Environmental finance: towards a better understanding of climate-related financial risks

Throwing the light of academic research on the performance and risks of green assets

“A major current challenge for institutional investors is to identify and quantify the potential financial risk differential between assets according to their environmental impact.”, says Olivier David Zerbib. As pointed out by the project manager on AXA’s side, Lise Moret, Head of Climate Strategy and Sustainability Standards for AXA Investment Managers (IM), “current asset allocation models do not take into account the exposure to climate-related risks”. “Traditional finance and green finance have not really intertwined yet, and this is what we are trying to do with this JRI. We are turning to academic research for guidance, so that we, in turn, can give informed advice. This is a way for us to address investors’ appetite for green assets in a practical way”. Since 2018, AXA IM has created a dedicated unit piloting Climate Strategy and Sustainability Standards. This unit is responsible in particular for supervising the governance of AXA IM’s climate strategy but has also been assigned the task of supporting the AXA Group in its climate strategy. “There’s a cross-fertilization of skills and ideas in this project. The academic team shares their invaluable insights with us, which we then pass on to investors, and AXA IM provides the research team with financial and ESG (Environmental, Social and Governance) data, helps them keep in touch with the realities of the field and find practical applications.”

So far, the first objective the team involved set for itself is to identify and estimate the impact of investors' pro-climate preferences on the expected returns and extreme risks of financial assets. The problematic will be explored in two separate research projects: the first, led by Olivier David Zerbib, examines from a theoretical and empirical viewpoint the effects of ESG integration and exclusionary screening, implemented by a group of sustainable investors, on expected asset returns. The second, under the supervision of prof. Christian Robert, in collaboration with Olivier David Zerbib, investigates the financial extreme risks of financial assets with respect to their environmental impact. This second project proposes to analyze and compare the dynamics of financial assets with a low climate impact and that of assets with a high climate impact in periods of market stress. “Performance and risks are the two cornerstones of financial investments. It was only logical to begin with them”, summarizes Lise Moret. “A third project is also in the pipeline, but we are still debating the topic”.

According to the World Bank, the impact of extreme natural disasters forces some 26 million people into poverty each year and is equivalent to a global $520 billion loss in annual consumption. However, visibility on the performance and risks associated with greening portfolios is so far limited. By offering to fill part of the current academic gap on climate-related risks in asset allocation calculations, the present JRI addresses one of today’s most pressing issue for institutional investors. The results, which will be submitted to top finance journals and presented at international conferences, will undoubtedly contribute to clearing up some of the uncertainties that are still slowing down the development of climate finance strategies.