Lessons from CBES for non-participants

The Bank of England’s Climate Biennial Exploratory Scenario (CBES) results were published on 24 May 2022. In this article we highlight how those firms who were not selected for participation in CBES can use the Bank of England (BoE) report to reap the benefits of being a fast follower on climate scenario analysis and enhance their existing risk management.

Background

CBES was devised by the BoE to evaluate the impacts of a range of climate scenarios on the UK financial system, covering the largest banks and insurers, and a selection of Lloyd’s Syndicates and building societies.

The BoE developed three scenarios designed to explore the physical and transition risks of climate change, and asked participating firms to evaluate their risk exposure across their largest counterparties and the longer-term implications on their business models in the following scenarios.

• Early Action (EA): Under this scenario, climate policy is ambitious from the start. Global carbon dioxide emissions are reduced to net-zero by around mid-century and global warming (relative to preindustrial levels) reaches 1.8°C by the end of the scenario, decreasing to 1.5°C by 2100.
• Late Action (LA): Here, the implementation of policy to drive the transition to a net-zero economy is assumed to be delayed by a decade. Global warming reaches 1.8°C by the end of the 2050 relative to pre-industrial levels, but stays about this level at the end of 2100
• No Additional Action (NAA): Here, we assume no additional action is taken to address climate change. The scenario features chronic changes in precipitation, ecosystems and sea-levels, which are unevenly distributed globally, and in some cases irreversible.

What firms can learn from CBES

The exercise was a massive undertaking and the BoE is clear in its report that all firms struggled with aspects of the work. While there was a need to answer the “exam question” set by the BoE it is important now to take a step back and read between the lines. While the Bank is interested in the results and will use them to make future recommendations, far more of its report is focused on data and tooling. CBES, then, can be seen as a wake-up call to the industry that there are some huge challenges to solve on data and tooling before climate scenario analysis can be effective as part of the decision-making process.

Most CBES participants relied on third parties for data and modelling, and firms who were not involved in the exercise and whose thinking is at an early stage can take some reassurance from the embryonic nature of the market for solutions. However, the pace of development is now extremely rapid, in part thanks to CBES, and there is a real risk of being left behind.

Firms can benefit from being “fast followers” and capitalise on the now more developed solutions and greater range of third parties to quickly catch up to the CBES participants who have a head start.

Climate scenario analysis best practice

Firms can benefit from the work done by CBES participants by learning the best practice lessons from this exercise, including those set out by the BoE in their report. In our view, the key messages to take from the CBES results are:

• “Models are only as good as the data that feeds them”.
  • CBES was not prescriptive on the approach to climate modelling, so participants had the flexibility to choose their own approach and assumptions. While this improved their climate risk management in some areas, it revealed that there are significant limitations and gaps in data (such as details about corporates’ current emissions and the location of corporate assets) to enable the assessment of the physical risks on those assets at a more granular level. Data challenges require considerable time and effort to solve, and there is unlikely to be a single one-size fits all data solution that meets all companies’ needs. A good way to approach this challenge is to start now in building better processes that can enhance data capture, and can evaluate the data providers that best meet your needs on an ongoing basis.
• “Companies need to be clear on their requirements for climate models now, while building flexibility to refine them in future”.
  • Even the largest CBES companies relied on third party providers for modelling, especially for private assets. Firms will need to consider the offerings from different providers on the market and understand their relative limitations. One of the best practices noted in the BoE report for insurance participants was expanding the list of physical perils beyond the scope of the prescribed catastrophe models. Choosing the most appropriate model is a balance of cost and flexibility, and none are perfect; but we are regularly seeing solutions rapidly evolving, and new solutions coming to market that use the latest scientific & academic research to further improve risk modelling.  Being clear on your requirements, while understanding which of these are most important to your organisation at a point in time, while having the flexibility to refine them for future changes in the market, will help you to keep the right balance between pragmatic solutions and market developments.
• “Companies could save time and cost and improve effectiveness by specifying their modelling in such a way to meet multiple disclosure requirements by design”.
  • There is a lot of buzz around upcoming disclosure regimes, including SFDR and TCFD from industry bodies, as well as proposals from the main regulatory bodies (the SEC, the ISSB and EFRAG). The efficiency and effectiveness of producing scenario results can be enhanced by identifying up front how the disclosure regimes align and interact, and by approaching scenario modelling in a way that is suitable for multiple disclosures. This will save time in the long run, as well as improving consistency - ensuring a single version of the truth across multiple disclosures.

The CBES Exercise has been a valuable learning experience for participants in terms of understanding their exposures and sizing up the extent of the challenges they face in enhancing climate scenario modelling. Other firms can benefit from the best-practices discussed above, but will need to work hard to avoid being left behind by leading firms as scenario modelling develops.

Crowe's climate expertise

Crowe has a track record of helping clients to build a sustainable future and deliver improved performance by putting sustainability considerations at the heart of their organisations.  We have considerable experience in supporting Financial Services clients across all aspects of climate modelling and reporting including:

• identifying and collecting climate data, carrying out data quality assurance and understanding the value and use of proxy data
• working in collaboration with third party models to help our clients to choose and implement models, and analyse scenarios to assess their future organisational vulnerability to climate change
• helping firms to address their climate and sustainability reporting requirements and voluntary disclosures in a way that supports their engagement with stakeholders and future-proofs them against upcoming changes to disclosures.

If you would like further information on any of the issues discussed above, please get in touch with Justin Elks or Lloyd Richards.