Ian Pollick, Global Head of FICC Strategy at CIBC Capital Markets joins host Dominique Barker to provide key insights and explanations on the Bank of Canada and OSFI climate scenario analysis.
Dominique Barker: Welcome to The Sustainability Agenda, a podcast series focusing on the evolving complexities of the sustainability landscape with a view on addressing current issues in a concise format to help you navigate and take action. I’m your host, Dominique Barker. Please join me as we explore today’s most pressing matters with special guests that will give you some new perspective and help you make sense of what really matters.
Ian Pollick: A promise tomorrow is worth a lot less than trying today. My mom used to tell me that in effect, delayed action leads to a very steep transition curve. That just means you have a much smaller window to achieve those goals.
Dominique Barker: Today, we’re going to talk about the recently published Bank of Canada scenario analysis in conjunction with Ossfy. So let me just start by giving a little bit of background before we speak to our guest, Ian Pollick today. Six financial institutions in Canada were included in the analysis. They included RBC and TD, which are considered having systemic risk to the financial system. And there was also a study of all the bond holdings for insurance companies and those included Manulife Sun Life, as well as some property and casualty insurance companies such as Intact and Co-operators Group. So the primary reason for this undertaking was knowledge by the Bank of Canada. And it’s interesting to note I just want to note that they narrowed the risk to transition risk. And as a reminder, we’ve talked about this on the show before. Transition risk is the risk to business strategy in a net zero world. And that’s important because I would note that around the same time, the ECB came out with similar scenario analysis and they focussed on physical risk of climate change. And as a reminder, again, physical risk of climate change is the impact of floods and fires to physical assets. And if you think about it, that makes sense. Canada over indexes on transition risk. Given a lot of our extractive industries and we’re an export economy and Europe has more physical risk of climate change. And if we think about some of those low lying levels of cities such as London or the Netherlands, we can think about how that might be a more important climate change risk to look at from a central bank perspective. So the Bank of Canada undertook this climate analysis, and today we’re going to speak to Ian Pollick about this. Ian is a managing director and head of fixed income, currency and commodity strategy here at CIBC Capital Markets. And I would note he also has his own podcast, so please check that out. He’s a pro on podcast. Welcome, Ian.
Ian Pollick: Oh, thanks for the pressure.
Dominique Barker: Let’s start with a setup. Do you want to give us a little bit of background information and maybe you can discuss the four scenarios that were considered?
Ian Pollick: Absolutely. So before we talk about what those four scenarios were, some context is important. And let’s start off talking about why did they even do a scenario analysis? I think it’s not too surprising to suggest that there’s obviously considerable uncertainty, obviously, around the endpoint of the energy transition. We know exactly where we want to go, but the path to get to that point, it’s just ripe with a lot of risks by mapping those risks out now. I think that policymakers can have a better understanding of just how to course correct in real time. And moreover, you know, the scenarios they do vary in their timing. They vary in their reach of how you achieve that endgame. All those scenarios really look to structural supply side change and not just on the hope that technology in of itself will get better to facilitate the transition. So all the scenarios were pretty much consistent with baselines that we know exist today. That is to limit global warming to below two degrees Celsius and rely on what the current negative emission technologies as they stand are right now. So obviously, you know, there’s endless scenarios that you could run. So it’s important for policymakers, I think, just to focus on the climate transition related credit and market risks that you were talking about in the introduction. And they really focus on 10 of the most sensitive sectors. And you know, for context, I’ll try and ramble this off top of my head. You know, I think they included primary energy, agriculture, electricity, energy intensive industries. And I think more broadly there were some transportation as well as some others. So ultimately, the end objective of the analysis was to increase the understanding of the financial sectors potential exposure. And that, just like I said earlier, just helps regulators understand how current governance, how current risk policies may actually exacerbate these risks, as well as to identify opportunities more generally. So let’s just talk about the size of the risks. I know you briefly mentioned it, you talked about bond holdings. You talked a little bit about what the loans outstanding are. And you know, collectively, we’re talking about a quarter trillion dollars of potential financial assets at risk. And for further context, that’s about 12 percent of the Canadian economy. This is a very big number. So obviously we have to manage expectations going into it, which is why this analysis is so crucial. You know, also note that if we think about the timeline of the analysis and believe it started in twenty twenty, I believe it had an end goal of twenty fifty. So it’s really a 30 year kind of window that people are thinking about how to get out of that transition. The last thing I’ll say is that this isn’t an actual forecast, right? It’s imperfect knowledge. It’s just a scenario analysis. And because facts on the ground change, I’ll tell you right now, Dominique will probably be back on this podcast a year from now talking about the exact same thing, but with very different scenarios. So let’s just kick off. I’m done with my background info. What were the scenarios? Scenario number one is the baseline assumption, and that baseline assumption is based on 2019 global climate. Policies, this scenario assumes that you have a continued rise in emissions. You have a continued increase in average global temperatures in the range of about two and a half to three and a half degrees per year by two thousand one hundred. And from a technology perspective, and this is key. This scenario, which is the baseline again, it assumes a very slow pace of innovation and it assumes very limited carbon dioxide removal technology. The second scenario assumes an immediate policy remediation, and that remediation effectively helps to limit the average global warming to below two degrees Celsius. Now, implicitly, this scenario also assumes that beginning in twenty twenty collective global action is taken, and that action produces that reduction of two degrees by twenty one hundred. When we think about the technology, that’s implicit in the assumptions in this scenario, it is for a moderate pace of tech change, as well as very limited CD-R technology. The third scenario assumes a delayed policy action, really one that limits average global temperature warming. This is the slow now faster later scenario that cedes about a decade of inaction, so nothing really happens until 20 30 in this scenario. The real ambition the real kind of urgency kicks down, kicks in the road later on and similar to scenario two. You have very similar technology restrictions. The final scenario is what I like to call the Fast and Furious scenario. Pretty telling right there, it just assumes that there’s more ambition behind the policy. The temperature growth is actually pushed to one and a half degrees. As a result, the tech assumptions have changed that you have a faster adoption of new technologies and just generally more access to CDRs.
Dominique Barker: And just to remind everyone that carbon dioxide removals. Thank you for that. So let’s talk about some of the takeaways from the analysis, and I’m particularly interested in in the takeaway of the impact to GDP of that you talked about, you know, the immediate action versus the delayed action. Can you just talk about some of the takeaways and in particular focus on that?
Ian Pollick: For sure. And I don’t think anyone’s going to be very surprised about what these takeaways were. And I think ultimately the results are largely intuitive. But first and foremost, you know, delayed action leads to a sharper transition period down the line. And broadly, when we think about how policymakers are thinking about modelling the ultimate impact, every scenario has an assumed impact on the price of carbon. And it’s that price of carbon that ultimately feeds through into the various GDP assumptions. So if you delay the transition, obviously that leads to the largest increase in carbon prices because you squeeze a lot of that transition activity into a very short period of time. Obviously, if you have an immediate move to bring to temperatures that two degrees Celsius target has a smallest move compared to that baseline scenario. So as carbon prices become more expensive and this is key, it effectively serves like a tax on consumption and that negative consumption is modelled as a negative demand shock more broadly for Canadian GDP global GDP. And when you have the prices of carbon change, it’s the relative prices that are within the economy that it’s hard to adjust. And when you start to see if you think back to kind of your macro one on one macro, one to one when you have relative price changes, you have substitution effects. And the substitution effects basically mean that you have less demand towards the high intensity energy sectors, high intensity energy output consumption, and that ultimately matters. So, you know, to me, the Fast and Furious approach has the least sectoral impact. It puts less pressure on the industry to transition because in that scenario, you have a very rapid pace of technological advancement. Now, if we think about the Canadian economy in particular, it’s the rise in carbon price is pushing up the prices for fossil fuels. That leads to lower demand for those products and more broadly for the commodity producing sectors. So from an investor’s perspective, that’s obviously something that’s super important. When you think about the GDP impacts, we’ll get to those in a moment. But let’s just talk about the financial perspective. And you know, there was a really interesting take in this scenario analysis saying, well, what happens to equity valuations across some of these key energy sectors? So not too surprising valuations in the electricity sector skyrocket under all scenarios and also, not too surprisingly, valuations for oil and gas decline as this call as does refined oil products. You know, commercial transportation was an interesting one, and energy intensive industries really are only assumed to show very modest declines from the 20 20 baseline. You know, you asked about GDP and you asked why the delayed action scenario had a much more negative impact on overall GDP. Well, again, I think this is largely intuitive. You know, here it’s really a story of a promise. Tomorrow is worth a lot less than trying today. My mom used to tell me that in effect, delayed action leads to a very steep transition curve. That just means you have a much smaller window to achieve those goals. And because that window is smaller, we have to squeeze a lot of initiatives into a smaller time. Frame that exacerbates the channels that impact the macro economy and therefore the level and growth rate of GDP. You know, the bonding link here again is the price of carbon. That’s the wild card. And the delayed response just leads to a relatively sharper rate of change compared to the immediate carbon scenario. Now for context, you know, when we look at what the pricing scenarios are, the price of carbon under the delayed scenario climbs to like twelve hundred bucks. What’s interesting, though, is that it’s actually about twelve hundred dollars level is actually flat to the Fast and Furious scenario. It’s just you reach that end price at a very different time frame. That’s really interesting. And for further context, both the delayed and the net zero twenty fifty one and a half degree simulation, both expected to have carbon prices that are about double what the baseline scenario is right now.
Dominique Barker: Ok, great, and thank you very much for your colour. Do you have any advice for some of our corporate clients when you read through this analysis, and I know you mentioned this is just a scenario analysis, it’s not a prediction. I think that’s very clear. And another takeaway from the Bank of Canada is that because we’re an exporting nation, we’re more impacted than than other areas. But do you have any bottom line advice for some of our corporate clients?
Ian Pollick: Yeah, I think I think it’s a three fold number one is it’s a bull market for ESG analysts. It’s a very small talent pool. You know that I know that and it’s a skill set that will be much more desirable going forward. So grab them while you can. The second thing, obviously, is that a lot of corporate practises right now. From a liability perspective, we tend to think most about foreign exchange risk. We think about interest rate risk. There’s not a ton of hedging going on right now in terms of what the ESG world means with the transition means and inherently it’s inflationary. So margin protection is very key and thinking about, you know, innovative financial products that could maybe help mitigate some of the negative impact corporates that that’s very, very clear. And number three is just keep up with your trusted partners on the street. You know, things move very quickly. We’ll provide the information as it comes in. But it’s one of those situations where, you know, like I said earlier, because these simulations are just a starting point and they will undoubtedly shift. It’s just good to keep abreast of what’s happening.
Dominique Barker: Ian, thank you very much for your knowledge and you’re a great communicator. And I just want to point out to our audience, please, if you want to check out Ian’s podcast, is it called Curve Your enthusiasm? Is that it?
Ian Pollick: It’s called Curve Your Enthusiasm, yes.
Dominique Barker: Yes. It’s clever name and I know the way I find it is. I just Google, CIBC Capital Markets Insights and you can see a bunch of podcasts, including, for example, Lisa Raitt’s, The Raitt Stuff and many others. Thank you very much for your time. Thank you very much for giving your views on this important topic. Thank you.
Ian Pollick: Thanks, Dominque.
Dominique Barker: Please join us next time as we tackle some of sustainability biggest questions providing different perspectives to help you move forward. I’m your host, Dominique Barker, and this is the sustainability agenda.
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