and supervisors
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Figure 4 UK emissions today
Source: Bank calculations based on the Committee on Climate Change 6th Carbon Budget
Assessment
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Figure 5 Reaching Net Zero in the UK
Source: Committee on Climate Change 6th Carbon Budget
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Figure 6 Global shadow carbon prices consistent with Net Zero 2050
Source: Preliminary analysis for the updated NGFS Climate Scenarios
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Figure 7 Impact on global GDP (relative to prior trend)
Source: Preliminary analysis for the updated NGFS Climate Scenarios