The project jointly launched by IIGF and NRDC, focuses on environmental and climate risk management of financial institutions and energy companies, especially stress testing methods and explores “how to comprehensively consider the credit risk and market risk brought by environmental and climate issues from the perspective of financial institutions and improve institutions’ ability to deal with environmental risks” and “how to incorporate environmental factors such as carbon prices, water prices, sewage charges and environmental protection taxes into the corporate environmental risk change system to accelerate the low-carbon transformation of fossil energy companies.”
After China launched its strategic objectives of “Carbon-Peaking and Carbon-Neutrality”, both of the environmental protection thresholds and the demand for low-carbon transformation increased. Industries with high-pollution and high-emission have to face more severe challenges since they behave more characteristics that related to environmental risks. Meanwhile, as climate and environment-related events increasingly draw people’s attention in terms of the scale and frequency, there has been tighter bonding among various risks. The risks may be further transmitted from the enterprise side to the financial side, bringing tough challenges to credit risk management in banking.
In Case 1, this report utilizes the environmental risk pricing model to evaluate environmental risks of sample companies in the power, heat production and supply industry. Through the monetization of risks, it provides a quantitative reference for evaluation between the environmental factor and corporate earnings. In Case 2, as for banking financial institutions, this report adopts the IIGF “bottom-up” corporate financial model and capital asset pricing model to deeply analyze the environmental risk conduction path. Based on environmental stress tests on the sample companies in the cement, power and petrochemical industry respectively, we measure the environmental risk that the high-pollution high-emission industries may bring for banking institutions.
From Case 1, we find that the sample company ‘s return of the environmental factor can have a significant positive impact on the return of its stock, that is, the higher return of the environmental factor, the higher return rate in the stock. Therefore, in the future, the company needs to strengthen the environment-related risk management, such as investigating the existed internal control deeply, improving the system of risk assessment and data collection, and organizing pertinent training to avoid the excess loss due to stranded assets.
From Case 2, we find that the credit risk of cement industry will be significantly affected by the tighter macro environment, thus financial institutions should focus more on multi-external environmental factors that related to this industry, including carbon price fluctuations, domestic environmental protection investment, the increase of standards in CEAs and environmental protection taxes, etc. Second, considering that China carbon market is now only open to the power industry, financial institutions should pay more attention to the impact of carbon prices and CEAs with regard to the risk management. Finally, the petrochemical industry is more sensitive to carbon price fluctuations, so that for financial institutions, the industry’s exposure to credit risks will increase as the maximum possible loss increases due to higher carbon prices.
This report aims to ameliorate domestic environmental risk management and assist the green and low-carbon transformation in sample industries, so as to achieve more effective practices in China green finance field. Based on the analysis above and relevant regulatory requirements, we propose the following six suggestions:
- Gradually improving the methodology of environmental stress tests for financial institutions;
- Improving the construction of functional institutions and promoting market research and publicity;
- Collaborating to promote the standardization of environmental and climate risk assessment systems;
- Developing diversified financial instruments to alleviate the pressure of environmental and climate risks;
- Combining with the credit mechanism and guiding capital to facilitate sustainable transformation;
- Improving the level of energy efficiency and technological innovation and accelerating the
realization of China “Carbon-Peaking and Carbon-Neutrality”.
Full report in Chinese available HERE