Costs and Uncertainty Climb as Markets Price in Climate Risk

Bloomberg:

For years, climate experts have insisted that markets will naturally push companies to take climate change more seriously as risks become more apparent. Fresh research indicates that borrowers are now starting to face a financial penalty for ignoring the dangers ahead.

This month, a paper published by the European Central Bank found that banks with the greatest so-called transition risks now “face significantly higher borrowing costs” in funding markets. That followed a December paper by analysts at the Central Bank of Ireland, which showed that companies facing physical climate risks are in a similar predicament, and will need to provide more collateral.

The studies examined the two main ways companies should, theoretically, feel the pain of global warming. Transition risk — the notion that companies slow to cut high-carbon activities will be punished by regulators and markets — has often seemed difficult to quantify, in part because many governments keep delaying efforts to move toward net zero emissions. But physical risk — which covers the real-world impact that extreme weather has on assets such as buildings — is getting harder to ignore as climate disasters mount.

“These papers illustrate well how the economics of the transition is working on a micro-, day-to-day level in the financial system,” said Ulf Erlandsson, chief executive of the Anthropocene Fixed Income Institute.

Margherita Giuzio, a senior economist at the ECB, along with Bige Kahraman and Jasper Knyphausen of the Oxford Saïd Business School, explored how banks’ exposure to carbon-intensive borrowers affects funding costs in the European repo market. (The repo market allows banks to manage short-term cash by selling and then buying back high-quality securities such as government bonds, often overnight.)

The researchers combined data on European banks’ 2019-2022 repo borrowings with information on their financed emissions (the carbon footprint of firms’ capital allocations). They found that banks with higher financed emissions consistently pay more to borrow on the repo market. Specifically, an increase of one standard deviation in financed emissions translates into repo rates that are 7% to 12% higher on average, they said.

The study “provides the first evidence that climate risks affect the pricing of bank liquidity in Europe’s core funding market and highlights how climate transition risks can amplify financial fragilities and interplay with monetary policy transmission,” the researchers wrote.

European Central Bank:

This paper examines how climate transition risks — particularly banks’ exposure to carbon- intensive borrowers — affect short-term funding costs in the European repo market. The repo market is the backbone of bank liquidity and a core channel for transmitting central bank policy rates. It is generally considered one of the safest financial markets, given the short maturities and collateralized nature of transactions. Our findings show, however, that even here climate risks are priced in, with meaningful consequences for financial stability and monetary policy.

Using transaction-level data from 2019–2022, we combine information on European banks’ repo borrowing with data on their “financed emissions,” that is, the greenhouse gas emissions of the firms they lend to. We find that banks with higher financed emissions consistently pay higher borrowing rates in the repo market. Quantitatively, a one standard deviation increase in financed emissions translates into repo rates that are 7–12% higher, on average. This “car- bon premium” cannot be explained by usual drivers of repo pricing, such as collateral quality, transaction maturity, or counterparty relationships.

Wall Street Journal:

John Simeone was sure his vacation condo, nestled in New Hampshire’s White Mountains, would sell easily. Then the listing went live in August: “It was like a bolt of lightning hit me in the head.”

The three-bedroom townhouse in Lincoln, N.H., was labeled on the home-listing site Zillow as an “extreme” 9 out of 10 flood risk.

Simeone was shocked. The home is around 60 feet above the nearest river, and the flood rating shown on Zillow linked to a report with a different address.

He thinks the rating spooked buyers. Despite a price cut, his $769,000 home remains unsold. 

Millions of home sellers and buyers are caught in the battle over how to rate a home’s exposure to natural disasters—and who gets to see that information. 

Until November, all the major listing platforms showcased scores from First Street, a small but influential climate-research company. It rates homes by their vulnerability to wildfire, flood, wind, heat and poor air quality.

A backlash from the real-estate industry prompted Zillow in November to remove the scores from display, while still allowing buyers to click through to the data. Other listings sites still show the scores, but some will suppress them if a seller objects. The flood score for Simeone’s home no longer appears on Redfin or Realtor.com at his request.

A very high flood or fire score makes a house less likely to sell, according to a Zillow analysis last year. It can also create a “disaster discount,” with high-scored homes that do sell more likely to go for under the initial list price, the analysis found.

Home buyers are especially attuned to how climate change is unleashing disasterswith unexpected frequency, location and intensity. With the housing market shifting in their favor, they can avoid homes with high risk scores or use the warnings to negotiate lower prices.

Some sellers have said that their First Street scores can be inaccurate and difficult to change.