Climate & finance

Christina has been a consultant at Carbone 4 since 2017, specialized in climate change mitigation and carbon topics. Thanks to her technical and political environmental training,&nbsp;Christina has developed expertise pertaining to the pluri-disciplinary&nbsp;energy-climate field. Notably, she has contributed to the development of greenhouse gas reduction strategies in several sectors such as, banking, retail and real estate.Before joining Carbone 4, Christina&nbsp;gained professional experience in the private sector at EY in environmental consulting and at the institution for international cooperation GIZ GmbH in&nbsp;sustainable energy development in Africa, where she also published a study on the energy sector and&nbsp;climate change&nbsp;adaptation.&nbsp;

Extra Financial Reporting

physical risks and adaptation

financial sector

energy industry

climate strategy

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Consultant

MyCRIS

Président de la fondation Nicolat Hulot

Créé en novembre 2018, il est composé de douze autres scientifiques, économistes, ingénieurs, et experts, il est chargé d’apporter un éclairage indépendant sur la politique du gouvernement en matière de climat.

Membre du haut conseil pour le climat

Alain Grandjean, Pascal Canfin (wwf france) et Gérard Mestrallet (Engie) sont missionnés pour la rédaction d’un rapport portant sur la tarification du carbone, en Europe, en France et dans le monde, remis en juillet 2016.

Co-président de la mission la tarification du carbone pour la ministre de l’environnement, Ségolène Royal, présidente de la cop21.

Avec Pascal Canfin remis en juin 2015 au Président de la République, François Hollande

Co-rédaction du rapport « mobiliser les financements pour le climat »

Président du comité des experts du débat national sur la transition énergétique

Membre de la commission Rocard sur la contribution climat energie

Membre de la commission Juppé/Rocard sur le grand emprunt

Membre du conseil économique pour le développement durable

Membre de la commission du conseil d’analyse économique sur la valeur tutélaire du carbone

Conférencier et formateur

Création et développement de Carbone 4

Membre du comité scientifique de la fondation Nicolas Hulot

Création et développement d’AGconseil, conseil de direction

Alain Grandjean is one of the founding partners of Carbone 4 created in 2007. His expertise on the energy transition, with a special focus on its economic and financial aspects, is widely recognized. He has been a member and sometimes presided, several government commissions, and is involved in think-tanks and foundations.He has 30&nbsp;years of experience as a corporate executive and adviser to corporate executives, and is the author of several books and reports. Since 2007 he also lectures and leads training sessions on energy and climate issues and on financing of the energy transition.&nbsp;Publications&nbsp; Chroniqueur régulier pour Altereco+Auteur de nombreux articles dans la presse économiqueAuteur de son <a target="_blank" rel="noopener noreferrer" href="https://alaingrandjean.fr/">site internet</a>Coauteur des livres suivants&nbsp;:Financer la transition énergétique. Carbone, climat, argent&nbsp; (Les éditions de l’atelier, 2016) avec Mireille MartiniMiser (vraiment) sur la transition écologique(Les éditions de l’atelier, 2014), avec Hélène Le Teno.C’est maintenant ! 3 ans pour changer le monde, (Seuil 2009), avec Jean-Marc JancoviciLes Etats et le Carbone&nbsp;(PUF 2009) avec Benoît Faraco et Patrick CriquiLe Plein s’il vous plait&nbsp;(Seuil 2006), avec Jean-Marc JancoviciEnvironnement et Entreprises : En finir avec les discours&nbsp;(Village Mondial 2006), avec Thierry Libaert et Dominique BourgLa monnaie dévoilée&nbsp;(l’Harmattan 1996), avec Gabriel GalandAuteur d’un ou plusieurs chapitres des livres suivants&nbsp;:Science conscience et environnement. Penser le&nbsp;monde complexe (¨resses universitaires de France, 2016) coordonné par Dominique Bourg et Gérald HessDictionnaire de la pensée écologique (Presses Universitaires de France),&nbsp;article de définition de la transition écologique co-écrit avec Hélène Le Téno. Coordonné par Dominique Bourg et Alain Papaux.20 propositions pour réformer le capitalisme&nbsp;(Flammarion 2012), sous la direction de Cécile Renouard et GaelGIraud.Vers une société sobre et désirable&nbsp;(PUF 2010), sous la direction de Philippe Bourg et Alain Papaux.Crise écologique, crise des valeurs ? Défis pour l’anthropologie et la spiritualité sous la direction de Dominique Bourg et Philippe Roch

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partner

Jean-Yves Wilmotte is a manager at Carbone 4. He is the leader of the finance practice, helping actors of the financial sector to integrate climate in their strategy and risk management. He is head of methodological development for Carbon Impact Analytics, innovative methodology to assess the climate impact of financial portfolios.Jean-Yves has worked on several carbon footprint methodologies and environmental impact assessment tools, mainly in finance, energy, buildings and transport, including measuring green bond’s impact. He has also led strategic and forward-looking analyses of the energy and climate transition.Jean-Yves is also a member of the Technical Expert Group on Sustainable Finance of the European Commission.

prospective

Real estate and construction industry

methodology development

transport sector

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Manager

CIARA

Clémence Lacharme is manager at Carbone 4. Clémence has worked on a tool to measure the contribution of SRI funds to the energy transition and to climate change mitigation at both company and portfolio levels.Clémence has also worked on several carbon footprint analyses.&nbsp;She worked on the carbon footprint of the City of Paris and has developed tools to measure CO2eq emissions for the population of Paris using the eco2climat and PAS 2070 methods.She is a member of the Buildings and Finance expert groups at Carbone 4, and of the Carbon Impact Analytics team. She has developed methods for the waste and water sectors.Before joining Carbone 4, Clémence worked as Head of Environment at Barclays RBB France where she implemented an Environmental Management System and monitoring carbon tools.&nbsp;

water sector

manufacturing industry

cities and territories 

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At Carbone 4, Juliette has participated in several methodological development tasks, measurement of carbon impact as well as several training sessions.Among her assignments at Carbone 4, Juliette has carried out several carbon accounting exercises in the power and construction sectors.She has participated in methodological development and climate analysis work for investment portfolios (listed and unlisted companies, and infrastructure assets). She has also worked on a tool to measure the energy, carbon and economic impacts of energy transition projects implemented by public authorities.She has conducted several training sessions on energy and climate topics.Before joining Carbone 4, Juliette worked for nine months in the Think &amp; Do TankCliMates as Education Coordinator.&nbsp; She has organized two large-scale simulations (serious games) of the COP21 conference with high school students, in partnership with the Ministry of Education and the Ile-de-France regional government. Within Climates, Juliette also led the international project COP in MyCity for two years and supervised a 10-person team.

training

electricity industry

infrastructure

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Webinar de Carbone 4 et LTIIA&nbsp;: L’éléphant dans la pièce&nbsp;: Défis climatiques et opportunités pour les investisseurs en infrastructures«&nbsp;Les infrastructures existantes représentent déjà 95% de notre budget carbone nous permettant de rester au-dessous de 2ºC de réchauffement global » (Agence internationale de l'énergie).&nbsp;» L'infrastructure est essentielle pour le défi climatique afin de respecter l'engagement international pris par la COP21 de limiter le réchauffement planétaire à bien en dessous de 2 ° C par rapport aux niveaux préindustriels. Dans cette optique, les investisseurs et les gestionnaires d’infrastructure sont confrontés à des défis commerciaux stratégiques, tels que :&nbsp;<ul><li>L’exposition à des actifs immobilisés liés à la transition énergétique&nbsp;(par exemple, dans quelles conditions les aéroports pourraient-ils fonctionner conformément à une trajectoire compatible à 2 ° C ?)&nbsp;</li><li>L’exposition aux conséquences physiques du changement climatique&nbsp;(par exemple, quels sont les coûts financiers des aléas climatiques de plus en plus nombreux pour les actifs routiers ?)&nbsp;</li><li>La compatibilité des actifs avec une trajectoire 2 ° C&nbsp;(par exemple, comment mettre en place des feuilles de route durables pour réduire l’empreinte carbone d’un portefeuille ? Quels critères faut-il utiliser pour sélectionner des actifs durables ?) LTIIA et Carbone 4 vous remercient pour votre participation&nbsp;à ce webinar. Programme&nbsp;: Les présentateurs et les participants à ce webinar ont été&nbsp;invités à s’exprimer sur les sujets suivants&nbsp;:&nbsp;</li><li>Comment les gestionnaires d'actifs peuvent-ils intégrer l'impératif climatique dans leur processus de sélection d'actifs d'infrastructure et leur gestion de portefeuille ? Comment les gestionnaires d'actifs peuvent-ils comparer leurs investissements à une trajectoire compatible à 2 ° C ?</li><li>Comment les gestionnaires d'actifs peuvent-ils effectuer une évaluation du risque de transition énergétique et de la résilience de leur portefeuille ? Comment identifier d'éventuels actifs immobilisés ?</li></ul>Webinar Europe et Amériques&nbsp;: le 11 juin 2019 à 17h à Paris, 16h à Londres et 11h à New-York.&nbsp;<ul><li>Animé par François Bergere, Directeur exécutif, LTIIA</li><li>Juliette Decq, Alexandre Joly, Manager et Consultant senior, Carbone 4</li><li>Ginette Borduas, ESG compliance officer, Meridiam</li><li>James Pass, Directeur général, Guggenheim Partners</li><li>Questions / réponses du public</li></ul>Retrouvez également notre publication : "<a href="http://www.carbone4.com/infrastructures-a-key-asset-category-for-the-climate/?lang=en">Les infrastructures, une classe d'actif au coeur des enjeux climatiques</a>"&nbsp;Visionner le <a href="https://www.youtube.com/watch?v=7IdsxsWEpCo">webinar</a>&nbsp;

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Webinar - Investissement, infrastructures et changement climatique

Working for Carbone 4 since 2015, Sylvain assists players in the agri-food sector with their entire climate transition process: carbon footprint, reduction targets, action plan, training, strategic reviews, etc.Sylvain also works on the CIARA project, which assesses the 2°C alignment of infrastructure portfolios.&nbsp;

agri-food

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Senior consultant

The Basel Committee on Banking Supervision, is the primary global standard setter for the prudential regulation of banks.&nbsp;It has 45 members comprising central banks and bank supervisors from 28 jurisdictions.&nbsp;Its mandate is to strengthen the regulation, supervision and practices of banks worldwide with the purpose of enhancing financial stability.&nbsp;It has been the developer of the Basel Accords, a widely applied framework for the regulation, supervision and risk management of banks.&nbsp;The Basel Committee made one step further in its strategy to integrate climate-related financial risks in the prudential framework for banking regulation.&nbsp;On April 14th 2021, The Basel Committee released two reports on climate-related financial risks: on the transmission channels&nbsp;[<a target="_blank" rel="noopener noreferrer" href="https://www.bis.org/bcbs/publ/d517.pdf">1</a>] between (i) climate physical and transition risks and (ii) traditional financial risk categories; and on measurement methodologies [<a target="_blank" rel="noopener noreferrer" href="https://www.bis.org/bcbs/publ/d518.pdf">2</a>], outlining the need for improved climate data and methodologies, naming the Climate Risk Impact Screening methodology [<a target="_blank" rel="noopener noreferrer" href="http://crisforfinance.com/">3</a>], developed in 2017 by Carbon4 Finance.&nbsp;Climate change is an existential threat posing major risks to our economies. The Basel Accords and their implementation are key elements of the financial system stability, requiring banks to maintain capital buffers against the risk they take. We thus welcome this step forward by the Basel Committee, as banks are still lacking data and methodologies to properly integrate climate change in their risk management framework.<h4>The Basel Committee has developed a strategy on prudential climate change integration.&nbsp;</h4>On February 2020, the Basel Committee on Banking Supervision announced the set up of a high-level Task Force on Climate-related Financial Risks (TFCR) with the mandate of enhancing global financial stability through the following initiatives:&nbsp;<ul><li>A stocktake on members’ existing regulatory and supervisory initiatives on climate-related financial risks,</li><li>A set of analytical reports on transmission channels and measurements methodologies&nbsp;for climate-related financial risks,</li><li>The development of supervisory practices in order to mitigate climate-related financial risks.</li></ul>The results of the stocktake&nbsp;[<a target="_blank" rel="noopener noreferrer" href="https://www.bis.org/bcbs/publ/d502.pdf">4</a>] on existing initiatives has been published on April 2020. The two reports on transmission channels and measurements methodologies have been published on April 14th, 2021. We will expect Basel Committee members to build upon the results of these reports and market reactions to develop supervisory practices integrating climate related financial risks into prudential banking regulation.<h4>Basel Committee members would like to integrate climate change; but data, methodologies and understanding are lacking.</h4>In the April 2020 stocktake of existing initiatives, the Basel Committee looks at the way in which climate-related financial risks are integrated by its members: among which the European Central Bank, the European Banking Authority, national central banks and financial markets regulatory and supervisory bodies.&nbsp;It notes that the members "consider it appropriate to address climate-related financial risks within their existing regulatory and supervisory frameworks” and that research has been conducted to determine how this can be achieved. However, operational hurdles remain such as data availability, methodological challenges, and difficulties in mapping transmission channels.&nbsp;<figure class="image"><img src="http://www.carbone4.com/wp-content/uploads/2021/04/1.png" alt=""></figure>Key challenges identified by Basel Committee (number of votes)Source: Basel Committee&nbsp;&nbsp;3 responding members out of 5 had not integrated climate-related financial risks into their prudential capital framework.&nbsp;<figure class="image"><img src="http://www.carbone4.com/wp-content/uploads/2021/04/2.png" alt=""></figure>Number of respondents who have issued supervisory guidance on climate-related financial risksSource: Basel Committee&nbsp;<h4>The April 2021 publication of two analytical reports precises what needs to be done and which type of data and methodologies is needed.</h4>Transmission channels&nbsp;&nbsp;The report outlines how the banking system is exposed to climate change through micro and macro economic transmission channels that arise from two distinct types of climate risk drivers: physical risks and transition risks.&nbsp;<figure class="image"><img src="https://strapipreprod.s3.eu-west-3.amazonaws.com/bale_publi.svg"></figure>Financial risks from climate risk driversSource: <a href="https://www.bis.org/bcbs/publ/d517.pdf">https://www.bis.org/bcbs/publ/d517.pdf</a> (p4)Traditional banking risk categories (Credit, Market, Liquidity and Operational risk) can then be used to assess climate-related financial risks impacts on banks and the banking system stability. This mapping of transmission channels from climate risk drivers to traditional risk categories will allow climate risk integration into the existing prudential rules without the need to completely overhaul the existing framework. &nbsp;<figure class="image"><img src="http://www.carbone4.com/wp-content/uploads/2021/04/Capture-d’écran-2021-04-21-à-12.56.07.png" alt=""></figure><figure class="image"><img src="https://strapipreprod.s3.eu-west-3.amazonaws.com/2_Capture_d_ecran_2021_04_21_a_12_56_07_1.png"></figure>&nbsp;Source: <a href="https://www.bis.org/bcbs/publ/d517.pdf">https://www.bis.org/bcbs/publ/d517.pdf</a>Measurement methodologies&nbsp;&nbsp;To date, measurement of climate-related financial risks by banks and supervisors have focussed on short-term transition risks, with a dominant use of the carbon footprint/carbon intensity and sectoral exposure such as coal sectoral exposure.&nbsp;The report outlines the need for granular, bottom-up and forward looking data and methodologies.&nbsp;High granularity of exposure data may as well be necessary, both in terms of geolocational data and counterparty- and industry-level data.&nbsp;New and unique type of data will be needed, spanning across three areas:&nbsp;<ul><li>data translating climate risk drivers into economic risk factors,</li><li>data linking climate-adjusted economic risk factors to exposures,</li><li>and data to translate climate-adjusted economic risk into financial risk.</li></ul>The report evaluates candidate methodologies for estimating climate-related financial risks. It describes that conventional risk measurements approaches can be adapted to assess climate risks but “[in] practice, […] the range of impact uncertainties, time horizon inconsistencies, and limitations in the availability of historical data on the relationship of climate to traditional financial risks, in addition to a limited ability of the past to act as a guide for future developments, render climate risk measurement complex and its outputs less reliable as risk estimators”.&nbsp;Among those risk measurement processes, the report highlights the most prominent and conventional practices:&nbsp;climate risk scores and ratings, scenario analysis, stress testing and sensitivity analysis.&nbsp;Climate risk scores aim to assess the relative climate exposure of existing and prospective credit intermediation. Among the measurement processes&nbsp;identified, the Basel Committee report&nbsp;outlines the Climate Risk Impact Screening methodology, developed in 2017 by Carbon4 Finance, noting that “Climate risk rating methodologies [are] often developed with highly granular data, enabling them to be location-specific, and incorporate supply chain and company-specific information”.&nbsp;We note that the French central bank (Banque de France) has also built on the data provided by Carbon4 Finance to assess the climate change-related transition risks associated with its collateral portfolio&nbsp;[<a target="_blank" rel="noopener noreferrer" href="https://blocnotesdeleco.banque-france.fr/en/blog-entry/climate-risks-and-collateral-methodological-experiment">5</a>].&nbsp;The report concludes with the need for investments to address methodological and data gaps, which will foster improved prudential management and mitigation of climate-related financial risks.<h4>Futur developments in global prudential regulation</h4>The next objective for the Basel Committee and its&nbsp;Task Force on Climate-related Financial Risks is to develop climate-related financial risk supervisory practices.&nbsp;These practices will be ultimately translated into banking regulation, building on improved climate data and methodologies.&nbsp;As a pioneer in the development of bottom-up and forward-looking climate data and methodologies, Carbone 4 welcomes the issuance of these two analytical reports clearly paving the way for climate-integrated global prudential regulation standards.&nbsp;

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<a target="_blank" rel="noopener noreferrer" href="https://www.bis.org/bcbs/publ/d517.pdf">Climate-related risk drivers and their transmission channels</a>, Basel Committee on Banking Supervision, April 2021.

<a target="_blank" rel="noopener noreferrer" href="https://www.bis.org/bcbs/publ/d518.pdf">Climate-related financial risks – measurement methodologies</a>, Basel Committee on Banking Supervision, April 2021.

<a href="http://crisforfinance.com/">Climate Risk Impact Screening</a>, Carbon4 Finance.

<a target="_blank" rel="noopener noreferrer" href="https://www.bis.org/bcbs/publ/d502.pdf">Climate-related financial risks: a survey on current initiatives</a>, Basel Committee on Banking Supervision, April 2020.

<a target="_blank" rel="noopener noreferrer" href="https://blocnotesdeleco.banque-france.fr/en/blog-entry/climate-risks-and-collateral-methodological-experiment">Climate risks and collateral: a methodological experiment</a>, Banque de France.

Towards climate integration into global prudential banking regulation

The ACPR (the French Prudential Supervision and Resolution Authority) together with the Banque de France (French Central Bank) conducted a climate stress testing pilot exercise from July 2020 to April 2021&nbsp;<a class="footnoteLink" href="#footnote-1">[1]</a> to assess the exposure of banks and insurers climate risks. It mobilised 9 banking and 15 insurer groups, covering respectively 85% and 75% of their total balance sheet.&nbsp;This exercise is part of movement from European supervisors and regulators to assess the risks and challenges posed by climate change on financial stability: the Bank of England and the European Central Bank will conduct climate stress testing exercises on the basis of the same scenarios (provided by NGFS, the Network for Greening the Financial System); while the Basel Committee is advancing on its strategy to integrate climate related financial risks into banking prudential regulation (<a href="http://www.carbone4.com/towards-climate-integration-into-global-prudential-regulation/">see the analysis from Carbone 4</a>).&nbsp;Despite current limitations due to the pioneering nature of this exercise, we welcome its realisation which has the merit of raising awareness on climate-related financial risk.&nbsp;As climate stress testing will become recurrent, banks and insurers will have to gain expertise in climate scenario modeling, understanding of climate risk transmission channels and rely on better forward-looking data and improved methodologies.&nbsp;This exercise involves stressing the balance sheets of French banks and insurers with a set of common hypotheses: a long time horizon (2050), the use of transition and physical risk scenarios broken down in sectors, and a dynamic balance sheet&nbsp;assumption (institutions can adapt their balance sheet over time).&nbsp;Participants were subject to three transition risk scenarios (all reaching “net zero” emission), and one physical risk scenario, (the RCP8.5 from the IPCC, or a “Business as Usual” scenario), based on a 30-years time frame. The exposure of French banks and insurers to transition risks is revealed as “moderate”, but our analysis shows that several elements indicate a potential downward bias, or an underestimation of transition risks. Physical risks lead to a significant increase in sinistrality and insurance premiums. While these do not directly endanger insurers balance sheets, it will widen the insurance protection gap, with the insurability line being pushed further. &nbsp;<h4>A «&nbsp;moderate&nbsp;» exposure to transition risks showing potential for methodological improvement</h4>Regarding transition risk, three transition scenarios were used. All three imply a steady decline of emissions to reach “net zero” in 2050, including one in line with the SNBC&nbsp;(French Low Carbon National Strategy), one with a “sudden” transition and one with a “delayed” transition (see Chart 1). &nbsp;<figure class="image"><img src="http://www.carbone4.com/wp-content/uploads/2021/05/1-300x163.png" alt=""></figure>Chart 1 – Schematic representation of the transition and physical risk scenarios included in the ACPR pilot exerciseThe exposure of French banks and insurers to transition risk is deemed as “moderate”, with an increase of French banks’ cost of risk&nbsp;<a class="footnoteLink" href="#footnote-2">[2]</a> between 30% and 40% (the covid-19 crisis increased it by 100%). However, several elements suggest a downward bias in this result, underestimating the level of exposure to transition risks. &nbsp;<h4>A decoupling assumption between GDP growth and emissions leading to an absence of an output shock</h4>Scenarios rely on a decoupling between emissions and GDP growth, since they all envision GDP growth while reaching emissions “neutrality”. This has nos been a reality in the past and the fact that it will become so in the future is questionable (see Chart 2). &nbsp;&nbsp;<figure class="image"><img src="http://www.carbone4.com/wp-content/uploads/2021/05/chart-2.png" alt=""></figure>Chart 2 – Growth rate of the GDP (US$ 2010)/World Primary Energy Consumption (EJ)Historical data:&nbsp;World Bank; BP Statistical Review of World EnergyFrom 2020: NGFS scenarios used for the stress tests (REMIND-MAgPIE 1.7-3.0)This implies that a rapid reduction of emissions could be achieved without a significant impact on GDP (by way of comparison, regular biannual stress tests conducted by the EBA require scenarios based on three consecutive years of GDP contraction). Consequently, banks’ credit exposures are subject to variations in prices from the trajectory of a carbon tax, and productivity of factors, but not to a decline in economic output.&nbsp;Having three scenarios that include (some) GDP growth, and a net zero trajectory diminishes the variability between the scenarios, and thus between the output of the stress tests, a pitfall identified by the ACPR. &nbsp;&nbsp;<figure class="image"><img src="http://www.carbone4.com/wp-content/uploads/2021/05/2-bis-1.png" alt=""></figure>Chart 3 - Carbon emissions and pricing trajectories of ACPR scenarios (source <a target="_blank" rel="noopener noreferrer" href="https://acpr.banque-france.fr/sites/default/files/medias/documents/principales_hypotheses_pour_lexercice_pilote_climatique.pdf">ACPR</a>, p.20)&nbsp;<h4>The limits of the sectoral classification</h4>The sectoral structure of French banks’ balance sheets contributes to the assessment of a “moderate” exposure to transition risks. The seven most impacted sectors, described as “sensitive sectors”, see their cost of risk raise threefold by 2050. These sectors represent 9,7% of banks' corporate credit exposures, limiting the global exposure. The ACPR underlines the large scale of impacts in these sectors: “However, the substantial increase in the cost of risk in some sensitive sectors, which is already induced by the orderly transition scenario, indicates that the energy transition which is necessary in order to comply with the Paris Agreement, presupposes a considerable effort to adjust the system and the economic structures”. &nbsp;&nbsp;<figure class="image"><img src="http://www.carbone4.com/wp-content/uploads/2021/05/3-bis.png" alt=""></figure>Chart 4 - Sectoral structure of credit exposures (source <a target="_blank" rel="noopener noreferrer" href="https://acpr.banque-france.fr/sites/default/files/medias/documents/20210504_as_pilot_exercise_climat_change.pdf">ACPR</a>, p.16)We note that the “Electricity and gas” sector, “which stands to benefit from the transition in the scenarios, sees its share in total exposure increase sharply”. Thus, gas, a fossil fuel, see the share of credit exposure in the sector in which it is included, increase to reach the highest exposure of French banks balance sheets by 2050. As a reminder, electricity generation from a gas power plant emits 418gCO2e/kWh&nbsp;<a class="footnoteLink" href="#footnote-3">[3]</a> and would be sensitive to a carbon tax increase (after potentially benefiting from the rule-out of more carbon intensive sources of electricity production such as coal). The scenarios used in these stress tests see the carbon pricing reach 704$/t (delayed transition) or 917$/t (sudden transition) in 2050 (see Chart 3). The report recognises a potential for methodological improvement. «&nbsp;A […] difficulty lies in the identification of sectors that are sensitive or exposed to climate risk: this identification first of all depends on the method used. It then implies assumptions on the evolution of the energy mix, the intensity and the energy efficiency of production, which were not properly integrated in this exercise&nbsp;». &nbsp;<h4>The lack of a feedback mechanism between sectorial reallocation and prices could create a downward bias in transition risk exposure assessment</h4>In this exercise, banks (and insurers) were free to adapt their balance sheet under the three transition scenarios, enabling participants to redistribute their corporate credit portfolio in different economic sectors. For instance, under the sudden transition scenario, banks’ exposure to electricity and gas, construction and wholesale trade industries increases in most cases, while financial institutions lower their exposure to coke &amp; refined petroleum products, mining &amp; quarrying, and agriculture &amp; animal breeding sectors. French insurers did not alter significantly their portfolio structure.&nbsp;The ability of banks to dynamically adjust their balance sheet reduces the cost of risk, especially in sensitive sectors. However, a limit to this exercise is the absence of consideration of second round effect from sectorial reallocation (further decline in asset prices as exposures are removed from balance sheets). The report also notes that the “absence of feedback effects between the sectoral structure of the balance-sheet of the financial sector and financial risks (generated by climate change) does not necessarily encourage institutions to implement an active risk reduction policy, as most of the transition scenarios considered reach the objective of carbon neutrality in 2050”. This implies that further sectoral reallocation could be considered, triggering a downward spiraling effect in terms of asset prices, macroeconomic data such as GDP and the level of interest rates. &nbsp;<h4>Physical risks: an increase in sinistrality and insurance premiums</h4>Physical risks were based on a “Business as Usual” scenario (the RCP 8.5 scenario from the IPCC - Intergovernmental Panel on Climate Change), assuming a temperature increase comprised between 1.4°C and 2.6°C on a 30 years’ time span to 2050. &nbsp;&nbsp;<figure class="image"><img src="http://www.carbone4.com/wp-content/uploads/2021/05/4-bis.png" alt=""></figure>Chart 5 - Physical risk assessment based on the RCP 8.5 IPCC scenario (source <a target="_blank" rel="noopener noreferrer" href="https://acpr.banque-france.fr/sites/default/files/medias/documents/20210504_as_pilot_exercise_climat_change.pdf">ACPR</a>, p.33)For insurance groups, the pilot exercise was split by property and human health damages, including mosquito-borne diseases, pandemics and air pollution, the human dimension being quite innovative in climate change stress testing. As a result, natural disasters are projected to double, and a surge in vector-borne infections and in air pollution impacts on health (“leading to respiratory and cardiovascular diseases, cancers, and premature deaths”) is expected between 2019 and 2050.&nbsp;Loss-models were put in place as to assess the impact of a surge in natural disasters on the property damage business. It resulted in an escalation of claims throughout the French territory (though with large regional discrepancies), due to an increase in the scale and frequency of natural disasters. The stress test concludes that “premiums increase by between 130% and 200% over 30 years depending on the category, i.e., an increase in insurance premiums comprised between 2.8% and 3.7% per year”.&nbsp;As yearly pricing review is common in the insurance industry, insurers are relatively protected against an increase in loss ratios caused by natural disasters. However, the long-term horizon used in these tests showcases an expected twofold increase in climate disasters, shedding light on the widening of the&nbsp;insurance protection gap (where some sectors will become too burdensome to be insurable – see Chart 6). &nbsp;&nbsp;<figure class="image"><img src="http://www.carbone4.com/wp-content/uploads/2021/05/5-bis.png" alt=""></figure>Chart 6 - Insurance coverage gap (% of world GDP)&nbsp;Questions are raised by the exercise: which underwriting framework should be adopted to ensure that the most exposed geographical areas do not become uninsurable? As reinsurance will play a key role in supporting insurance, which legal frameworks should be put in place as to monitor this risk transfer?&nbsp;For this exercise, insurers have not adopted any change in their reinsurance program. The share of premiums ceded under reinsurance program decreases, while the absolute amount of ceded premium increase by 2050. The gradual decrease in the share of ceded premiums therefore appears to be mainly driven by the insurers' assumption that the claims/premiums ratio will remain stable over time.&nbsp;Banks were not able to fully participate on the physical risks’ side. The limitation being due to the absence of key exposure data (counterparty and geolocational data) and methodological difficulties regarding risk transmission channels (from physical risk to traditional risk categories). Those limits are those identified to develop a new set of prudential rules integrating climate-related financial risks, in a recent set of reports from the Basel Committee on Banking Supervision (<a href="http://www.carbone4.com/towards-climate-integration-into-global-prudential-regulation/">read the analysis of Carbone 4</a>). &nbsp;<h4>A pioneer exercise to become an industry standard</h4>The ACPR already advanced it will perform more regular climate stress tests (planned for 2023/24). The results of this test will also enable to better prepare for the upcoming exercise which will be undertaken by the ECB in 2022. Other international working groups will involve the European Insurance and Occupational Pensions Authority, the Basel Committee on Banking Supervision, the International Association of Insurance Supervisors and the Financial Stability Board.&nbsp;We recognise that this assessment is unprecedented in financial institution stress testing, paving the way for further reflection in the broader EU Sustainable Finance Agenda. This pilot exercise aims&nbsp;at supporting both those targeted economic actors and regulators to take decisive actions on the herculean tasks awaiting in tackling climate change.&nbsp;This encouraging pioneer exercise has shown that some progress could be made with the help of improved methodologies and key climate change data. Advances in climate disclosure requirements (notably the revision of the directive on non-financial reporting) and reliance on bottom-up, forward-looking and granular climate data will&nbsp;be decisive in these regards.&nbsp;------------ &nbsp;&nbsp;&nbsp;Article written by Victor Murzeau, Carbone 4 consultant, and Mona Huys, Carbon4 Finance carbon data analyst.&nbsp;

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<a href="https://acpr.banque-france.fr/sites/default/files/medias/documents/20210504_as_pilot_exercise_climat_change.pdf">Scenarios and main assumptions of the ACPR pilot climate exercise</a>, ACPR, May 2021.

The annual cost of credit risk is calculated by dividing the total annualised provisioning flows for each time interval by the average exposure over the same time interval.

Climate Stress Tests: how to read the results of the exercise?

Victor joined Carbone 4 in September 2020 as a member of the Finance practice. He assists financial players, particularly asset management companies, in designing and deploying climate impact investment strategies. He is also a trainer for the "Climate and Finance" cycle of the Carbon 4 Academy.&nbsp;Before joining Carbone 4, Victor worked in asset management (investment funds sales at Amundi, credit research at Kepler Cheuvreux), then in investment banking (quantitative and regulatory impact studies for the Securitization business line, then member of the Acquisition Finance &amp; Advisory division at Crédit Agricole CIB). Victor has also been involved in climate change-related voluntary work within The Climate Fresk and The Shifters associations.His education, professional and associative experiences have prepared Victor, within Carbone 4, to make a difference in the immense challenge of aligning financial flows with the Paris Agreement.&nbsp;

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