Climate -related risks in asset prices
Pierre Monnin (CEP, GRI-LSE)Agenda
• How do climate risks affect financial asset prices?
• How do climate risks impact financial stability?
• What are the consequences for central banks and supervisors?
Asset price fundamentals
No transition – Full physical risks
Transition – Mitigated physical risks
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Transition risks are frontloaded
Climate risks and market inefficiencies
• Markets are myopic (Tragedy of the horizons)
• Markets underestimate climate risks
• Markets amplify (climate) shocks
• Markets do not internalise their impact on climate change
How do climate risks impact financial stability?
Markets are myopic
• Climate risks are accelerating and subject to tipping points
• Sudden change of expectations when environmental costs “become visible” for market participants
• Potential rapid repricing downward on markets when environmental costs “kick in”
• Transition benefits are overlooked
Markets underestimate climate risks
• Data are not observable
• Past is a poor blueprint for climate future
• Can markets be constantly negatively surprised? No
• Downward revision of expectations when first few negative surprises become available
Markets amplify (climate) shocks
• Expectations can rapidly shift
• Amplified by fire sales
• Limited edging possibilities with climate risks
Markets do not internalise their climate impact
• Double materiality becomes single materiality
• Benefits of physical cost mitigation are not perceived as dependent on own actions
• Transition costs are overestimated because benefits of transition are not internalised
• Possible lock-in of markets on a no- transition path
Climate risks and market inefficiencies
• Markets are myopic (Tragedy of the horizons)
• Markets underestimate climate risks
• Markets amplify (climate) shocks
• Markets do not internalise their impact on climate change
Potential systemic financial risk
Do market price climate risks in?
• Empirically impossible to test
• We start with a consensus that they are not in 2019
• We see some pricing in, and it is accelerating
• Is it fully priced in now? Difficult to think that everything has changed in four years
• Financial institutions are not sufficiently prepared
• Climate risks have not materially decreased in the last years
• Risks might be more concentrated in some markets than others
What are the consequences for central banks and supervisors?
Central banks are exposed like any other financial institution
• BCBS principles on how to manage climate risks apply to central banks too
• Integration in overall risk management strategy
• Margin of conservatism
• Expert judgment when necessary
Supervisory policies
• Holistic approach covering all pillars of the Basel framework
• Implementation of sound micro-prudential policies
• Macroprudential policy overlay