Greenwashing Regulation

EDHEC-Risk Climate Newsletter - February 2024 Issue

Editorial

Edito - Greenwashing Disclosure (Frederic Ducoulombier)

Greenwashing Regulation

The demand for investments integrating Environmental, Social, and Governance (ESG) dimensions has increased significantly in the past decade and the assets that financial intermediaries claim to manage responsibly and sustainably have close to trebled, reportedly growing to represent a third of overall assets under management. However, the industry-accepted definition of sustainable and responsible investing is nothing if not inclusive. As incorporating ESG issues into investment management now suffices to claim the responsible investment badge, the industry welcomes a dazzling array of strategies with heterogeneous objectives, potential sustainability contributions, and methodologies. Furthermore, there remains considerable disagreement in respect of basic terminology across jurisdictions, voluntary standard setting bodies and industry associations. Regulating sustainability claims and mandating appropriate disclosures is required to protect investors from confusing or misleading claims and to facilitate the matching of investment products with sustainability preferences. Beyond investor protection, such regulation could accompany the integration of sustainability concerns by businesses through better capital allocation and stewardship.

Feature

Bridging the Gap: Making Climate Scenarios Fit for Investors

EDHEC-Risk Climate Impact Institute Scientific Director Riccardo Rebonato offers a concise overview of the key findings from the foundational White Paper from our research programme on modelling the impact of climate change on asset prices. The article delves into the crucial role of scenario analysis and stress testing in grasping the economic consequences of climate change on asset valuation. It explains how we enhance the powerful IPCC framework with probabilistic data to improve its relevance for risk and investment practitioners. It shows how empirical analysis is used to identify strong relationships between economic, demographic, and technological variables and how we derive valuable insights into the likelihood of various climate outcomes, including extreme events. By offering distributions of climate scenarios, such as temperature variations, damages, and cash flow impairments, this novel framework equips financial decision-makers with vital tools to effectively manage climate-related risks.

Interview

Climate Risk Integration: A Global Investor Concern

In this interview, Felix Goltz, Research Director at Scientific Beta, discusses the integration of ESG in factor investing, the pivotal role of academic research and the important insights gained over the years, the strategic shifts in research themes to meet investors' evolving needs, the rationale behind Scientific Beta's climate index series, and the Scientific Beta and EDHEC-Risk Climate Impact Institute research chair established recently to further research into climate risk modelling.

Industry Analysis

Scope for Divergence – The Status of Value Chain Emissions Accounting, Reporting and Estimation and Implications for Investors and Standard Setters

The number of companies disclosing estimates of greenhouse gas emissions in their value chains is set to increase rapidly in the second half of the decade as mandatory climate reporting ramps up in key jurisdictions and more companies are enticed or pressured by capital providers, business partners, and customers to produce such emissions. While value chain emissions are widely regarded as critical to understanding an organisation’s climate-related impact and transition risks and opportunities, the perspective of their inclusion in the scope of a US Securities and Exchange Commission (SEC) climate disclosure rule has led to unprecedented backlash against the integration of sustainability issues into financial management. In this piece, the author explains why value chain emissions matter; describes the state and future of corporate value chain emissions disclosure; discusses estimation and modelling challenges; and concludes with recommendations for investors and standard setters.

Measuring the Greenness of Green Bonds

With the growth of green bonds as an asset class, the certification of the actual climate footprint of projects financed with these bonds is gaining momentum among investors and policymakers. The authors investigate the informative content of Second Party Opinions (SPOs) issued by external reviewers who assess the quality of green bonds by collecting a global sample of over 1200 corporate green bonds and analysing matching results for 336 of them. They show that the market assigns a premium to the green bonds with the best SPOs' valuation - namely, the “dark” and “medium” green bonds. However, in presence of a formal credit rating, SPO external reviews do not appear to incorporate distinctive information priced by the market. Using a difference-in-difference approach, they find that stricter green investment regulations, like the adoption of the “EU Taxonomy,” produce a “fly-to-quality” effect that widens the spread between dark and lighter green bonds' returns.

On the Triple Illusion of Double Materiality

In an op-ed published by French reference newspaper Le Monde on 10 October, IFRS Foundation International Sustainability Standards (ISSB) Board Chair Emmanuel Faber represents that the double-materiality approach to sustainability reporting is a simplistic concept whose popularity derives from a “triple illusion.” Mr Faber argues that single or financial materiality is the only type of materiality that can reorient the required funds towards the just transition within the allotted time. Frédéric Ducoulombier, Director of the EDHEC-Risk Climate Impact Institute, reviews the key elements of this debate.

EDHEC-Risk Climate Publications

Climate Scenario Analysis and Stress Testing for Investors: A Probabilistic Approach

In this paper, the authors propose a framework to produce scenarios that reflect the full uncertainty of outcomes, and give an (approximate) assessment of the relative likelihood of their occurrence. A substantial body of high-quality work has already been devoted to creating climate scenarios. However, they were not designed with financial decision-makers in mind, and therefore are not well suited to their needs.

Portfolio Losses from Climate Damages: A Guide for Long-Term Investors

Regulators and stakeholders are pressing institutional investors to assess and manage their exposure to climate change risks. In this context, financial professionals need to critically assess the tools at their disposal. In this piece, Scientific Director Professor Riccardo Rebonato carefully examines the (de)merits of the advice given to pension trustees and engages with critics who assert that pensions are being put at risk by the flawed research and groupthink of climate economists.

Value versus Values: What Is the Sign of the Climate Risk Premium?

Given the conflicting messages about the magnitude and sign of the climate risk premium provided by the empirical studies to date, the author undertakes a theoretical estimation of the sign of the risk premium. He finds that, in absence of tipping points, the payoff of green (brown) securities covaries positively (negatively) with consumption growth, and should therefore command a positive (negative) risk premium.

Selected Academic Publications

Investigating the Influence of News Sources and Language Models on Climate Beta Estimates

Investors need to be mindful of the potential impact of climate change on asset prices. Following pioneering work by Nobel Prize Robert Engle, several papers have examined the link between climate news and equity market returns with a view to isolating “climate beta” that could be used to construct climate-risk hedging portfolios with easy-to-trade assets. In this paper, the authors investigate the use of climate news as a measure of climate risk. Linguistic dictionary, lexical sentiment-based techniques, and state-of-the-art transformer-based models like Chat-GPT are used to capture daily variations in climate change concerns over a 15-year period.

Asleep at the Wheel? The Risk of Sudden Price Adjustments

Many studies have failed to identify a robust and economically significant climate risk premium or climate beta, either at the aggregate or at the sectoral level. The author examines several explanations of why this may be the case and finds that a mispricing of climate risk is the most likely explanation. If this is true, price adjustments will eventually occur, either in a gradual or in an abrupt way. This is a novel source of risk that should be on the radar screen of long-term investors.

What’s in a Shade? The Market Relevance of Green Bonds’ External Reviews

EDHEC Research Beyond EDHEC-Risk Climate

EDHEC Infrastructure & Private Assets Research Institute: Highway to Hell

This paper presents an assessment of transition and physical risks in the privately invested infrastructure sector. Leveraging the NGFS scenarios, the authors quantified the costs associated with delayed or uncoordinated transition and evaluated the potential portfolio value loss resulting from physical risks in the absence of climate action. The analysis reveals the importance of transition risk for the infrastructure sectors. A disorderly scenario could result in a substantial value loss of infrastructure investments, accounting for nearly US$600bn.

Rethinking Planetary Boundaries: Accounting for Ecological Limits

The concept of planetary boundaries is meant to delineate a safe operating space in which human activities must remain to ensure the stability of critical Earth processes. In this brief commentary accompanying a Call for Papers for a special issue of Social and Environmental Accountability Journal (“Bringing planetary boundaries back to Earth: Rethinking accounting for ecological limits”), Professor Sobkowiak and her coauthors introduce the fundamental principles of planetary boundaries, describe the challenges and criticisms faced by the framework, review current accounting research relating to planetary boundaries, and discuss the need for broader approaches towards accounting for ecological limits.

Climate Risk and Financial Stability: Evidence from Syndicated Lending

The authors study the impact of unexpected climate shocks on banks' individual and systemic risks. Employing climate risk measures developed using the Billion-Dollar Weather and Climate Disasters data from the National Oceanic and Atmospheric Administration (NOAA) and Dealscan syndicated lending data, they find that climate risk exposure acquired through cross-state lending increases banks' individual and systemic risks. They also find that bank profitability helps offset some of the adverse effects of climate risk.

Videos & Podcasts

Education

Financial Times Ranks EDHEC 7th Best Business School in Europe for the Second Year in a Row

This result attests to EDHEC’s overall excellence and the appeal of its full range of programmes. EDHEC especially stands out in terms of ESG criteria, placing the ecological transition and the fight against climate change at the heart of its teaching and research strategy.

Climate and Finance: is it Now, or Right Now?EDHEC-Vox January 2024 Newsletter is Out

This month, EDHEC Business School professors explore the critical role of the financial sector in essential transitions within economies and societies. But why is it a two-way street? What role are researchers – and in particular those at EDHEC – already playing? What would a genuine #sustainablefinance look like, and why are education, research, and collaboration the pillars of it?

EDHEC Business School to Host GRASFI PhD Workshop in Sustainable Finance

EDHEC Business School will host a GRASFI PhD workshop on April 2 & 3, 2024. Collaborating with Université Paris-Dauphine, HEC Liège, and Maastricht University, this workshop offers a platform for PhD candidates to present their research work on sustainable finance including climate finance, asset pricing, impact investing, ESG Investing, non-financial reporting, and engage in scholarly discussions. Submissions are welcome until February 23.

News

Gianfranco Gianfrate Research 'Highly Commended' in the 2024 FT Academic Research Awards

Research by Gianfranco Gianfrate "Highly Commended" in the 2024 FT Academic Research Awards

We are delighted to announce that EDHEC Professor Gianfranco Gianfrate’s academic research paper "Determinants of Internal Carbon Pricing," published in Energy Policy, has been Highly Commended in the FT Responsible Business Education Awards, in the category “Best business school academic research”.

A Great Success for the Webinar ‘Climate Risks: Are the Markets Asleep at the Wheel?’

"Climate Output at Risk" Distinguished by the French Association of Institutional Investors

The French Association of Institutional Investors (Af2i) unveiled the winner and runners-up of its yearly Academic Prize for excellence in applied investment research. "Climate Output at Risk" by EDHEC-Risk Climate Impact Institute Professor Riccardo Rebonato, Dr. Dherminder Kainth, and Dr. Lionel Melin, was amongst three articles shortlisted by the association's research commission.

A Great Success for the Webinar ‘Climate Risks: Are the Markets Asleep at the Wheel?’

During the webinar, with over 600 professionals registered from 60 countries, EDHEC-Risk Climate Scientific Director reviewed the merits of various market efficiency explanations for the elusive sensitivity of asset prices to climate risk and explored why current market prices may be underestimating the effects of climate risk on government revenues and the cashflows of companies.

Riccardo Rebonato Invited to Discuss Climate Stress Tests with Moody’s Head of Scenario Modelling

In this 30-min conversation hosted by Christian Doherty (The Actuary), climate experts Riccardo Rebonato and Nick Jessop, Head of Scenario Modelling Research, Insurance and Pension at Moody’s Analytics, engage in a thought-provoking discussion, exploring how standard climate scenarios can be used to create short-term stresses for financial markets and broaden the scope of climate analysis.

What Were EDHEC-Risk Climate’s Top 10 Most Read Articles in 2023?

As we enter a new year, EDHEC-Risk Climate Impact Institute takes a look back at the most read articles in 2023, covering a diverse range of topics that are at the heart of its expertise (climate change, climate risks, scenarios analysis, double materiality, sustainability reporting, ESRS, SFDR, carbon pricing and ESG).

Events

27 February 2024

Carbon Pricing - EDHEC Speaker Series

Speaker: Robert B. Litterman (Kepos Capital)

Moderator: Riccardo Rebonato (EDHEC, EDHEC-Risk Climate).

12 March 2024

Climate Investing - EDHEC Speaker Series

Speaker: Thierry Roncalli (Amundi, University of Evry-Paris-Saclay)

Moderator: Frederic Ducoulombier (EDHEC-Risk Climate).

14 March 2024

Webinar: How to Enhance Climate Scenarios for Investors?

Existing climate scenarios, inspired by the IPCC framework, provide invaluable insights but were not designed for financial uses. New research by EDHEC-Risk Climate Impact Institute explores approaches to enrich the existing framework with probabilistic information. This allows finance practitioners to both understand which outcomes are more likely and should therefore attract greater attention; and to get a better appreciation of what lies in the tails of the damage distribution. At this webinar, Riccardo Rebonato, Scientific Director and Dherminder Kainth, Research Director at EDHEC-Risk Climate, will provide insights into their white paper "Climate Scenario Analysis and Stress Testing for Investors: A Probabilistic Approach", and will answer the audience's questions.