Presentation from the OECD Workshop “Climate transition scenarios: integrating models into risk assessment under uncertainty and the cost of delayed action” (6 July 2022) - Sessions 2 & 3, Irene Monasterolo, EDHEC Business School, ERCII

1. OECD Workshop on Climate
Transition Scenarios 2022
Irene Monasterolo, Professor of Climate Finance, EDHEC and EDHEC-
Risk Climate Impact Institute (ERCIII)
irene.monasterolo@edhec.edu
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2. 2
Assessing carbon stranded assets: lessons learned
1. Stranded assets not well defined yet: typically research focuses on fossil fuels
reserves and production plants, and specific sectors (e.g. NACE B, C)
2. Beyond sectors: chain of directly/indirectly affected activities (e.g. combustion
engines), and firms with mixed business lines (green coexisting with high-carbon)
matter. This is why we developed the Climate Policy Relevant Sectors in 2017
3. Exposure is not financial risk: we need to consider investor’s leverage, adjustment
in default probability, mispricing, interconnectedness
4. Focus on the assets that matter: bonds, loans (role in investors’ portfolios and
balance sheet). Challenging (e.g. consider default correlation)
5. Climate stress test: from forward-looking distribution of losses, financial valuation
adjustments, financial contagion model (interbank), conditioned to scenarios
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3. 3
Battiston, S, ea (2017): A climate stress-test of the financial
system. Nature Climate Change
• Climate Policy Relevant Sectors (CPRS): a classification
of economic activities in transition risk categories to
quantify stranded assets (Fig. 1)
• CPRS consider activity’s (i) role in energy value chain,
(ii) revenue, business model (input substitutability) (iii)
cost sensitivity to policy (ministries, lobbies), (iv) GHG
• We map NACE 4 digit codes in CPRS considering
different levels of granularity (CPRS1, 2, granular)
• Why CPRS? Because GHG emissions and carbon
intensity misleading (Scope 1, 3)
Fossil-fuel
U,li,es
Energy-
intensive
Housing
Transport
B
C
D
F
H
NACE2 codes
Climate-sensi,ve
sectors
Asset PorBol
by instrumen
Equity
Bonds
Loans
Reclassifica,on of economic sectors
from NACE2 into climate-sensi,ve
sectors
Classifica,on
instrument a
sectors
Fossil-fuel
U,li,es
Energy-
intensive
Housing
Transport
B
C
D
F
H
NACE2 codes
Climate-sensi,ve
sectors
Asset PorBolio
by instrument
Equity
Bonds
Loans
Reclassifica,on of economic sectors
from NACE2 into climate-sensi,ve
sectors
Classifica,on of
instrument and c
sectors
Fig 1: mapping economic activities into Climate Policy
Relevant Sectors to assign a transition risk profile to a
portfolio of contracts: Battiston ea (2017)
Climate transition risk exposure:
Climate Policy Relevant Sectors (CPRS)
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4. 4
Investors’ exposure to Climate Policy
Relevant Sectors is high even after Paris
Fig. 2: Percentage composition of portfolio of syndicated loans of major U.S. banks by
climate-policy-relevant sector. Source: CERES 2020
CPRS exposure of US banks’ loans (2020)
• JRC study of EU Taxonomy financial
impact (Alessi ea 2019)
• ECB Financial Stability Review 2019, 2020
• EIOPA’s Financial Stability Review 2019
• EBA Risk assessment of the EU banking
system, Dec. 2020
• ESMA Advice to European Commission
under Article 8 of the Taxonomy
Regulation (2020)
• National Bank of Austria, Financial
Stability Report 2020
• Banco de Mexico 2021, J.Fin. Stab.
• International Association of Insurance
Supervisors (2021)
• ECB/ESRB: Climate-related risk and
financial stability (2021)
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5. Asset level risk assessment: CPRS-Granular
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• CPRS-Granular integrates info about energy tech of plants owned by the firm,
considering business lines and contribution to revenues. This info is associated to the
financial contracts for adjustments in financial valuation and risk metrics.
• Why this matters? Because firms’ plants may differ by technology thus being
positively/negatively affected in the transition. Firm level info would average losses
CPRS Main CPRS-2 CPRS Granular
3-energy-intensive 3-energy-intensive energy-intensive
3-energy-intensive 3-energy-intensive energy-intensive|cement
3-energy-intensive 3-energy-intensive energy-intensive|electrical
3-energy-intensive 3-energy-intensive energy-intensive|fertilisers and agrochemicals
3-energy-intensive 3-energy-intensive energy-intensive|iron and steel
3-energy-intensive 3-energy-intensive energy-intensive|non-fossil mining
3-energy-intensive 3-energy-intensive energy-intensive|other
3-energy-intensive 3-energy-intensive energy-intensive|pharmaceutical
3-energy-intensive 3-energy-intensive energy-intensive|rubber and plastics
Source: Battiston et al. (2022)

6. Bridging asset level risk into climate scenarios
6
• CPRS-Granular allows us to assign a transition risk profile to IAM variables, and to map
NACE 4-digit codes to relevant IAM trajectories across climate scenarios
NACE CPRS1 CPRS2 CPRS-Granular NGFS_Granular
45.11 5-transportation 5-transportation|roads transportation|vehicles|combustion Final Energy|Transportation|Liquids
45.11 5-transportation 5-transportation|roads transportation|vehicles|electric Final Energy|Transportation|Electricity
45.11 5-transportation 5-transportation|roads transportation|vehicles|hybrid Final Energy|Transportation|Electricity
45.11 5-transportation 5-transportation|roads transportation|vehicles|hydrogen Final Energy|Transportation|Hydrogen
46.71 1-fossil-fuel 1-fossil-fuel fuel|fossil|sale Primary Energy|Fossil
47.30 1-fossil-fuel 1-fossil-fuel fuel|fossil|oil|sale Final Energy|Transportation|Liquids
49.10 5-transportation 5-transportation|railways transportation|infrastructure|land|railways|fossil Energy Service|Transportation|Passenger|Railways
49.10 5-transportation 5-transportation|railways transportation|infrastructure|land|railways|electric Energy Service|Transportation|Passenger|Railways
49.20 5-transportation 5-transportation|railways transportation|infrastructure|land|railways|fossil Energy Service|Transportation|Freight|Railways
49.20 5-transportation 5-transportation|railways transportation|infrastructure|land|railways|electric Energy Service|Transportation|Freight|Railways
Monasterolo_OECD_climate_transition_2022
Source: Battiston et al. (2022)

7. • In the climate stress tests (Battiston et al. 2017), we translated trajectories of Integrated
Assessment Models (IAM) across scenarios into financial valuation adjustment, individual and
systemic risk in interbank network model (ECB data)
• Banks with high-carbon investment strategy will face larger losses (Climate VaR, Fig.3)
conditioned to climate scenarios. Adding contagion (light) polarizes losses.
Investors’ leverage and interconnectedness
Fig. 3: Value at Risk (5% significance) on equity holdings of 20 most affected EU banks under scenario of green
(brown) investment strategy. Dark/light colors: first/second round losses.Source: Battiston ea (2017)
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8. Application: climate-aware portfolio rebalancing
• ECB to include climate change considerations
into its monetary policy framework
• How? It will decarbonize its corporate bonds
portfolio by tilting (i.e. increasing) the share of
holdings in firms with better climate performance
• Issuers’ climate performance measured by lower
GHG emissions (backward looking) ambitious
carbon reduction targets (forward-looking)
• Challenges:
• GHG emission data are not yet adequate to
support portfolio rebalancing: scarce,
inconsistent reporting, see scope 3 in Figure 4
• Scope 1 and 2: most data are estimates by data
provides (different models)
Fig. 4: Selected companies in transport and electricity generation. Differences
in reporting for scope 1+2+3 emission intensity against fundamentals (e.g.
renewable capacity, fleet emissions) that should be related to those
intensities. Source: Bressan et al. 2022
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9. An enhanced greenness measure for tilting
• We developed an enhanced measure of greenness
to account for limitations of GHG emissions:
• Climate Policy Relevant Sectors: energy technology
profile disclosed by CPRS-Granular
• Renewable energy capacity (utility, source: BNEF and
proprietary database of company reported data)
• Green CAPEX (utility, source: BNEF and Refinitiv)
• Algorithm to perform the climate-aware portfolio
rebalancing shifting weights from bonds that are more
exposed to transition risk to bonds less exposed to
• Fig. 5 shows the consistency of the enhanced measure
of greenness: the higher GHG emissions or ESG risk,
the lower the greenness.
• Rebalacing with enhanced greeness allows for portfolio
decarbonization and reduction of ESG risk profile
Fig. 5: Consistency of the enhanced measure of greenness,
showing expected (negative) correlations with variables such
as scope 1, 2, 3 emissions and ESG risk.
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10. Portfolio and market impact
• We show that the ECB can reduce climate
transition risk in its portfolio under weaker
market neutrality defined as investing
proportionally to the amount outstanding in
eligible bonds by sector (CPRS 1, Figure 6)
Fig. 6: Changes in portfolio weights within fossil and
transportation sectors as a consequence of the rebalance.
Fig. 7 : Market impact of the rebalance (0.01=100bp). Red: outliers.
Grey box: boxplot of positive movements. Gold box: negative
movements. Delta=1: move from Engie to Iberdrola
• The market impact of the rebalancing on bonds
held would be limited (average close to zero. Fig.
7) but can be larger for individual securities:
• Delta: amount moved from more to less exposed
bonds. Positive, net movement.
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11. Effective portfolio rebalancing
requires economic policies
• Market structure is still a constraint for
portfolio rebalancing, also under weaker
market neutrality, (Figure 5), see fossil
and blue bars by country (nothing
greener than OMV to buy in the same
sector in AT)
• Thus, greening monetary policy alone
would not suffice. Economic policy are
needed for structural change in the
economy and market
Figure 8: Exposure of the ECB portfolio by country of domicile and CPRS
Main, after reclassification.
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12. Take away messages
• Quantifying carbon stranded assets and their materiiality for finance is crucial
to inform decision making (investors, financial supervisors, etc). European
financial supervisors moved fast to meet the new challenge
• However, being aware of the methodological challenges, and addressing
them, is fundamental to avoid the underestimation of risks and
opportunties in the transition
• 2022, EDHEC-Risk and Climate Impact Institute (ERCII): research on
finance impact on climate mitigation and adaptation.
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13. References
Battiston S., Mandel A, Monasterolo I., Schuetze F. & G. Visentin (2017). A Climate stress-test
of the EU financial system. Nature Climate Change, 7, 283–288.
Battiston, S., Monasterolo, I., van Ruijven, B., Krey, V. (2022). Mapping economic activities into
climate scenarios and transition risk classes: the NACE-CPRS-IAM classification Technical
report to the NGFS 2022 scenario report.
Bressan, G., Monasterolo, I, Battiston, S. (2022). Sustainable investing and climate transition
risk: a portfolio rebalancing approach. Journal of Portfolio Management, Special issue “Novel
Risks”, forth. (previous version available at SSRN: abstract=3770192)
CERES (2020): Financing a net-zero economy: measuring and addressing climate risks for
banks. Report available at: https://bit.ly/3B850Jp
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