Introduction
The financial sector faces an urgent need for accurate and comprehensive climate scenarios. Accurate pricing of risk is essential if there is to be a smooth shift in the flow of a capital to accommodate both transition and adaptation. The current suite of available scenarios falls short in providing the necessary breadth, transparency and detail.
Our proposed climate scenario taxonomy offers a valuable tool for enhancing the transparency, reliability, and applicability of climate scenarios in the financial sector. By addressing the existing gaps in understanding and documentation, this taxonomy can contribute to more effective risk management and sustainable financial practices.
Climate economics is a complex multidisciplinary topic. We must improve the flow and comprehensibility of knowledge from the academic to the financial services sector if financial decision makers are to accurately price and manage these risks. This paper introduces a three-dimensional, six-level taxonomy designed to help address this need. The taxonomy categorises climate scenarios based on their narrative, macro-modelling, and micro-expansion elements, while also identifying geographical and sectoral variations. By understanding the assumptions and calibration choices at each stage of scenario construction, both scenario builders and financial end-users can better evaluate and utilise scenario pathways.
Key Benefits
Guidance for Improved Model Development: The taxonomy and model review will help model developers avoid pitfalls and improve model design and implementation.
Improved Documentation: The taxonomy supports more transparent and detailed documentation by scenario builders, enhancing understanding and credibility.
Enhanced Peer Review: A standardized framework encourages academic peer review, leading to more rigorous evaluation of scenarios.
Expanded Scenario Range: The taxonomy promotes the development of a wider range of scenarios, better reflecting the spectrum of potential climate futures.
Decision-Useful Analysis: By providing a clear understanding of scenario characteristics, the taxonomy enables financial institutions to make more informed decisions.
Regulatory Adoption: Central banks and supervisors should encourage the use of such a taxonomy, driving investment in improved modelling and knowledge transfer between academia and finance.
International Collaboration: International bodies like the NGFS and CGFI can play a pivotal role in creating a comprehensive library of well-documented climate scenarios.
Recommendations
Regulatory Adoption: Central banks and supervisors should encourage the use of such a taxonomy, driving investment in improved modelling and knowledge transfer between academia and finance.
International Collaboration: International bodies like the NGFS and CGFI can play a pivotal role in creating a comprehensive library of well-documented climate scenarios.
