Carbon Risks of the Economy and Stress Test for the Financial Sector

Navigant supported the German government to detect and mitigate risks related to a carbon bubble

Challenge

The transition to a low carbon economy poses risks to the financial sector. In 2015, the G20 questioned whether investments in fossil-fuel-dependent infrastructure could lead to global financial risks — the so-called carbon bubble. A carbon bubble refers to the idea that companies relying on fossil fuels are incorrectly valued on the stock markets as the true costs associated with climate change and respective policies have not yet been taken into account.

Solution

As G20 president at the time, the German government by means of the German Environment Agency (UBA) commissioned a consortium to analyze and evaluate the risk of a carbon bubble in the German financial system. Navigant Consulting, Inc., along with the University of Oxford (Smith School of Enterprise and the Environment), Triple A Risk Finance, Global Climate Forum, University of Zurich (Finexus), and Germanwatch, were part of this consortium and jointly:

  • Assessed the carbon risks in the German economy
  • Conducted a carbon stress test for German financial institutions
  • Developed regulatory instruments to mitigate carbon risks in financial markets in Germany and beyond

Impact

The outcome of this highly relevant project enabled the German government to detect, understand, and mitigate risks related to a carbon bubble. A tool was developed for the UBA that enables the German government to assess the financial loss of a given sector due to the materialization of carbon risks under different climate scenarios, such as, for example, the 2°C climate scenario of the International Energy Agency. In addition, the project team developed an open-source tool that can be used by financial institutions to stress test financial portfolios against carbon risks under different climate scenarios. The experts also proposed regulatory instruments to the German government to mitigate carbon risks in financial markets in Germany and beyond, such as disclosure and reporting of carbon metrics and including carbon risks in fiduciary duties of institutional investors and asset managers.

About the Experts

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