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EU investment funds face €62bn losses under worst case NGFS climate scenario, says ECB (amended)

Only 1% of fund assets are currently aligned to the EU green taxonomy

The article has been amended to correct the value of potential climate-related losses faced by EU investment funds 

EU investment funds could lose up to €62bn over the next 15 years if climate change is not kept in check, the European Central Bank (ECB) has warned.

In addition, climate risk is concentrated among EU banks, said the ECB, with 70% of credit exposure to firms subject to physical climate risks concentrated in the portfolio of only 25 banks. This means that banks could be left vulnerable to “potentially destabilising financial market corrections” such as credit rating downgrades as a result of climate change, it added.

The findings were presented in a joint analysis with the European Systemic Risk Board (ESRB) which aimed to size the risk posed by climate hazards over long dated financial risk horizons. The analysis was based on three climate scenarios issued by central banking body the Network for Greening the Financial System, although the researchers noted to RI that the scenarios were less severe than those previously issued by the Dutch central bank.

It follows the ECB’s first economy-wide stress test on the impacts of climate change which published preliminary results in March. 

ECB and ESRB analysts identified flooding rivers as “the most economically relevant widespread climate risk driver in the EU over the next two decades”, while wildfires, heat stress and water stress were also expected to have a strong impact. Such climate hazards may “impact up to 30% of euro area bank corporate exposures”, they said. 

According to the report, only 35% of climate losses were thought to be currently insured in the EU, resulting in significant ‘protection gaps’ which could further compound the stranding of assets.

Portfolio greening needs are even greater for investment funds, the report concluded. Analysts estimated that over 55% of EU investment fund assets are tilted towards high-emitting firms, while only 1% of assets are aligned with the EU green taxonomy.

While the ESRB is based in the ECB offices, it is run independently and is responsible for the prevention and mitigation of systemic risks to the EU’s financial system.

Separately, the Danish central bank has called for a combination of tax incentives and green investments to meet global climate goals. According to the supervisor, “a greenhouse gas tax that is levied uniformly across industries and activities is considered to be a particularly cost-effective way to reduce emission” as it makes emissions-intensive products more expensive. 

According to the Danmarks Nationalbank, such a policy could only be adopted by a coalition of countries which agree to common measures on climate transition, or ‘climate clubs’, as no global consensus currently exists. At the same time, these clubs can introduce common import tariffs on countries that do not lower their emissions, also referred to as a carbon border tax.

While this is the first time that the Bank has opined on climate-related risk, it will continue to issue a “series of publications” on the topic, it said.