Professor Tatsuyoshi Okimoto (Keio University) delivering his presentation

Professor Tatsuyoshi Okimoto (Keio University) outlined the rapid expansion of global ESG investment over the past 15 years and pointed out the importance of understanding how financial markets have reflected corporate carbon emissions in financial asset prices. He then presented an empirical analysis of market evaluations of carbon emissions, focusing on credit default swaps (CDS) (joint work with Professor Sumiko Takaoka (Seikei University)).

He stated that if market participants view carbon emissions as the other side of the same coin of active corporate activity, then a negative relationship would be observed between carbon emissions and CDS spreads that capture corporate risk. On the other hand, if market participants view carbon emissions as the cost of future regulatory compliance (carbon risk premiums), a positive relationship between carbon emissions and CDS spreads would be observed. He then analyzed the existence of carbon risk premiums and their changes over time using data from the Japanese CDS market from 2005 to 2019.

Based on the empirical results, he pointed out that prior to 2006, when the Principles for Responsible Investment were proposed by the United Nations among others, no significant carbon risk premium was identified, and a negative relationship existed between carbon emissions and CDS spreads. He noted that over the years, however, as investors had become more aware of ESG issues, the premiums had become visible and greater. He also pointed out that the size of the premiums depended on the sector, and, in particular, the premium was smaller for those sectors in which reducing emissions is considered to be relatively difficult. Finally, as a policy implication, he argued that it might be important to utilize subsidies for introducing emission abatement technologies in sectors that face difficulties in reducing emissions, since financial market evaluations may not provide sufficient incentive for these sectors to reduce emissions, as an increase in emissions does not necessarily lead to a widening in CDS spreads.

The discussant, Professor Yoko Shirasu (Aoyama Gakuin University), praised the study as a valuable work providing rich empirical analyses, including various robustness checks, using time-series data on CDS spreads of Japanese firms and a credible climate-related database. She pointed out that it would be beneficial to deepen the analysis further, focusing on the possibility of changes in investor behavior following the adoption of the Paris Agreement in 2015, and on differences in how emissions are reduced, such as business downsizing and technology development, differences between countries and regions in investment methodologies, such as divestment and engagement, and differences in environmental strategies even among investors who have adopted the Principles for Responsible Investment.

Next : 4. Research Presentation on Scenario Construction for Analyzing Climate-Related Risks

Azusa Takeyama (BOJ) delivering his presentation

Azusa Takeyama (Director, BOJ) first noted that financial authorities and financial institutions were giving increasing attention to the impact of climate change and its countermeasures on the financial system and financial institutions. He pointed out that the absence of appropriate reference cases and historical data was a major challenge in assessing the impact of these developments. He argued that, even under these circumstances, scenario analyses could serve as an effective tool for measuring and managing risk, and he added that scenario analyses had been conducted in more than 60 countries and regions in recent years, including Japan.

He emphasized that the purpose of this study was to organize the issues and future challenges related to scenario analyses by discussing the models used to construct scenarios, and he explained the study's main models and their characteristics (joint work with Yui Matsui (International Monetary Fund) and Takaaki Minamii (BOJ)).

He gave an example of the DICE model proposed by William D. Nordhaus (2018 Nobel Laureate in Economics, Reference 3). He explained that the model was constructed by incorporating into the standard economic growth model the mechanisms through which greenhouse gas emissions from economic activities raise the global temperature and have a negative impact on economic activities, thereby enabling the analysis of the relationship between climate change and economic growth. He pointed out that the main results of such a simple model could however change significantly, depending on key parameter values.

In light of these issues, he said that international organizations, among others, used the extended models that incorporate energy and land use conditions when constructing scenarios. He pointed out, however, that even in such extended models, smooth supply-demand adjustment through market mechanisms was assumed, and the scenarios constructed by the models were treated as a kind of baseline scenario with no frictions or shocks, which would otherwise impede economic growth. He also pointed out that, as a future challenge, it is important to expand the variation of scenarios, taking into account the economic environment and industrial structure of each country, in order to appropriately measure and manage climate-related risks that involve a high degree of uncertainty.

The discussant, Yoshiyuki Suimon (Executive Director, Nomura Securities Co., Ltd.), commended the study for elucidating the structures of the models used in constructing scenarios and the issues involved in the constructed scenarios. He then pointed out that it will become more important to improve the transparency of the models and take into account the consistency of assumptions and the interaction of economic activities in each country and region. In addition, he raised issues regarding the implications for how monetary and economic policies should be conducted in light of the issues involved in the scenario analyses.

Next : 5. Closing Remarks