The 25th United Nations Climate Conference (COP 25) has just ended in Madrid without any significant progress in international coordination to combat global warming. But climate change is
ever more in evidence, as shown by the increase in natural disasters in 2019 and the preceding years. The decade 2010-2019 has been the hottest since meteorological records began in 1850.

Despite this irrefutable scientific evidence – to the dismay of climate sceptics – the growing mobilization of civil society, especially young people, and the declarations of intent by major corporations, business-as-usual still holds sway and the prospect of limiting global warming to 2°C at the end of the century is becoming ever more in doubt. To help counter this worrying trajectory, top-quality scientific research is essential and should be further pursued.

At the Institut Louis Bachelier (ILB), our ambition is to contribute to sustainable growth and finance through French scientific research of excellence, under the guiding principle “Together, we seek answers for a world in transition”. There is no doubt that climate change is the greatest challenge of facing the world in 21st century and that it cannot be overcome without strong synergies. It was in this context that the interdisciplinary Green and Sustainable Finance programme was launched in 2018. Its objective is to bring together the French and foreign academic community on issues related to the financing of the environmental transition. It is also able to draw on the many research projects carried out by Chairs hosted at the ILB, such as the Climate Economics Chair, the Sustainable Finance and Responsible Investment Chair, the Finance and Sustainable Development Chair and the Energy and Prosperity Chair.

This new issue of Cahiers Louis Bachelier provides an overview of some of the recommendations offered by scientific research for achieving a low-carbon transition and sustainable finance. It opens with an important interview with Christian de Perthuis, who discusses his recently published book Le tic-tac de l’horloge climatique. The second article is devoted to the work on carbon pricing by Christian Gollier, who also published a landmark book this year: Le climat après la fin du mois. The third article summarizes the book Detox Finance, by Stéphane Voisin and Jean-Baptiste Bellon, which offers a number of noteworthy solutions for making finance greener and more sustainable. The fourth and final article looks at Peter Tankov’s work on the lack of reliable data for financially assessing physical climate risks.

Enjoy your reading!

Ryadh Benlahrech, editor-in-chief of Cahiers Louis Bachelier


Despite the promises made after the conclusion of the Paris Climate Agreement in 2015, which was ratified by more than 180 countries, it has to be said that the joint efforts to limit global warming are falling far short of the scientific recommendations. Worse still, instead of diminishing, greenhouse gas (GHG) emissions are setting new records. For example, the concentration of GHGs in the atmosphere (total emissions less absorption by natural carbon sinks) was the highest ever in 2018, according to the World Meteorological Organization (WMO). Other studies, some more alarming than others, suggest that there is a limited time in which to reverse this dangerous trend for the future of the planet and future generations. It was in this context that Christian de Perthuis wrote his book Le tic-tac de l’horloge climatique, published by De Boeck. In the book he clearly analyses and sums up the main issues in relation to global warming and the implementation of the low-carbon transition. So without further delay, let’s move on to the interview.


ILB : The title of your book refers to the ticking climate clock. Could you elaborate on this sense of urgency?

Christian de Perthuis : It must be understood that the driving force behind global warming is the increase in the stock of greenhouse gases in the atmosphere. This amount changes in accordance with two main parameters: the incoming flow (the level of greenhouse gas emissions); and the outgoing flow, resulting from the elimination of non-CO2 gases at the end of their life and the carbon sinks that absorb CO2 present in the atmosphere. The stock of GHGs has a very high inertia in relation to these flows and therefore to the system’s reactions to climate policies.
When climate scientists model the time remaining, they calculate an overall carbon budget. This budget represents the cumulative quantities of CO2 released into the atmosphere, giving a two-thirds probability of limiting global warming to 1.5 or to 2 degrees Celsius. At the current level of emissions (2018 figures), we have fewer than 20 years left to limit global warming to 2 degrees and only 10 years to limit it to 1.5 degrees. The urgency regarding the climate is not a matter of predicting the end of the world, but refers to the very little time remaining to stabilize emissions and thus achieve carbon

Today, 80% of the world’s energy sources are of fossil origin.

The current situation stems from the various energy transitions that have taken place since the first industrial revolution. What has happened?

CdP : Très souvent, la question de la transition énergétique actuelle est abordée sous l’angle de l’augmentation des sources d’énergies renouvelables et des gains d’efficacité énergétique. Ce n’est qu’un volet du problème. La transition bas-carbone est différente de celles qui ont eu lieu depuis le début de la révolution industrielle. Historiquement, les nouvelles sources d’énergie se sont additionnées à celles préexistantes : au milieu du XXIe siècle, la quasi-majorité de l’énergie utilisée était la biomasse. Ensuite, le charbon est apparu sans faire disparaître la biomasse. Idem pour le pétrole et le gaz fossile, qui se sont ajoutés sans remplacer les sources existantes. C’est un schéma de l’empilement des différentes sources, qui a démultiplié l’accès à l’énergie et contribué à l’essor économique du siècle dernier. Aujourd’hui, 80 % des sources d’énergie utilisées dans le monde sont d’origine fossile. Elles constituent le premier facteur d’augmentation des émissions de gaz à effet de serre. Cette proportion est constante depuis les années 1970. La transition bas-carbone implique de sortir de cette logique de l’empilement des énergies en passant à une logique de substitution permettant de renoncer au plus vite aux trois produits que sont le charbon, le pétrole et le gaz.

Comment expliquer cette résistance des énergies fossiles ?

CdP : Very often, the issue of the present energy transition is addressed in terms of increasing renewable energy sources and energy efficiency. But that is only part of the problem. The
low-carbon transition is different from the other transitions that have occurred since the beginning of the industrial revolution. Historically, new energy sources have been added to those already in place. Thus in the mid-19th century, most of the energy used came from biomass. With the arrival of coal in the energy mix, biomass continued to be used. The same applies to oil and natural gas, which were added to the mix without replacing existing energy sources. The various energy sources have been stacked up, one on top of the other, and it is this process that has increased access to energy and contributed to the economic development of the past hundred years. Today, 80% of the world’s energy sources are of fossil origin, and these constitute the primary factor in the increase in greenhouse gas emissions. This proportion has been constant since the 1970s. The low-carbon transition entails moving away from the logic of stacking up energy sources and moving towards a logic of substitution, thereby ending the reliance on coal, oil and gas as quickly as possible

Conversely, how can we promote the growth of renewable energies?

CdP : The proportion of renewable energies will increase under all scenarios, even business as usual, thanks to lower production costs, electricity storage and smart grid information system management. The crucial question is not
the increase in renewables, but their capacity to rapidly drive fossil fuels out of the energy system and put an end to the stacking-up process described above. But to do so, it will be necessary to overcome the great inertia of fossil energy systems, which is reflected in the many assets dedicated to exploration and production, in transport and distribution networks (oil and gas pipelines) and even in end uses, the most striking examples of which are combustion engine-powered cars and oil boilers. These various forms of inertia extend the duration of the low-carbon transition.

In addition to speeding up the tempo and the exit from fossil fuels, what other factors are involved in the low-carbon transition?

CdP : The stakes vary from one society to another. There are three main groups of countries, each of which faces a different situation.

− Most of the old industrialized countries have passed their peak CO2 emissions. In Europe, this occurred in the early 1980s, after the first two oil shocks, and in the United States the decline in emissions began in 2005. In these countries, there needs to be rapid disinvestment in the various forms of fossil energy infrastructure. This process will necessarily involve costly restructuring, which could be higher than expected. Take, for example, the automotive sector, where electrification will increase: assembling electric vehicles requires only;

− The least developed countries need to increase their access to energy, as more than 50% of their population has no access to electricity and uses traditional cooking methods. In these countries, improving access to energy is therefore a priority, though not through the traditional pattern of stacking up fossil fuels. But it will be difficult for them to manage completely without fossil fuels, particularly for the rapid improvement of cooking systems, which often involves increased use of natural gas;

− Intermediate and emerging countries are already engaged in a historical catch-up process. The challenge here is to change the trajectory of highly carbon-intensive economic development. Since 1970, these countries have been driving the growth of carbon emissions. They will therefore also be the driving forces behind the low-carbon transition in the coming years and decades, particularly in Asia. There are still positive signals coming from China, which has been adapting its energy policy since 2012. India has also become a big investor in renewables, but not fast enough or to a sufficient extent, in that it is investing in green energy without reducing its reliance on fossil fuels, especially coal.

Having analysed the findings, let’s now discuss the solutions. You mention in particular the preservation of biodiversity and living carbon. What does this involve?

CdP : This is a fundamental point. Yet it is sidelined and downplayed in public policy considerations. Carbon neutrality involves speeding up the energy transition and improving the planet’s natural capacity to absorb CO2. This has two components:

– The oceans constitute the Earth’s primary carbon sink. However, there are growing signs that the oceanic carbon absorption pump is being altered by acidification and loss of biodiversity, as shown, for example, by the deterioration of coral reefs, an environment that is particularly rich in marine

−Agriculture and forestry, through the mechanism of photosynthesis, allow growing plants to store carbon. When there are fires and deforestation, the stored CO2 is released into the atmosphere, and is added to human emissions. Hence the need to preserve these natural resources. However, the main cause of deforestation is agriculture and livestock farming, whose production methods are not always environmentally responsible. The agricultural and forestry issue is therefore crucial. In this regard, agroecology and agroforestry would help to increase biodiversity and the storage capacity of soil.                                                      

Why is the agricultural and forestry issue so crucial?

CdP : The latest IPCC (Intergovernmental Panel on Climate Change) assessment report estimates that 25% of the world’s greenhouse gas emissions result from deforestation and agriculture. The latter is the main source of methane and nitrous oxide emissions, the two most important non-CO2 greenhouse gases. Here I see three main challenges:

− Improving carbon storage capacity in soils and plants through ecologically intensive agricultural methods;

− Adapting to the impacts of climate change, which are very significant on industrial agricultural methods. Agro-ecology would thus enable farmers to better resist the growing impact of climate change;

− Conserving biodiversity, which is threatened by climate change. Greater biodiversity slows climate change by storing more carbon, instead of releasing carbon when it is endangered. It is a matter of turning a vicious circle into a virtuous circle.

What is the situation regarding carbon taxation, given that it is struggling at the national level and even more so at the international level?

CdP : Carbon taxation only applies to the energy sector. A carbon price will not help manage the preservation of the Amazonian forest or change agricultural methods. In the energy system, the best way to avoid burning fossil fuels is to increase the cost of using them by taxing carbon. However, a carbon tax – or an emissions trading scheme – poses multiple distribution problems. In France, for example, carbon taxation imposes a greater burden on low-income households, whose fuel expenditure is proportionally higher than that of wealthier households. To raise the carbon price, it is essential to provide incentives through a higher price signal and redistribute some of the proceeds of the tax to households that are most affected or by financing alternatives for these communities, which are often located at some distance from city centres.
At the international level, an ambitious climate agreement would involve extending carbon taxation and redistributing the proceeds of the tax to countries in transition and to the least developed countries.

Climate policies appear to put mitigation and adaptation to climate change in opposition to each other, and the same applies to the local and national levels

CdP : The local level is fundamental in terms of adaptation to climate change. In the Mediterranean region, global warming is aggravating water stress. In Northern Europe, on the other hand, it increases the intensity of precipitation. Hence the importance of acting locally to increase resilience to the impacts of climate change and to gain the support of the population.
Regarding the mitigation of emissions, most of the solutions seek to influence day-to-day uses and ways of life in terms of housing, transport and food. Local management is therefore more relevant. Take the example of investment in charging stations for electric vehicles in France. These need to be increased in number and distributed in the most strategic places so as to create a dense geographical network. The right way to do this is not for the government to invest directly, but to send the right incentives to local authorities (with adequate financial resources) and to public and private operators

What options are there for obtaining a truly binding international agreement and linking emerging countries to the climate issue?

CdP : In the face of climate change, there is no single miracle solution. As a climate economist, I have long believed that carbon pricing is the most effective way of speeding up the low-carbon transition. Today, I think that the issue of climate justice is crucial. Global warming exacerbates inequalities, and has the greatest impact on people and nations that in many cases have been least responsible for the increase in emissions. That is why I have tried to define four criteria for a “fair” climate policy:

− Build climate policies on criteria for adapting to the impacts of climate change that remedy the inequality of citizens and
countries in the face of global warming;

− Establish an impartial MRV (Measuring, Reporting and Verification) system based on indisputable scientific information, to which all countries agree to submit. Progress in this area is very slow, especially in emerging countries;


− Enforce the polluter pays principle, which entails making the burden of the low-carbon transition fall first and foremost on greenhouse gas emitters;

− Redistribute a portion of the tax proceeds to populations and countries that are unable to finance the low-carbon transition. At the international level, this would call for much larger transfers than those currently envisaged, so as to reconcile climate change mitigation and economic development.

To conclude, is energy efficiency compatible with the existing growth model?

CdP : : Energy efficiency has often been put forward as a solution. But this ignores a basic economic principle, namely the rebound effect, which encourages people to consume more when there are improvements or efficiency gains. Consequently, even greater energy efficiency is then required. This situation calls into question lifestyles based on growth and consumerism. The climate emergency will force us to ask ourselves questions about the viability and sustainability of our overly individualistic consumerist societies. Solutions to climate change require cooperation between actors, not competition. The traditional rules of competition and trade policy will therefore have to be subordinated to the requirements of the low-carbon transition.

Watch Christian de Perthuis’ web TV in French


To limit global warming to two degrees Celsius by the end of the century, it will be necessary to put a price on carbon. The level and rate of growth of this price over time depend on expectations regarding the emergence of economically mature green technologies in the coming decades. The researcher Christian Gollier has developed an innovative model incorporating the main technological uncertainties into the determination of the evolution of the carbon price so that the climate objectives set by different countries can be achieved.


“Carbon pricing is essential for combatting climate change within the time-frame between now and 2050 with a view to meeting the targets set by the Paris Agreement, because carbon emissions will affect future generations”, Christian Gollier emphasizes. Furthermore, this economic instrument is particularly effective in promoting a low-carbon energy transition with the least impact on purchasing power. But implementing the transition will be far from easy and gives rise to various technical questions, quite apart from its acceptability to the public. At what price should a tonne of carbon be set? How fast should it increase each year? How are
macroeconomic and technological uncertainties to be incorporated into the pricing mechanism? What is the cost of the long-term damage caused by a tonne of carbon emitted into the atmosphere now? What are the social and private benefits of carbon pricing?

At present there is little consensus on these and other issues within the scientific community and on the part of the governments of the various countries. In France, for example, in early 2019 the Quinet 2 commission on the shadow price of carbon recommended applying an annual growth rate of 8% to the carbon price with a floor price of €69 in 2020. On that basis, a tonne of carbon would be priced at €775 in 2050 – twenty times the current level! In the United Kingdom, the Department for Business, Energy and Industrial Strategy estimates the growth rate per tonne of CO2 at 15% and a price of £13.84 in 2020, whereas in the United States, the figure is only 1.65% with a price of $42 per tonne in 2020. Given such disparities, it is difficult to address the issues mentioned above.

If the relevant technologies improve in the coming years, the fight against global warming would be less costly and would call for less effort today.


To make matters worse, there are two different methods for setting a carbon price:

− The first is a cost-benefit calculation based on the polluter pays principle. This has been used for the past twenty years and has been popularized by William Nordhaus, winner of the Nobel Prize in economics in 2018. This method presupposes that the price of carbon will be higher in the future, due to the greater concentration of carbon in the atmosphere and greater marginal damage in the long term. “This method is the first option, but it has many limitations. Most international negotiations are not based on a carbon price, but on each country limiting emissions over time, with a carbon budget for each region,” Christian Gollier says;

− The second is a cost-effective approach, with the aim of defining an optimal strategy for allocating the carbon budget over the next three decades, so that it is compatible with the objective of limiting global warming to 2 degrees. “This method has developed because the damage functions are very difficult to calculate in the long term, in particular estimating the damage in 30 years time of a tonne of CO2 released today. It is, in addition, better aligned with the Paris Agreement, which is also based on the quantity of emissions and not on a carbon price,” Christian Gollier explains. In his opinion, the outstanding question is whether to impose a high price immediately, or whether a lower price would be acceptable in the short term if it is compensated by a high price in the long term.


While both these calculation methods and the difference in carbon price growth rates present problems, the Intergovernmental Panel on Climate Change (IPCC) has also addressed this issue. On the basis of 356 different models, the average annual carbon price growth rate is 7.90%, a figure very close to the one calculated by the Quinet 2 commission in France. “According to Hotelling’s theory, the growth rate of the carbon price should be equal to the riskfree interest rate. But this theory does not take into account the major uncertainties mentioned above. Moreover, if the carbon price were to increase by 8% per year with certainty, investors would be happy to trade this carbon asset, which shows that it cannot be in equilibrium. But the IPCC models do not incorporate uncertainties,” Christian Gollier says. However, if the relevant technologies improve in the coming years, the fight against global warming would be less costly and would call for less effort today. “Technological uncertainty must be taken into account. So we need to review the Hotelling rule,” Christian Gollier says. In addition, calculating a growth rate for the carbon price taking into account uncertainties could encourage investment in the low-carbon energy transition.


To calculate an annual growth rate of the carbon price taking into account uncertainties, Christian Gollier developed a Consumption Capital Asset Pricing Model (CCAPM) that incorporates macroeconomic and technological uncertainties and optimizes the emissions reduction effort over time. “With a limited carbon budget, it is not possible to guarantee a rate of return on a low-carbon investment that matches the growth rate of the carbon price,” Christian Gollier explains. In other words, we cannot make the price of carbon play the role of a price signal associated with the country’s carbon budget and at the same time guarantee stable returns on today’s green investments, much to the regret of renewable energy producers. But Christian Gollier offers a way of overcoming this problem: “The risks taken by investors in low-carbon projects can be offset by a positive risk premium. This can be done by offering a carbon price growth trend higher than the risk-free rate. End of the Hotelling rule!”

In addition, to determine the sign and level of the risk premium offered to investors to encourage them to invest now, the “beta” of the marginal abatement cost of a tonne of CO2 needs to be measured. If the abatement cost is positively correlated with economic growth, the idea of postponing most of the effort makes sense, since the effort will be less costly in the event of a recession. In this positive beta configuration, one can start with a low carbon price, offset by an expected high price growth rate, even if it means reducing the price in ten or twenty years time if the secular stagnation hypothesis put forward by some economists is confirmed. A Monte Carlo simulation of the model shows that the carbon price is positively correlated with growth, as shown by the fall in carbon prices on the European allowance market during the 2008 economic recession.

Without going into technical details, the mathematical determination of the researcher’s model shows that the optimal real growth rate of the carbon price should be set at about 3.5% per year. “The carbon price is fundamental and must be compatible with other assets in the economy, but governments fail to understand that quantitative emissions reduction targets entail the pricing of carbon.


And to conclude: “The carbon price in 2050 needed to meet European commitments is very uncertain, and this is a problem for responsible financial management. The good news, however, is that these risks can be offset by a rate of carbon price growth that is higher than the interest rate, without it being unduly high”. Whether or not the recommendations of scientific research on the carbon tax are implemented remains to be seen, while in the meantime the climate emergency is becoming ever more critical.


The financial sector is gradually becoming aware of its exposure to climate change and the need to invest in the environmental transition. COP 21 served as a catalyst for this dynamic, but there is still a long way to go if the sector is to fully serve the common interest. In their book Detox Finance, published last August by Eyrolles, Jean-Baptiste Bellon and Stéphane Voisin provide an extremely well-documented overview and an analysis of the toxic excesses of finance that led to the crisis. As indicated on the cover of the book they also put forward concrete solutions to make finance “useful, positive, green and sustainable”. Detox Finance is essential reading, especially for professionals in the sector, as the following discussion clearly shows.

Even before opening Detox Finance, the back cover arouses great interest with comments from such well-known personalities in their field as Christian de Boissieu, Professor Emeritus at the University of Paris 1, André Levy-Lang, President of the Institut Louis Bachelier, and Nicolas Hulot, the Honorary President of the Nicolas Hulot Foundation for Nature and Mankind, whose commitment to the environment cannot be overstated. He writes, “It is essential that finance detoxify itself by serving the general interest and supporting the ecological and solidarity transition. The authors of this book hold out the hope that it can do so. I would like the future to prove them right and make us forget about the social damage caused by toxic finance. The environmental challenges we face call for the energy and intelligence of all. It’s up to finance to play its part too.


From the beginning of the first part of the book, “Toxic Finance”, finance is described in terms of a provocative and well-justified metaphor: it is hooked on profit-seeking, like an addict dependent on cocaine! And like any harmful dependence, it leads to excesses, which in turn provoke crises. By examining the bankruptcies of Lehman Brothers and the Franco-Belgian Dexia bank, the authors show how finance gradually emerged into public view, in particular because of the waves of deregulation that took place in the 1980s and 1990s and in the early 2000s. “The crisis had three main causes: the greed of the sector, which had been blinded by the ease of making profits, as with its toxic loans to municipalities; the complexity and opacity of the revenues generated by the sector, with the massive use of models whose limitations have become apparent; and the failure of the bodies responsible for bank governance, characterized by the absence of safeguards,” Jean-Baptiste Bellon and Stéphane Voisin explain.


Despite this trenchant diagnosis, the regulatory measures introduced and the many fines levied, the financial sector is still recovering and has not yet regained the trust of investors and savers. European banks clearly illustrate this: their stock market performance is still very volatile compared to their American counterparts, and their overall valuation has dropped by 80% since 2007, whereas the financial markets have recovered or even surpassed their pre-crisis levels.

“More than ten years after the crisis, the financial sector remains in disarray. The banking intermediation model does not guard against risks, because these only arise after the development and growth phases,” the two authors point out. “Finance, on the other hand, having performed poorly, has the capacity to recover by incorporating sustainability.” Especially as the financing requirements to fight global warming are estimated at several trillion dollars per year.


The second part of the book, “Detox Finance”, like the work as a whole, discusses solutions that allow finance to contribute to the common interest. One of the approaches strongly recommended is the systematic integration of environmental, social and governance (ESG) criteria into the assessment of investment and financing projects implemented by banks. While these extra-financial criteria have become more important to asset managers, investment funds, institutional investors and even individual investors, this trend needs to be amplified and speeded up if finance is to become sustainable with a net positive impact on society.

“The inclusion of sustainability by the financial sector is very difficult to achieve, because it is almost impossible to assess the sustainable performance of an organization or company. And the rating agencies are certainly not in a position to do so. To overcome this challenge, the financial sector should try and convert traditional risk analyses into ESG analyses,” the authors suggest. While France is relatively well positioned in this area with the integration of ESG criteria by several major banks and the growth of funds in sustainable investments, green financing accounts for barely 1% of investors’ portfolios worldwide, according to Climate Chance.

To increase this proportion and expand green investment or disinvest in brown assets (fossil fuel sectors) in the absence of any real political will to impose carbon pricing, the authors devote an entire chapter to a detailed list of solutions to align financial flows with the trajectory of the Paris Agreement. “Thermos finance” (chapter 8) provides a critical analysis of emerging tools for measuring market temperature, green bonds and green securitisation (a growth area, particularly in the United States).

“Article 2 of the Paris Agreement aims to measure the carbon footprint of all financial flows with the objective of decarbonizing the economy. To do this, a measurement system must be developed. And the European Commission’s action plan to require carbon measurement of market indices and portfolios could contribute to this,” the two authors say.


In addition to the success of ESG integration and green bonds, two promising market niches for sustainable finance have developed in recent years. The first is impact finance, which aims to achieve concretely measurable social and/or environmental outcomes, such as the preservation of biodiversity, by financing agroecology and/or agroforestry for example. “These recent instruments offer a range of indicators and quantifiable objectives that go beyond profits alone. Moreover, profit can be more accurately defined as solid positive performance coupled with maintaining financial and non-financial capital,” the authors say.

The second is “chlorofinance” , which is undeniably a very specific niche in impact finance, but is no less interesting by virtue of its approach. “This market concerns both the financing of ultra-green projects and the absence of financing for certain projects, thereby making it possible to finance nature conservation rather than production. This is an important and noteworthy paradigm shift, because it changes the risk/return trade-off by incorporating a social utility function,” say Jean-Baptiste Bellon and Stéphane Voisin. While these market segments are still negligible, they will undoubtedly add welcome layers of sustainability to the financial sector.

At a time when bankers and regulators around the world, through central banks and financial actors, are stepping up their commitment to inclusive and sustainable finance, Detox Finance is a valuable guide to show them more clearly what is at stake and to help reconcile finance with the general interest.

Watch Stéphane Voisin’s web TV


While financial institutions are increasingly expected to disclose and take into account the physical climate risks contained in their portfolios, they lack the data to do so. Yet the financial sector’s exposure to this type of risk will increase due to climate disruption and climate change. To help overcome these shortcomings, two researchers have developed a review of the available climate data.


Global warming is leading to increasing risks for the economy and the financial sector. These include physical risks “characterized by the risk of asset destruction or disruption of operations and supply chains due to meteorological events related to climate change and climate variability,” explains Peter Tankov.


A recent example shows that these risks should not be taken lightly by the financial sector. In February 2019, Pacific Gas & Electric Company, seen as the “EDF of California”, which supplied 16 million households, was forced to declare bankruptcy as a result of the impact on the company of the forest fires that devastated the southern part of the U.S. West Coast. With hundreds of lawsuits and damages estimated at $30 billion, the energy giant collapsed. Nor is this case likely to be the last of its kind. According to a study published in 2016 by Nature Research, physical risks could reduce the value of global financial assets by between $2,500 billion and $25 trillion! By way of comparison, the Lehman Brothers bankruptcy caused a chain reaction that eroded the value of global equities by $10 trillion.

Given figures such as these, it would be an understatement to say that climate change is a growing source of risk for the financial sector. To protect themselves against it or at least to prepare for it as much as possible, financial players have every interest in assessing the risks carefully. Financial physical risks combine three factors:

− Climate hazard, defined as the meteorological condition or event whose frequency and severity may be affected;

− Exposure, which refers to assets or systems that may be impacted by climate hazard;

− Vulnerability, defined as the extent of damage to the exposed asset or system.

“Climate data is needed to assess the type, frequency and severity of climate hazard, which is the first factor in physical climate risk. Assessment of the other two factors requires access to asset data: the geographical position and the specific characteristics of the assets or systems. In our study, we have focussed solely on climate data, which is difficult to collect and analyse,” emphasizes Peter Tankov.


Before embarking on an assessment of physical climate risk, financial actors must choose a data set on which to base their analyses. The choice of data depends on the type of risk and the variables to be analysed. “Study of a specific site calls for local observations that reduce statistical bias because they correspond well to reality. But local observations do not have good spatial coverage,” Peter Tankov says.

For a regional climate study, re-analysis may be more appropriate “Re-analysis involves running climate models over a historical period, using all observations as model constraints. It provides an accurate representation of reality, especially in regions and periods well covered by the data. It also has a wide and uniform spatial and temporal coverage,” explains Peter Tankov. Nevertheless, the use of historical data is based on the assumption that the climate is does not change over time scales relevant to the study. Yet it is clear that the climate cannot be considered to be stationary, as shown by changes that are harmful for the planet, such as melting ice, rising ocean temperatures or the increase in the frequency of heat waves. Indeed, climate non-stationarity may be due to natural variability occurring over a period of 5 to 10 years or to climate change whose effects are visible in the longer term, over a period of 20 to 30 years. Consequently financial actors have to use climate projections obtained with future climate scenarios generated by a model, which itself is conditioned by specific hypotheses about economic activity.

“These hypotheses are formulated on the basis of economic reasoning, but the feedback from the climate system to the economic system is not modelled. In contrast, integrated assessment models (IAMs) aim to jointly describe the evolution of the climate system and the economic system. Unfortunately, most IAMs to date are not realistic enough to be used in physical risk analysis,” says Peter Tankov.


Another difficulty lies in the many biases found in climate data. These are not uniform: some variables such as rainfall are more sensitive to measurement and model errors than others, such as the average temperature. The biases are more pronounced at finer scales and in the tails of the distribution. Internal climate variability and uncertainty between models are preponderant in the short term, while factors such as the level of greenhouse gas emissions will predominate in the longer term. “It is therefore important, in impact studies based on climate data, to take into account data errors, using multimodel ensembles and different socio-economic scenarios,” Peter Tankov explains.