research handbook on climate finance and investment

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Research Handbook of Climate Finance and Investment

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T1 - Research Handbook of Climate Finance and Investment

A2 - Mehling, Michael

A2 - van Asselt, Harro

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Debt for Climate: Green Bonds and Other Instruments

RESEARCH HANDBOOK ON CLIMATE FINANCE AND INVESTMENT LAW (Edward Elgar, forthcoming 2021); Ohio State Legal Studies Research Paper No. 595

28 Pages Posted: 12 Jan 2021 Last revised: 5 Apr 2021

Case Western Reserve University School of Law

Date Written: December 17, 2020

This chapter, prepared for the Edward Elgar Research Handbook on Climate Finance and Investment Law (2020, Michael Mehling and Harro van Asselt (eds.)), examines the rise of green bonds, climate bonds, and other green financial instruments. Although climate finance has enjoyed positive momentum in recent years, this momentum is at risk—with the possibility of reversal—if climate markets fail to provide competitive risk-adjusted returns. For climate finance to compete effectively, governments, issuers, and investors must resolve a set of interrelated problems. First, green investments must compete with traditional “brown” investments, some of which enjoy significant subsidies. Even when not competing against subsidized industries and investments, green investments may still lack an advantageous risk-return profile and may suffer lower demand compared to standard investments. Second, green investments must create sufficient trust in their “greenness” so as to avoid accusations of greenwashing that would not only jeopardize a given issuer’s offerings, but would also erode trust in green markets generally. This chapter describes public and private efforts to develop a robust deal infrastructure for climate finance, including mechanisms like distributed ledgers and other financial technologies that are designed to make green investments more competitive with brown investments, while also increasing trust and reducing transaction costs.

Keywords: green bonds, climate finance, green loans, green equity, green loans, sovereign debt

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2020 Chapters (Layout Features)

Reforming International Investment Law for Climate Change Goals

Brauch, Martin Dietrich

To achieve global climate change mitigation and adaptation goals under the Paris Agreement, international investment law should enable and expedite the transition away from high-emission investment toward low-emission investment. Existing international investment agreements (IIAs) providing for investor–state dispute settlement (ISDS) fail to advance climate goals and can effectively hinder states’ climate action. In this chapter, I discuss the implementation of two main policy options for climate-oriented reform of international investment law – termination of climate-unfriendly IIAs and negotiation of climate-friendly ones – at various governance levels, ranging from unilateral to multilateral action. Given the mounting risks and impacts of IIAs and ISDS, as well as the lack of evidence that they encourage foreign investment flows, terminating IIAs or withdrawing from them appears to be the most effective reform option. States seeking to conclude new climate-friendly treaties or to amend existing IIAs must ensure that the treaties legally distinguish between low-emission and high-emission investments. Climate-friendly IIAs must not hinder climate action (‘do no harm’), by denying treaty protections to high-emission investments, limiting their establishment and expansion, removing incentives such as fossil fuel subsidies, and requiring investments to be made responsibly. In addition, IIAs should leverage the potential contribution of foreign investment to climate goals (‘do good’), by incentivising, promoting, facilitating, and protecting low-emission investments only, and by supporting a just transition to a low-emission world. In line with broader efforts to reform international investment law, climate-aligned IIAs should also exclude or circumscribe controversial provisions (fair and equitable treatment [FET], legitimate expectations, indirect expropriation, and most-favoured-nation [MFN], to name a few), prohibit treaty-based challenges to climate policy measures, and deny substantive rights and access to treaty-based dispute settlement mechanisms to high-emission investments. Climate-unfriendly investors would instead need to rely on substantive rights and procedural avenues based on domestic laws.

• Investments, Foreign (International law)
• Climatic changes--International cooperation
• Climatic changes--Government policy
• Climate change mitigation

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Climate-resilient finance and investment

• Climate change
• Environment
• Climate adaptation and resilience
• Environment, society and economy

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Achieving climate-resilient economies and societies will not only require increasing the billions of financial flows for adaptation, but also shifting broader -- public and private -- financial flows and investment away from potentially mal-adapted activities towards those that contribute to climate-resilient economies and societies. The goal of aligning finance with climate-resilient development is included in article 2.1c of the Paris Agreement, yet efforts to define and operationalise this concept are at an early stage. This framing paper summarises the current status of these efforts and outlines a way forward for defining, measuring and mobilising adaptation-aligned finance.

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Climate finance: What does the research say?

2021-02-26T09:50:00+00:00

Stefano Giglio, Yale School of Management, NBER and CEPR, Bryan Kelly, Yale School of Management, AQR Capital Management and NBER and Johannes Stroebel, New York University, Stern School of Business, NBER, and CEPR

Climate change is one of the defining challenges of our time, potentially impacting the health and well-being of every person on the planet. It also poses a large aggregate risk to the financial system. Economic tools, designed for valuing and managing risky future outcomes, can therefore help society assess and respond to climate change risk.

While there is a large body of literature examining the interactions between climate change and the economy, many important aspects, such as the pricing and hedging of risks stemming from climate change, have received less attention.

In our article, Climate Finance, we review the literature on the role of climate risk in macro-finance models and the empirical analysis of climate risk effects on asset prices.

Climate risk in macro-finance models

There are two popular approaches to adding climate change-related uncertainty to economic models. The first emphasises climate change uncertainty as a direct source of economic risk. It thinks about climate risks in terms of a low-probability catastrophic event that could dramatically impact the economy: a climate disaster, often motivated by a tipping point, affects the future path of the economy since it directly impacts expected consumption growth.

In the second approach, climate change uncertainty stems primarily from uncertainty about the future of economic activity. The typical model embeds the following events: the economy experiences a growth shock, pollution increases alongside output, the increase in CO 2 emissions accelerates climate change, which in turn accelerates climate-related economic damage. In short, higher growth today is associated with larger negative effects on future growth through the climate feedback channel.

The two approaches have different implications for climate damage risk premia. When uncertainty emanates directly from climate disaster risk, climate damage tends to be unexpectedly high while consumption is low, because climate disasters drive reduced consumption. Assets that mitigate climate damages – those with high payoffs when climate damages are high – hedge investors’ marginal utility and thus tend to earn negative risk premia.

For example, consider an investment that reduces CO 2 emissions by one ton today, the value of which is often referred to as the social cost of carbon. In climate disaster models, this cost is relatively high, because payoffs to investments that mitigate climate damages are discounted at lower than risk-free rates.

Conversely, if the future of the economy creates uncertainty, it has the opposite impact on the climate risk premium. In these models, climate damages are larger when the economy is performing better. An investment that mitigates climate damages tends to pay off in times when consumption is high and marginal utility is low. In this case, mitigation investments carry positive risk premia, and the associated social cost of carbon is relatively low.

Empirical evidence on the pricing of climate risk

Investors and academics are increasingly exploring how climate risk is already reflected in asset prices. Climate risks can be divided into two types. Physical risks result directly from the effects of climate change on economic activity, such as impairment of property and equipment due to rising sea levels. Transition risks cover the effects on firms’ operations and business models that come from a possible transition to a low-carbon economy, such as a carbon tax leaving fossil fuel companies with stranded assets. When these risks occur, they will create winners and losers in asset markets. For example, while coal companies would likely suffer from the low-carbon transition, renewable energy companies might benefit.

Alok et al. (2020) show that fund managers adjust their portfolios in response to climatic disasters. Bolton & Kacperczyk (2020) analyse US equity markets and demonstrate that firms with higher carbon emissions trade at lower prices, all else being equal. Engle et al. (2020) document that stocks of firms with high environmental scores, which the authors argue are less exposed to regulatory climate risk, have higher returns during periods with negative news about the future of climate change.

How can investors mitigate the significant risks that climate change poses to their portfolios?

Engle et al. (2020) propose an approach to hedging climate risk that combines traditional dynamic trading arguments with novel statistical measurements using text analysis. They construct a climate news index based on The Wall Street Journal’s coverage of climate change. They systematically overweight stocks that rise in value when negative news materialises and underweight those that fall in value on the arrival of such news. In doing so, the hedged portfolio profits from adverse climate news.

A growing literature has started exploring the effects of climate change on real estate valuations, and correspondingly, on the mortgage market. This focus is hardly surprising. Hauer et al. (2016) estimates that a 1.8-meter sea-level rise by 2100 would affect about 13.1 million Americans, and Rao (2017) estimates that a six-foot sea-level rise would put 1.9 million homes, worth about US$882 billion, at risk of flooding.

Giglio et al. (2020) explore the pricing of rising sea level risks in coastal US states. They document substantial variation in climate risk exposure (e.g., differences in elevation) across properties in the same narrow geography. While properties in a flood zone generally trade at a premium compared to otherwise similar properties (likely because of positive amenities such as beach access), this premium significantly compresses when there is an elevated focus on climate risk.

Since most residential real estate is purchased with a mortgage, climate risk also affects these valuations. Consistent with this, recent research has shown that wildfires and flooding lead to increased mortgage default and affect banks’ securitisation decisions (Issler et al., 2019, Keenan & Bradt, 2020).

A research agenda in climate finance

Climate change will be a first-order issue facing our society for many years. Much progress has been made on modelling the relationship between climate change, the economy, and asset prices and on documenting how climate risk is already priced in financial markets. But much work remains to be done.

Computational advances will allow researchers to model the various feedback loops between climate change and the real economy with increasing sophistication. While the basic economic mechanisms of these models will be like those discussed in this review, such advances will provide new and improved quantifications of important objects such as the social cost of carbon.

Empirically, there is substantial scope for improving how climate risk exposures in different asset classes are measured. Improved firm-level disclosure and more creative use of alternative data (such as news text or satellite imagery) will be critical for this work. Improved data can also feed into much-needed research on how climate risk affects financial stability. It will allow financial institutions and investors to better assess their climate risks and will allow regulators to ensure that they do not threaten financial stability.

 Read our article Climate Finance here . 

This blog is written by academic guest contributors. Our goal is to contribute to the broader debate around topical issues and to help showcase research in support of our signatories and the wider community.

Please note that although you can expect to find some posts here that broadly accord with the PRI’s official views, the blog authors write in their individual capacity and there is no “house view”. Nor do the views and opinions expressed on this blog constitute financial or other professional advice.

If you have any questions, please contact us at  [email protected]

Alok S, Kumar N, Wermers R. 2020. Do fund managers misestimate climatic disaster risk. The Review of Financial Studies 33:1146-1183

Baker M, Bergstresser D, Serafeim G, Wurgler J. 2018. Financing the response to climate change: The pricing and ownership of us green bonds. Tech. rep., National Bureau of Economic Research

Bolton P, Kacperczyk M. 2020. Do investors care about carbon risk? Tech. rep., National Bureau of Economic Research

Engle RF, Giglio S, Kelly B, Lee H, Stroebel J. 2020. Hedging climate change news. The Review of Financial Studies 33:1184-1216

Giglio S, Maggiori M, Rao K, Stroebel J, Weber A. 2020. Climate change and long-run discount rates: Evidence from real estate

Hauer ME, Evans JM, Mishra DR. 2016. Millions projected to be at risk from sea-level rise in the continental united states. Nature Climate Change 6:691-695

Issler P, Stanton R, Vergara-Alert C, Wallace N. 2019. Mortgage markets with climate-change risk: Evidence from wild res in California. Available at SSRN 3511843

Keenan JM, Bradt JT. 2020. Underwaterwriting: from theory to empiricism in regional mortgage markets in the us. Climatic Change :1-25

Painter M. 2020. An inconvenient cost: The effects of climate change on municipal bonds. Journal of Financial Economics 135:468-482

Rao K. 2017. Climate change and housing: Will a rising tide sink all homes? Zillow Research

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The Centre for Climate Finance & Investment undertakes cutting-edge research on how capital markets are responding to global climate change.

Helping investors and policymakers overcome the lack of clarity about risk and opportunities arising in a changing climate. Our research covers five workstreams: Climate Risk Scenarios and Stress Testing; Nature; Clean Energy Investing; Climate Finance Markets and Instruments; and Adaptation and Resilience.

The Centre works closely with the  Grantham Institute – Climate Change and the Environment  and the  Brevan Howard Centre for Financial Analysis . Imperial College Business School launched the  MSc Climate Change, Management & Finance  in September 2016 in partnership with the Grantham Institute.

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Handbook of international climate finance

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• Contents: Introduction to the handbook of international climate finance: is climate finance a meteoric fashion or a stable pillar of the global response to anthropogenic climate change? / Axel Michaelowa and Anne-Kathrin Sacherer
• Part I. Basic concepts underlying climate finance
• 1. Same but different? Understanding divergent definitions of and views on climate finance / Igor Shishlov and Philipp Censkowsky
• 2. Climate finance effectiveness: Matching in-depth analysis with stakeholder dialogues / Angela D. Falconer and Barbara K. Buchner
• 3. Climate finance as development aid / Katharina Michaelowa and Chandreyee Namhata
• Part II. Lessons from international climate finance to date
• 4. Financial aspects of international legal regulations of climate change: Between two concepts : The common concern of humankind and the common but differentiated responsibilities / Izabela Ratajczak-Juszko and Maciej Nyka
• 5. Lessons from fast-start finance / Smita Nakhooda and Charlene Watson
• 6. The green climate fund: History, status and legitimacy / Rishi Basak and Sylvia Karlsson-Vinkhuyzen
• 7. National climate funds / Luis Gomez-Echeverri
• 8. 20 years of adaptation finance: Taking stock of origins, destinations and determinants of allocation / Sam Barrett
• 9. Experiences from the German international climate initiative (iki) / Sonja Butzengeiger-Geyer, Johanna Christensen, Matthias Poralla, Aayushi Singh and Joachim Schnurr
• 10. The rwandan approach to maximising benefits from international climate finance / Faustin Munyazikwiye and Axel Michaelowa
• Part III. Contributions to and allocation of international climate finance
• 11. Aligning finance flows with the paris agreement: The role of multilateral development banks / Anja Carolin Gebel, Aki Kachi and Lauren Sidner
• 12. Financing forest conservation and restoration through climate policy instruments : lessons from the cdm and redd+ / Anne-Kathrin Sacherer, Stephan Hoch, Sandra Dalfiume and Ruth Kassaye
• 13. Allocating climate finance: A contributor's view / Stefan Schwager
• 14. Enhanced direct access: The first decade / Benito Müller and Rishikesh Ram Bhandary
• 15. The role of carbon market mechanisms in climate finance / Aglaja Espelage, Hanna-Mari Ahonen and Axel Michaelowa
• Part IV. The future of international climate finance
• 16. The future of climate finance: Balancing ownership and accountability / Joe Thwaites, Gaia Larsen and Athena Ronquillo-Ballesteros
• 17. The future of climate finance: Multinational company participation under rising peer pressure / Martin Stadelmann and Dominique Gangneux
• 18. Mobilising climate finance for adaptation through the adaptation benefits mechanism / Gareth Phillips
• 19. How to ensure that investment in new climate solutions is sufficient to avert catastrophic climate change / Yannick Glemarec
• Part V. Outlook
• 20. A vision for international climate finance after 2025 / Axel Michaelowa

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Handbook of Green Finance

This handbook deals with various financial instruments, policies, and strategies in a policy-oriented approach for financing green energy projects . Re ...

This handbook deals with various financial instruments, policies, and strategies in a policy-oriented approach for financing green energy projects . Recently, global investment in renewables and energy efficiency has declined, and there is a risk that it will slow further, Clearly, fossil fuels still dominate energy investments. This trend could threaten the expansion of green energy needed to meet energy security, climate, and clean-air goals. Several developed and developing economies are still following pro-coal energy policies. The extra CO2 generated from new coal-fired power plants could more than eliminate any reductions in emissions made by other nations.

Finance is the engine of development of infrastructural projects, including energy projects. By providing several thematic and country chapters, this handbook explains that if we plan to achieve sustainable development goals, we need to create opportunities for new green projects and scale up the financing of investments that furnish environmental benefits. New financial instruments and policies such as green bonds , green banks, carbon market instruments, fiscal policy, green central banking, fintech, and community-based green funds are among the chief components that make up green finance.

Gianfranco Gianfrate contributed to the book with the chapter:  'Stimulating Non-bank Financial Institutions’ Participation in Green Investments.

This chapter analyzes the approaches adopted by institutional investors to manage climate risk in their portfolios and proposes policies to increase climate awareness in this large segment of the capital markets. Because of their size and their role as a conduit of savers’ climate concerns to the capital markets, most non-bank financial institutions are ideally positioned to steer corporate capital allocation towards more sustainable uses. Over the past decades, an increasing number of institutional investors have adopted strategies to mitigate climate exposure. These include negative screening , positive screening , active ownership , sustainability ratings , and hedging of climate risks . These strategies reflect specific fund manager mandates and the recognition that climate risks can have a tangible impact on financial assets’ valuations and, as a result, institutional fund performance. We review the evidence from the adoption of these strategies, in both advanced and developing capital markets. We then analyze the pros and cons of each strategy in promoting more sustainable climate practices and identify best practices.

Author concludes with policy recommendations for capital markets regulators to incentivize the adoption of sustainable practices among institutional investors.

Climate risks, Asset management, Institutional investor, Carbon pricing, Sustainability 

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Operating from campuses in Lille, Nice, Paris, London and Singapore, EDHEC is one of the world’s top 15 business schools. Fully international and directly connected to the business world, EDHEC commands a strong reputation for research excellence and the ability to train entrepreneurs and managers capable of breaking new ground. EDHEC functions as a genuine laboratory of ideas and produces innovative solutions valued by businesses.  The School’s teaching is inspired by its research work and a focus on “learning by doing”, all with the aim of equipping people with the skills to succeed in business.

About EDHEC-Risk Climate Impact Institute

Marking the priority assigned by the School to sustainability issues and building on its research programmes exploring the relationships between climate change and finance, EDHEC-Risk Institute became EDHEC-Risk Climate Impact Institute in October 2022. The Institute's mission is to help private and public decision-makers manage climate-related financial risks and make the best use of the financial tools available to transition to low-emission and climate-resilient economies. The Institute’s research programmes explore the relationships between climate change and finance and our key ambition is to become a leading academic reference point for long-term investors, helping them to manage the asset-pricing implications of climate change as well as mitigation and adaptation efforts. 

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Article Contents

1. an inconvenient void, 2. launching a call for new research on climate finance, 3. contributions to the climate finance research program, 4. where does climate finance research go from here, 5. one final remark, acknowledgement, climate finance.

• Article contents
• Figures & tables
• Supplementary Data

Harrison Hong, G Andrew Karolyi, José A Scheinkman, Climate Finance, The Review of Financial Studies , Volume 33, Issue 3, March 2020, Pages 1011–1023, https://doi.org/10.1093/rfs/hhz146

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Climate finance is the study of local and global financing of public and private investment that seeks to support mitigation of and adaptation to climate change. In 2017, the Review of Financial Studies launched a competition among scholars to develop research proposals on the topic with the goal of publishing this special volume. We describe the competition, how the nine projects featured in this volume came to be published, and frame their findings within what we view as a broader climate finance research program.

Climate finance is defined by the United Nations Framework Convention on Climate Change (UNFCCC) to be “local, national, or transnational financing—drawn from public, private, and alternative sources of financing—that seeks to support mitigation and adaptation actions that will address climate change.” It is about investments that governments, corporations, and households have to undertake to transition the world’s economy to a low-carbon path, to reduce greenhouse gas concentrations levels, and to build resilience of countries to climate change. The European Commission estimates that energy and infrastructure investments, mainly from the private sector, would have to rise to 2.8% of European Union gross domestic product (GDP) from 2% today (or an additional |${\$}$| 376 billion annually) to reduce EU net greenhouse gas emissions to zero by midcentury. 1 Estimates for decarbonizing power generation in the United States are comparable. Absent mitigation and adaptation, a major scientific report issued by thirteen U.S. federal agencies in November 2018 predicted that the potential damage from the consequences of climate change would knock as much as 10% off the size of the U.S. economy by century’s end. 2

These large estimates only coarsely encapsulate the significant risks of global warming for firm profits, capital markets, and household wealth. Many sectors, ranging from energy, food, and insurance to real estate, are directly impacted by risks generated by a potential price on carbon, adverse shocks to agricultural productivity, or exposures to rising sea levels, to name a few. Underlying these concerns are difficult questions regarding the distribution of damages from global warming, how society should price and mitigate risks from global emissions, and whether capital markets—to the extent that they can assess and price these exposures—can raise such large sums and potentially help households and institutions hedge climate change risks.

Answers to these questions in turn depend on expectations that agents in the economy hold. A case in point is that ongoing worries by some in the private sector about wavering commitments to the Paris Climate Agreement goals have prompted efforts to mobilize, such as the Climate Finance Leadership Initiative and the newly launched Principles for Responsible Banking. 3 Such sustainable investing initiatives have the potential to influence the cost of capital for high carbon emissions companies even in the case of explicit carbon taxes. Raising the trillions necessary over the coming decades to address global warming will also no doubt rely on financial innovations.

Even though questions such as pricing and hedging of risks, the formation of expectations, and financial innovations are natural ones for financial economists to tackle, little research has been published to date in our top finance journals. The award of 2018’s Nobel Prize in Economics to William Nordhaus for his work on integrated assessment models for climate change going back to the mid-1970s (for example, Nordhaus 1977 ) reminds us of the missed research opportunity for financial economists to assess the risks associated with climate change as a global externality ( Nordhaus 2019 ).

The current volume represents the effort of the Review to remedy this dearth of research on climate finance. It was a problem that the editorial team of the Review recognized back in 2016. To this end, the editors, with the support of the Society for Financial Studies, launched a competition in 2017 using a novel editorial protocol—a Registered Reports (RR) format—that drew 106 submissions from scholars around the world on the topic. This competition paralleled in structure another one focused on the similarly under-researched topic of fintech that was published in the Review in May 2019 (see Goldstein, Jiang, and Karolyi 2019 ).

The idea behind RRs, a peer-reviewed editorial protocol developed in the cognitive sciences by the journal Cortex , is simple. Authors submit for review a research plan that designs an experiment, outlines the data to be collected, and describes potential interpretations of what findings may come; expert reviewers judge the proposed plan on its merit and not on the basis of the findings. Further, editors offer in-principle acceptance of the submission before final results are known. While the primary goal of RRs is to eliminate disincentives to publish negative or non-results and to mitigate publication bias, the editors of the Review believed this would be the ideal editorial protocol for a topic as controversial as that of climate change and global warming. 4 Not only would it allow for the truth about the potential economic consequences of climate change for financial markets to come to the fore, but it might provide the incentives needed to draw out hesitant scholars who might be inclined to take on new research on climate finance.

We, as the editors of this special volume, needed to secure additional support beyond that of the Society to make this competition work. Major financial support came from Norges Bank Investment Management for the preliminary project proposal workshop at Columbia University (November 2017) and for a conference co-hosted by Imperial College Business School in London (October 2018) at which the findings would be unveiled. We also received additional support from the Program for Economic Research at Columbia University, the Brevan Howard Centre at Imperial University, and two of the Prince of Wales’s charities, Accounting for Sustainability (A4S) and the University of Cambridge Institute for Sustainability Leadership (CISL).

The editorial team assembled a twenty-three-person scientific council of reviewers to help review the proposals among the first pass of 106 submissions and the finalists who were to be invited to the Columbia University workshop, at which a number of them served as discussants. 5 We also drew on dozens of additional anonymous reviewers who participated in one or more of the three rounds of reviews that each of the ultimately nine successful proposals survived.

In the remainder of this editorial, we will outline how the research competition evolved and what we received, and then lay out the findings on climate finance that this special volume represents within what we view going forward as a broader climate finance research agenda.

Our call for proposals was launched on January 31, 2017. We purposefully allowed a short five-month window for proposals to come forward with a deadline of July 30, 2017, in order that the competitive process would feature bona-fide proposals true to the goals of the RR process.

In the call for proposals, we asked for research on a number of questions, including: (i) linking trends in global temperatures to firm and industry cash flows; (ii) modeling valuations of vulnerable sectors to a warming climate; (iii) agency, governance, and general incentive problems that might distort corporate climate risk management; (iv) the risks of stranded assets for energy- and carbon-intensive firms and industries; (v) the building of hedge portfolios of climate state variables; and (vi) understanding a firm’s climate risk exposures based on sparse corporate disclosures or environmental ratings by public/private agencies.

Our expectations about what might come forward were modest given that there were so few available working papers dealing with such questions. Remarkably, we received 106 proposals from 281 scholars affiliated with 183 different universities, government agencies, banks, and private firms from around the world. Many of those scholars are from outside North America. Figure 1 shows that only 46% (129) of the scholars on the proposal teams are domiciled in the United States and only 5% (14) are from Canada. Figure 2 demonstrates that it was younger scholars that revealed an appetite for climate finance research; 63% of the contributing scholars were either assistant professors (141) or Ph.D. students (23).

Composition of authors among RFS climate finance proposals submitted by geographic location

This figure reports the country of domicile of affiliated academic institution for the 409 authors among the 106 RFS climate finance proposals received by July 30, 2017, to the open call issued on January 31, 2017.

Composition of authors among RFS climate finance proposals by academic rank

This figure reports the rank of the 281 authors among the 106 RFS climate finance proposals received by July 30, 2017, to the open call issued on January 31, 2017.

Figure 3 shows that the largest number of proposals fell into what we called the category of “Carbon,” which focused on carbon trading, adaptation, and stranded assets. This was not unexpected, as climate economics as a line of inquiry had already delved into this area. 6 The next largest category of submissions was under “Disclosure,” which examines mandated disclosures, the study of attitudes and actions of institutional investors and analysts; followed by “Investing,” which focuses on investing strategies, priced risk factors, and informational efficiency; “Uncertainty,” which examines modeling uncertainty, long-run risks, learning, beliefs, and ambiguity; and finally, “Weather,” which emphasized extreme weather risk.

Topic areas featured among the RFS climate finance Registered Reports proposals

This figure reports the topic areas among eight major topic areas among the 106 climate finance proposals received by July 30, 2017, to the open call issued on January 31, 2017.

The final nine papers that make up this special issue on climate finance reflect the diversity of the topics addressed in the submissions. They ask questions and use tools that have been emphasized by financial economists and show how finance can contribute to the discussion on the impact of climate change. We frame these contributions along the lines of what we view as a reasonable climate finance research agenda going forward.

3.1 Uncertain social cost of carbon

There has been considerable work and controversy surrounding the choice of discount rates in the climate economics literature on the social cost of carbon. Gollier (2013) provides a useful review. Financial economics has emphasized the importance of the Arrow-Debreu insight that discounting of payoffs should be state-contingent. Barnett, Brock, and Hansen (2019) combine asset pricing methods and decision theory to estimate the social cost of carbon. They point out that this estimation must face both the uncertain impact of climate on human welfare and the uncertainty concerning models that describe the transmission mechanism of human activity to climate.

Barnett, Brock, and Hansen (2019) nest influential models in the literature, such as those of Nordhaus (1977) and Weitzman (2009) . They show that the interaction of these two sources of uncertainty is multiplicative, such that the impact on the social cost of carbon is substantial when each component is important. They also show that the presence of ambiguity aversion and aversion to model misspecification can substantially increase the estimates of the social cost of carbon. Their methodology shows how one can effectively integrate simplified models developed by physical scientists with tractable models of the economic damage caused by climate change.

3.2 Hedging climate risks

While Barnett, Brock, and Hansen (2019) demonstrate how asset pricing approaches can inform even developed topics in academic research on climate change, Engle et al. (2019) show how traditional portfolio approaches can raise new topics such as how to hedge climate risks. They use another standard tool of asset pricing, namely that of mimicking portfolios, to build portfolios that are hedged against innovations in climate change news. They start by constructing a series of innovations on views on climate change using textual analysis of newspapers and then use the mimicking portfolio approach to build climate-change-news hedge portfolios. Engle et al. (2019) then show that the mimicking portfolios they construct can successfully hedge the innovations in climate change news using a number of out-of-sample performance tests. To the extent climate change news is a good proxy for underlying climate change risks, their mimicking portfolio approach can serve as a hedge against climate change risks.

This work harkens back to a large finance literature on economic tracking portfolios and macroeconomic variables such as GDP. An interesting avenue for future research would then focus on the extent to which temperature or other climate variables such as droughts can be economically tracked using the returns of stock portfolios.

3.3 Efficiency of capital markets and climate change

Given the macroeconomic impact of climate change, asset prices should be particularly sensitive to the exposure of their cash flows to climate risks. Murfin and Spiegel (2019) use a data set of recent residential real estate transactions matched with property level elevation and tidal data to ask whether house prices reflect differential sea level rise risk. In particular, they are able to separate the impact of sea level rise as distinct from the hedonic value of property elevation by using the pace of land subsidence and rebound as a source of variation in the expected pace of regional relative sea level rise. In contrast to the work of Bernstein, Gustafson, and Lewis (2019) or Baldauf, Garlappi, and Yannelis (2019) , their findings indicate limited price effects, perhaps due to optimism about sea level rise or the possibilities of mitigation and bailouts.

Baldauf, Garlappi, and Yannelis (2019) use transactions data to measure the effect of flooding projections of individual homes and local measures of beliefs about climate change on house prices. They document that houses projected to be underwater in believer counties sell at a discount when compared with houses in denier counties, suggesting substantial difference-in-beliefs across locations. In contrast to Murfin and Spiegel (2019) , Baldauf, Garlappi, and Yannelis (2019) emphasize the importance in beliefs about climate risk to how or if it is priced. Also, the National Oceanic and Atmospheric Administration (NOAA) data they use ignores land rebound and subsidence but accounts for local and regional tidal variability and variation in property risk due to protective land topography between a property and the nearest shoreline.

These two papers directly address an important and wide-ranging debate on the efficiency of capital markets in pricing risks associated with climate change. And whereas regulatory discussions on market efficiency have mostly focused on the “stranded asset issue” (or energy corporations’ exposures to potential carbon taxes), these papers point to more general vulnerabilities of other asset classes to climate change risks such as agricultural output from droughts ( Hong, Li, and Xu 2019 ) or even aggregate stock market performance ( Bansal, Kiku, and Ochoa 2016 ).

3.4 Beliefs and climate change risks

Beliefs play a crucial role in financing new technologies for climate mitigation and in determining prices of assets that are sensitive to climate change. Hence, characterizing the beliefs of investors and of key insiders of corporations such as CEOs is crucial to the efficient markets debate when it comes to pricing of climate change risks.

Three papers in this issue deal directly with the impact of beliefs. Choi, Gao, and Jiang (2019) seek to measure the impact of abnormally high local temperature on beliefs about climate change. They document that Google search volume for “global warming” in different cities around the world increases when the local temperature is abnormally high, indicating that attention to the topic increases at those times. In addition, by examining trading volume and returns in the stock markets of those cities during these events, retail, but not institutional, investors sell carbon-intensive stocks, and carbon-intensive firms underperform firms with low emissions.

Although institutional investors do not react to abnormal local temperature, Alok, Kumar, and Wermers (2019) document that professional money managers overreact to large climatic disasters that happen close to them, underweighting disaster-zone stocks to a much greater degree than distant mutual fund managers. They also document that this overreaction can be costly to fund investor performance.

Krueger, Sautner, and Starks (2019) survey global institutional investors on perceptions related to climate risk. They find that although institutional investors rank climate risk down the ranks relative to financial, legal, and operational risks, they still regard them to be important. The investors also believe these risks already affect firms they invest in. In addition, many investors report that they do take actions related to climate risks. Risk management and engagement are considered preferable to divestment. Krueger, Sautner, and Starks (2019) also found that these institutional investors believe that equity valuations in some sectors do not fully reflect climate risks.

3.5 Damage functions

A crucial input for analysis of climate change risks is the causal impact of higher temperatures on economic activity, what is called the distribution of damages. A large economics literature finds that years with abnormally higher temperatures (due to exogenous weather fluctuations) lead to lower economic activity in less developed countries. The literature argues that one can use these estimates to extrapolate the likely impact of 2 |$^{o}$| Celsius increases on output holding fixed any adaptations ( Dell, Jones, and Olken 2014 ; Schenkler and Roberts 2009). This analysis is subject to two caveats: (i) adaption in the long run should lessen the shock; (ii) climate scientists emphasize that short-term temperature variations are not a reliable gauge of long-run climate change, particularly if there are tipping points in damage functions.

Addoum, Ng, and Ortiz-Bobea (2019) extend this literature to account for the effects of temperature on establishment sales by building a detailed panel of temperature exposures for economic establishments across the United States to estimate how location-specific temporary temperature shocks affect establishment-level sales and productivity. They find that the population average effects on sales and productivity of these shocks are close to zero, indicating that establishments are able to accommodate these temporary shocks. This conclusion is subject to a caveat that long-run changes in temperature can and do lead to a rise in extreme weather risks. So extrapolating from short-term temperature changes is also potentially problematic for this reason. This study suggests that companies in developed countries are less likely to be affected by extreme temperature, at least on average.

3.6 Short-termism and corporate emissions

Given that corporations and insiders (CEOs) ultimately need to make investments to address climate change, two traditional corporate finance issues loom large: agency problems associated with corporate short-termism and financing constraints. Even absent the issues of externalities, agency and financial constraint consideration can result in a less than first-best level of investment to address climate change.

To this end, Shive and Forster (2019) use data on greenhouse gas emissions to show that independent private firms are less likely to pollute or incur Environmental Protection Agency (EPA) penalties than public firms. These results suggest that ownership structure, and hence agency and horizon considerations, may affect the climate change impact of firms. It would be interesting to further link emissions to real innovations as measured by patents geared toward climate change risks.

The taxonomy that we have laid out above is not a bad place to start as far as advancing the climate finance agenda. However, there are several other areas not covered by our set of nine papers that we think researchers should also tackle.

We see an important open question about the modeling and sharing of extreme weather risks. Extreme weather risks, such as the impact of Hurricane Sandy in 2012 on New York City property prices or the impact of the 2018 California wildfires on the Pacific Gas & Electric bankruptcy, are a reminder that climate change risks need not be confined to long horizons. Scientists predict that climate change will lead to more frequent and ever more extreme weather risks. Remote sensing (primarily through satellite or drone imaging) and machine learning can potentially help companies and society manage these risks.

Financial economists can use these tools to characterize the loss distributions using insurance data for floods or fires. These distributions in turn can depend on locational decisions by households and firms, technology decisions (such as by means of fire suppression or building codes) in terms of mitigating the damage of disasters, and the underlying weather processes themselves. Modeling these interactions and how they contribute to tail risks would be valuable for managers and policy makers.

Beyond modeling these loss distributions, the insurance and mortgage industries play critical roles in facilitating risk-sharing and extending credit in the aftermath of extreme weather events. Recent work by Ouazad and Kahn (2019) shows that mortgages in areas adversely affected by hurricanes are more likely to be securitized. This evidence is suggestive of the important role played by the finance industry in helping households manage climate risks.

A second major research push should focus on divestment, stranded assets, and the consequences for financial stability. Energy companies have become the new “sin stocks” facing divestment campaigns and lawsuits from shareholders alleging misleading disclosures regarding the costs of climate change. These divestment and legal campaigns are similar to what tobacco companies faced a generation ago and have the potential to influence the cost of capital of these companies (see, among others, Heinkel, Kraus, and Zechner 2001 ; Hong and Kacperczyk 2009 ). Recent work by Bolton, and Kacperczyk (2019) documents that institutions might indeed already be screening out companies of high carbon exposure based on similar considerations.

Such a divestment scenario in conjunction with lawsuits and lobbying for potential regulation would lead to significant stranded asset risk. Given the importance of the energy sector, this could be just the kind of systemic or financial stability type of event raised by outgoing Bank of England governor Mark Carney (2015) . Modeling this stranded asset risk requires integrating analyses of lobbying and regulation into otherwise standard asset pricing or corporate finance frameworks and would be extremely interesting.

A third research initiative is on the impact of climate change on municipal finance. Cities are increasingly affected by severe weather events. Even abnormal precipitation can cost millions to clean up and stretch already limited city budgets. Ratings agencies are considering incorporating climate change resilience measures into municipal bond ratings. How to measure resilience of municipalities and the impact of this resilience on municipal bond prices would be valuable. There is some preliminary evidence that municipal bonds have begun responding to some of these potential risks ( Painter Forthcoming ).

A fourth research agenda should focus on the impediments to corporate and financial innovation related to climate change. Despite numerous papers in climate economics, there is surprisingly little on corporate adaptation to climate change via innovations. The few notable exceptions include Miao and Popp (2014) , who address how droughts lead to more patent activity geared toward drought-resistant crops. Given the rich literatures in corporate finance on the determinants of corporate innovation and patent activity, a focus on the subset of patents associated with adaptation to climate change and the determinants or impediments to such adaptations would be valuable. To fund these corporate innovations, there will no doubt also have to be financial innovations. Some of these innovations, such as green bonds, are gradually emerging ( Flammer 2018 ; Baker, Bergstresser, Serafeim, and Wurgler 2018 ), and the nature and impact of such innovations will be worthy topics of future study.

Even though we financial economists are late to the game, we hope that this climate finance issue illustrates that there are many important questions where financial economists are naturally suited given their toolkit and interests. We are confident that the engagement of the broader academic finance community on these issues will no doubt lead to valuable contributions to improving the usefulness of the finance field to help society address perhaps unprecedented risks from climate change in the upcoming years.

This editorial is written for a special issue of the Review of Financial Studies focused on climate finance. The authors served as the editors of the special issue of papers, which was curated using a Registered Reports editorial format. The papers were presented at a workshop event in November 2017 at Columbia University and at a conference hosted by Imperial College London in October 2018. The presentations by the authors and the comments from plenary discussions at the workshop and conference were valuable in shaping the views shared in this editorial. We thank Norges Bank Investment Management (NBIM) and the Norwegian Finance Initiative (NFI) for substantial financial support and the invaluable advice of Wilhelm Mohn and Carine Smith Ihenacho of NBIM without which the workshop and conference events could not have happened. We thank the Program in Economic Research at Columbia University, Stephanie Cohen, and Sophia Johnson for help with the workshop. We thank Franklin Allen, Jaswinder Gil, and the Imperial College Business School’s Brevan Howard Centre for Financial Analysis for help with the London conference. Comments on this editorial are gratefully acknowledged from Jawad Addoum, Shashwat Alok, Darwin Choi, Jessica Fries, Lorenzo Garlappi, Itay Goldstein, Matt Linn, Justin Murfin, Sophie Shive, Matt Spiegel, Alexis Wegerich, and Zacharias Sautner. We finally thank the members of the Scientific Review Committee who agreed to help with this initiative as well as Charlie Donovan, Jessica Fries, Hannah Brockfield, Andrew Voysey, Nina Seega, and Yazid Sharaiha. Editorial assistance was gratefully received from Managing Editor Jaclyn Einstein and Dawoon Kim. Of course, all errors in the editorial remain the responsibility of the authors.

1 See “EU’s 2050 Climate Plan Sees Benefits of Up to 2% of GDP,” Euractiv , November 28, 2018. See also the joint letter to Commissioner Miguel Arias Canete from ministers from ten EU countries charting a “credible and detailed path” to net-zero emissions by 2050.

2 See “U.S. Climate Report Warns of Damaged Environment and Shrinking Economy,” New York Times , November 23, 2018.

3 According to the International Energy Agency, spending on renewable power such as wind, solar and biomass projects slipped 1% in real terms to |${\$}$| 304 billion in 2018, the lowest level since 2014 (“Falling Renewables Investment Stalls Paris Climate Goals,” Financial Times , May 14, 2019). Former mayor Michael Bloomberg, the UN Secretary-General’s Special Envoy for Climate Action, together with former SEC chairperson Mary Schapiro, announced the Climate Summit for the 74th UN General Assembly in September 2019. The UN Environment Program’s Finance Initiative launches the Principles for Responsible Banking at the same UN General Assembly.

4 The concept was outlined on May 3, 2013, in an editorial by Chambers and Della Sala (2013) , entitled “Journal Cortex Launches Registered Reports.” Further details are in Chambers et al. (2014) . Our editors are grateful to Chris Chambers for his advice early in planning in 2016, as well as helpful discussions with Brian Nosek of the Center for Open Science, which tracks all publications across disciplines using RR formats, and Rob Bloomfield and Christian Leuz of the Journal of Accounting Research , which published its own RR special volume in 2018.

5 We want to thank our committee including Ravi Bansal, Patrick Bolton, Francesca Cornelli, Magnus Dalhquist, Robert Engle, Xavier Gabaix, Stefano Giglio, Michael Goldtsein, Valentin Haddad, Lars Hansen, Leonid Kogan, Ralph Kojien, Per Krusell, Robert Litterman, Christopher Sims, David Sraer, Heather Tookes, Rossen Valkanov, Jessica Wachter, Jiangmin Xu, Jialin Yu, and Motohiro Yogo.

6 According to the Social Sciences Research Network (SSRN), there are 772 working papers posted (as of July 20, 2019) that fall under the topic area of “carbon trading” and another 45 under “stranded assets,” and the vast majority of those were posted before 2019.

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Climate Finance

Supporting a Sustainable Energy Transition

• © 2024
• Dayong Zhang   ORCID: https://orcid.org/0000-0001-8722-176X 1 ,

Southwestern University of Finance and Economics, Chengdu, China

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Southwestern University of Finance & Economic, Chengdu, China

Chinese Academy of Sciences, Beijing, China

• Provides a comprehensive discussion on frontier issues in climate finance
• Tackle critical financial issues in coping with climate change
• Illustrate the importance of climate finance on supporting energy transition

Part of the book series: Climate Change and Energy Transition (CCET)

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About this book

This book focuses on the frontier issues in climate finance and aims to develop a general framework to understand the financial pathways towards a successful energy transition. It builds upon the general descriptions of the current status and future challenges towards carbon neutral targets, and then bring forward a combination of theoretical and empirical analysis on the critical issues related to climate finance.

Estimated by the International Energy Agency (IEA), trillions dollars of investment in energy sector are needed to achieve net-zero emission scenario. It provides a huge opportunity for our economies, meanwhile creates considerable challenges to the existing system. Both financing and investment in such an unprecedented scale cannot possibly be satisfied by the current financial architecture, which creates demands for restructuring in the financial sector, developing innovative financial instruments, building mechanisms to attract private investment, and establishing human resources to facilitate climate financing and investment. This area is essentially interdisciplinary, which requires a fundamental reconsideration of standard approaches.

Aiming to satisfy the broad interests from both academia and policymakers, the contents of this book range from general discussions on critical issues to advanced statistical analyses on key topics. Authors hope to bring forward a general picture about climate finance and facilitate the demands for both academic research and policymaking. It should also provide a good guidance for graduate students interested in this subject. The main contents of this book are based on solid research outcomes but with clear policy relevance. The book combines finance theory and practices in both financial markets and energy sectors to reflect the complex nature of financing for energy transition. While the materials can provide useful knowledge to policymakers, the book can also inspire new research ideas in the relevant area.

• Climate change
• climate finance
• Green finance
• Climate policy
• Climate investment
• Sustainable finance
• Carbon finance
• energy transition
• Sustainable development
• Green investment

Table of contents (11 chapters)

Front matter, the emerging field of climate finance: theory, practice, and frontiers.

• Fei Wu, Dayong Zhang, Qiang Ji

Global Climate Finance Architecture: Institutional Development

• Yajie Chen, Fei Wu, Dayong Zhang

Climate-Driven Financial Innovations: Green Financial Tools

• Xiangyang Zhai, Qiang Ji, Fei Wu

Measuring Climate Risks and Impacts

Climate risks and financial markets, esg and corporate climate actions.

• Lei Lei, Dayong Zhang

Governance and Climate Finance in the Developing World

• Byeong-Hak Choe, Tilsa Ore-Monago

Climate Finance and Investment in Africa: A Case Study of Ghana

• Solomon Nborkan Nakouwo, Dayong Zhang

Climate Finance and Green Transition

• Fei Wu, Qiang Ji, Dayong Zhang

Climate Finance and Green Innovation

• Xinrui Li, Xiuqin Wu, Chin-Hsien Yu

Climate Finance: Policies and Regulations

• Jingyan Huang, Kun Guo

Editors and Affiliations

Southwestern university of finance & economic, chengdu, china.

Dayong Zhang

About the editors

Dayong Zhang is currently a Professor of Financial Economics at Southwestern University of Finance and Economics (China). His research interests cover energy finance, climate finance, banking and finance, and general economic and financial issues in emerging economies. He is the president of the Society for the Studies of Climate Finance (SSCF) in China, vice president of International Society for Energy Transition Studies (ISETS), the founding editor of Journal of Climate Finance. He published over 100 articles in peer reviewed journals. He is on the Elsevier's list of China's Most Cited Scholars in 2020 and 2021; and awarded the 2021 Clarivate Highly Cited Researcher in cross-field, 2022 in Economics and Business. Qiang Ji is deputy director of Institute of System Analysis and Management in Institutes of Science and Development, Chinese Academy of Sciences (ISDCAS). He engaged in the research of energy and climate finance, energy strategic management, big data and energy prediction. He is the co-founder of China Energy Finance Network, Vice President of International Societyfor Energy Transition Studies and Society for the Studies of Climate Finance. He was a founding editor of Journal of Climate Finance. He published more than 150 SCI/SSCI indexed articles in peer-reviewed journals and was selected into Clarivate's List of Highly Cited Researcher in 2021 and 2022, and also the World’s Top 2% Scientists List published by Stanford University in 2020 and 2021.Dr. Fei Wu is currently an Associate Professor of Finance at the Research Institute of Economics and Management, Southwestern University of Finance and Economics in China. She obtained her Ph.D. from the University of Birmingham. Her research interests include systemic risk and its contagion, financial markets, commodity markets, energy finance, climate finance, and banking. Her works have been published in peer-reviewed journals such as Energy Economics, Energy, Annals of Operations Research, and Sustainability Science. She has received grants from the National Natural Science Foundation of China and the National Social Science Fund of China.

Bibliographic Information

Book Title : Climate Finance

Book Subtitle : Supporting a Sustainable Energy Transition

Editors : Fei Wu, Dayong Zhang, Qiang Ji

Series Title : Climate Change and Energy Transition

DOI : https://doi.org/10.1007/978-981-97-3308-8

Publisher : Springer Singapore

eBook Packages : Economics and Finance , Economics and Finance (R0)

Copyright Information : The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2024

Hardcover ISBN : 978-981-97-3307-1 Published: 28 July 2024

Softcover ISBN : 978-981-97-3310-1 Due: 11 August 2025

eBook ISBN : 978-981-97-3308-8 Published: 27 July 2024

Series ISSN : 2731-9903

Series E-ISSN : 2731-9911

Edition Number : 1

Number of Pages : V, 461

Number of Illustrations : 4 b/w illustrations, 50 illustrations in colour

Topics : Public Finance , Public Policy , Environmental Policy , International Finance

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