Climate change: financial risk, greatest commercial opportunity



There are growing concerns - albeit slow - about the financial cost of climate change among those with decision making power on what should and should not be financed. Weather events caused insurance losses and economic losses of $150 billion for the global economic system in 2019. There are those who think that the existential risk could become the greatest commercial opportunity of our time. Actors in the financial and banking system have engaged in a dialogue with CitiPlat on this issue.



This critical reflection gained momentum in 2015, when the then Governor of the Bank of England, Mark Carney, stated very clearly: “Climate change is the tragedy of the horizon. We don’t need an army of actuaries to tell us that the catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors – imposing a cost on future generations that the current generation has no direct incentive to fix.”


The pandemic is the most recent, though probably the clearest, event to expose the many contradictions of our production system and its negative effects on the environment. This has strengthened the point of view of those who support the need for sustainable economic development.


The interruption of many production activities and the isolation of a large part of the world‘s population due to the pandemic have led to a decrease in pollution levels in all countries. According to the European Space Agency (ESA), between 13 and 23 March of this year nitrogen dioxide emissions in Europe decreased by 50% compared to the same period of the previous year.


The International Energy Agency, together with the International Renewable Energy Agency, have estimated that a transition to low-carbon economic models by 2050 would cost about $3.5 trillion per year, and that by 2050 another $29 trillion should be invested in renewable energy and low fossil fuel technologies. At the same time, these investments would lead to an increase in overall Gross Domestic Product (GDP) of 19 trillion and to the creation of 6 million jobs, only in the clean energy sector, by 2030.


An analysis by the Committee on Economic Affairs and Sustainable Development calculated that if the goals of the 2030 Agenda for Sustainable Development—an action plan subscribed by 193 member countries of the United Nations—could be achieved, economic opportunities with a potential of around $12 trillion would be created over the next ten years. In the light of this data, it is essential to understand what role banks, and the financial sector in general, can play in this potential transformation. Several times in recent years the central banks of different nations have stressed the importance of a sustainable economic transition, insisting among other things on the need for greater transparency on investments.


On February 27, Carney, who since last February has taken on the mantle of UN Special Envoy for Climate Change and is finance advisor for COP26 to the UK Prime Minister, previewed his new role with a speech to companies, banks, investors and insurers in London. He stressed the central role of private finance in delivering the net zero transition, successful adaptation, and an ambitious COP26. He spoke of the need for greater disclosure of climate risks by financial institutions, and by the companies they lend to. He spoke of the need to measure and manage these risks, and of the role of central banks in forcing the institutions they oversee to properly analyse their exposure. He also spoke about the opportunity to generate profits from the low-carbon transition. “Achieving net zero,” he said, “will require a whole economy transition - every company, every bank, every insurer and every investor will have to adjust their business models. This could turn an existential risk into the greatest commercial opportunity of our time.”


In addition, the role of green-related stress tests, simulation of the possible reaction of a given bank to various recession scenarios to identify its vulnerabilities and understand how to deal with them, has become increasingly important in recent years.


After the signing of the Paris Accord in 2015, a process of building a more sustainable financial system has begun, able to invest in technological innovation in the private sector and thus facilitate the transition to a zero-emission economy.


According to Carney, however, these first steps are not enough and it is therefore necessary to pursue greater transparency on the transformation of risk management and to ensure that sustainable investments are more widespread. For the former Governor of the Bank of England, all financial decisions must take climate change risks into account.


The standards of the Task Force on Climate Related Financial Information (TCFD)—created in 2015 by the Financial Stability Board, which monitors international financial stability as mandated by the G20, the international forum for the governments and central bank governors from nineteen countries and the European Union—should be revised to make disclosure of all information related to environmental issues mandatory. Risk management should be based on a long-term approach that assess the resilience of the financial system in a transitional period. As for the issue of returns, managers and owners will have to increasingly assess the transition plan for their investments so that they can provide their customers with information about their impact. In the end, citizens will be able to understand whether or not their investments are in line with the objective of a zero-emission economy.


The European Central Bank (ECB) plays a key role in the transition to a sustainable economy in Europe, given its decision-making power in the euro zone monetary policy. Last February, Christine Lagarde, President of the ECB, recalled some of the financial risks associated with climate change. In 2018, for example, weather events caused insurance losses and economic losses of 0.1% and 0.2% of global Gross Domestic Product (GDP) respectively. The direct and indirect effects of these events generated losses of $150 billion for the global economic system in 2019, a 250% increase from $60 billion in 1980. All this has also increased the risk of insolvency for those involved.


In order to facilitate the path towards a sustainable economy, the ECB President also highlighted the need for public authorities to intervene through regulation and taxation. The timing of this intervention and coordination between individual national governments will be essential to avoid a disorderly transaction with negative effects on the economy. European governments in the euro zone are examining precisely the extent to which climate-related risks have been understood and assessed by the market.


At the same time, the ECB has undertaken to examine and evaluate banks‘ choices and strategies in the face of climate risks, developing a dedicated supervisory system.


Lagarde also pointed out, “The financial sector will play a key role in mobilising the resources needed to complete the transition and support national economic systems. For this reason, in 2018 the European Investment Bank, the first to issue green bonds in 2007, directed 31% of its lending to projects related to climate mitigation and adaptation, thus promoting the expansion of the market share of green bonds in Europe”.


The Bank of Italy is also highlighting the financial and economic risks linked to climate change. As the ECB has pointed out, an uncoordinated global transition can have devastating negative effects on entire production sectors and end consumers themselves.


Ivan Faiella, of the Economics and Statistics Department of the Bank of Italy, gives an example, “The case of fossil fuels and companies operating in that sector is particularly illustrative if we talk about dangers. If the use of hydrocarbons and fossil fuels were banned, the value of these resources would be zero, with that of the companies that produce them. Bearing in mind that, given their large size, oil companies often tend to be in debt, their collapse would be reflected in the whole financial system, involving all operators. The systemic repercussions would also be reflected in the real economy with unpredictable effects”.


In this perspective the European Green Deal, the guidelines indicated in 2019 by the European Commission to define the environmental and climate strategy of the European Union over the next thirty years, could prove to be a winning tool to guide the transition to a new economic model.


However, it is not only the central banks that have to deal with the risks caused by climate change. The sensitivity of commercial banks to these issues has also increased in recent years. Simone Grillo, from the Department of Ethical Finance Proposal of the Italian Banca Etica, explains: “On the subject of environmental sustainability, the financial sector has taken unthinkable steps until a few years ago. This is because people‘s perception of the climate issue has changed and as a result has pushed the banks to take on board society‘s point of view.” For Grillo, the younger generation of future savers and investors are much more environmentally conscious than the generations before them, which has obligated credit institutions to pay greater attention to these issues.


For this reason, several commercial banks are no longer limited to lending solely on the basis of the economic and financial performance of the company in question but also take into account other information, such as management characteristics, transparency, reputation and environmental impact.


In the latter case, the focus on companies is mainly focused on behaviours concerning environmental and regulatory risk, as indicative of the importance these risks may have on the activities of the companies themselves.


With this in the mind, the new credit guidelines of the European Banking Authority (EBA)—came into force last 30 June—introducing banks to an assessment criteria focused on sustainability, environmental, social, governance including green lending.


In Italy, for example, Banco BPM is implementing a number of specific policies in the real estate sector aimed at taking advantage of opportunities linked to the construction and redevelopment of properties in accordance with environmental safe standards.


Banco BPM is actively participating in the Action Plan for an Energy Efficient Mortgage Initiative (EeMAP), which, through favourable financial conditions, aims to create a standardised mortgage at European level to encourage the redevelopment of buildings and the purchase of highly environmentally efficient properties.


According to Damiano Carrara, manager of the Corporate Social Responsibility of UBI Banca, “for the same credit institutions, sustainable financing is also an opportunity to get in touch with investors and portfolios different from traditional ones, as happened to our bank, which thanks to the issuance of a green bond has managed to expand its investor base.” In the beginning, UBI Bank wanted to place 500 million Euros in bonds on the market, but in the end the actual demand was higher than expected.


The perspective on sustainability of Banca Etica, which links the issue to social cohesion and fairness, differs. “The real challenge,” says Grillo, “would be to combine environmental issues with social issues. Green finance is not only an opportunity to improve the quality of life, the environment and the relationship with the territory, but also, and above all, a tool to ensure the inclusion of skilled young people in the labour market, at the moment at risk of social exclusion. On the contrary, environmentally friendly initiatives create numerous opportunities for social inclusion.”


If you look wider and consider the whole financial system, it becomes complicated to calculate the percentage of sustainable investments in relation to the total financial operations. Alessandra Franzosi, Head of Asset Owners & ESG Investing, Capital Markets, London Stock Exchange Group says, “Under the umbrella of sustainability, there is a very high number of highly diversified investment strategies, as well as different investor sensitivities. For some people, the term sustainability means medium and long-term risk management, for others it represents an investment opportunity in specific sectors, for others it means analysing the risk, return and impact of their investments.” She believes a rough estimate can be made, however, that a quarter of global wealth is managed by people who have committed themselves to investing in an increasingly sustainable way.


By Valentina Ardizzone, Fabiana Azzolino, Lorenzo Mariani, Luca Mazza, Kristina Terekhova, Simona Vellami (*)

(*) Students at MICRI, the Master on Communication for International Relations, IULM University, Milan, Italy

Coordination and Italian editing: Emanuele Valenti - English editing: Mina Zahine