Climate Change in the Theory of Finance

One Earth

2000

UBS integrates environmental aspects into its various banking activities (commercial banking, asset management and investment banking). For many of our clients, environmental considerations not only represent financial risks, they also mean new business opportunities. This paper highlights UBS' efforts to explore possible environmental market o#n-tunities resulting from the increasingly signaficant impact of global climate policies on the banking business. A careful analysis of the Kyoto Protocol-the international agreement to control global warming by reducing emissions of greenhouse gases-and its impact on thefinancial sector has led UBS to assess the new market potentialfor a climate value investment product. In this article, the authors describe thepremises behind such an investment vehicle as well as the most important steps and criteria needed for setting up the project portfolio. In addition, besides clatifiing the most significant operational modalities of such an investment poduct, this paper also explains the importance of being an early mover in the greenhouse gas reduction market.

SSRN Electronic Journal, 2011

This study investigates whether corporate climate risk is priced by the capital markets. Using carbon dioxide emission rates of publicly traded U.S. electric companies, we find that climate risk is positively associated with cost of capital measures, more specifically the implied cost of equity and the cost of debt. Additionally, we find that equity and debt investors evaluate corporate climate risk differently. The results show that the cost of debt decreases with the level of capital intensity, suggesting that debt investors value the increase in efficiency resulting from current capital investments. The results also show that the cost of equity decreases and the cost of debt increases with the newness of assets in places. Newer equipment is likely to be operationally and environmentally more efficient. While the results concerning the cost of debt are puzzling, we consider that debt investors may account for other performance indicators. We conclude that equity and debt investors evaluate climate risk differently according to their different payoff functions.

2021

Climate Financing is the state, national or multinational funding that aims to facilitate climate change mitigation and adaptation measures. The Kyoto Protocol Convention and the Paris Agreement call for financial help to those who are less privileged from developed countries that have more financial capital. The need for Climate Finance is linked to the enormous investments needed to reduce emissions. In this edition of the Conversations in Development Studies Journal, we try to explore the need for considerable financial capital to adapt to the adverse effects and reduce the threat of climate change. We focus on Climate Finance as articulating the needs and financial flow of different geographical regions and designing a more robust monitoring and guiding parametric framework that is done at a national, sectoral, or local level. This edition of the Journal also explores Climate Finance and South Asian Projects of fossil fuel transition in India.

2013

International climate finance is the transfer of funds from the North to the South to help enable developing countries adapt to the unavoidable impacts of climate change (i.e. adaptation), reduce greenhouse gas emissions (i.e. mitigation) , and embark on clean energy development paths. If we are to avoid the dangerous impact of climate change we must limit global mean temperature increase to 2 0 C above pre industrial levels. This means stabilizing atmospheric GHG concentration below 450ppm carbon dioxide equivalent. Emission reductions required for a 450ppm pathway adapted from Mckinsey global GHG abatement cost curve. Failure to cut emissions on this kind of scale would result in serious risks of temperature increases of 3,4,5 deg. C and higher. Scientists tell us that to have a 50-50 chance of holding temperature below 2 0 C global emissions would need to be below 35Gt CO2e by 2030. The 2009 Copenhagen Accord pledged funds of $10 billion a year from 2010 to 2012, increasing to $1...

Research Journal of Finance and Accounting, 2020

Global warming evidence is worrisome, and its impact has spread across all continents of the world. Unfortunately, many countries are not paying sufficient attention to environmental damages resulting from climate change. Commitments to emissions reductions are also not being honored by countries. This exploratory paper seeks to justify the need for African countries to pursue clear-cut climate mitigation and adaptation strategies and the necessity of integration across multiple disciplines and embraced by both public and private sectors. Climate change is a source of financial risk; it threatens the stability of the financial system through systemic risk factors, produces negative externalities, and creates moral hazard. Innovative debt and equity instruments for funding climate-compatible urban infrastructure are discussed and recommendations made for assessing climate projects.

Policy briefs, 2016

Real economic imbalances can lead to financial crisis. The current unsustainable use of our environment is such an imbalance. Financial shocks can be triggered by either intensified environmental policies, cleantech breakthroughs (both resulting in the stranding of unsustainable assets), or the economic costs of crossing ecological boundaries (eg floods and droughts due to climate change). Financial supervisors and risk managers have so far paid little attention to this ecological dimension,...

Journal of Technology Management for Growing Economies

In light of the observed changes in climate patterns, this paper reviews the evidence forwarded under climate science research for analysing the climate related stresses on assets across different sectors. The review provides insights on the need for a shift in investment decisions and portfolio management activities. The paper follows an exploratory research method to focus on key climate science research themes. Thereby, the paper synthesizes the existing scientific information to identify those opportunities in climate change that require climate investments. Additionally, the research also discusses the points of uncertainty for climate investment that arise due the limitations of existing climate science related information and methods. The synthesis of climate science information in the paper will provide a foothold to the interdisciplinary research community in the area of sustainable investments for identification of investable climate assets and insights on the factors of c...

CASCADES paper, 2022

Is climate change a financial risk that financial institutions need to worry about? Despite the rapid increase in climate financing and the rise of the dominant discourse on the importance of climate change and environmental, social and corporate governance (ESG) criteria, financial markets do not seem to show much sensitivity to the increasing climate risks. The problem arguably lies in the fact that the markets seem to have difficulties estimating the specific costs of climate change, which, although potentially high, often remain long-term and uncertain. The benefits of adjusting to climate risks also seem harder to quantify for shorter-term investments. Most international actors that provide development finance seem to have difficulty estimating the specific costs of climate change risks. Climate risks can be low or high, short-term or long-term, and more or less uncertain. Yet, understanding the particular nature of climate risks clearly could help in pricing climate-risk finance and the proper allocation of funding for climate action. In particular, investments in climate adaptation, which are perceived by many financial actors as a costly endeavour, could become financially more attractive if the corresponding reduction in climate risk exposure were not only qualitatively considered, by explicitly priced. This would have serious implications for development finance institutions and their incentive to invest in climate adaptation operations in developing countries most affected by climate change, with a high socio-development impact. This paper considers why effective climate risk assessment should matter for financial institutions. We present different approaches to measuring climate risk used by some European financial institutions with a public mandate, including a multilateral development bank (MDB) - the European Investment Bank (EIB), development financial institutions (DFIs) - the British International Investment (BII) and the Dutch entrepreneur development bank (FMO), national promotional and development banks - the German Kreditanstalt für Wiederaufbau (KfW) and Italian Cassa Depositi e Prestiti (CDP); and export credit agencies - the Atradius Dutch State Business (Atradius DSB), and French Bpifrance. These institutions have adopted climate, and often explicit ESG, approaches and climate risk assessments. Increasing efforts are also dedicated to further improving their approaches. Yet, they encounter several difficulties and limitations in their attempt to assess climate risks. Limitations encountered in climate risk assessment that could lead to mispricing include: 1. Underestimation or overestimation of the climate risks 2. Lack of proper methodologies to measure climate risks 3. Assessments are generally done at the macro-level 4. Data on climate risk variables is usually missing 5. Lack of a central database providing data on all climate risk indicators 6. No harmonised industrial standards and a proper regulatory framework It is essential to overcome the challenge of climate change mispricing (over- and under-estimation) of the risks to ensure that physical and transition risks are precisely predicted. This necessitates that financiers and investors, in general, alter their strategies, incentives and approaches, including by exploiting the opportunities provided by climate risk assessment models and strategies. Development financiers can play a pioneering role in that respect. MDBs like the EIB and DFIs like BII and FMO should not only continue their respective current endeavours to further enhance their overall climate/ESG, and climate-risk assessment approaches. They should also coordinate their efforts to lead the (European) development finance community in better addressing climate change, improve risk assessment approaches and try to explicit price climate risks. By doing so, they can also leverage private finance actors and have a catalytic demonstration effect on how to better climate risks. While climate finance has significantly increased for mitigation, it is seriously lagging for adaptation. In particular, in Europe, financial institutions for development have generally failed to invest at scale in climate adaptation, often arguing that they are not enough bankable projects. Improving climate risk approaches, explicitly pricing climate risks, can play a significant role in boosting private and public finance to tackle climate change, including for adaptation. In terms of physical climate risk, there is a need to adopt proper methodologies to assess the risk from chronic and acute shocks on a highly granular level and connect asset-level physical risks to firms’ and investors’ financial risks. Such enhanced approaches could usefully draw on Bressan et al. (2022). They developed the first comprehensive methodology that logically connects asset-level physical risks to financial risks for firms and financial actors and, more broadly, to systemic risk for the financial system. It does so by translating economic losses on physical assets and sectors from chronic and acute climate physical risks into financial losses and shocks on prices in the market. It allows for a dynamic, asset-level assessment of physical climate risk, considering the cascading losses through the ownership chains of firms and investors. Key policy recommendations for financial institutions that could lead to better assessment and improved climate risk pricing include: 1. Develop a reliable database to provide information on climate-related risks 2. Improve the transparency of the risk assessment methodologies 3. Develop harmonised climate risk assessment methodologies 4. Support the establishment of project-level climate risk assessment 5. Exploit the potential of insurance companies 6. Address the information asymmetry and knowledge gaps 7. Enforce climate-related regulation at all levels 8. Embody climate risk assessment in overall sustainable investment strategy and use concessional financing to cover high climate risks 9. Explicitly price climate risks and net returns from climate adaptation. This work was conducted in the European Commission H2020-funded CASCADES (CAScading Climate risks: towards ADaptive and resilient European Societies) project, Grant agreement number 821010. https://www.cascades.eu/publication/climate-risk-mispricing-why-better-assessments-matter-in-financing-for-development/

KOREA REVIEW OF INTERNATIONAL STUDIES , 2023

In today's world, the sole pursuit of financial gain by organizations is a thing of the past. Instead, there is a growing recognition of the vital importance of natural resource preservation and environmental protection across all aspects of life. This shift has prompted extensive global research to uncover innovative strategies for achieving sustainability. To address the urgent need to safeguard the environment, combat climate change, invest in renewable energy sources, expand green spaces, and support various sustainable development endeavour's, the concept of "Climate Finance" has emerged. This article delves into the multifaceted components of green financing, encompassing green banking, green insurance, and green bonds. Furthermore, it explores the potential and challenges associated with Climate Finance. Drawing from contemporary literature, the article endeavours to shed new light on Climate Finance as a valuable tool for promoting sustainability, particularly in developing nations like India.

SSRN Electronic Journal, 2021

In, et al. (2020) (1) propose a framework that assesses material financial impacts from climate change and a transition to a low-carbon economy on energy infrastructure investments. This study demonstrates the application of the framework using three downstream energy assets: natural gas, coal, and solar photovoltaic power plants. We identify physical and transition risks that an asset is highly exposed to with its asset type, geographic location, time frame, and financing structure, and build highly-likely climate risk scenarios. We then project an energy asset's cash flow under multiple scenarios and investigate whether and how these scenarios would affect the asset's debt and equity investments. While extant climate risk assessments are mostly at sovereign, industry, or portfolio levels, this study focuses on infrastructure assets. Instead of estimating net present value (NPV), we estimate an energy asset's probability of default due to climate risks and the size and time of the losses by the given default using debt service coverage ratio (DSCR). Lastly, this comparative case study also shows how the values of investment would vary across energy assets.

SSRN Electronic Journal, 2018

2016

under the project Addressing the Poverty and Inequality Challenge, grant for Climate Change Adaptation and Poverty Reduction co-benefits: human capabilities toward green micro-enterprise. The contents of this work are the sole responsibility of the authors and can in no way be taken to reflect neither the views of the European Union nor the National Research Foundation.

SSRN Electronic Journal, 2020

This paper presents a framework for pricing the climate resilience of an energy infrastructure project through assessing the value of its required debt and equity investments. Integrating climate scenarios into an asset valuation model provides useful and specific insights for risk management, but there is a lack of academic and market tools that effectively address this need. The critical barrier is that climate-related risks (physical and transition) are typically indirect variables in the cash flow calculation, and they should be computed based on the direct variables such as revenue, capital expenditures (CAPEX), operating expenses (OPEX), and financing costs. The implementation of this framework shows how to delineate climate-related risks that are assetspecific and transforms them into financial risks. Using cash flow simulation and scenario analysis, it estimates an energy infrastructure asset's probability of default due to climate-related risks and the size and timing of the losses for any given default. To demonstrate the framework's application, we simulate the price climate-related risks of a utility-scale electricity generation facility (i.e., a downstream energy asset) powered by natural gas. Highlights: • The framework consists of three parts. First, it identifies the climate risks that an individual energy project would be exposed to under a multitude of feasible climate risk scenarios and economic trajectories • Second, it prices the identified climate risks at the level of the individual energy project's cashflows by downscaling and translating climate risk information • Third, it calculates the probability of default and identifies the largest potential gains and losses due to the identified climate risks for an individual project

International Journal of Research in Business and Social Science (2147- 4478)

The Paris Agreement has highlighted the worldwide significance of adaptation. Many investors are considering the effects of climate change and resource scarcity when making decisions. Even while the whole amount of the environmental harm caused by climate change is yet unknown, recent scientific evidence is more frightening, and many governments are taking substantial measures to avert a calamity. The financial innovations and mechanisms created to ease the transition to a low-carbon economy will have far-reaching effects on markets, firms, intermediaries, and investors. Although economists have been working on the subject for decades, financial-economics professionals have only recently become interested in climate change. There has been a growing body of empirical and theoretical contributions in recent years that analyse the influence of climate risks on investment decisions for firms, financial intermediaries, and national governments, as well as the pricing and hedging of clima...