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EDHEC-Risk Climate Institute Challenges Overly Optimistic Climate Projections in Pension Fund Reports

EDHEC-Risk Climate Institute Challenges Overly Optimistic Climate Projections in Pension Fund Reports

Sustainable Investing

New Study Critiques Misleading Climate-Risk Advice to Pension Funds

A recent position paper from EDHEC-Risk Climate Impact Institute has raised significant concerns about the misleading nature of climate-risk advice given to pension funds, particularly those under the UK Local Government Pension Scheme (LGPS). The paper, titled “Portfolio Losses from Climate Damages: A Guide for Long-Term Investors,” authored by Professor Riccardo Rebonato, Scientific Director at the institute, critically examines the advice provided to pension trustees and its implications.

Riccardo Rebonato | EDHEC BUSINESS SCHOOL

Background of the Issue

In response to growing pressure from regulators and stakeholders, institutional investors have been assessing and managing their exposure to climate change risks. This has led to a slew of reports! Moreover, largely based on advice from investment consultants. As a result, suggesting that pension portfolios would face only marginal impacts, even under severe global warming scenarios. These optimistic projections have been met with skepticism from various quarters, raising questions about their validity.

Key Findings of the Position Paper

Professor Rebonato’s research identifies several critical issues in the current approach to climate-risk assessment in pension funds:

  1. Misapplication of DICE Models: The paper highlights the inappropriate use of dynamic integrated climate-economy (DICE) models, originally developed for policy design, for scenario analysis in pension funds.
  2. Potential for Model Modification: Despite their misuse, the paper notes that the modular nature of DICE models allows for adjustments to make them suitable for scenario analysis.
  3. Divergence in Economic Estimates: Contrary to the notion of a tame consensus among climate economists, the paper points out a significant divergence in estimates regarding the severity of climate damages.
  4. Undercommunication of Uncertainty: Furthermore, a major critique is the failure to adequately communicate the uncertainties surrounding climate change, climate action, and economic impacts.

Flawed Advice to Pension Trustees

The research concurs with critics who argue that pension trustees have been poorly advised, with many reports underestimating the potential losses due to climate change. The paper deems these estimates as “implausibly tame,” criticizing the precision with which they are often presented.

Call for Probabilistic Approach

Echoing EDHEC-Risk Climate Impact Institute’s broader scientific stance, Professor Rebonato recommends attaching approximate probabilities to different climate scenarios. This approach aims to provide a more realistic and nuanced perspective on the potential impacts of climate change on pension fund portfolios.

Concluding Remarks

The paper serves as a wake-up call to pension consultants and financial markets, warning against complacency in the face of the climate crisis. Thus, by highlighting the shortcomings in current practices and advocating for a more probabilistic approach, the study aims to foster a more informed and realistic assessment of climate risks in the pension fund sector.

Implications for the Future

In conclusion, this research underscores the need for a reevaluation of climate-risk advice and methodologies in the pension industry. It emphasizes the importance of acknowledging uncertainties and diversities in economic predictions. Lastly, paving the way for more robust and realistic climate risk assessments in investment strategies.

See the full study!

Portfolio Losses from Climate Damages: A Guide for Long-Term Investors | EDHEC Risk Climate Impact Institute

EDHEC-Risk Climate Institute Challenges Overly Optimistic Climate Projections in Pension Fund Reports