Caoimhe Kennedy

From a corporate perspective, transition risk encompasses the uncertainty surrounding the pace of achieving carbon neutrality. On a broader scale, EU nations aspire to become the world’s first climate-neutral economy and society by 2050, as outlined in the Paris Agreement. Advanced economies must reduce their CO₂ emissions from 8.8 to 3.8 tonnes per capita by 2030 to stay within the 1.5°C threshold. Yet, the current trajectory suggests a perilous 3°C increase in global heating. Aligning portfolio structures with evolving EU policies is crucial for financial institutions as they navigate the imperative shift toward a low-carbon economy. This transition holds the potential for substantial ripple effects on financial systems, prompting sudden reassessments of assets. 

The European Central Bank has heightened regulatory measures, compelling financial institutions to disclose climate risks as per the 2023 directives. As such, increasing scrutiny will place growing pressure on portfolio managers to adjust their portfolio exposures. Non-compliance with the new regulations, resulting in a failure to disclose climate information, not only signifies a breach of EU law but also triggers supervisory action. Furthermore, with an expected surge in the size of the wealth management industry due to demographic shifts and rising consumer demands for increased investor involvement in promoting sustainable business practices, financial institutions must reshape their portfolio compositions to contribute to a carbon-neutral world. 

In the realm of financial stability, long-term institutional investors play a pivotal role in the recalibration and redistribution of carbon transition risks. Mitigating the escalating threat of natural disasters is facilitated through the utilisation of hedging instruments, such as catastrophe bonds. Additionally, various financial tools, including green stock indices and green bonds, emerge as valuable mechanisms for redirecting investments towards environmentally sustainable sectors. Furthermore, the world’s excessive dependence on oil, primarily sourced from politically unstable authoritarian regimes, presents a compelling case for the urgent redirection of funds towards renewable energy sectors. Historical patterns reveal that hikes in oil prices frequently precedes recessions. To bolster stability in the financial sector, a strategic shift away from investments tied to oil holds significant benefits. 

The green economy opens a world of opportunities for investors. Climate change, with its far-reaching impact beyond the EU, underscores the need for a global approach. If the green transition remains confined solely to Western nations and China, projections suggest that by 2050, South Asia, Southeast Asia, and Africa could contribute to a staggering 64% of global emissions. This scenario makes the achievement of Paris Agreement goals virtually impossible without substantial investments in green technologies within emerging markets. Notably, a mere 14% of green investments in these burgeoning economies are privately funded, in contrast to the 81% in developed nations. This evolving market, coupled with innovative investment instruments, provides a fresh avenue for investors to generate alpha returns. Simultaneously, it offers the strategic advantage of hedging portfolio risks by diversifying exposure across different global regions.