carbon risk management (carima) rollout conference · excel-tool – carbon risk factor bmg....

Carbon Risk Management (CARIMA)

Rollout Conference

2nd July, 2019, Frankfurt am Main

Marco Wilkens, Maximilian Görgen, Andrea Jacob, Martin NerlingerUniversity of Augsburg

Bernd Wagner, Henrik Ohlsen, Sven RemerVfU e.V.

Frankfurt – 2nd July, 2019 University of Augsburg & VfU2

Change in society, politics, and economy necessary Transition process of the economy

Sources: NOAA, NASA, UK Met Office/CRU (2017); climate.nasa.gov (2018); Rogelj et al. (2016); IPCC (2018)

Temperature anomalyincreases steadily

CO2 concentration in the atmosphererises rapidly

Climate Change and CO2 concentration in the atmosphere


Current and future firm values depend on the expected development of the transition process of

the economy towards a Green Economy

This is associated with uncertainty

− Uncertainty concerning the speed of the transition process

− Uncertainty concerning the direction of the transition process

Risks and opportunities for firm values and respective financial assets result from this

Various new agreements and legislation

Sources: NY Times (2009), EEA (2015), thenation.com (2015), unepfi.org (2017), Fossil Free (2018)

e.g., Paris Agreement e.g., Divestment movement e.g., Emissions certificates

Transition process of the economy creates "Carbon Risks and Opportunities"

Changing economic framework conditions

Shift of interests


Concrete aim: Make these financial opportunities and risks for firms, investors, politics, and society

transparent, quantifiable, and manageable

Overarching aim: Support the societal transition process of the economy from a Brown Economy

to a Green Economy

supports the 2°C target

contributes to an optimal transition of the economy for society

contributes to the prevention of unnecessary societal welfare losses

BMBF Project CARIMA – Definition Carbon Risk and aim

Definition Carbon Risk: Risks (and opportunities) for the values of financial assets and portfolios,

which are the result of the uncertainties of the transition process from a carbon-intensive, brown

economy to a low-carbon, green economy


Title: 'Carbon Risks' and 'Financed Emissions' of Financial Assets and Portfolios – Measurement, Management and Reporting based on Capital Market Data

Website https://carima-project.de/en (e.g., literature database)

Interviews with asset managers and experts from the financial sector

Workshop with sustainability experts

Workshop with asset managers

Review-loops with financial professionals

Manual and accompanying Excel Tool

Working Paper „Carbon Risk“ and practical-oriented articles

BMBF Project CARIMA – Overview

Modules year 2017 2018 2019

calendar month 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8

Module 1 Building the knowledge base

Module 2 Development of the CARIMA concept

Module 3 Systematic involvement of practice in the CARIMA concept development

Module 4 Presentation, distribution, and diffusion of CARIMA

https://carima-project.de/en


Manual


CARIMA concept


Carbon Risk Factor BMG – Return


Carbon Risk Factor BMG – cumulative returns


Use of the Carbon Risk Factor BMG is possible in addition to all traditional factor models The

result is the Carbon Beta as a measure of Carbon Risk

Preconditions for the calculation of the Carbon Beta via CARIMA (e.g., of the Siemens stock)

- Time series of the historical returns has to be available (here of the Siemens stock)

- Time series of all factors of the chosen factor model have to be available (freely available on the

internet, incl. our Carbon Risk Factor BMG)

- One (single) regression has to be performed Carbon Beta of the Siemens stock

Factor Model

Example: Carhart Model Carbon Risk FactorBrown-minus-Green

Carbon BetaExample: CAPM


Carbon Betas of stocks – Interpretation

stocks Carbon Beta

Gazprom 1.58

BP 1.13

Tata Motors 0.73

IBM 0.10

Adobe -0.04

Johnson&Johnson -0.08

Philips -0.50

Toyota -0.93

Vestas -2.34

Carbon Beta >> 0Stock value decreases in comparison to other stocks if transition process is unexpectedly

successful

Carbon Beta << 0Stock value increases in comparison to other stocks if transition process is unexpectedly

successful

Carbon Beta ≈ 0Transition process influences stock value on

average


Which type of return is used in the regression model?

− Discrete vs. continuous returns

− Total returns (Total Return Index) vs. „simple" returns (Price Index)

How large is the ideal length of the time period of the historical returns for the estimation of the

Carbon Beta?

− More stable estimation of the beta factors vs. potential biases due to structural breaks

Should monthly or daily return data be used for the estimation of the Carbon Beta?

− More stable estimation of the beta factors vs. potential biases in the daily return data gathering

Which risk-free interest rate should be used for the calculation of the excess returns?

Which investment universe is assumed for the regression model?

− Global vs. regional vs. sector specific factors

Which currency for the historical returns is used in the regression model?

Practical determination of the Carbon Beta with the Carbon Risk Factor BMG


Manual


Determination of the Carbon Beta for different asset classes

Equity

Corporate Bonds

Funds

Portfolios

Loans


Excel Tool – Table of Contents


Excel-Tool – Imprint


Excel-Tool – Carbon Risk Factor BMG


Excel-Tool – BMG


Excel-Tool – Risk Factors


Excel-Tool – Asset Returns


Excel-Tool – Equity


Excel-Tool – Equity

1 2

3

4

5


Points of contact in practice Determination of the carbon risk of single

stocks Comparative analysis of the carbon risks of

different stocks

Exemplary evaluation in the Excel ToolPrinciple Calculation of the Carbon Beta per stock

eri,t = αi + 𝛽𝛽𝑖𝑖𝑚𝑚𝑚𝑚𝑚𝑚 erM,t + 𝛽𝛽𝑖𝑖𝑠𝑠𝑚𝑚𝑠𝑠 SMBt + 𝛽𝛽𝑖𝑖ℎ𝑚𝑚𝑚𝑚 HMLt + 𝛽𝛽𝑖𝑖𝑤𝑤𝑚𝑚𝑚𝑚 WMLt + 𝜷𝜷𝒊𝒊

𝒃𝒃𝒃𝒃𝒃𝒃 BMGt + εi,t

Result: Carbon Beta as risk measure on single-stock level

Equity

Variations/Extension possibilities Risk measure in addition to existing key figures,

e.g. carbon footprint


Equity


Points of contact in practice

Quantification of the Carbon Beta on corporate bond level

Identification of green and brown bonds

Selection criterion for investments

Exemplary evaluation in the Excel ToolPrinciple Calculation of the Carbon Beta for corporate

bonds with regression model

eri,t = αi + 𝛽𝛽𝑖𝑖𝑚𝑚𝑚𝑚𝑚𝑚 erM,t +𝛽𝛽𝑖𝑖𝑠𝑠𝑚𝑚𝑠𝑠 SMBt + 𝛽𝛽𝑖𝑖ℎ𝑚𝑚𝑚𝑚 HMLt

+𝛽𝛽𝑖𝑖𝑚𝑚𝑡𝑡𝑡𝑡𝑚𝑚 Termt + 𝛽𝛽𝑖𝑖𝑑𝑑𝑡𝑡𝑑𝑑 Deft + 𝜷𝜷𝒊𝒊

𝒃𝒃𝒃𝒃𝒃𝒃 BMGt + εi,t

Result: Carbon Betas for corporate bonds

Corporate bonds

Variations/Extension possibilities Application of Merton model possible


Corporate bonds


Idea: Carbon Betas of corporate bonds based on the Merton model

Equity

Debt

Assets

LiabilitiesAssets Balance Sheet

Carbon Beta

Carbon Beta

Carbon Beta


Carbon risk in loans – Principle



Quantification of the Carbon Beta on portfolio level possible top-down and bottom-up

Identification of green and brown portfolios


Exemplary evaluation in the Excel ToolPrinciple Calculation of the Carbon Beta from the return

time series per portfolio

erp,t = αp + 𝛽𝛽𝑝𝑝𝑚𝑚𝑚𝑚𝑚𝑚 erM,t + 𝛽𝛽𝑝𝑝𝑠𝑠𝑚𝑚𝑠𝑠 SMBt + 𝛽𝛽𝑝𝑝ℎ𝑚𝑚𝑚𝑚 HMLt + 𝛽𝛽𝑝𝑝𝑤𝑤𝑚𝑚𝑚𝑚 WMLt + 𝜷𝜷𝒑𝒑

𝒃𝒃𝒃𝒃𝒃𝒃 BMGt + εp,t

Result: Carbon Betas for portfolios

Portfolios

Variations/Extension possibilities Determination of the contribution of single

stocks to the carbon risk of the portfolio


Portfolios



Quantification of the Carbon Beta on fund level top-down and bottom-up

Identification of green and brown funds


Exemplary evaluation in the Excel ToolPrinciple Calculation of the Carbon Beta from the return

time series per fund, e.g.:

erf,t = αf + 𝛽𝛽𝑑𝑑𝑚𝑚𝑚𝑚𝑚𝑚 erM,t +𝛽𝛽𝑑𝑑𝑠𝑠𝑚𝑚𝑠𝑠 SMBt + 𝛽𝛽𝑑𝑑ℎ𝑚𝑚𝑚𝑚 HMLt + 𝛽𝛽𝑑𝑑𝑤𝑤𝑚𝑚𝑚𝑚 WMLt + 𝜷𝜷𝒇𝒇

𝒃𝒃𝒃𝒃𝒃𝒃 BMGt + εf,t

Result: Carbon Betas for funds

Funds

Variations/Extension possibilities Implementation for bond and balanced funds


Funds


Equity funds Carbon Beta

US Global Investors World Precious Minerals 2.60

Rydex Variable Trust Dow 2x Strategy 0.85

iShares MSCI World ETF 0.02

LO Funds Generation -0.02

iShares Global Clean Energy ETF -0.15

RobecoSAM Sustainable EE -0.16

UniNachhaltig Aktien Global -0.16

Triodos Sustainable Equity -0.20

ProShares UltraShort Oil & Gas -1.92

Carbon Betas of equity funds

Carbon Beta identifies green and brown funds

Carbon Beta >> 0Fund reacts negatively if transition process is unexpectedly successful

Carbon Beta << 0Fund reacts positively if transition process is unexpectedly successful

Carbon Beta ≈ 0Fund reacts on average if transition process is unexpectedly successful


Manual


Points of contact in practice Analysis of political measures Analysis and comparison of portfolio allocation

strategies

Exemplary evaluation in the Excel ToolSteps

Step 1: Specify the country/sector to be analyzed

Step 2: Select the relevant stocks per country/sector

Step 3: Determine the Carbon Beta per stock

Step 4: Aggregate all Carbon Betas within a country/sector

Step 5: Illustrate the Carbon Betas graphically using, e.g., maps or box-and-whisker plots

Step 6: Analyze country-/sector-specific Carbon Betas and derive appropriate measures

Determining the carbon risk at country and sector level


Determining the carbon risk at country level


Determining the carbon risk at sector level


Points of contact in practice Precise management of the carbon risk in

portfolios Construction of carbon risk neutral portfolios


Step 1: Select the portfolio whose carbon risk is to be managed

Step 2: Determine the desired carbon risk level of the portfolio

Step 3: Determine the Carbon Betas of potential portfolios

Step 4: Compare potential portfolios and select one with the desired strategy

Step 5: Implement the selected strategy

Management and hedging of carbon risks


Management and hedging of carbon risks


Points of contact in practice Composition of indices and benchmarks Implementation of investment strategies


Step 1: Define the investment universe

Step 2: Select the investment strategy

Step 3: Determine the Carbon Betas at stock level

Step 4: Compile the Best-in-class and Worst-in-class portfolios based on a defined threshold value

Step 5: Implement the investment strategy

Best-in-class approach based on the Carbon Beta


Sharpe Ratio: risk normalized performance measure calculated as the ratio of the excess return of an asset and the return volatility of the asset

Best-in-class approach based on the Carbon Beta


Points of contact in practice Construction of a multi-factor strategy Consideration of carbon risks in conventional

strategies


Step 1: Determine all factor betas for all stocks

Step 2: Select the factor strategy

Step 3: Implement the factor strategy based on portfolio formation

Step 4: Classify the portfolios into "brown" and "green" based on the Carbon Betas

Step 5: Implement the investment strategy

Factor Investing taking carbon risks into account


Factor Investing taking carbon risks into account



Use in risk measurement

Illustration of the effects of carbon risk on portfolio value

Risk-bearing capacity of portfolios

Exemplary evaluationPrinciple Scenario and sensitivity analyses, e.g. via

historical simulation Instrument of risk management

Result: Information on the sensitivity of the portfolio on events, for example

A "brown" portfolio under stress test (Carbon Beta = 1)

Variations/Extension possibilities Determination of hedging strategies Analysis of the market carbon risk


A "brown" portfolio under stress test (Carbon Beta = 1)


Manual


Do portfolios become riskier due to Divestment?

How can carbon risks in derivative financial instruments be determined?

How risky are Low Carbon Benchmarks?

− Reference to EU Action Plan (European Commission, 2018)

− Progress Report of the Technical Expert Group regarding climate benchmarks (EU Technical

Expert Group on Sustainable Finance, 2019)

How high are the expected returns of green vs. brown firms?

How can carbon risks and financed emissions be optimized simultaneously in portfolio

management?

CARIMA as a political indicator?

Outlook on further applications of CARIMA


Which questions do you have concerning CARIMA?

carbon risk management (carima) rollout conference · excel-tool – carbon risk factor bmg....

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