giovedì 19 aprile 2018

Written by Alberto Parigi

The issue of climate change has led politicians, economists and companies to a new awareness of the impacts that policies and business plans can have on the environment. In the last few years we have seen a soaring in the number of advertisements and congress about the sustainability of a certain product or policy. The growing sensibility of the public opinion to those topics has created an opportunity for the financial world.  Banks, Investments Funds and Public Institutions have started to create new products that fit the necessity of investing in projects and companies that are prone to create a greener world. Green bonds, Environmental Asset Management are wide spreading among the financial world and not only.
This growing awareness of the environmental and social problems that climate change creates led the UN to create in 2014 a coalition of institutional investors that are committed to create a carbon-free financial market. This coalition of Companies and Funds is called Portfoglio Decarbonization Coalition.

What is Portfoglio Decarbonization?

As we can read from the website of the United Nation Environment Programme the Portfoglio Decarbonization consists in “withdrawing capital from particularly carbon-intensive companies, projects and technologies in each sector and by re-investing that capital into particularly carbon-efficient companies, projects, and technologies of the same sector”, so this program doesn’t aim to an immediate change of the investor’s policies but wants to empower the sensibility of the financial world to the issue that carbon exploitation generates in the ecosystem.

Which companies and investment funds are taking part? And why?

The Portfolio Decarbonization Coalition was founded in 2014 and since that year it has started to gain new members every year. At the end of 2017 (last data available) the coalition was counting 28 asset owner and asset manager signatories, representing over 3 trillion US dollars in assets under management. Among those investors there are companies such as Allianz, Amundi and BNP Paribas which are respectively 3 of the biggest Insurance company, Investment Fund and Bank worldwide.
The key motivation of why those companies are switching to decarbonization is financial. A survey made among the participants finds out that the reduction of the portfolio exposure to greenhouse gas emissions and carbon-intensive industries is seen by them as a means of strategic risk mitigation.
This response is extremely important because it means that being involved in sustainable finance is not only good for the planet but also for the wallet.

Perspectives and results

The best way to analyze the results of this program consists in tracking the CO2 footprint per euro invested, this means that if a company is investing in carbon and oil the ratio will probably be extremely high.  The last research made by the UN shows that among the participants of the Coalition the CO2 ratio has decreased up to a maximum of 37.5% (FRR Pension Fund).  It is important to say that this project has just started and the biggest results are expected to arrive in the next future. Now the UN is trying to convince most of Investment Fund to switch to a transitional decarbonization to raise the awareness of the financial markets.
The economical results of Portfoglio Decarbonization are not evident. This absence of information is unsurprising given that portfolio decarbonization is a novel activity, and that the financial benefits
are expected to be achieved over the longer rather than the shorter term.
Nonetheless there are important insight that can be drawn from the experience. The first insight is that decarbonized portfoglio offers potentially significant long-term benefits, thanks to a reduction of the correlation between the investments and the climate change-related regulation.  Secondly, from an ethical point of view, the investors can achieve the same performance than before with a low CO2-footprint investment contributing to aware the financial world to the issues of the climate-change.

To sum up it is possible to say that the Coalition has set a milestone for the future of the sustainable finance, however there is limited information on how the efforts of PDC (Portfoglio Decarbonization) are affecting the real economy, up to now the best result that has been achieved using the words of Thibaud Clisson (BNP Paribas), is that the investors and managers are far more aware of the climate impact of their choices than before.

martedì 17 aprile 2018

Written by Massimo Campi

Perfect competition, the Promised Land of every young microeconomics student. Until they learn about negative externalities: a damage caused by the actions of an individual with whom the damaged party has not had any economic transaction. Put it simple: somebody is bearing the burden of negative effects stemming from someone else’s actions.
From academic theory to real life the leap is short, the most evident example being pollution arising from industrial production. And the question immediately becomes: is there a way to limit negative externalities, like pollution? The answer, as we know, is yes. What few people know, though, is that such ways to deal with pollution can arise from the most capitalistic industry in the world: finance.
Does this mean that finance people working in bulge bracket investment banks are more attentive to switch off the lights when leaving the office or even that they prefere using public transports rather than a luxury car? Not really. In this case finance is just the means used by Governments to reduce negative externalities. In particular, the reference is to a relatively new type of financial instruments like white certificates (also called Energy Savings Certificate or Energy Efficiency Credit).


What is the connection between white certificates and pollution? One of the main sources of air pollution is known to result from the burning of fossils fuels to produce electricity. When a Government’s target is the reduction of air pollution it can therefore intervene on electricity consumption, for example by setting a minimum level of electricity saving that electricity distributors must guarantee in a specific year with reference to a baseline. Which means that the Government requires the electricity providers to find a way to reduce electricity consumption by the public; an example could be by providing the public incentives to substitute old applinces with new, more efficient ones. And here comes the role of white certificates: when an electricity provider meets the electricity savings target, it is given a white certificate. The larger the amount of electricity savings with respect to the target, the higher number of white certificates the electricity distributor is given.
What makes white certificates innovative, though, is that they can be traded, similarly to securities. What happens in fact is that while some electricity provider meet the target, some others do not and therefore incur in the payment of heavy penalties unless they buy white certificates from those who obtained them.

The incentives towards the implementation of electricity saving technologies is twofold: from one hand distributors would try to avoid paying huge penalties, from the other hand virtuous distributors would be able to sell white certificates and cash in the price. Also, there exist white certificates with the same characteristics for gas and fossil fuels providers, industrial companies, etc., thus enlarging the possible beneficial impact of the certificates.


Now, coming from theory to reality, do white certificates have a real impact on limiting pollution?
The answer is not easy and straighforward, but some figures might help understanding. First, volumes and prices of white certificates have increased since 2005 (the year in which they were introduced in Italy, the first country ever adopting white certificates). While at that time a white certificate was traded at an average price close to the face value of 100 €, nowadays a white certificate price is roughly 300 €. More certificates outstanding probably means more electricity/gas/fuel have been saved, while higher prices are a bit more complicated to interpret. With reference to the number of certificates that have been assigned to distributors, the graph below sums up the key trends:

The graph comprises figures reported by GSE, the publicly owned entity that supervises the activities in the energy industry in Italy. Clearly, the number of certificates issued (in red) in 2017 is much higher than in 2005, which is a positive sign of the interest in green technologies by electricity and gas providers, even though the trend has not alway been upward and only half the times the target (in green) hoped by the regulator has been met.
What may arise a bit of concern, instead, is the actual amount of energy that has been saved (measured in Ktep, a specific unit of measure for the purpose) thanks to white certificates according to ex-post estimates (in blue). This means that the new projects to save energy thanks to which electricity and gas companies have been rewarded white certificates has actually underperformed during the last years in terms of efficiency delivered.
Moreover, the increase in price of white certificates may be problematic as well. Before discussing the effects of such increase, a brief look at the causes may be interesting. First, the market for white certificates is structured by the regulator in order to seldom have more offer than demand, thus pushing price up; second, there might be opportunistic and speculative behaviour taking palce, but according to some studies by GSE this is unlikely; finally, it seems that the reason for such an increase may lie in the new regulations which restricts the kind of projects that can be considered valid for the assignment of white certificates, thus making less easy to obtain them.
The effects of an increase in price are different, the most evident ones being the higher degree of financial risk for those companies who do not comply with the energy saving standards, and the impact on cost of consuming electricity for a typical family. The increase of price in white certificates, indeed, is expected to be transferred to final consumers of electricity and gas through higher bills according to GSE. However, this is something that cannot last long when the reduction in energy saving witnessed in the last years is taken into consideration. So apparently in the short term families are going to pay higher costs for utilities without having a sufficient improvement in efficiency.


So, are white certificates another example of public intervention contributing to a more efficient market when in presence of negative externalities? The answer is probably positive, considering the overall results achieved so far, but still the above mentioned issues must be addressed by the regulator in order to obtain the best results.

The most problematic issue is probably the one related to a possible increase in costs for electricity and gas consumes for families, which could potentially counterbalance the social benefits gained on the environmental side. Furthermore, a better matching of actual energy savings and assignment of white certificates could be performed, as shown in the graph.
Nevertheless it is true that white certificates are relatively young and still retain a lot of potential for further improvements as a means to limit pollution. Moreover, a good point in favour of white certificates is that no public expense is required, while private sectors participation is encouraged. Finally, probably one of their best features is that while the reguator defines the participants and the rules, the market decides which techonologies to develop, thus stimulating creativity to deal with environmental issues.