The Intergovernmental Panel on Climate Change’s (IPCC) report on “Global Warming of 1.5°C”, published in October 2018, emphasized a renewed call for urgent action to limit global temperature increases. Human-generated emissions are estimated to have already resulted in 1°C of global warming above pre-industrial levels. The consequences are apparent. The IPCC report highlighted that total losses from natural catastrophes and synthetic disasters in 2018 was about USD 165 billion. The insurance industry covered around USD 85 billion of those losses, the fourth-highest one-year aggregate industry payout to date.1
In the face of a growing global mobilization to fight climate change, policy makers and regulators have started to take action. The Paris Agreement (2015) stands as a reference point with 186 ratifications. The Agreement demands a dramatic global response in support of three key objectives: 1) climate change mitigation, 2) adapting to the adverse impacts of climate change, and 3) aligning financial flows to make them consistent with a pathway towards low greenhouse gas emissions (GHG) and climate resilient development.
Building on this, groups of leading institutional investors responded positively by integrating climate change into investment processes. Their work has focused on two sets of actions. First, investors looked to reduce their exposures to the financial risks of climate change. Analyzing climate change risks at the portfolio level upholds their mandates to achieve long-term stable returns. For example, the Portfolio Decarbonization Coalition consisting of 32 investors, with over USD 800 billion of assets under management, aims to reduce their exposure to greenhouse gas emissions.2 In November 2019, Sweden’s central bank sold its bond holdings in Western Australia and Queensland citing worrying levels of GHG emissions.3 Second, investors looked to allocate investments towards dedicated sustainable finance instruments. For example, according to the Global Sustainable Investment Alliance, global “sustainable investing assets” grew 126 % from 2010 to USD 30.7 trillion by 2018, with public equities and fixed income accounting for 51 % and 36 % of the respective growth. Investing in green bonds further supports the capital expenditure needed from private and public institutions to meet the financing needs of global climate change goals.
Despite encouraging steps towards addressing climate change in the capital markets, such mobilization lacks a holistic approach at the market and institutional levels. At the market level, there is a lack of appropriate standardization. Sustainable investment instruments proliferated and diversified since the first green bond issuance in 2007, followed by sustainability and social bonds. However, as such labeled bonds are use-of-proceeds instruments, the current standards make it diffcult for investors to easily select issuers who actively consider achieving Paris Agreement objectives through their business activities. At the institutional level, most initiatives such as the Climate Action 100+, focus on selecting issuers that work towards addressing individual objectives of the Paris Agreement, instead of selecting issuers that do this for all three objectives. The latter is an essential approach that investors should consider in order to help them spot companies that are adequately prepared, or on a good transition path towards mitigating risk and capturing opportunities in a climate-changed world.
This Climate Change Investment Framework (henceforth “the Framework”) aims to provide investors with a benchmark tool for assessing an investment, at the issuer-level, in relation to climate change-related financial risks and opportunities. The approach translates the three objectives of the Paris Agreement into fundamental metrics that investors can use to assess an investment’s level of progress towards achieving climate change mitigation, adaptation, and low-carbon transition objectives.
This paper showcases a first implementation case study in the context of the AIIB Asia Climate Bond Portfolio, which is executed in partnership with Amundi Asset Management and focuses on emerging market corporate bonds. The Framework and its analytical tools can be applied across a global range of issuer types and asset classes. While the authors are cognizant that the data referenced in the case- study application may evolve in a fast-changing environment, they hope that the Framework’s principles and the guidance provided in this paper will make a modest contribution in helping investors and market practitioners to integrate more systematically and holistically climate-related issues in their investment decisions.
1. Swiss Re Institute, 2019
Vincent BOUCHET, Theo LE GUENEDAL
This article studies the impact of carbon risk on stock pricing. To address this, we consider the seminal approach of Görgen et al. (2019), who proposed estimating the carbon financial risk of equities by their carbon beta. To achieve this, the primary task is to develop a brown-minus-green (or BMG) risk factor, similar to Fama and French (1992). Secondly, we must estimate the carbon beta using a multi-factor model. While Görgen et al. (2019) considered that the carbon beta is constant, we propose a time-varying estimation model to assess the dynamics of the carbon risk. Moreover, we test several specifications of the BMG factor to understand which climate change-related dimensions are priced in by the stock market. In the second part of the article, we focus on the carbon risk management of investment portfolios. First, we analyze how carbon risk impacts the construction of a minimum variance portfolio. As the goal of this portfolio is to reduce unrewarded financial risks of an investment, incorporating the carbon risk into this approach fulfils this objective. Second, we propose a new framework for building enhanced index portfolios with a lower exposure to carbon risk than capitalization-weighted stock indices. Finally, we explore how carbon sensitivities can improve the robustness of factor investing portfolios.
Théo RONCALLI, Theo LE GUENEDAL, Fréderic LEPETIT, Thierry RONCALLI, Takaya SEKINE
Theo LE GUENEDAL