HC 11 Flashcards
Physical risk
corporations, household and countries experience climate shocks (eg: fires, drought, hurricanes, rising sea level): mortgage loan + corp defaults
Transition risk
losses on exposures to firms with business models not built on sustainable strategies (eg: low carbon economy). consumer preferences and technology disruption cause more defaults
ESG Transparency of banks
Environmental impact disclosure: Banks are responsible for disclosing their environmental impact, including carbon footprints and resource usage. This encompasses not only their direct operations but also the environmental impact of their lending and investment activities.
Social Responsibility: This involves transparency about how banks address social issues, including labor practices, human rights, community engagement, and contributions to economic
development. It also covers their policies and practices related to customer fairness and protection.
Governance Practices: Banks need to be transparent about their governance structures, including board composition, executive compensation, ethical business practices, and internal controls. This transparency helps stakeholders evaluate the effectiveness and integrity of the institution.
PCAF
Part A - Financed Emissions
Seven Asset classes:
1. Listed equity and corporate bonds
2. Business loans and unlisted equity
3. Project finance
4. Commercial real estatee
5. Mortgages
6. Motor vehicle loanss
7. Sovereign debt
Part B - Facilitated Emissions
Part C - Insurance-Associated Emissions
Availability of emissions data
– Option 1: collect reported emissions (verified or unverified from c)
– Option 2: emissions estimated based on primary physical activity of c (eg: megawatt-hours of natural gas consumption, or tons of steel produced)
– Option 3: emissions estimated based on economic activity of c (use official stats data with sector-specific avg emission factors per economic activity (eg: tCO2e/euro of revenue)
Data quality PCAF guidance:
- Transition to Primary Data: Bank should obtain direct emissions data.
- Update Emission Factors: Where direct data isn’t available, the guidance could suggest using updated, segment-specific emission factors, possibly by geographic relevance, to refine the bank’s emissions estimations.
- Implement Regular Updates and Reviews: The bank could be advised to set up a schedule for regular review and updating of their data sources to keep their emissions estimates current and reflective of any operational changes within their investments.
Green bond
debt security that is issued to raise capital to support climate related or environmental projects (World Bank definition).
Verification green bonds
Intl Capital Markt Assoic (ICMA):
(1) use of proceeds disclosure,
(2) ongoing reporting on green use ofproceeds,
(3) provision of second opinion by indep 3 rd party certifying green aspects
Critical comments on green bonds
- Lack of contractual protection for green bond investors
None of the critical key elements confer actionable rights on bondholders asset: covenants often do not contain use of proceeds, ongoing maintenance of green review, or annual reporting. Therefore, the lack of compliance does not trigger default nor an increase in coupon rate
Dilemma bondholders: what if breach in ‘green’ investment criteria of investor? - Quality of reporting metrics and transparency
Bond issuer has discretion over implementation of eligible green projects (agency problem of asset substitution) with varying levels of specificity and detail. Post-issuance reporting is often opaque: frequency, detail, and level of compliance.
Greenwashing (i.e. deceptive promotion of green attitude/actions of issuer) because of: no single global standard, no single recognized legal
definition of green bond, voluntary compliance - Issuer confusion and fatigue
– Issuers face ever-increasing set of rules and disclosure reporting guidelines and standards:
* Rating agencies
* Stock exchanges and bond markets
* Second party reviewers
* Certifiers - Perceived lack of pricing benefits for issuers
– Not a full understanding of pricing differences between green bonds vs non-green plain vanilla bonds of the same issuer
– Issuers need a clear discount on the primary sale of the bond
Hans-Martin Henke, 2016, The effect of social screening on bond mutual fund performance, Journal of Banking & Finance, 69-84
“screening outperformance”
* SRI bond mutual funds that apply ESG screening outperform conventional funds by 0.58-0.70% annually
* SRI bond mutual funds without ESG screening are not different in performance form conventional funds
Risk-mitigation results
* ESG funds perform best in crisis periods (2001-03,2008-09,2011-12):
* ESG funds with screening are even better in crisis periods
