New research reveals high carbon risks for Frankfurt Financial Center
Carbon Risks for the Frankfurt Financial Center
New research conducted at University of Stuttgart reveals the possible financial losses for investors invested in stocks and mutual investment funds traded at the financial center of Frankfurt. The study is taking into account the effects brought by if new regulations would occur in order to achieve the Paris Agreement's two degree target. The research report is based on detailed climate impact assessment data provided by South Pole Group and yourSRI.
Prior to the international climate agreement sealed in December 2015 at COP21 in Paris, a few initial institutional investors reduced some of their invested stocks that were highly dependent on fossil resources and energy.
"Meanwhile a growing discussion among financial markets participants evolved about the possible impacts of a carbon bubble and the thread of stranded assets to their portfolios. More and more it is accepted, that financing directly and indirectly is jointly responsible for global greenhouse gas emissions (financed emissions), global warming and induced adverse environmental impacts." write the authors, Henry Schaefer & Björn Stoltenfeldt. "The current amount of greenhouse gas emissions of firms listed at the Frankfurt stock exchange are only compatible with a 4°C to 6°C target and conflict with the politically intended two degree target."
The conclusion is that the intended reduction of greenhouse gas emissions called for in the Paris Agreement will require radical adjustments in firm- and market behavior. If public institutions regulated according to the 2°C degree target, the study reveals high financial risks associated with high carbon exposure of funds. For firms and investors not prepared for climate friendly regulations, future regulatory changes and mechanisms implemented in line with the Agreement will lead to market price risks for stocks and subsequently for investors, financial markets and financial centers.
English Abstract:
Prior to the world climate protection agreement in December 2015 in Paris (COP21) some first institutional investors reduced their stocks they had invested in firms, that are highly depending on fossil resources and energy. Meanwhile a growing discussion among financial markets participants evolved about the possible impacts of a carbon bubble and the thread of stranded assets to their portfolios. More and more it is accepted, that financing directly and indirectly is jointly responsible for global greenhouse gas emissions (financed emissions), global warming and induced adverse environmental impacts. The intended reduction of greenhouse gas emissions by political actions due to COP21 will require severe adjustments in firms and markets. It will be accompanied by market price risks for stocks of those firms affected mostly by climate-friendly regulations and subsequently for investors, financial markets and financial centers. As such risks are caused by greenhouse gas emissions of fossil resource consumption they are called investment carbon exposures.
The following contribution demonstrates the possible financial losses for those who are invested in stocks and mutual investment funds traded at the financial center of Frankfurt, if new regulations would occur in order to achieve the two degree target, manifested in the Paris agreement. The Emission Trading System (EU-ETS) of the European Union plays a crucial role in such a regulation as it was agreed by COP21. The necessary reforms of the EU-ETS are not yet finalized and the resulting future price level for emission allowances is still not determined on a reliable basis. As a consequence the following analysis assumes three different price scenarios with which the shadow costs of the greenhouse gas emissions of firms listed a the Frankfurt stock exchange (resp. the CDAX) can be measured. With the construction of an artificial stock portfolio consisting of stocks out of the CDAX universe, with an assumed investment of one million Euros and a holding period of one year the impact the portfolio's return and the damage of that portfolio with respect to its assumed greenhouse gas emission were calculated. In similar ways a second simulation was carried out for a portfolio consisting of mutual investment funds, traded at Frankfurt's stock exchange and being invested solely in stocks.
The result of the stock portfolio simulation showed, that the three supposed scenarios resulted in partly very different carbon investment exposures. Referring to the stock portfolio simulation greenhouse gas emissions of 807,8 t were calculated with a resulting carbon investment exposure for the Frankfurt financial center of 15,96 Bill. Euro based on the EU-ETS medium price scenario and 66,3 Bill. Euro of the top price scenario. In the case of the medium price scenario the average annual return of the stock portfolio would be 2 per centage points below the annualized return of the assumed stock portfolio according to its 2015 value (9% ten year average). If the top price scenario would assumed, the calculations exhibit a nearly complete reduction of the 2015 return. Particularly stocks of the energy sector would lose mostly.
The simulations of the second portfolio consisting of mutual investment funds showed a much lower investment carbon exposure and therefore a much lower exposure for investors and the entire financial center. In the medium and top price scenarios the historical return of the investment portfolio was threatened by 10% and 50%. In the latter the maximum loss of the investment funds' portfolio would result in 5,7 Bill. Euro.
The results should be interpreted carefully as they are preliminary mainly due to some shortcomings in the calculation method and the availability and reliability of data. On the other hand they give first indications of possible financial damages in portfolios consisting of stocks of German firms listed at the Frankfurt stock exchange and mutual investment funds traded at the German financial center, if public institutions undertake measures to achieve the two degree target demanded by COP21. Severe investment carbon exposures for investors would be a negative side effect of such processes depending on the future market price for emission allowances in the EU-ETS. The analysis can also be interpreted as follows: the current amount of greenhouse gas emissions of firms listed at the Frankfurt stock exchange are only compatible with a 4°C to 6°C-target and conflict with the politically intended two degree target.
To download the full report (in German), please click here.