How Norges Bank is modelling climate change
As a long, hot summer draws to a close (hopefully), Ginni Goldin, senior climate risk analyst at Norges Bank Investment Management, which runs the $2.2tn Norwegian pension fund, tells AOX how the manager has been building a model that can quantify how the companies in the portfolio will be affected by climate change (Fredrik Solstad/Bloomberg)
Good morning. It’s been a long, hot summer for many of us and that highlights the ways in which climate change may affect our lives.
This obviously has an investment angle that asset owners will have to bear in mind. Can a company’s business model survive climate change?
One of the asset owners that has been thinking carefully about this is the $2.2tn Norwegian pension fund.
Ginni Goldin, senior climate risk analyst at Norges Bank Investment Management, which runs the fund, explained to me how the manager has been building a model that can quantify how the companies in the portfolio will be affected by climate change.
She said: “Every model that we use and have used rests on a number of assumptions and the question is how plausible are the assumptions we make.”
The model NBIM uses takes a bottom-up approach which, as Goldin describes it, is “off-the-shelf” and has been used by the fund for several years. It looks at the physical risk to companies of climate change.
It also uses an internal, top-down approach that NBIM has developed itself.
Goldin said: “The second approach is to plug some of the holes in the first. It looks at how economies are impacted by chronic physical risk and translates that to our portfolio by asset pricing.
“There is obviously a relationship between the GDP of a country and the companies which operate in that country.”
So far this approach is only being applied to listed US equities, which make up about 55 per cent of the fund’s equity exposure and nearly 40 per cent of the total fund.
Using a bottom-up model, Norges Bank estimates that between 1 and 8 per cent of the whole portfolio is at risk across multiple scenarios.
The top-down approach estimates losses for its US equity holdings, in a scenario consistent with current policies, to be between 8 and 10 per cent relative to a baseline scenario without climate change.
(The results of the bottom-up model and top-down model are not cumulative, nor is one more accurate than the other, they are just different ways of measuring the same thing)
But then we get to the bits where Norges Bank is less certain.
Goldin said: “We know what our approach doesn’t include and that is the links between countries.
“Economies are not isolated. If there is a flood in China and China supplies some parts of semiconductors to Europe, then that would impact the European economy.
“We are not capturing that and the reason is not because it is outside the scope of the model but there is no consensus in academia about what the model is we should be using for that.”
Things get less clear and more theoretical when you get to systemic impacts, such as the impact of slowing ocean currents such as the Gulf Stream.
Goldin said: “These currents regulate the climate. What does that mean for a specific geography? Is it that Europe is cooling? But what could happen to the US? It might impact other systems.
“Let’s say it is cooling, then how much? The reality is that on the science side there is no consensus on whether it is slowing down.
“The assumptions you need to make become so large that it becomes almost indefensible.”
Christopher Wright, head of sustainability and geopolitical risk at NBIM, said: “We are trying to capture plausible scenarios which give you a meaningful output which you can explain.
“If it is simply a number that there is so much uncertainty attached to then you are not providing anyone with good information.”
The result is that Norges Bank admits that its model does not capture the risks and uncertainties involved.
So with so much uncertainty, is there any reason to be optimistic that asset owners will be able to get a handle on the portfolio effects of climate change?
Goldin said: “You have to be optimistic. Some of the smartest people in the world are trying to solve these problems.”
Wright added: “There is a lot of effort to crack this particularly with more information driven by AI.
“In some cases we compete [with other asset owners] but on this there is a lot of information sharing. People are trying to reach the same goals - bilaterally and through academia.”
