RISKS FORUM 2022 ANALYSES CLIMATE RISKS IN FINANCE

The 15e Financial Risks International Forum (Risks Forum), organised by the Institut Louis Bachelier (ILB), took place on 21 and 22 March at the Paris Ile-de-France Chamber of Commerce and Industry (CCI). For a day and a half, in a hybrid format (face-to-face and digital), around one hundred speakers (academic researchers, regulators, professionals) met to discuss the impact of climate risks on the financial sector. Here is a look back at this major scientific event.

After two years of pandemic and for its 15th anniversary, the Risks Forum returned to CCI Paris. And in this historical place, the public came in great numbers with nearly 300 people present to follow the presentations and exchanges made by around one hundred experts in finance.

Climate change, a growing concern for finance

Opening the forum, Jean-Michel Beacco, General Delegate of the ILB, said: “It is no secret that climate change is one of the major challenges of our time. Tackling climate change and moving the global economy towards a low-carbon path will require the support of the financial sector. It will also require the development of new models to assess the interactions between the climate and the economy, to measure physical and transitional climate risks and incorporate them into asset prices, and to assess investors’ attitudes and beliefs towards these risks. Financial institutions are interconnected, and climate change poses a serious threat to financial stability.” He added: “I would like to thank all the speakers and participants for their contribution to the Risks Forum and to our quest for excellence in research to support sustainable development in economics and finance.“

For her part, Marie Brière, Scientific Director of the Risks Forum, provided some background on the climate risk issues facing financial players. “Climate change is a key issue. The financial sector must contribute to the development of a low-carbon economy by financing research and development in renewable energy and infrastructure. We also need new financial products: climate derivatives, green funds, insurance solutions, etc. Finally, the role of supervisors is crucial. Climate change is now a systematic source of risk for our economies and financial markets, and a risk to financial stability. We need financial institutions to disclose their climate risk exposures. Central banks and regulators are key to designing climate stress test scenarios. But to ensure an effective transition, we urgently need academic research to better understand and model the interactions between climate risks and our economies and to determine what may be an optimal transition path. Fortunately, the academic world is very active on this topic. The Risks Forum is the ideal place to bring together researchers and professionals.”

An innovative approach to hedging portfolios against climate risks

Following these introductory remarks, Stefano Giglio, Professor of Finance at the Yale School of Management, presented his latest research paper entitled “A Quantity-Based Approach to Constructing Climate Risk Hedge Portfolios“, in which he and his co-authors developed a new methodology for constructing climate risk hedged asset portfolios. “Climate change is a significant and complex risk. Traditional methods of constructing risk-hedged portfolios do not work very well, as there are many limitations to the time series used in these methodologies“, said the researcher, while continuing: “We have developed a new approach based on the quantities of securities traded by sub-categories of investors, who have experienced shifts in their beliefs about climate“. This new methodology, which focuses on the amount of stock traded by certain investors, assumes an increase in investor concern about climate change in a specific area of the United States. If climate awareness spreads to several US regions, more investors will buy green stocks, increasing their prices, thus hedging a portfolio against climate risks.

Many gaps in ESG data

Following this presentation, a roundtable discussion entitled “Data Gaps and Needs for Sustainable Research” brought together a number of experts to discuss the importance of ESG data for assessing climate risk. “A fundamental issue for investors is to identify the winning and losing companies of the climate transition. The biggest gap is on Scope 3 and future emissions. It is even harder for policy-makers and researchers who have to go even further than the company level. One of the solutions lies in the standardisation of data,” said Stefano Giglio. Jocelyn Martel, professor of finance at ESSEC, stressed: “We need data, but it has to be of good quality. There is a need to develop more data and disseminate it. We need to be very careful with ESG data.“

For his part, Stéphane Voisin, Head of the ILB’s interdisciplinary Green and Sustainable Finance (GSF) programme, emphasised the long lead times for reporting ESG data. “ESG data is based on company reporting, which takes place several months after the fact, whereas financial and extra-financial analysts make forecasts with a time horizon of 2 or 3 years. There is a significant time gap. In some cases, there may be only one piece of data per year, which is not very dynamic. There is a need for more granularity by type of activity and more forward-looking data. The use of data differs depending on whether we want to measure exposure to climate risks or align portfolios with the Paris Agreement.” To complete this panel, Léa Grisey from the Banque de France presented the work carried out by the NGFS (Network for Greening the Financial System) and Thibaud Barreau, data scientist at the ILB, spoke about the launch of a new research project on ESG data.

Cascading climate risks and scenario building

On the second day of the Risks Forum, Irene Monasterolo, Professor of Climate Finance at EDHEC Business School and EDHEC-Risk Institute, presented her latest research paper “Asset-Level Climate Physical Risk Assessment and Cascading Financial Losses“, co-authored with three other researchers. The paper proposes an innovative methodological framework for assessing physical climate risks at the asset level in relation to corporate revenues, macroeconomic dynamics, financial valuation and investor risk. “The assessment of physical risks poses several challenges: physical risks receive less attention than transition risks, data on physical assets is lacking, scenarios tend to underestimate the occurrence of physical risks, physical risks are financially undervalued, they can cause unexpected shocks because heterogeneity is not taken into account,” she said. In her recent work, the scientist and her co-authors applied their new methodology to calculate the exposure of European investors, who hold shares of companies with assets in Mexico and are exposed to hurricane risks. “An acute climate shock to assets can lead to large adjustments in the value of the shares and in the risks faced by investors. The location of assets and their type lead to different shocks and dynamics on stocks,” she said.

After this remarkable presentation by the green finance specialist, a panel of experts joined her on stage to discuss the development and construction of macro-financial climate scenarios. This round table discussion was an opportunity to talk about the climate stress tests launched by the European Central Bank (ECB) at the beginning of the year. “The ECB believes that institutions should assess their own risks, but the ECB’s climate stress test will be instructive: it will be a joint learning exercise, it will create awareness of climate risks, identify banks’ vulnerabilities and identify best practices,” said Christopher Kok, Head of the ECB’s Stress Test Division.

Afterwards, a professional, Marc Irubetagoyena, Head of Stress Tests and Financial Synthesis at BNP Paribas Group, took the floor to express his point of view: “We participate in the ECB exercise, but we favour the long-term horizon, because we have a dynamic balance sheet. With a medium-term horizon, we do not have a real assessment of the exposure of our assets to climate risks. We have our own climate scenario to calculate our regulatory capital. This is a complementary exercise to that of the ECB. We are also working on the alignment of our portfolios, but we use more the International Energy Agency (IEA) scenarios rather than the NGFS one.“

The remainder of the round table provided further insights into the construction and use of macro-financial climate scenarios: “There is little macroeconomics in the IEA scenarios, which focus more on energy. At the NGFS, the work is done from a macro-financial perspective. We are indeed facing a transformation of the economy and it is important for banks to be able to cope with it by improving the scenarios and the accessibility of the data“, explained Jean Boissinot, Deputy Director of Financial Stability at the Banque de France and Secretary General of the NGFS. Irene Monasterolo pointed out two pitfalls of climate scenarios: “Endogeneity is not included in the transition scenarios and the impact of investor reactions to different scenarios is not measured.”

Europe is on the front line

Following the previous panel, Stanislas Pottier, Senior Advisor to Amundi’s General Management, addressed the role of Europe and Paris in financing a low-carbon economy. His speech coincided with the recent publication of the Perrier report “Making the Paris financial centre a reference for the climate transition: a framework for action“, commissioned by the Ministry of the Economy, Finance and Recovery, of which he is a co-author: “Europe is at the forefront of the fight against climate change, as shown by its Fit-for-55 climate package, which requires a sharp reduction in carbon emissions by 2030,” he said, before specifying some of the challenges ahead: “Climate change implies a major revolution for the economy and society: the energy mix must move towards zero carbon, electricity capacities are set to double worldwide, and many products and services must be converted. And this revolution concerns all sectors. To achieve its objectives by 2050, Europe will have to invest 1,000 billion euros per year.” He ended his speech with some recommendations: “We need to organise a new economic policy: states must re-evaluate their commitments in the economy in co-construction with other stakeholders (investors, companies…), even if this is not currently the case. Savings and long-term financing are good financial channels. We also need to focus on brownfield activities in order to transform them. Paris is at the forefront with many initiatives underway. We now need to implement our climate commitments.”

The end of the morning of this second day of the Risks Forum included the traditional IEF / SCOR Foundation for Science Best Young Researcher Award in Finance and Insurance ceremony.

Are green investments more profitable?

After a lunch break during which participants and speakers gathered around a buffet to exchange views, Lucian Taylor, Professor of Finance at the Wharton School, University of Pennsylvania, presented a research paper entitled “Dissecting Green Returns“. In this paper, he and his co-authors provide explanations for the better performance of green stocks compared to other stocks during the 2010 decade. In a video conference from Philadelphia, the American researcher said: “Responsible fund holdings and green asset values are increasing in the United States. Can we therefore expect sustainable finance to outperform? Investors and asset managers believe so, as past performance shows. In our research paper, we take the opposite view and say that this is not the case. Investors like green stocks, which represent a hedge against climate risk.”

In their research paper, Lucian Taylor and his colleagues tracked changes in concerns related to climate change using the Media Climate Change Concern Index (MCCC) and a textual analysis. The author noted that these concerns have increased significantly in recent years: “Bad news about climate change is good news for green investment returns. Since 2010, green stocks have outperformed expectations.” He concludes: “As a result: ESG investors did not expect green assets to outperform; the cost of capital for green companies is lower than recent stock performance suggests; and it may be dangerous to measure expected returns on green stocks by the average of recent returns.” Nevertheless, he believes that green stocks were not in a bubble, as their valuations are not distorted.

To conclude this 15e edition of the Risks Forum, parallel sessions for the presentation of research articles, as well as two round tables. The first, under the auspices of Natixis, was dedicated to the greening of financial institutions’ balance sheets. The second, initiated by the ILB Finance and Insurance Reloaded (FaIR) interdisciplinary programme, discussed the environmental impact of Bitcoin production.

See you next year for the 16e edition of the Risks Forum!

Watch the replay of the Risks Forum 2022.