The Sustainability Story: Episode Summary

Title: Livio Stracca, PhD: Pioneering Short-Term Climate Scenarios for Financial Decision-Making
Host: Deborah Kidd, CFA Institute
Release Date: July 23, 2025

Introduction

In this insightful episode of The Sustainability Story, host Deborah Kidd engages with Dr. Livio Straka, the Deputy Director General for Financial Stability at the European Central Bank (ECB). Dr. Straka delves into the groundbreaking work of the Network for Greening the Financial System (NGFS) in developing the first publicly available short-term climate risk scenarios. These scenarios are designed to aid regulators and financial institutions in understanding potential disruptions to financial systems caused by climate policies, extreme weather events, and economic shocks within immediate business and policy planning horizons.

Dr. Livio Straka's Sustainability Journey

Timestamp [02:18]

Dr. Straka shares his unexpected entry into the sustainability field:

"I stumbled on sustainability in the sense that I was working on most other issues... I was asked to chair the scenario workstream of the NGFS... it was by chance."

Despite initially having no extensive background in climate and sustainability, Dr. Straka embraced the challenge, rapidly acquiring the necessary knowledge and developing a deep commitment over three years:

"It was a steep learning curve at the beginning, but I think now... I feel I'm really into it now."

Development of Short-Term Climate Scenarios

Timestamp [04:45]

Dr. Straka explains the motivation behind creating short-term climate scenarios. While long-term scenarios had been established by organizations like the IPCC, NGFS recognized the need for scenarios aligned with the shorter decision-making horizons typical of economic and financial authorities.

"Decisions are taking place on a much shorter horizon... it became quite natural to want to shorten the horizon of these scenarios."

Additionally, feedback from user surveys highlighted a significant demand for short-term scenarios, prompting NGFS to innovate in this area.

Overview of the Four Short-Term Climate Scenarios

Timestamp [06:26]

NGFS developed four distinct short-term climate scenarios, categorized into transition risks and physical risks:

Transition Risk Scenarios

1. Highway to Paris

   • Nature: Orderly and efficient convergence to net-zero emissions.
   • Narrative: Countries implement policies that align closely with their Paris Agreement commitments.

2. Sudden Wake-Up Call

   • Nature: Abrupt and less efficient transition.
   • Narrative: An unexpected shift towards net-zero leads to more distortionary carbon policies.

Physical Risk Scenarios

3. Pure Physical Risk

   • Nature: Severe climate events occurring based on historical extremes.
   • Narrative: Events like floods and droughts cause significant economic disruptions, varying by region.

4. Emerging Realities

   • Nature: Interaction between physical and transition risks.
   • Narrative: Severe climate events in emerging economies disrupt the supply of critical raw materials, elevating transition costs in advanced economies.

Dr. Straka emphasizes the intentional design of these scenarios to provide meaningful, narrative-driven frameworks that serve as useful starting points for stress testing and financial planning.

Key Results and Implications of the Scenarios

Timestamp [10:43]

The short-term scenarios reveal substantial economic impacts across different regions:

• Africa: Up to 12.5% GDP loss under disaster scenarios, with ripple effects globally.
• Europe: Approximately 5% GDP loss.
• Asia: Around 7% GDP loss.

Dr. Straka notes that physical risks have more pronounced economic effects than anticipated:

"The physical risk scenarios all have rather large effects... probably larger than what most people expect."

Additionally, transition risks notably influence macroeconomic indicators like inflation:

"The impact on inflation is rather muted for the physical risk scenarios, but it's actually larger for the transition risk."

The scenarios also include a comprehensive set of macro and financial variables, such as:

• Macro Variables: GDP, inflation, sectoral impacts.
• Financial Variables: Interest rates, equity prices, risk premia.
• Sectoral Variables: Agriculture, energy production (coal vs. renewables), etc.

These variables are accessible and can be utilized by financial institutions for detailed analysis.

Applications for Central Banks and Financial Institutions

Timestamp [16:36]

Central Banks

Central banks can integrate these scenarios into their monetary and fiscal policy frameworks. For example, under transition risk scenarios that lead to inflation spikes due to abrupt shifts in carbon pricing, central banks might respond by adjusting interest rates accordingly.

"In the transition risk scenario... you have larger inflation spikes... and you have a rise in interest rates."

Financial Institutions

Investment firms and insurance companies can use the scenarios to evaluate geographic and sector-specific risks. For instance, a real estate investor could assess the impact of physical climate risks on properties in different regions.

However, Dr. Straka advises that while the scenarios provide a robust framework, users may need to adapt the data for specific applications:

"Users can make some basic adjustments... expect users to run some kind of auxiliary analysis."

Future Directions and Continuous Improvement

Timestamp [23:05]

Dr. Straka outlines NGFS's commitment to regularly updating both long-term and short-term scenarios to reflect evolving climate policies and scientific advancements:

"The long-term scenarios... are updated every three years... we should make significant and positive adjustments for the next release."

He also acknowledges the dynamic nature of climate science, particularly concerning tipping points and non-linearities, emphasizing the importance of staying grounded in current scientific understanding while remaining open to new developments.

"We are really used to being very analytical, cautious... we need to be very grounded as much as possible in science."

Engaging with NGFS and Providing Feedback

Timestamp [28:48]

NGFS encourages users to engage with their resources and provide feedback to refine future scenario iterations:

"We are particularly interested in the experience of those who actually use the scenarios... users can email questions... it was a real pleasure."

The organization views the current release as a prototype and actively seeks input to enhance the tool's relevance and accuracy.

Conclusion

In this episode, Dr. Livio Straka sheds light on the innovative short-term climate risk scenarios developed by NGFS, highlighting their significance in shaping financial stability amidst evolving climate challenges. The detailed discussion underscores the collaborative efforts between central banks, regulatory authorities, and financial institutions to integrate sustainability into economic decision-making. As NGFS continues to refine these tools, the dialogue between experts and users remains pivotal in advancing robust, science-based strategies for a sustainable financial future.

Connect with the Hosts:
For more information or to reach out regarding sustainability-related topics, contact:

• Deborah Kidd: Deborah.Kidd@cfainstitute.org
• Nicole Gehrig: Nicole.Gehrig@cfainstitute.org
• Paul Moody: Paul.Moody@cfainstitute.org

Learn More: Visit ngfs.net for detailed documents, scenario releases, and resources related to climate risk management.