Transition Risks | EDHEC Climate Institute

Presentation

Transition risk assessment, traditionally focused on direct emissions and carbon tax implications, often overlooks the full scope of transition-related risks. This narrow view fails to address the broader challenges companies face in a transition toward a low-carbon economy. To better understand these risks, a comprehensive assessment of the entire value chain is necessary. This includes not only direct emissions but also the complexity of Scope 3 emissions, as well as indirect impacts across various sectors.

EDHEC Climate Institute (ECI) recognises this challenge as an opportunity to develop innovative methods for assessing transition risks in a holistic manner, addressing complexities at the geo-sectoral level and capturing the various trade-offs companies face during the transition. By improving how we quantify these risks, ECI aims to provide a clearer picture of the potential consequences of the transition to a low-carbon economy.

To effectively quantify transition risk, ECI will develop advanced climate-financial scenario analysis models that go beyond conventional emissions assessments. These models will integrate a variety of factors, including:

Geo-Sectoral Challenges: Incorporating regulatory changes beyond carbon taxes, considering local policies, and addressing industry-specific obstacles that affect different sectors.
Scope 3: Provide a reliable estimate of Scope 3 emissions and its potential financial impact distinguishing between upstream Scope 3 emissions (emissions from raw material extraction, production processes, and logistics) and downstream Scope 3 emissions (emissions generated from the use and disposal of sold products). This also means having a comprehensive view of sectoral supply chains and their related emissions.
Climate sentiment: Develop AI-based tools to better quantify climate sentiment which can be representative of consumer choices and citizens’ concerns which lead to climate societal pressures driving regulation.
Consumer Behaviour Models: Understanding changes in consumer preferences, such as a shift toward low-carbon products or substitutions that affect demand.

Last publications

The Link Between Physical and Transition Risk

We argue that what is usually referred to as climate ‘transition risk’ can be more usefully decomposed in an expectation part and a variability around this central value.

We show that there is a strong inverse relationship between the expectation component of transition costs and the expectation of physical damages, and how this relationship can be estimated.

Our results indicate that the uncertainty in transition costs decreases as the abatement policy becomes more aggressive (and physical damage decrease), but remains large as a fraction of the expectation component.

We also show that, with the definition we provide, our transition costs match well the corresponding quantities from the benchmark IPCC scenarios.

We argue that what is usually referred to as climate ‘transition risk’ can be more usefully decomposed in an expectation part and a variability around this central value. We show that there is a strong inverse relationship between the expectation component of transition costs and the expectation of physical damages, and how this this relationship can be estimated.

Sustainable investing and climate transition risk: a portfolio rebalancing approach

The Journal of Portfolio Management Novel-Risks 2022, Vol. 48, Issue 8

The authors study how greenness can be combined with other investment criteria to construct sets of corporate bonds portfolios with decreasing exposure to climate transition risk.

They apply the methodology to the European Central Bank’s asset purchase program. They define a weaker market neutrality principle as investing proportionally to the bonds’ amount outstanding within Climate Policy Relevant Sectors. The portfolio rebalancing leads to a 10% reduction of exposure to climate transition risk.

Then, the authors study the relation between bonds’ rebalancing and issuers’ Environmental, Social and Governance (ESG) characteristics and Greenhouse Gas (GHG) emissions. Bonds issued by firms with low (high) ESG risk and GHG emissions are more likely to be bought (sold) in the rebalancing.

Finally, they analyse implications of portfolio rebalancing on financial markets finding that changes in yields would be limited to less than 80 basis points on individual bonds. The approach can contribute to inform climate-aware portfolio rebalancing and sustainable investment strategies.

The authors study how greenness can be combined with other investment criteria to construct sets of corporate bonds portfolios with decreasing exposure to climate transition risk.