Blueprint to Foundations: A New Generation of Climate Scenarios

EDHEC-Risk Climate Newsletter - December 2024 Issue

Editorial

Blueprint to Foundations: A New Generation of Climate Scenarios

Two years ago, EDHEC-Risk Climate Impact Institute was established with a clear priority: to advance the integration of climate considerations into financial decision-making. Our mission has been to equip investors, financial managers, and policymakers with the tools to navigate the evolving economic landscape shaped by climate change and climate action. This included modelling interactions between climate change and policies, assessing their economic and financial impacts, and developing better tools for climate-aware investment and risk management.

Eighteen months ago, in a Financial Times editorial, we challenged the financial industry to rethink its approach: existing climate scenarios rigidly link socio-economic narratives to warming outcomes, overlook critical uncertainties—such as variability in climate responses and dynamic policy and economic feedbacks—and remain silent on the relative likelihood of different pathways. Furthermore, global approaches obscure regional and sectoral disparities, limiting their practical value for decision-makers.

In this editorial, we reflect on the progress made in addressing these shortcomings: extending Integrated Assessment Models to incorporate state-of-the-art climate science and align them with financial economics, demonstrating how discount rates can be recovered to price assets under emissions abatement schedules while integrating multiple dimensions of uncertainty into the modelling framework, and creating a methodology to assign probabilities to climate abatement pathways and deliver fully probabilised climate scenarios. These advances, delivered in a modular architecture, are further enhanced by high-resolution geospatial research, which allows us to explore sectoral and geographic implications at a subnational level and refine global damage functions—offering decision-makers a more precise and actionable understanding of climate risks.

Feature

Why We Need Climate Scenario Probabilities and How to Get Them

When investors and policymakers are faced with the garden-variety uncertainty associated with financial quantities, they have at their disposal well-established statistical tools, such as Value-at-Risk or Expected Shortfall. Knowing that there are more things between heaven and earth that are dreamt of in the statisticians’ philosophy, the same investors and policymakers often also make use of scenario analysis. The two approaches complement themselves: as the slogan goes, statistical tools are backward-looking and scenarios (can be) forward-looking. Financial scenarios are rarely, if ever, accompanied by explicit probabilities. However, the 'expert knowledge' of the end users allows them to understand whether a given scenario represents a clear and present danger, or whether it belongs to the meteorite-falling-on-Earth category. And, if they so wanted, the same users could avail themselves of a hundred-years-plus of financial data to carry out a formal assessment of the scenario likelihood. So, with financial scenarios, probabilities are at least in the back of the users' mind, and can be brought centre stage with relatively little effort. Climate scenarios are different.

Interview

Refining Risk Assessments with High-Resolution Climate Simulations and Advanced Econometric Modelling

In this interview, Nicolas Schneider, Senior Research Engineer at EDHEC-Risk Climate Impact Institute, explores the advancement of high-resolution climate-economic modelling to assess climate risks at regional and subnational levels. He explains the necessity of moving beyond global averages to uncover localised vulnerabilities and threshold effects, highlighting the innovative methods and data improvements behind this research. Nicolas discusses how this work builds on recent studies, addresses critical gaps in climate models, and delivers actionable insights for policymakers, investors, and financial institutions. He also shares key findings on regional economic impacts, the importance of adaptation strategies, and the role of robust climate data in understanding and mitigating climate-driven risks.

Industry Analysis

Charting a Pathway for Transition Finance: Challenges and Opportunities in the EU Framework

Transition finance is increasingly recognised as a critical tool for achieving net-zero targets, enabling high-emission sectors to decarbonise, adopt cleaner technologies, and phase out outdated facilities. Yet, the scale of transition and green investments remains far below what is required to meet the Paris Agreement goals. According to the Intergovernmental Panel on Climate Change (IPCC), mitigation investments must increase three- to six-fold this decade in scenarios that limit warming to 2°C or 1.5°C. Scaling up transition finance is therefore an urgent imperative and, as the IPCC notes, requires “clear signalling and support by governments.” Despite its importance, transition finance lacks a globally accepted definition, and few major regulatory frameworks have addressed it comprehensively. Even the European Union, often seen as a pioneer in sustainable finance, faces significant gaps and inconsistencies in its treatment of transition finance, creating barriers to its effective deployment. This article examines the definitional challenges of transition finance, analyses its treatment in the EU Sustainable Finance Framework, and explores the role of private-sector initiatives in bridging these gaps. Finally, it offers policy insights and implications for financial professionals, charting a pathway to properly integrate transition finance into sustainable finance frameworks.

EDHEC-Risk Climate – Academic Papers

Optimal Climate Policy with Negative Emissions

The authors utilise a modification of the DICE model to analyse the optimal policy responses to climate change, focusing on emissions abatement and CO2 removal. By calibrating the marginal costs of these interventions to the latest scientific data, they demonstrate that carbon removal plays a critical role in crafting an economically optimal climate policy. Their findings indicate that achieving the Paris Agreement’s target of limiting global warming to 1.5-2°C by 2100 is not only aspirational but also optimal when carbon removal is prioritised.

EDHEC Research Beyond EDHEC-Risk Climate

Scientific Portfolio: Attribution Analysis of Greenhouse Gas Emissions Associated with an Equity Portfolio: A Comparison of Existing Frameworks

Understanding the drivers of greenhouse gas emissions in financial portfolios is essential for designing and monitoring effective climate-aligned investment strategies. In recent years, various frameworks have been developed to perform attribution analyses aimed at identifying the key factors driving portfolio decarbonisation over time. This article provides both a qualitative and quantitative comparative analysis of these frameworks, focusing on the primary drivers identified and the methods employed to isolate their individual effects. Building on this review, the author formalises a generalised approach to integrate these frameworks and proposes five tailored models designed to address specific analytical questions.

Scientific Portfolio: Special Issue of the EDHEC Research Insights Supplement to Investment & Pensions Europe (IPE)

The authors focus on the ESG challenges that investors face today. The lead article explores the potential of digitalised self-indexing to help asset owners integrate ESG and climate objectives alongside other fiduciary demands. They also provide guidance on setting greenhouse gas emissions reduction targets and avoiding "greenwashing" in portfolios. Additionally, the authors contribute to the European debate on the consistency of equity funds labeled as sustainable.

EDHEC Infra & Private Assets - Special Issue of the Research for Institutional Money Management Supplement to Pensions & Investments (PandI)

EDHEC Infra & Private Assets: Special Issue of the Research for Institutional Money Management Supplement to Pensions & Investments (P&I)

The authors focus on ESG and climate risks in the context of infrastructure investment. The first article explores the challenges of using the EU Taxonomy for Sustainable Activities to assess infrastructure sustainability, concluding that while the Taxonomy is a step forward, it lacks comprehensive insights. The second introduces Social Risk Sector Ratings and a case study on UK water companies, showing how social acceptance aligns with sector trends and impacts social risk levels. The next two articles address the investment implications of climate risk for global infrastructure. One highlights the significant financial risks posed by climate change, including both physical and transition risks, while the other reports on a survey of investors concerned about the lack of reliable data on climate risks, which could lead to substantial portfolio losses.

Shaping Nature Outcomes in Corporate Settings

Transnational companies have substantive impacts on nature: a hallmark of living in the Anthropocene. Understanding these impacts through company provision of information is a precursor to holding them accountable for nature outcomes. The effect of increasing disclosures (of varying quality) is predicated on ‘information governance’, an approach that uses disclosure requirements to drive company behaviour. However, its efficacy is not guaranteed. The authors argue that three conditions are required before disclosures have the possibility to shape nature outcomes, namely: (1) radical traceability that links company actions to outcomes in particular settings; (2) developing organisational routines, tools and approaches that translate strategic intent to on-the-ground behaviour; and (3) mobilising and aligning financial actors with corporate nature ambitions.

Biodiversity and Climate: Friends or Foes? †

The authors propose a portfolio optimisation framework that jointly incorporates biodiversity and climate considerations. Their empirical application to sovereign bonds demonstrates that investors can construct portfolios that enhance both biodiversity and climate outcomes without sacrificing absolute risk-adjusted returns. While adding a biodiversity objective to a portfolio with an existing climate objective may slightly reduce relative performance, this reduction diminishes for more ambitious sustainable portfolios and dissipates when long-only constraints are removed. Findings are robust across various choices of sustainability measures and modelling approaches.

Videos & Podcasts

Education

Financial Times Ranks the EDHEC MiM 4th in the World in 2024

EDHEC Business School moved up seven places in the 2024 Financial Times Masters in Management ranking to clinch 4th place. This remarkable advancement highlights the strength of EDHEC’s programmes, the success of its graduates, and its leadership in academic innovation and sustainability. It also spotlights EDHEC’s top standing in ESG and net-zero teaching, reinforcing its mission to equip students with the knowledge to address global challenges. Generations 2050, EDHEC’s strategic plan, aims to reimagine business education and foster a net-positive economy, restoring biodiversity and ensuring a sustainable future.

EDHEC's Open Executive MBA Ranked 4th worldwide for ESG and Net-Zero Education by the Financial Times

The EDHEC EMBA has moved up one spot to rank 4th worldwide for its teaching on ESG and net-zero topics. This ranking evaluates the percentage of course hours dedicated to ethics, social and environmental issues, and solutions for achieving carbon neutrality. The programme integrates ESG throughout the 16-month journey and offers specific courses, workshops, and business explorations on ESG subjects, in line with EDHEC’s “Generations 2050” strategic plan for net-positive impact.

News

Riccardo Rebonato’s Book on Climate Economics Recognized by the Financial Times

Riccardo Rebonato’s Book on Climate Economics Recognised by the Financial Times

Riccardo Rebonato’s recent book, "How to Think About Climate Change: Insights from Economics for the Perplexed but Open-minded Citizen", has been selected as one of the best economics books of the year by Martin Wolf in the Financial Times. The book is particularly praised for its accessibility to non-specialists. Avoiding complex mathematics, it introduces readers to cutting-edge Integrated Assessment Models and demonstrates how modern economic approaches support rapid and decisive decarbonisation action to achieve the Paris Agreement targets.

The Second Edition of EDHEC’s Climate Finance Research Highlights is Out

This quarter, EDHEC experts in Climate Finance delve into the growing demand for transparency in climate risk assessments, the essential role of finance in driving the climate transition, and the need for more robust climate scenario models. They also discuss decarbonisation strategies, the financial sector’s contribution to climate action, and the potential costs of inaction on infrastructure sustainability.

EDHEC-Risk Climate Scientific Director Discussed Climate Risk at GFRA Conference

On 12 December, Professor Rebonato participated in the Green Finance Research Advances (GFRA) event co-organised by the Banque de France and the Institut Louis Bachelier. He presented on the topic of “What is the Impact of Physical Climate Risk on Equity Valuation?”, exploring how physical climate risks, such as extreme weather events and long-term environmental changes, impact the financial valuation of equity markets.

Frederic Ducoulombier Discussed SFDR Product Labelling, Transition Finance, and ESG Data Challenges at Reuters Conference

Frederic Ducoulombier Reviewed SFDR Product Labelling, Transition Finance, and ESG Data Challenges at Reuters Conference

Frédéric Ducoulombier, Director of EDHEC-Risk Climate Impact Institute, delivered critical insights during a session titled "What’s Next for the SFDR and Sustainable Fund Labels" at the Reuters Events: Sustainability Europe 2024 summit in London. This event was held in front of 600 leading global business leaders and investors to discuss the EU Sustainable Finance framework, with particular emphasis on recent developments in the ongoing review of the SFDR and addressing key issues around product naming and labeling and transition finance.

Gianfranco Gianfrate win SIDREA prize for research on the market impact of green bonds' external reviews

Gianfranco Gianfrate Wins SIDREA Prize for Research on the Market Impact of Green Bonds' External Reviews

The Italian Society of Accounting and Business Administration (SIDREA) has awarded Professor Gianfrate and co-authors the Commission on Internationalization Project Prize for the ‘Best Scientific Article Published in an International Journal in 2023’ for their article “What’s in a shade? The Market Relevance of green bonds’ external reviews", published in The British Accounting Review.

A Great Success for the Webinar 'How to Enhance Climate Scenarios for Investors'

Professor Rebonato presented the key findings of a new study, "How Does Climate Risk Affect Global Equity Valuations? A Novel Approach". This study introduces a groundbreaking approach to understanding the impact of climate change and related policies on global equity valuations. During the webinar, attended by over 800 professionals, he reveals that even in the absence of tipping points, failure to take abatement action can reduce global equity valuation by over 40%.