Bulletin No. 248, article 7. Investment funds are exposed to the risks associated with climate change, and especially to transition risks. There are two possible channels of transmission: a fall in the value of the financial assets in fund portfolios (notably “brown assets” which are those issued by companies carrying out activities that are bad for the climate); and investor outflows caused by changes in investor behaviour in response to climate challenges. French funds steadily sold off certain types of brown assets between 2011 and late 2022, and appear to be less exposed to climate risks than their European peers. However, climate risks remain significant and still pose a threat to numerous funds, as an average of 24% of portfolio assets were still brown at the end of 2022. This relatively high share of brown assets also affects the climate risk exposure of financial actors holding shares in these funds (e.g. insurers).
1 Climate change poses a risk to financial stability
Climate change is a source of numerous financial risks and could therefore be a major threat to financial stability (Allen et al., 2021; Bolton et al., 2020). It notably increases the probability of a fall in the value of a large range of financial assets (i.e. market risk; Carney, 2015) due to a failure by investors to anticipate policy and regulatory changes and the rise in climatic hazards. Physical climate risks refer to the effects on economic actors (and, indirectly, on financial actors) caused by the physical consequences of climate change, such as extreme weather events. Transition climate risks are the potential effects of changes in: (i) consumer and investor preferences; (ii) technology; and (iii) public policies, for example changes in regulations or the introduction of a carbon tax (G20 Green Finance Study Group, 2017; NGFS, 2019). These costs can affect the productive capital of highly polluting firms, as well as their order books, their ability to obtain financing and their competitiveness.
The multifaceted nature of climate risks, the uncertainty over their magnitude and timing, and the difficulty in estimating their impact on economic agents can cause financial players and markets to misjudge the severity of the threat (IMF, 2020; NGFS, 2022). To protect themselves, financial institutions will seek to lower their exposure to securities issued by or loans granted to highly polluting firms (“brown assets”), and guide them with their transformation. They may also try to allocate more funding to assets that are better aligned with ecological transition targets (“green assets”), although this allocation shift is not strictly speaking part of a risk management approach. Accordingly, in July 2019, French financial players agreed to gradually phase out the financing of thermal coal and, more generally, to develop strategies consistent with a target of net zero by 2050.
This article focuses on the exposure of French investment funds to transition risks. These risks can affect investment funds via two channels: a fall in the value of the financial assets in their portfolios that are linked to brown activities or issuers; and sudden outflows as investors alter their investment behaviour after reassessing the severity of the climate risks. Given investment funds’ size and their key role in financial intermediation, their exposure to climate risks could have systemic consequences for the financial system (see Box 1).