• Charlotte Gardes

Weekly News: our selection of recent analysis on climate risk and sustainable finance


Long time no see for our Policy Shift weekly news! But to start the New Year off just right, we’ve compiled below a wide selection of articles on sustainable finance – demonstrating how the fall of 2020 was a restless time for sustainable finance and climate-related research, and how 2021 is a pivotal year when it comes to mainstreaming climate-related considerations into financial and investment decision-making.


On divestment

Divestment was a key theme in 2020 in the area of sustainable finance, notably with the Paris marketplace pledge to divest from coal by 2030 in the EU and the OECD area (for which the French securities markets authority and the prudential authority have published a dedicated report (in French and in English) at the end of 2020) and specific pledges by banks all around the world (see this Bloomberg article dated November 2020 on Bank of America’s pledge to stop financing of O&G exploration in the Arctic region). Coal has even made the headlines of The Economist twice in a row (here and here) and the world’s largest private sector coal producer – Peabody Energy – announced that there was a risk it would go bankrupt for the second time in five years, as it rushed to renegotiate debts as a result of falling demand for fossil fuels.


2021 will be a crucial year for divestment with the COP26 coming up and its dedicated axis on energy and coal divestment, as well as with a reinforced Paris marketplace pledge to stop financing of unconventional O&G.


A research article by A. Hoepner and al. on the impact of fossil fuel divestment on capital flows into the Oil & Gas sector. This article is notable as it does not only show that increasing O&G divestment pledges in a host country are negatively related with new capital flows to domestic O&G companies (based on the analysis of syndicated lending, equity and bond underwriting across 30+ countries from 2000 to 2015), but because it demonstrates - through the lens of institutional theory - that the unintended effect of such countries adopting high divestment commitments and stringent environmental policies lays on the displacement of financing by domestic banks to projects abroad. This “pollution haven” hypothesis had not yet been shown by such data, though the study illustrates that it may hold only when both regulatory and normative institutions reinforce each other. The article shows that this emergent “institutional change” is indeed not yet stabilized, due to the spatially specific nature of the customs, rules, regulations and organizations that investors interact with at the territorial level.

It has also yet to be analyzed whether lower O&G financing translates into more investment in low carbon technologies and if the exact transmission channel through which this capital reduction to fossil fuels occurs. Irene Monasterolo and Marco Raberto (2019) have for instance shown that a smooth phasing out of fossil fuels subsidies contributes to improving macroeconomic performance, to decreasing inequality and helping the government to find fiscal space to support stable renewable energy policies.


A comprehensive article by W. Carton about the relevance and actionable characteristics of fossil fuel energy companies’ pledges to achieve “net-zero” goals notably by relying on carbon capture and storage technologies. The article explores the relevance of integrated assessment models on which IPCC scenarios are based (i.e. transformational change led by carbon pricing only; cost-maximization focus; allowing for BECCS (Bioenergy with carbon capture and storage) and afforestation mechanisms) and the performative nature of such scenarios on climate policy. It also tackles the broad issue of the discount rate in the context of such scenarios, demonstrating that it has the effect of deferring mitigation costs into the future therefore making attractive negative emission technologies. On this topic of carbon offsetting, Oxford University has recently launched new principles to help ensure such means achieve a net zero goal (i.e. prioritizing carbon reductions and shifting offsetting towards carbon removal and long-lived storage).

On financial regulation and transition finance



With the increasing focus on the role of financial regulation in achieving net-zero goals by the financial sector, and the unfolding of the European Union’s sustainable finance strategy, a few recent reports are worth noting here.





The Principles for Responsible Investment and the World Bank have recently published a toolkit for sustainable investment policy and regulation where they underline the role of corporate ESG disclosures, stewardship codes, investor ESG regulations (notably fiduciary duty) and taxonomies to bridge the gap between the financial sector and the wider economy. To understand more broadly the advances of sustainable finance in 2020, this report by Climate Change – published in November 2020 – is very comprehensive. The recent OECD’s report on resilient and sustainable finance is much worth the read as well (available here).

Entering 2021, three studies are worth noting considering the challenges ahead:


  • The Peterson Institute for International Economics has published a memo to the Financial Stability Board on supporting the transition to net zero carbon emissions (available here), identifying three main priorities: (i) creating consensus around and embedding a globally consistent framework for climate-related reporting (“by establishing pathways to mandatory climate disclosure for the largest companies in the largest jurisdictions”); (ii) improving climate risk measurement and management, by integrating climate risks into the FSB’s guidance and frameworks and ensuring climate risk management and stress-testing in the largest firms and financial institutions; and (iii) developing the metrics for the financial sector to disclose its alignment with net zero by charging the TCFD with including forward-looking metrics for investors and banks in their recommendations framework; and identifying the data gaps that exist to accurately measure alignment of lending and investment with the transition;

  • This memo by the economist Helena Wright points out the issues associated with the current objectives set by financial institutions to transition their portfolios towards net zero emissions by 2050 (and their potential inconsistency with a maximum temperature rise of 1.5°C). Such calculations are often derived through carbon accounting but often do not include scope 3 (indirect) emissions (that dominate the overall footprint of financial institutions), are backward-looking, allow avoided emissions and do not take into consideration the firm’s business model. Moreover, the time lag between the moment of the investment and the lifetime emissions of the financed infrastructure is not taken into account. The memo highlights the need for regulators to take into account the gaps of current methodologies by setting forward-looking methods and ensure regular review with evolving climate science;

  • This article by Ben Caldecott (available here) on the alignment with climate outcomes highlights the need for regulators to (i) makie TCFD recommendations mandatory, spurring the next generation of data and analysis capabilities required to properly measure and manage such risks; and change supervisory expectations globally so all supervised firms, from asset owners to insurers, need to include climate-related risks at the board and senior management-levels or risk supervisory action; and (ii) introduce mandatory “alignment with climate outcomes” targets and transition plans for financial institutions, setting out how portfolios and loan books could become increasingly compatible with different global warming thresholds at given levels of confidence as well as how financial institutions could scale the provision of transition finance to support clients realize such alignment.


The World Bank has published a report on Spatial Finance, as an independent assessment of the location of a company’s or a country’s assets and infrastructure using ground data, remote sensing observations and modelled insights, offers a potentially transformative means to gain improved quantitative ESG insights. For a company whose environmental impact is primarily created through its supply chains, its footprint can be defined by running a spatial finance assessment that includes all the suppliers’ assets as well as its own direct assets. For example, to understand the footprint of a major car manufacturer, they may run a spatial finance assessment of the car manufacturer’s physical assets, their factories, headquarters etc., and a second assessment on their supply chain assets. The report outlines a possible taxonomy and hierarchy for spatial finance, showing how discrete forms of technology, approaches and data can be considered within a single consistent framework. Using this framework, spatial finance could indeed provide insights at differing scales for different applications from the asset-scale for project finance, to company-scale for investment, to country scale for sovereign debt.



Green bonds have also been under the spotlight, given the notable increase in issuance in 2020 - which has also sparked a debate around their relevance when issued by heavy emitters willing to finance their transition (as underlined by this recent Bloomberg article).

Therefore, this report by the Bank of International Settlements (available here) argues that while “naïve” investors might expect firms with very high carbon intensities to be disqualified as issuers of green bonds, a large fraction of green bond issuers have carbon intensity above 100T of CO2eq per million dollars of revenue. The comparison of the carbon intensities of green bond issuers with those of other firms indeed buttresses that (i) even if bond proceeds flow into green projects (e.g. renewable energy), issuers may be heavily engaged in carbon-intensive activities elsewhere (e.g. coal power plants); and that (ii) the wide range of varying green bond standards allows a very broad range of firms to issue green bonds, each deemed to be green for different reasons. The study shows that green bond projects have not necessarily translated into comparatively low or falling carbon emissions at the firm level. The authors therefore discuss the potential benefits of a firm-level rating based on carbon intensity (emissions relative to revenue) to complement existing project-based green labels, which could provide a useful signal to investors and encourage firms to reduce their carbon footprint.


Finally, this brief (in French) published by Alexis Masse, the president of the French Sustainable Investment Forum, points out to what extent can the financial sector also make progress on the social front, in relation with developments on climate change.

On Biodiversity


While several recent studies have confirmed the link between biodiversity loss and the increasing spread of zoonotic diseases (such as this report to the European Parliament dated December 22nd, 2020) and the need to rebuild the economy with nature after Covid-19 (the World Business Council for Sustainable Development published a dedicated dashboard on December 15th, 2020), the reinsurer Swiss Re has recently confirmed that more than half of the global GDP is under threat due to biodiversity loss.


In this context, three studies are worth looking at:


This article by Strassburg and al. published in the review Nature, which shows that global priority areas for ecosystem restoration that account for spatial variation in benefits and costs have not yet been identified despite increasing national and global targets. Their study finds that restoring 15% of converted lands in priority areas – with the inclusion of a variety of biomes (community of plants and animals that have common characteristics for the environment they exist in) could avoid around 60% of expected extinctions while sequestering enormous amounts of CO2eq (about a third of the total increase in the atmosphere since 1850!);


The Institut du Développement Durable et des Relations Internationales (IDDRI) published an article (in French) about the way companies can transform the test by (i) increasing substantially the scope of industries making credible commitments towards biodiversity protection and restoration ; (ii) presenting plans that focus on the production activity of the company, include its supply chain and encourage consumers to buy sustainably; and by (iii) effectively measuring their biodiversity footprint;


The OECD has published a policy brief issuing recommendations on how governments can better integrate biodiversity in their Covid-19 stimulus measures and recovery efforts (i.e. regulations on land-use, wildlife trade and pollution; screening and monitoring of stimulus measures for their biodiversity impacts; setting biodiversity spending targets; promoting jobs in biodiversity conservation, sustainable use and restoration; reforming subsidies harmful for biodiversity…).


The role of carbon sinks has also been studied thoroughly in 2020, and some articles are worth pointing out:


  • This post by Shutler and Watson in Carbon Brief (describing their study published in Nature) highlighting the crucial role of oceans in carbon absorption and showing that they are a larger sink than expected;

  • The exposure of financial institutions to deforestation risks has been highlighted by the NGO Global Canopy (available here), showing direct exposure (direct financing of companies in the intensive agriculture sector) and indirect exposure (through investment chains). The role of agriculture – and nitrogen fertilizers for instance – has indeed been under the spotlight this past year.


On Climate Risk and Scenarios


While the Network for Greening the Financial System recently published a comprehensive report about environmental risk analysis by financial institutions, some central banks are initiating climate stress-testing (see Bruegel’s article here), the Financial Stability Board published its updated document on climate risk, and the European Central Bank a guide on the supervision of climate-related financial risks (see a memo on this guide here), several other research articles are worth pointing out in order to gauge the extent of the analytical and methodological work that remains to be done in order to ensure that climate risks are effectively taken into account by the financial sector.


First of all, for introductory purposes, the speech by Andrew Bailey, Governor of the Bank of England, was delivered on November 9th 2020 and entitled “The time to push ahead of tackling climate change”, where he insisted on the utter need for financial institutions and companies to assess climate risks, despite the commonly highlighted “lack of data”: “As we have set out in our supervisory expectations, firms must assess how climate risks could impact their business and review whether additional capital needs to be held against this. Investments that look safe on a backward look may be existentially risky given climate risks. And investments that might have looked speculative in the past could look much safer in the context of a transition to net zero. Uncertainty and lack of data is not an excuse. We expect firms to make reasonable judgements rather than default to “zero”. UK banks and insurers must work to develop these capital assessments over the coming year and the Bank will be working in tandem to develop its approach to reviewing them”.


Second of all, a reminder of low-carbon transition risks thanks to this graph extracted from a working paper authored by Semieniuk, Campiglio, Mercure, Volz and Edwards (March 2020), available here. Worth checking out is the recent EIOPA’s report on the sensitivity analysis of transition risk, that analyzes current holdings of corporate bonds and equity that can be related to key climate-policy relevant sectors (e.g. fossil fuel extraction, carbon‐intensive industries…), quantifies potential transition risks and presents insights into possible impacts on these investments as economies transition away from fossil fuel-dependent energy production and carbon-intensive production.


Third of all, the Climate Disclosure Standards Board’s synthesis of the IPCC’s 1.5°C Special Report for Financial Policymakers is recommended (available here) to understand the implications of climate science for financial markets.


Policy Shift has therefore selected four studies of particular relevance:


A research article by Bingler A., Colensanti Senni C. and Monnin P., published in December 2020, which aims to fill the gap in terms of assessing the convergence of climate risk metrics, by focusing on transition risks. While there exists a significant degree of heterogeneity in the risk assessments currently delivered by providers, risk metrics tend to converge for firms that are most and least exposed to transition risks. Due to the complexity and uncertainty in the assessment of climate risks, the authors believe that instead of a single standard, common transparency principles would be useful for metrics users and a set of metrics to assess the transition risk of portfolios should be defined.


A research article by Monasterolo I. and Battiston S. on the dependence of investor’s probability of default on climate transition scenarios (available here) that highlights that climate risk brings about a new type of financial risk that standard approaches to risk management are not adequate to handle. Their research aimed at developing a specific model to compute (i) the valuation adjustment of corporate bonds, depending both on climate transition risk scenarios and on companies’ shares of revenues across low/high-carbon activities; and (ii) the corresponding adjustments of an investor’s Expected Shortfall and probability of default. Implications for climate financial risk management include that climate stress test exercises should allow for a wide enough set of scenarios in order to limit the underestimation of losses.


An article published in the review Nature in November 2020 has assessed the relevance of the scenario framework that has been developed by the climate community, combining alternative futures of climate and society to facilitate integrated research and consistent assessment to inform policy. In a context of mixed successes and a changing policy and research landscape, the authors have underlined seven recommendations for policymakers:


  1. Integrating resilience aspects (i.e. social protection, financial inclusion, strength of governance and political institutions…) and extending shared socioeconomic pathways to include quantified indicators of vulnerability and resilience; as well as downscaling climate projections at regional and local scales;

  2. Improving applicability to regional and local scales (especially of shared socioeconomic pathways);

  3. Applying scenarios to research domains beyond climate change, for instance on biodiversity (i.e. relationship between nature and people);

  4. Producing a broader range of reference scenarios (i.e. scenarios that do not include the feature of interest that is being estimated) that include climate policies and impacts (e.g. conflicts);

  5. Capturing a wider range of uncertainties and a broader set of perspectives with a manageable number of alternative futures (e.g. with no or limited growth in high-income countries);

  6. Keeping scenarios up to date (e.g. changing societal conditions, advancing knowledge, evolving policy landscape and nationally determined conditions under the Paris Agreement, alternative possible Covid-19 futures…);

  7. Creating climate change scenario services in view of the variety of scenario users (that now include financial institutions, subnational actors and civil society) and communicating on scenario results through novel approaches.

A policy brief published by van der Hurk and al. (available here) under the Cascades project, about the lessons from Covid-19 on the treatment of climate risks in Europe. Researchers take the context of the pandemic as a new starting point when planning for future crises, considering that climate change impacts also have the potential to disrupt society via interconnected global networks. Therefore, governments, businesses and large organizations trying to anticipate future disruption must take a “systemic” perspective when designing policies to reduce and manage these risks. There is a need for greater multilateral and regional attention to resilience, particularly in terms of trade, fiscal stimulus policies and social safety-nets. In this context, actions to approach climate change as a systemic rather than a localized risk include collaborative ways to identify and visualize direct and indirect impact cascades that cross economic sectors and regional boundaries, and redefine the goals of climate adaptation plans to address system-wide resilience. The policy brief finally points out that scenario tools and social simulation techniques are useful tools to support stakeholders’ preparedness and contingency planning, and should be deployed more widely to foster system-wide risk mitigation and management strategies.

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