The European Securities and Markets Authority (ESMA) published two articles, one outlining an approach to modelling the impact of asset price shocks from adverse scenarios involving climate-related risks, the other exploring the use of environmental, social and governance (ESG)-related controversies for the purpose of monitoring greenwashing risk.
Dynamic modelling of climate-related shocks in the fund sector: ESMA’s article presents a methodological approach to modelling climate-related shocks in the fund sector, which includes dynamic impacts, such as inflows and outflows from investors and portfolio rebalancing by managers. The analysis focuses on the overall direction of these effects, finding that investor outflows can worsen falls in fund values following an initial shock.
Dynamic modelling of climate-related shocks in the fund sector is part of ESMA’s work in relation to its mandates in the area of climate stress testing. To anticipate the impact of climate-related shocks on the financial system, the European Commission has mandated the ESAs to perform regular climate change stress tests or scenario analyses and to develop methods, parameters and scenarios for supervisors to use in their own climate stress testing. In addition, the ESAs have a mandate to conduct a coordinated one-off climate change stress test across the financial sector in coordination with the European Central Bank (ECB) and the European Systemic Risk Board (ESRB), reporting results by 1Q25.
Financial impact of greenwashing controversies: ESMA’s article highlights how data on ESG controversies can be useful to monitor potential reputational risks around greenwashing. It also outlines the challenges involved in using such data. The number of greenwashing controversies involving large European firms increased between 2020 and 2021 and tended to be concentrated within a few firms belonging to three main sectors, including the financial sector. Growing public scrutiny highlights the importance of clear policy guidance by regulators and efforts by supervisors to ensure the credibility of sustainability-related claims.
The analysis on the financial impact of greenwashing controversies is important since the transition to a low-carbon economy requires trust in the commitment and ability of corporates companies to adapt their business operations to help deliver climate-related objectives. However, greenwashing risks undermine this trust by sapping consumer and investor confidence, underlining the importance of monitoring and tackling the problem.