Glossary

A climate index refers to a time series or measure that is representative of climate risk. It is constructed using methods such as textual analysis or the use of observable characteristics that proxy for unobservable risk factors. Climate indices are employed to estimate the sensitivity of asset returns to climate risk and to analyse how financial markets incorporate, or fail to incorporate, climate-related shocks.

Source: Rebonato, R. (2023). Asleep at the Wheel? The Risk of Sudden Price Adjustments for Climate Risk. EDHEC Climate Institute. July. 

Abatement policy refers to the set of measures aimed at reducing greenhouse gas (GHG) emissions at their source, particularly from fossil-fuel combustion, industrial processes, and other emitting activities. It encompasses actions such as improving energy efficiency, deploying low-carbon and renewable energy technologies, or switching to less carbon-intensive fuels. Abatement policy is distinct from negative emissions approaches, which remove CO₂ already present in the atmosphere, but both interact in comprehensive climate strategies.

Source: Rebonato, R., Kainth, D., Melin, L., & O’Kane, D. (2023). Optimal Climate Policy with Negative Emissions. EDHEC Climate Institute. April.

Active ownership refers to the proactive role that institutional investors play in influencing the behaviour of the companies in which they hold investments. This involvement may take various forms, including direct engagement with company management (including via participation in collaborative initiatives), utilisation of ownership rights, and potentially resorting to public campaigns or litigation. The overarching goal is to impact policies, strategies, practices, or specific decisions of the invested companies. Active ownership may encompass considerations related to both financial and impact objectives. In the realm of climate change, it can target various aspects such as advocating for enhanced disclosure of climate impact, risks, and opportunities. This may extend to influencing the integration of climate considerations into decision-making processes, as well as advocating for measures that contribute to the reduction of adverse climate impacts.

Source: Gianfrate, G., Kievid, T., & Nunnari, A. (2021). Institutional Investors and Corporate Carbon Footprint: Global Evidence. EDHEC Climate Institute. October.

Agency problems at firms arise when the managers (agents) do not act in the interest of the shareholders (principal).

For example, the CEO may decide to use corporate cash to purchase a private jet instead of distributing an extra-dividend to shareholders. Shareholders do not have full information about what is happening at the company. At the same time, managers can make decisions that benefit themselves instead of the stakeholders (including the shareholders). The corporate inefficiencies that are associated with the conflict of interests between management and shareholders are called agency costs.

Source: Gianfrate, G., Ghitti, M., & Palma, L. (2022). The Agency of Greenwashing. EDHEC Climate Institute. February

An insurance contract by which the insured person pays a premium today in exchange for receiving lifetime income.

Anthropogenic climate change refers to changes in the climate that are primarily caused by human activities, such as the burning of fossil fuels (coal, oil, and natural gas), deforestation, industrial processes, and agricultural practices, all these activities causing emissions of greenhouse gases, such as carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), and others, into the atmosphere. 

Asset-liability management (ALM) refers to the adaptation of the portfolio management process to the presence of constraints relating to the commitments represented by the investor's liabilities. 

Best-in-class or positive screening involves selecting, for each investment sector, the assets with the most positive scores on relevant environmental, social, and governance ESG criteria. An aggregate ESG score may be determined based on combinations of single factors by a third party. External ESG scores can be used to obtain a proxy for a company’s ESG performance through a standardized system and, as such, can prove useful for asset managers or asset owners with a limited understanding of how to design their own selection criteria based on various sustainability factors. Positive screening is based on more objective criteria than negative screening, since there are now rating agencies producing ESG scores based on an aggregation of factors. However, there is still a great lack of convergence between the ratings of the various rating agencies. 

Source: Le Sourd, V. and L. Martellini (2021). The EDHEC European ETF, Smart Beta and Factor Investing Survey 2021. EDHEC Climate Institute. September.

Brown assets are financial assets or investments associated with sectors or activities that are highly carbon-intensive or heavily reliant on fossil fuels. Because of their environmental profile, they are more exposed to climate-related risks, including policy and regulatory changes, technological developments, and physical impacts of climate change. Such risks increase their vulnerability to abrupt market repricing and the potential for financial underperformance as economies transition towards lower-carbon pathways.

Source: Rebonato, R. (2023). Asleep at the Wheel? The Risk of Sudden Price Adjustments for Climate Risk. EDHEC Climate Institute. July. 

The Carbon Disclosure Project (CDP) is a global not-for-profit organisation that collects and analyzes data on climate change and carbon emissions, such as greenhouse gas emissions and internal carbon price (ICP),  from thousands of organisations worldwide. The CDP is reported to be the largest effort to assemble standardised data on carbon emissions as well as information on companies’ risks, opportunities, and strategies to manage the effects of climate change. The CDP started in 2002 at the request of 35 institutional investors managing more than $4.5 trillion of assets. By 2023, CDP endorsement has grown to 740 investors with more than $136 trillion of assets under management, collecting information from more than 23,000 companies, representing two thirds of global market capitalisation.

Source: Bento, N. and G. Gianfrate (2020). Determinants of Internal Carbon Pricing. Energy Policy 143.

A measure of the total greenhouse gas (GHG) emissions caused by a corporation, categorized into 3 groups. Scope 1 covers direct emissions from owned or controlled sources. Scope 2 covers indirect emissions from the generation of purchased energy sources. Scope 3 includes emissions outside the boundaries of operational control of a firm, either downstream, generated by product use by the customer, or upstream, generated by a firm’s supply chain.

In the context of the fight against climate change, it has become increasingly important for a large number of organisations to report the so-called carbon footprint. Simply put, the carbon footprint is a quantitative measure of carbon emission or CO2 emissions by a given institution/corporation as a function of the activities.

An approach that consists in internalizing the social costs of carbon emission in economic transactions. Carbon pricing can be implemented via the introduction of carbon taxes, and/or via the introduction of carbon markets, involving emissions trading systems (ETS) where emitters can trade emission units to meet their emission targets.

Carbon risk refers to the potential negative impact of unexpected changes in carbon prices on corporations and investment portfolios. Sudden shifts in carbon taxation or pricing mechanisms can lead to abrupt revaluations of carbon-intensive assets, exposing firms and investors to financial instability. These risks highlight the importance of integrating carbon price dynamics into financial decision-making.

Source: Amenc, N., Blanc-Brude, F., Gupta, A., Jayles, B., Orminski, J., & Marcelo, D. (2023). Highway to Hell: Climate Risks will cost hundreds of billions to investors in infrastructure before 2050. Scientific Infra & Private Assets. September.

A carbon tax is a fee imposed on the carbon content of fossil fuels, which is intended to encourage companies and individuals to reduce their carbon emissions by making it more expensive to use fossil fuels. The revenue generated from a carbon tax can be used to fund climate change mitigation and adaptation measures, or to reduce other taxes. Carbon taxes are one of the policy instruments that can be used to achieve the goals of the Paris Agreement and limit the rise of temperatures below 2°C.

Source: Bento, N. and G. Gianfrate (2020). Determinants of Internal Carbon Pricing. Energy Policy 143.

The clean-tech sector, short for clean technology, refers to industries and business activities focused on developing and scaling products, services, and processes that reduce environmental impact, promote the use of renewable resources, and support the transition to a low-carbon economy. It includes areas such as renewable energy generation (e.g., solar, wind, and bioenergy), electric mobility, energy storage, and water treatment technologies.

Source: Gianfrate, G. (2023). “Can venture capital coinvestments address cleantech underfunding?” in The Role of Green and Transition Finance in Achieving Carbon Neutrality and Sustainable Energy. Elsevier

Climate Beta refers to the sensitivity of asset prices to climate-related risks and shocks, reflecting the extent to which such risks are incorporated into market valuations. In principle, it measures the responsiveness of different asset classes or sectors to climate factors, in a manner analogous to how traditional betas capture exposure to financial risk factors. However, empirical attempts to identify a robust and economically significant Climate Beta have so far produced weak, inconsistent, and often statistically insignificant results. This muted or elusive sensitivity suggests that markets may not yet be fully pricing climate risks, raising the prospect of mispricing and the possibility of abrupt and substantial price adjustments once these risks are recognised.

Source: Rebonato, R. (2023). Asleep at the Wheel? The Risk of Sudden Price Adjustments for Climate Risk. EDHEC Climate Institute. July.

The changes in global temperature, ice melting, precipitation, wind patterns and other climate occurrences that are particularly apparent from the mid of last century onwards. Such changes are attributed largely to the increased levels of greenhouse gas (GHG) produced by human activities.

Climate damages refer to the adverse impacts and economic costs arising from changes in the Earth’s climate, particularly those driven by human-induced global warming. They encompass a broad spectrum of effects, including reduced agricultural productivity, heightened frequency and severity of extreme weather events, rising sea levels, and damage to infrastructure. These damages are often assessed through integrated assessment models and damage functions, which seek to link temperature increases to economic losses, providing a framework for long-term risk evaluation.

Source: Rebonato, R. 2023. Portfolio Losses from Climate Damages: A Guide for Long-Term Investors. EDHEC Climate Institute. November.

Climate emulators are simple reduced-form models often used to explain the output of more complex climate change models. The latter model the complex interactions between various components of the climate, such as the atmosphere, oceans, land surface, and ice. Their high computational costs, however, render these models unsuitable for studying the feedback between the planetary system and human behaviour. Hence the academic community often resorts to simpler, appropriately calibrated, reduced form models.

The climate emulators found in Integrated assessment models (IAMs) such as DICE typically consist of two submodels: a temperature model, which determines how the CO2 concentration in the atmosphere translates into an increasing average temperature, and a carbon cycle model, which predicts how atmospheric CO2 concentrations evolve as a result of biogeochemical processes.

Source: Rebonato, R., Kainth, D., Melin, L., & O'Kane, D. (2024). Optimal Climate Policy with Negative Emissions. International Journal of Theoretical and Applied Finance, Special Issue on the Impacts of Climate Change on Economics, Finance, and Insurance, 27(01), February.

Refers to the array of financial markets, institutions, instruments, and investment practices aiming at reducing global greenhouse gases (mitigation) and at enhancing the resilience of human and ecological systems to negative climate change impacts (adaptation).

Climate news refers to news coverage, reports, or information specifically related to climate change, its environmental and socio-economic impacts, and associated policy responses. Such news spans scientific findings, extreme weather events, technological developments, and regulatory initiatives. In financial research, climate news is often analysed as an information variable that can affect investor sentiment and asset prices by influencing expectations about climate-related risks and opportunities.

Source: Maeso, J.-M., & O’Kane, D. (2023). The Impact of Climate Change News on Low-minus-High Carbon Intensity Portfolios. EDHEC Climate Institute. September.

Climate risk refers to the potential negative impacts of climate change on economic, social, and environmental systems. It encompasses both physical risks, such as the impact of extreme weather events, sea-level rise, and changes in temperature and precipitation patterns, as well as transition risks, such as policy, legal, technological, and market changes needed to address mitigation and adaptation requirements related to climate change.

Source: Maeso, J.M. and D. O'Kane (2023) The Impact of Climate Change News on Low-Minus-High Carbon Intensity Portfolios. EDHEC Climate Institute Publication (June).

Climate scenarios are structured representations of possible future climate outcomes, used to assess risks, impacts, and potential economic and financial losses linked to climate change. Unlike financial scenarios, they require at least order-of-magnitude estimates of their likelihood, as they are designed to capture uncertainty about physical, transition, and systemic risks over long horizons. Scenarios typically combine assumptions about socio-economic pathways, technological developments, and policy responses to provide coherent narratives and quantitative projections against which strategies and portfolios can be tested.

A number of international initiatives have developed climate scenarios, including the Shared Socioeconomic Pathways (SSPs), Representative Concentration Pathways (RCPs), the Network for Greening the Financial System (NGFS), and Oxford Economics. While their details differ, scenarios are often grouped into three broad categories:

• Orderly transition: Climate policies are introduced early and consistently, containing physical risks while keeping transition risks manageable. Net-zero emissions are achieved through innovation, investment, and policy coordination.
• Disorderly transition: Action is delayed or fragmented, leading to abrupt policy shifts (e.g. sharp carbon tax increases) that heighten transition risks while still aiming to contain warming.
• No transition: Policies remain largely unchanged, implying low transition risks in the short term but escalating physical risks and long-term economic costs.

Source: Rebonato, R. (2025). How to Assign Probabilities to Climate Scenarios. EDHEC Climate Institute Publication. May.

Climate transition risk is expected to emerge from a disorderly transition to a low-carbon economy. This is defined as a situation in which climate policies and regulations are introduced late and suddenly, or technological shocks occur, that negatively affect fossil fuel and high-carbon firms' performance, and thus the value of their financial contracts. In a disorderly transition, "carbon stranded assets" could materialize for both firms and investors, potentially leading to large asset price volatility (negative for high-carbon, and positive for low-carbon firms). In this condition, investors cannot fully anticipate shocks on firms' performance and assets. Portfolio rebalancing and hedging could not be fully possible if the economic and market structure is prevalently high-carbon. Thus, investors who are exposed to fossil fuel and high carbon firms will incur losses. Losses from carbon stranded assets could then reverberate in the financial network, with implications on financial stability at the individual and systemic level. 

The Coupled Model Intercomparison Project (CMIPs), produced by the Intergovernmental Panel on Climate Change (IPCC), make available periodic standardised comparisons of the outputs of around 100 academically accepted Global Climate Models (GCMs), developed by approximately 50 different climate research groups worldwide, for climate adaptation, mitigation and resilience planning.

Source: Rebonato, R., Kainth, D., Melin, L., & O'Kane, D. (2024). Optimal Climate Policy with Negative Emissions. International Journal of Theoretical and Applied Finance, Special Issue on the Impacts of Climate Change on Economics, Finance, and Insurance, 27(01), February.

Credit risk is the possibility of a loss resulting from a borrower's failure to repay a loan or a bond.

A damage function is a mathematical representation linking temperature anomalies to the resulting economic damages. It is widely used in integrated assessment modelling to estimate climate-related losses under different warming pathways. However, current damage functions are not derived from a structural model of how damages occur. Instead, they are essentially interpolation or extrapolation devices, whose validity is limited to the specific application and range of values considered. This lack of structural grounding raises significant uncertainty about their reliability, especially when applied outside the calibrated domain.

Source: Rebonato, R. (2023). Portfolio Losses from Climate Damages: A Guide for Long-Term Investors. EDHEC Climate Institute. November.

Decarbonisation is the process of reducing or eliminating carbon dioxide emissions from the economy. Decarbonisation of the economy is the key aspect of the transition towards achieving the 1.5-2C target.

Source: Rebonato, R. (2024). Decarbonization and the Pace of Economic Growth. EDHEC Climate Institute, April.

The goal of diversification is to find the most efficient way to harvest risk premia across and within risky asset, earn the highest expected return for a given risk budget.

Double materiality is an approach to corporate reporting and sustainability that takes into account two distinct but interrelated dimensions of materiality: financial and impact

Financial Materiality: This dimension aligns with traditional accounting principles, emphasizing the significance of information to the financial decisions of capital providers. It encompasses factors directly related to a company's financial performance and impacts on its ability to generate profits and returns for investors.

Impact Materiality: In contrast to financial materiality, impact materiality broadens the scope to consider the impacts of a company's activities on various stakeholders, including the environment and society, irrespective of their immediate financial implications. This perspective acknowledges the wider responsibility of corporations and aims to capture non-financial factors relevant to stakeholders and the broader sustainability goals and policies.

Double materiality, as embraced by the European Sustainability Reporting Standards (ESRS), requires companies to disclose both their material sustainability impacts and any material financial risks or opportunities arising from sustainability matters. It seeks to strike a balance between financial and non-financial considerations, recognizing the interconnectedness between economic and ecological factors in corporate decision-making.

The risk that savings cannot finance as much replacement income in retirement as they could

Downstream activities are the processes that occur after a company’s own operations, further along the value chain. They include the distribution, use, and end-of-life treatment of products and services sold by the company, such as transport to customers, retail, product consumption, and disposal or recycling.
These activities are part of Scope 3 greenhouse gas (GHG) emissions, since they take place outside the reporting entity’s direct control but are a consequence of its operations. Considering downstream activities is essential for understanding the full carbon footprint of a business.

Source: Ducoulombier, F. (2021). Understanding the Importance of Scope 3 Emissions and the Implications of Data Limitations. The Journal of Impact and ESG Investing 1(4): 63-71.

The Dynamic Integrated Climate-Economy model (DICE), developed by Nordhaus (1992), is an integrated assessment model, modelling economic growth, the resulting CO2 emissions, the climatic response (e.g., temperature impact of these CO2 emissions), and finally the damage of increased global temperature on economic consumption. Its output is a calculation of the resulting current economic welfare, which is the sum of the discounted values of the consumption-based utilities between now and the long-term horizon. By maximizing welfare over the control variables (the savings rate and the abatement function), the DICE model determines the optimal CO2 abatement pathway that maximizes current welfare.

Sources: Rebonato, R., Kainth, D., Melin, L., & O'Kane, D. (2024). Optimal Climate Policy with Negative Emissions. International Journal of Theoretical and Applied Finance, Special Issue on the Impacts of Climate Change on Economics, Finance, and Insurance, 27(01), February.

Rebonato, R., Ronzani, R., & Melin, L. (2023). Robust Management of Climate Risk Damages. Risk Management, 25, 15. June.

EIRIN Stock-Flow Consistent model is a macroeconomic model with heterogeneous, interacting agents of the real economy and finance, developed first in Monasterolo & Raberto (2018). Each agent is represented by its balance sheet entries, and is endowed with behavioural rules (e.g. regarding investment and consumption decisions) and adaptive expectations.

Emissions Trading Systems (ETSs) are market-based mechanisms designed to reduce greenhouse gas emissions by putting a price on carbon. Under an ETS, a cap is set on the total amount of emissions that can be released by covered entities, such as power stations or industrial facilities. These entities are then allocated a certain number of emissions allowances, which they can trade with one another. The idea is that entities able to reduce their emissions more cheaply will do so and sell their unused allowances to those for whom reductions are more costly. This creates a financial incentive for companies to cut emissions and helps to achieve reductions at the lowest possible cost.

Environmental, Social, and Governance factors, known as ESG factors, are non-financial criteria used to evaluate companies and countries sustainability. 

ESG investing refers to an investment approach that incorporates environmental, social, and governance (ESG) criteria into the decision-making process. ESG criteria are a set of non-financial indicators that are used to evaluate a company's performance in terms of its environmental impact, social responsibility, and governance practices. From the original ethical exclusion funds, based purely on moral principles, ESG investing has evolved in the 1990s to best-in-class selection in each investment sector and very few sectors are completely excluded. Environmental criteria have replaced ethical considerations, with investors putting pressure on companies to change their behaviour in various areas.

The EU Climate Benchmarks are regulatory categories of climate indices created under the EU Benchmark Regulation. They impose minimum construction rules to ensure portfolios follow a decarbonisation trajectory consistent with the Paris Agreement.
The Climate Transition Benchmark (CTB) requires portfolios to start with at least a 30% lower weighted-average carbon intensity than their parent index and to reduce this intensity by at least 7% every year.
The Paris-Aligned Benchmark (PAB) sets stricter conditions, requiring at least a 50% initial reduction in carbon intensity, the same 7% annual decarbonisation, and the application of exclusions for fossil-fuel activities.
While these benchmarks are intended to support alignment with climate goals, they mainly rely on backward-looking emissions intensity metrics and sector constraints. As a result, they promote portfolio decarbonisation but only weakly incentivise real-economy emissions reductions.

Source: Ducoulombier, F. (2024). Charting a Pathway for Transition Finance – Challenges and Opportunities in the EU Framework. EDHEC Climate Institute Newsletter. December

The EU Taxonomy is a classification system that defines environmentally sustainable economic activities within the European Union. It provides a framework for identifying which activities can be considered environmentally sustainable based on their contribution to key environmental objectives, such as climate change mitigation, adaptation, and other environmental goals.

Source: EU taxonomy for sustainable activities - European Commission (europa.eu)

The European Sustainability Reporting Standards (ESRS) are a set of reporting guidelines and standards introduced under the Corporate Sustainability Reporting Directive (CSRD). These standards aim to enhance corporate transparency and accountability by requiring listed and large companies to disclose information related to environmental, social, and governance (ESG) issues.

Double Materiality Principle: ESRS align with the "double materiality" principle, which means that reporting entities are obligated to report on both financial materiality (how ESG issues affect financial risks and opportunities) and impact materiality (how ESG issues impact people and the environment). This approach acknowledges the interconnectedness of financial and non-financial aspects in corporate reporting.

Source: Ducoulombier, F. 2023. Sustainability Reporting and Material Delusions. EDHEC Climate Institute Newsletter. October 

An exchange-traded fund (ETF) is a basket of securities that trade on an exchange, just like a stock

Factor investing is an investment paradigm under which an investor decides how much to allocate to various factors, as opposed to various securities or asset classes. 

Factor investing in fixed-income requires to identify the specific risk factors inherent to this market, selecting bonds exposed to the desired factors, and applying an efficient weighting scheme.

The Financial Stability Board (FSB) is an international body that promotes global financial stability by coordinating national financial authorities and international standard-setting bodies. Established in 2009 by the G20, it monitors vulnerabilities in the global financial system, develops regulatory and supervisory policies, and fosters consistent implementation across jurisdictions. 
In response to growing concerns about climate-related risks, the FSB created the Task Force on Climate-related Financial Disclosures (TCFD) in 2015 to improve the availability of climate-related financial information. Since then, the FSB has continued to oversee the TCFD’s legacy and to support global convergence in climate and sustainability reporting standards.

Source: Ducoulombier, F. (2021). TCFD Recommendations and 2021 Guidance - Overview. Scientific Beta. November.

Global Climate Models (GCMs) are sophisticated models of the global climate system attempting to capture atmospheric, oceanic, ice, and terrestrial behaviour. A number of distinct models have been built up over the past 30 years, and they are still being improved. The CMIPs (Coupled Model Intercomparison Projects) make available periodic standardised comparisons of the output of these models for climate adaptation, mitigation, and resilience planning.

Source: Schneider, N. (2025). EDHEC-CLIRMAP: The How-To Guide. EDHEC Climate Institute, June. 

Goal-based investing (GBI) implements dedicated investment solutions to generate the highest possible probability of achieving investors’ goals, with a reasonably low expected shortfall in case of adverse market conditions.

Green bonds are defined by the International Capital Markets Association (ICMA) as “any type of bond instrument where the proceeds will be exclusively applied to finance or re-finance, in part or in full, new or/and existing eligible green projects”.

Source: Gianfrate, G. (2024). Measuring the Greenness of Green Bonds. EDHEC Climate Institute Newsletter. January.

Greenhouse gas emissions refer to the release of gases into the atmosphere that trap heat and contribute to the warming of the Earth's surface. These gases include carbon dioxide, methane, nitrous oxide, and fluorinated gases. The increase in greenhouse gas emissions, primarily from human activities such as burning fossil fuels and deforestation, is a major contributor to climate change. 

Source: Ducoulombier, F. 2021. Understanding the Importance of Scope 3 Emissions and the Implications of Data Limitations. The Journal of Impact and ESG Investing 1(4): 63-71.

Greenhouse Gas (GHG) Protocol Corporate Standard: The leading international accounting framework for measuring and reporting corporate greenhouse gas (GHG) emissions. Developed by the World Resources Institute (WRI) and the World Business Council for Sustainable Development (WBCSD), it provides consistent methods for companies to prepare a GHG inventory, introducing the widely used classification of Scope 1, Scope 2, and Scope 3 emissions.
By standardising how emissions are defined, measured, and reported, the GHG Protocol enables comparability across firms, underpins regulatory and voluntary disclosure frameworks worldwide, and ensures emissions are expressed in carbon dioxide equivalent (CO₂e) using recognised global warming potentials.

Source: Ducoulombier, F. (2021). Overview of Scientific Beta Low Carbon Option – Supporting the Transition to a Low Carbon Economy and Protecting Multifactor Indices against Transition Risks. Scientific Beta. August.

Hedge funds are private and not regulated investment funds that use sophisticated instruments or strategies, such as derivative securities, short positions or leveraging, to generate alpha.

The safe portfolio should be efficient at matching risk factor exposures on the asset and liability sides. The proper risk management technique that should be used to ensure protection against systematic risks is not diversification – it is hedging. Just as diversification tells you how to be efficient when taking risks, hedging tells you how to be efficient when you avoid taking risks.

A high carbon intensity portfolio refers to a portfolio of assets that have a relatively high carbon footprint or are associated with high greenhouse gas emissions. These assets may include companies in sectors such as energy, transportation, and manufacturing, which are known to have a significant impact on the environment and contribute to climate change. The carbon intensity of these assets is typically measured by their carbon emissions per unit of output or revenue. A high carbon intensity portfolio may be contrasted with a low carbon intensity portfolio. 

Implicit carbon prices refer to the costs associated with carbon emissions that are not explicitly accounted for through mechanisms such as carbon taxes or emissions trading systems. These implicit costs can arise from various sources, including regulations, subsidies, and other market distortions that affect the true cost of carbon emissions.

Source: Joseph E. Aldy & Gianfranco Gianfrate (2019). Future-Proof Your Climate Strategy. Harvard Business Review.

Indirect emissions are greenhouse gas emissions that occur as a consequence of an organisation’s activities but arise from sources it does not own or directly control. They are commonly categorised as Scope 2 and Scope 3 emissions.

• Scope 2 emissions come from the generation of purchased energy (electricity, heat, steam, cooling) consumed by the reporting entity.

• Scope 3 emissions occur across the value chain, both upstream (e.g. purchased goods and services, business travel, transportation, waste) and downstream (e.g. product use and end-of-life).

For corporates, indirect emissions typically dominate their carbon footprint and pose data and management challenges. In the sovereign context, indirect emissions can also capture cross-border trade and consumption effects (e.g. imported goods), which complicates national accounting of climate impacts.

Source: Ducoulombier, F. (2021). Understanding the Importance of Scope 3 Emissions and the Implications of Data Limitations. The Journal of Impact and ESG Investing 1(4): 63-71.

The main benefit of insurance is that it allows investors to dynamically allocate to the well-diversified and risky performance-seeking portfolio more than the surplus available after having secured all essential goals.

Integrated Assessment Models (IAMs) are comprehensive frameworks that link economic activity with the Earth’s climate system to analyse the interactions between greenhouse gas emissions, global warming, and economic impacts. They are used to explore policy options, estimate the costs and benefits of abatement, and provide guidance on efficient climate strategies.
Early IAMs, such as Nordhaus’s DICE model, were criticised for recommending gradual abatement and low carbon prices, but modern versions incorporate uncertainty, more realistic risk preferences, and improved damage functions. These advances make IAMs more consistent with international climate goals, showing that limiting warming to 1.5–2°C can be justified as an optimal policy path.
While IAMs remain dependent on assumptions about discounting, damages, and technological progress, they continue to be valuable tools for policymakers and investors by highlighting the scale of abatement required and the risks of delayed or insufficient action.

Source: Rebonato, R. (2023). What Integrated Assessment Models Can Tell us about Asset Prices. IPE EDHEC Research Insights Supplement. Spring

The IPCC is is the United Nations body for assessing the science related to climate change; it was established in 1988 by the World Meteorological Organization (WMO) and United Nations Environment Programme (UNEP) to provide governments with regular assessments of the scientific basis of climate change, its impacts and future risks, and options for adaptation and mitigation  in order to develop climate policies.

Source: Gianfrate, G. (2023). Finance and Climate Action  – Perspectives from the sixth Assessment Report. EDHEC Climate Institute. May.

Internal carbon pricing (ICP) involves companies setting a price on carbon emissions within their own operations, which can help them identify their carbon footprint and to engage a transition to a low-carbon economy. The disclosed level of internal carbon prices can depend on macroeconomic, regulatory, industry, and firm-specific characteristics. There is a wide diversity of ICP both by industrial sector and by region, due to the non-existence of global standards for pricing of carbon emissions.

Source: Bento, N. and G. Gianfrate. (2020). Determinants of Internal Carbon Pricing. Energy Policy 143. 

The International Sustainability Standards Board (ISSB) was created in 2021 by the IFRS Foundation to deliver a global baseline of sustainability disclosure standards. It was formed through the consolidation of the Value Reporting Foundation (itself the merger of SASB and the IIRC) and the Climate Disclosure Standards Board (CDSB), a CDP initiative.

The ISSB’s standards—IFRS S1 on general sustainability disclosures and IFRS S2 on climate-related disclosures, both issued in 2023—aim to improve the consistency and comparability of sustainability reporting across jurisdictions, responding to market demand for reliable information on climate and other sustainability risks and opportunities. The standards build on frameworks such as the TCFD recommendations and SASB’s industry-based metrics.
 

While the ISSB represents a major step towards harmonisation, challenges remain:

• Adoption is voluntary and depends on national regulators choosing to integrate ISSB standards into their reporting frameworks.
• Tensions exist between the ISSB’s investor-focused approach (financial materiality) and the double materiality model promoted in the EU’s Corporate Sustainability Reporting Directive (CSRD).

Source: Ducoulombier, F. (2023). Sustainability Reporting and Material Delusions. EDHEC Climate Institute Newsletter. October

A latent climate factor refers to an underlying, unobservable source of systematic risk that captures how environmental or climate-related characteristics influence asset returns. Unlike observable proxies, such as emissions data or ESG scores, latent factors are statistically inferred from the covariation in stock returns using methodologies such as instrumented principal component analysis (IPCA). These factors are particularly valuable because they isolate the climate-related component of risk that is orthogonal to traditional financial drivers. Empirical evidence shows that such latent green factors can explain the pricing of assets in carbon-intensive sectors, like energy and utilities, and can be used to build long-short portfolios that hedge climate news and measure exposure to transition risk.

Source: Chini, E., & Rubin, M. (2023). Time-Varying Environmental Betas and Latent Green Factors. EDHEC Climate Institute. April

The level risk factor is defined as a long exposure on a long-maturity bond funded by the sale of a short bond expiring at the end of the investment period. 

Liability risks refer to economic and financial actors who have experienced losses from the effects of climate change or climate policies and regulations and seek compensation from those they hold responsible.

We already see examples of liability risks involving fossil fuel extractive companies and sovereigns that passed legislation aimed at preventing new fossil fuels explorations (see e.g. the case of Rockhopper Exploration against Italy)

The Liability-Driven Investing (LDI) strategy consists in combining two distinct portfolios, one dedicated to performance seeking and the other one dedicated to the hedging of liabilities.

A low carbon intensity portfolio refers to a portfolio of assets with a relatively low carbon footprint or lower greenhouse gas emissions compared to the broader market. The construction of low carbon intensity portfolios involves selecting assets from sectors or industries that are considered to have a smaller environmental impact in terms of carbon emissions and climate-related risks.

Source: Maeso, J.M. and D. O, Kane. (2023). The Impact of Climate Change News on Low-Minus-High Carbon Intensity Portfolios. EDHEC Climate Institute. June. 

Machine learning involves fully-automated classification (supervised learning) and identifying patterns in data (unsupervised learning). It embodies the notion that data will tell the story, with an emphasis on massive micro-level data. 

The momentum risk factor is designed to buy assets that performed well and sell assets that performed poorly over the past 3 to 12 months.

The Intergovernmental Panel on Climate Change (IPCC) defines Negative Emission Technologies (NETs) as anthropogenic activities that remove CO2 from the atmosphere and durably store it. NETs are in reality a range of technologies from nature-based practices, such as forestation, soil carbon sequestration and wetland restoration, to technological alternatives such as enhanced weathering, bioenergy with carbon capture and storage, and direct air capture and storage.

Source: Rebonato, R., Kainth, D., Melin, L., & O'Kane, D. (2024). Optimal Climate Policy with Negative Emissions. International Journal of Theoretical and Applied Finance, Special Issue on the Impacts of Climate Change on Economics, Finance, and Insurance, 27(01), February.

Negative screening excludes securities, often qualified as sin stocks, if the company activity is considered unethical or immoral, based on religious or philosophical views. Sin stock sectors usually include alcohol, tobacco, gambling, weapons, animal testing or pornography. 
Negative screening strategies can also refer to internationally accepted norms, such as the International Labor Organization standards, UN Global Compact, Universal Declaration of Human Rights and/or other globally recognized norms. This type of screening, called norm-based screening, is considered to be more objective, as the decisions to exclude sectors or companies are taken in accordance with standards established by international organizations. 

Source: Le Sourd, V. and L. Martellini. (2021). The EDHEC European ETF, Smart Beta and Factor Investing Survey 2021. EDHEC Climate Insitute. September.

Net zero investment refers to a set of investment frameworks designed to guide investors in aligning their portfolios with the most ambitious goals of the Paris Agreement on Climate Change, which aim to limit global warming to well below 2°C above pre-industrial levels and pursue efforts to limit warming to 1.5°C. Net-zero investment frameworks provide guidance for investors to reduce greenhouse gas emissions in their portfolios and promote progress in the real economy towards a net-zero emissions future.

Source: Ducoulombier, F. (2022). Overview: Understanding Net-zero Investment Framework and their Implications for Investment Management. Scientific Beta February.

The Network for Greening the Financial System (NGFS) is a coalition of central banks and financial supervisors established to strengthen the role of the financial system in managing climate and environmental risks and to support the mobilisation of capital for green and low-carbon investment. A core contribution of the NGFS has been the development of climate scenarios, which provide internally consistent projections of future economic activity, energy use, technological change, and climate policies within the constraints of carbon budgets and physical laws. These scenarios are widely employed for climate stress testing and risk analysis by financial authorities and institutions.

Source: Monasterolo, I., M. a J. Nieto and E. Schets. (2023). Assessing the “Tragedy of the Horizons”: Conceptual Underpinnings of the NGFS Scenarios and Suggestions for Improvement. The European Money and Finance Forum SUERF Policy Brief 602. June.

The Non-Financial Reporting Directive (NFRD) was adopted by the European Union in 2014 and entered into force in 2016, with the first reports published for the 2018 financial year. It required certain large companies, insurers, credit institutions, and listed firms in the EU to disclose non-financial information on their environmental, social, and governance (ESG) performance alongside their annual management report.

The NFRD set the EU on a path towards greater transparency of corporate performance on social and environmental issues. However, it did not mandate standardisation or independent assurance of disclosures. As a result, reports were often found to be incomparable, unreliable, and of limited relevance. These shortcomings led to the adoption of its successor, the Corporate Sustainability Reporting Directive (CSRD), which expands scope and introduces mandatory assurance and detailed reporting standards.

Source: Ducoulombier, F. (2023). Sustainability Reporting and Material Delusions. EDHEC Climate Institute Newsletter. October.

The Paris Agreement on Climate Change is a legally binding international treaty adopted on 12 December 2015 at the UN Climate Change Conference (COP21) in Paris, and in force since 4 November 2016. It has 195 Parties.
Its central aim is to hold the increase in the global average temperature to well below 2°C above pre-industrial levels and to pursue efforts to limit the rise to 1.5°C. The Agreement also seeks to strengthen countries’ ability to adapt to climate impacts and to make financial flows consistent with low-emission, climate-resilient development. 
The Paris Agreement operates through a bottom-up architecture of nationally determined contributions (NDCs), with countries required to prepare, communicate, and maintain climate plans that are to be strengthened every five years (the “ratchet mechanism”). It also includes provisions on transparency, climate finance, technology transfer, and capacity building, while recognising the principle of common but differentiated responsibilities and respective capabilities.

Source: Ducoulombier, F. (2024). Charting a Pathway for Transition Finance – Challenges and Opportunities in the EU Framework. EDHEC Climate Institue Newsletter. December.

Physical risks refer to the potential impact on a company of event-driven (acute) or longer-term shifts (chronic) in climate patterns. This includes risks associated with extreme weather events such as hurricanes, wildfires, extreme rainfall, droughts, and sea-level changes, which can have destructive effects on industries such as agriculture and infrastructure. Additionally, physical risks encompass threats to the functioning of firm assets, such as real estate and industrial plants, due to flooding, storms, and excessive temperatures. The Intergovernmental Panel on Climate Change (IPCC) expects these physical risks to increase over time as the severity of climate change impacts becomes more pronounced.

Portfolio alignment refers to the process of aligning investment portfolios with the most ambitious goals of the Paris Agreement on Climate Change. This involves developing a strategy and setting portfolio-level objectives for decarbonization and investment in climate solutions, as well as determining the optimal asset allocation and assessing alignment at the asset-class level based on asset-level criteria.

Source: Bouchet, V. (2024). Attribution analysis of greenhouse gas emissions associated with an equity portfolio. Scientific Portfolio. November.

Best-in-class or positive screening involves selecting, for each investment sector, the assets with the most positive scores on relevant environmental, social, and governance ESG criteria. An aggregate ESG score may be determined based on combinations of single factors by a third party. External ESG scores can be used to obtain a proxy for a company’s ESG performance through a standardized system and, as such, can prove useful for asset managers or asset owners with a limited understanding of how to design their own selection criteria based on various sustainability factors. Positive screening is based on more objective criteria than negative screening, since there are now rating agencies producing ESG scores based on an aggregation of factors. However, there is still a great lack of convergence between the ratings of the various rating agencies. Source: Le Sourd and Martellini (2021).

Source: Le Sourd, V. and L. Martellini. (2021). The EDHEC European ETF, Smart Beta and Factor Investing Survey 2020. EDHEC Climate Institute Publication September.

The income, expressed in dollars per year, that can be sustained with an individual's retirement savings for their expected lifetime.

The potential source of additional performance because of the simple act of resetting portfolio weights back to the original weights is referred as the rebalancing premium. It is also sometimes known as the volatility pumping effect or diversification bonus because volatility and diversification turn out to be key components of the rebalancing premium

A financial asset that pays fixed income at regular intervals for an individual's retirement period, with a cost-of-living adjustment.

The cost of acquiring income of $1 per year beginning at the retirement date and lasting the expected lifetime.

Retirement investing solutions are intended to meet the needs of future retirees, namely to generate enough replacement income to finance their expenses in retirement.

A risk premium is the extra return above the risk-less rate that must be offered by a security that pays well in good states of the world and badly when investors would need the money.

Characteristic-based portfolios constructed using a dependent, symmetric sorting using whole-name breakpoints.

Scenario analysis refers to the systematic use of models to construct and explore alternative scenarios that combine assumptions about greenhouse gas emissions, climate policies, technological change, and macroeconomic developments. In the context of climate finance, scenario analysis is employed to assess the potential impacts of physical and transition risks on economies, sectors, and investment portfolios. It allows investors and policymakers to evaluate a range of possible futures, quantify vulnerabilities, and develop resilience strategies in the face of deep uncertainty.

Source: Rebonato, R., Kainth, D., & Melin, L. (2024). Climate Scenario Analysis and Stress Testing for Investors: A Probabilistic Approach. EDHEC Climate Institute. January.

According to the Greenhouse Gas (GHG) Protocol, Scope 1 emissions are direct greenhouse gas emissions from sources that are owned or controlled by the reporting entity. They include, for example:

• Emissions from fuel combustion in owned or controlled facilities (e.g. boilers, furnaces).
• Emissions from owned or controlled vehicles.

Scope 1 represents the most immediate emissions responsibility of an organisation, as they arise from activities under its direct operational control.

Source: Ducoulombier, F. (2024). Scope for Divergence – The Status of Value Chain Emissions Accounting, Reporting and Estimation and Implications for Investors and Standard Setters. EDHEC Climate Institute Newsletter. February. 

According to the Greenhouse Gas (GHG) Protocol, Scope 2 emissions are indirect greenhouse gas emissions from the generation of purchased or acquired energy that is consumed by the reporting entity. These emissions occur outside the organisation’s direct control but result from its activities.
 

They include emissions associated with:

• Purchased or acquired electricity.
• Purchased steam, heating, or cooling consumed by the organisation.

Scope 2 thus captures the emissions responsibility linked to the organisation’s energy demand, even if generation occurs elsewhere.

Source: Ducoulombier, F. (2024). Scope for Divergence – The Status of Value Chain Emissions Accounting, Reporting and Estimation and Implications for Investors and Standard Setters. EDHEC Climate Institute Newsletter. February. 

Under the Greenhouse Gas (GHG) Protocol, Scope 3 emissions are all other indirect greenhouse gas emissions that occur in a company’s value chain, apart from those classified as Scope 2. They arise from both upstream and downstream activities linked to the organisation’s operations, products, and services.

Examples include:

• Upstream: purchased goods and services, business travel, employee commuting, transportation and distribution, waste generated in operations, and capital goods.

• Downstream: use of sold products, end-of-life treatment of sold products, investments, downstream transportation and distribution, and leased assets.

Scope 3 emissions typically represent the largest share of a company’s total carbon footprint, but they are also the most difficult to measure and verify due to data limitations and the complexity of supply chains.

Shared Socioeconomic Pathways (SSPs) are a set of five standardised scenarios developed to support climate change research and used as inputs for integrated assessment models (IAMs) and climate models. They provide alternative narratives of global socio-economic development, exploring how different trajectories of human activity, policy choices, and technological change may influence greenhouse gas emissions and climate outcomes. The five pathways are: SSP1 (Sustainability), SSP2 (Middle of the Road), SSP3 (Regional Rivalry), SSP4 (Inequality), and SSP5 (Fossil-fuelled Development).

In practice, SSPs are combined with Representative Concentration Pathways (RCPs) to create integrated scenarios, which form the basis of many climate risk assessments and policy analyses. While the SSP/RCP framework has become a cornerstone of climate science and has been adopted by the financial sector, it is important to note that these scenarios are deliberately designed without assigned probabilities. This limits their direct use in financial decision-making and underscores the need for complementary approaches, such as probabilistic methods and model risk management, when applying them in an investment or stress-testing context. 

Source: Kainth, D. (2024). Assessing the RCP / SSP Framework for Financial Decision Making. EDHEC Climate Institute. April

Pure seasonal effect where investors can grasp abnormal return from being long in the size factor in January and short in the last quarter.

Smart Beta gathers all alternative forms of indexations departing from cap-weighting, that aim to generate superior risk-adjusted returns, compared to traditional indexation.

Stress testing is the assessment of the financial impact on a portfolio of severe but plausible events, of nature or magnitude often beyond what has been observed in the past.

According to the Global Sustainable Investment Alliance (GSIA ), “Sustainable investment is an investment approach that considers environmental, social and governance (ESG) factors in portfolio selection and management” , i.e. non-financial issues. 

Source: Global Sustainable Investment Alliance. 2021. Global Sustainable Investment Review 2020.

A category of mutual funds in which equities are gradually replaced by bonds as the target date approaches.

The TCFD was established by the Financial Stability Board (FSB) in December 2015 to improve the quality, consistency, and comparability of climate-related financial disclosures. Its recommendations are designed primarily for entities issuing public securities but are also encouraged for adoption by asset managers, asset owners, and other financial institutions. The framework seeks to enhance transparency on climate-related risks and opportunities, thereby supporting informed decision-making by investors and promoting financial stability.

The TCFD recommendations are structured around four pillars of disclosure: governance (board and management oversight of climate issues), strategy (actual and potential impacts of climate risks and opportunities), risk management (processes for identifying, assessing, and managing climate risks), and metrics and targets (quantitative indicators used to manage climate-related issues and assess performance).

Source: Ducoulombier, F. (2021). TCFD Recommendations and 2021 Guidance – Overview. Scientific Beta. November.

The International Sustainability Standards Board (ISSB) was created in 2021 by the IFRS Foundation to deliver a global baseline of sustainability disclosure standards. It was formed through the consolidation of the Value Reporting Foundation (itself the merger of SASB and the IIRC) and the Climate Disclosure Standards Board (CDSB), a CDP initiative. 
The ISSB’s standards—IFRS S1 on general sustainability disclosures and IFRS S2 on climate-related disclosures, both issued in 2023—aim to improve the consistency and comparability of sustainability reporting across jurisdictions, responding to market demand for reliable information on climate and other sustainability risks and opportunities. The standards build on frameworks such as the TCFD recommendations and SASB’s industry-based metrics. 

While the ISSB represents a major step towards harmonisation, challenges remain:

• Adoption is voluntary and depends on national regulators choosing to integrate ISSB standards into their reporting frameworks.
• Tensions exist between the ISSB’s investor-focused approach (financial materiality) and the double materiality model promoted in the EU’s Corporate Sustainability Reporting Directive (CSRD).

Source: Ducoulombier, F. (2023). Sustainability Reporting and Material Delusions. EDHEC Climate Institute. October

Transition finance refers to financial activities, products, and investments that enable high-emission sectors and companies to decarbonise in line with climate goals. It supports actions such as retrofitting industrial facilities, adopting cleaner technologies, switching to lower-carbon processes, or responsibly decommissioning carbon-intensive assets. Transition finance complements green investment by targeting activities that are essential to the economy but cannot immediately become low-carbon, thereby playing a pivotal role in achieving net-zero pathways while minimising risks of greenwashing and stranded assets.

Source: Ducoulombier, F. 2024. Charting a Pathway for Transition Finance – Challenges and Opportunities in the EU Framework. EDHEC Climate Institute Newsletter. December.

ransition pathways are modelled trajectories that describe how economies, sectors, or companies can reduce greenhouse gas (GHG) emissions over time under different climate scenarios (e.g., 1.5°C, well-below 2°C, or other outcomes). They set out the required pace and scale of decarbonisation and typically combine three levers:

• Climate solutions (e.g., low-emission energy, clean transport, efficiency measures).

• Transition activities in high-emission sectors where no immediate low-emission substitutes exist, including retrofits, fuel or process switches, and, where necessary, managed phase-out.

• Carbon sinks (nature-based or technological) to offset residual emissions.

Transition pathways are context-specific, reflecting national and sectoral circumstances, and are used by policymakers, companies, and investors to benchmark strategies, assess transition risk, and guide the alignment of financial flows with climate goals.

Source: Ducoulombier, F. 2024. Charting a Pathway for Transition Finance – Challenges and Opportunities in the EU Framework. EDHEC Climate Institute Newsletter. December.

Transition risks are the financial, operational, and reputational risks that companies, sectors, and investors face as economies shift toward a low-greenhouse-gas future. They arise from policy and regulatory changes (beyond carbon pricing), technological innovation, evolving social norms, and shifts in consumer behaviour. Transition risks can affect companies directly or through their value chains, including Scope 3 upstream and downstream emissions. They are typically more pressing in the short- to medium-term than physical climate risks, as the pace and form of the policy response, market dynamics, and societal pressures can significantly alter costs, asset values, and business models.

Source: Rebonato, R., Kainth, D., & Melin, L. (2024). The Link Between Physical and Transition Risk. EDHEC Climate Institute. April

The unexpected climate news index (UCNI) is a metric used to capture the unexpected component of daily changes in climate change news. It is derived by assuming an auto-regressive AR(1) process for the climate news indices (CNI), where the changes in unexpected climate change news represent the innovations. The UCNI provides a tool for understanding and quantifying the influence of unexpected climate news on equity portfolios, thereby aiding investors and industry professionals in making informed decisions.

Source: Maeso, J.M. and D. O'Kane. (2023). The Impact of Climate Change News on Low-Minus-High Carbon Intensity Portfolios. EDHEC Climate Institute. June.

Upstream activities are the stages in a product’s value chain that occur before production, involving the sourcing and supply of inputs required for manufacturing. They include the extraction and processing of raw materials, the production of components, and their transportation to manufacturers. These activities are an important source of indirect (Scope 3) greenhouse gas emissions for companies, as they reflect the environmental impact embedded in purchased goods and services.

Source: Ducoulombier, F. (2021). Understanding the Importance of Scope 3 Emissions and the Implications of Data Limitations. The Journal of Impact and ESG Investing 1(4): 63-71

The value risk factor is defined as a long exposure to assets that are cheap and a short exposure to those that are expensive, according to a valuation measure.

A yield curve is a chart that represents, at a given date, the yields of similar quality bonds versus their maturities.