ESG Club interview – EDHEC-Risk Climate Impact Institute INTERVIEW – PROFESSOR RICCARDO REBONATO


“A significant risk re-pricing may be overdue.”


The scientific director of the EDHEC-Risk Climate Impact Institute and a professor of finance, tells Andrew Holt about why he is encouraged by efforts to address climate change, but says institu- tional investors should move from ‘canned scenarios’ and raises issues about carbon removal.


How well do you think institutional inves- tors are approaching climate change and the risks associated with it? There are many encouraging efforts to come to terms with the financial implica- tions of climate change. Understanding what the climate future might look like is an essential first step in being prepared. Several international organisations have provided climate scenarios, which are invaluable. However, so far these scenarios have been devoid of any assessment of their likeli- hood – relative or absolute – and this makes them difficult to use. Faced with a garden-variety market scenario, financial planners routinely build probabilities ‘in their own heads’ and qualitatively assess whether the scenario is worth losing sleep over or not. But this is only possible because of a centu- ry-long experience of market crashes, credit crises, asset bubbles, interest rate hikes and the like. This ‘institutional mem- ory’ is absent in the case of climate scenar- ios because we have not yet encountered this situation in the history of Western civ- ilization, let alone of financial markets.


26 | portfolio institutional | July-August 2023 | Issue 125


Any portfolio manager worth her salt can express an informed opinion about whether a market scenario such as ‘yields move up by 100 basis points in a month’ is reasonable or not – and she does not need to run a formal model to arrive at her conclusion.


So how can investors assess whether breaching the 1.5-degrees target in 20 years’ time is likely or not?


This is why investors and financial plan- ners need science-based models to assess what they should worry about and what belongs to the category of ‘meteorite risk’. This lack of any probability assessment is a big gap in what is being provided to investors.


One should also keep in mind that stand- ardised scenarios are great for compara- bility and reporting but can easily gener- ate tunnel vision and encourage group think. The ‘wisdom of crowds’ is good indeed when it comes to estimating aver- ages but fails badly when it tries to assess the tails of distributions. So, my recommendation to investors is not to think that the ‘canned scenarios’ availa-


ble cover all that can happen. Instead try to embed climate scenarios in the wider mac- ro-financial picture. For instance, if subsi- dies prove more politically palatable than carbon taxes, and if subsidies – as it hap- pening in the US and in Europe – acquire a progressively protectionist focus, what will the consequences be for trade agree- ments, globalisation, etc?


Or if the 150 million people living in the already extremely dry and agriculturally ‘marginal’ Sahel


area were forced to


migrate because of a modest temperature increase, what might the economic and political repercussions be for European countries? Nobody can know with certainty how severe climate change in itself will be, but the nature of the problem is that it is deeply pervasive and has ramifications in every aspect of the economy.


How do you see the debate surrounding climate change, net zero and investors? Is it going in the right direction or taking the wrong course?


There is no doubt that emission abate- ment must play a key, and increasingly


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