NGFS launches nature framework for central banks and supervisors

The Network for Greening the Financial System (NGFS) has launched a beta conceptual framework to help central banks and supervisors consider nature-related financial risks and develop policies to tackle them.

In March 2022, the NGFS said that nature-related financial risks could have significant macroeconomic implications, and that failure to account for, mitigate and adapt to these implications is a source of risks relevant for financial stability.

To address these risks, the NGFS set up a biodiversity loss and nature-related risks taskforce to help mainstream the consideration of the issue across the group.
Thursday’s report is the first official output of the taskforce. Alongside seeking to create a “common science-based understanding of, and language for, nature-related financial risks among NGFS members”, it includes a framework to help operationalise that conceptual understanding.

The principle-based risk assessment framework consists of three phases.

As a first step, central banks and supervisors can identify and prioritise the sources of physical and transition risk that are potentially material from a microprudential, macroprudential or macroeconomic perspective. During this phase, the report draws particular attention to the relevance of forward-looking, location-specific and systemic dimensions.

Following this, as a second step, central banks and supervisors can then assess the potential economic effects and risks that can stem from the above exposures.

Finally, as a third step, central banks and supervisors can assess the risks to, from and within the financial system that stem from exposure to sources of physical and transition risks.

Unsurprisingly, throughout the report, the climate-nature nexus is highlighted, and an integrated approach is taken in that “climate-related financial risks are strongly interconnected with the broader environmental-related financial risks”.

Speaking at the launch of the framework, European Central Bank board member and vice-chair Frank Elderson commended the work; however, he said that “the time to market” of science-based insights by the NGFS is “way too long”.

And later on, expanding on a point he has made many times, that thinking about nature-related risks are part of central bank mandates, Elderson said it has to be truly operationalised in all the work done.

“So in the speeches, in the conferences that we organise, in the budgets that we make, in the work plans we make, in the training of our people, in the issues that we bring to the international table.”

Next steps
Moving forward, the framework will be refined and supplemented over time. In particular, before the end of its mandate in the first half of 2024, the taskforce aims to supplement the framework with illustrative case studies and evaluate – based on the case studies and progress made in the other taskforce teams – whether the framework needs to be updated.

In addition to the framework, the taskforce is also developing a technical document with specific recommendations towards the development of nature-related scenarios to facilitate forward-looking risk assessments of nature-related financial risks.

During the launch François Villeroy de Galhau, governor of the Banque de France, said this work should be released in December. “The development of these scenarios is a priority as they will underpin the nature-related stress tests we know we will need to conduct, as for climate today, within a few years.”

On scenarios, Klaas Knot, president of De Nederlandsche Bank, said the central bank has embarked on “a first attempt to measure financial risks for a few transition scenarios, such as ending harmful subsidies. We aim to share our findings later this year”.

Knot also said that DNB has started a pilot to explore how the Taskforce on Nature-related Financial Disclosures framework could apply to its own reserves.

ISSB
In de Galhau’s speech, he also stressed that one near term priority is the need for “interoperable standards on nature to facilitate and amplify prudential actions”.

The governor pointed to the recent consultation by the ISSB on its future priorities – which included a proposed project focused on biodiversity, ecosystems and ecosystem services – as well as the European Commission finalising its reporting standard on disclosure rules related to biodiversity and ecosystems.

“I hope that the work undertaken by the Commission and EFRAG, but also by the NGFS will serve as a source of inspiration for the ISSB,” he said.

On a less positive note, and shifting focus to climate change, de Galhau said he has some concerns that this priority is at risk of fading away, “as observed in the most recent G20 and international discussions, due also to the increased polarisation of political debates around climate and environmental issues in the United States”.

“Europe is ahead; the rest of the world shouldn’t lag behind.”