GREEN FINANCE RESEARCH IN CONSTANT EVOLUTION

To face the major challenge of global warming, the financial sector has an important role to play in directing capital towards a low-carbon economy. And this crucial issue, aimed at making finance greener and more sustainable, requires the contribution of academic research. The 6th edition of the Green Finance Research Advances conference – co-organised by the ILB and the Banque de France in a hybrid format, which took place on December 7th and 8th, 2021 – was an opportunity to review the latest advances in this field.

This international scientific conference started with the intervention of Jean Pisani-Ferry, who presented his work on the macroeconomic implications of the climate transition. The economist, affiliated with the Bruegel Institute, the European University Institute and the Peterson Institute for International Economics, explained why the climate transition has become a macroeconomic issue, whereas according to the traditional approach, this problem is rather rooted in the public economics: “Awareness of the climate emergency has made it a macroeconomic issue for several reasons: the abrupt change in trajectory and shorter-term targets by 2030; the increase in the price of carbon; stricter regulations (e.g. the ban on the sale of fossil fuel heating systems and combustion engine cars).”

Uncertainties about the costs of the climate transition

It is true that the climate transition is bringing about sudden changes, especially for the European Union, whose objective is to achieve carbon neutrality by 2050. By that date, net carbon emissions must be close to zero, which is only possible with a significant increase in the price of CO2. Consequently, the macroeconomic consequences may vary according to the intensity and modalities of the transition, thus raising many questions: will the development of low-carbon technologies allow for a low-cost transition? How to deal with the major uncertainties? Will the relatively late consideration of the transition not be too costly?

“There is a need for a framework to clarify relevant policy issues at different horizons”, said Jean Pisani-Ferry, who continued his keynote by presenting an analytical framework based on an optimal scenario of transition to net-zero emissions in 2050. The latter incorporates the consequences of an unanticipated change in trajectory on the capital stock, as well as frictions (reallocation, stranded capital and stranded assets, insufficient credibility, inefficient policies, macroeconomic instability). With this analytical approach, it is then possible to model the implications of climate action on transition costs, macroeconomic policy and public finances.

The transition-induced shock can be severe

While the need for an analytical framework to estimate the macroeconomic impacts of climate action is relevant and necessary, many questions over different time horizons remain. A striking example is the hike in the price of carbon and the tightening of regulatory constraints, which lead to a short-term supply shock. “What should the price of carbon be? Currently, at the global level, a tonne is between 3 and 10 dollars, according to the IMF. But by taking the figure of $75 per tonne from the Stiglitz-Stern Commission and multiplying it by the number of gigatonnes emitted into the atmosphere, the increase in the price of carbon would represent 3.1% of world GDP in 2019, or the equivalent of the first oil shock in 1973”, estimated Jean Pisani-Ferry. And this very significant shock would affect the entire world economy, but much more the emerging countries than the developed countries.

In addition to the effects of higher carbon prices, the economist described other categories of costs that could add to those of the transition: stranded assets; heterogeneity, bankruptcies and reallocation of labour in the most affected sectors; lack of credibility of climate policies with regard to the objectives to be achieved; and economic instability. Here again, it is the emerging countries that will be the most affected.

In conclusion, Jean Pisani-Ferry recalled the analytical and economic challenges to be met in order to better understand the macroeconomic consequences of the climate transition, while insisting on the interest of a clear and transparent political agenda in order to: “Identify and name the benefits and costs for a desirable future and/or a challenging transition, define an action programme for cost minimisation and guidelines for public finances, and mitigate instability”.

Assessing the climate transition through different models

While the macroeconomic costs of the climate transition can be variable, significant and highly uncertain, the conference continued with a comparison of the models used to best anticipate the transition. On this occasion, the first results of technical work carried out by four French institutions (Ademe, Seureco, Cired and the Banque de France) were unveiled, explained and compared. This first half-day ended with exchanges between the speakers in order to compare the different points of view and methodologies.

A bridge between academic research and practitioners

After the half-day session the day before, the second day of the conference started with a reminder of the need to bring together academic researchers, regulators and financial practitioners. “The objective of this conference is to bridge the gap between academic researchers and financial sector practitioners to exchange on the evolution of climate change risks,” stated Nathalie Aufauvre, Director General of Financial Stability and Operations at the Banque de France, by adding: “With the development of green finance within central banks, academic institutions and the private sector, more research is needed to facilitate exchanges and try to have a common agenda.”

Companies facing climate risks

After these introductory remarks, presentations of academic work followed. Quyen Nguyen, a post-doctoral researcher at the University of Otago in New Zealand, addressed the effects of climate risk on corporate bankruptcies. In her study, the researcher analysed the evolution of the debt structure (loans, bonds) of a sample of American non-financial companies in the S&P 500 index between 2010 and 2018: “The transition risk is not just a long-term phenomenon, it is also a current one, as shown by the bankruptcy of the Californian electricity company PG & E in 2019”, before describing one of her main results: “The physical climate risk has negative effects on companies by increasing the default risk. These effects increased with the Paris Agreement, but have diminished in subsequent years.”

For his part, Julien Daubanes, a researcher at the University of Geneva and MIT, addressed the subject of green bonds, whose issuance by companies has increased considerably since 2013. In his research, he wanted to understand the reasons why companies issue this type of securities. What are they? Empirically, green bonds have been found to boost the stock market performance of issuing companies and reduce their environmental footprint. And according to his results: “Green bonds are effective when carbon prices are sufficiently high. They are therefore complementary and are not a substitute for a carbon price. What about issuers’ incentives? “The incentives to issue green bonds come from short-term considerations and financial interests of managers whose variable remuneration is indexed to stock market performance.”

In turn, Jean-Stéphane Mésonnier, attached to Sciences Po Paris and the Banque de France, studied the benefits of requiring financial institutions to disclose their financing of fossil fuels. This issue has been widely debated since the COP21 in Paris. Following the recommendations of the TCFD (Task Force on Climate Financial Disclosure), regulators in many countries have implemented this measure, notably in France since 2016. According to the researcher, the French law has resulted in a relative reduction of 44% in the ownership of fossil fuel companies by financial institutions. Despite this significant result, asset managers remain the investor class most exposed to fossil fuels. To conclude, Jean-Stéphane Méssonier makes several recommendations: “Disclosure requirements on fossil fuel exposure are regulations that should be extended to more investors and, ideally, at the European level. Voluntary coalitions can help, but not as much as regulations. Finally, improving practices implies harmonising reporting”.

Lastly, to complete this morning dedicated to the exposure of companies to climate risk, Romain Svartzman from the Banque de France presented work on biodiversity. Although this subject has long been sidelined as a result of the priority given to the fight against climate change, it is increasingly discussed within the financial sphere: whether it be the private sector with the Taskforce on Nature-related Financial Disclosures (TNFD) coalition or central banks with the Network for Greening the Financial System (NGFS). Indeed, economic activities are highly dependent on the services provided by natural ecosystems. This dependence can have direct consequences for the companies concerned and, in turn, for the financial players who are exposed to them.

Green finance research rewarded

The last half-day of the conference – the afternoon of December 8th – saw the awarding of the “Young Researchers in Green Finance » prize, financed and bestowed by the Banque de France. “This prize was launched four years ago for doctoral students and young doctors, who are affiliated with French academic institutions. And this year again, we received excellent applications,” said Emmanuelle Assouan of the Banque de France, before awarding the prize to Mathias Reynaert of the Toulouse School of Economics for his work on the environmental regulation of the European automobile market. “I am honoured to receive this prize, which marks the recognition of my research work in environmental economics”, said the young researcher.

Modelling for green finance

Within one of the last sessions of this event, Frédéric Ghersi, researcher at Cired, and Peter Tankov, researcher at CREST and scientific director of the Green and Sustainable Finance research programme of ILB, presented their work, which is part of an issue of the Opinions & Debates collection published by the Institut Louis Bachelier, entitled “Climate-Economic Scenarios and Models: A Reading Guide for Sustainable Finance“. This latest publication proposes a state-of-the-art and the main challenges to be met in the context of integrated climate models, which have become a “jungle” over the past 30 years.

Indeed, between the different scenarios to be used, the information to be extracted and the degrees of uncertainty to be quantified, the levels of complexity are such that it is currently difficult for a financial institution to use these models, which are nonetheless necessary to assess the alignment of portfolios with the Paris Agreement, as well as to measure the transition and physical risks. “The best option is to establish partnerships between academics and economic agents to provide scientific backing and credibility“, concluded Peter Tankov. Clearly, bridges between academics and professionals are more necessary than ever. This is an appropriate recommendation since it is one of the initial aims of this international conference, which will be held again in December 2022.