NGFS launches recommendations for developing nature scenarios

Report seeks 'as much synergy as possible' with the approach and methodologies of NGFS scenarios developed to assess climate-related risks.

The Network for Greening the Financial System (NGFS) has published recommendations to help central banks and supervisors develop scenarios for assessing nature-related economic and financial risks. 

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 created a taskforce focused on biodiversity loss and nature-related risks to help make mainstream the consideration of the issue across the group. 

The first official output of the group came in September with the launch of its beta conceptual framework to help central banks and supervisors consider nature-related financial risks and develop policies to tackle them. 

Climate synergies and differences

According to Wednesday’s report, the recommendations “seek as much synergy” as possible with the approach and methodologies of the NGFS scenarios developed for the purpose of assessing climate-related risks, “so as to minimise additional work and additional resources”. 

However, the report noted that although existing climate scenarios and future nature scenarios will naturally overlap in many ways, “they can also diverge and even generate trade-offs, limiting the possibility for a single risk assessment framework”. 

Ravi Menon, chair of the NGFS and managing director of the Monetary Authority of Singapore, said: “While the NGFS will leverage on existing knowledge in building climate-related scenarios, the highly localised impact of nature loss introduces complexities on data needs and modelling capabilities. We hope to inject further rigour and advance the work of central banks and financial supervisors collectively on this endeavour.” 

The report is structured around two topics, which the NGFS said corresponds to the two steps typically needed to conduct forward-looking risk assessments: identifying hazards (sources of physical and transition risk) and identifying methods and tools – models – through which the impact of these could be assessed.

The first provides guidance on how central banks and supervisors can develop narratives through which they can identify relevant physical and transition nature-related hazards.

However, the report said developing such narratives of nature-related scenarios “poses at least three significant challenges”.

One challenge is the fact that ecosystem functions and processes are more complex than climate change, with multiple metrics to be tracked – for example species abundance, genetic diversity and surface and underground water. Another challenge is the “potential non-linear dynamics at stake” because of “positive and negative feedback loops within and among ecosystems”. 

To overcome these challenges, the NGFS suggests two complementary methodologies for physical risks: the Environmental Sustainability Gap – Strong Environmental Sustainability index (ESGAP-SESi) and INCAF-Oxford.

For transition risk, the report suggests a methodology based on “a comprehensive assessment of different frameworks that help understand the variety of policies and socioeconomic evolutions that could be implemented to reverse nature loss”.

“The outcomes of such narratives could then be used as inputs to economic models and tools aimed at assessing nature-related financial and economic risks,” said the report.

The second step outlined in the report focuses on the modelling of economic impacts of the narratives identified. For example, the impact on GDP of a disruption in an ecosystem or how nature-related policies could affect different regions and sectors. The NGFS suggests models and tools that can help understand the macrofinancial relevance of the narratives.

In its final section, the report sets out short and long-term options for central banks and supervisors to help them move forward with the development of quantified nature-related scenarios.