Think tank develops first Covid-19 stress test scenarios

The think tank, 2 Degrees Investing Initiative (2DII) has developed stress tests based on Covid-19 scenarios to assess the financial risks of the virus.

Known for its stress tests on climate risks, the think tank said it is bolstering its partnerships with supervisory authorities such as the European Insurance and Occupational Pensions Authority (EIOPA) as a way to strengthen its analysis of potential future market impacts caused by Covid-19.

It has published a discussion paper on what it believes are the first stress-test scenarios for Covid-19 that have been developed. Currently, it has developed six possible scenarios for use by its stakeholders.

“These scenarios will be improved on an ongoing basis in the next few months, integrating all the available inputs from other supervisors, financial institutions, credit rating agencies, and the broader research community, as the situation evolves,” it stated. The stress tests are part of several emergency response measures being launched by the think tank to support stakeholders and members in managing and mitigating the crisis.

“The speed and magnitude of the disruption might eventually – based on our preliminary modelling – exceed the scale of past stress tests. Moreover, as with climate, many shocks are cross-cutting, based on specific sector characteristics (e.g. sectoral exposure to people’s movements) that are not considered in existing stress-tests. The ‘Minsky Moment’ described by the Bank of England for climate risks – mixing economic disruption, policy responses, and overnight shift in market sentiment – is happening now, at scale, for Covid-19,” 2DII warned.

Building on its data, methodology and partnerships with supervisory authorities, insurers and banks on long-term stress-testing on climate, 2DII will support a rapid response to help integrate the Covid-19 risk into the ongoing stress-testing, risk management and mitigation exercises.

In terms of its partnerships with supervisory authorities, it said it will be extending existing partnerships with financial supervisors on climate stress-testing and scenario analysis to apply ‘snap stress-tests’ using a series of Covid-19 stress-test scenarios.

“We will be working with the European Insurance and Occupational Pensions Authority (EIOPA) in the context of our existing partnership to use these scenarios as a way to strengthen their analysis of potential future market impacts of the COVID-19 crisis,” the think tank said.

It will be launching a dedicated website designed to bring all the analytical resources together on the Covid-19 crisis as a repository for information, analytical insights, and tools to respond to the crisis. Stakeholders can email 2DII with material they are developing or aware of to feature on that platform.

“To support this response, 2DII will temporarily reallocate some of its resources dedicated to climate stress-testing. We welcome every technical input and expression of interest to join forces on this effort,” it stated.

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