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The Commitment to Sustainability in Financial Investments

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Financial Risk Management and Climate Change Risk

Part of the book series: Contributions to Finance and Accounting ((CFA))

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Abstract

In economics and finance, sustainability has been empirically framed around the Environmental, Social and Governance (ESG) factors. In recent years, the urgency of climate change effects has become prominent in the sustainability debate. Policymakers have developed several initiatives aimed at reducing greenhouse gas emissions and contributing to sustainable development. In this context, the financial system can crucially mobilise resources to support the transition to a more sustainable economy. This chapter focuses on the integration of the ESG and climate-related risks into risk and investment strategies. It starts with a description of the main policy initiatives taken at the international and European levels and of the market developments in sustainable finance. We then discuss the role of central banks in scaling up sustainable and green finance, owing to the potential effects of ESG and climate risks on the central banks’ ability to pursue their institutional goals. Finally, we consider central banks’ initiatives in monetary policy, supervision, and portfolio management.

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Notes

  1. 1.

    In the final Report of the World Commission on Environment and Development: Our Common Future in 1987 it was specified that: ‘Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs’ (World Commission 1987).

  2. 2.

    For many years, reflections on sustainability have focused on the relationship between economic growth and natural resources scarcity. The works of the Club of Rome in the 70s, inspired among others by Aurelio Peccei, identified the risks associated with demographic growth, the pressure that this would have exerted on consumption and therefore on available resources. These analyses were criticised arguing that resources scarcity, through the price mechanism, would have promoted the emergence of new technologies and would have induced a more efficient use.

  3. 3.

    The 2030 Agenda for Sustainable Development is a plan of action for people, planet and prosperity. Signed on 25 September 2015 by the governments of the 193 Member Countries of the United Nations and approved by the UN General Assembly, the Agenda sets out 17 Sustainable Development Goals, SDGs, which are part of a broader programme of action consisting of 169 associated targets to be achieved in the environmental, economic, social, and institutional domains by 2030.

  4. 4.

    The Paris Agreement is an international treaty on climate change signed on 12 December 2015 during the XXI Conference of the Parties (COP) from 196 countries. Among its objectives, the most important goal is to limit the increase in the global average temperature below 2 °C compared to pre-industrial levels and preferably at 1.5 °C. According to the Report of the Intergovernmental Panel on Climate Change (2021), the planet has already experienced an average increase of the temperature of 1.09 °C compared to the temperature before the industrial revolution (1850–1900). In the absence of drastic reductions in the production of greenhouse gases, there would be an increase of temperatures between 1.4 and 4.4 °C by 2100, depending on the emissions path of greenhouse gases. It is necessary to halve emissions every 10 years to achieve carbon neutrality (equivalence of emissions produced and absorbed) in 2050.

  5. 5.

    IPCC (2021) and European Commission (2019).

  6. 6.

    Responses to the climate crisis have been spurred by increasingly alarming scientific data and by the protests of many movements, especially of young people, such as ‘Fridays for future’ (Figueres and Rivett-Carnac 2020).

  7. 7.

    IPCC (2021) and European Commission (2019).

  8. 8.

    Italian Sustainable Investment Forum, BVA Doxa (2019), ISS ESG, Adelphi (2020).

  9. 9.

    Even before the meta-study by Friede et al. (2015), a positive effect of environmentally sound business management on yields was found (Klassen and McLaughlin 1996). Gompers et al. (2003) show that corporate governance provides a key (positive) contribution to returns; a weak governance negatively affect financial performance (Core et al. 1999). Auer (2016) finds that investment selection based on corporate governance profiles improves financial results and that companies with higher ESG scores are able to attain higher returns. In another influential series of articles, Edmans (2011, 2012) shows that portfolios invested in companies with highly satisfied employees generate significant excess returns.

  10. 10.

    The commitments undertaken by the institutional investors to the UNPRI reflect the duty to act in the best long-term interests of the beneficiaries of the managed financial resources. In this fiduciary role, environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios. The signatories also recognise that applying these Principles may better align investors with broader objectives of society. Therefore, the commitments undertaken by UNPRI signatories are:

    1. 1.

      integrate ESG issues into investment analysis and decision-making processes;

    2. 2.

      be active shareholders and incorporate ESG issues into ownership policies and practices;

    3. 3.

      seek appropriate disclosure on ESG issues by the companies and organisations in which they invest;

    4. 4.

      promote acceptance and implementation of the Principles within the investment industry;

    5. 5.

      work together to enhance our effectiveness in implementing the Principles; and

    6. 6.

      report on their activities and progress towards implementing the Principles.

  11. 11.

    The financial initiative of the United Nations Environment Program (United Nations Environment Program Finance Initiative, UNEP FI) is a collaboration between the Environment Program of the UN and the global financial sector. UNEP FI works closely with over 200 financial institutions signatories of the UNEP FI Statement on Sustainable Development, as well as with a number of organisations partners, to develop and promote links between sustainability and financial services.

  12. 12.

    The United Nations Global Compact (UNGC) is a global and multilateral initiative to help aligning business activities and strategies to ten universally accepted principles in the fields of human rights, labour, the environment and fight against corruption, as well as catalysing private sector actions in support of the wider objectives of United Nations.

  13. 13.

    EU Regulation n. 2019/2088.

  14. 14.

    The EU taxonomy is one of the three pillars of the Action Plan, which also includes the European standards for green bonds and the EU Climate benchmark standard. These two initiatives set the reference criteria for classifying bond issues and indices in relation to specific sustainability criteria.

  15. 15.

    In 2022, the Commission adopted a Complementary Climate Delegated Act including, under strict conditions, specific nuclear and gas energy activities in the list of economic activities covered by the EU taxonomy.

  16. 16.

    The six goals are: climate change mitigation; climate change adaptation; the sustainable use and protection of water and marine resources; the transition to a circular economy; pollution prevention and control; the protection and restoration of biodiversity and ecosystems.

  17. 17.

    In 2019, the EU launched at the annual meetings of the Monetary Fund and the World Bank in Washington, the International Platform on Sustainable Finance (International Platform on Sustainable Finance, IPSF). The ultimate objective of the IPSF is to scale up the mobilisation of private capital towards environmentally sustainable investments. The IPSF therefore offers a multilateral forum of dialogue between policymakers that are in charge of developing sustainable finance regulatory measures to help investors identify and seize sustainable investment opportunities that contribute to climate and environmental objectives. Through the IPSF, members can exchange and disseminate information to promote best practices, compare their different initiatives and identify barriers and opportunities of sustainable finance, while respecting national and regional contexts.

  18. 18.

    The minimum standards associated to these indices were introduced by the Commission Delegated Regulation (EU) 2020/1818, which supplements the regulation (EU) 2016/1011/EU of the European Parliament and of the Council as regards the standards for the indices of EU Climate Transition Benchmark (CTB) and for EU Paris Aligned Benchmarks (PAB).

  19. 19.

    Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement.

  20. 20.

    Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups.

  21. 21.

    Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting.

  22. 22.

    The Corporate Sustainability Reporting Directive amends the existing reporting requirements of the Non-Financial Reporting Directive (NFRD). The Directive: (a) extends the perimeter to all large companies and all companies listed on regulated markets; (b) requests verification of the reported information; (c) introduce more detailed reporting requirements and the obligation to report according to mandatory standards; and (d) requires companies to digitally mark the information communicated so that it can be interpreted by a computer.

  23. 23.

    The rules introduced by the NFDR (Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014) remain in force until companies have to apply the new rules of the CSRD.

  24. 24.

    Whereas n. (29) ‘…reporting not only on information to the extent necessary for an understanding of the undertaking’s development, performance and position, but also on information necessary for an understanding of the impact of the undertaking’s activities on environmental, social and employee matters, respect for human rights, anti-corruption and bribery matters. Those Articles therefore require undertakings to report both on the impacts of the activities of the undertaking on people and the environment, and on how sustainability matters affect the undertaking. That is referred to as the double materiality perspective, in which the risks to the undertaking and the impacts of the undertaking each represent one materiality perspective’.

  25. 25.

    Corporate Sustainability Due Diligence Directive, published on 23 February 2022.

  26. 26.

    UN PRI data for the fourth quarter of 2022. The value considers the assets managed by fund managers and fund owners, the latter weighing slightly more than 20 billion.

  27. 27.

    According to Trackinsight data, 15 of the 17 Sustainable Development Goals (Sustainable Development Goals, SDG) set by the United Nations, are covered by ESG ETFs. More than 400 ETFs are lined up with an SDG and most of the resources are aligned with three goals: a) climate action (SDG 13); b) industry, innovation and infrastructure (SDG 9); and c) affordable and clean energy (SDG 7) (Trackinsight 2023).

  28. 28.

    Data on green and sustainable bonds, referred to mid-August 2021, are computed from Bloomberg Finance L.P. data.

  29. 29.

    The classification has been developed by Eurosif and is included in the Principles of Responsible Investment of the United Nations (UNPRI).

  30. 30.

    Berg et al. (2019).

  31. 31.

    In the first case, factors affecting the company financial value will be identified (revenues, costs, profitability, etc.), in the second case all the factors that have an impact on the environment will be identified, regardless their financial relevance.

  32. 32.

    A significant initiative is the agreement signed by the five main sustainability standard-setters: Sustainability Accounting Standards Board (SASB), Global Reporting Initiative (GRI), Carbon Disclosure Project (CDP), Climate Disclosure Standards Board (CDSB), International Integrated Reporting Council (IIRC), in order to coordinate their standards and create a global reporting system, able to integrate with financial reporting (see Statement of Intent to Work Together Towards Comprehensive Corporate Reporting) or the proposal to set up a global body for the definition of reporting rules that integrate sustainability data with accounting data (Sustainability Standards Board) under the aegis of the IFRS.

  33. 33.

    Shoenmaker and Shramade (2019).

  34. 34.

    2° Investing Initiative (2017).

  35. 35.

    Visco (2020).

  36. 36.

    Bernardini et al. (2021).

  37. 37.

    Physical risk arises from progressive climate change and, in particular, from growth of temperatures, by the greater irregularity of the precipitations and by the increase of the probability of extreme natural events. Transition risk arises from the possibility of a disorderly transition towards a low-carbon economy.

  38. 38.

    NGFS (2020a).

  39. 39.

    Signorini (2020).

  40. 40.

    Carney (2015).

  41. 41.

    Monasterolo (2020).

  42. 42.

    NGFS (2021b).

  43. 43.

    NGFS (2020b).

  44. 44.

    As far as credit operations are concerned, the interventions may consider adjustments on valuation (to reflect the exposure to climate risks of loan counterparty or composition of the collateral), the eligibility criteria of the counterparties on the basis of their sustainability reporting and green investments. As far as collateral is concerned, the interventions may regard margins, negative (or positive) screening in the eligibility criteria, or the alignment of the collateral with climate indicators. As far as purchases are concerned, different weighting strategies can be envisaged based on the climate change indicators (tilting) or negative screening (NGFS 2020a, 2021a).

  45. 45.

    Schnabel (2020).

  46. 46.

    Visco (2019).

  47. 47.

    The agreement has been reached following extensive preparatory work carried out by the Eurosystem and it benefited from the analysis developed at the NGFS, whose recommendations it incorporated.

  48. 48.

    Hoepner et al. (2020).

  49. 49.

    Bank of Italy (2019) and Cipollone (2021).

  50. 50.

    The exclusion criteria are based on the fundamental conventions of the International Organization of labour, on international treaties on controversial weapons, on the non-proliferation treaty of nuclear weapons, and on the protocols to the Convention on the prohibitions or restrictions on the use of some conventional weapons.

  51. 51.

    Engle et al. (2019).

  52. 52.

    Lanza et al. (2020).

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Authors and Affiliations

  1. Bank of Italy, Climate Change and Sustainability Hub, Rome, Italy

    Enrico Bernardini

  2. Bank of Italy, Financial Risk Management Directorate, Rome, Italy

    Marco Fanari

  3. Bank of Italy, Directorate General Markets and Payment Systems, Rome, Italy

    Franco Panfili

Authors
  1. Enrico Bernardini
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  2. Marco Fanari
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  3. Franco Panfili
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Corresponding author

Correspondence to Marco Fanari .

Editor information

Editors and Affiliations

  1. Bank of Italy, Rome, Italy

    Antonio Scalia

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Bernardini, E., Fanari, M., Panfili, F. (2023). The Commitment to Sustainability in Financial Investments. In: Scalia, A. (eds) Financial Risk Management and Climate Change Risk. Contributions to Finance and Accounting. Springer, Cham. https://doi.org/10.1007/978-3-031-33882-3_8

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