by Gianfranco Gianfrate, Professor of Finance, EDHEC Business School, and Sustainable Finance Lead Expert, EDHEC-Risk Institute
All those involved, participants and speakers alike, agreed that the conference was a great success, with over 50 scholars attending the academic session (December 16) and 140 professionals in attendance at the plenary conference (December 17), including delegates from investment and wealth management companies, banks, institutional investors and academics. Our mandate was to explore the current state of the art – of both theoretical research and investment practice – when it comes to quantifying and managing climate change financial risks and opportunities. The remarkable level of engagement from all participants, which was facilitated by the chosen format, made it uniquely enjoyable and instructive for all.
Financial decisions worldwide are increasingly influenced by the scarcity of resources and the physical and transitional risks associated with climate. The extent of the environmental impact of climate change is still uncertain but the recent scientific evidence is increasingly worrisome and many governments are taking decisive steps to avert a catastrophe. The transition towards a low-carbon economy requires a broad array of financial instruments and innovations that will have far-reaching implications for markets, corporations, intermediaries, and investors. The financial implications of climate change risks – against the backdrop of evolving climate policies and heightened physical risks posed by climate change – are still understudied in academia and mostly overlooked in the investment realm.
The conference, in collaboration with the Journal of Corporate Finance, started on 16 December with 9 distinct panels featuring 27 academic papers. These covered topics such as the use of capital markets to create market-based emissions trading systems, the efficiency of the market pricing of climatic risks, the role of venture capital and alternative finance to develop new low-emissions technologies, climate risk assessment and disclosure for banks and non-financial companies, the contribution of project finance and private equity to building clean energy projects, the financial management decisions affected by climate risks and policies, the corporate governance conflicts and incentives in addressing climate risks, and the design of investment strategies to hedge climate risks and liabilities.
The first day also featured two keynote speakers. First, Elroy Dimson (Emeritus Professor at the London Business School and Chairman of the Centre for Endowment Asset Management at Cambridge Judge Business School) highlighted the apparent inconsistencies of some sustainability ratings and presented interesting evidence about how institutional investors can collaborate to affect the sustainability footprint of investee companies. Second, Harrison Hong (John R. Eckel Jr. Professor of Financial Economics at Columbia University) questioned the sustainable investing proposition according to which firms "do well by doing good" and the idea that a firm's ranking on ESG criteria has a causal effect on its financial performance, for example by lowering its cost of capital; he argued that, on the contrary, sustainability scores simply reflect potential selection effects, whereby successful firms are more likely to be socially responsible for a variety of other reasons.
The plenary conference took place on 17 December and began with an introductory presentation by Lionel Martellini (Director of EDHEC-Risk Institute) about the landscape of climate finance. The presentation highlighted the shortcomings of some sustainability and climate metrics, the conflicting evidence of early studies on carbon footprint and investment performance, and the future avenues of academic and professional investment research on climate risks and opportunities.
Harrison Hong, who kindly delivered a second keynote speech on 17 December, further challenged the “sustainable investment proposition”. He stressed that climate change risks will be more and more manifest in the future, and as a consequence sustainable investing might evolve from studying sustainability scores to granular modelling of firms’ exposure to such risks, be it exposure to carbon or to natural disasters. In a world with greater regulatory scrutiny or greater climate change risks, a sustainable investing approach that is robust regarding measurement concerns might deliver significant value to investors.
The subsequent section of the conference featured a presentation by Abraham Lioui (Professor of Finance at EDHEC Business School), who discussed the possibility of identifying safe assets in cases of climate-related disasters such as hurricanes. If such negative shocks have real effects, we may observe a flight to safety. According to the evidence, during hurricane periods gold stocks uniquely experience (short-lived) positive abnormal performances. Intriguingly, only tech company stocks seem to provide a safe investment harbour during hurricane episodes.
Erik Christiansen (ESG and Low Carbon Solutions Specialist, Scientific Beta) illustrated the work of Scientific Beta as a producer of smart factor indices. He stressed that they display worse carbon metrics than a cap-weighted index, due to their factor exposures. In order to reduce their weighted average carbon intensity by at least 35% relative to their cap-weighted reference benchmarks (-50% on average), ex-ante filtering of a low number of stocks can be used. This approach is efficient both when it comes to reaching the carbon impact reduction objective and preserving the financial characteristics of the smart factor index.
The morning presentations were followed by a panel discussion chaired by Frédéric Samama (Head of Responsible Investing at Amundi). This lively and insightful panel discussion stressed the nature and evolution of climate-related financial risks and opportunities from the point of view of asset owners, featuring contributions from Jaap van Dam (Managing Director of Investment Strategy, PGGM), Olivier Rousseau (Executive Director at Fonds de Réserve pour les Retraites – FRR), and Andreas Stang (Head of ESG, PFA Pension).
In the afternoon I gave a presentation about the relationship between climate risks and corporate credit risks. I showed that the distance-to-default, a widely used market-based measure of corporate default risk, is negatively associated with the amount of a firm’s carbon emissions and with carbon intensity. Therefore, companies with high carbon footprints are perceived by the market as more likely to default, so investors and policymakers should carefully consider the impact of climate change risks on the stability of both lending intermediaries and corporate bond markets.
Riccardo Rebonato (Professor of Finance at EDHEC Business School) gave an inspirational and provocative presentation about climate risk stress testing. He explained how climate history shows that positive feedback mechanisms are very likely to have played a key role in past rapid warming episodes. Very strong non-linearities are likely to be present: stress testing is therefore key. Also, the magnitude of the eﬀort for serious mitigation is best compared in scale to a war eﬀort, so rosy projections of GDP growth on the back of ‘green investment’ are misleading. Because population growth, economic growth, carbon intensity, and technological breakthroughs are endogenous variables in the climate change problem, any reasonable stress testing or scenario analysis must take this interdependence into account. We should expect ample innovation in the ways scholars and practitioners think of and measure climate risks.
Finally, a plenary panel concluded by focusing on the challenges in measuring and managing climate risks. It was chaired by Jean-Michel Beacco (CEO of the Louis Bachelier Institute), and featured contributions from Clément Bourgey (Deputy Head of the Financial Stability Department, Banque de France), Charlotte Gardes (Deputy Head of Unit, Sustainable Finance & ESG reporting, French Treasury), Laurent Chatelin (Managing Director, Marguerite Fund), and Bernard de Longevialle (Global Head of Sustainable Finance and Managing Director, S&P). The discussion was very insightful, helping delegates understand the current debate at policymaker level and the extent to which regulatory aspects in this area can impact investment decisions.
It would be very difficult to encapsulate the key takeaways from two full days of presentations and discussions, featuring very rich and diverse insights from asset owners, scholars, asset managers, and policymakers. However, in my personal view, three messages stand out:
1) climate change risks are now high on the agenda of financial market professionals and there is growing awareness that they are poised to become even more pervasive and material for the investment world;
2) as the saying goes, “you can’t manage what you can’t measure”, and there is now a real appetite for better, more granular, and more reliable measures of both transitional and physical climate risks; and
3) risk, in the climate change context, should be interpreted as a financial term, thus encompassing both downside and upside possibilities. Climate change, while dauntingly threatening for the exiting economy and societies, is also opening up a brave new world of investment and financial innovation opportunities.