The impact of phasing out fossil fuel subsidies on the low-carbon transition

There is growing consensus on the fact that fossil fuel subsidies provided by governments in high-income countries represent a misalignment on emissions\u2019 reduction with the global climate agenda. In addition, a discussion emerged on the negative socio-economic and environmental externalities associated with fossil fuel subsidies. Nevertheless, pathways for phasing out fossil fuel subsidies in high income countries and their implications on the low-carbon transition have not yet been assessed. With the aim to narrow this knowledge gap, we extend the EIRIN Stock-Flow Consistent behavioral model to study the implications on sustainable development of the gradual phasing out of fossil fuels subsidies, whose revenues could be used by the government to subsidize energy investments in green capital (e.g. solar panels), either via fiscal policies or green bonds. We assess the effects on green growth, employment, credit and bonds market, as well as the distributive effects across heterogeneous households and sectors. A smooth phasing out of fossil fuels subsidies contributes to improve macroeconomic performance, to decrease inequality and helps the government to find fiscal space to support stable renewable energy policies. Renewable energy subsidies contribute to foster the low-carbon transition but could imply distributive effects, depending on the way in which they are implemented

Sustainable investing and climate transition risk: A portfolio rebalancing approach

The authors studied how greenness can be combined with other investment criteria to construct sets of corporate bond 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 bond amount outstanding within Climate Policy Relevant Sectors. The portfolio rebalancing leads to a 10% reduction of exposure to climate transition risk. Then, the authors studied the relationship 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 analyzed the 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

Profiling identification with Europe and the EU project in the European regions

Recent political events in the European Union (EU) highlighted a growing dissatisfaction of citizens in several EU regions with the EU institutions' management of socio-economic and financial challenges. This eventually led to a political legitimization crisis, whose drivers are partially shared among EU regions and partially area-specific. However, the relation between citizens' identification with the EU project and the regions' characteristics has not been analysed yet. In this article, we fill in this gap by addressing three research questions: i) To what extent do EU citizens identify with Europe and the EU project? ii) Do European regions have different patterns and level of identification? iii) Are the results driven by specific socio-economic variables? Answering these questions is crucial to inform a more inclusive and resilient design of the EU Cohesion Policy in a crucial period for reforming the EU. To this purpose, we develop a novel probabilistic classification model, IdentEU, which embeds with the concept of individual identification with Europe. We use micro-level data from a survey implemented within the PERCEIVE project. We find that the influencing variables that mostly affect (citizens and) regions' identification with the European project are: trust in the EU institutions, the effectiveness of EU Cohesion Policy and spending, and the level of corruption. These issues gain relevance at the light of three main challenges that affected the EU socio-economic development path in the last decade, i.e. the 2008 financial crisis, the globalization process, and Brexit

Assessing the cascading impacts of natural disasters in a multi-layer behavioral network framework

Natural disasters negatively impact regions and exacerbate socioeconomic vulnerabilities. While the direct impacts of natural disasters are well understood, the channels through which these shocks spread to non-affected regions, still represents an open research question. In this paper we propose modelling socioeconomic systems as spatially-explicit, multi-layer behavioral networks, where the interplay of supply-side production, and demand-side consumption decisions, can help us understand how climate shocks cascade. We apply this modelling framework to analyze the spatial-temporal evolution of vulnerability following a negative food-production shock in one part of an agriculture-dependent economy. Simulation results show that vulnerability is cyclical, and its distribution critically depends on the network density and distance from the epicenter of the shock. We also introduce a new multi-layer measure, the Vulnerability Rank (VRank), which synthesizes various location-level risks into a single index. This framework can help design policies, aimed to better understand, effectively respond, and build resilience to natural disasters. This is particularly important for poorer regions, where response time is critical and financial resources are limited

Compounding COVID-19 and climate risks: The interplay of banks’ lending and government's policy in the shock recovery

We assess the individual and compounding impacts of COVID-19 and climate physical risks in the economy and finance, using the EIRIN Stock-Flow Consistent model. We study the interplay between banks’ lending decisions and government's policy effectiveness in the economic recovery process. We calibrate EIRIN on Mexico, being a country highly exposed to COVID-19 and hurricanes risks. By embedding financial actors and the credit market, and by endogenising investors’ expectations, EIRIN analyses the finance-economy feedbacks, providing an accurate assessment of risks and policy co-benefits. We quantify the impacts of compounding COVID-19 and hurricanes on GDP through time using a compound risk indicator. We find that procyclical lending and credit market constraints amplify the initial shocks by limiting firms’ recovery investments, thus mining the effectiveness of higher government spending. When COVID-19 and hurricanes compound, non-linear dynamics that amplify losses emerge, negatively affecting the economic recovery, banks’ financial stability and public debt sustainability

Accounting for finance is key for climate mitigation pathways

The financial system—the ecosystem of investors (e.g., banks, investment funds, insurance), markets, and instruments—is often considered to play an enabling role in climate mitigation pathways to a low-carbon transition. But it can also have a hampering role, e.g., if investors’ perceptions of low risk from a missed transition and low opportunities from a transition fail to trigger a reallocation of capital into low-carbon investments. This increases the chance of the transition not occurring within the time window required to stabilize the climate or occurring in a disorderly fashion. Indeed investors, who can influence the realization of climate mitigation pathways, themselves rely on estimates of climate mitigation pathways from process-based integrated assessment models (IAMs). And IAMs do not model the financial system or investors’ decisions; thus, the feedback loop between the financial system and mitigation pathways is not taken into account, neither by the IAMs nor by the finance community. This limitation to our understanding of the dynamics and the feasibility of the low-carbon transition weakens the ability of IAMs to inform policy and investment decisions. We propose a framework to capture the interdependence between investors’ perception of future climate risk, depending on the credibility of climate policies, and the allocation of investments in the economy

The NACE – CPRS – IAM mapping: A tool to support climate risk analysis of financial portfolio using NGFS scenarios.

We propose a mapping from NACE codes of economic activities, into Climate Policy Relevant Sectors (CPRS) and into the variables of the process-based Integrated Assessment Models (IAM) used by the Network for Greening the Financial System (NGFS) to provide its climate scenarios. We discuss the classification of CPRS at the disaggregation level provided by CPRS Granular, which distinguishes across energy technologies (e.g. within transport, motor vehicles powered by combustion vs electric engines). Then, we describe the mapping of NACE 4-digit – CPRS Granular – IAM variables used in the scenarios of the NGFS. CPRS enable users to group the large number of NACE codes into few categories of climate transition risk. At this point, it is possible to identify for each NACE economic activity the most relevant IAM variable to use in the NGFS scenarios. This procedure enables the use of climate scenarios (e.g. NGFS) for climate-related financial disclosure and climate stress testing. The goal of this note, and of the proposed mapping is to support practitioners, financial supervisors, investors and academics in climate transition risk disclosure and climate transition risk assessment, providing a science-based, transparent and operational tool

Climate Risk Assessment of the sovereign bond of portfolio of European Insurers. In: EIOPA Financial Stability Report, December 2019

In the first collaboration between climate economists, climate financial risk modellers and financial regulators, we apply the CLIMAFIN framework described in Battiston at al. (2019) to provide a forward-looking climate transition risk assessment of the sovereign bonds’ portfolios of solo insurance companies in Europe. We consider a scenario of a disorderly introduction of climate policies that cannot be fully anticipated and priced in by investors. First, we analyse the shock on the market share and profitability of carbon-intensive and low-carbon activities under climate transition risk scenarios. Second, we define the climate risk management strategy under uncertainty for a risk averse investor that aims to minimise her largest losses. Third, we price the climate policies scenarios in the probability of default of the individual sovereign bonds and in the bonds’ climate spread. Finally, we estimate the largest gains/losses on the insurance companies’ portfolios conditioned to the climate scenarios. We find that the potential impact of a disorderly transition to low-carbon economy on insurers portfolios of sovereign bonds is moderate in terms of its magnitude. However, it is non-negligible in several scenarios. Thus, it should be regularly monitored and assessed given the importance of sovereign bonds in insurers’ investment portfolios

Climate Risk Assessment of the sovereign bond of portfolio of European Insurers. In: EIOPA Financial Stability Report, December 2019

In the first collaboration between climate economists, climate financial risk modellers and financial regulators, we apply the CLIMAFIN framework described in Battiston at al. (2019) to provide a forward-looking climate transition risk assessment of the sovereign bonds’ portfolios of solo insurance companies in Europe. We consider a scenario of a disorderly introduction of climate policies that cannot be fully anticipated and priced in by investors. First, we analyse the shock on the market share and profitability of carbon-intensive and low-carbon activities under climate transition risk scenarios. Second, we define the climate risk management strategy under uncertainty for a risk averse investor that aims to minimise her largest losses. Third, we price the climate policies scenarios in the probability of default of the individual sovereign bonds and in the bonds’ climate spread. Finally, we estimate the largest gains/losses on the insurance companies’ portfolios conditioned to the climate scenarios. We find that the potential impact of a disorderly transition to low-carbon economy on insurers portfolios of sovereign bonds is moderate in terms of its magnitude. However, it is non-negligible in several scenarios. Thus, it should be regularly monitored and assessed given the importance of sovereign bonds in insurers’ investment portfolios

Climate change challenges for central banks and financial regulators

The academic and policy debate regarding the role of central banks and financial regulators in addressing climate-related financial risks has rapidly expanded in recent years. This Perspective presents the key controversies and discusses potential research and policy avenues for the future. Developing a comprehensive analytical framework to assess the potential impact of climate change and the low-carbon transition on financial stability seems to be the first crucial challenge. These enhanced risk measures could then be incorporated in setting financial regulations and implementing the policies of central banks