Climate Finance 2022/23 Winter

This course explores the connections between climate change (global warming) and the financial system. Climate change causes risk/“uncertainty” and our societies must adapt. This is directly relevant for the financial system because this system connects risk-takers (speculators) with risk-avoiders. How can we use financial markets in order to deal with risks associated with climate change? What are the risks? How do they correspond to the different categories of “financial” risks?

Given that the financial system performs key functions in economic adaptation to climate change, we can expect that prices in financial markets contain information about climate change. Can we use the prices to „value“ policies for mitigating climate change? What does the financial market tell us about the social cost of greenhouse gas (GHG) emissions?

How can the financial system contribute to economic adaptation to climate change? Sustainable finance requires distinguishing between risks of financial and economic distress, where financial distress means a risk of insolvency which is purely caused by a temporary lack of cash („liquidity“) while economic distress means that a certain type of economic activity becomes unsustainable. As a (by definition) temporary phenomenon, the weather  causes risks of financial distress in non-financial firms, while the climate (and climate policy) will cause economic distress. This can happen not only because of effects on firms` cash flows, but also because of changes in investors’  valuations of the cash flows. For example, heavily polluting firms may become “distressed” when their stock prices drop and they end up looking over-indebted and no longer credit-worthy. What determines the valuation of more or less polluting firms in a financial market in which some investors shun the stocks of heavy polluters?

We will address these questions while distinguishing between different types of “players” in the financial system: investors, asset managers and index funds, banks, and central banks/financial supervision authorities. Climate change and climate policy confronts these different players with different questions. Here are some examples:

1.     How should environmentally concerns investors structure their portfolios?

2.     Should index funds pressure firms to reduce their GHG emissions?

3.     Should banks refuse to accept polluting assets (e.g., coal-fired power plants) as collateral for loans?