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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
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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
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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
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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
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Manual
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Manual
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CARIMA concept
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Carbon Risk Factor BMG – Return
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Carbon Risk Factor BMG – cumulative returns
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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
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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
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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
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Manual
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Determination of the Carbon Beta for different asset classes
Equity
Corporate Bonds
Funds
Portfolios
Loans
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Excel Tool – Table of Contents
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Excel-Tool – Imprint
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Excel-Tool – Carbon Risk Factor BMG
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Excel-Tool – BMG
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Excel-Tool – Risk Factors
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Excel-Tool – Asset Returns
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Excel-Tool – Equity
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Excel-Tool – Equity
1 2
3
4
5
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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
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Equity
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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
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Corporate bonds
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Idea: Carbon Betas of corporate bonds based on the Merton model
Equity
Debt
Assets
LiabilitiesAssets Balance Sheet
Carbon Beta
Carbon Beta
Carbon Beta
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Carbon risk in loans – Principle
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Points of contact in practice
Quantification of the Carbon Beta on portfolio level possible top-down and bottom-up
Identification of green and brown portfolios
Selection criterion for investments
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
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Portfolios
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Points of contact in practice
Quantification of the Carbon Beta on fund level top-down and bottom-up
Identification of green and brown funds
Selection criterion for investments
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
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Funds
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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
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Manual
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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
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Determining the carbon risk at country level
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Determining the carbon risk at sector level
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Points of contact in practice Precise management of the carbon risk in
portfolios Construction of carbon risk neutral portfolios
Exemplary evaluation in the Excel ToolSteps
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
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Management and hedging of carbon risks
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Points of contact in practice Composition of indices and benchmarks Implementation of investment strategies
Exemplary evaluation in the Excel ToolSteps
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
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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
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Points of contact in practice Construction of a multi-factor strategy Consideration of carbon risks in conventional
strategies
Exemplary evaluation in the Excel ToolSteps
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
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Factor Investing taking carbon risks into account
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Points of contact in practice
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
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A "brown" portfolio under stress test (Carbon Beta = 1)
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Manual
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Manual
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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
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Which questions do you have concerning CARIMA?