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Climate change and sustainable finance

In December 2015, France will welcome the twenty-first climate change conference. The stakes for the planet are crucial, because governments must reach agreement on limiting global warming to less than 2 degrees. Finance has an important role to play. Within this perspective, the Revue d’économie financière summarizes the thinking and studies on the subject.

The first section of this issue is devoted to the challenges of financing energy transition. How can an economy that emits only a limited quantity of greenhouse gases be financed? What risks flow from climate change and how can they be best anticipated? In the second section, the authors propose strategies—a carbon tax/reward system, green bonds, cutting investment in sectors tied to fossil fuels, better risk analysis, setting up low carbon emission indicators, the carbon imprint on funded projects, and so on. The third section takes a more general point of view by examining sustainable finance, finance that serves social interests and takes into account the planet’s limited resources.

Besides this main theme, this issue offers two articles on different current economic and financial topics. One of them raises the question of central bank strategy concerning financial stability. The other article returns to the last international financial crisis and to the Eurozone crisis that followed.

REF 117 Climate change and sustainable finance

publication : March 2015 312 pages

In memoriam Edmond Malinvaud accès libre

A New Financial History Column accès libre

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No summary is available for this article.

Xavier Mahieux Olivier Pastré François Champarnaud Thierry Walrafen

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Climate change and sustainable finance

Foreword accès libre

Introduction accès libre

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No summary is available for this article.

Jean Boissinot Patrice Geoffron

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Climate risks and financing needs

Financial Way to a Climate Agreement in 2015? accès libre

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The Paris climate summer represents the last chance to lay the foundations for a universal agreement. An ambitious climate agreement is based on: (1) a commitment by governments, (2) an independent monitoring, reporting and verification (MRV) system and (3) the introduction of international carbon pricing. In this paper we propose a method combining taxation and allowances markets. First, the introduction of an international carbon bonus-malus system, with a tax of around $7 per tonne of CO2, calculated for each country on the basis of the difference between its average emissions per capita and the world average. This pricing system would have the dual objective of encouraging countries with low emissions per capita to join the common MRV system and of facilitating compliance with the pledge to make an annual transfer of $100 billion to the least developed countries. Second, the creation of a transcontinental carbon market, based on the emissions trading systems being developed in Europe, China and the United States. Interconnecting these markets requires setting up a common system of governance to ensure that major emitters fully commit themselves to trajectories consistent with the objective of limiting global warming to 2°C.

Classification JEL : F53 F59 H23 Q54


Christian de Perthuis Pierre-André Jouvet

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Objectifying the Debate on Financing the Energy Transition: What Lessons from the French Case? accès libre

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This article looks at issues related to financing the fight against climate change and the broader energy transition. There is a heated and exciting debate both nationally and globally on these issues today. However, discussions often rely on methodological approaches and data which are sometimes insufficient or poorly understood. With this in mind, this article presents the results of a recent study identifying financial flows dedicated to the fight against climate change in France. It then addresses the limitations of such an exercise, including the difficulty of looking at the more general redirection of flows towards investments coherent with a future low-carbon economy that is also resilient to extreme climate events. For this, the article proposes a paradigm shift towards thinking in terms of consistency and inconsistency related to a “transition” rather than focusing on investments “dedicated” to the fight against climate change. The use of reliable and shared future low-carbon climate resilient scenarios seems promising – and necessary.

Classification JEL : H54 O44 Q01 Q51 Q54 Q56


Ian Cochran Benoît Leguet Romain Morel

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The Macroeconomic Assessment of Energy Transition Policies: Difficult but Much Needed accès libre

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The energy transition requires the implementation of various policy instruments (carbon prices, subventions, etc.) which in turn affect the macroeconomic output. For this reason, a sound macroeconomic assessment of the impact of this policy is needed. This assessment is not straightforward. First, the macroeconomic evaluation of the consequences of action versus inaction as regards climate change turns out to be very difficult. Still, macroeconomic analysts are more at ease when they try to analyze the macroeconomic consequences of certain policies compared with others. These consequences will strongly depend on the functioning of the economy, its institutions, its rigidities etc. It is thus almost an empirical question and macroeconomic models can be very useful in this respect. In the case of climate change policies, some key aspects of macroeconomic models must be emphasized, notably sound equilibrium mechanisms, an accurate description of financing capacities, or the impact of technological progress. In practice, different macroeconomic models often lead to very different evaluation of the impact of energy transition policies, which illustrate how crucial certain macroeconomic mechanisms are.

Classification JEL : E17 Q01 Q54 Q56


Jean-François Ouvrard

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Maladaptation to Climate Change: A Risk for Investment Profitability? accès libre

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This article outlines the theoretical framework of both adaptation and maladaptation. The literature dedicated to climate change adaptation shows that resilience is the concept that has to be favoured in the reduction of maladaptation risk. A tool dedicated to avoidance of maladaptation is briefly exposed in the last section of this article.

This tool would evaluate projects on four main themes, namely water uses, energy uses, structural dependence (through networks) and functional dependence to climate change of the various links lying in the project value chain. This could be a first step towards the adoption of a complementary approach of the environmental impact study, in which would be assessed, not the impact of projects on the environment, but the possible impact of the environment on the project, due to future climate changes. Such reflection seems essential, particularly in the framework of the EFSI (European Fund for Strategic Investments) which aims to result in investments of €315 billion (of whom €16 billion come from the EU budget) across the EU by 2020, or European regulation proposal on ELTIFs (European Long Term Investment Funds) in order to avoid waste of public and private money.

Classification JEL : E61 Q01 Q54


Pierre Serkine

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Natural Hazards and Housing Markets accès libre

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Casualties and material losses caused by natural catastrophes are mainly driven by geographical patterns and residential choices. Environmental hazards impose a kind of easement to homes, so housing prices should reflect the different hazard levels. Nevertheless, this housing characteristic is random, so agents will make informed choices only if they have a correct perception of the risk. The hedonic price model in uncertainty predicts a price differential between at risk and not at risk homes equal to the expected damages plus a risk premium. The flood hazard discount price estimated on French data, compared to the average cost of flood natural catastrophe damages, suggests that housing market does not or barely capitalize natural hazards, except in the immediate aftermath of a major flooding. The Cat' Nat' insurance system, imperfect information, perception bias and memory effect are possible explanations.

Classification JEL : D81 Q54 R21 R52 Q54


Amélie Mauroux

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Financial tools and mechanisms addressing climate risks

Shaping Financial Markets Dealing with Climate Change accès libre

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We are witnessing an energy transition where renewable energy is becoming a more competitive technology than traditional fossil fuels. Besides, the climate imperative is pressing policy makers to internalize negative environmental externalities. Scientific evidence demonstrates that the cost of inaction is larger than the cost to face the challenges posed by climate change. In this sense, adapting the economy to a more stressful reality and dealing with huge and promising niches compose the new environment that needs to be assumed by the financial community in their investment decisions. On the other hand, engagement with climate change solutions will aid finance to recover the public legitimacy highly damaged since the Great Recession.

On the eve of Paris agreement this paper explores the first steps required to make a systemic change in financial markets ; to make them fitter to deal with the challenges of climate change. How public sources are expected to move in the short term and how private finance can innovate and scale up means to best deal with these changes.

Classification JEL : G18 Q38 Q54


Carlos García Paret Santiago Lorenzo

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The Prevention of Natural Disasters: Target the Long Run without Delay accès libre

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Urbanization in areas prone to natural hazards is massive and will grow. Economic analysis offers several tools to contain this phenomenon: insurance pricing in relation to risk, and zoning and building standards in exposed areas. Both approaches are theoretically equivalent, but their applications pose different challenges, and financial incentives were exaggeratedly reduced in France. In both cases, a more rigorous policy will meet opposition, because it will affect more specifically certain places. We discuss the difficult management of the past, and we explain why the grandfather rights or expropriation can not be considered sustainable responses.

Classification JEL : H23 G22 R52 Q54


Céline Grislain-Letrémy Bertrand Villeneuve

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Expanding Credit Risk Analysis accès libre

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Traditional risk categories embodied in credit research – business risk and financial risk – can capture a number of Environmental, Social and Governance (ESG) issues. However, there are some risks that are difficult to assess in this framework, primarily because ESG categories themselves are not particularly efficient, or even meaningful, as analytical categories. We propose that a better analysis of these risks can be obtained by categorizing what are currently called ESG risks into three specific risk categories: operational or management risks, climate risks, primarily mitigation and adaptation risks, and natural capital risks, a category intended to capture natural capital depletion, subsidy loss risks, and certain geopolitical risks-risks associated with water resources perhaps being the best example of a natural capital risk.

Classification JEL : G21 M14 Q32 Q56


Bob Buhr

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Green Bonds and the Development of a 2°C Finance accès libre

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It is difficult to allocate capital consistent with ensuring that temperature will rise to less than 2°C as agreed in Copenhagen in 2010. However, a combination of factors are aligning and may provide the right environment for 2°C finance (the financing of a 2°C world) to gain momentum. The development of green bonds is a prime example of this shift.

Classification JEL : G11 G12 M14 Q54 Q56


Zoe Knight

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Low Carbon Indices: Mobilizing Institutional Investors through Climate Risk Hedging Strategies accès libre

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Climate change is now increasingly recognized as a major financial threat. We develop a simple dynamic investment strategy that allows long-term passive investors to hedge climate risk without sacrificing financial returns. Our proposed hedging strategy goes beyond a simple divestment of high carbon footprint or stranded assets stocks. This is just the first step. The second step is to optimize the composition of the low carbon portfolio so as to minimize the tracking error with the reference benchmark index. By investing in such an index investors are holding, in effect, a “free option on carbon”: as long as the introduction of significant limits on CO2 emissions is postponed they are essentially able to obtain the same returns as on a benchmark index, but the day when CO2 emissions are priced the low carbon index will outperform the benchmark. This Low TE low CO2 strategy can mobilize investors on financial grounds, support disciplining pressure to reduce CO2 emissions, and contribute to build an investor constituency in support of climate change mitigation policies.

Classification JEL : G11 Q54 Q56


Mats Andersson Patrick Bolton Frédéric Samama

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Quantifying Greenhouse Gas Emissions of the Financial Sector accès libre

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To answer the challenges of climate change, a massive reorientation of private and public financing flows is required. The financial sector appears to be a key player to engage the energy transition. One of its first objectives in the context of this low-carbon transition is to have methods and tools to estimate emissions of greenhouse gases (direct and indirect). The estimate of GHG emissions enables the financial sector to better understand and manage its exposure to climate change and to identify development business opportunities related to greenhouse gas emissions. Among the indirect emissions of greenhouse gases in the financial sector, the key issue is to quantify financed emissions, i.e. caused by the detention of a financial asset. The purpose is to present the existing practices for quantifying GHG financed emissions of financial institutions across the two types of existing methodological approaches, to date.

Classification JEL : G12 Q54 Q56


Anne Gerardi Alain Grandjean Emmanuel Martinez

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Other topics on sustainable finance

Governance and Corporate Social Responsiblity: New Frontier of Sustainable Finance? accès libre

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This article investigates the relationships between corporate governance and Corporate Social Responsibility (CSR) at the fore-front of sustainable finance. The underlying intuition is that governance factors are major determinants of CSR policies and extra-financial performance. More precisely, we identify three main factors that determine the strength of CSR engagement and sustainable finance: the structure of equity ownership (identity of shareholders), the composition and structure of board of directors, and the regulatory framework on corporate governance and CSR. We show how evolutions regarding corporate governance over the three previous decades have paved the way and shaped the rise of CSR and sustainable finance.

Classification JEL : G34 M14


Patricia Crifo Antoine Rebérioux

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Why Do We Need a Sustainable and Responsible Financial System? accès libre

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Is the present conception of finance inevitable? Is there a more sustainable alternative? And if so, what does it look like?

In the first part, this article discusses why, when deregulated, finance suffers from pronounced recurring financial cycles, favoured by a strong procyclicality of risk perception with a highly negative impact on the real economy. Understanding how this led to a major crisis is one of the preconditions for conceiving what a sustainable and responsible financial system would look like. In the second part, we point to the necessary reforms of the financial and banking system to lead us out of the crisis and allow for investments with a long-term perspective, particularly important for the coming ecological transition. Finally, this article argues in favour of a model of finance capable of better taking into consideration environmental, social and governance risks in the investment decisions being made – long-term investments, capable of generating new dynamics in different sectors of the economy, whether industry, agriculture or services.

Classification JEL : G01 D62


Esther Jeffers

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Finance Serving Society? accès libre

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Relying on recent articles and books, this paper aims to highlight how finance could serve society and which bases could allow financial activities to actually benefit society. In the aftermath of the crisis public authorities have been reshaping the regulatory framework to prevent finance abuses and their dangerous consequences. However, if a sound framework is necessary, ethics appears unavoidable from its place in finance curriculums to its effective implementation in financial corporations.

Classification JEL : A23 G00 G01 M14


Jean Boissinot

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Financial history column

A Primer on United States Free Banking accès libre

Articles

How has the Crisis Affected the ‘Clean' Versus ‘Lean' Debate amongst Central Bankers? accès libre

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Has the financial crisis led to a paradigm shift in monetary policy? In particular, has central banks' strategy to deal with financial stability changed? Does the central bankers' pre-crisis consensus on dealing ex post with the financial instability during the bust of the bubble (cleaning up the bust afterwards) still prevail? Or on the contrary do central bankers now prefer acting ex ante against the growth of the financial bubble (leaning against the wind)?

We examine whether the financial crisis has impacted this debate clean versus lean. We use the methods of the central bank communication literature. Ninety-four speeches on this debate, from members of the European Central Bank (ECB), the Federal Reserve (Fed) and the Bank of England, are studied over the period 2002-2012.

Two main results emerge from the analysis and coding of these speeches. First, following the crisis the consensus on the ‘clean' strategy is relaxed in the three central banks inspected. The ECB particularly becomes clearly favorable to the opposite strategy of ‘lean'. Secondly, yet, there is no signal of a new central banking paradigm on financial stability as the Bank of England and the Fed remain favorable to the ‘clean' strategy.

Classification JEL : D83 E52 G01


Emmanuel Carré

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The Financial Crisis: Lessons for the Future accès libre

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The causes of the major financial crisis that surfaced in 2007 are identical to those of virtually all crises that have occurred since the beginning of the 19th century – a credit and debt crisis, a speculative asset bubble (in this case real estate) and a liquidity crisis – but the latest crisis had the particular feature of being significantly accentuated by a new element, namely unbridled securitisation. A phenomenon which at the same time facilitated higher indebtedness and considerably intensified the liquidity crisis. Macroeconomically, it was a crisis of overproduction and overindebtedness caused by poorly regulated globalisation.

The eurozone crisis, which began in 2010, is not simply a consequence of the financial crisis that preceded it. It is essentially the result of having constructed an incomplete monetary zone. Convergence criteria prevented neither a profound divergence in current account balances between the countries of the north and those of the south, nor a growing industrial polarisation. Symetrically, the hopes of subsequent deeper federalism within the zone were dashed.

How can we avoid the pitfalls of illusory federalism and of a return to convergence criteria via policies of internal devaluation which may increase the political and social risk within the eurozone itself, potentially undermining its very existence?

Classification JEL : F36 F55 G01


Olivier Klein

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