Doctoral defence: Limiting global warming - why financial actors matter
In her research, Katia Vozian studies whether and how financial system participants account for climate-related transition risk in their assessment of credit risk. To facilitate an orderly transition to a low-carbon economy, the climate-related transition risk needs to be gradually priced in by financial system participants, for example banks, investment funds and credit rating agencies.
The process of adjustment of our economy requires a series of changes, like changes in public sector policies and technological innovation. These will have to come together with changes in market sentiment of investors as well as of consumers. If the timing and speed of such changes is managed disorderly, the changes may carry financial risks, which are referred to as climate-related transition risk (further information about the definition below*).
Since 2015 financial system participants have increasingly published commitments to support the low-carbon transition. In the absence of a market-wide practice of pricing of climate-related transition risk, an abrupt repricing of climate-related transition risk may lead to financial market losses and disturb the financial stability of our economies.
“Caveats on availability, reliability, and comparability of data on greenhouse gas emissions, emissions reduction targets and other indicators of a firm’s transition exist. Yet, as emphasized by the Network for Greening the Financial System and the European Central Bank, such caveats should not prevent from better leveraging already available data sources, using proxies, and exploiting such data under informed methodological choices,” Katia Vozian explains.
One of the main challenges cited by financial market participants as impediment are the data needs for assessing the climate-related transition risk of firms. In her research, Katia Vozian assembles quantitative data of firms’ emissions, on how firms plan to reduce their emissions, and on how financial market participants assess the credit risk of these firms.
“Starting 2016 – the year when credit rating agencies committed to account for climate-related transition risk – firms with highest level of emissions in Europe saw their credit ratings deteriorate.”
This adverse effect was larger for European than US high-emitting firms, probably reflecting differential expectations around climate policy in the European Union versus US during the Trump-era. As such, credit rating agencies do seem to account to some extent for climate-related transition risk.
However, when looking at the financial market of credit default swaps (CDS) in Europe and its participants - which are mostly banks and investment funds – the pricing effect of emissions in CDS, albeit present, seems to be very small. Meanwhile, other relevant indicators of a firms’ transition risk do not seem to be assessed by market participants yet.
This research has contributed to policy discussions by introducing new evidence on the pricing of climate-related transition risk. It has been disseminated at research conferences and workshops involving central banks (Bank of Finland, European Central Bank, Sveriges Riksbank) and policy-driven institutions (European Investment Bank).
You can read the whole thesis here:
“Understanding financial stability: climate-related considerations and financial markets operations”
Katia Vozian will defend her doctoral thesis on Friday, November 4 at 9:00 EEST remotely. You can attend the defence online by clicking on this Teams link.
Opponent: Professor Juha Junttila, University of Jyväskylä
Chair: Professor Ari Hyytinen, Hanken School of Economics, Helsinki GSE
*Definition of climate-related transition risk
The process of adjustment of our economy shall require a series of changes. First of all, changes in public sector policies (for example policy banning sale of new petrol and diesel cars) will be required. Moreover, technological innovation and changes in the affordability of existing technologies (for example electric cars) will be needed. Last but not least, these will have to come together with changes in market sentiment of investors (for example ESG or clean energy investment, fossil fuel divestment), as well as of consumers (for example less demand for air travel). Timing and speed of such changes need to be managed. Yet, if managed disorderly, such changes may carry financial risks, which are referred to as climate-related transition risk. Transition risk arising from such changes may negatively affect a firm’s performance and increase the credit risk associated with this firm. Such a development may further cause losses for banks and financial markets participants (see figure 1).
Figure 1. How climate transition drivers may affect a firm's performance, credit risk, and banks and financial markets. Source: adapted from BCBS (2021), ECB (2021)